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This guest post was written by my long-time friend, college classmate, and co-author, Gary Pecquet, an associate professor of economics at Central Michigan University.

Today, June 5th is celebrated as Adam Smith’s birthday.  In just nine years Adam Smith’s 300th will be celebrated. Not many thinkers have had the impact on the world as he over these previous three centuries.

Adam Smith’s brief biography:  http://www.biography.com/people/adam-smith-9486480#awesm=~oGjIQ8sfw9CIvA

They do not know his actual day of birth, but on June 5, 1723 his birth was actually recorded in Kirkaldy, Scotland. His father, a custom’s official, came from the lower middle class ranks of Britain died before Adam’s birth. Thanks to his mother’s meager savings and help from relatives Adam Smith received an education and became a professor of Moral Philosophy in Glasgow University. Glasgow was not a prestigious institution. It was like what is today what would be referred to as a teaching college. At Glasgow Professors were paid only a pittance from the University and were required to produce good lectures in order to receive most of their income from the contributions of their students at the end of the term, like tips. (These teaching evaluations were thus very effective.)

It was at Glasgow University where he wrote his first major work Theory of Moral Sentiments (1756). It was a product representative of the Scottish Enlightenment.   Smith embraced the classical virtues from Aristotle (prudence, temperance, fortitude and justice) and the three Christian virtues (faith hope and charity). What made Smith’s book so interesting was that he tried to explain the process that people learn and practice the virtues in society. According to Smith, people develop the moral sentiments through a process of at first evaluating the actions of others and then internalizing them by becoming conscious of how others may evaluate us. People seek the approval of others and both judge others and attempt to be seen as worthy by others by acting appropriately.  Thus, in contrast to Jean Jacques Rousseau, Adam Smith did not believe that modern society “corrupted”modern man. Thus, to Smith primitive man was a not so noble savage, who became corrupted by modern civilization. On the contrary, Smith believed that social interaction helps us to develop our moral sentiments and helps us to advance morally as the volume and quantity of our interpersonal exchanges increases.

The Theory of Moral Sentiments won Adam Smith success and fame so this helped him to gain connections from important British officials.  After travel and examination of many businesses, Adam Smith wrote and published his most famous work in 1776. Its complete title is An Inquiry into the Nature and Causes of the Wealth of Nations. This work is oft-considered to be the founding document of modern economics. The very name of this work indicates that Smith’s primary purpose was to study “growth theory.” Smith directly challenged the prevailing theories and practices of mercantilism. Mercantilism embraced three fallacies: bullionism, the false notion that national wealth consisted of gold and precious metals, protectionism and artificial trade barriers to save domestic industries and jobs and the zero-sum view of wealth.

Smith showed that a nation’s wealth consisted of its ability to produce goods and services and gold or money was only a unit of account.

Protecting domestic industries and jobs from foreign competition by high tariffs and other import restrictions was also a bad idea. Adam Smith argued that the Wealth of Nations could be enhanced by specialization and division of labor according to the most productive employments. Production should be based upon the most efficient mans to serve consumers. Smith correctly recognized that the goal of production is to deliver the goods to consumers. (Producers exist to satisfy consumers, not the other way around. “Jobs” (at least particular jobs) are not ends in themselves and should not be granted immunity from competition. Moreover, protectionist trade restrictions in Smith’s time lead the nations of Europe into many costly colonial wars against each other to secure monopoly profits at the expense of other nations and consumers in general.

This brings us to the third fallacy which still rears its ugly head today. The idea that wealth is a fixed sum or static quantity that cannot be increased but only fought over is perhaps the greatest fallacy made by non-economists. Specialization and division of labor result in increasing the economic pie. So do domestic policies that secure property rights and promote trade and technological innovation. Adam Smith wrote that “the division of labor is limited by the extent of the market.” As we reduce trade barriers, the market expands. In a small isolated village the same person may produce all furniture, but in a larger city separate businesses will likely produce tables, desks, beds, etc. And Smith also described the dynamic of learning by doing as we specialize we can become more productive over time.

We economists also assert that the test of a theoriy’s usefulness is in its ability to predict: Well Adam Smith made a number of remarkable predictions that have proven the test of time. Smith was a technological optimist. He believed that despite the many misdeeds of politicians to steer the economy into senseless protectionism and wars, the long term consequences was for the vast majority of people would realize the rise of opulence that would benefit even the lowest ranks of society. Today we can observe untold commodities that have become available to the poorest of Americans. Many of these modern goods and conveniences were not even conceived in Smith’s own time.

Smith believed in both the moral and material progress of the human race. Commerce increased the linkages between people and tended to raise the moral standards that we expect from each other as our connections increase and the gains of trade are increasingly realized we began to appreciate the value that other can bring to us. As we become more urbanized, we tend to adopt more urban values of tolerance and respect for diversity.

Human material and moral progress does not advance evenly or without interruptions and its does not proceed as rapidly as we may hope, but comparing data shows that historical decline in murder rates. (For example the number of homicides in Europe gradually fell from between 10 and 100 per 100,000 per year in 1400 AD to about 1 per 100,000 per year today.) Slavery was abolished throughout the western world during the 19th century and colonialism declined during the 20th century. People hold officials up to higher standards of human rights than a century ago. Scientific advances continue. Globalization in the 21st century has created networks of multinational firms reducing the tendency for nations to fight border wars.

Happy Birthday, Adam Smith

 

About three weeks ago, this story broke about rationing of appointments and treatment in a Phoenix VA hospital facility, rationing which has supposedly led to at least 40 deaths as these vets awaited treatment.  The rationing is due to two factors: 1) global budgeting of the VA hospital system capping total spending and 2) a lack of incentives for VA personnel to be as productive as private sector health professionals.  Both of these taken together  has led to rationing of health care to veterans–not diagnosing and treating veterans.  Two weeks ago, CNN reported in this story that many other VA hospitals were having rationing problems similar to the Phoenix facility.

Rationing at VA hospitals has long been a problem.  In fact, in 1992 a movie titled Article 99 was released detailing a VA hospital plagued with shortages of everything except very sick veterans.

Now, another VA scandal is emerging.  This one starts here in Louisiana.  As you can see in this story, back in February, President Obama, frustrated that congress would not pass his 39% increase in the federal minimum wage, issued an executive order requiring his $10.10 minimum wage for all federal contract workers.   There are many nursing homes across the country that care for vets and provide these services through contracts with the VA, meaning they are federal contractors.

Obama’s hike in the contractor minimum wage, without changing the reimbursement rate for veteran nursing home care, has led a nursing home in Louisiana to not renew its contract with the VA, as we read in this story.  This will cause their current veterans and their families to find other facilities and potentially other ways of paying for their long-term care.

Either President Obama did not think this federal contractor wage hike through very well, or he planned to use the veterans as political leverage to get unpopular tax hikes or equally unpopular spending cuts through Congress.

-MC

 

Here is a news story from a right wing media outlet, CNS, but they are just pointing out what the Bureau of Labor Statistics reports are showing, that young adults in the 25-29 age group are now at the lowest point in the labor force participation since the data was first collected in 1982.  Of course, it is not just in this age group where we have seen reduced rates of labor force participation, as labor force participation is down by a substantial amount all around.

This is not good news for the US economy.  Once a person has left the labor force, it is more difficult for them to come back, as their skills deteriorate more.  Smaller proportions of Americans working and producing means a lower average income and slower economic growth for us all.

-MC

Democracy is the theory that the common people know what they want and deserve to get it good and hard.

H. L. Mencken US editor (1880 – 1956).

I recently received the following comment from one of my better students in my Econ 211 class on my post last month, “Water Shortages.”  He writes about the protests against Bechtel and its water monopoly.  I usually reply to comments with the comment section, but, after reading a bit about what happened in Bolivia, I had much more than a comment to write.

Here is the comment from JW:

Whenever I hear of water shortages, I think of Bechtel, a company from here in the U.S. that tried to privatize one of Bolivia’s most precious natural resources – WATER! If Bechtel had won the fight, which they did at first, effectively taking control of Bolivia’s water supply, then it wouldn’t be the Bolivian government setting the water prices for that country, it would be the largest construction and engineering company in the United States with 37.9 billion dollars in revenue. It is also pertinent to note that Bechtel is he 5th largest privately owned company in the United States. And shortly after they took control of Bolivia’s water they raised they rates by 35%, which immediately sparked protests, and led by the Coalition in Defense of Water and Life and a machinist Oscar Olivera, Bechtel was dethroned, and the people one a major victory against multinational corporations trying to profit off of their water supply. Good for them. We have to fight against the parasitic economic principles of large corporations that claim allegiance only to their bottom line.

JW,

I can understand why a water shortage would remind you of that tragic situation in Bolivia.  Here are a couple of points, however.

First, when there is a shortage, the last folks you want to help you out of the situation are government officials.  Here is why: Government officials depend on their popularity to remain in power, and they do want to remain in power.  Raising prices that the common people pay is never popular.  Popular is not always right, however.  With a shortage there just is not as much as people want to buy at that price.  Shortages have their roots in scarcity, but are not the same, but since scarcity is a ubiquitous problem, there is nothing that can make it go away.  People never want to be told they can’t have all they want.  A shortage is what results when prices do not fully ration scarce resources, but require some additional rationing.

How are government officials going to ration anything, in particular, how will they ration water? They might use first-come, first-served, but then people will compete to get there first.  In Bolivia, the richer folks were connected to water systems with pipes, but the poor had to get water in jugs and transport it.  Guess who would have gotten their water first? The government may have had to turn water on and off to various parts of Cochabamba (the Bechtel water monopoly was only for one city, Cochabamba, the third largest city in Bolivia).   What is more likely is that the government would have played favorites, providing water to the parts of the city that supported the government more than the parts of the city where their opponents were more concentrated.

Also, in a shortage situation, it would be helpful if instead of just finding different ways of sharing the existing amount of water that could be provided; the rationing institution (practice) gave an incentive to folks to provide more water, to alleviate the shortage.

Government rationing does not do this.  However, raising prices does.  Governments have little incentive to raise prices, because it is so unpopular.  Private firms have a profit incentive and care little about popularity.

The second thing is that you should take a closer look at just what happened in Bolivia.  Here are two excellent sources:  2000 Cochabamba protests from Wikipedia and Timeline: Cochabamba Water Revolt from PBS.

The problems started back in the 1980s when an irresponsible government spending far exceed their taxing (spending: popular, taxing: unpopular), leading to hyperinflation of over 25,000% in 1985.  Bolivia only had the World Bank to turn to after that, because they no one else trusted investing in Bolivia, even their own citizens did not want to.  But having to turn to the World Bank meant having to comply with World Bank requirements for loans, which meant privatization for things such as water infrastructure.

Local water systems are, by their nature, monopolies, what we have called in class, “natural monopolies.”  One distribution company can provide water to an area more cheaply than two, as more distributors would require expensive duplication of infrastructure (water mains and such).  Water systems throughout the country were in trouble due to years of inadequate investment in maintenance.

The World Bank required the government(s) of Bolivia to get out of businesses from oil refineries to water distribution.  A Bechtel subsidiary somehow became the lone bidder for the SEMAPA water company in Cochabamba (can you say “rent seeking?”).

As part of the requirements for the contract to run the water system for Cochabamba, local politicians required Bechtel’s subsidiary, Aguas del Tunari and the other members of the consortium had to invest in a dam project that Cochabamba Mayor Reyes Villa wanted for them to get the $2.5 billion contract.   They also had to pay the debts of the old water agency, pay to expand the system and fix the existing and failing system.  The World Bank had warned that the Mayor’s dam project was not needed and that an existing dam could provide the needed water.  Opponents of the mayor claimed that the project was for the profit of the mayor’s major donors.

To do all that was required, particularly build the new dam, prices had to be raised by around 38%, or to nearly $20, but this was not affordable to poor Bolivians.  There were also rumors that the vague law that enabled this deal gave the company rights over all water, including rain water and water from wells and such.

It looks like the Bolivian officials dangled the potential for a monopoly in front of the noses of Aguas del Tunari and said you can have it if you build our dam, then charge what you want.

Of course, part of the problem is that the Bechtel and their subsidiary, Aguas del Tunari, ran the project just with their engineers, not economists or marketers who would have looked at what they would be able charge based on demand in the market.

Anyway, the rate hikes sparked protests and the protestors eventually won, as JW mentioned.  In the end, the control of the water system was restored to the local government.  The system continues to deteriorate.  The poor are still without safe water and pay far more than do the rich and businesses, as was the case before privatization.  Those with connections, pipes, only get water for about 4 hours a day, so the shortages persist.

The problem here was not as much the greedy capitalists, but the greedy politicians and their backers who forced requirements into the agreement that were helpful for them, but not for their customers and citizens.  Of course, both sides have a bit of blame to share.

As a side note, this story was the theme for the the Bond movie, Quantum of Solace.

Anyway, JW, thanks for pointing out this piece of recent international history.  This story has a lot of lessons for us, from rationing methods and dealing with shortages, to natural monopolies and the waste of rent seeking.

 

I just took a look at the Drudge Report and saw these three headlines:

92,594,000: Americans not working hits record

Women Not in Labor Force Hits Record High…

Unemployment plummets to 6.3%…

Notice that the unemployment rate has dropped, but the number of Americans not working has reached a record.  The unemployment rate, you should remember, is not about the number not working, but is a percent of those unemployed to the labor force (which is the sum of those employed and unemployed.  To be qualified as “unemployed,” a person mus have been actively looking for work in the previous four weeks.  What has happened is that more and more people have given up looking for work and are now out of the labor force.  The decline in the labor force is especially troubling as it is very hard for these people to become employed and supporting themselves once they stop looking for a job.  The rest of the workers will have to support them.  Taxes and deficits (future taxes and inflation) will have to go up, reducing the incentive for remaining workers to stay in the labor market.  This is a death spiral not unlike the one that we see with insurance.

-MC

Watch this CNN Money interview with Warren Buffett.  Buffett, correctly, suggests that the Earned Income Tax Credit (EITC), which works as a negative income tax, transferring money from richer taxpayers to pooerer taxpayers, particularly those with children, does a better job of helping the poor than does the minimum wage.  The EITC does not raise the costs of hiring low-skilled, low-educated, and low-experienced workers, as does increasing the minimum wage.  It does reduce the incentive to work as does our usual welfare programs that cut benefits when workers earn an income over a certain amount.

A person can work and remain in poverty in two ways, their wage can be low or their hours can be low.  Raising the minimum wage reduces the number of hours employ these minimum wage workers.  Raising someone’s wages is not an automatic increase in their incomes.  Also, many people who get paid the minimum wage are not from poor familyies.  The EITC targets the poor and is based on their family income (a teen making minimum wage living with rich parents will not get the EITC).  The EITC is based on a person’s earned income, not on their hours.   For the cost, the EITC is a better anti-poverty program than the minimum wage.

What got edited from the TV interview I heard for this CNN video clip was that the interviewer suggested that a problem with the EITC came out of tax revenues, while increases in the minimum wage did not, and contributed little to the deficit (except to the extent that the federal government pays minimum wage for some government jobs).

What the interviewer did not recognize is that increases in the minimum wage serve as a tax on businesses, one that is paid directly to the recipient instead of being funneled through the government.  It is done to serve a supposed national interest, just as the EITC does. Raising the minimum wage works just as a tax does, increasing the costs of doing business, increasing the costs of anything that is done with low-skilled labor.  It seems that with the minimum wage government action has no costs, while we see the deficit or taxes go up with the EITC.

The part of the minimum wage hat is paid above the wage rate that would have been paid without the law amounts to a tax on business, but one that does not show up on the federal budget.  One difference between increasing the deficit with more generous EITC policies or with the minimum wage is that we do not notice that EITC raises the deficit and the deficit actually affects us just as a tax does, and the minimum wage is off budget and seems not to affect our budget.

The difference, of course, is that we never see the minimum wage tax being collected and spent, so it appears that government is not as intrusive as it really is, it is unseen government action.

Just as people take steps to avoid paying income taxes or state taxes on cigarettes by buying them from lower-taxed states, people and businesses take steps to avoid paying minimum wages.  They cut hours and employment.  They replace several unskilled workers with fewer skilled workers and equipment where they can.

Those who lose their jobs or new workers who have a harder time finding jobs are usually the most vulnerable—the young, the inexperienced, the high school dropout, the minority and the worker with few connections.

-MC

Most words in the English language have multiple meanings.  Early in my courses I point out how using a word one way and then another in the same line of reasoning can lead to faulty conclusions.  Orwell’s idea of doublethink in his novel, 1984, gave birth to a related idea, doublespeak, political speech, where words come completely unhinged from their original meaning, and sometimes come to mean the exact opposite.

We see politicians urging fairness to promote what is unfair.  “Sensible” solutions are urged that are not only nonsense, but make problems worse instead of solving any problem.  And we see politicians hiding behind their transparency.

In 2010, the Affordable Care Act, aka ObamaCare, became law, a push toward universal health coverage.  Universal health care and health insurance coverage have been debated for many years in the U.S.  In this 1999 talk before the Physicians for a National Health Program, Karen Palmer outlines the history of efforts to establish universal health coverage in the U.S. and traces the efforts back to the late 1800s.

While the roots are deep, the modern debate in the U.S. is linked to Hillary Clinton’s advocacy for universal health coverage in 1993, after 12 consecutive years of Republican control of the White House and a decade of health care prices rising much more rapidly than other prices and two decades of great turbulence in the job market, leading to uncertainty in health insurance coverage.

Since the passage of Medicare covering the elderly and Medicaid covering the non-elderly poor in the mid 1960s, the debate over universal coverage focused on the problem of the high costs of health care made it difficult for the middle class to afford health insurance.  We should understand that the very programs that subsidized the health care insurance the elderly and the poor, both increased total demand for health care and made these health care consumers less careful about their own health care costs, pushing health care costs up rapidly for everyone in the 1970s and even more in the 1980s as our population became older.  The promise of universal health care thus was led by a promise to control rising costs.

Though government cutting spending sounds like a somewhat facetious joke, there are three main ways in which the rise in health care spending might be brought down: by some limit on health care prices and the prices of health care inputs;  by limiting access to some treatments and procedures; by reducing the barriers to entry into medical professions and by even more rapid technological advances in health care.

Of course, instead of increasing the technological development, the Affordable Care Act is likely to impede technological advances by placing heavy taxes on some health care devices, reducing the profitability of such devices, cutting incentives to develop them.

For many of the insurance companies to be selected to offer insurance on these state “exchanges,” their prices had to be low.  To get their prices low, they set low rates of reimbursement for doctors and other providers.  Many doctors and hospitals chose not to be providers.  In California, though, a major plan listed almost 1000 doctors who never agreed to be providers, leading to a great deal of confusion by consumers.

To make matters worse, though, many of the patients in California who have ObamaCare coverage are beginning to find out the hard way that having health care insurance is not at all the same thing as having access to health care.  What these partients are discovering is that most doctors have all of the patients that they can handle and are no longer taking more patients and patients just cannot find a doctor.  In other words, there is a shortage of doctors with the California ObamaCare system.

The shortage of health care providers was something I anticipated when national health insurance was brought up in 1992 during the Clinton and Bush campaign for president as you can see in this column I wrote for the Thibodaux Chamber of Commerce Magazine. (Sorry for the crazy symbols in the file—these were added by changes in versions of servers that we have for the Nicholls website.)

In that column, I suggested one of the few things we can really do to reduce the rate of increase in health care costs: reduce the barriers to entry into health care professions by prying the control of health care professional school accreditation away from the professionals they educate.  In just about any line of business, including health care, people want to have no extra barriers to entry into the field while trying to get in.  Once in, just about everyone wants to close off the business off to newcomers, to new competition.

From my column on health insurance, you can see that by trying to keep the pay to doctors down, some people are denied care.  Of course,  my students will note that these price controls, this time by the insurance companies, have brought on shortages and these shortages have brought on very high search costs as people try to find doctors that just are not there.  The combined costs of looking and looking for doctors who are not there and of waiting to see a doctor once you find one along with the jacked up premiums for ObamaCare to cover treatment you are not interested in to subsidize someone else, and the higher tax bills to cover subsidies and expanded Medicaid enrollments will surely be higher than what we had before.

Welcome to the new meaning of “affordable.”

-MC

For at least four thousand years (see the blog post by Tom DiLorenzo), political leaders in monarchies and democracies alike have instituted price ceilings.  The results have always been the same: chronic shortages.  Anyone who has read my posts here, especially my recent posts, have found me lamenting both the pharmaceutical shortages in the US and the many, assorted shortages in Venezuela.  Shortages come, not from the greed of merchants and other business people, but from government officials who delude themselves and their followers into believing they are better suited to set prices than those greedy forces of supply and demand.  They do this as if the political leaders are not greedy, themselves—but their greed to rule over others’ lives is perhaps the worst form of greed.  Well, this time, I turn my attention away from Venezuela and to Venezuela’s Marxist role model, Cuba.

Cuba, like Venezuela, is plagued by shortages of many goods and services.  Sometimes shortages occur in one area, but not in others, in one item, but not in others.  The reason for this is that prices are set by the government in Cuba, and not by market forces.  Markets create incentives for self-correction of shortages and surpluses.  Shortages lead businesses to raise prices which both give them an incentive to produce more and for buyers to cut back.  Surpluses lead to price cutting, reductions in production and increases in purchasing.  Bureaucracies do not provide such self-correcting incentives.

Well, what has caught the attention of the press is not the food shortages, or the shortages of corrugated roofing metal while having a surplus of nails, or even shortages of medical gauze, but a shortage of condoms.  Juan O. Tamaya, reports on the condom shortage here (read it!) in the Cuba section of the Miama Herald.  When the prices of items are held below the price that the market would predict, what economists call “equilibrium prices,” shortages will appear to raise havoc.  This particular shortage could lead to shortages a little down the line, perhaps in several months as unplanned pregnancies and STDs begin to increase.

While smuggling is not the cause of the problem, you can be sure that having separate markets, with prices held low for Cubans and higher prices for foreigners, encourages “arbitrage”  or buying large quantities at the low price to resell at the higher price.  Tamaya reports “Celaya wrote earlier this month in her blog Sin Evasion (“Without Evasion”) that the chronic shortages on the island seemed to be more frequent and affecting more products, including some that are usually widely available at steep, hard-currency prices.” (Read more here: http://www.miamiherald.com/2014/04/16/4063871/condom-shortage-hits-cuba.html#storylink=cpy).  I noted the same type of problem that worsens shortages in this recent Bastiat’s Bastions post on Venezuela.

I am sure you have heard the maxim that “people who do not study history are bound to repeat it.”  Price controls and chronic shortages occur when people fail to study economics and economic history.

-MC

As some of my students are about to take exams covering the minimum wage, among other topics, I thought I would point them to some old, but still relevant columns I wrote in the late 1990s on the topic.

Why the minimum wage should not be increased (1998)

Minimum-wage increases and high school dropout rates  (1999)

And here are some of my prior posts on this blog:

Obama’s own former adviser gives thumbs down on pushing up the minimum wage

President’s proposal to raise the minimum wage sounds good, but could there be unintended consequences?

The minimum wage hike fumbles teen jobs
Update:  Here is a blog post that I wrote after this one was originally posted.

-MC

 

The shortages in Venezuela, as I have discussed in previous posts, are due to price ceilings which suppress the quantity offered on the market while encouraging extra consumption. Low prices also encourage exports of those price controlled items and discourage imports.  As a result, people in Venezuela are continuously frustrated in their basic attempts to buy groceries.   A country with perhaps the most oil reserves in the world, cannot seem to feed its people.

You may have noticed that there has been quite a bit of violence in the streets in Venezuela.  Opposition media has been shut down so that only the government’s side gets out in regular media.  Many opposition leaders have been jailed sending others into hiding.  Here is an article from the U.K.’s The Telegraph, that will give you a sense of the street conflicts.

Mentioned in the article is one of the opposition leaders who has been jailed, the Harvard trained Venezuelan economist, Leopoldo Lopez with trumped up charges.

A peculiar fact mentioned in this article is that Venezuela has been supplying Cuba, the sponsor of the Venezuelan regime (the puppet masters?), with low-priced crude oil in exchange for thousands of military consultants and doctors.  You should ask yourself “why does Venezuela needs to import doctors? Why don’t people in Venezuela train to be doctors?”  I am sure they do.  I am sure the problem is the same we see with food.  Prices for doctors are held low by decree, making doctor’s incomes in Venezuela lower than in other countries, leading them to seek better lives elsewhere.  What keeps Cuban doctors from fleeing, too?  The families of the Cuban doctors are still in Cuba.

-MC

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