Basic Economics

by Sowell, Thomas

  The U.S. Department of Agriculture says the meat it buys for the National School Lunch Program “meets or exceeds standards in commercial products.”

  That isn’t always the case. McDonald’s, Burger King and Costco, for instance, are far more rigorous in checking for bacteria and dangerous pathogens. They test the ground beef they buy five to 10 times more often than the USDA tests beef made for schools during a typical production day.

  And the limits Jack in the Box and other big retailers set for certain bacteria in their burgers are up to 10 times more stringent than what the USDA sets for school beef.

  For chicken, the USDA has supplied schools with thousands of tons of meat from old birds that might otherwise go to compost or pet food. Called “spent hens” because they’re past their egg-laying prime, the chickens don’t pass muster with Colonel Sanders—KFC won’t buy them—and they don’t pass the soup test, either. The Campbell Soup Company says it stopped using them a decade ago based on “quality considerations.”{286}

  While a market economy is essentially an impersonal mechanism for allocating resources, some of the most successful businesses have prospered by their attention to the personal element. One of the reasons for the success of the Woolworth retail chain in years past was founder F.W. Woolworth’s insistence on the importance of courtesy to the customers. This came from his own painful memories of store clerks treating him like dirt when he was a poverty-stricken farm boy who went into stores to buy or look.{287}

  Ray Kroc’s zealous insistence on maintaining McDonald’s reputation for cleanliness paid off at a crucial juncture in the early years, when he desperately needed a loan to stay in business, for the financier who toured McDonald’s restaurants said later: “If the parking lots had been dirty, if the help had grease stains on their aprons, and if the food wasn’t good, McDonald’s never would have gotten the loan.”{288} Similarly, Kroc’s good relations with his suppliers—people who sold paper cups, milk, napkins, etc., to McDonald’s—had saved him before when these suppliers agreed to lend him money to bail him out of an earlier financial crisis.

  What is called “capitalism” might more accurately be called consumerism. It is the consumers who call the tune, and those capitalists who want to remain capitalists have to learn to dance to it. The twentieth century began with high hopes for replacing the competition of the marketplace by a more efficient and more humane economy, planned and controlled by government in the interests of the people. However, by the end of that century, all such efforts were so thoroughly discredited by their actual results, in countries around the world, that even most communist nations abandoned central planning, while socialist governments in democratic countries began selling off government-run enterprises, whose chronic losses had been a heavy burden to the taxpayers.

  Privatization was embraced as a principle by such conservative governments as those of Prime Minister Margaret Thatcher in Britain and President Ronald Reagan in the United States. But the most decisive evidence for the efficiency of the marketplace was that even socialist and communist governments, led by people who were philosophically opposed to capitalism, turned back towards the free market after seeing what happens when industry and commerce operate without the guidance of prices, profits and losses.

  WINNERS AND LOSERS

  Many people who appreciate the prosperity created by market economies may nevertheless lament the fact that particular individuals, groups, industries, or regions of the country do not share fully in the general economic advances, and some may even be worse off than before. Political leaders or candidates are especially likely to deplore the inequity of it all and to propose various government “solutions” to “correct” the situation.

  Whatever the merits or demerits of various political proposals, what must be kept in mind when evaluating them is that the good fortunes and misfortunes of different sectors of the economy may be closely related as cause and effect—and that preventing bad effects can prevent good effects. It was not coincidental that Smith Corona began losing millions of dollars a year on its typewriters when Dell began making millions on its computers. Computers were replacing typewriters. Nor was it coincidental that sales of film began declining with the rise of digital cameras. The fact that scarce resources have alternative uses implies that some enterprises must lose their ability to use those resources, in order that others can gain the ability to use them.

  Smith Corona had to be prevented from using scarce resources, including both materials and labor, to make typewriters, when those resources could be used to produce computers that the public wanted more. Some of the resources used for manufacturing cameras that used film had to be redirected toward producing digital cameras. Nor was this a matter of anyone’s fault. No matter how fine the typewriters made by Smith Corona were or how skilled and conscientious its employees, typewriters were no longer what the public wanted after they had the option to achieve the same end result—and more—with computers. Some excellent cameras that used film were discontinued when new digital cameras were created.

  During all eras, scarcity implies that resources must be taken from some in order to go to others, if new products and new methods of production are to raise living standards.

  It is hard to know how industry in general could have gotten the millions of workers that they added during the twentieth century, whose output contributed to dramatically rising standards of living for the public at large, without the much-lamented decline in the number of farms and farm workers that took place during that same century. Few individuals or businesses are going to want to give up what they have been used to doing, especially if they have been successful at it, for the greater good of society as a whole. But, in one way or another—under any economic or political system—they are going to have to be forced to relinquish resources and change what they themselves are doing, if rising standards of living are to be achieved and sustained.

  The financial pressures of the free market are just one of the ways in which this can be done. Kings or commissars could instead simply order individuals and enterprises to change from doing A to doing B. No doubt other ways of shifting resources from one producer to another are possible, with varying degrees of effectiveness and efficiency. What is crucial, however, is that it must be done. Put differently, the fact that some people, regions, or industries are being “left behind” or are not getting their “fair share” of the general prosperity is not necessarily a problem with a political solution, as abundant as such proposed solutions may be, especially during election years.

  However more pleasant and uncomplicated life might be if all sectors of the economy grew simultaneously at the same lockstep pace, that has never been the reality in any changing economy. When and where new technologies and new methods of organizing or financing production will appear cannot be predicted. To know what the new discoveries were going to be would be to make the discoveries before the discoveries were made. It is a contradiction in terms.

  The political temptation is to have the government come to the aid of particular industries, regions or segments of the population that are being adversely affected by economic changes. But this can only be done by taking resources from those parts of the economy that are advancing and redirecting those resources to those whose products or methods are less productive—in other words, by impeding or thwarting the economy’s allocation of scarce resources to their most valued uses, on which the standard of living of the whole society depends. Moreover, since economic changes are never-ending, this same policy of preventing resources from going to the uses most valued by millions of people must be on-going as well, if the government succumbs to the political temptation to intervene on behalf of particular industries, regions or segments of the population, sacrificing the standard of living of the population as a whole.

  What can be done instead is to recognize that economic changes have been going on for centuries and that there is no sign that this will stop—or that the adjustments necessitat
ed by such changes will stop. This applies to government, to industries and to the people at large. Neither enterprises nor individuals can spend all their current income, as if there are no unforeseeable contingencies to prepare for. Yet many observers continue to lament that even people who are financially prepared are forced to make adjustments, as a New York Times economic reporter lamented in a book about job losses with the grim title, The Disposable American. Among others, it described an executive whose job at a major corporation was eliminated in a reorganization of the company, and who consequently had to sell “two of the three horses” she owned and also sell “$16,500 worth of Procter stock, cutting into savings to support herself while she hunted for work.”

  Although this executive had more than a million dollars in savings and owned a seventeen-acre estate,{289} it was presented as some tragic failure of society that she had to make adjustments to the ever-changing economy which had produced such prosperity in the first place.

  PART III:

  WORK AND PAY

  Chapter 10

  PRODUCTIVITY AND PAY

  Government data, if misunderstood or improperly used, can lead to many false conclusions.

  Steven R. Cunningham{290}

  In discussing the allocation of resources, we have so far been concerned largely with inanimate resources. But people are a key part of the inputs which produce output. Most people do not volunteer their labor free of charge, so they must be either paid to work or forced to work, since the work has to be done in any case, if we are to live at all, much less enjoy the various amenities that go into our modern standard of living. In many societies of the past, people were forced to work, whether as serfs or slaves. In a free society, people are paid to work. But pay is not just income to individuals. It is also a set of incentives facing everyone working or potentially working, and a set of constraints on employers, so that they do not use the scarce resource of labor as was done in the days of the Soviet Union, keeping extra workers on hand “just in case,” when those workers could be doing something productive somewhere else.

  In short, the payment of wages and salaries has an economic role that goes beyond the provision of income to individuals. From the standpoint of the economy as a whole, payment for work is a way of allocating scarce resources which have alternative uses. Labor is a scarce resource because there is always more work to do than there are people with the time to do it all, so the time of those people must be allocated among competing uses of their time and talents. If the pay of truck drivers doubles, some taxi drivers may decide that they would rather drive a truck. Let the income of engineers double and some students who were thinking of majoring in math or physics may decide to major in engineering instead. Let pay for all jobs double and some people who are retired may decide to go back to work, at least part-time, while others who were thinking of retiring may decide to postpone that for a while.

  How much people are paid depends on many things. Stories about the astronomical pay of professional athletes, movie stars, or chief executives of big corporations often cause journalists and others to question how much this or that person is “really” worth.

  Fortunately, since we know from Chapter 2 that there is no such thing as “real” worth, we can save all the time and energy that others put into such unanswerable questions. Instead, we can ask a more down-to-earth question: What determines how much people get paid for their work? To this question there is a very down-to-earth answer: Supply and Demand. However, that is just the beginning. Why does supply and demand cause one individual to earn more than another?

  Workers would obviously like to get the highest pay possible and employers would like to pay the least possible. Only where there is overlap between what is offered and what is acceptable can anyone be hired. But why does that overlap take place at a pay rate that is several times as high for an engineer as for a messenger?

  Messengers would of course like to be paid what engineers are paid, but there is too large a supply of people capable of being messengers to force employers to raise their pay scales to that level. Because it takes a long time to train an engineer, and not everyone is capable of mastering such training, there is no such abundance of engineers relative to the demand. That is the supply side of the story. But what determines the demand for labor? What determines the limit of what an employer is willing to pay?

  It is not merely the fact that engineers are scarce that makes them valuable. It is what engineers can add to a company’s earnings that makes employers willing to bid for their services—and sets a limit to how high the bids can go. An engineer who added $100,000 to a company’s earnings and asked for a $200,000 salary would obviously not be hired. On the other hand, if the engineer added a quarter of a million dollars to a company’s earnings, that engineer would be worth hiring at $200,000—provided that there were no other engineers who would do the same job for a lower salary.

  PRODUCTIVITY

  While the term “productivity” may be used to describe an employee’s contribution to a company’s earnings, this word is often also defined inconsistently in other ways. Sometimes the implication is left that each worker has a certain productivity that is inherent in that particular worker, rather than being dependent on surrounding circumstances as well.

  A worker using the latest modern equipment can obviously produce more output per hour than the very same worker employed in another firm whose equipment is not quite as up-to-date or whose management does not have production organized as efficiently. For example, Japanese-owned cotton mills in China during the 1930s paid higher wages than Chinese-owned cotton mills there, but the Japanese-run mills had lower labor costs per unit of output because they had higher output per worker. This was not due to different equipment—they both used the same machinery—but to more efficient management brought over from Japan.{291}

  Similarly, in the early twenty-first century, an international consulting firm found that American-owned manufacturing enterprises in Britain had far higher productivity than British-owned manufacturing enterprises. According to the British magazine The Economist, “British industrial companies have underperformed their American counterparts startlingly badly,” so that when it comes to “economy in the use of time and materials,” fewer than 40 percent of British manufacturers “have paid any attention to this.” Moreover, “Britain’s top engineering graduates prefer to work for foreign-owned companies.”{292} In short, lower productivity in British-owned companies reflected differences in management practices, even when productivity was measured in terms of output per unit of labor.

  In general, the productivity of any input in the production process depends on the quantity and quality of other inputs, as well as its own. Thus workers in South Africa have higher productivity than workers in Brazil, Poland, Malaysia, or China because, as The Economist magazine pointed out, South African firms “rely more on capital than labour.”{293} In other words, South African workers are not necessarily working any harder or any more skillfully than workers in these other countries. They just have more or better equipment to work with.

  The same principle applies outside what we normally think of as economic activities, and it applies to what we normally think of as a purely individual feat, such as a baseball player hitting a home run. A slugger gets more chances to hit home runs if he is batting ahead of another slugger. But, if the batter hitting after him is not much of a home run threat, pitchers are more likely to walk the slugger, whether by pitching to him extra carefully or by deliberately walking him in a tight situation, so that he may get significantly fewer opportunities to hit home runs over the course of a season.

  During Ted Williams’ career, for example, he had one of the highest percentages of home runs—in proportion to his times at bat—in the history of baseball. Yet he had only one season in which he hit as many as 40 homers, because he was walked as often as 162 times a season, averaging more than one walk per game during the era of the 154-game season.

  By co
ntrast, Hank Aaron had eight seasons in which he hit 40 or more home runs, even though his home-run percentage was not quite as high as that of Ted Williams. Although Aaron hit 755 home runs during his career, he was never walked as often as 100 times in any of his 23 seasons in the major leagues. Batting behind Aaron during much of his career was Eddie Mathews, whose home-run percentage was nearly identical with that of Aaron, so that there was not much point in walking Aaron to pitch to Mathews with one more man on base. In short, Hank Aaron’s productivity as a home-run hitter was greater because he batted with Eddie Mathews in the on-deck circle.

  More generally, in almost any occupation, your productivity depends not only on your own work but also on cooperating factors, such as the quality of the equipment, management and other workers around you. Movie stars like to have good supporting actors, good make-up artists and good directors, all of whom enhance the star’s performance. Scholars depend heavily on their research assistants, and generals rely on their staffs, as well as their troops, to win battles.

  Whatever the source of a given individual’s productivity, that productivity determines the upper limit of how far an employer will go in bidding for that person’s services. Just as any worker’s value can be enhanced by complementary factors—whether fellow workers, machinery, or more efficient management—so the worker’s value can also be reduced by other factors over which the individual worker has no control.

  Even workers whose output per hour is the same can be of very different value if the transportation costs in one place are higher than in another, so that the employer’s net revenue from sales is lower where these higher transportation costs must be deducted from the revenue received. Where the same product is produced by businesses with different transportation costs and sold in a competitive market, those firms with higher transportation costs cannot pass all those costs along to their customers because competing firms whose costs are not as high would be able to charge a lower price and take their customers away. Businesses in Third World countries without modern highways, or efficient trains and airlines, may have to absorb higher transportation costs. Even when they sell the same product for the same price as businesses in more advanced economies, the net revenue from that product will be less, and therefore the value of the labor that went into producing that product will also be worth correspondingly less.