Economics Dr. Madsen Pirie Economics Dr. Madsen Pirie

Economic Nonsense: 50. Capitalism is unstable, subject to periodic crises, and should be replaced

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Capitalism is not a fixed thing, but rather a process which develops and changes in response to changing conditions, and especially changing technology.  To say it is unstable is basically to say that it changes.  It is not by its nature stable.  The capitalism of the 21st century is very different from that which prevailed at the beginning of the 19th century.  It evolves as circumstances change, adapting itself to cope with the new realities that present themselves.

It is certainly subject to periodic crises.  The business cycle has long characterized it, with economists divided as to its ultimate causes.  Periods of growth are followed by periods of a sluggish or even contracting economy, with some observers suggesting that this is a good thing, helping to weed out underperforming businesses and redirect their capital to newer and more successful ones.

Over and above this cyclical behaviour, there are occasional crises that seem to threaten the whole basis of the capitalist economy.  The Great Depression was one such period, and the 2008 recession was another.  Critics look for some alternative that lacks these wild and damaging fluctuations.  No-one has yet produced a better system.  For all its flaws, capitalism is the best way humans have found to generate wealth and to allocate resources.  Even including its great crises, it has still produced steady average growth in developed economies for the best part of two centuries.  In less developed economies it has recently produced growth and wealth on an unprecedented scale.

Capitalism learns from these crises.  It adjusts itself.  Governments learn from the mistakes that led to them, and devise new rules to prevent the same happening again.  Capitalism develops and adjusts, renewing itself each time.

When the 2008 crisis came, critics prematurely celebrated capitalism's decline and wondered what might follow it.  The answer was capitalism, modified to prevent countries repeating the mistakes of the past.  It is certainly imperfect.  Most institutions made by humans are subject to the frailty and imperfection of humanity.  But they can improve by learning from their mistakes and adapting, and this is what capitalism does and why it endures.

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Economic Nonsense: 49. Government was wrong to use austerity to deal with the 2008 financial crisis

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Gordon Brown as Chancellor and Prime Minister spent money profusely, believing that he could spend the British people's money more appropriately than they could spend it themselves, and by a political desire to have a large section of the populace on state largesse and thus supportive of a party that promised big spending.  The result was to make the UK hugely indebted, with an annual deficit that required borrowing to sustain that spending and increase the debt year by year.

The coalition government that followed him took action to reduce the deficit by a reduction in government spending.  This was the so-called 'austerity' package, although some critics claimed it was more talk than substance, with reductions in the increase in the debt, rather than in the debt itself.

Crucially, though, the policy was not only one of austerity.  It was accompanied by quantitative easing (QE), or increasing the money supply to reduce the more baneful effects of austerity.  Latterday Keynesians claim that government should have increased its spending to stimulate demand instead of decreasing it to tackle the deficit.  Their critics in turn suggest that it is not demand by government that sustains real economic growth, but investment by businesses in anticipation of future private demand.

The United States followed a similar policy of reduced spending combined with QE, whereas the eurozone countries led by a cautious Germany did not.  They imposed austerity on the over-extended countries of Southern Europe, but without the QE used in the UK and the US.

Britain and America experienced significant economic growth after a few flat years, whereas the eurozone countries did not.  Anti-austerity campaigners have suggested that the recovery is weak, perhaps "not even real," but the evidence does not support this.  The empirical result suggests that the combination of austerity and quantitative easing has worked, but that the eurozone policy did not.  Significantly, the QE countries did not suffer the big rise in inflation which some critics predicted.  In 2015, the eurozone countries announced their own quantitative easing, some 7 years after the UK and US did so.

The conclusion has to be that government was right to use austerity and quantitative easing to deal with the crisis.  They did not repeat the mistakes that turned a recession into the Great Depression of the 1930s.

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Economic Nonsense: 48. Labour Unions are essential to improve wages and conditions for workers

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It is actually improved productivity, not labour unions, that has improved the rewards of labour.  People earned less money in former times because productivity was low.  People were paid according to the worth of their input into the production process.  When each worker contributed little, they were low paid.  As technology and production methods improved, so did the worth of each worker's input, and wages increased accordingly.

Employers compete for labour to produce goods and services and to make profits.  They have to pay wages that attract enough workers, and compete with other employers to do so.  It is true that unions can use coercive methods to impose higher costs on employers, but this limits total employment in those sectors, and thus opportunities for employment to non-unionized labour.  The US auto industry features somewhat higher wages in unionized car plants, but there are far fewer of them than there are non-union plants.

Although it is improved productivity that brings higher wages, the effect of unions is often to lower productivity through restrictive work agreements that spread work out among more employees.  More employees equals more members paying union dues.

In post war Britain, one group that received among the highest reward increases was the completely non-unionized sector of people who clean homes – the ones who used to be called char-ladies.  The demand for their services from businessmen and women who did not have the time to do it themselves, coupled with declining numbers available to do it, led to huge pay increases.

The fundamental truth is that unions do not increase pay for workers generally.  They can increase pay for their own members, but at the expense of non-members rather than at the expense of employers.  Declining union membership in both the UK and the US has been the result in changes in the type of work being done.  Mass manufacturing has become more automated, meaning higher wages for fewer workers, leaving others to seek non-unionized work elsewhere.  Some goods once produced domestically are now bought more cheaply from countries with non-unionized workforces.  The result is fewer union jobs.  In the UK unionization has increasingly become a feature of public sector workers rather than private industry.

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Economic Nonsense: 47. The state should pay for university education because it benefits society

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University education benefits society in several ways.  A skilled, university-educated workforce can boost economic growth and make society richer than it would have been without them.  Less well-off and less well-educated people benefit from this, just as a rising tide lifts all boats.

The experience of going through university generally produces people who are not only educated in their chosen subjects, but who have been exposed to more cultural influences in the process.  Many people would think a society to be a better one if it contained significant numbers of educated and cultured people.  It provides more opportunities for intellectual stimulation and self-development.

All of this is true to some degree, and benefits society as a whole, but there is little doubt that by far the greatest value of a university education accrues to the person who undertakes it.  There is firstly the personal fulfilment that comes from attaining more of one's potential, but there are more material rewards as well.

Possession of a university degree in the UK increases one's employability.  For those in the workforce, aged 18-65, employment among graduates is 87%, as opposed to 70% for non-graduates.  Median salary is higher, too, with graduates on average earning £9,000 more per year than their non-graduate counterparts.  Over a working life this could top £400,000 of extra salary attributable to the degree.  

This constitutes an overwhelming advantage accruing to the individual who undertakes a university degree.  While there are undoubted benefits to society, those gained by the individual are high and measurable.  They make the loans undertaken to finance university, perhaps £36,000 for a 3-year degree, a very good investment indeed.

When people suggest the state should pay for this, they mean taxpayers should.  It seems strange that a person not equipped to benefit from university, someone who leaves school at 16 to become a bricklayer, for example, should be called upon to pay higher taxes so that someone else, already endowed with more academic and intellectual ability, should benefit from what amounts to a ticket to a higher salary for life.  

Some would call this unfair, and suggest that those who gain the most from university education should finance most of its costs.

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Economic Nonsense: 46. Profit is a sign of exploitation

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No.  Profit is the reward for investment.  An investor defers gratification and uses their money instead to try to make more money later.  Profit is the compensation he or she receives for doing this.  Part of it takes account of risk, the risk that the investment might not pay off or that the investor might lose the money they put up.  Part of the profit is reward for taking that risk.

The notion of profit as exploitation derives from a mistake made by Karl Marx.  He supposed that value resides in objects, rather than in the mind of the beholder.  Because he thought it resides in objects, he asked how it got there, and answered that value represents the labour it takes to make something.  A price charged above the value of that labour represents "surplus value," and is exploiting the workers who make the object.  Hence comes the notion of profit as exploitation.

In fact people value things differently, which is why they trade.  An object's value to me might represent the other uses I might have made of the money, had I not expended it in producing the object.  If someone values it more than that they will pay a price that includes a profit for me.  Far from being a sign of exploitation, profit serves a valuable human purpose in motivating people to produce goods and services that are of value to their fellow human beings.  It directs us to serve the needs of others in seeking a return for ourselves.  The butcher, the brewer and the baker might seek their own reward in terms of the profit they make, but in doing so they provide others with meat, ale and bread.

Profit is legitimate, and sends signals to others.  If some areas of production show high profits, others are motivated to enter that field themselves and bring extra production onto the market.  The competition with other producers will generally act to restrain or reduce the high profits.

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Economic Nonsense: 45. Unbridled capitalism brought about the Great Depression

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In the popular account the stock market went wild in the late 1920s, with people gambling recklessly on stocks and shares, often with money they didn't have.  Shares could only go up, they thought, but they were wrong.  The market crashed, people went broke, investors jumped off high buildings, and without investment GDP plunged and the Great Depression came about.  If it were true it might be a major indictment of unbridled capitalism, but it isn't.

People did overstretch recklessly, assuming the market could only rise, helped by easy money from the Federal Reserve Bank, and the Great Crash came in 1929.  It wiped out many investors, but it did not lead to the Great Depression.  That came later as a direct result of bad policy decisions.  Had those decisions not been made, the stock market crash might have instigated a cyclical downturn and corrected itself after a year or two.

The Federal Reserve Bank, observing that people had bought shares with easy credit, decided to tighten credit and restrict the money supply.  This is what you do not do in a recession, when struggling companies need credit to keep going and companies that see opportunities ahead need money to invest in expansion.  It was a disastrous mistake.

The folly was compounded by protectionist policies.  The Smoot-Hawley Tariff of 1930 shut out most foreign goods to boost home-produced goods in the name of protecting American jobs.  Its effect was catastrophic.  It sparked a beggar my neighbour trade war as other countries responded with tit-for-tat measures.  Unable to sell goods in America, they stopped buying American goods.  International trade plunged and much of the world sank into recession. 

There were other contributing factors.  Banking regulation had been clumsy and restrictive, and left American banks unable to play their part in promoting investment and expansion.  Income taxes were massively hiked in 1932, just when tax cuts could have helped.

Unbridled capitalism did not cause the Great Depression, incompetent government did.  It is another piece of economic nonsense that President Roosevelt's New Deal government activism helped America's recovery from the Great Depression.  It didn't.

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Economic Nonsense: 44. Big business thrives on poor country sweatshops and child labour

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In undeveloped countries people struggle to survive in agricultural economies.  Life is characterized by dawn to dusk heavy labour, even for children, and the rewards are meagre.  Diet is poor and the risk of starvation or at least malnourishment is prevalent.  

In the early years of Britain's industrial revolution, conditions were poor.  Workers toiled for long hours amid safety standards that were often low.  There were sweatshops, and children worked in factories and mines.  This represented an early stage in economic development.  It was a considerable step up from life on farms, where conditions had been worse.  As capital grew, so did the machines that increased productivity and enabled labour conditions to be improved, and for women to leave sweatshops and children to leave the labour force.  It was wealth that made this possible.

Today in developing economies things are made cheaply in crowded working conditions with safety standards considerably below those in the developed world.  Although most countries have rules against it, there are undoubtedly children at work in several of them.  This, too, represents an improvement on the conditions found in the countryside.  The wages paid in sweatshops, well below those in the West, are far above those afforded by the agrarian economy.  Sweatshop workers enjoy higher living standards than their counterparts outside, and put their families' and relatives' names on the waiting list for any vacancies that occur.

This is not "big business" grinding the poor.  It represents a country's labour force reaching up to improve its lot by earning wages not possible elsewhere.  Globalization has made this possible, bringing many of the world's poorest people into the world market.  The goods made cheaply in poorer countries sell to richer ones, providing an inflow of cash to boost the poor country's economy.  This is how China and India have achieved growth rates that have lifted over a billion people out of dire poverty.

As the UK became richer, it was able to improve working conditions and pay, and to eliminate sweatshops and child labour.  The same will be true of today's developing countries.  Many of them are already doing so.  The faster they become wealthy, the sooner this will happen.  The way to speed it up is for rich countries to open their markets and buy as much as they can from poorer ones.

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Economic Nonsense: 43. Private enterprise cannot generate public goods such as lighthouses

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In fact private enterprise supplies many public goods, although few commentators think they should provide all public goods.  Lighthouses are often cited as an example of essential services that only the state can provide, but the Nobel laureate Ronald Coase showed that many lighthouses were indeed built and operated by private enterprise.

They had their origin in the hilltop fires that were lit near ports to guide incoming ships.  These eventually evolved through wooden or stone towers into their modern form with steady improvement in their illumination.  They were financed by contributions from nearby ports, which incorporated the costs into landing fees charged on boats entering the harbour.  The state's role was to allow operators to levy such charges, in order to counter free riders who might seek to benefit from the lighthouse without contributing to its upkeep.  When the state took over their maintenance and operation, it was not because they were failing, but to standardize the charges which were then subject to wide local variations. 

Britain's Royal National Lifeboat Institution (RNLI) is an example of an independent public service supported by voluntary contributions rather than out of taxation.  For a few years in the 19th century the RNLI did take government money, but found its private contributions dropped off by more than it received in tax support, so it reverted to voluntary finance, which it maintains to this day.  Because contributions are voluntary, there are undoubtedly freeloaders who benefit without contributing, but there are enough public-spirited people to sustain it through their support.

The usual way of providing public goods privately is by a charge levied on users, as the early lighthouses did.  Modern technology makes it easier to identify users and to charge those who wish to benefit from the service.  The BBC was originally financed by a licence fee to provide and broadcast its programmes, but later media providers have used first advertising, as with ITV, and then subscription services, as with Sky.  Many would say that it is fairer and more appropriate for public services such as these to be paid for by those who benefit from them, rather than use taxpayer funds.

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Economic Nonsense: 42. A planned economy is more rational than an unplanned one

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Very few people advocate an unplanned economy.  At a simple level people might suppose that having intelligent and informed people direct the economy is better than having it proceed by blind chance.  But this is not the choice.  The choice is between an economy in which millions of individual decisions made daily interact with each other to produce an overall order, and an economy whose overall order is sought by a few people gathered around a table trying to direct it.  In other words the choice is not between planning and chaos, but between an order produced by the few and an order produced by the many.  It is between planning done by a few at the centre, and planning done by many at the periphery.

When a person makes an economic choice, to buy or not buy, to stay in a job or to change employment, it is not necessary for the information about that choice to be collected and relayed to a directing authority.  The choice itself impacts upon the economy sending information through it that causes it to change and respond.  In a centrally planed economy the information has to be relayed to the centre so that those in charge can add it to other inputs and decide how to respond to it.  That process takes time, and much of the information is outdated or submerged into a fog of other data before it can reach the centre and be acted upon.  In a spontaneous, interactive economy, its effect is immediate.

Much as the directing authority might try to ascertain the circumstances of individual economic participants, they cannot hope to have more knowledge of them than the individual concerned.  The market economy thus has more information at its disposal, and it can act more rapidly, responding to imbalances and redressing them.  This means that the centrally planned economy is by no means more rational than the spontaneous one.  It is true that the billions of transactions that have input into a market economy might be too large for an individual mind to encompass, but that makes it complex rather than irrational.  

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Economic Nonsense: 41. Immigration is bad for the economy

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Many argue that immigration harms the economy.  Some suppose that immigrants are attracted by welfare, and come to live off benefits at the taxpayers' expense.  Others assert the contradictory claim that "they come here to take our jobs."  Schrödinger's immigrant, like his cat, seems to manage two states simultaneously.  Some point to the pressure on services and resources, with immigrant children filling classrooms and their sick taking up hospital beds and lengthening waiting times to see doctors.

The reality is that most immigrants are young and ambitious, coming to better their lives.  They are overwhelmingly fit and looking for work.  Many of the jobs they take up are ones whose low pay and long hours do not appeal to the native population.  Most do not draw benefits or take up hospital space.  In some sectors they help fill skill shortages, and many UK businesses clamour for more educated and talented foreigners to be allowed in.

The work they do adds to our GDP and boosts growth.  The taxes they pay boost our public finances.  Most immigrants have shown some drive in being prepared to move to a new country to improve their lot.  Some have scraped up cash to finance their trip.  Some have taken risks on their journey.  They constitute a huge net plus to the economy, not a minus.  

It is true that in some areas, particularly if they concentrate, they can put pressure on local facilities.  A minority seeks to retain a culture that sits ill alongside the tolerance and liberalism that Britain has developed over its history.  These are indeed problems, but they are ones that can be addressed and dealt with, and some are temporary rather than long-term. 

Immigrants do one more positive thing for the economy.  Most countries in Europe face declining and ageing populations, and will encounter difficulties if there are not enough young people in work and paying taxes to support the elderly with appropriate services.  The UK population is not declining, and it is immigration that is making the difference.  Far from constituting a problem, it is in this case a solution.  

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