How Does a Barber Thrive?

            Yesterday I had to cut my own hair (again--thanks COVID).  I cannot say that I did a great job, but it got me thinking about barbers.  How much has the job of a barber changed over the past several decades?[1]  I don’t think it has changed too much.  So what does a barber need?  A chair.  A cloth and a strip of paper that tucks under into the collar.  Scissors.  An electric clipper and attachments.  A comb and some blue liquid to drop the comb into.  And maybe a water squirt bottle.  Maybe.  And not much more.

            So here is my question: As the world progresses, how does the barber thrive?  I can imagine a company which comes out with a new product, expands into new markets and thrives.  I can also see a scenario where a company cuts its costs, thereby increasing its profitability and thrives.  However a barber, not a chain of barber shops, can’t really come out with new products nor expand into new markets.  And it isn’t likely that the barber is able to cut his costs year-after-year to enhance his profit margins.  So how does a barber thrive?  In other words, how does the barber increase his standard of living when he doesn’t have the same paths open to him as other businesses do?  Let’s explore some possibilities.

            If the barber raises his prices each year, would he then be able to raise his standard of living?  Let’s think that through.  First of all, it is probably true that the barber’s prices do rise, but this is most likely due to inflation.  As the money supply expands, each dollar loses some of its value.  This drop in purchasing power requires the barber to raise his prices to keep pace.  So the real question is not whether the barber can raise his prices each year, but can he raise his prices faster than inflation and make a larger profit?  To answer this question, we first have to recognize that demand curves slope downward.  That means as the price falls, people will want more; and as the price rises, people will want less.  So as the barber raises his prices faster than the rate of inflation, he will lose some business.  It comes down to which change is bigger: quantity or price.  A business’s revenue is Price × Quantity.  If the change in price (say +10%) is larger than the loss in quantity (-5%), then the revenue will increase.  Economists call this situation inelastic demand.  Whenever a company faces inelastic demand, raising prices will lead to an increase in revenue.  However, there comes a point where the demand stops being inelastic.  And so companies (even in complete absence of competition) stop raising their prices when they reach that last point of inelasticity.

            So let’s assume that our smart barber has found that point.  Now what?  He can’t raise his price any further without losing too many customers.  In fact, let’s assume that barbers found that most profitable point long ago.  Let’s say they found it some time back in the 1950s.  How can we explain that the barbers’ standard of living has improved even though they can’t raise prices faster than inflation, can’t diversify into other markets, and don’t really have any mechanisms to consistently cut costs?

            What can the barber do to raise his standard of living?  The simple answer is nothing.  There is nothing that he can do, all by himself, to raise his standard of living.  He needs the help of others.  And this truth is the miracle of the market.  Markets help people and improve lives without intending to do so.

            The barber’s life improves every time another person introduces a good idea to the market.  When that other person figures out a new way to cut his own costs, he is able lower his price.  He doesn’t lower his price to help the barber.  He does it to gain market share and increase profits.  Nevertheless, the barber’s standard of living improves as the price falls.  Every time an entrepreneur improves a product, he does it for his own gain.  However, the barber benefits from that improvement, too.  As the smart phone replaces the flip phone, the barber’s life is improved.  As streaming services replace expensive cable and satellite providers, the barber’s life improves.  When a business launches a new product, it does so out of its own greed for profits.  However, the barber now has another option on which to spend his money. 

The barber’s life is improved, not because he has done anything different.  He hasn’t raised his prices, increased his revenue, increased his market share, nor cut his costs to increase profits.  Nevertheless, his standard of living improves year-after-year because of the help and cooperation of countless numbers of strangers that he could never meet even if he were to try. 

The miracle of the market is quite simply something that we too often take for granted.  It is invisible.  It is quiet.  It is humble and does not boast.  And it is possibly the most powerful force to improve human life the world has ever seen.  So before we throw it all away, let’s pause and think about why a barber thrives.

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[1] One caveat: I know nothing of women’s hair dressing.  I am only thinking about men’s barbering.

Being data driven into a ditch

(Originally posted for Carolina Journal on June 4th, 2020 here.)

Written by Paul F. Cwik and Abir Mandal

Governors across the nation announced that the coronavirus-related policies for closing businesses were based on “data driven” analyses by medical professionals. Next, they announced that the reopening phases also would be strictly “data driven.” Over and over, the officials said that they were being guided by “the science” and “the data.” Of course, being guided by science and data is appropriate in a time of crisis; we wouldn’t want it any other way.

However, what if the decision makers were getting only a small fraction of the overall picture? This is not to say what they had was wrong. The information was most likely the best available. Our question is, “What is the likelihood that good decisions can be made if only a small part of the overall picture is considered?” It would be like the chance a blind man has in guessing the weight of an elephant by only touching its trunk.

From the start, officials have been looking at incomplete data. The key statistics that a data driven analysis would need to have is the number of COVID-19 infections, the number of people who are hospitalized by COVID-19, and the number of deaths caused by the virus. If we had instantaneous data of those three variables, then creating an appropriate response would be a straightforward process. Unfortunately, data of this sort never actually occurs.

Taking the wrong path

Where did we go wrong? To get perfectly accurate results would require health care workers to test everyone. Unfortunately, we simply do not have enough tests. When we cannot test the entire population, we take a sample and extrapolate results. In essence, we create a model. Models require simplifying assumptions.

The first hurdle we needed to overcome was the issue that people may be infected and yet asymptomatic. As a result, health care workers had no way of knowing who to test. Since COVID-19 is a novel virus, for which our testing capacity has been and is likely still constrained, the next step would have been to test random people.

Unfortunately, medical necessity and proper statistical methods do not always line up. Medical workers needed to know if the patient in front of them was a risk to others and with a limited supply of tests (especially in March 2020) tests were restricted only to those who were symptomatic. The nonserious and asymptomatic cases were left out. Thus, the data that we were collecting was skewed from the very beginning. This sort of error is called sample selection bias.

Sample selection bias is where the data points of the test sample is not gathered in a random process. As we are observing now, making deductions and deriving estimates based upon biased data is misleading and can lead to disastrous consequences. In fact, it is precisely this bias that has led to the assumption of the death rate being between a range as wide as 0.5% and 16%, as calculated as a proportion of the total number of people tested positive for COVID-19. This estimate depends on the number of people tested positive, which in turn depends on the testing capacity of the country — hardly consistent across the world.

Governments around the world and in North Carolina have based their projections using such biased figures, implying that the disease was many-fold deadlier than the seasonal flu (which has about a 0.1% mortality rate). Unfortunately, this assumption should never have been taken as accurate, because the sample of people tested did not accurately reflect the population of those actually infected.

The rates of infection were unknown at the beginning. But estimates could have been roughly “ballparked” using the lab-derived figures for rates of infection and the empirical multiplier used each year by the CDC to estimate the annual flu load from confirmed cases. Policy makers, who were mostly led by a team of health experts, chose not to pause and do so. Therefore, the projected death rates are likely to be too high by a factor of 50 to 100 times, as now evidenced by the serology tests on the general population which test for COVID-19 antibodies.

Consequences of poor understanding

The overall result was massively inaccurate projections and apocalyptic scenarios. The number of infected people was projected from biased data. Using the number of people infected as the base, the projections of the number of ventilators needed and resulting deaths were grossly exaggerated. A statistician could have helped matters, in our opinion, by highlighting the dangers of conflating the case fatality rate with the overall mortality rate. The unfortunate result was that flawed models, which predicted between 500,000 deaths with social distancing completely implemented, and 2.2 million deaths if nothing were done in the United States, were touted as scientific truth.

The data that has now been released to the public show that these projections are clearly flawed. Furthermore, many government officials, including Gov. Roy Cooper, have simply refused to release the data and models used in making their executive orders. (See here and here.) When looking at more recent numbers, the death rate and hospitalization rates are likely not significantly different than that of an average or bad flu season.

It seems that government officials continue to use the inflated metrics to determine whether, for example, North Carolina should open. Additionally, the debate has shifted from “flattening the curve” to “stopping the spread.” Again, looking at the spread of the virus is also falling into the trap of sample selection bias. Today health departments are looking at the proportion of positive cases, which on the face of it sounds like a reasonable number at which to look. As the number of tests increase, even given a constant number of infections in a community, the number of positive tests would increase.

However, this is where the trap of sampling bias occurs. The tests are still predominantly performed on those who are sick enough to seek testing. People who feel fine (and are not at risk) are not going out of their way to get testing. The collected results do not constitute a true representation of the state’s population and shows nothing about whether the disease’s spread in the community is increasing or decreasing. The only reasonable metric that the state should use is the number of hospitalizations due to COVID-19 like diseases.

Where to look

In our opinion, North Carolina officials should focus on the number of serious hospitalizations (as imperfect as it may be) as the primary metric for its policy making. However, we should not be myopic and only focus on one statistic.

Always, the goal is to use the data properly. Let’s consider the following scenario. Suppose that there is an outbreak of COVID-19 cases in Wake County, what should the government do? Should the entire state be shut down? Or more to the point, should we close Graham or Hyde counties if there is a spike in Wake County?

It is upon these questions that we see science and the law come together. When a political area engages in a lockdown, it is purposefully suppressing the citizen’s legal rights. Recently judges have been rolling back executive overreach by claiming that the restrictions of rights must be of the greatest concern. When rights are to be violated, it must be done in a manner that is targeted and not expansive, it must be short-term and not perpetual, and it must be done under scrutiny of the other governmental branches.

The science is required to assist the law by showing the least oppressive limits of a lockdown. The best statistic to start with is how is the most likely to die. Then who is the most at risk of suffering severe problems. Stemming from these we come to the number of serious hospitalizations. The capacity of hospitals is a limit that cannot be crossed. We have seen the results in Europe when people are denied beds or are “overflow” in hallways because this limit is crossed. Many needlessly suffer. The U.S. goal from the beginning has been to “flatten the curve.” Which curve? The curve of serious hospitalizations.

Setting a better policy

When focusing on serious hospitalizations, government officials at the local and county levels can look at the stress on the area’s hospitals and compare it to the area’s hospital capacity. There are significant differences between regional areas. For example, there are no hospitals in Hyde County but there are 10 in Wake County. Wake County has much more capacity than Hyde County, but it also has a much larger population. If there are 10 cases in Hyde County, a lockdown may be required. However, if there are 10 cases in Wake, a lockdown could be excessive. Using the data in this manner requires policies to be focused. Our concern is the overreach across the entire state.

Furthermore, there is no evidence that statewide lockdowns work. South Dakota did not lock down. Their numbers are no worse than states with the worst encroachments on the freedoms of movement of citizens. Sweden did not lock down. Its death rate of around 330 per million due to COVID-19 is slightly higher than the U.S.’s 295 per million. Sweden’s economy is projected to contract by 5.6%, but not as bad as the rest of Europe at -8.1%. When North Carolina began Phase Two on May 23, the state reported a “surge” in cases. However, this surge of 1,107 cases is an aggregate number of people who have tested positive and is based on a record-setting 26,000 tests. In terms of the number of cases tested positive as a proportion of total tests, the figure for that day is just 6.9%, lower than the dataset average of 7%. Additionally, there is no mention if these cases are in a single county, spread across the whole state, or in areas that have hospital capacity.

A better path

The largest consequence of this statistical illiteracy on the part of American policy makers is that we have essentially destroyed our economy. The irony is that antibodies and herd immunity, either via infection and recovery or gained through a vaccine, are the key to defeating the virus. Keeping ourselves locked up in isolation from each other would not really save lives because the virus is here to stay. Isolation and quarantining are only prolonging our misery. If statewide lockdown measures were not put in place, and instead we chose to protect the most vulnerable, the virus would spread throughout the population, harmlessly for most, while generating antibodies and herd immunity.

The very fact that a spike in the number of cases as our testing capacity increased did not correspond to a similar spike in deaths should have given our politicians pause. Government officials, like all people, are very reluctant to admit that they were wrong. The result of this stubbornness is an overreaching and illogical lockdown that continues today. We need to account for sample selection bias, meaning that we should not focus simply on the number of cases. For example, NC Department of Health and Human Services reports that the plurality of positive tested cases (43%) are for people between the ages 25 and 49. However, 64% of the deaths are 75+ years old. The probability of someone younger than 45 succumbing to the disease is so low, that it can be taken as zero.

Does it make sense to quarantine the people who are in their prime working age range? When we more closely examine the governor’s executive orders, we see that restaurants can open but not bars. Day camps are allowed to open, but not playgrounds. Salons can open but not gyms. For all the calls for data and science, Governor Cooper seems to have regressed to whimsy. Yes, precautions for the most vulnerable need to be taken, but it is past time for our state’s economy to be reopened. If we fail to open soon, it will be as President Trump mentioned: The cure for COVID-19 in North Carolina will turn out to be much worse than the disease itself.

Paul F. Cwik is the BB&T Professor of Economics and Finance at the University of Mount Olive. 

Abir Mandal is an assistant professor of economics at the University of Mount Olive.

Extending the Tree of Knowledge through Branching

A striking feature of the Great Depression was the number of bank failures. Between 1930 and 1933, over 9,000 banks suspended operations, never to conduct business again.  The problem became so desperate that newly-elected President Roosevelt declared a “Bank Holiday” in which an inspection was to occur and only the sound ones would be allowed to reopen.  There are many reasons for the number of bank failures, but curiously Canada’s banking system didn’t suffer the same fate.  In fact Canada had zero bank failures between 1927 and 1980.  (That’s over fifty years without a failure!)  What could be the difference?  The answer is simple: branch banking was allowed in Canada, but not allowed in the US.  The simple principle of diversification was denied to the US banking industry and when the crisis hit, the banks fell like dominos.

Today, there is another industry set up for a similar failure: US colleges and universities—private institutions in particular.  In the same way that the US imposed “unit banking” on the financial industry, we currently have a similar anti-competitive, and anti-diversification, system targeting higher education.

It wasn’t until just recently that I discovered this situation firsthand.

I teach Economics and Finance at the University of Mount Olive in North Carolina.  UMO is a small, private, Christian and non-profit school in eastern North Carolina.  In January 2014, we launched our first graduate program, a Masters of Business Administration.  As a part of our business strategy we decided to launch the program entirely online.  The original idea was once we had the program up and running, we would look into seated and hybrid courses.  The business strategy was simple.  We wanted to diversify.  First, by adding a Graduate Program and, second, by extending ourselves outside of our region.  We had all seen the ads on TV by other schools pitching their online degree programs.  We wanted to get into that market where the world could provide us with students.  At UMO, a majority of our students are adult learners and many of those are affiliated with the military.  Working around deployments is nothing new for us.  For example, I have had a student who had to finish his Money and Banking course from Qatar.  So the faculty’s acceptance of the idea of an online degree for adult learners from all over the country came naturally.

The ability of a small Southern, Christian school to diversify is necessary.  As a regional school, we have been putting too many of our financial eggs in a single basket.  Some have made the quiet projection that within the next 5 years, 3 to 4 North Carolina colleges may disappear.  Mount Olive has had its fair share of financial difficulties, has successfully emerged from them and is better as a result.  We have learned, the hard way, the difficulties for a private school competing against tax-supported public schools.  We owe it to ourselves, our students and most importantly to our alumni that we not simply survive, but flourish.  (Imagine having a degree from a school that no longer exists.)

Last January, I had the honor to teach the very first MBA course offered at Mount Olive.  Of course, the first class drew heavily from our Alumni.  Over the following semesters, I have seen graduates of other schools join our program, however, they were still local to Mount Olive’s region.  This result, of course, makes sense because people who aren’t all that familiar with the school won’t apply.  Then I noticed that our reach extended west of I-95 and into the Triangle Area.  And so I asked our program director, almost off-handed, when we would see students from Virginia and South Carolina.  It was then that I learned the awful truth: we were not allowed to compete for students in other states!  It is against the law.  (My jaw hit the floor.)

In 2010, the US Department of Education issued a regulation that stated colleges and universities could only offer online programs in states where they also had a physical presence.  In July 2011, the DC District Court struck down this regulation.  However, the Department of Education appealed and in 2013 it issued a Notice of Proposed Rulemaking (NPRM).  Simply, the DOE announced that it intends to make a rule on the topic of State Authorization.  And this is where we stand today.

So while there is technically no Federal Rule preventing a college from advertising online programs across state lines, individual states have their own individual laws that prevent competition.  In other words, in order for the University of Mount Olive to compete across the country, UMO would have to request special authorization from each and every state that has a State Authorization law, which apparently is every state except maybe Hawaii.  Furthermore, the state would have to specifically name the school that it allows to compete with its own local schools (that means we’d have to lobby other states’ legislators—which is never cheap and hardly a guaranteed result).  There are other loophole-ish ways around some state laws.  Apparently some state laws are fairly vague.  In fact, I was told that some of the schools that advertise across the country have, in some states, a single guy with a phone in an office that creates their “physical presence.”  I am not sure if this is truly the case, but as with all loophole strategies, a single court case or amendment to state legislation can crush that approach.  (If you are interested in reading legalese for yourself, you can find it in the Code of Federal Regulations, Chapter 34, Section 600.9 State Authorization, http://www.ecfr.gov/.  Enjoy!)  The reality of these government restrictions is the creation of a chilling effect to new and innovative methods of delivering education; and it is a costly one as well, both in terms of schools lobbying for authorization and in terms of lost revenue. 

Diversifying how a school offers its courses is an act of entrepreneurship.  Reaching beyond the school’s natural regional limitation is also an act of entrepreneurship.  Both are necessary for a healthy and growing institution.  I teach entrepreneurship in my economics classes, and I see case after case of entrepreneurial ideas being squashed by the heavy hand of government.  In many cases, state legislators want to restrict online competition from “outside” educational institutions, especially if the competitor is a for-profit entity.  Regardless of the stated reason, it is the same protectionist argument that David Hume and Adam Smith fought against centuries ago.  It is the same argument made against bank branching in the early 20^th century.  In each and every case, the result is that cost of protection exceeds the benefits.

The greatest strength of US Higher Education is that there is free and open competition.  Unlike the failing public K-12 system, where students are assigned to schools, US colleges and universities must persuade customers to freely opt for one’s school.  This competition ensures higher standards and lower costs.  Increasingly, each decade the government erodes this market connection through tax subsidies, grants, and so forth, but nevertheless, the link still exists.  At UMO, we are very aware of the importance of each and every student.  These students consciously choose to enroll with us and not somewhere else.  It is difficult enough to compete with institutions that benefit from the taxes that come out of my paycheck.  And it is beyond enraging to learn that we are banned from competing across state lines.  Nevertheless, I am optimistic.  Technology seems to find interesting ways around bureaucratic obstacles. 

The best solution is to extricate government from the higher education market.  Although such a goal may be wildly optimistic, we can at least do away with these State Authorization laws.  When the crisis hit the financial markets in the early years of the Great Depression, the result was that more than 9,000 banks closed their doors forever.  It is no secret that today there is a bubble in Higher Education.  If schools are unable to properly diversify, I shudder to think about how many Alumni will have degrees from schools which will no longer exist?

Secondary Consequences--Blackmailing Batman

One of the most important concepts that we stress in economics is that of secondary consequences.  Too often, we simply focus on the immediate, on the short-term, on what happens to a particular group.  Economics teaches us that we need to go beyond a narrow focus.  In the movie "Batman: The Dark Knight," an employee discovers Batman's secret identity and thinks that he should be paid $10 million a year for the rest of his life to keep quiet.  Here is the scene:

The reason why this scene is funny is because the extortionist has not thought his proposition through.  He hasn't looked beyond the immediate.  What will Batman's reaction be to someone who wants to release his secret?  What will happen to him?  Will he ever be able to enjoy that money?

Earlier this week I attended my Town's Council Meeting.  There was a proposition to limit Electronic Gaming Businesses by saying that these businesses had to stay at least a quarter mile away from each other.  What they are failing to do is think about the secondary consequences.  Let's set aside the issue of whether such a rule will achieve its purpose--to frighten away such businesses from the Town of Garner.  (It won't.  It's like preventing Burger King from locating near a McDonald's because we fear that people are getting too fat.) 

The secondary consequences of creating these spacial regulations is that the town is carving out islands of monopoly.  Each business gets its own territory and all competitors are prevented from encroaching on your business.  The cost of enforcing this rule is picked up by the government.  It's a sweet deal for those already in business.  As an island of monopoly, the business doesn't have to compete as hard and so the product to the consumers is inferior and at a higher price.

So if the Town Council hates competition and wants to stick it to the consumers, then by all means let's pass this rule.  Or perhaps, we should think it through before we go up against Batman.

Capitalism and The Godfather Movies

The History Channel recently broadcast a show called "The Godfather: Legacy."  It was a look at the three movies and was fairly informative.  Several of the key people who helped make the trilogy were interviewed, and of course, this included the director Francis Ford Coppola.  Unfortunately, Coppola said that what happened in the movie shows the consequences of capitalism.  ARGH!  Really?!?  No, no, no!  Wrong, wrong wrong!  This is wrong with wrong sauce.


While I like the movies and think that they are beautifully crafted, I cannot accept that if we had a pure capitalistic system it would look like the world of the Godfather.  A free market means that I am free to choose to buy or not to buy, hence the word "free."  A free market does not force or even threaten the use of force to get people to buy or not buy.  If there is such a threat, then we have a system other than that of a free market.  Making an offer one cannot refuse in a free market means a really good price, not the threat of being shot in the head.


A system that threatens or uses force to get its way is the opposite of the market.  Such a system is really the system of government.  Government cannot do anything without taking from someone first.  The government must take before it can do.  The only way it can take is through the use or threat of force.  So when we watch the Godfather movies do not think that this is a movie about capitalism.  If anything, they are movies about power and coercion. It is the use of power and coercion that is more closely connected to the actions of the state than to any market.

Competition vs. Conflict

Last week President Obama said that we do not live in autarky.  In other words, one person did not build a business, he had help.  Well, duh!  No one argues that we should each live in solitude, not even the more ardent Randian Objectivist.  


So what is he really getting at?  He is trying to emphasize that communities need to work together.  Fine.  However, his emphasis is on the public sector's "contribution" to society.  Here are a few thoughts on this...


First, before government can make any contribution to society, it must first take from society.  Just because the public sector has spent money on an area, e.g., roads, schools, etc., it does not mean that such things would not be produced if the private sector was left alone.  In deed, the public sector tends to crowd out the private sector whenever it does anything.  Additionally, the public sector is unable to determine whether it is spending money efficiently and thus is always more wasteful of resources than the private sector.


Secondly, autarky may be a starting point for economic theorizing, but it does not mean that we stay there.  Austrians almost always start with the assumption of a lone individual on an island when developing theories of capital and interest.  However, one of the most important insights of all of economics is the Law of Comparative Advantage, which Mises takes to the level of the individual and calls it the Law of Association.  It says that when we specialize and trade, we are made better off.


Finally, many on the left simply do not understand how a free society works.  At the center of the economic system all they see is one person trying to out-compete all rivals--doing whatever it takes to get resources for that dollar of profit.  This conception of the market economy is a skewed envisioning by Marx and the left.  


While there is competition, to be sure, the market cannot operate at odds with itself.  The market is less about competition than it is about harmony.  Consumers have preferences that are subjective and unknown to the producers of goods and services.  Manufacturers have resources and plans to make goods, but do not know which goods to make and in what quantity or quality.  The problem that faces every society is to convert the resources into  goods and services, but not just random goods and services.  They need to make items that satisfy the most intense wants and desires first, and then work down the consumers' preference list.  The market coordinates the conversion of these resources through the use of the price system.  The result is a harmony of action.  Different firms, through trial-and-error, through profit and loss, through competition discover the best combination of resource blends.  The result is that more people are served with less waste than any other system ever.


The reason why the left, Marxists in particular, focus on the single aspect of competition is that they view the world through the lens of conflict.  Marxism is born from Hegelianism.  Hegel saw the world in terms on conflict.  There is a thesis, which is today's mainstream.  Through time, a reaction builds in opposition to it, the antithesis.  A conflict eventually ensues and a synthesis emerges.  For Marx, the Monarchy was the thesis and the exploited were the antithesis.  The result that emerged from the French and American revolutions were the rise of Capitalism.  Capitalism is the new thesis, in which the proletariat will rise up against the bourgeoisie.  The result of this conflict will be Communism.  To the Marxists, the totality of history is conflict, so why should the internal workings of a free society be any different?


What a horrid way to look at the world--conflict, fighting and death!  A vision of a free society is one of liberty and one of individual responsibility.  In this vision, I need you and rely on you so that I can better myself.  When I trade with you, we are not in conflict, we are mutually helping each other.  We are both made better off by the trade.  A free society is the furthest thing from autarky.  If, in college, our President read Bastiat instead of Marx,  I doubt he would be able to make such foolish statements.

The Purpose of Corporations II

Every once in a while I get a comment that can be used as a teaching tool. Here is a comment I received on my post on “The Purpose of Corporations.” It may be crossing the line of proper etiquette, but I could not help myself. I have basically gone line-by-line examining the comment. The comment is in red and my responses are below them.




I can't believe a supposed doctor wrote this.

Starting an anonymous response with an attack like this is always a sign of class.



It's so woefully shortsighted and is pretty much everything wrong about the modern economy.

Then I hope that you clearly explain how shortsightedness creates an error that encompasses the whole of the modern economy.



Is the system working as you describe right now? A resounding NO!

Actually, I agree that the current system is not working as I described it. I described how a system would work in a free market. We do not live in a free market. We live in a world permeated with government rules and regulations that tip the scales in favor of some at the expense of others. I am very much in favor in getting rid of the government’s ability to intervene in the economy. Please join me in rejecting crony capitalism and crony socialism. No more bail-outs for businesses. And no bail-outs for students either.



Profits are being made with no real resource being managed.

What does this mean? Why is a real resource needed to gain a profit? The problem with this point is the word “real,” meaning that there is a dividing line between the tangible and intangible, where only the tangible matters. This idea of an objective value is simple-minded. Providing information can be a very profitable business. Education might be considered to be a business in which no real resource is being managed, so does this mean that there are no gains to education? (Remember: Profits are the surplus of the gains over opportunity costs.)



It's profit being made off of profit itself, leeching away the value of real labor resources from the working classes. That's the problem!

The idea that value comes from the labor of the working classes is clearly a labor theory of value reference. While this theory has been smashed time and again, it keeps coming back in different incarnations--like a bad zombie film. Value does not stem from any class nor does it stem from the time or effort of the labor involved. To say otherwise is to say that the amount of time working is directly related with value or the amount of effort has a direct relationship with value. (“Directly related” in this sense means the opposite of “inversely related.”) In other words, my anonymous friend is saying that the longer one works, the more valuable the output. A watch that has 1,000 labor hours is twice as valuable as a watch made with 500 labor hours. Or “he” is saying that a watch made with twice the effort is twice as valuable as another watch.

Of course, both of these propositions are ridiculous. My students earn their grade based upon the correctness of the answer and nothing else. If one student studies twice as long or works twice as hard has no bearing on the grade received. All that matters is what is put on the answer sheet. The same is true when it comes to goods and services. It does not matter if one producer worked twice as long or twice as hard as another. All that matters is the judgment of the consumer. The value of the good is a product of the consumer’s mind and nothing else. If the consumer values the good at $5, then he will be willing to pay up to $5 for it. If the consumer values the good at $0, then the amount of time and effort of the producer is irrelevant. It is all wasted.



Prices do not simply function as pieces of information, they are extremely powerful implements of social control.

“Implements of social control?” In a sense, yes of course they are. They signal to any one who wishes to use a resource its relative scarcity. It allows the user to calculate the opportunity cost of using that resource. When the price rises, it tells the users of such resources that the resource in question is more scarce. It gets users of the resource to reduce their use, conserve. The least important uses of the resource are dispensed with first. It gets users to look for substitutes. It is in this sense that prices “control” society. But in saying this it is no more control than a red stop light saying, “Stop.” If the entrepreneur ignores the price signals, he will be out of business. If I ignore the red stop light, I will likely get into a car accident.

If fact, prices are such important signals that without them very little economic calculation could be done. Society could not exist without prices. Indeed, prices are what allow societies to exist. So I suppose that in this sense, there could be no “social” to control without prices.



Who is the consumer in a stock transaction?

The buyer of the share of stock.



The answer today is really no one, there is no person deriving use from a good that is sold. The primary "use" of stocks today is as placeholders of value -- their prices.

The owner of the share derives a dividend, a portion of the profit generated by the company serving its customers. The cash flow, the dividend, is the benefit of the stock and is the reason for its ownership. The cash flow is the return on the money saved. The money saved was invested into the company. The company combines resources to serve customers. The extent to which people trade with the company is a reflection of how well it is combining resources to meet consumers’ needs, wants and desires. And not just random or trivial needs, wants and desires, but the most intense needs, wants and desires first. The value of the company is reflected in the stock, the equity. Call it a “placeholder” if you want, it does not change its nature as the reflection of how well a specific group of people are pleasing customers.



How then does a "good" get priced when its value is its price? The answer is that it cannot be priced in any way that is beneficial to an economy, by any system that makes any sense.



Again this is naïve. Here is a quick lesson in Corporate Finance…. A firm looks into the future and must project what it will do to combine resources to meet future needs, wants and desires of its customers. It creates a pro forma statement. It looks at the projected revenues and the projected costs. It creates a projection of cash flows occurring in future periods. Then it uses its opportunity cost, the Weighted Average Cost of Capital (WACC) to discount all of those future cash flows to the present. Then it subtracts the upfront costs of the endeavor. This process yields a Net Present Value (NPV) of the project. If the NPV is positive, the endeavor should be undertaken. If the NPV is negative, the firm looks for something else. The greater the NPV, the more valuable is the company’s endeavor. As the company announces its future plans, the eyes of the world evaluate the firm’s decision. If they agree that this project adds value (or more precisely will add value) to the firm, then this increase in value is reflected in the share price of the firm. Bad decisions (in the eyes of the market) lower the price of the company. The benefit of these capital markets is merely the efficient allocation scarce resources to good decision makers and away from bad decision makers. Without profit and loss, without economic calculation, without the ability to value projects and companies, there is no ability to efficiently allocate scarce resources. The opposite of the stock market is evaluating which is a better user of resources: the DMV, the Post Office, or the Judicial System? There is no method to know. But I can easily tell you which for-profit company is a better user of resources. And I can do it at a glance. We can’t even come close with bureaucracies.



This is how the global financial system has essentially turned into a gigantic casino game. And that is not good at ALL.

The idea that the financial world is the same as a casino game is an argument by analogy and wrong on its face. There is no house. When I win a chip, someone must lose a chip. It’s all just random luck based upon probabilities. Apple Inc. was not random chance. Successful corporations are not just random luck based upon probabilities. Creating a successful company is hard work and long hours. It is being “others focused.”


You have to know what will please your customers and then constantly strive to please them. And customers are fickle. They don’t tell that they are coming to your store in advance. They just show up and you have to be ready. They don’t tell you what they are looking for, but you had better have it on your shelves. They don’t tell you what they think is a good price, but if you don’t meet their price, they walk out without a word. Running a business is hard. Being successful is harder. Going global, that’s mindboggling!


And yet, we take it for granted. I expect to walk into a Walmart at 2am in the middle of rural North Carolina and buy Kiwi 3/$1! How insane is that? We need to take the time and marvel at this economic system, which has built the highest standard of living ever known in the last 5,000 years of recorded human history. Before we tear it down and decry the free market and the role of corporations, we had better take a very close look at what it is that we intend to do away with. I absolutely know that if we tear down the market economy, we sentence ourselves to a life of future poverty. I cannot and will not sentence my children to that fate.

Failure is a Necessary Option

An often repeated and overused phrase is, "Failure is not an option."  How ridiculous!  In fact, the reverse is not only true, but it is a necessity.

One major problem with the public school system is that failing schools do not close.  In fact, a failing school usually gets more funding the next year in order to "turn it around."  Ask yourself if this policy really makes long-term sense.  What sort of incentives are being created when failing schools are given expanded budgets?  An axiom in economics is that people respond to incentives.  If we pay people more for failing schools is it any wonder that we get failing schools?

In the private sector, the customer is sovereign.  The customer chooses what to buy (or not buy) and no one can force such a decision on another.  An entrepreneur who is able to please his customers receives continued business as his reward.  Hopefully, with proper management, profits also accrue to the entrepreneur.  However, if the company does not please the customer, regardless of reason, the business suffers.  Maybe there was rudeness, maybe the product was shoddy, or maybe the price was too high, the reason doesn't matter because the end result is the same: the loss of business.  When the customer is not pleased with the entrepreneur, he takes his business elsewhere.  The entrepreneur had better shape up quickly or the venture will close its doors and the resources will be transferred to others who are better at satisfying customers. 

The continuous process of pleasing customers continually shifts resources to those who are the most efficient users and most effective satisfiers.  This phenomenon is relatively new; it has only been around for the last couple of hundred years.  During this short period of history, we have achieved higher living standards for more people than at any other point in recorded human history.

When we step away from the market and into the world of public provision of goods and services, we see that it operates by a whole different set of rules.  In the public sector, the government collects the revenue to operate the institution.  However, it can't simply hand someone billions of dollars and say, "Go educate some kids."  Along with the dollars come the rules and regulations.  These reorient the focus of the employees and managers away from "customer" and toward the rulebook.  Additionally the same system strips away all vestiges of competition between providers of education.  The children are assigned schools; the parents are not allowed to choose.  Imagine if such were the case with phone and Internet providers.  (Actually I can imagine it, because it was the law of the land for decades.  What was the result?  Poor quality, high costs, lack of convenience, ugly phones, and attaching an answering machine was considered illegal because it was "installing a foreign device.")

Our public education problems are far too complex to simply say that the answer is competition between our schools, but don't discount that simple phrase too quickly.  Imagine the impact the following three changes would have on our public schools:

1. allow parents to choose which school to send their child to;
2. attach the dollars to the child so that a school's budget is based upon the number of students that enroll at their location; and
3. allow schools that cannot cover its costs to close and be sold.

Such a proposal will cause the teachers' and administrators' unions to howl, but I am not concerned with protecting their jobs any more than I am concerned about protecting McDonald's workers' jobs when I go to Burger King.  In fact, our university system has this feature and it seems that we have a large and diverse set of higher educational institutions.

Competition will weed out the bad teachers and they should lose their jobs.  Competition will weed out the bad administrators and they should lose their jobs.  Competition will weed out the unnecessary overhead and reward quality.  It will reward good schools, good teachers and good administrators.  

Many think that competition is scary because some producers are winners and some are losers.  Unfortunately, too many people think this way.  I say "unfortunately," because this thinking is backwards.  There is too much focus on the providers and too little attention paid to the customers, the children.  When there is competition, the customers are the big winners.  And, paradoxically, the only way that we can guarantee a successful school system is if we make failure not only an option, but a necessity.

Moore Nonsense on Taking and Giving

To start the new year, I have been receiving free movie channels through a promotion.  On one of them, Michael Moore's movie, "Capitalism: A Love Story" came on.  Since there is no way that I'd ever pay to watch one of his movies, free was about the right price.  I soon discovered that even free was too much.

Either the first or second sentence out of Moore's mouth was this, "[Capitalism] is a system of taking and giving."  It is mind-numbing how completely wrong this is.  Capitalism, or rather the free market, is a system of giving and giving.

Suppose you go to the store because you want to buy a snack for a dollar.  In order for you to give up the dollar, which do you have to value more: the snack or the dollar?  The answer is the snack.  In order for a trade to occur, what does the guy behind the counter have to value more: the snack or the dollar?  His answer has to be the dollar.  If both sides of the exchange value the dollar more, there would be no trade.  Also if both sides value the snack more, again there would be no trade.  We trade because each side values what they gain more than what they are giving.  Trade requires unequal valuations.  Since value is in the eye of the beholder, meeting this requirement is not difficult.

When we trade both sides say, "Thank You" because both sides are giving and benefiting. 

A system where one side gives while the other side takes also has a name: it is called stealing.  It is a system where one side has no choice in the matter while the other side has all the power.  An example of this relationship is the one between the individual and the state.  The individual must give whenever the state decides to take.  Try not paying your taxes and see what happens. 

The relationship of giving and taking is between unequal parties.  The relationship between giving and giving is necessarily between equals, since both sides can walk away from the trade at any time.  The ability to refuse and say, "No" is the most fundamental power that an individual has in expressing one's individuality.

In his movie, it's clear that Michael Moore thinks that we were harmed by the national bail-outs of the large banks and corporations.  I completely agree that this was a disgrace and that it never should have happened.  These banks and corporations should have been left to fail.  However, the bail-outs weren't market phenomena, rather they were the actions of the state repeatedly intervening in the economy.  The government took tax money and gave it to these institutions. 

Furthermore, the underlying cause of the economic crisis wasn't too little government, it was that there was too much.  The free market has a system of natural checks and balances that prevent massive business cycles.  It is when the government disrupts this system, that bubbles form and burst.  Those that cannot see the past the immediate and are unable to look at deeper causes blame "capitalism" in a knee-jerk reaction. 

Michael Moore's movie was just that—a classic case of haphazard economics and laziness.  He could learn much from Henry Hazlitt's single lesson:

[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence.  The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

The Real Thanksgiving Story

The first Thanksgiving is not a story of dumb whites who came to the New World to conquer and spread disease amongst the idyllic, nature-loving natives.

It is, instead, a story of the triumph of Capitalism over Socialism.

There have been several retellings of the first Thanksgiving, I have linked to Richard Ebeling's recounting last year.  Thomas DiLorenzo writes an excellent account in the third chapter of his book, How Capitalism Saved America.

This year I found a nice YouTube version that does a good job.  It explains why private property rights saved the pilgrims and triumphed over the collectivist ideal.

I find Thanksgiving to be one of the best holidays for exactly that reason.




Since the posting of this video, I have found Reason.TV's version.  Very funny.

Austrian Economics Forum Fall 2010 #5—MegaPost

Socialism is a failure, but why does it keep coming back? That’s the perennial question. In the latest Austrian Economics readings Group forum at NC State University, we discussed the final Hayek readings on socialism. In particular, "Socialist Calculation II: The State of the Debate (1935)" and "Socialist Calculation III: The Competitive 'Solution.'" These are chapters 8 and 9 in Individualism and Economic Order.

To Hayek, the problem that faces an economic system is one of coordination. How do individuals coordinate their actions with one another without the guidance of a central planner? And if there is a central planner, then will that system be able to incorporate all of the information necessary to not waste resources while satisfying the most intense wants and desires of the consumers? Will the people who live under a central planner still be able to choose their own consumer goods, or will goods just be rationed to them? Will workers get to choose where they work or will they simply be assigned their station in life?

Hayek begins by pointing out that the Russian experiment is a failure. The people are more impoverished than under the Czarist régime. Turning to the theoretical side of the debate, Hayek focuses on the mathematical approach to solving the production and distribution questions. In order to calculate the correct solution, the knowledge of opportunity costs is needed. More than mere “technical” knowledge is needed to run an economy. Just because we know how to build something does not answer the question of should it be built at all.

Furthermore, there is a need for the knowledge of consumer goods. Consumers’ tastes and preferences are continuously changing and the central planner, to be successful, will need some sort of feedback mechanism to incorporate the changes. Bureaucracies move too slowly to accomplish this task. The bottom line of this analysis is that the market processes the information that the central planners cannot. In order to achieve some sort of solution, consumer sovereignty has to be sacrificed. Consumers no longer can choose what they prefer; must simply take whatever goods and services that are placed before them.

In the conclusion, Hayek seems to have left the door open to the possibility of a workable socialist solution. Hayek states,

“that today we are not yet intellectually equipped to improve the working of our economic system by ‘planning’ or to solve the problem of socialist production in any other way without very considerably impairing productivity. What is lacking is not ‘experience’ but intellectual mastery of a problem which so far we have learned only to formulate but not to answer. No one would want to exclude every possibility that a solution may yet be found. But in our present state of knowledge serious doubt must remain whether such a solution can be found.”

I argued that unlike Mises, Hayek is leaving the door open. Cordato said that he thought the Hayek was being gracious towards his academic colleagues. While this may very well be the case, this is not how the debate progressed in the 1940s. The chief rivals to the Austrian challenge, like Lange, thought that Hayek was retreating from Mises’ position that socialism is impossible, even on paper.

It was at this point in our discussion that I read from an article that was published in 1948. The article, “Socialist Economics” was published by the American Economic Association in a collection of papers entitled, A Survey of Contemporary Economics. The article was written by Abram Berson, at that time he was a professor at Columbia University and earned a Ph.D. from Harvard. So his interpretation of the debate is not some fringe interpretation, it was, basically, the mainstream of the time. Furthermore, Bergson cites, not just the two articles that we read for the readings group, but he also cites “The Use of Knowledge in Society,” and Schumpeter and Mises as well.

Here is what Bergson says,

“To come finally to Mises, there are two questions to ask: What does he say and what does he mean?

“On the first question, let Mises speak for himself:”

Then there is a lengthy quote from Mises on how without private property there can be no market and no prices and then no economic calculation. Mises concludes, “Exchange relations between production goods can only be established on the basis of private ownership of the means of production.”

[back to Bergson]

“As to what Mises means, there appear to be two views. According to that which seems to have gained the wider currency, Mises’ contention is that without private ownership of, or…a free market for, the means of production, the rational evaluation of these goods for the purposes of calculating costs is ruled out conceptually. With it goes any rational economic calculation. To put the matter somewhat more sharply than is customary, let us imagine a Board of Supermen, with unlimited logical faculties, with a complete scale of values for the different consumers’ goods and present and future consumption, and detailed knowledge of production techniques. Even such a Board would be unable to evaluate rationally the means of production. In the absence of a free market for these goods, decisions on resource allocation in Mises’ view necessarily would be on a haphazard basis.

“Interpreted in this way, the argument is easily disposed of. Lange and Schumpeter, who favor this interpretation of Mises, point out correctly that the theory is refuted completely by the work of Pareto and Barone. …

“According to the other interpretation of Mises, which has the authority of Hayek, the contention is not that rational calculation if logically inconceivable under socialism but that there is no practicable way of realizing it. Imputation is theoretically possible; but, once private ownership of the means of production has been liquidated, it cannot be accomplished in practice.

“Hayek’s own thinking and that of Robbins, seems to be along these lines. Lange, who interprets the views of Hayek and Robbins as being in reality a retreat from the original position of Mises, considers that his own analysis refutes their argument…”

In the second reading, Hayek argues that it is the Socialists who have changed their arguments. And it is he who is chasing after them. Hayek states, “[I]t is surely unfair to say, as Lange does, that the critics, because they deal in a new way with the new schemes evolved to meet the original criticism, ‘have given up the essential point’ and ‘retreated to a second line of defense.’ Is this not rather a case of covering up their own retreat by creating confusion about the issue?”

So each side accuses the other of retreating and shifting the debate because of the other side’s inability to respond to the criticism. Personally, I am less interested in who shifted first. What does interest me is the shift in the debate. I agree with the first Bergson interpretation of Mises that under Mises’ analysis, socialism is unworkable, even on paper. I think that Mises’ argument that grounds itself on the fundamental foundation of socialism—communal property—is the stronger argument, because it attacks the very core of socialism. There is simply no getting around it. Either there is private property and a market that guides production or there is a central planner who controls it all.

I find it amazing that Bergson so easily dismisses the first interpretation of Mises. Bergson, Lange, Taylor, etc, all say that Mises was answer by Pareto and Barone. However, in the second reading, Hayek cites Pareto and shows that Pareto “expressly denied” the mathematical solution. Bergson obviously read this article and makes no attempt to address this point. Why?!?

I liked the second article more than several other people in the group. In section 5 of the article, we can clearly see the famous phrase “the circumstances of time and place” appear before the “Use of Knowledge” article. We also see an early sketch of the “man on the spot” concept a few paragraphs later.

One last point in the article that needs attention comes at the end of section 6. Hayek points out that under central planning there will be no improvements made. He states, “Any improvement, any adjustment, of the technique of production to changed conditions will be dependent on somebody’s capacity of convincing the SEC (Supreme Economic Council) that the commodity in question can be produced cheaper and that therefore the price ought to be lowered. Since the man with the new idea will have no possibility of establishing himself by undercutting, the new idea cannot be proved by experiment until he has convinced the SEC that his way of producing the thing is cheaper. Or, in other words, every calculation by an outsider who believes that he can do better will have to be examined and approved by the authority, which in this connection will have to take over all the functions of the entrepreneur.”

Innovation and creation will die under central planning. There is no incentive for the bureaucrat to take a risk. Bureaucrats, are by their nature, the opposite of risk-takers. They are the opposite of entrepreneurs.

For more on this debate, I found an article written by Murray Rothbard. It is found here:
http://www.lewrockwell.com/rothbard/rothbard132.html

Investing Social Security Funds arises from the Dead (Just in time for Halloween?)

Today I was listening to the radio and a story came up stating that Andy Stern, former President of SEIU (the state employees union), suggested that in order to keep Social Security solvent, a portion should be "invested" into the stock market.  So I looked for the story and sure enough it is found on the Huffington Post here.  (Okay the article is from the end of June, but I heard it today, hence the Halloween reference.)

As mentioned in the article, this idea was once proposed in the Clinton Administration.  This idea was bad then and it is bad now.  Fortunately in May 1999, I wrote an article on the dangers of "investing" Social Security funds into the stock market.  That article, "A Socialist Stock Market?" is found here.

Here are a few paragraphs...

Murray Rothbard once asked Ludwig von Mises at what point on the spectrum of statism can a country be designated as "socialist." To his surprise, Mises said that there was, indeed, a clear-cut delineation: the stock market.

Mises said, "A stock market is crucial to the existence of capitalism and private property. For it means that there is a functioning market in the exchange of private titles to the means of production. There can be no genuine private ownership of capital without a stock market: there can be no true socialism if such a market is allowed to exist."

A corollary to this idea is that if the government is allowed to "invest" in the stock market, then the economy can no longer be called market-based. President Clinton has proposed a plan to use up to one-fourth of new Social Security funds to buy shares in our stock markets. The danger of this plan may not be as obvious as his previous health-care plan, but they are just as serious. The justification for this argument is that the Social Security system is unstable and will face financial strains in about 2014 and will be exhausted by 2032. There are a few options that the Washington elite have deemed as "solutions." Most of these ideas are politically unpalatable. The first is an increase in taxes. Over time, the needs of the Social Security fund will be so high that it will stifle the entire economy. There have been some projections showing FICA taxes as high as 82 percent in forty years.

The second option is to reduce the "benefits" being paid out by the fund. This action is also politically unacceptable. The third alternative is to somehow increase the rate of return on the current surpluses to cover the future. The thinking in the Clinton administration is simplistic at best. The plan assumes (wagers) that the stock market will continue to increase (forever) at rates high enough to meet the projected needs.

The fundamental problem that the Clinton administration ignores is that the Social Security program is based on what is called a Ponzi Game or a pyramid scheme. You have probably seen this if you've ever received a chain letter that states, "Send money to the first five people on the list, remove the first person's name, and place yours at the bottom." In other words, the first people in the program (those at the top of the pyramid) are currently getting money from the new people enrolling (those who are at the lower stages of the pyramid).

Social Security works in the same way. Those who are retired are receiving money from those who are currently working. As long as the base of the pyramid is expanding at a geometric rate, the system will continue to function. However, U.S. demographics show that after the baby-boom generation, the base of the pyramid shrinks. It is mathematically impossible to continue the Social Security program indefinitely.

The best solution is to phase out the Social Security program by taking two steps.

The rest of the article is found here: http://mises.org/freemarket_detail.aspx?control=27.