CAUSE AND EFFECT THINKING IN ECONOMICS NEEDS A SERIOUS RESET

Carl Menger, founder of the Austrian School of Economics, made clear that in Economics, as in all walks of life, causality rules the roost. “All things are subject to the law of cause and effect,” said Menger, and “this great principle knows no exception…”

If a nation seeks lower unemployment, for example, it should expect to deal with a higher rate of inflation and vice versa. The cause and effect relationship in this case might perhaps be obvious although there have been periods of time when this inverse, or Phillip’s curve (named after economist William Phillips), relationship did not hold. Less obvious is the explanation that lies behind the exponential increase of 260% in the cost of college tuition or the 200% increase in healthcare costs from 1980 to the present. The Consumer Price Index (CPI), by way of comparison, has notched up only 120% during the same period.

Classical economists explain, ad nauseum, that prices are the result of supply and demand. These same economists place a lot of stock on the cost of production as a means of determining prices. The aforementioned uptick in the CPI of 120%, therefore, should be a close approximation of the increased cost of production across all sectors of the economy. True, both of these sectors of the economy are cost-based payment sectors with few, if any, economic incentives to work more cost-effectively. Even so, that still leaves a yawning gap in what consumers are paying for college tuition and healthcare.

So, what explains a buyer’s willingness to pay no-matter-what for tuition and healthcare? Isn’t a higher market price an incentive for buyers to consume less and an incentive for sellers to produce more? And, what about competitive suppliers who now have an opportunity to operate under the umbrella of higher-priced, low service providers? In postsecondary education, at least, the law of supply and demand might be working after all. How else can one explain the fact that student enrollment in for-profit colleges has grown on the order of five to one over conventional institutions during the last twenty years and now totals over three million students but that for-profit institutions deliver better value and better service? I’m not altogether ready to have my faith restored in supply and demand curves, however, as the sharp increase in the cost of services with little or no productivity gains and the unquenching demand for those services remains a quandary.

TO THE LOSERS GO THE SPOILS

Economist William Baumol has suggested that the rising cost of services is the direct result of the nation’s rising affluence generally. Mr. Baumol’s explanation or Baumol’s “cost disease”, as his explanation has come to be known, is predictably pessimistic: as worker productivity in the manufacture of tangible goods increases, there is a corresponding increase in wages. So far so good. But according to Mr. Baumol, the further consequence is that wages in all sectors of the economy, not just manufacturing, will increase. The rise of wages in sectors without productivity gains, says Mr. Baumol, comes from the need of employers to compete for workers who are holding or might have held jobs that paid higher wages. Mr. Baumol’s thesis requires the huge leap that all labor markets are tightly connected.

Again, what happened to supply and demand? Higher wages in a sector should increase the supply of labor such that a decrement in prices begins to take hold. And, it’s not all about money. Does a federal government agency fairly compete with a technology startup for the services of a computer programmer no matter how much money is thrown at him? In my view, it is likely that low productivity individuals gravitate to low productivity sectors of the economy. This might be a more logical explanation for the meteoric rise in the cost of education and healthcare in the absence of meaningful productivity gains. (I’m tempted to call my explanation “Pupo’s productivity disease” but I’ll let that ride for now).

In the vernacular, Mr. Baumol’s argument is that a “rising tide lifts all boats.” But not necessarily, as hourly wages have grown by only 115% since 1973. Again, this is a far cry from the vertiginous rise in the cost of tuition and healthcare. Worse, these labor-intensive, low productivity sectors are not just riding a vortex of ever-increasing costs but they are also, in the process, dishing out miserable customer service. According to the American Customer Satisfaction Index (ACSI) government services rated a paltry 68 out of 100 with consumers in 2016 for customer satisfaction. Hospitals fared not a whole lot better at 75 out of 100. In school, the former score would earn you a D+ in your report card. The latter, a C grade.

Approximately 80% of our Gross Domestic Product (GDP) and 80% of our employment base is engaged in services.  Most of the sectors which make up the services component of our GDP might create value – as might be the case with healthcare, retail, education, leisure and hospitality, social services, and government programs – but they do not create wealth for the nation. It is no wonder that the service economy of the United States is in the red zone as I argue in a separate essay.

INDIVIDUALS ARE LED BY AN INVISIBLE HAND FOR THE GREATER GOOD

Adam Smith’s aphorism above cannot be denied despite the protestations of central planning advocates. Many of the lethargic service sectors of the economy are beyond the reach of the free-market for the simple reason that they owe their existence to monopolistic or regulatory protections or are safely ensconced in the government’s purview. Interference in free markets, however, is the best way known to inhibit growth, increase cost, and render slipshod service to paying customers. It is no wonder that history is littered with the failed economic experiments of one central planning regime after another.

As economist Julian Simon stated in his pioneering book, The Ultimate Resource, “Not understanding the process of a spontaneously ordered economy goes hand-in-hand with not understanding the creation of resources and wealth.” Simon’s book was countercultural when it first came out in 1981 – and might still be in some liberal circles – when he argued that the limits to economic growth have all to do with not having enough skilled workers endowed with liberty to exert their imaginations and nothing to do with a shortage of natural resources. Mr. Simon’s observation was an obvious riposte to proponents of limits to growth who from the time of Thomas Malthus, in the late eighteenth century, have argued that continued levels of population growth would return us all to subsistence-level conditions.

Notable among contemporary doomsayers is Paul Ehrlich who in his 1968 book, The Population Bomb, predicted that hundreds of millions of people would starve to death in the 1970’s. Clearly, no such thing even came close to happening. The key, Mr. Simon further states in his book is “…that human imagination can flourish only if the economic system gives individuals the freedom to exercise their talents and to take advantage of opportunities.”

Still, there are some that are calling for more government intervention to spur economic growth. The Economic Policy Institute, which has disparagingly referred to our nation as the “Unequal States of America”, has called for a whole panoply of interventions including increasing the minimum wage, making it easier for workers to form unions, creating a path to citizenship for illegal aliens, changing how employers schedule employees for work, having taxpayers foot the bill for childhood education, meddling in monetary policy to achieve full employment, and so on as part of its Twelve Point Plan.

It is doubtful, however, that slow growth, and low productivity can be overcome through additional and more aggressive government intervention. Especially if, as Nobel Laureate economist Milton Friedman says, “…we continue to authorize a “new class” of civil servants to spend ever larger fractions of our incomes…Sooner or later, an ever bigger government would destroy both the prosperity that we owe to the free market and the human freedom proclaimed so eloquently in the Declaration of Independence.”

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