Basic Economics

by Sowell, Thomas

  While it is obvious that discrimination imposes a cost on those being discriminated against, in the form of lost opportunities for higher incomes, it is also true that discrimination can impose costs on those who do the discriminating, where they too lose opportunities for higher incomes. For example, when a landlord refuses to rent an apartment to people from the “wrong” group, that can mean leaving the apartment vacant longer. Clearly, that represents a loss of rent—if this is a free market. However, if there is rent control, with a surplus of applicants for vacant apartments, then such discrimination costs the landlord nothing, since there will be no delay in finding a new tenant, under these conditions.

  Similar principles apply in job markets. An employer who refuses to hire qualified individuals from the “wrong” groups risks leaving his jobs unfilled longer in a free market. This means that he must either leave some work undone and some orders from customers unfilled—or else pay overtime to existing employees to get the job done. Either way, this costs the employer more money. However, in a market where wages are set artificially above the level that would exist through supply and demand, the resulting surplus of job applicants can mean that discrimination costs the employer nothing, since there would be no delay in filling the job under these conditions.

  Whether these artificially higher wages are set by a labor union or by a minimum wage law does not change the principle. Empirical evidence strongly indicates that racial discrimination tends to be greater when the costs are lower and lower when the costs are greater.

  Even in white-ruled South Africa during the era of apartheid, where racial discrimination against blacks was required by law, white employers in competitive industries often hired more blacks and in higher occupations than they were permitted to do by the government—and were often fined when caught doing so.{329} This was because it was in the employers’ economic self-interest to hire blacks. Similarly, whites who wanted homes built in Johannesburg typically hired illegal black construction crews, often with a token white nominally in charge to meet the requirements of the apartheid laws, rather than pay the higher price of hiring a white construction crew as the government wanted them to do.{330} White South African landlords likewise often rented to blacks in areas where only whites were legally allowed to live.{331}

  The cost of discrimination to the discriminators is crucial for understanding such behavior. Employers who are spending other people’s money—government agencies or non-profit organizations, for example—are much less affected by the cost of discrimination. In countries around the world, discrimination by government has been greater than discrimination by businesses operating in private, competitive markets. Understanding the basic economics of discrimination makes it easier to understand why blacks were starring on Broadway in the 1920s, at a time when they were not permitted to enlist in the U.S. Navy and were kept out of many civilian government jobs as well. Broadway producers were not about to lose big money that they could make by hiring black entertainers who could attract big audiences, but the costs of government discrimination were paid by the taxpayers, whether they realized it or not.

  Just as minimum wage laws reduce the cost of discrimination to the employer, maximum wage laws increase the employer’s cost of discrimination. Among the few examples of maximum wage laws in recent centuries were the wage and price controls imposed in the United States during World War II. Because wages were not allowed to rise to the level that they would reach under supply and demand, there was a shortage of workers, just as there is a shortage of housing under rent control. Many employers who had not hired blacks or women before, or who had not hired them for desirable jobs before the war, now began to do so. The “Rosie the Riveter” image that came out of World War II was in part a result of wage and price controls.

  CAPITAL, LABOR AND EFFICIENCY

  While everything requires some labor for its production, practically nothing can be produced by labor alone. Farmers need land, taxi drivers need cars, artists need something to draw on and something to draw with. Even a stand-up comedian needs an inventory of jokes, which is his capital, just as hydroelectric dams are the capital of companies that generate electricity.

  Capital complements labor in the production process, but it also competes with labor for employment. In other words, many goods and services can be produced either with much labor and little capital or much capital and little labor. When transit workers’ unions force bus drivers’ pay rates much above what they would be in a competitive labor market, transit companies tend to add more capital, in order to save on the use of the more expensive labor. Buses grow longer, sometimes becoming essentially two buses with a flexible connection between them, so that one driver is using twice as much capital as before and is capable of moving twice as many passengers.

  Some might think that this is more “efficient,” but efficiency is not so easily defined. If we arbitrarily define efficiency as output per unit of labor, as some do, then it is merely circular reasoning to say that having one bus driver moving more passengers is more efficient. It may in fact cost more money per passenger to move them, as a result of the additional capital needed for the expanded buses and the more expensive labor of the drivers.

  If bus drivers were not unionized and were paid no more than was necessary to attract qualified people, then undoubtedly their wage rates would be lower and it would then be profitable for the transit companies to hire more of them and use shorter buses. Not only would the total cost of moving passengers be less, passengers would have less time to wait at bus stops because of the shorter and more numerous buses. This is not a small concern to people waiting on street corners on cold winter days or in high-crime neighborhoods at night.

  “Efficiency” cannot be meaningfully defined without regard to human desires and preferences. Even the efficiency of an automobile engine is not simply a matter of physics. All the energy generated by the engine will be used in some way—either in moving the car forward, overcoming internal friction among the engine’s moving parts, or shaking the automobile body in various ways. It is only when we define our goal—moving the car forward—that we can regard the percentage of the engine’s power that is used for that task as indicating its efficiency, and the other power dissipated in various other ways as being “wasted.”

  Europeans long regarded American agriculture as “inefficient” because output per acre was much lower in the United States than in much of Europe. On the other hand, output per agricultural worker was much higher in the United States than in Europe. The reason was that land was far more plentiful in the U.S. and labor was more scarce. An American farmer would spread himself thinner over far more land and would have correspondingly less time to devote to each acre. In Europe, where land was more scarce, and therefore more expensive because of supply and demand, the European farmer concentrated on the more intensive cultivation of what land he could get, spending more time clearing away weeds and rocks, or otherwise devoting more attention to ensuring the maximum output per acre.

  Similarly, Third World countries often get more use out of given capital equipment than do wealthier and more industrialized countries. Such tools as hammers and screwdrivers may be plentiful enough for each worker in an American factory or shop to have his own, but that is much less likely to be the case in a much poorer country, where such tools are more likely to be shared, or shared more widely, than among Americans making the same products. Looked at from another angle, each hammer in a poor country is likely to drive more nails per year, since it is shared among more people and has less idle time. That does not make the poorer country more “efficient.” It is just that the relative scarcities of capital and labor are different.

  Capital tends to be scarcer and hence more expensive in poorer countries, while labor is more abundant and hence cheaper than in richer countries. Poor countries tend to economize on the more expensive factor, just as richer countries economize on a different factor that is more expensive and scarce there, namely labo
r. In the richer countries, it is capital that is more plentiful and cheaper, while labor is more scarce and more expensive.

  When a freight train comes into a railroad stop, workers are needed to unload it. When a freight train arrives in the middle of the night, it can either be unloaded then and there, so that the train can proceed on its way intact, or some boxcars can be detached and left on a siding until the workers come to work the next morning to unload them.

  In a country where such capital as railroad boxcars are very scarce and labor is more plentiful, it makes sense to have workers available around the clock, so that they can immediately unload boxcars, and this very scarce resource does not remain idle. But, in a country that is rich in capital, it may often be more economical to detach individual boxcars from a train, letting the train continue on its way. Thus the detached boxcars can sit idle on a siding, waiting to be unloaded the next morning, rather than have expensive workers sitting around idle during the night, waiting for the next train to arrive.

  This is not just a question about these particular workers’ paychecks or this particular railroad company’s monetary expenses. From the standpoint of the economy as a whole, the more fundamental question is: What are the alternative uses of these workers’ time and the alternative uses of the railroad boxcars? In other words, it is not just a question of money. The money only reflects underlying realities that would be the same in a socialist, feudal or other non-market economy. Whether it makes sense to leave the boxcars idle waiting for the workers to arrive or to leave the workers idle waiting for trains to arrive depends on the relative scarcities of labor and capital and their relative productivity in alternative uses.

  During the era of the Soviet Union and its Cold War competition with the United States, the Soviets used to boast of the fact that an average Soviet boxcar moved more freight per year than an average American boxcar. But, far from indicating that their economy was more efficient, this showed that Soviet railroads lacked the abundant capital of the American railroad industry, and that Soviet labor had less valuable alternative uses of its time than did American labor. Similarly, a study of West African economies in the mid-twentieth century noted that trucks there “are in service twenty-four hours a day for seven days a week and are generally tightly packed with passengers and freight.”{332}

  For similar reasons, automobiles tend to have longer lives in poor countries than in richer countries. Not only does it pay many poorer countries to keep their own automobiles in use longer, it pays them to buy used cars from richer countries. In just one year, 90,000 used cars from Japan were sold to the United Arab Emirates. Dubai, one of those emirates, has become a center for the sale of these used vehicles to other Middle Eastern and African countries. The Wall Street Journal reported: “Many African cities are already teeming with Toyotas, even though very few new cars have been sold there.”{333} In Cameroon, the taxis “are beaten-up old Toyotas, carrying four in the back and three in the front.”{334} Even cars needing repairs are sold internationally:

  Japan’s exporters also ship out thousands of cars that have been dented or damaged. Mechanics in Dubai can repair vehicles for a fraction of the price in Japan, where high labor costs make it one of the world’s most expensive places to fix a car.{335}

  By and large, it pays richer countries to junk their cars, refrigerators, and other capital equipment in a shorter time than it would pay people in poorer countries to do so. Nor is this a matter of being able to afford “waste.” It would be a waste to keep repairing this equipment, when the same efforts elsewhere in the Japanese economy—or the American economy or German economy—would produce more than enough wealth to provide replacements. But it would not make sense for poorer countries, whose alternative uses of time are not as productive, to junk their equipment at the same times when richer countries junk theirs. The fact that labor is cheaper in Dubai than in Japan is not a happenstance. Labor is more productive in richer countries. That is one of the reasons why these countries are more prosperous in the first place. The sale of used equipment from rich countries to poor countries can be an efficient way of handling the situation for both kinds of countries.

  In a modern industrial economy, many goods are mass produced, thereby lowering their production costs, and hence prices, because of economies of scale. But repairs on those products are still typically done individually by hand, without the benefit of economies of scale, and therefore relatively expensively. In such a mass production economy, repeated repairs can in many cases quickly reach the point where it would be cheaper to get a new, mass-produced replacement. The number of television repair shops in the United States has therefore not kept pace with the growing number of television sets, as mass production has reduced television prices to the point where many malfunctioning sets can be more cheaply replaced than repaired.

  A book by two Russian economists, back in the days of the Soviet Union, pointed out that in the Union of Soviet Socialist Republics “equipment is endlessly repaired and patched up,” so that the “average service life of capital stock in the U.S.S.R. is forty-seven years, as against seventeen in the United States.”{336} They were not bragging. They were complaining.

  Chapter 11

  MINIMUM WAGE LAWS

  Supply-and-demand says that above-market prices create unsaleable surpluses, but that has not stopped most of Europe from regulating labor markets into decades of depression-level unemployment.

  Bryan Caplan{337}

  Just as we can better understand the economic role of prices in general when we see what happens when prices are not allowed to function, so we can better understand the economic role of workers’ pay by seeing what happens when that pay is not allowed to vary with the supply and demand for labor. Historically, political authorities set maximum wage levels centuries before they set minimum wage levels. Today, however, only the latter are widespread.

  Minimum wage laws make it illegal to pay less than the government-specified price for labor. By the simplest and most basic economics, a price artificially raised tends to cause more to be supplied and less to be demanded than when prices are left to be determined by supply and demand in a free market. The result is a surplus, whether the price that is set artificially high is that of farm produce or labor.

  Making it illegal to pay less than a given amount does not make a worker’s productivity worth that amount—and, if it is not, that worker is unlikely to be employed. Yet minimum wage laws are almost always discussed politically in terms of the benefits they confer on workers receiving those wages. Unfortunately, the real minimum wage is always zero, regardless of the laws, and that is the wage that many workers receive in the wake of the creation or escalation of a government-mandated minimum wage, because they either lose their jobs or fail to find jobs when they enter the labor force. The logic is plain and an examination of the empirical evidence from various countries around the world tends to back up that logic, as we shall see.

  UNEMPLOYMENT

  Because the government does not hire surplus labor the way it buys surplus agricultural output, a labor surplus takes the form of unemployment, which tends to be higher under minimum wage laws than in a free market.

  Unemployed workers are not surplus in the sense of being useless or in the sense that there is no work around that needs doing. Most of these workers are perfectly capable of producing goods and services, even if not to the same extent as more skilled or more experienced workers. The unemployed are made idle by wage rates artificially set above the level of their productivity. Those who are idled in their youth are of course delayed in acquiring the job skills and experience which could make them more productive—and therefore higher earners—later on. That is, they not only lose the low pay that they could have earned in an entry-level job, they lose the higher pay that they could have moved on to and begun earning after gaining experience in entry-level jobs. Younger workers are disproportionately represented among people with low rates of pay in countries around the world. Onl
y about three percent of American workers over the age of 24 earn the minimum wage,{338} for example.

  Although most modern industrial societies have minimum wage laws, not all do. Switzerland has been a rare exception—and has had very low unemployment rates. In 2003, The Economist magazine reported: “Switzerland’s unemployment neared a five-year high of 3.9% in February.”{339} Swiss labor unions have been trying to get a minimum wage law passed, arguing that this would prevent “exploitation” of workers. However, the Swiss cabinet still rejected the proposed minimum wage law in January 2013.{340} Its unemployment rate at that time was 3.1 percent.{341}

  Singapore likewise has no minimum wage law and its unemployment rate has likewise been 2.1 percent.{342} Back in 1991, when Hong Kong was still a British colony, it too had no minimum wage law, and its unemployment rate was under 2 percent.{343} In the United States, during the Coolidge administration—the last administration before there was any federal minimum wage law—the annual unemployment rate got as low as 1.8 percent.{344}

  The explicit minimum wage rate understates the labor costs imposed by European governments, which also mandate various employer contributions to pension plans and health benefits, among other things. Higher costs in the form of mandated benefits have the same economic effect as higher costs in the form of minimum wage laws. Europe’s unemployment rates shot up when such government-mandated benefits, to be paid for by employers, grew sharply during the 1980s and 1990s.