Labor Economics – Page 101 – artdiamondblog.com

Good Rules Encourage Entrepreneurship, Resulting in Vibrant Economy

Some useful observations from the 2004 co-winner of the Nobel Prize in Economics, Edward Prescott:

Good tax rates, . . . , need be high enough to generate sufficient revenues, but not so high that they choke off growth and, perversely, decrease tax revenues. This, of course, is the tricky part, and brings us to the task at hand: Should Congress extend the 15% rate on capital gains and dividends? Wrong question. Should Congress make the 15% rate permanent? Yes. (This assumes that a lower rate is politically impossible.)
These taxes are particularly cumbersome because they hit a market economy right in its collective heart, which is its entrepreneurial and risk-taking spirit. What makes this country’s economy so vibrant is its participants’ willingness to take chances, innovate, acquire financing, hire new people and break old molds. Every increase in capital gains taxes and dividends is a direct tax on this vitality.
Americans aren’t risk-takers by nature any more than Germans are intrinsically less willing to work than Americans. The reason the U.S. economy is so much more vibrant than Germany’s is that people in each country are playing by different rules. But we shouldn’t take our vibrancy for granted. Tax rates matter. A shift back to higher rates will have negative consequences.
And this isn’t about giving tax breaks to the rich. The Wall Street Journal recently published a piece by former Secretary of Commerce Don Evans, who noted that “nearly 60% of those paying capital gains taxes earn less than $50,000 a year, and 85% of capital gains taxpayers earn less than $100,000.” In addition, he wrote that lower tax rates on savings and investment benefited 24 million families to the tune of about $950 on their 2004 taxes.
Do wealthier citizens realize greater savings? Of course — this is true by definition. But that doesn’t make it wrong. Let’s look at two examples: First, there are those entrepreneurs who have been working their tails off for years with little or no compensation and who, if they are lucky, finally realize a relatively big gain. What kind of Scrooge would snatch away this entrepreneurial carrot? As mentioned earlier, under a good system you have to provide for these rewards or you will discourage the risk taking that is the lifeblood of our economy. Additionally, those entrepreneurs create huge social surpluses in the form of new jobs and spin-off businesses. Entrepreneurs capture a small portion of the social surpluses that they create, but a small percentage of something big is, well, big.
Congratulations, I say. Another group of wealthier individuals includes those who, for a variety of reasons, earn more money than the rest of us. Again, I tip my hat. Does it make sense to try to capture more of those folks’ money by raising rates on everyone? To persecute the few, should we punish the many? We need to remember that many so-called wealthy families are those with two wage-earners who are doing nothing more than trying to raise their children and pursue their careers. Research has shown that much of America’s economic growth in recent decades is owing to this phenomenon — we should encourage this dynamic, not squelch it.

For the full commentary, see:
EDWARD C. PRESCOTT. “‘Stop Messing With Federal Tax Rates’.” The Wall Street Journal (Tues., December 20, 2005): A14.

Never Say Die: Milton Friedman on Vouchers, Again

From an opinion-piece by Milton Friedman, at age 93, in today’s Wall Street Journal:

Whatever the promise of vouchers for the education of New Orleans children, the reform will be opposed by the teachers unions and the educational administrators. They now control a monopoly school system. They are determined to preserve that control, and will go to almost any lengths to do so.
Unions to the contrary, the reform would achieve the purposes of Louisiana far better than the present system. The state’s objective is the education of its children, not the construction of buildings or the running of schools. Those are means not ends. The state’s objective would be better served by a competitive educational market than by a government monopoly. Producers of educational services would compete to attract students. Parents, empowered by the voucher, would have a wide range to choose from. As in other industries, such a competitive free market would lead to improvements in quality and reductions in cost.
If, by a political miracle, Louisiana could overcome the opposition of the unions and enact universal vouchers, it would not only serve itself, it would also render a service to the rest of the country by providing a large scale example of what the market can do for education when permitted to operate.

MILTON FRIEDMAN. “The Promise of Vouchers.” The Wall Street Journal (Mon., December 5, 2005): A20.

Dobby’s Absence Tarnishes Goblet of Fire

Source of image: Warner Brothers photo posted at: http://www.newsday.com/features/booksmags/sns-potter-movie-jpg,0,7776280.photogallery?coll=ny-homepage-bigpix2005
You can’t make a long and complex novel into a movie, even a long movie, without cutting and simplifying. Harry Potter and the Goblet of Fire is a good movie, but not as good as the book. Much has been said of the movie’s dark side. The book had a dark side too, but what is missing from the movie is a key element of the book’s light side: Dobby, the rascally, loyal, house-elf with the mismatched socks. For those who have seen the movie, without having read the book, here is one of my favorite (albeit serious) Dobby passages:

“Dobby has traveled the country for two whole years, sir, trying to find work!” Dobby squeaked. “But Dobby hasn’t found work, sir, because Dobby wants paying now!”
The house-elves all around the kitchen, who had been listening and watching with interest, all looked away at these words, as though Dobby had said something rude and embarrassing. Hermione, however, said, “Good for you, Dobby!”
“Thank you, miss!” said Dobby, grinning toothily at her. “But most wizards doesn’t want a house-elf who wants paying, miss. ‘That’s not the point of a house-elf,’ they says, and they slammed the door in Dobby’s face! Dobby likes work, but he wants to wear clothes and he wants to be paid, Harry Potter. . . . Dobby likes being free!” (p. 378; ellipsis in original)

Rowling, J.K. Harry Potter and the Goblet of Fire (Book 4). New York: Arthur A. Levine Books, 2000.

Massive Firings Get Reported; Massive Hirings Do Not

The media have a tendency to cover massive layoffs and firm failures but rarely mention when firms hire a large number of people or when a surprisingly large number of new firms are being formed in particular months. From an evolutionary point of view, firm bankruptcies are undesirable only if they are not brought about by other firms that provide better products and services. Joseph Schumpeter’s (1942) characterization of capitalism as a process of creative destruction underlines the evolutionary view that better economic structures can only be achieved by allowing underperforming entities to be replaced by organizations that can make better use of their resources. (p. 225; italics in original)

Murmann, Johann Peter. Knowledge and Competitive Advantage: The Coevolution of Firms, Technology, and National Institutions, Cambridge Studies in the Emergence of Global Enterprise: Cambridge University Press, 2003.

Rioting Caused by Economy Closed to Creative Destruction

Source of photo: WSJ online version of article quoted and cited below.

The French rioters face very high unemployment. French restrictions on the labor market, and the economy more generally, cause the high unemployment. For example, the French make it hard for firms to fire employees, so as a result, firms are more reluctant to hire workers in the first place, resulting in higher unemployment. Although they do not know it, the rioters are rioting because France is closed to creative destruction. The following commentary is on point:

(p. A16) Like other Americans, immigrants often dramatically improve their quality of life and economic prospects by moving out to less dense, faster growing areas. They can also take advantage of more business-friendly government. Perhaps the most extreme case is Houston, a low-cost, low-tax haven where immigrant entrepreneurship has exploded in recent decades. Much of this has taken place in the city itself. Looser regulations and a lack of zoning lower land and rental costs, providing opportunities to build businesses and acquire property.

It is almost inconceivable to see such flowerings of ethnic entrepreneurship in Continental Europe. Economic and regulatory policy plays a central role in stifling enterprise. Heavy-handed central planning tends to make property markets expensive and difficult to penetrate. Add to this an overall regulatory regime that makes it hard for small business to start or expand, and you have a recipe for economic stagnation and social turmoil. What would help France most now would be to stimulate economic growth and lessen onerous regulation. Most critically, this would also open up entrepreneurial and employment opportunity for those now suffering more of a nightmare of closed options than anything resembling a European dream.

For the full commentary, see:
Joel Kotkin. “Our Immigrants, Their Immigrants.” The Wall Street Journal (November 8, 2005): A16.

Nazi Economy Was Not Efficient

A common view of National Socialism is that it was evil, but efficient. A recent book by Richard J. Evans challenges the “efficient” part of the common view. Here is a relevant paragraph from a useful review of Evans’ book:

(p. B5) The Nazi machine, as Mr. Evans describes it, moved forward with a good deal of creaking and squeaking. The economy was no exception. On many fronts, the Nazis managed nothing more than to bring the economy back to the status quo that existed before the Depression. As late as January 1935, one estimate put the number of unemployed at more than four million, and food shortages were still a problem in 1939. Workers put in longer hours simply to stay even.

For the full review, see:
WILLIAM GRIMES. “The Radical Restructuring of a Germany Headed to War.” The New York Times (Weds., October 26, 2005): B8.

The reference to the book is:
Richard J. Evans. The Third Reich in Power: 1933-1939. The Penguin Press, 2005.

Greenspan on Creative Destruction

This morning, Alan Greenspan delivered an excellent speech on “Economic Flexibility” at Georgetown before the National Italian American Foundation, Washington, D.C. Here is the part of the speech most directly relevant to the process of creative destruction:

Starting in the 1970s, U.S. Presidents, supported by bipartisan majorities in the Congress, responded to the growing recognition of the distortions created by regulation, by deregulating large segments of the transportation, communications, energy, and financial services industries. The stated purpose of this deregulation was to enhance competition, which had come to be seen as a significant spur to productivity growth and elevated standards of living. Assisting in the dismantling of economic restraints was the persistent, albeit slow, lowering of barriers to cross-border trade and finance.
As a consequence, the United States, then widely seen as a once-great economic power that had lost its way, gradually moved back to the forefront of what Joseph Schumpeter, the renowned Harvard professor, had called “creative destruction”–the continual scrapping of old technologies to make way for the innovative. In that paradigm, standards of living rise because depreciation and other cash flows of industries employing older, increasingly obsolescent technologies are marshaled, along with new savings, to finance the production of capital assets that almost always embody cutting-edge technologies. Workers, of necessity, migrate with the capital.
Through this process, wealth is created, incremental step by incremental step, as high levels of productivity associated with innovative technologies displace less-efficient productive capacity. The model presupposes the continuous churning of a flexible competitive economy in which the new displaces the old.
As the 1980s progressed, the success of that strategy confirmed the earlier views that a loosening of regulatory restraint on business would improve the flexibility of our economy. No specific program encompassed and coordinated initiatives to enhance flexibility, but there was a growing recognition that a market economy could best withstand and recover from shocks when provided maximum flexibility.

The full speech is available at the Federal Reserve web site at: http://www.federalreserve.gov/boarddocs/speeches/2005/20051012/default.htm

If Only Caroline Had Read Schumpeter

Innovation is sometimes slowed because innovators do not know that creative destruction will replace old jobs with equally good, or better, new jobs:

In 1834 Walter Hunt of New York City made such a leap in lateral thinking. In his little machine shop down a narrow alley in Abingdon Square, he devised a machine for stitching cloth with two threads from two separate sources, one a needle on a vibrating arm and the other a transverse shuttle fed by an unwinding bobbin.
. . .
Hunt, an altruistic Quaker, never pursued his invention because his 15-year-old daughter, Caroline, recoiled from the thought that it would put seamstresses out of work. (p. 87)

Source:
Evans, Harold. They Made America: Two Centuries of Innovators from the Steam Engine to the Search Engine. New York: Little, Brown and Co., 2004.
(Note: ellipsis added.)

Sewing Machine Benefitted Laborers

Speaking of the invention of a practical, affordable sewing machine:

It was a democratizing influence. James Parton was exaggerating only a little when he wrote in the Atlantic Monthly in 1867 that it was “one of the means by which the industrious laborer is as well clad as any millionaire.” (p. 84)

Evans, Harold. They Made America: Two Centuries of Innovators from the Steam Engine to the Search Engine. New York: Little, Brown and Co., 2004.

When People Change

(p. 462) People don’t change when you tell them they should. They change when they tell themselves they must. Or as Johns Hopkins foreign affairs professor Michael Mandelbaum puts it, “People don’t change when you tell them there is a better option. They change when they conclude that they have no other option.”

Source:
Friedman, Thomas L. The World Is Flat: A Brief History of the Twenty-First Century. New York: Farrar, Straus and Giroux, 2005.

Thomas Friedman’s claim here is plausible, but I find it surprising, given his strong push for a worker safety net when the worker loses a job to creative destruction. The safety net Friedman proposes, in this book anyway, is one that does incorporate some incentives to find a job, but sounds like it could be ‘gamed’ to delay the tough decisions that might need to be made. Hayek had some useful observations on this issue way back in his Road to Serfdom.

Yes to Growth, No to Change

Apparently a perq of being a columnist for the New York Times, is that you get access to pretty high quality economics tutors. Tom Friedman tells us:

My economics tutor Paul Romer is fond of saying, “Everyone wants economic growth, but nobody wants change.” Unfortunately, you cannot have one without the other, especially when the playing field shifts as dramatically as it has since the year 2000. (p. 339)

Friedman, Thomas L. The World Is Flat: A Brief History of the Twenty-First Century. New York: Farrar, Straus and Giroux, 2005.