Voluntary Exchange and Regulation

We are nearing the end of our chapter-by-chapter discussion of Shawn Ritenour’s Foundations of Economics; it looks like we’ll wrap it up next Wednesday on schedule. Chapter 17, the topic of today’s post, deals with the impact of state regulation on the economy. It’s important to include the qualifier “state” to the discussion of regulation because in the popular press inaccurate statements are frequently made about this or that industry or business practice being “unregulated,” when what is really meant is that no state-imposed regulations exist in that area. The impression created is that an “unregulated” industry operates in a lawless environment resulting in harm to the public. In fact, non-state regulations can and do exist throughout every industry and area of the economy. Sometimes these regulations are formal, as when producers in an industry cooperate to create an “industry standard” that facilitates transactions, or when third parties offer certification of a product or of personnel in service industries to show that certain standards have been met. Other times the regulation in informal: scuttlebutt on the quality of companies’ products and services, or the consciences of individual businessmen and customers. The point is that nothing in the economy is unregulated, and we let our ourselves be deceived when we listen to those who argue that the government is the only regulatory force out there.

As in all other areas, the difference between governmental and non-governmental regulation is that the latter is voluntary whereas the former is coerced. Governmental  occurs most frequently in the form of production controls; “rulers mandate what types of goods can be sold by what sellers under what conditions.” Ritenour lays out the economic impact of the coercive regulations. Most fundamentally, “production controls amount to a grant of special privilege to particular owners.” The controls impose certain costs on producers, and those unable or unwilling to pay the costs (often small-scale producers) are shut out of the market. In extreme cases, only one seller complies with the controls and becomes a legal monopoly. More frequently, a relatively small number of big producers comply and become an oligopoly in that market. Economically this results in greater inelasticity of demand for the controlled product and thus the potential for higher profits for the favored sellers. The value of the protected firms’ assets also increase as the privileges are priced in, so the great benefits of the regulatory protection are reaped by the owners who received the protection on the front end.

Ritenour discusses in some detail several types of monopolistic privileges conferred by governments, beginning with occupational licensure. In the U.S., this is normally done at the state level. All 50 states issue licenses for certain occupations (the particular occupations licensed vary by state), and anyone found practicing that occupation without the requisite license can be fined or jailed. (The Institute for Justice recently released a massive study on this phenomenon.)

Another common form of government regulation is quality standards, where goods are not permitted to be sold unless they meet a certain standard established by the government. The impact, in addition to the protection of the certified sellers, is the taking away of certain price/quality choices from consumers. Another effect is the potential hampering of innovation in the regulated industry or product line.

A third monopolistic privilege Ritenour discusses is safety standards. These standards can affect either the production facilities of producers or the goods themselves. Asa with quality standards, safety standards take choices away from employers, employees, and customers. No such thing as absolute safety exists; risk is a permanent feature of life, and marginal improvements in safety can always be made at some cost. Governmental safety standards enforced through agencies such as OSHA or the FDA prohibit voluntary transactions past an (arbitrarily) defined point on the price/safety scale. Again, they can prevent innovations; for example, ideas for new drugs frequently “die on the vine” because the FDA’s approval process costs hundreds of millions of dollars, and very few companies can afford such costs.

Anti-trust laws are based on the doctrine of consumer sovereignty as discussed in an earlier chapter. We have already seen that there are several problems with claims that monopolies or oligopolies in a free market harm consumers. Historically, the effect of anti-trust legislation and regulation has actually been to prevent prices from falling and to protect inefficient companies. Ritenour cites several such examples, such as the federal lawsuits against Standard Oil in 1911 (brought after the company’s market share had declined significantly), and Microsoft in the 1990s (brought because Microsoft was giving away its web browser for free).

The final and perhaps most emotionally charged set of government regulations Ritenour discusses is child labor laws. Economically, these “forbid the labor competition of workers below a certain age.” Ritenour relates a personal anecdote of how he lost a job at which he had worked briefly when his emplyer discovered he was too young legally to work in that particular environment. Such laws artificially reduce the supply of labor and result in higher wages for the protected workers (those above the minimum age). By reducing the working population while leaving the consuming population unchanged, child labor laws result in a less productive economy. They also harm families with children by prolonging the period in which children are net economic liabilities. This can be especially harmful in the developing world, where families live at or near the subsistence level and need economic productivity from as many members of the family as possible. Ritenour states:

We cannot improve the family’s financial situation by merely saying the children should not have to work. As a former professor wisely pointed out, if people are poor because they have few opportunities, we cannot improve their situation by reducing the number of their opportunities still further.

In the chapter’s final section, Ritenour considers governmental regulations from a Christian perspective. Certainly, he writes, Christians often agree with the ends for which government regulations are proposed: safe products and workplaces, a curbing of greed and unscrupulous behavior, etc. However, we again return to the issue of using the right means to achieve good ends. “We have seen that economic regulation violates a person’s right to his own property by forbidding exchanges seen as beneficial by all of the parties involved. As such, it is a form of state thievery and violates the commandment against theft.”

While Ritenour agrees that the government should punish instances of fraud, it cannot be entrusted with the punishing of greed. No bureaucrat can look into a person’s heart and know for sure one’s motivation for particular economic acts. One of the benefits of the free market is that turns even people’s greed to a socially beneficial result because greed must be satisfied through helping others to achieve their ends. Thus Ritenour recommends the removal of production controls from the economy.

Taxing and Spending

In Chapter 16 of Foundations of Economics Shawn Ritenour gives a detailed discussion of the economic impact of taxation and government spending. Government participates in the monetary economy because it is the most efficient way for it to secure the economic goods it needs to realize its goals, whatever those may be. Taxation is a coerced levy paid to the government. Even if you believe that paying taxes is a religious or patriotic duty, you are still being coerced because you cannot not pay taxes without risking fines or imprisonment. Tax revenue is transferred to favored individuals or groups who provide goods and services the government desires. Taxation thus divides society into two classes: tax payers and tax consumers. Ritenour defines tax payers as those who pay more in taxes than they receive from government spending. Tax consumers are those who are net recipients of government spending. Under this definition, government employees, government contractors, etc., are tax consumers even if they pay a portion of their salaries back in taxes themselves. On the other hand, recipients of government grants and the like may in fact be tax payers if their tax bill exceeds the amount of government spending they receive.

One question I have regarding this schema is how to understand the status of anyone at a further remove from the actual government spending. For example, the owner of a downtown café in a state capital may derive the majority of his income from the patronage of state employees who eat lunch there every day. Is this man a tax consumer, or is he merely a tax payer who is part of the shifting of resources that results from government spending?

Ritenour specifies two economic results of taxation. First, it changes the allocation of resources from what it would have been in a free market. Tax payers are able to satisfy fewer of their wants because they have on net fewer resources with which to demand goods and services. Businesses and industries favored by tax payers earn less revenue and attract less capital. On the other hand, demand in tax-consuming industries rises, increasing returns and attracting investment. People who compete with the government for the products of tax-consuming industries must pay higher prices.

The second economic impact of taxation, according to Ritenour, is a severing of production from distribution. In the free market, a market participant’s demand is equal to his supply at the market price of the land, labor, and capital he owns. Government spending distorts this balance, artificially lowering the demand of tax payers (the relatively productive) and increasing the demand of tax consumers (the relatively unproductive).

Ritenour notes that some economists believe higher taxes are just fine because they may motivate people to work harder to maintain the net income they enjoyed before their taxes rose. While higher taxes may indeed motivate some to work harder, there is a price in terms of reduced leisure that will not show up in the economic statistics. The tax payer will be worse off than he was before.

Government spending has a significant economic impact beyond what was described above. In addition to being used to finance government activities, government spending is also used to promote certain favored social purposes through subsidies. If the government decides, for example, that print newspapers are critical to American life, but the newspapers can’t produce a viable business model, then the government might grant them a subsidy to keep them afloat. The subsidy reduces the incentive for capitalists to invest in industries other than the newspaper industry, and the result will be more newspapers than society demands, and fewer alternatives.

Ritenour devotes a substantial section to welfare payments to the low-income population and treats not only their economic impact, but also their appropriateness in view of Christian teaching. After citing several scriptures that affirm the Church’s responsibility to help the poor, Ritenour notes some important points. First, the Bible’s definition of a poor person is not the same as the modern State’s definition of a poor person. The former is absolute, whereas the latter is relative. Large percentages of people the U.S. government treats as poor enjoy many amenities hard to square with the poverty discussed in the Bible.

Second, because subsidies always lead to more of the subsidized activity, welfare programs lead to an increase in government-defined poverty. The direct effect of welfare payments is to reduce the opportunity cost of leisure time, and welfare recipients at the margin find their relatively modest welfare checks plus leisure more attractive than the slightly higher income they could earn by working full time in a low-skilled job. The long-term impact of these policies is that more people will never gain on-the-job skills that make their labor more valuable. Thus Ritenour concludes that welfare programs fail in their stated aims of reducing poverty; in fact, they increase it. Because of this and also because of the coercive means of financing these programs, he argues that Christians should reject them in favor of more direct action by individuals and churches to help the truly poor among us.

One other major component of government spending examined in this chapter is the spending intended to spur economic growth. Having already discussed the problems of Keynesianism a couple of chapters before, Ritenour focuses here on the fact that any money the government spends to stimulate the economy it must acquire from somewhere, either through taxation, borrowing, or inflation. The harmful effects of taxation and inflation (including the effects of borrowing from the banking system) have been established. When the government runs a deficit through borrowing from the non-bank public (via the sale of savings bonds and the like), it redirects capital from private investment to government consumption. This leads ceteris paribus to less capital, a shorter structure of production, and a lower standard of living. Moreover, when the loans must be paid back down the road, taxes must increase, causing even more disruption. The “we owe it to ourselves” canard is false; some citizens owe the debt to other citizens.

To sum up:

1. Government taxation and spending distorts the division of labor.
2. We get more of what we subsidize over time; therefore, wealth transfer programs will increase poverty.
3. Government spending cannot grow the economy, but it can shrink it. The negative consequences of taxation, borrowing, and spending outweigh the localized benefits of the spending.

Price Controls

Chapter 15 of Shawn Ritenour’s Foundations of Economics discusses a government intervention into the economy so obviously flawed that even most mainstream economists condemn it. Moreover, even a large number of government officials seem to understand that it doesn’t work. Nevertheless, this intervention remains a seemingly permanent fixture in certain areas of the economy. I’m referring to price controls.

Compared to some of the topics dealt with in earlier chapters, price controls are fairly simple to understand once you grasp the laws of supply and demand. Governments normally don’t fix prices absolutely, but will sometimes establish for specified goods either price ceilings (maximum legal prices) or price floors (minimum legal prices). Ritenour deals with each of these in turn, distinguishing between “effective” and “ineffective” controls. An ineffective control is a price ceiling set above the market price or a price floor set below the market price. Ineffective controls have no practical economic effect; economic activity proceeds as it would have in the absence of any such controls.

“Effective” price controls, on the other hand, can have a significant economic impact. Ritenour discusses price ceilings first. When the price ceiling is below the price at which the market clears, there are too few sellers and too many would-be buyers at the ceiling. This produces a shortage which is more acute the more elastic the demand for that particular good. Producers who cannot profit at the price ceiling cease their operations, and new capital is diverted into other avenues of investment. The effects of this can be severe. Ritenour relates how his own father was thrown out of work when a price ceiling on beef led to a shutdown of the packing plant where he worked in the 1970s.

Shortages are not the only result of effective price ceilings. In an effort to make a positive return on investment, sellers of goods affected by a price ceiling may charge for ancillary activities such as customer service, or they may scrimp on quality, using inferior components in production. All these results are evident in the form of rent control, the effective price ceiling Ritenour highlights in this chapter. In cities with rent control, there are always shortages of apartments. Existing apartments are inefficiently allocated and are often maintained poorly. Capital goes into condominiums not subject to the controls. The policy of rent control fails in its attempt to ensure affordable housing for the poor.

Effective price floors lead to fewer buyers and an excess of too many would-be sellers. The result is a surplus of the controlled good or service at the floor. The more elastic the demand for the product, the more severe the surplus is. Potential buyers look for cheaper substitutes for the controlled product.

The form of price floor Ritenour focuses on is the minimum wage. Recall that wages are the price of labor. An effective minimum wage results in a surplus of labor at that price and thus more unemployment. Unskilled workers the value of whose labor is below the minimum wage are unable to break into the job market and are prevented from developing skills normally learned on the job that makes their services more valuable.

Employers will also use relatively inefficient methods to get below-minimum-wage tasks done. For example, when I delivered pizzas in college, I often got pulled away from necessary tasks in the back of the store to answer the telephone and was less productive as a result. The manager would have been willing to hire someone whose only job was to answer the phone, but the minimum wage ($4.25 at the time) was too high to pay someone just to stand by the phone except during the rush of orders around suppertime. The result was that the entire staff suffered a loss of productivity. Ritenour points out that not only labor, but also land and capital goods will often be allocated inefficiently as a result of minimum-wage laws.

This chapter also contains a short section summarizing Ludwig von Mises’s argument that the shortages and surpluses resulting from price controls inevitably lead to calls for further government interventions in the marketplace. Mises’s essay “Middle-of-the-Road Policy Leads to Socialism” develops this case effectively.

Ritenour concludes the chapter by writing that price controls are acts of aggression and are incompatible with a Christian ethic that proposes policy to achieve just ends by just means.

Macroeconomic Policy

In Chapter 14 of Foundations of Economics, Shawn Ritenour discusses macroeconomic policy, focusing on the monetarist and Keynesian schools. He first outlines their tenets and then explains why he considers each a flawed approach to the questions of inflation and the business cycle.

Monetarism and Keynesianism both prescribe government intervention into the economy, particularly into the monetary system, to manage the business cycle. Monetarism is based on the Quantity Theory of Money, developed by David Hume, David Ricardo, John Stuart Mill, and Irving Fisher. In recent memory its most prominent proponent is Milton Friedman.

The central premise of monetarism is the equation MV=PT, where M is the stock of money, V is the velocity of money (rate at which it circulates), P is the price level, and T is the total quantity of goods bought with money. Monetarists believe that the business cycle is managed in part by maintaining a stable P, so as T increases through rising productivity, M should also increase by a proportional amount. Monetarists thus prescribe inflation.

While acknowledging that this equation contains some truth in connecting the stock of money to the overall price level, Ritenour argues that an “inferior mathematical approach” is unnecessary to reach the same conclusion already discussed in earlier chapters. In the equation MV=PT, T is a meaningless variable because there is no common unit of measurement that can be used to add up all the different goods in an economy. Since T is meaningless, P is meaningless as well because it can only be calculated in reference to T. Prices of goods measured in different units cannot be averaged. Attempts to solve this problem through the use of weighted price indices such as the CPI fail because ultimately the weighting assigned to each component of the index is arbitrary.

Ritenour states that market participants’ voluntary actions will lead to an appropriate adjustment in price for each good as productivity and the demand for money change. There is no need to manipulate the PPM through inflation, as this will lead to the harmful effects discussed in the previous chapter.

On to Keynesian theory! John Maynard Keynes’s General Theory of Employment, Interest, and Money was the most influential economics text of the 20th century not, as Ritenour states, because of its compelling arguments, but because it provided a justification for policies that governments already favored and in many cases were implementing. Keynes contended that recessions are caused not by inflationary booms, but by insufficient aggregate demand.

Keynes used the mathematical equation Y=C+I, where Y is national income, C is consumption spending, and I is business investment. Keynes is responsible for the current emphasis on GDP. He believed that saving was not linked to investment and was simply a residual left over after people had spent all they wanted on consumption. He called the fraction of income spent on consumer goods the “marginal propensity to consume” (MPC).

In Keynes’s thinking, the MPC was relatively stable, so the trick to ensuring economic growth is to increase business investment when it falters. He thought this could be done without increasing savings, positing a “multiplier effect” that brought about increased national income above and beyond the increase in business investment. (Ritenour uses a hypothetical example with some math I don’t want to reproduce. The bottom line is that Keynes severed the link between saving and investment, and then declared saving next to useless.)

Keynes viewed the interest rate, which he thought was purely monetary, and the return on investment as completely separate things, and that harmful economic effects resulted when the former rose above the latter. So he proposed a policy of inflation to force interest rates down and encourage greater investment. From this perspective, the one big danger of a policy of inflation is that rates could get so low that a “Liquidity Trap” would result, in which people would opt simply to hold cash rather than invest.

Having laid out the Keynesian view in twelve pages, Ritenour points out several problems with the paradigm. They largely have to do with Keynes’s ignoring of the time component in the economy. There can be no investment without prior savings. An increase in the demand for money does not necessarily lead to a change in the ratio of consumption spending to investment spending. In this scenario interest rates will not change because time preference is unaltered. Prices of consumer goods may fall, but prices of factors of production will fall, too, and a balance will be maintained. Because interest rates are a time phenomenon and not a money phenomenon, Keynes’s “liquidity preference” theory of interest is unsound.

Additionally, we’ve already seen that return on investment is a form of interest, so Keynes’s separation of interest from investment returns is flawed. Finally, the focus on aggregate demand without concern for supply puts the cart before the horse. Nothing can be consumed that has not first been produced. Attempts to raise consumption by itself will only lead to capital consumption and a fall in standards of living over time.

From the chain of deductions originating in the Christian insight that people made in God’s image act purposefully, Ritenour argues that the monetarist and Keynesian prescriptions for inflation will fail to solve the problem of the business cycle. The same holds true for “fiscal stimulus” of the kind we’ve seen over the last few years in this country. What is needed is the restoration of policies that favor capital accumulation and market-clearing prices. What is needed is a free market.

Inflation and Recession

Chapter 13 of Shawn Ritenour’s Foundations of Economics marks a significant change in the author’s approach. Up to this point, the discussion of economic phenomena has been purely descriptive. Ritenour follows Ludwig von Mises in arguing that economics as a social science is value-free to the extent that it seeks to understand the laws that govern human action. These laws have an objective quality and cannot be changed because they are built into the structure of creation by God.

However, in Chapter 13 Ritenour enters into a discussion of economic policy, or “action that the state takes in the economy.” Now suddenly we are in a world of “ought” rather than a world of “is,” and thus questions of ethics come into play. Ritenour states that good economic policy must satisfy two criteria: it must seek a proper result, and it must seek that result by proper means. Both an understanding of economic law and a sound moral standard (a Christian one for Ritenour) must be operative.

With this understanding of policy as a context, Ritenour enters a discussion of inflation. Building on the material in the previous chapter, he states that a general rise in prices (what the word “inflation” normally denotes in contemporary usage), or a fall in the PPM, is a result of an increase in the stock of money. In nearly all cases this is brought about by governments, which have monopolized the production of money in the modern world. When money was still defined as a unit of a commodity, governments increased the stock of money through a process called “debasement,” by reducing the quantity of the commodity in the money unit (clipping coins, mixing in base metals with gold/silver/copper coins, or simple redefinition of the money unit). The government forces the populace to accept the debased money through “legal tender” laws and makes a short-term profit (“seigniorage”) on the money commodity it held through the debasement.

Once the use of fiduciary media (e.g., bank notes) became common, the government could also increase the stock of money by increasing the quantity of fiduciary media in circulation. This expansion of paper money often leads to a devaluing of the paper money in comparison to the money commodity when people realize the government does not have enough “real money” to redeem the fiduciary media. Even if the government forbids the populace access to the real money, as the United States did from 1933 to the 1970s, it still must deal with foreign governments seeking to redeem the paper for the commodity. This scenario led to the United States’ repudiating of all obligations to redeem paper dollars for gold in 1971. Since that time we have operated on a pure fiat standard.

Because banks operating on a fractional-reserve basis fear redemption demands for “real money” they have promised to provide but do not have in their vaults, they have an incentive to form cartels which will reduce their risks. Cartel members agree to paper clearing of redemption demands against each other and thus reduce their need for cash. However, the same problems that exist for other cartels exist for bank cartels.

Thus modern banks have tended to favor the existence of a central bank backed by the government that will act as a “lender of last resort” and bail them out when they get into trouble. They also favor the creation of “deposit insurance” in which the government promises to restore the deposits (through the creation of new money, if needed) of people whose savings are in banks that fail. This also reduces the risk of bank runs. Central banks also establish a “required reserve ratio” which regulates how much fiduciary media banks can create, thus protecting them from competition. In the United States, the Federal Reserve performs these functions and also influences the stock of money in the economy through “open market operations,” mainly through the buying or selling of government bonds in the financial markets. When the Fed buys bonds, it does so with newly created money, increasing the stock of money. When it sells bonds, it takes the money it collects out of circulation, thus reducing the stock of money.

So this is how inflation occurs: through an increase in the stock of money created and regulated by the central bank. The consequences of inflation are significant. The rise in prices does not happen all at once, but gradually as the new money works its way through the economy. This means that people who get their hands on the new money first (e.g., banks, governments, government contractors) have a short-term opportunity to make purchases with it before prices rise. Those who get the money last (generally people on fixed incomes, such as pensioners) suffer because they have to pay higher prices before getting of the new money. Additionally, inflation benefits debtors and harms creditors because debts are paid back with money worth less than the money that was originally borrowed. As expectations of higher prices increase, the demand for money and thus the PPM falls even more, and in extreme situations this can result in “hyper-inflation,” or the complete collapse of the money unit, as happened in Germany in 1923 and in Zimbabwe in the 2000s.

The remainder of the chapter explains the Austrian Business Cycle Theory. In a nutshell, governments often desire the effects of economic growth without the necessity of savings and consumption accumulation that make it possible. So through the central bank’s open market operations it forces interest rates to an artificially low level. This low interest rate encourages more borrowing by entrpreneurs looking to start or expand business operations. The expansion of capital spending creates a temporary boom, but the real resources needed to sustain both the long-term projects of entrepreneurs and the current consumption of the populace do not exist. Thus many of these entrepreneurial projects ultimately fail for lack of resources, the result of a “cluster of errors” that would not have occurred absent the artificial lowering of interest rates. These failures bring on the bust. Employment falls, and society must expend much effort to liquidate the bad investments made during the boom. Ritenour states that the bust must be allowed to run its course to clear the decks for sustainable economic growth thereafter; efforts to prop up failed industries will only drag things out.

This post is running long, but I’m sure I’ll have occasion to return to business cycle theory later in this project, so I’ll wrap up here.

Bad Philosophy Leads to Moral Corruption

It’s Great Books Monday, and this week we’ll come within a whisker of our 8,000th page of reading since January 2011. Things sure do add up after awhile.

Here are the readings for the upcoming week:

1. Adventures of Huckleberry Finn by Mark Twain, Ch. 11-16 (GBWW Vol. 48, pp. 292-310)
2. The Nicomachean Ethics of Aristotle, Book X (GBWW Vol. 8, pp. 426-436)
3. “Caesar” by Plutarch (GBWW Vol. 13, pp. 577-604)
4. “Of Followers and Friends” by Francis Bacon (GGB Vol. 7, pp. 20-21)
5. The Origin of Species by Charles Darwin, Ch. 6 (GBWW Vol. 49, pp. 80-98)
6. The City of God by St. Augustine, Book XX (GBWW Vol. 16, pp. 600-632; in the linked text, it’s the material under the second of the headings “Of the last judgment . . .” and its subheads)

This week we finish Aristotle, but don’t despair; we’ll come back to another work of his in a few weeks.

Here are some observations from last week’s readings:

1. Adventures of Huckleberry Finn by Mark Twain, Ch. 4-10: More comical relation of Huck and Jim’s superstitions here. I found the description of the Mississippi’s flooding pretty striking, and I’m sure the East Coast people who read Twain’s work had the same reaction. Huck lives in a world where the population density is so low he can live as a hunter-gatherer where no one else can find him. How times have changed.
2. The Nicomachean Ethics of Aristotle, Book IX: Continuing the discussion on friendship, Aristotle also deals with the issues of self-love and self-sufficiency along with the desire of friends to spend time together. Good quote: “The friendship of bad men turns out an evil thing (for because of their instability they unite in bad pursuits, and besides they become evil by becoming like each other), while the friendship of good men is good, being augmented by their companionship.” Make friends with good men, and if no good men want to be your friend, make yourself into the kind of person that good men want to befriend!
3. “Alexander” by Plutarch: What a fascinating read this was! There were so many engaging anecdotes, and I will probably use one or two of them in my lectures from now on. I thought it was significant that Plutarch attributed Alexander’s eventual corruption of character to a philosopher who kept telling him that everything a conqueror does is just by definition. Ideas have consequences.
4. “Literature of Knowledge and Literature of Power” by Thomas De Quincey: I really enjoyed this essay. It blows up the Baconian “knowledge is power” dictum in a way. It also is an effective answer to utilitarian educators who insist on a “practical” curriculum shorn of the humanities.
5. The Origin of Species by Charles Darwin, Ch. 5: What we have here is essentially a series of speculations on how natural selection might operate within a species. We still see Darwin leaving the door open for acquired characteristics being passed on to offspring, something I find surprising. 
6. The City of God by St. Augustine, Book XIX: Reading this book in conjunction with the Alexander biography was very interesting because on its face it appears that Alexander disproves Augustine’s contention that everyone wants peace; Alexander seemed to like war itself. Obviously Augustine knew all about Alexander, and I think he would argue that Alexander’s true desire was to prove himself the greatest in war. Once an enemy was defeated there was no further need for conflict, and thus Alexander was aiming for a state of peace in which he had established his preeminence.

It was 95 degrees here over the weekend. Ick. Maybe tropical storm Beryl will give me a little rain to cool things down slightly. Until then, I’ll read indoors.

Money and Its Purchasing Power

In Chapter 12 of Foundations of Economics, Shawn Ritenour inally gives us a detailed discussion of “what makes the world go round.” For something that is universally used, it seems as though the understanding of money in our society is pretty poor, so I thought this was a very valuable chapter.

Early on Ritenour explains the often-used phrase “purchasing power of money” (PPM). Just as the price of a good is expressed in how much money it takes to buy it, money’s purchasing power is expressed is how much of a particular good a unit of money will buy. For example, if gasoline is $4.00 per gallon, the purchasing power of a dollar is 1/4 gallon of gasoline. The PPM is determined by two things: the quantity of money in circulation, and the demand for money (or the demand to hold money in cash balances). As the quantity of money in circulation increases (inflation), the PPM falls ceteris paribus, and prices increase. As the demand for money increases, so does the PPM because money is withheld from circulation in people’s cash balances. In a free market, the PPM will be determined by supply and demand in the same fashion as every other good or service.

Marginal utility and the other laws of human action apply to money just as much as they do to other things. This insight is one thing that distinguishes the Austrian school of economics from the mainstream, which often attempts to treat money as a “king’s X” to which ordinary economic laws don’t apply.

Of course, money is unique in that it has no use subjective value as money apart from its exchange value. No one will want it if they don’t believe they can exchange it for other things. How then did money acquire its exchange value in the first place? Here Ritenour explains the regression theorem of Ludwig von Mises. Mises demonstrated that we must factor in the time component of the value of money; there must have been a point in time where money was valued for its use, and this usefulness is what gave rise to its exchange value. In other words, money could not have originated by fiat; it must have been a commodity valuable in its own right.

Ritenour also explains how the stock of money in society can increase. Here he explains the nature of fractional-reserve banking and how banks engage in the practice of allowing multiple claims to exist for each unit of money they hold in their vaults. These claims (in the form of bank notes or checking accounts) circulate as money themselves and thus increase the quantity of money in circulation.

My discussion of this chapter hasn’t been as detailed as most of my other summaries have been; my excuse is that I am putting in a prodigious amount of work this weekend to get a couple of online courses ready to roll out next week. Still there’s more to come; I must finish this book in the next ten days!

More on Environmental Religion

I’ve posted a time or two about how environmentalism behaves like a religion in many ways. Here, for example, I discuss the religious language used in connection with national parks, and here I post about predictions for a “new god” tied to environmentalism.

This week’s episode of Research on Religion features an interview with Robert Nelson, the author of The New Holy Wars, which I wrote about in this post. Nelson rambles a bit, but he makes several great points about secular religion and the policy implications of the State’s favoring of such religions (which is definitely happening right now). Give it a listen, and come back tomorrow for more economics.

The Production Structure and the Social Economy

In Chapter 11 of Foundations of Economics, Shawn Ritenour makes the transition from what is often called “microeconomics” to what is often called “macroeconomics,” where the discussion centers on “big stuff” like business cycles, inflation, and unemployment. He disapproves of this terminology:  ”At most any division between microeconomics and macroeconomics is topical. The same principles of human action to develop principles of exchange and price determination are the same we use to examine the determination of the purchasing power of money and cause of recession.”

After a review of some key characteristics of the market economy, Ritenour moves into the chapter’s main topic: the production structure. Whereas production effort runs down the structure of production–higher-order goods must be produced before they can be used in lower-order processes–income runs up the structure of production, beginning with the consumers who demand the end product and moving from lower-order producers to higher-order producers.

Monetary income in production is allocated to owners of land, labor, and capital. With the first two groups, what you see is what you get; their gross and net incomes are identical. But the owners of capital goods had to expend money to produce them, so their net income differs from their gross income. The net income of the owner of a capital good is interest, reflecting the social time preference.

The key to the structure of production is saving, which must take place continuously to create the capital goods used in the higher orders of production. Contra those who claim that consumer spending drives the economy, Ritenour states the following:

All of the exchanging of present money for future money that takes place at every stage of production in the entire economy points to one inescapable fact: the amount of money spent at any time on capital goods is much larger than the amount spent during the same period on consumer goods. The production of consumer goods is an must be supported by a vast, complex capital structure. The entire structure of production is supported by saving and investment.

Rates of interest at each stage of the structure of production tend to even out over time, just as the rates of interest in different industries tends to do. The income an owner of capital receives tends to equal DMRP (see the post on Ch. 9) of the capital good, and this form of income is usually called “rent.” The overall value of a capital good (or “capital value”) is based on the discounted amount of all future rent payments the capitalist expects to receive.

Entrepreneurs can acquire capital for their ventures from their own savings, by borrowing from other savers, or by pooling their savings with other investors and sharing ownership in the venture. The shares of ownership under the latter arrangement are called “stock,” and it’s these shares of ownership in businesses that are traded daily in the stock market. Owners of stock hope to receive not only interest but also entrepreneurial profits (many of them, of course end up receiving entrepreneurial losses). Savers who lend to a business by buying a bond, by contrast, expect to receive only interest, not profit.

Capital values change along with changes in the social time preference. If the latter rises, capital values will decline because a more interest is demanded by savers, leading to a fall in the DMRP of capital goods. On the other hand, if social time preference falls, capital values will rise to reflect the higher DMRP of capital goods. Ritenour argues that the lowering of the social time preference leads to economic progress as more savings increase the capital stock, thus lengthening the structure of production. When the social time preference rises, the opposite occurs, and the economy regresses.

The chapter’s final section discusses the Gross Domestic Product (GDP) a statistic that attempts to measure the overall size (and presumably health) of the economy. Ritenour points out many problems involved with trying to calculate GDP; in fact, some eminent economists have argued that the margin of error in the number is so wide that it can often indicate a growing economy when the economy is actually shrinking and vice versa. That policymakers normally invoke this number as a primary piece of evidence when arguing for or against a particular agenda is evidence of a broken system (my view, not Ritenour’s, although he might agree with me).

Ritenour concludes the chapter by arguing that it’s essential for the different stages of the production structure to be coordinated in a peaceful and productive way to avoid surpluses and shortages. Interest rates make this intertemporal coordination possible. (I smell a critique of the Federal Reserve coming soon.)

Competition and the Number of Sellers

Chapter 10 of Shawn Ritenour’s Foundations of Economics treats us to an analysis of three phenomena that have been the subjects of much discussion, not to say hand-wringing, over the past 150 years: cartels, monopolies, and labor unions. In the process of explaining these arrangements, Ritenour provides us with an important understanding of economic competition.

First, we are reminded that entrepreneurs and the owners of factors of production have no ethical obligation to offer goods or services for sale at prices we like, nor do they have an ethical obligation to compete with each other so that we can enjoy lower prices. These alleged obligations, in which many people tacitly believe, cannot be deduced from any principle of human action discussed earlier in the treatise. Thus arrangements such as cartels may be unobjectionable from a Christian perspective, provided they do not violate anyone’s real rights. The oft-cited notion of “consumer sovereignty” is a description of what a free market usually produces, not a prescription for public policy.

A cartel is an arrangement formed by agreement among producers of a particular good or service (Ritenour uses the example of barbers) to increase their profits by acting as though they were one firm. This involves attempting to take advantage of price inelasticity by reducing supply and raising prices.

Ritenour writes that in a free market, cartels tend not to survive for long. Usually, one of three things will happen in short order:

1. Competition from outside the cartel will increase supply and lower the price of the good or service in question, leading the cartel members to abandon the arrangement.
2. One or more of the cartel members will “cheat” by increasing supply and lowering prices in an attempt to maximize his own revenue, again leading to the cartel’s disintegration.
3. If the cartel members find they like the arrangement and are able to keep outside competition at bay, they will take the logical next step of merging their concerns into a single firm.

The final point above provides a nice segue into a discussion of monopoly, something that people seem to fear more even than cartels. Ritenour gives a nice discussion of the problems involved even in defining the term “monopoly.” The etymological definition of “one seller” is not helpful, because depending on how broadly or narrowly we define a product, either everyone or no one could be a “monopolist.” Ritenour favors a definition common in the 19th century, that of a state-granted privilege to be the exclusive seller of a particular product.

However, the most commonly used definition today is “a firm that has market power,” in which “market power” means “the power to charge a monopoly price” as opposed to the “competitive price” that “ought” to prevail in the marketplace. Ritenour points out that the problems of definition for these terms are also significant. All entrepreneurs attempt to maximize their revenue, as we’ve already seen, and this includes taking advantage of price inelasticity where it exists. Does this make every entrepreneur a monopolist? Nor can the reduction of output be used as an infallible test of a monopoly because entrepreneurs frequently reduce their output of a product in response to losses. Ritenour concludes that in a free market the concept of monopoly is practically meaningless.

Like cartels and monopolies, labor unions attempt to increase their revenue by restricting supply of a service (in this case labor), but a major difference is that the union restricts not the labor of its own members, but that of non-members. The union typically attempts to negotiate higher wages for its members in part by getting the employer to agree not to hire non-members. When the union strikes, pressure is put on non-members not to cross the picket line to work for a wage deemed too low by the union. Where unions are successful, they lower the wages for workers in non-unionized industries because the supply of labor for those industries increases as the supply of labor in the unionized industry shrinks.

Ritenour maintains that, as in the case of the cartel, there is nothing inherently wrong with labor unions as long as they do not violate other people’s rights in the pursuance of their ends. However, he acknowledges that in modern society, such violations often take place.

Concluding the chapter, Ritenour notes, “Competition should not be understood in an artificial way that presumes a certain large number of sellers who have perfect information about the market and who never make mistakes.” If we avoid this fallacious way of thinking, we will recognize that economies where property rights are protected do in fact manifest true competition, even if we don’t always like the results of that competition.