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EMPLOYMENT
There are two kinds of experts in the world. There are those who cannot see the forest for the trees and those who cannot see the trees for the forest.
Economists are an ambidextrous lot. When they are being experts in micro-economics they see only the individual firms and not the economy as a whole. When they show their skills as macro-economists they see the economy as a whole, but not individual companies. I think I may have discovered another advantage of not being an expert. To show the cause and cure for unemployment we will look at both the forest and the trees.
When demonstrating what economists mean by demand-pull and cost-push it was said that the arguments seem reasonable. There is a reason for this. The arguments are true. It is only when these arguments are used to explain inflation that they become false. They do explain the effect of individual price changes.
Now we all know that inflation is a rise in prices. But there is a difference. Inflation is the forest and prices are the trees. Some trees grow and some die. Some prices go up and some come down. This is why it made a difference between using gold as the commodity to compare to the price index and using potatoes for this purpose.
That is, because gold is not included the forest of things that make up the Consumer Price Index, when it grows in price or dies it has no effect on the size of the Consumer Price Index.
When the price of potatoes goes up, either the Consumer Price Index must go up or the price of something else in the index must fall. In terms of the forest, if one tree grows then either the forest gets bigger or some other tree or trees must get smaller. A bigger forest would be useful, but a loss in the value of dollars cannot reasonably be called an advantage.
The example of the car maker in the last chapter was an example of a cost-push price increase. The cost-push could have come from other than a labor contract. It could have come from a rise in the cost of the materials our car maker buys. It could even have come from our car maker deciding to increase his profits. Well, there may be a problem with this last choice.
If our car maker raises his price, his sales will become less and he could make less profit. We saw this happen in our last example. The drop in sales made his profits fall instead of rise. Not a very nice result in the eyes of our car maker.
The simple truth is that our car maker does not know which direction he should change his price in order to make the best profit. A price increase will reduce his sales. But will it reduce sales more or less than it reduces costs? A price decrease will increase his sales but will it increase sales more or less than it increases his costs?
The only way our car maker can determine this is to try different prices. If he increases his price and his profit goes up he can increase the price again and see what happens. We can now see that the real problem of unemployment is that our greedy car maker keeps raising the price of cars. After all, each time he raises the price he sells fewer cars, needs fewer workers, and needs less material. And all this time he gets richer and richer. That is, he does until the fall in sales is more than the fall in his costs.
When this happens our greedy car maker becomes a good guy. He knows that his last price increase caused him to make less profit. Knowing this he lowers his price to increase his profits. Doing this he even had to hire more workers and buy more material.
Like all things there is a reason for this trial and error problem with prices. Up to now we have looked at the costs to our car maker in three classifications: labor, material, and profit. However, there are other ways of classifying costs. One way is to classify costs as either fixed costs or variable costs.
A floundie can be classified as a monetarist or a non-monetarist and still be a floundie. A cost can be classified as a fixed cost or a variable cost and still be a labor cost, a material cost or a profit. Well, maybe not profit, but at least the other two can be either fixed or variable costs. The trouble with profits is that they are only what is left over after all other costs have been paid.
An example of a labor cost that is also a fixed cost is the security guards our car maker must hire to protect his property. He must pay these guards no matter how many cars he makes. (This is how economists classify fixed and variable costs. That is, a fixed cost is one that does not change with production and a variable cost is one that does. It is interesting to note that it can also be said that the opposite is true. That is, economists say a fixed cost is one in which the total cost of production does not change with an increase in production. But, that means that the unit cost of production from such a cost must vary with production and it could just as well be called a variable cost. Likewise, economists define a variable cost as be one that total cost increases proportionately with production which means that the unit cost is fixed. However, these problems will be held for later consideration. For the remainder of this analysis, we will use the economists terminolgy and refer to fixed and variable costs on the basis of total cost of production.)
The obvious example of a variable labor cost is the cost our car maker must pay the people who actually build and sell cars. If he wants to make more cars he must hire more workers. If he is going to make fewer cars he then lays off workers. Thus labor can be either fixed costs or variable costs. Material costs can similarly be classified as either fixed or variable costs.
Our car maker is a rich man. In our example he was also a cheapskate. He was so cheap he did not put aside any money to buy a new factory or replace worn machinery. Factories and machinery are funny things. Sometimes factories wear out because they are being used. When they do that they behave like variable costs. Other times they deteriorate or grow obsolete just sitting there. Then they behave like fixed costs. That is, when they wear out from use the wear is a variable cost proportional to the number of cars made. When they deteriorate from age or become obsolete the loss of value is independent of the number of cars made and the cost is a fixed cost.
This discussion was started with the implication that the reason for the trial and error problem with prices would somehow be caused by the difference between fixed and variable costs. But in the example in the last chapter both labor and material costs were variable and there were no fixed costs. Still there was this problem of determining what was the best number of cars to make.
If all the costs are variable our car maker could simply set a price for his cars at any number he wants then hire and fire workers and buy or not buy materials for whatever number of cars people buy at the price he sets. Since all his costs are variable costs he would always receive enough from the sale of his cars to cover his costs. However, our car maker could not do that. And why not? Because he insisted on making a profit! Nasty him. We will re-do those computations without a profit and you will see that so long as there are only variable costs it does not matter how many cars are made. The costs and revenue will always be equal.
In our first computation our car maker set his price at $10,000 and sold one million cars. But this included a $1 billion profit for our car maker. If we remove this one billion dollar profit our car maker will only charge $9,000 for his cars. If one million people were willing to pay $10,000 for his cars we can expect more than a million people will buy one at $9,000. Let us guess 10% more people want his cars. At $9,000 times one million one hundred thousand cars our car maker receives a total of 9.9 billion dollars instead of just $9 billion ($9,000 times one million cars equals $9 billion.) That is the revenue side of the equation. What about costs?
Well, our car makers costs for labor and materials to build one million cars was $9 billion. To build 10% more cars he must buy 10% more material and hire 10% more workers. To pay for this will cost him 10% more. Adding 10% to his $9 billion cost for one million cars makes his total cost $9.9 billion. Lo and behold, our car maker makes the same profit no matter how many cars he builds, if only he chooses to make no profit. But what happens if he has some fixed costs that do not change with the number of cars he makes?
Let us say when he was building one million cars he was making no profit but had fixed costs of $1 billion. In this case to make this many cars he would have to charge $10,000 per car just like he did when he made a $1 billion profit and had no fixed costs. So long as he makes one million cars he has no problem. But if people only buy 950,000 cars we find things are a little different.
With 950,000 cars being sold at $10,000 each he receives only $9.5 billion in revenue. Since he is now making 5% fewer cars his $9 billion variable cost can be reduced by 5% or $450 million. This now makes his variable costs only $8.55 billion. Add this to the fixed cost of $1 billion and we have a total cost of $9.55 billion. But his revenue was $9.5 billion. Now our car maker is losing $50 million. Our car maker does not like this. He did not care much for making no profit, but this is ridiculous.
The fact is that the effect of this one billion dollar fixed cost is the same as our car maker's one billion dollar profit when it comes to determining the price he will charge. Should we regard profit as a fixed cost?
Well, almost. What an economist does is call a "normal" profit a cost and any additional profit he calls a monopoly or economic profit. Economic profits are not classified as costs. To keep our classification of fixed and variable costs mutually exclusive and all inclusive like our floundies and non-floundies classification we will have to find a place to put our normal profit. In this case it behaves like a fixed cost. We need not concern ourselves with economic profits at this point since they are not classified as a cost.
Now that we have classified a normal profit as a fixed cost it would probably be nice to know what a normal profit is. Is it whatever the owner (the car maker) wants? Is it whatever the government says? Or is there some kind of magic in the world that determines what a normal profit is? As the economist sees things he calls this magic "opportunity" cost. If you have not been asleep, lo, these many years, you have probably heard the phrase - "There ain't no such thing as a free lunch." What people usually imply when they say this is that somebody pays even if you do not. This true and venerable saying has been repeatedly proven by the best minds the world has ever seen. Why should we doubt it?
Well the actuality of this argument is much like the truth of demand-pull and cost-push for prices but not for inflation. That is, in the hands of self-righteous zealots a certain truth is craftily used as semantic nonsense to prove true that which is false. It is a certain truth that "there ain't no such thing as a free lunch." How do we know this? We know this because it's a tautology. The reason there is no free lunch is because there is an opportunity cost of accepting a lunch that you do not buy yourself. This opportunity cost is not what someone else pays for the lunch. It is the opportunity you had to be somewhere else or to do something else while you were eating your free lunch.
For instance, you could have been at the beach getting a suntan. If that were your next best choice of things to do, that was your opportunity cost and was what you paid for the "free lunch." If instead of being at the beach you could have worked during lunch and made a billion dollars, then you paid the opportunity cost of one billion dollars for your free lunch.
This opportunity cost is what economists call a normal profit. Now it makes better sense why economists call a normal profit a cost. But how do we quantify opportunity cost? What is the worth of a suntan? To examine this question, we will examine our car company to find the opportunity cost of building cars.
Let us say that our car maker paid $10 billion for his car factory. If he had not bought that factory he could have put his $10 billion in a passbook savings account and received 5% in interest. If that were his next best choice his opportunity cost would then be $500 million. Surely he would not risk his money in the car business if he could not make at least $500 million from selling cars. But, with his car company he thought he could make more.
Another possible opportunity would be to buy government bonds that pay 10% interest. There he could get $1 billion in interest and not have to negotiate with that union leader that insists on a 20% pay raise for his members. Perhaps we should consider one billion dollars as the opportunity cost to build cars. Now that we know that our car maker will make less than a billion dollars if he gives that 20% pay raise, we must ask why would he give in? Why not take his $10 billion factory and trade it for $10 billion in government bonds?
Obviously there is nobody else that is fool enough to pay ten billion dollars for his factory when they can buy $10 billion in government bonds and make more than they could with the car factory. Our car maker is in a bind. He can sign the contract and make less profit or he can refuse to sign and make no profit. At least that is what the accountants say.
He signed the contract of course. He does not recover his "normal profit" and according to the economist he will have an economic loss. Still he stays in business. Even the economists agree he should. Economists must be crazy. Operate the factory at an economic loss? Aren't economists supposed to be in favor of profits? How do they explain this?
Fixed costs are the bills the car maker must pay even if he builds no cars. Variable costs are those costs that are dependent on building cars. What the economist will say is this, "So long as our car maker can sell cars for more than his variable costs he should continue in business. If our car maker cannot cover his variable costs he should shut down his factory." Now what does all this have to do with unemployment? Let us review and see.
First we know that a demand-pull price increase causes an increase in sales and employment. We also know that a cost-push increase causes a fall in sales and employment. This cost-push can come from a greedy union or a greedy company or a greedy landowner or a greedy banker, etc. It could also come from any of a multitude of causes that are generally considered legitimate by the current morality of society, but the source of the cost-push does not change its effect on production and employment.
We must choose among economic policies that encourage production and employment, discourage production and employment, or leaves production and employment to chance or to the equally uncertain result of our moral beliefs.
Leaving economic growth to chance is called "Laissez-Faire" economic policy. It is the policy favored by Libertarians. Not because they do not prefer economic growth and high employment. It is just that they believe that the best way to attain that goal is to leave things alone. They have a pretty good argument.
Have you ever seen a government intervention into the economy that has not gone haywire? If you have I would like to hear about it. Every government program I know of has cost more than planned, provided less benefit than planned and, more often than not, the outcome is quite nearly the opposite of the planned benefits.
Socialists believe the opposite. That is, they believe that it is better for government to intervene in the economy with regulation than to leave production and employment to chance. They often justify their position with some perception of moral good such as a more just distribution of wealth. They also know that government intervention has rarely, if ever, worked in the past, but optimists always - perhaps it will the next time.
Now that I have shown my preference for Libertarianism and my disdain for Socialism: Why, you must ask, do I call myself a Socialist-Libertarian? It is because I am a genius. I know I am because I was a member of MENSA. MENSA is a social club whose members are all geniuses.
In the spring of 1983 I wrote a short article demonstrating the cause of unemployment and how it can be cured. I dislike being poor so I tried to sell that article to several magazines. The experts were not interested. Since I could not sell this article I thought if I gave it free then at least there would be some readers that would understand and I would make my mark on the world. Who better to understand my words of wisdom than the members of MENSA. So, in June 1983, my article was published in "THE ECPHORIZER." This is a small circulation publication, but most of the readers are geniuses like me. I then waited for all the speedy action to implement my suggestions.
I was not to wait long. On the seventh of July 1983 I received the following note postmarked Chicago:
"Dear John,
Thank you for your delightful satire on
pseudo-economic theory in the June
Ecphorizer. It gave me a good laugh.
You've got a great sense of humor and I
hope to see your amusing work in the
Ecphorizer again.
Cordially,
_______________"
Now, if you recall, Chicago is the center of monetarist theory advocacy. You can imagine my disappointment. Not only has my great discovery not been implemented, it has been called satire. And even worse, my accuser may well be a brethren monetarist.
Why do I tell you all this? Well, I am not a glutton for punishment, but I am repeating that article here. Perhaps now that I have more fully explained how I arrived at my conclusions, the recommendation will be understood. In any case, that article follows.
A CURE FOR UNEMPLOYMENT
There have been many arguments presented
addressing the problem of unemployment. These range
from accepting the business cycle as a natural
occurrence to proposals of government make-work programs
as a corrective measure.
My contention is that unemployment is neither a
natural occurrence nor correctable by government make-
work programs. Rather, it is a result of abuse of
monopoly power by government, management, or labor. It
can be corrected only by correcting the cause.
To support this contention it is first necessary
to define what is meant by monopoly power. Monopoly
power is that discretion to set prices for goods or
services held by an individual or group because of
uniqueness of those goods or services or a compelling
force preventing others from providing those goods or
services. This definition sounds somewhat complex so a
few examples are in order.
The first source of monopoly power is uniqueness.
This type comes about by the particular talent of an
individual or the singularity of a good. If you want
Frank Sinatra to sing at your wedding, you will pay the
price he demands or do without. If you want to posses
the Brooklyn Bridge you will pay the price the owner
demands or do without. If Frank Sinatra sets his price
for singing at weddings too high, he will not be
employed in the business of singing at weddings. If the
owner of the Brooklyn Bridge sets the price too high,
he will not be employed in the business of selling the
Brooklyn Bridge.
These examples show a distinct relationship
between monopoly power and unemployment, but, since no
one is hurt, they can hardly be called abuse of that
power.
The second source of monopoly power is use of
compelling force to prevent others from providing
particular goods or services. This source is more
diverse, but the same relationship to unemployment
holds. Some examples of this source are:
(1) The force of government used to protect the
property rights of patent and copyright owners.
(2) Corporations setting prices for their goods
high in order to extract monopoly profits.
(3) Unions setting the price of labor's services
high in order to extract a monopoly advantage.
The first of these is limited in time and is
generally considered a useful encouragement to the
development of new inventions and arts. This does not
fit the concept of abuse.
The other two examples may be a little more
suspect. When management uses its monopoly power to set
its prices too high, they sell fewer goods. When they
sell fewer goods, they hire fewer people to make those
goods. When unions set the price of labor too high, the
price of goods made by labor must be set high to
recover the excess cost of labor. When the price is set
high, fewer of these goods are sold and fewer people
are employed in making and selling and servicing these
goods. When fewer people are employed the general
economy becomes depressed. This depression can
reasonably be called deleterious to the general welfare
of the society and thereby an abuse of monopoly power.
In these United States of America, the Congress is
empowered to enact laws promoting the general welfare.
I therefore propose that Congress enact a law to
correct these abuses of monopoly power. The law I
propose is:
(1) If in any month employment of a large
corporation is 500 or more persons below the level
of employment in the same month of the prior year
and
(a) If the profits of that company equals 5%
of sales, the prices of that company's products
shall be reduced by 1% or more; or
(b) If the profits of that company are less
than 5% of sales, the wages of all employees of
that company shall be reduced by 1% or more, and
the prices of that company's products shall be
reduced by the same percentage times the fraction
of cost of labor divided by total costs of sales.
(2) These controls shall be cumulative until the
employment of the corporation is increased to the
same level of the prior year, at which time the
controls shall be recinded.
(3) A large company shall be defined as an
employer of 20,000 or more persons or such other
number as the Secretary of Commerce shall from time
to time establish.
(4) The Secretary of Commerce shall establish such
procedures and regulations as necessary to carry
out the provisions of this act.
I believe this law, or one of a similar nature,
would bring an end to the cyclical problem of boom and
bust with the attendant problem of chronic
unemployment. If you agree, tell the Congress; if you
don't, don't.
---------------------------
The above article may imply that wage and price increases will inevitably lead to either inflation or unemployment. This, of course, is not true. Not all price increases are cost-push. Some are demand-pull. Demand-pull price increases result from new consumer opportunities or price reductions of existing opportunities.
An example of a new opportunity is the introduction of Cabbage Patch Dolls. When such a new product is greeted with consumer enthusiasm the demand pulls the price up and encourages greater production and employment. Another source of demand-pull price increases at first sounds contradictory. What happens is this. As the price of an existing opportunity (product) is reduced demand for the labor and material to make this product increases. Further, the savings by consumers and the earnings of the newly employed exert a demand-pull on other segments of the economy. Thus a price decrease of an existing product causes productive demand-pull price increases elsewhere in the economy.
The commonest objection to the proposal in the above article has not yet been addressed. This is the feeling that some seem to get that this proposal is just a sneaky way to get at the hard won benefits of labor. Part of this feeling probably comes from the lack of clarity in defining labor in this article.
It has been assumed that any effort by people is labor. That is, the multi-million-dollar a year boss is assumed to be paid for his labor the same as is the lowliest paid employee of a company. This is in keeping with the economists perception of land, labor and capital being the factors of production. ( The inadequacy of this perception will be addressed in Book II of this series.)
In implementing the proposal, it would probably be better to consider the compensation to management as profit rather than wages or salary when determining whether or not to impose wage reductions along with the called for price reductions. By so doing, the affect of the price reductions will be felt directly by the shareowners of the company and they will undoubtedly demand greater influence on the ludicrous process of management compensation that now prevails in corporations. That is, management is now generally compensated on the basis of the size of the corporation rather than on the basis of performance. With the earnings of shareholders so directly affected by ncompetence of management, it is likely they will pay much more attention to their manager's performance and this will result in better management of resources. It would also obviate the possible use of excessive management compensation to cause this proposal to exploit wage and salaried employees. Use of such force would be limited to cases that are clearly the result of monopoly labor.
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