Escher’s Waterfall Economics Revisited

Robbing Peter to simply to pay Paul no longer wins the debateWaving pens still does not create wealthThe rich spend money, tooEscher’s Waterfall economics revisitedRedistribution stimulates consumption and taxes productionMore consumption with comparatively less production will cause prices to riseWe’ve seen this before in the market for higher educationYou still can’t get something for nothing

The 2020 election season is picking up, so I’m bound to see more posts like this one on facebook in the coming months. This is a commercial from the British Labour party, rationalizing various government economic interventions to stimulate consumption. Though made for British politics, American progressives and Democrats make similar arguments. They call it “common sense”. Watch for yourself, then I’ll give you my reaction:

Robbing Peter to simply pay Paul no longer wins the debate

The debate about what, if anything, the government should do to help the poor is ageless. For a while, one could argue simply that many people need an economic safety net; therefore, from a moral standpoint, taking money from the rich and giving it to the middle-class, the poor, and the disabled was the just and compassionate thing to do. Onecan’t just let the poor and the disabled go hungry. To help them, get the government to spot them some cash so they can buy the things they need to live in relative comfort. That’s the right thing to do, or so the argument went.

That argument hasn’t convinced enough people, and the result is that we now have Republicans in the White House and Tories in Parliament who oppose redistribution on economic grounds. They’ll argue, “Welfare creates a culture of dependency”, or they’ll argue, “A higher minimum wage will cause unemployment.” These are pragmatic responses.

The Labour Party must now return volley on the economic point. It hasn’t been enough for them to argue simply that robbing Peter to Pay Paul helps Paul. That argument hasn’t garnered enough votes for progressive politicians lately, so now they’ve got to expand their argument. They argue now that robbing Peter to pay Paul helps not only Paul, but also lots of other people in Paul’s community. Robbing various Peters to help various Pauls improves the economy generally, or so the argument now goes. In the final version of this argument, rising tides raises all ships, including the Peters’s, who also benefit in the end from their own expropriation.

I’m still not convinced.

Waving pens still does not create wealth

The wish underlying progressive economic politics is this: If only some politician would make a good rule and sign a paper, then the populace will be wealthy. However, making rules and signing papers does not create resources, and nor does it generate wealth. Similarly, printing pieces of paper called money does not generate wealth, and neither does taking such pieces of paper away from one person and giving them to another. Wealth is created only through the difficult work of extracting resources form the earth, transforming them into useful consumer products, and making those products available to the public. Creating wealth entails performing actual work on actual resources. Politicians’ signatures on pages of rules does not substitute for the work required to generate wealth. It never can.

The conservative pundit Bill Whittle made a compelling viral video some years ago, which argued that if one could confiscate every penny of ever dollar that every individual in America earns over $250,000 a year and then some, that money would pay only the government’s expenses for the fiscal year 2011. While that may be superficially good news, the plan would cover only one year of government expenses while completely destroying the capital structure of the nation, rendering future wealth production impossible. Moving resources from one set of people to another does not create resources.

The British Labour party asks us essentially to consider a lite version of this public policy. It asks us to confiscate a smaller portion of the wealth of the wealthiest and give it to lower earners, where it is expected to create wealth, i.e. grow the economy. However, as in previous examples, simply moving money from some people to other people can not and does not create wealth. It does not make more natural resources magically appear. It does not stock store shelves with useful consumer goods. To do those things takes actual work. Politicians making rules and waving pens is no substitute for actual work.

The rich spend money, too

The biggest tip that the Labour Party’s narrative does not hold water is its cartoonish treatment of wealthy business owners. The Party asks us to believe that when the owners of business earn money they do nothing—literally nothing—with it. They put it in their pockets and simply forget about it. It makes me wonder what all the alleged corporate greed is about. It’s like, let me get this straight: They greedy owners of business kick workers around and tear down the rain forests and evict people from houses and sully the environment with oil and sell war to politicians only to … do nothing … with all of the money they earn from it? It hardly rings true. Of course the rich do plenty with their money, and we can use this CNBC article about Jeff Bezos as a case study.

First of all, note that 90% of Bezos’s wealth is not in cash or bank deposits, but rather in stock in the Amazon company, which itself owns warehouses, web hosting resources, and inventory or merchandise that sells to the public. In other words 90% of Bezos’s wealth is his share of a business that exists to satisfy consumer demand. That’s far from nothing, but there still is the matter of the remaining 10%.

CNBC describes some of the other things Bezos buys: He founded an aerospace company call Blue Origin, which probably employs people. He owns a private jet, as many of the elite do, which he probably bought from some company that employs people. He invested about $42 million in a project to build a 10,000 year clock, for some reason. You and I might question the value of this kind of investment, but it cerrainlty isn’t nothing. It employs people, it purchases resources, and therefore gets money back into the economy. Bezos invests in various businesses. He travels a lot. His trips presumably put money into the hands of travel agencies and their employees. By the end of the article, we read that Bezos is a philanthropist who donates millions to hospitals and cancer research. These things aren’t nothing. Even if Bezos simply left all of his money in a bank account, that money circulates in the form of loans made to the public.

When the rich do literally anything besides nothing with their money, the Labour Party’s narrative—that regular people drive the economy and the rich are pure parasitic hoarders—breaks right down. It’s a wonder they included such an unbelievable bit in their video at all. To better their argument, they should have just left the rich bloke out of it entirely and left the viewer to draw their own conclusions.

Now, deferring to the Labour Party a little bit on this issue, I have seen and heard statistics that run like this: It is true that rich spend money. They don’t just leave money in their shirt pockets as this Labour Party ad suggests. However, when the rich spend their money, much of it, if not most of it, swirls around among the one percent. Not so much of it makes its way down to the general economy with the rest of us middle class and working poor. I don’t have the expertise to evaluate that claim, but for the sake of argument, lets give it credence.

Also, there are bound to be many people reading this whose brains go dark the moment they see anything resembling a “trickle down” argument. If they smell so much of a whiff of an argument that perhaps the health of the working class depends substantially on the health of the business, they’ll blurt, “Nope! Trickle Down!”, turn off their brains, and that will be the end of the discussion.

For their benefit, let’s take the Labour Party’s narrative at face value. Let’s assume for the sake of argument that the video is right about rich people. Let’s assume that whenever owners of business earn £20,000, they just put it in their pockets, leave it there and forget all about it.

Escher’s Waterfall economics revisited

About four years ago I wrote a piece at Medium.com on roughly this issue. In the time since, I’ve waited and hoped for someone on my side, a free-market libertarian economist, to weigh in. Tom Woods finally has, both in podcast form and in writing. I’m pleased with how my little piece held up, but I think Mr. Woods’s explanation is a little more complete.

In my piece, the owner of an ice cream shop, Molly Moon, defended her own decision to pay workers $15 per hour, plus benefits. “The economics are simple,” she argued. “I sell more ice cream when working families have more money in their pockets to spend.” Is it really that simple?

I wondered: Does Molly really do better when she gives more money to her workers for nothing? Sure, the working families have more money to spend in her store, but where did this money come from? I came right from Molly’s own pocket. When these workers give Molly her own money back, she gives them ice cream. How does Molly end up better off by the end of this process?

I concluded: Molly probably gets her money’s worth when she spends $15 an hour on labor. She probably takes fewer chances on hiring young and inexperienced workers. Workers who do not bring $15 an hour worth of value to the company are probably let go until she has a core group of higher skilled workers who earn their paychecks.

While I believe that this reasoning is still valid, it is limited only to its facts: raising the wages in a single business. In a post entitled Elizabeth Warren Supporter Teaches Econ 101, the economic historian Tom Woods generalized my position to other methods of redistribution and across the economy as a whole.

Redistribution stimulates consumption and taxes production

Tom Woods writes:

Suppose we have a lucky unskilled laborer (lucky because the doubling of his wages did not force him out of a job through layoffs or through the suddenly hastened automation of his job, or did not force him to do extra work, or did not take away his fringe benefits, etc). Then this happens:

(1) This lucky person takes some of his extra pay and buys five gallons of milk.
(2) The milk seller takes the money he earns from this sale and buys a new shirt.
(3) The shirt seller takes the money from selling the shirt and buys a few gallons of gas.

And so on. All consumption. Nothing is saved or productively expended.

This means:

(1) No wages are paid (since making payroll is not consumption).
(2) No business-related bills are paid (again, not consumption).
(3) No intermediate goods are ordered by later-stage production (again, not consumption).

The result of all this spending: inventories of consumer goods dwindle, and, the gross saving necessary to keep the production structure up and running not having occurred, the productive capacity of the economy collapses. There’s your utopia of consumption.

Tom overstates the case, perhaps to demonstrate the end result of this way of thinking taken to an extreme. Given only a modest redistribution, it isn’t true that “nothing would saved or productively expended”. When the lucky man takes his extra money and buys milk, the milk seller keeps only a small part of that for profit to later spend. The rest of it is remitted to the wholesale milk supplier, who keeps some of it and remits the rest of the money to the milk producers, and so on up the chain of production. This money does go toward keeping the production structure running.

That said, I believe that Tom is right about the end stage: The process of redistribution demonstrated in the Labour Party’s video stimulates consumption and taxes production with the result that a modest redistribution will have some modest negative side effects. As the redistribution becomes more extreme, the economy will tend toward the dystopia that Tom described.

More consumption with comparatively less production will cause prices to rise

Modest redistribution will not collapse the entire productive capacity of the economy, but it will skew economic activity toward consumption and away from production. This is on display in the Labour Party’s video: Consumers get free money. They take it to the store and buy, buy, buy. The owners of business, who actually arrange for the production of most of the objects being bought and sold by investing in capital equipment, stand around doing nothing to increase production. What you see happening in the video, right before your eyes, is the demand for goods and services increasing while supply of those goods stagnates.

You know what happens, don’t you, when demand for goods increases while the supply stagnates? Of course, prices rise.

The intermediate step between a free economy and the total collapse of a nation’s productive capacity is higher prices for everything. Sure, there will be an initial shopping spree, and many voters will appreciate that, but prices will rise as more demanders chase around comparatively fewer goods. By the 2024 election season, we’ll be right back where we started. Some people will still have a hard time affording the things they need, politicians will still rationalize for soaking the rich to subsidize the poor and middle class, and the cycle will continue again.

We’ve seen this before in the market for higher education

We’ve seen this scenario play out gruesomely in the market for higher education. The problem then, as now, was that some people were having trouble affording an important thing, in that case higher education. The proposed solution then, as now, was for the government to ignore the law of supply and demand and subsidize higher education by guaranteeing low-interest loans to millions of prospective students. The effect of ignoring basic economics then, as now, was that demand for the subsidized services rose sharply without a comparable rise in the production of those services. The end result then, as now, of subsidizing consumption without comparatively subsidizing production was a dramatic increase in the price of higher education.

Politicians and progressives will repeat this history in other sectors of the economy as long as they ignore the law of supply and demand.

You still can’t get something for nothing

As tempting as it may be to try to help the middle class and poor by taking resources away from the owners of business, the process has side effects for which there will be a later reckoning. Rationalizations that ignore the balance of supply and demand may sound superficially appealing, but reveal problems under scrutiny. You can’t avoid the law of supply and demand. You can’t defeat it. You can’t ignore it. It is a part of the fabric of reality. Politicians’ pens are not unstoppable forces, but the law of supply and demand is an immovable object. It must be recognized, accepted, and worked into any economic policy that would help the poor and middle class.

 

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