Tuesday, April 23, 2013

Economics, Labor, Capital, Recession and Blame

With an economic collapse followed by years of economic weakness, there is, of course, much discussion surrounding the idea of blame.  Who is at fault, and what did they do to create the mess in which we, as an economic society, find ourselves?

Before one can assign blame, one must understand the environment in which all actions take place.  That environment is - and will be for as long as scarcity exists - one that is inextricably linked to economic theory, thought and calculation.  Economic calculation is a means of making decisions for allocation of resources (eg, time, effort, money, lumber, knowledge, etc.).  Economic thought is a means of determining and understanding economic theory, which is, itself, a means for explaining the outcomes of economic calculations individually and in aggregate.

Such economic calculations are constantly occurring, and are occurring in every decision that is made.  When one decides to buy shoes, they have carried out a rational calculation regarding the worth of the shoes versus the worth of the scarce resources that are given up to obtain them.  In fact, even when one buys items without regard for price, they are acting rationally and have made the calculation that the act of weighing the cost and benefit is, itself, not worth the effort of doing so; so an economic decision has been made, not based on the scarcity of money, but the scarcity of time, energy and effort.

Various factors influence the outcomes of these calculations and decisions, and, at times, can be countless and unknown.  A person's decision not to buy a pair of shoes in New York City might be, unknown to them, influenced by an electrical fire in Taiwan that happened to cause a shut down of the production line that makes the shoe (which happens to be the newest, most desirable hit pair of shoes at the time) more expensive.  The decision-maker had no knowledge (and likely never will) of the fire.  But the pertinent portion of that knowledge was conveyed to him through a higher price.  The price system, therefore, is among the most important factors - and is really itself just an efficient combination of potentially countless factors - in making economic decisions (and the price is not always monetary; the same concept holds for the decision to study or work out).  A price is a measure of relative value of one currency, good, service, effort, etc. versus another currency, good, service, effort, etc.

Just like with shoes, price is a major factor in both sides of decisions regarding labor and capital.  A worker will decline to expend (sell) their effort, energy and knowledge if the price offered by a potential employer (buyer) is not enough for them to value the pay over the various benefits of not working.  The same holds true for the other side of the transaction.  It also holds for capital.  If an investor calculates his expected return relative to the risk to be insufficient, that capital will go elsewhere.  Capital will not invested in hiring workers or any other means of production if the return on that production falls below the desired return, given the risk involved.  This holds for decisions to invest in a company as whole, as well as the individual decisions that said company continuously makes, whether it be hiring, buying trucks, or building a warehouse.

So, what about our current problems?  Many people are out of work, and people want to work.  The truth is, people don't want to work.  They want the fruits of that work.  That is, they want the wealth it brings.  If one could get the same return sitting on the beach as they would going to their job, many would choose the beach.  This is why, so often, people strive to obtain a job doing something they love (like flying) and would do in their spare time regardless of wealth.

Because we can't, generally, accumulate wealth by sitting on the beach people seek work, because they understand that working is the most effective way to accumulate the desired wealth.  Many are without the work they seek, and the price system is a gold mine of knowledge regarding why this is so.  Simply, there are many factors that make the price of hiring a given worker rise above the level at which a given employer values the work enough to pay the price.  And, remember, this price is subjective.  So the level at which a certain price is too high is a spectrum, rather than a single point.  That is, one employer, for various reasons, may get enough value to make it worth hiring a widget maker at a given price while their competitor might not.  This can be caused by differing costs elsewhere in the production process, different thresholds for risk and reward, or a number of other factors.

The employer (just like the buyer of a pair of shoes) is always seeking the lowest cost to benefit ratio in purchasing labor.  On the other hand, the worker is always seeking the the very same, except the cost and benefit are reversed.  Both employer and worker compete against fellow employers and workers respectively.

As mentions, the price, relative to the value of the labor dictates whether a decision is made to hire.  The price, to the employer, includes more than what is directly paid to the worker.  Every worker hired has a tax imposed (up to a certain level) of about 15%.  This effectively raises the price of every worker by 15%.  It is hard to calculate how many people are priced out of a job by that 15%, but it is safe to assume that there is a number and that it is not insignificant.  And this is but one cost associated with hiring.

Others are priced out of jobs by legal minimum prices (wages) and by varying levels of de facto minimums.  The minimum wage creates situations in which people become unemployable, and thus unable to develop on the job skills.  While it may be a relatively small number of people, it is a real number and they are the most vulnerable.  The de facto minimums arise out of programs aimed at preventing poverty.  With the various benefits provided, one might choose, correctly, to limit the level and type of work they are willing to do because the risk of not doing it has been so heavily mitigated, and the marginal value of certain levels and types of work has been minimized to such a degree that it is not worth doing.  How many people are priced out of work by various minimums?  Hard to say.  But the number is likely significant.  And the decisions involved in not working or not hiring are made economically and rationally and based on various influencing factors.  The governmental factors mentioned can logically be understood to lessen the value of both working and hiring and, therefore, hamper the degree to which both occur.

Further impediments to growth in hiring relate to stifling of competition.  The costs discussed do that to a large degree.  But then there are various regulations and requirement imposed in every area of the economy that, whether aimed at helping customers, workers, etc., have the effect of helping the largest competitors most of all.  Mitt Romney, during his campaign for president, said he didn't think that you should be able to start a bank in your garage - that is, he felt certain regulations should exist to prevent individuals, companies, etc. from operating a bank.  This protects established banks from competition.  It gives them a more permanent and defensible seat in the banking world, and allows them the opportunity to operate in ways that they otherwise couldn't.  And this is a giant gift directly from government.  And it is a giant blow to start-ups, competition, growth and hiring.

All of these issues discussed (and others, like the amount of credit being funneled to the government, rather than productive investments through treasury bonds) are governmental creations that have clear causal links to the current weak growth and weak employment levels.

Many of these issues can, to a degree and in an environment of stronger economic prosperity, be overcome.  But they are, no doubt, greatly hampering our recovery.

But what are we recovering from?  Why did the economy crash, and who is to blame?

The answer lies in the market for credit.  Credit is what drives much of the economy.  It allows a person or business to borrow money, invest it, and create a return that is greater than the cost.  So investments are made when the profit goes above and beyond the expense (the interest).  Before economy crashed, the price (interest rate) of credit was very low.  So people, businesses and governments, rationally, utilized it heavily and investment grew, so the prices of the various things in which this money was invested grew.  The price was low, because the bank, created by government, with the sole control over the creation of new credit, the Federal Reserve, kept it's rate low to increase the flow of credit.  Eventually (as becomes necessary when the supply of money creates rapidly rising prices throughout the economy) this interest rate began to rise.  Investments (like homes and their derivatives) became less appealing due to the change in the price of the capital used to make the investments.  That is, the risk reward began to swing toward risk.  Because of this, the prices of those investments fell as demand fell.  Making matters worse, the higher cost of money meant that much of the debt became impossible to service, as the price increased beyond the return on the investment it funded.  And with all the credit that had been issued, much of which was now bad debt that could not be repaid (with collateral that is worth less than the debt) the house of cards collapsed.  On the bright side, this should have allowed for the rebuilding of a sturdy frame where the house once was.  Instead, as the collapse cascaded down, the weak base of cards was already being rebuilt to prop up investments that had proven to be bad.  So, instead of the bad debt clearing and the economy being rebuilt we have the same malinvestment being propped up by new debt that was supposed to fix the economy, but instead has been funneled, largely, in to government.  Making matters worse, since the rates are so low the risk/return ratio of investments in productive investments, especially in a weak economy, is just not as appealing to many investors as higher paying but risky derivatives as well as government bonds which are thought to be nearly risk free.

So who or what is to blame for the economic recession and following weakness?

The blame does not lie with corporations or small businesses, it does not lie with welfare recipients or the poor, it does not lie with the Koch brothers or the environmentalists, it does not lie with AARP or any other lobbyists, it does not lie with the 99% or the 1%, it does not lie with workers or CEOs or the greed of any of them. 

The blame lies with a small number of individuals who have, whether well-intentioned or not, taken it upon themselves to centrally plan countless aspects of the economy and the market.  Many of them will speak endlessly about the virtues - the benefits - of what they do.  And these virtues are great motivators for individuals to give of their vote and support for them.  And there certainly are benefits.  Rarely, though, do these individuals stress the cost.  I have listed a fraction of the costs.


Put simply, voters, Americans and individuals must ask themselves -- Is it worth it?

Is THIS - the economic crash we suffered through and the continued poverty and economic stagnation - an acceptable cost of the various benefits and promises offered by politicians?

No comments:

Post a Comment