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PART 4: The Capitalism They Hate - Anthony de Jasay, Political Economy, Concisely 
Political Economy, Concisely: Essays on Policy that does not work and Markets that do. Edited and with an Introduction by Hartmut Kliemt (Indianapolis: Liberty Fund, 2009).
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The Capitalism They Hate
THE CAPITALISM THEY HATE*
THE INEQUALITY MACHINE
Freedom of contract is inexorably followed by streams of voluntary exchanges and a widening division of labor. Individual ownership of the goods exchanged and of the factors that produce them completes the necessary conditions of the capitalist system. It is easy to grasp that this system must ceaselessly generate unequal distributions of income and wealth and also that these distributions will not settle down to any particular durable pattern.
Unequal distributions spring from two sources. One is inequality of endowments, inherited or acquired. Talent, force of character, strength of will, industry, and thrift may be genetically implanted or learned; knowledge, a “network” of friends, acquaintances, and patrons, and command over capital and credit may be inherited or acquired. Some of these differential endowments can in principle be destroyed or leveled out by forcible collective action. Capital, for one, may be confiscated and held in “social ownership” or redistributed equally. Knowledge may be more equally spread by setting up a universal and “anti-elitist” educational apparatus. Most endowments, however, cannot be eliminated or equalized and will inevitably produce unequal incomes and possessions. However, even if in some utopia all individual endowments could, by clever legal, fiscal, educational, and technical devices, be flattened out, there would still remain one generator of inequality, probably the most powerful of all, namely luck. It is by definition random; it rides roughshod over government policies as well as over personal merit and desert. If nothing else made for inequality, luck alone would suffice to keep the great Inequality Machine of capitalism churning out a kaleidoscopic pattern of incomes and wealth, in which any advantage gained would provide means for further advantage, helping the rich to become richer.
Dislike of inequality may have many motives. Some ascribe it to the genetic heritage of humanoids and preagriculture humans, for whom equal sharing may have been a good survival strategy for one’s genes—though it has become an obsolete and inferior strategy since man has learned to grow and store food for himself and his family. Others, plausibly enough, trace the roots of egalitarianism to plain envy. Be that as it may, the expectation of gain from the flattening out of the distribution would always serve as an egalitarian incentive for all with below-the-mean income or wealth. However, none of these motives is really avowable; none sounds unselfish or noble enough.
Charitably screening any such naked opportunism from open view, educated opinion has put up the moral imperative of “social justice,” whose runaway success in academic and other intellectual circles in the last half century is a sad illustration of how easily gaseous concepts and pompous jargon overcome straightforward logic. Instead of saying that many desire equality for a variety of more or less respectable reasons, we must now say that inequality is unjust—a very different proposition.
(A little thought reveals an awkward feature of “social justice theory.” If, by some miracle, complete equality were once brought about, social justice would still not be satisfied, for it can never be. It would at that point require the creation of new income inequalities in order to achieve equality of some other welfare criterion, e.g., utility levels. However, since nobody knows or can ever discover anybody’s utility level, to affirm that they are now equal is no more valid than to affirm that further income inequalities are required to make them equal. Any distribution could be found unjust on some ground and such a finding would be no less valid than any other. This insight highlights one of the pathetic infirmities of social justice, namely that it has no rules by which a socially just state of affairs could ever be identified. Trying vainly to capture it, the foolish carousel can keep going round and round forever.)
At all events, thanks to social justice “theory,” capitalism as the great Inequality Machine, stands guilty of spreading injustice all over the social landscape. From 1917 to 1989, the social and economic disaster that was the Soviet empire served as the great excuse that made most sober-minded people forgive capitalism’s sins. Capitalism delivered the goods, and socialism did not. This was very nearly a knockdown argument. Attempts at building social-democratic halfway houses in which one can have it both ways have had indifferent success. As the dynamics of the welfare state are coming to be better understood, these attempts carry less and less conviction. Yet, as the hopelessness of “real existing” socialism fades from immediate memory, and as it is being taken quite blithely for granted that no matter what, capitalism will always deliver the goods whether we prize or blame it, opinion toward it is becoming less forgiving.
“Globalization,” or rather its great acceleration in recent decades, has made forgiveness harder to grant. If the world economy were made up of many well-insulated compartments, the Inequality Machine would soon neutralize itself by starting to work in two opposing ways. Once capitalism took hold and the rate of capital accumulation exceeded the rate of growth of the active population, the rich would no longer become richer as the poor became poorer. Instead, with the supply of labor expanding less fast than the demand for it, both the rich and the poor would become richer, but the poor would become richer a bit faster, offsetting some of the extra inequality resulting from the rich having more capital working for them. The net effect would depend on the actual numbers and on the pace of technological change, but it is a fair conjecture that no Marxian “iron law” would rule the scene.
When, however, the compartments open up, this equilibrating effect may be much retarded. Goods are generally distant from where they are most wanted (or effectively employed), namely distant in time and in space. The distance in time may be overcome by borrowing from the future, and the cost of doing so is shown in the spectrum of interest rates augmented by some risk premium attaching to the borrowing. Today’s moderate interest rates and more particularly the unusually low risk premiums reduce the cost of overcoming distance in time, and make the economy more open to a wider range of choices. Distance in space is overcome by incurring transport costs and the communications costs of sending instructions and making payments.
To judge by the persistent widening of the range of tradable goods and of long-distance trade, the development of transport technology and communications may have been faster than the technology of production, and this development seems recently to have accelerated. The shrinking of time and space probably accounts for the greater part of “globalization,” dwarfing the effect of lower tariffs and weaker nontariff barriers to trade.
Quickening globalization in recent decades has impacted inequality in the developed economies of the Western world in two ways. The return on capital has increased and so has the share of capital in national income. Concurrently, the rate of increase in the real wages of the semiskilled and the unskilled has slowed down or, in some areas, stopped altogether. The joint effect accounts for the widely voiced impression that the rich are getting richer and the poor poorer, though the latter part of the diagnosis is not really correct. The impression is in any case strong enough to condemn severely the Inequality Machine for sacrificing the middle and lower working classes on the altar of free trade, and to lend urgency to demands for protection of all kinds.
Some defenders of globalization argue that it is not the opening up of economic compartments that causes the unskilled and semiskilled to be left behind, but labor-saving technological progress. Even admitting that technological change is nearly always labor-saving and hardly ever capital-saving, its supposed effect on the supply-demand balance in the labor market is conjectural. It can lead to the conjecture that a run of labor-saving innovations could push the level of wages crashing down unless generous unemployment pay is offered to those who will not work for lower wages. However, recent economic history suggests that chronic unemployment is more typical of welfare states obsessed with social justice than of countries where labor-saving information technology has made the fastest progress.
The most plausible explanation of stagnating or slowly rising wages in the Western world is that globalization is indeed the culprit. The elasticity of supply of labor in Western economies has been drastically increased by the addition to their labor force of hundreds of millions of Chinese, Indian, and Indonesian workers who have for practical purposes become part of the Western labor market due to the vastly reduced cost of bringing their output to Western product markets. There is, as yet, no matching increase in the supply of capital, even though its accumulation has accelerated somewhat. Elementary reasoning leads one to expect that income distribution in the West will tilt in favor of capital. The facts bear out this expectation. The Inequality Machine of capitalism is guilty as charged.
What this judgment conveniently fails to notice is that globalization is global. Income distribution is changing not only in Western Europe and North America in the wake of shrinking transport and communications costs, but also in China, India, and Indonesia. Third-world employment is expanding rapidly, labor is migrating from the subsistence to the market economy, and its wages, starting from an abysmal level, are catching up with first-world levels at a double-digit annual rate. The factor price equalization theorem is hard at work thanks to the fusion of insulated compartments into an open world economy. Here, the Inequality Machine is producing more equality on a colossal scale by lifting the Eastern very poor to near the level of the Western poor. Nothing else, no development program, no “war on poverty,” no humanitarian campaign is in sight that would be remotely capable of doing the job. The envious and the morally indignant may hate capitalism for making the rich richer, but would they rather have the very poor remain very poor?
At the end of 2006, a year of which the financial services industry had little reason to complain, the head of Wall Street’s most prominent investment bank was rewarded with a bonus of $40 million. Some less prominent houses gave their heads bonuses ranging from $20 to $50 million. Very successful security or commodity traders were given twice or thrice the bonus of their own chief executives.
Promoter-managers of what are, in most cases quite misleadingly, called “hedge funds” (for few of them really hedge anything) who take 1 percent off the bottom year in, year out and 20 percent of gains off the top had no reason to complain either. Their investors ran greater-than-average risks, but most of them were fairly well rewarded by the 80 percent of the gains going to them. The managers took no risk and their 20 percent share made some of them a very large fortune in a single year.
Some top corporate executives, in fact employees of the shareholders, received compensations in the low to middle eight figures for loss of office, in addition to their pensions, when asked to make room for someone else. Golden handshakes were 24-karat, often awarded by board committees whose members were acting by the Kantian rule: Do as you would be done by.
Promoters of private equity funds, unlike directors of publicly held corporations, have great freedom to operate with borrowed capital and are indeed encouraged by their investors to run high risks by using high leverage. By good judgment and good luck, they usually succeed in making astronomical fortunes for themselves while their investors are adequately but not indecently rewarded for carrying most of the risk.
Part of the public in the United States, and a tiny handful in Europe, contemplates these spectacular earnings with admiring awe. Everyone else considers them indecent. They provoke the most virulent kind of hatred for capitalism.
The reason is not so much the vastness of the sums involved and the glaring inequalities they create, as the great ease with which they seem to come and the perversity of the value system they are supposed to reflect (though there is no reason to suppose that they reflect anything like a value system). Glaring inequalities are as old as history, and though they were occasionally rebelled against, they were not really perceived as indecent, esthetically disgusting, and morally reprehensible. All ancient empires were extremely inegalitarian. The states of ancient Greece appear to have been fairly egalitarian with the king perhaps ten times richer than the shepherd or the fisherman, but in ancient Rome the wealth and income of a rich senator must have been thousands of times greater than that of the proletarian plebs, let alone his outdoor slaves. Many of these differences were a matter of hierarchical status and were part of the tacitly accepted established order of things. There is no compelling reason why some of capitalism’s inherent inequalities should not in the fullness of time also be so accepted or (more probably) grudgingly acquiesced in, though the reasoning spirit of enlightenment will want to understand why the established capitalist order deserves at least tacit acceptance.
The same forbearance would be much harder to obtain for the inequalities due to “indecent” earnings. One obstacle in the way of their social acceptance is that they accrue to upstarts, fast-talking, fast-moving smoothies who have had too easy a ride to the top. They are too unlike the Dick Whittingtons and the legendary shoeshine boys who overcame adversity and rose by hard work and harder thrift.
But a possibly deeper reason is that there is little or nothing in the “indecent” multimillionaires that strikes the observer as truly entrepreneurial. They do not invent and do not make things that the market might either accept with pleasure or reject with indifference. They take few or no risks, but are parasitic on the risks taken by their investors and clients. Many of them are pure intermediaries, a function whose contribution to the economy is seldom appreciated by the wider public. Others, typically executive board members of large corporations, appear to be abusing the principal-agent relation, and though they do serve their principals, the shareholders, with moderate zeal, they serve first and above all themselves. Paying them with stock options is designed to attenuate the principal-agent problem (and it does resolve it to some extent), but is on the contrary suspected of being a corrupt practice fixed up by crony directors who expect to be similarly fixed up in return.
Most of us react to the decency or otherwise of large incomes and quickly made fortunes by moral reflexes that evolved under the capitalism of a generation or two ago. They have not yet been adjusted to the changes capitalism has since undergone. One such change is the flood tide of pension funds in the Anglo-American type of capitalism which, after all, sets the mode of operation the rest of the world is beginning to imitate. The needs of pension funds and the competition between their managers sets the maximization of asset values as the primary goal, and the more classic goal of profit maximization by corporate enterprise tends to become a mere instrument of the primary goal. Socialists whose rejection of the “system” is visceral rather than intellectual call this “casino capitalism,” run by and for “speculators.”
An even more far-reaching change is the great increase of financial relative to nonfinancial capital in private ownership. This is no doubt due to ever greater intermediation, which in turn is a by-product of the splitting up of risks and the distribution of different types of risk-bearing instruments among those most willing to carry each particular type. One result is the availability of immense pools of financial capital demanding what by historical standards looks little in the way of risk premium.
How all this leads to “indecent earnings” is clear enough. Corporate assets are now very mobile. They are readily hived off or reassembled. Whole corporations merged with others at the drop of a hat with or without the intervention of private equity firms, often spurred on by advisers eager for commissions. On the whole, this is probably a good thing, as it makes it much easier to redeploy assets from less to more productive uses than was the case only a couple of decades ago. Today, a $2-3 billion merger or acquisition hardly makes the financial columns of the press, and a deal must exceed $20 billion to make real news. Consider a $20 billion deal. The principals on either side are probably prepared to pay some fraction of the deal’s value to make doubly and trebly sure that there is no hitch, that nothing has been overlooked, that regulatory problems have been duly considered, and there is no flaw in the documentation. One percent of this deal would be $200 million. In fact, the teams of bankers and the batteries of lawyers will between them probably share a 0.5 percent fee—an absurdly high sum that is absurdly low relative to what an avoidable mistake or a derailed transaction would cost. Competition should keep the fees down, but the need for the advisers to have prestigious names will keep them up.
The outrage roused in the public by such sums being thrown around may stir politicians to action against “indecent” earnings. Capitalism would presumably be less hated, and more assured of survival under majoritarian voting, if such earnings could be outlawed or otherwise wished away. On mature reflection, however, any legislative or regulatory remedy is likely to prove worse than the disease, ultimately leading to evasion, corruption, immobility, and an ever-lengthening series of further measures to correct the perverse effects of their predecessors. The experience made with the Sarbanes-Oxley legislation in a somewhat different domain should serve as a lesson before it is decided to let politics deal with indecent earnings.
The least bad remedy is still to leave it well alone. It is a remedy that, for all its homeopathic modesty, has a shining virtue. Experience shows that people who have made indecently large incomes sooner or later seek to earn the esteem of their fellow men by making correspondingly vast donations to good causes. If anyone is ill tempered and ill informed enough to think that Warren Buffett’s gains are indecent, he should be told that the gentleman in question has recently donated $35 billion to charity. All big earners are not like him, but even the most unpleasant characters tend to end up doing the right thing in their testaments, if not sooner. Society has ways of exerting gentle but persistent pressure on the new rich to do good after they have done well and yet leaves them with the satisfaction and good conscience that voluntary benefaction affords them. It is surely best to leave things at that and not wreck the chances of the world’s poor by trying to make the very rich less rich.
STRIVING TO GET RICHER AND POORER*
Among the “apple pie and motherhood” words, “democracy” shares pride of place with a small and select group of terms signifying un-contested value that nobody in his right senses would call into doubt. Democracy, however, is far more complex in its consequences than most other “value words.” It is a mark of poor judgment to accord it instant approval. Democracy has in particular many mutually contradictory consequences in the economic sphere, and it is incumbent on the economist to be at least aware of them.
“Government by the people for the people” is as apt to make them richer as it is liable to make them poorer. That its effects go both ways is not the fault of the government alone, but also of the people who, as the putative masters in this peculiar master-and-servant relation, send perverse signals and instructions to their putative servant. In obeying the people, the government does them much disservice. But it is in the nature of democracy that it has little choice in the matter if it wants to remain in office.
Normally constituted individuals do not deliberately seek to get poorer. The vast majority strive to get richer. For the economist and perhaps for the moralist, too, one undying virtue of democracy is that it lets them strive without brute prohibition, even if, like the beekeeper who lets his bees gather the honey, though it does not let them eat it all, it does interfere with the free disposition of the fruits of human striving. Dictatorships often try, sometimes successfully, to force people to give up striving for prosperity and devote all their efforts to some more or less insane goal they fix for them. Democracy is at least innocent of this sin.
Most economists ascribe further virtues to democracy that positively help people get richer. Such virtues are credited with giving society the rule of law, education, health, and (other) public goods. Each of these boons is contestable and needs a closer look.
To regard the rule of law, surely one of the most crucial positive externalities an economy can possibly enjoy, as a by-product of democracy is simply erroneous and is belied by history. The rule of law has prevailed in England from the end of the seventeenth century onward. It dominated some aspects of civil and even public life in France under the absolute monarchy of the Bourbons. It established itself in Prussia in the eighteenth and in Austria-Hungary in the nineteenth century. None of these countries waited for democracy before submitting to the rule of law. Democracy may produce a favorable climate for the rule of law to take root. However, it does not always do so, as witness some Latin American countries that adopted universal suffrage and majority voting as their means of choosing governments in the second half of the twentieth century. Saying that they are not really democracies because they do not have the rule of law would be to turn the relation of the two into an empty tautology.
Compulsory instruction of every child in the three R’s has strong arguments in its favor, apart from the obvious advantage literacy confers on the individual and the positive externality it represents for society. Compulsion may be excused by the fact that children cannot be asked to choose voluntarily, while voluntary choice by negligent parents may be detrimental to dependent children. Democracy, however, cannot stop at the three R’s. Electoral majorities soon come to find it iniquitous that some children’s education stops at twelve while others go on till sixteen, eighteen, or, at university level, to their midtwenties. The school-leaving age is thus ratcheted up, the socially very valuable institution of apprenticeship is stifled and often violently condemned by the teachers’ unions, and (at least in most of continental Europe) universities are thrown open to all comers with most or all of the cost of tuition being a charge on the community. Selective admission is resented as undemocratic, elitist, and inegalitarian. The result is a serious decline in the quality of higher education, an often unhappy and rebellious student body, a chronic shortage of skilled young entrants to blue-collar trades, and a hopeless surplus of graduates in “soft” subjects where even the unfit are allowed to scrape through and given a useless degree. This involves massive waste of time and resources, but much recent experience suggests that democratic political systems do not tolerate attempts to stop, let alone reverse, these trends. It is as if society were striving to impoverish itself by self-inflicted educational excess.
Nor is universal compulsory health insurance, a typical democratic objective now widely achieved in most European countries, immune from perverse effects. These act at the two ends of the demographic spectrum. Widely accessible health care, including the publicly financed benefits of advancing medical technology, is a major cause of the spectacular lengthening of life expectancy we are witnessing. It would probably not have happened without the spread of majority rule, and we should no doubt regard it as a welcome by-product of democracy. However, so are legalized and widespread abortion and the easy availability of the Pill. Democracy and some social trends that accompany it are at least partly responsible for the falling birthrate that casts a baleful shadow over the future, notably of the German and Italian peoples.
The obvious result is the “ticking time bomb” of increasing numbers of those who are retired and nonworking overwhelming the falling numbers of those who are still of working age. No creative national accounting can undo the fact that one way or another average incomes must fall. This effect can be mitigated by more immigration and a lengthening of the retirement age. However, neither measure is likely to help reelect an aspiring politician.
The provision by government of public goods in a democracy is likely to be more extensive and more costly than under political systems that depend less directly, or not at all, on majority support. The reason is, broadly speaking, that while everybody has a free-rider incentive to throw the cost of public goods on the community as a whole, it is only under majority voting that the free-rider can enforce his wish to ride free by voting for more public goods. The government cannot avoid bowing to this wish even if it leads to disproportionate spending. (Deficits, as we know, are a charge on future generations who do not vote at the next election.) The upshot is a “mix” of the national product between public and private goods that is apt to leave most people discontented, yet unable to resist the free-rider temptation that is the root cause of the “wrong” public-private balance.
WRECKING THE RESOURCE ALLOCATION
Voters do themselves probably the worst possible service when they try to use the mechanisms of democracy to obtain by politics what the economy is denying them. Car owners hurt by high gasoline prices will then demand an “energy policy,” sugar-beet farmers want an import tariff on cane sugar (euphemistically called a “trade policy”), assorted business interests tired of sundry taxes call for a “positive fiscal policy,” farmers blockade roads with their tractors to defend “national self-sufficiency in food,” small shopkeepers demand that supermarkets be refused building permits in the name of a “policy of proximity,” the labor unions threaten to strike if there is no “meaningful policy of employment,” regions ill served with roads urge a “balanced transport policy,” and all who have pet schemes in mind call for a “policy of purposeful public investment.” As some of these demands are met, the unmet ones are urged with ever greater stridency.
It would be starry-eyed classical liberal purism to claim that in the absence of politics, the allocation of resources in the economy would necessarily be optimal. We are not even sure whether “optimal allocation” really has a meaning except perhaps that it is the outcome of untrammelled voluntary exchanges. It is safe to say, though, that each “policy” will only make the allocation worse, more contorted, further removed from the position that free individuals would bring about by the matching of their marginal benefits and costs. “Policy” will block, upset, or reverse equilibrating forces. It will redistribute income, punish those who best succeed to satisfy the wants of their fellow humans, and reward those who fail to do so. Success is not always admirable and failure not always the fault of those who fail. But to make it a policy systematically to do justice in these controversial matters can only have the direst economic consequences.
It is thus that the striving of some to get richer (or less poor) by using the leverage democratic politics offers them looks very much as if they were striving to get poorer, though it takes an outsider to see how pitifully they defeat their own purpose.
“BREAD AND CIRCUSES” IN THE MODERN WELFARE STATE*
From about the third century ad onward, between a fifth and a quarter of the population of Rome, some 200,000 people, regularly received free distributions of bread and cooking oil from the emperor. The emperor, in turn, received the bread and the cooking oil one way or another from the producers of these goods. The welfare state had duly started to churn. We all know how the churning ended, in slow and messy agony, three centuries later. One quibble one could raise against Gibbon’s monumental History of the Decline and Fall of the Roman Empire is that he does not really answer the obvious question of why the agony lasted as long as it did.
As vital as the bread and the oil for keeping the people happy were the numerous and frequent circuses scattered all over the city, where gladiators fought wild beasts and each other. This free entertainment, too, was provided by the emperor. In the modern welfare state, the equivalent of the gladiators are professional football players and athletes, and the equivalent of the circuses are mainly provided by the television networks out of the advertising revenue they attract. Like in ancient Rome, so in our modern civilization, it is ultimately the final producers of all goods who provide both the bread and the circuses. They do so both for themselves and for those who do not produce.
As then and so too today, there is a variety of reasons for producing nothing, or at least less than one could with a reasonable effort. Laziness and shirking are probably not the chief culprits. The dominant causes are more complex. Some are bad and cannot be defended, but others can honestly be argued both for and against.
UNEMPLOYMENT: WHOSE FAULT?
Unemployment over and above the rate consistent with normal between-jobs mobility, about 3 to 5 percent of the labor force, cannot be defended. Rates much above this can perhaps be excused at the trough of a business cycle, but high rates that have become endemic in good times as well as in bad are unforgivable. At present, South Korea can boast the lowest unemployment at 3.4 percent, the Netherlands at 4.5, Britain 5, Japan 5.3, and the USA just below 6 percent. At the other end of the scale, Poland (for special and presumably transitory reasons) is at nearly 20 percent, Spain shows a notoriously overstated figure of 11.3, while France is stuck at just under 10, Germany at 8.7, and Italy 8.4 percent.
Some of this unemployment is widely suspected to be voluntary, in that some people prefer to live on the dole rather than go for jobs that look to them too lowly or too low-paid. Thus, the French construction industry is short of 300,000 workers, while Germany has just relaxed its immigration laws to let in people who would fill jobs for which no German is supposed to be available. The remedy against voluntary unemployment is well known. It consists mainly in reducing the period over which unemployment pay is available, and gradually cutting the link between the last salary and the unemployment compensation. The Netherlands, Britain, and Denmark have successfully done this, Germany is preparing to do it to a cautious extent. Elsewhere, it is still rejected as antisocial. Here one might rightly say that it is the political system that maintains voluntary unemployment.
The same is largely true of involuntary unemployment. It suffices to think of the array of labor laws and regulations that “protect workers’ rights” and make the laying off of workers so difficult that creating jobs and hiring workers whom you may have to keep paying till they retire (whether or not you have work for them to do) has become a reckless act few dare undertake. In fact, virtually all “social” measures have ultimately to be paid for in reduced employment, a truth European public opinion has until recently furiously denied.
WORK, LEISURE, BOREDOM
The other major cause of nonproduction is the way people prefer to divide their time between hours worked and hours off the job. To choose what one prefers is hardly inconsistent with rational conduct, so that it is difficult to quarrel with the length of time people arrange to spend on and off the job if time on, time off, and pay are freely negotiated. In language that now sounds a little unfashionable, economics used to teach that individuals seek to balance the marginal “utility” of wage income against the marginal “disutility” of work. The former falls as you earn more, the latter rises as you work more, and your preferred use of your time is where the two just match. Like other valid theorems, this is a truism, but it is not useless, for it helps in organizing the argument.
The average gainfully employed American works about 1,950 hours in the year. This corresponds to forty-nine standard 40-hour weeks, leaving three weeks for sick leave and paid holidays. Average annual hours worked in Britain are much the same. In sharp contrast, the average German and French working year is about forty-three standard 35-hour weeks. It takes an effort to believe that the balance between more income and less work is so vastly different for the English and the Americans on one side, and the Germans and the French on the other. In addition, these statistics tell us nothing about the intensity of effort the average worker in these countries devotes to his work. Per capita income in Germany and France is in fact a little higher than the low number of hours worked would predict.
Moreover, weekly hours are often not freely negotiated. For the last four years, France has had a monstrous law fixing the “legal” workweek at a maximum of 35 hours—a paternalistic impertinence that passes for a great “social advance.” Part of the present center-right majority would like to dilute or repeal this law, but President Chirac has vetoed attempts to do so. In Germany, there is no “legal” working week; but labor union hierarchies have done their utmost to whip their members into demanding shorter hours until it became the politically correct thing to prefer this “social advance” to higher wages (though it was preferable still to demand both).
Finally, with the gradual disappearance of heavy manual labor as well as of deadly monotonous assembly-line work, it is no longer evident that work necessarily involves “disutility.” Some people actually enjoy doing what they are paid for. Many more may not enjoy the work itself, but they enjoy the amenities and atmosphere of the workplace and the company they find there—often in pleasant contrast to the solitude and boredom of their evenings and weekends. Bread they can earn, and no doubt they would continue to get some, in the modern welfare state, even if they failed to work for it; but by way of circuses, most of them are reduced to watching television. If labor laws, institutional arrangements, and the motives of union officials were different, many workers might well settle for longer hours and higher incomes. They might also settle for longer hours rather than see their jobs disappear, if that was the choice that faced them and their government and their union permitted them freely to take it.
THE WORM THAT TURNED
Precisely such was the choice that recently faced two thousand employees of two Siemens plants in northwest Germany. The company could no longer make the production of mobile phones pay with a 35-hour week. It proposed to its employees to work 40 hours for the same pay, or else it would move the whole operation to Hungary, where willing and good quality labor was available at a fraction of the cost. The two thousand German workers massively accepted the 40-hour week.
One swallow does not a summer make, but a few more are now seen to be fluttering. Daimler Benz and Bosch have already followed Siemens. Over a hundred similar moves on hours or paid vacations are said to be in preparation. The political weather may be changing in Germany. A few months ago Chancellor Schroeder scolded German entrepreneurs who talked about moving their business to the former Soviet satellite countries to the east. Early in July, in what seemed a wildly improbable about-turn, the chairman of the ruling Social Democrat Party warned the labor unions against “selfishness.”
The significant thing is not that some groups of workers now dare ignore their unions or that politicians take the electoral risk of showing some understanding of economics. It is, rather, that business leaders, for long years cowed into timidly suffering “codetermination” and the exactions of both the tax collector and the labor hierarchy, have finally regained some courage and started boldly “telling it like it is.” The worm seems to have turned.
WHO MINDS THE GAP?*
At the Lisbon summit of European Union heads of government in 2000, there was much talk of how the blessings enjoyed by Europe—a civilization of the highest order, a well-educated population, good communications, an internal market of close on 400 million, peace, and the rule of law—fail to be translated into economic performance. In the debates and outside the conference room, the conservatives and Blairite “socioliberals” levelled some unspoken accusations against the German and French socialists for clinging to policies, notably in the matter of what was politely referred to as “labor market rigidity,” that greatly hindered the adaptation of the economy to worldwide free trade and fast technological progress. Though the words “labor market flexibility” made the socialists fume with silent indignation, a set of pious resolutions were adopted, amounting to what came to be known as the Lisbon Program that was supposed to transform Europe into “the world’s most competitive economy” by 2010.
At the March 2004 summit in Brussels, progress was cursorily reviewed, though other items on the agendas have left little time and interest for the economy. Each government awarded itself good marks for its wise and decisive policies. In fact, with the exception of Spain, Portugal, and the Netherlands (Britain was already ahead of the rest thanks to the radical Thatcher reforms of the 1980s that Labour has preserved and built upon), progress by most of the others consisted of two steps forward and two steps back. In France, “progress” has consisted rather of three steps back. Romano Prodi, the outgoing president of the European Commission, told them to their face that he wished they would stop pretending that they are even trying to implement the Lisbon Program.
MIND THE GAP!
Users of the London Underground are familiar with the sonorous warning of the loudspeaker at certain stations to “mind the gap!” between the carriage and the platform edge when getting on or off. The message of the Lisbon Program can be compressed into the same warning shout to “mind the gap,” though here both the gap and the danger it holds are metaphorical, but no less serious for all that.
The gap, of course, is that between the sadly wilting economic performance of the core states of Europe and the vigorous growth of China, South Korea, India, and—more painfully and embarrassingly—of the United States. For it must be recognized that while most Europeans think that fast development in Asia is rather a good thing, they find being outperformed by America in the last two decades quite hard to take.
In fact, one cannot really grasp the contradictions of European opinion in matters of political economy without constantly bearing in mind the mostly subconscious, visceral hostility to America felt by so many Europeans (the “intellectuals” and the politically articulate and active more than most) that Americans find so mystifying. Because America is growing faster, “we,” as the aforementioned Europeans argue, must speed up and at worst stop the gap from widening, at best close it. But because America is brazenly capitalist and knows no social justice, “we,” they argue further, reject capitalism (except as a last resort the well-regulated, tame sort) and insist on widening and deepening the sway of social justice.
The gap is deplored and there is a genuine desire to reduce it if that is feasible without sacrificing what goes by the name of “the European social model.” They wish this, but only in part because more growth is still widely regarded as good in itself despite ecological objections. In great part, however, reducing the gap is a matter of pride, a virility symbol that would sweep away any suggestion of superior American prowess.
To mitigate shame about the gap, a good deal is made of statistics that cast doubt on its very existence. Relatively recent growth rates of national product favor the U.S., but statistics going back fifty years or a century do not. Moreover, faster American growth since the 1970s was accompanied by a swelling of the current account deficit, i.e., by heavy capital imports from countries poorer than America, an apparent anomaly that tarnishes the U.S. record. In a sense, it was “too easy” for America to grow faster by hogging the savings of the rest of the world, even if the rest of the world had willingly lent itself to this aberrant relation.
Another line of European defense rests on productivity comparisons. It is accepted that American productivity per man-year in manufacturing is higher, and in services much higher, than the European one. But this is wholly accounted for by the much longer American workweek—an average of 42 hours against 34 in Western Europe (ex. Britain)—and the much shorter American vacation. Productivity per hour worked in the euro-zone is fully as high as, and in some areas higher than, it is in America.
(It is worth noting, though, that the high European productivity per hour is in part due to the age composition of the workforce. Many under-twenty-fives linger on in real or pretended higher education, and many over-fifty-fives go or are eased into early retirement. The twenty-three-to-fifty-five age group, which is somewhat more productive than the younger and the older ones, is thus overrepresented in Europe. Heavier unemployment among the young and the old acts in the same direction.)
Where the gap is more threatening, and where it ought really to be minded, is not in the comparative levels of productivity, but in their growth rates. Statistics can be made to say many things, but most things they say about productivity amount to a gap of about 1 percentage point between the U.S. and European growth rates of the various productivity measures in America’s favor. This would be no great matter if it were a passing phase. But if it is destined to persist for a generation—which on the present showing looks far from impossible—the gap could become abysmal and the effect truly shattering for European self-respect. Europeans might come to look upon America with the same sense of failure and despair as Arabs now look at Europeans.
THE FAVORITE MODEL
While large segments of European opinion—the self-employed and much of the political right—do “mind the gap,” the majority of opinion-makers and behind them the political center and left, hold a more ambiguous and self-contradictory position. For public consumption, they mostly refuse to see the gap or explain it away by citing transitory causes. When speaking more frankly, they acknowledge it as part and parcel of a “European model” that is less moneygrubbing, milder, gentler, and above all socially more just than the American one. Some diehards still insist, carrying on the Soviet tradition despite the catastrophic results it had brought, that with proper planning an egalitarian, socially just society is not only capable of creating wealth just as fast as the capitalist “free-for-all,” but can in fact show it a clean pair of heels.1 The great majority, however, reluctantly admit that this model is intrinsically slow and could only run faster if the parts they most cherish were drastically modified.
The long and short of it is that increases in material wealth and social justice are regarded by the dominant strand of European opinion as two rival goods. If the economy is driven to deliver more of one, it will inevitably deliver less of the other. The social and political mix incorporated in the American model will make it deliver more wealth and less social justice; the European model will make it do the opposite.
This is very broad-brush economic theorizing and it is easy to bring it down to earth with some hardheaded scrutiny. However, it has the great strength of meshing remarkably well with the ideological defense of social justice. For if material wealth and its equal distribution are two rival goods that can be “produced” in variable proportions—more of one entailing less of the other—asking which is “better” is a silly question. There shall be no dispute about tastes; it is for the consumer to decide what dose of each good he prefers. The American apparently wants to tilt the “product mix” more toward riches, the European favors a mix with more equality even if that means somewhat less wealth.
But how do we know this? The center-left and socialist answer is that we have it from the horse’s mouth: European voters time and again vote for the “European model,” punishing governments that flirt with liberal economic policies, dismantle subsidies, embrace free trade a little too heartily, tamper with the legal privileges of labor unions, refuse to finance an ever-growing share of health care from general taxation, try to reform pay-as-you-go pensions, and give public education an “elitist” twist. Governments do make small and cautious steps toward such goals simply in order to keep the system from seizing up. But they have to pay a heavy price and are lucky to last out a legislature if they deviate perceptibly from the pursuit of “social justice.” The electorate apparently knows very well which model is its favorite.
WHEN RATS START FIGHTING ONE ANOTHER
Something, however, must be wrong with the confident claim that the “European model” of superimposing on the economy a far-reaching redistributive mechanism is in fact a straightforward case of revealed preference: the electorate gets the advancing welfare state because that is exactly what it wants. How does one square this idyllic picture of consent and contentment with the infighting, the sourness, and the strife that are becoming the mark of everyday life in most of these societies?
A parallel suggests itself that is crude and disrespectful but—alas—fairly accurate. When population and the food supply are in equilibrium, a rat colony is internally peaceful, but when the balance tilts the wrong way, its members begin to quarrel and fight each other. Likewise, when the development of the welfare state takes place on the back of a vigorously expanding economy, creating a new welfare entitlement for one group—say, old-age pensioners, single mothers, aspiring college students—does not prevent the claims of other groups to be satisfied the following year. Health-care coverage improves, unemployment benefits increase or are prolonged, the unsaleable works of would-be artists are bought by the local government and warehoused (as was till recently the case in the Netherlands), and so forth. At a rhythm dictated by the electoral calendar, bits of additional social justice can be handed down all the time. Each claimant group gets its turn and there is enough, or nearly so, to go round.
These good times were enjoyed in “never had it so good” Britain in the 1950s and ’60s and in much of continental Europe in the 1970s and ’80s. In both areas, the trade-off between wealth and social justice eventually shifted much too far, and welfare started to stifle the economy. In Britain, the absurdity of the result became so apparent in the strike-bound ’70s that finally the Thatcher reforms became politically possible. On the Continent of Europe, rival interest groups are still mostly deadlocked, the economy is broadly speaking still stagnant, and unemployment is bumping against the 10 percent ceiling. Reform in Germany and Scandinavia is creeping on timidly, but is stuck fast in Italy and especially in France. Every interest group is defending its “social rights” with tooth and claw and is trying to gain additional ones to preempt similar attempts by the other groups. Outside the strict welfare sphere, the same preemptive infighting is going on in the public services and the industries where the employer is the government, so that in these sectors of the economy labor’s unbeatable bargaining lever is its voting strength.
Arguably, all this must first get worse before it can get better—as one day it probably will. Meanwhile, this desolate and strife-torn scene offers admirable scope for studying how the economics of social justice really works.
FLOAT OR SINK?
It has long been observed that instinct, the product of selective evolution, tells man to choose behavior that is most conducive to his and his genes’ survival. It has long been overlooked, however, that at some crucial junctures instinct tells man to choose behavior that does the exact opposite. When he falls in deep water, the nonswimmer should lie flat on his back, let his head submerge, and keep only his nose and mouth above the surface. If he does this, he may survive. Instead, he will instinctively try and straighten up to keep his head and neck out of the water, thrash about, swallow water, sink, and drown.
Behavior supposed to defend against some danger, but in fact making the danger more threatening and the defense ineffective, is worryingly frequent among groups that decide their conduct collectively, for example by majority vote. Job protection is a classic case. It is not hard to get a majority to vote for “workers’ rights,” including a worker’s right to his job that he should only lose under the most compelling circumstances. In Germany, it is left to the courts to say whether there are really compelling reasons for allowing this, and cases can drag on and on. Only firms with fewer than five employees have a relatively free hand (which provides a good reason for not expanding beyond that size). Comparable “job protection” measures have cropped up in other European countries over the last quarter century, and have mostly been tightened up as unemployment started to become endemic.
German businessmen now say that if you hire at all, you must know that you hire for the very long term and as long as an employee chooses to stay with you, you must pay him, rain or shine. The employer carries the risk that it will rain and not shine, and to cover this risk among many others, he must mentally add a risk premium to the wage he must pay. It is hardly surprising that the effect of “job protection” is to reduce the number of jobs that should be protected. Like the man trying to keep his head above the water, the German job market has been sinking at an accelerating rate; the latest unemployment figure is 10.6 percent, and the latest growth forecast is 0.1 percent per quarter for the current year (the only-just-positive number showing a naive faith in the precision of statistical output and income measurement).
Needless to say, job protection is not the only, nor even the main cause of the appalling performance of the once-mighty German economic machine. “Be assured, my young friend,” as Adam Smith famously remarked, “that there is a great deal of ruin in a nation,” and it took more than just a few manifestly counterproductive measures to bring about stagnation. The ever heavier millstone of the world’s most elaborate welfare state was carried with growing difficulty as Germany progressively emerged from the fiercely energetic and productive era of postwar reconstruction and settled into bourgeois comfort. The loss of buoyancy finally got the best of the “social market economy” that left-of-center world opinion used to applaud as the living proof of the “European social model,” the Third Way, social and market all rolled into one!
Like in other European countries where Left and Right outdo each other in being “social,” many horror stories circulate in Germany about how much it really costs to employ the average worker. Some employers claim that it costs them 300 euros in all the various statutory deductions, health, disability, unemployment and pension contributions, to give their employee a pretax take-home pay of 100. Aggregate national income statistics tell a less lurid, but still fairly preoccupying story. A pretax take-home pay of 58 must be topped up by employers’ and employees’ various social insurance contributions of 48, raising the total cost to the employer to over 100. To this must be added about 20, representing the contributions of the general taxpayer to the various social services. All in all, the total cost of a worker to the German economy is a little more than twice his take-home pay.
Many economists now believe that German labor has become too expensive and this is the root cause of high unemployment. The labor unions, whose power in Germany is still great because of the monopoly role labor legislation reserves for them in wage bargaining, furiously refute this. German wages are in fact too low, they argue, for if they were not, the country would not have a visible trade surplus year in, year out. Once again, here is proof that a little economics is worse than none, for the trade balance depends on many other things, and depends on them more strongly, than on domestic wages. Nevertheless, like the argument of the illiterate that if jobs are menaced, the lawmaker must protect them, the trade balance argument is widely believed to show that wages are not too high and the unions are responsible corporate bodies, exercising statesmanlike restraint in wage bargaining.
Cornered and finally persuaded that “something must be done,” Germany’s social democratic government is now proposing to turn against its own parliamentary supporters and introduce a long overdue reform of the “social market economy.” It has a majority of only eight seats in the lower house, and two-thirds of its legislators are union officials or union members. To pass reform legislation, it needs some support from the opposition, much of which is just as “socially” minded and, if only for sound electoral reasons, may refuse to curtail “workers’ rights.” As a result, the proposed reform package is decidedly timid. Some say it is just a bandage on a wooden leg, though others think that the very fact of a socialist government at last repenting is good news in itself.
A few items in the reform are significant. Entitlement to full unemployment pay is reduced from thirty-two to twelve months, a fixed tariff is proposed for severance pay, and the obligation to engage in industrywide wage bargaining is somewhat relaxed. If they pass, these would be useful measures. Much of the rest is little more than cosmetic. All in all, however, they are far too weak and far too anxious not to hurt, to restore the natural buoyancy of the economy.
Any but the boldest and widest-ranging reform is up against a force greater than itself, the dynamics of the advanced welfare state that acts as a giant automatic destabilizer. The incipient welfare state begins with social services absorbing under 20 percent of GDP. With the economy growing fairly briskly, more can be afforded, and bidding for votes ensures that “social” spending rises to the neighborhood of 25 percent. In fact, by 1990 the fifteen-country European average was 25.4 percent and Germany’s spending was exactly the same as the average. This level seemed sustainable though, from the point of view of productivity growth, probably not desirable. Some items of expenditure grow autonomously whatever you do; health service and pay-as-you-go state pensions are of this kind. Others grow when the economy starts doing less well; unemployment pay does this. The upshot is that the slower is economic growth, the more of GDP is absorbed in social spending.
By 1996, German social expenditure as a share of GDP passed the 30 percent mark, beaten only by a short head by France and the Scandinavian countries. After a slight easing in 1999-2000, the percentage continued its trend rise, and as we write it probably exceeds 32 percent.
Believers in socialist or communitarian doctrines will take it that this chunk of expenditure on all that is “social” rather than “market,” apart from its morally attractive aspect, is really a stabilizer. If things go awry on the market side, they are rescued by the rocklike solidity of social spending that, in addition, makes people feel safer and more willing to spend. I will not try and answer the claim of moral worth except to wonder about the moral worth of forcing workers to spend half or more of their gross wages on compulsory social insurance. Extortion is extortion even if it is “in your best interest.” However, let that pass.
Regarding the effect of a high and rising social service overhead on the course of the economy, to contend that it acts as a stabilizer is tantamount to saying that fewer incentives produce more jobs and more growth. Though such beliefs cannot be categorically disproved, they are very, very unlikely to be true. The commonsense view is that poor economic performance augments the relative share of social spending, and a higher share of social spending leads in turn to poorer economic performance—and so we go on until something totally unforeseen breaks this circle. Until then, thrashing about without quite sinking is probably the best the “social market economy” could hope for.
HOW GERMANY AND FRANCE, THE SICK MEN OF EUROPE, TORTURE THEMSELVES*
What used to be called the “welfare state” has lately been renamed the “European model.” This clever linguistic maneuver is meant to stress that it is the polar opposite of the “Anglo-Saxon” or, worse still, the “American model.” Therefore good Europeans ought to like it as much as they dislike the English and the Americans.
It is an absurd claim that this is a model that all, or even most, of Europe follows. It is essentially Franco-German. This is not the first time, though, that a French interest, idea, or claim is made less provocative by pretending that it is all-European. The “model” has origins in orthodox French socialism, in its Gaullist version, in German social democracy and trade unionism, and in a Christian socialist tradition that, though stronger in Germany, is also alive in France. Ideologically, it is eclectic and somewhat confused, as one would expect in view of its diverse origins.
It has two very basic and constant features, one old, the other relatively new. The old feature is a belief that the distribution of the national income is the government’s business as well as its natural prerogative, and that whatever it happens to be, the government must use its powers to make it tilt a little more, and a little more again, in favor of the lower income groups. It is very important, though, that such repeated redistribution should mainly take the form of “social” benefits in natura, rather than simply cash transfers.
The main ambition of the “model” is to develop an ever-wider system of “social” insurance against sickness, unemployment, and old age, as well as ever longer paid vacations and ever shorter “legal” working hours. This is supposed to be a more proper kind of government solicitude than to help the unions to press for higher money wages. In the deeply paternalistic spirit of its various authors, it is also supposed to be more valuable to working people than giving them the same money in cash rather than in kind. Herein lies the “model’s” most fatal defect.
The cost of all this “social” insurance, except a minor part which is financed from general taxation, is raised by payroll taxes. They are partly employers’, partly employees’ contributions; but this is just an accounting fiction, for in fact both contributions come out of the gross wage the employer pays but the worker does not take home. In Germany and France, taking the gross wage cost as 100, an average of 50-55 goes to social insurance contributions and 45-50 is pretax take-home pay. The two together, however, are not worth 100 to the worker, but always a little less, perhaps 80 or 90, for cash can buy anything (including insurance), but insurance cannot. There is a permanent gap between the subjective value to the worker of what he gets and what it costs the employer to give it to him.
The upshot of this gap—the excess of the cost of labor to the employer over the value of the wage the worker gets—is that the market for labor cannot clear. No matter how desperately governments try to create jobs by fancy make-work schemes, unemployment becomes chronic. In the thirty years since the “social model” has become a political “must,” unemployment has crept up from an average of 4 percent to over 10 percent in France and over 12 percent in Germany.
Unsurprisingly, these sickly economies are incapable of growing at the same rate as their neighbors Spain, Great Britain, Holland, and the Scandinavian countries, let alone the new east-central European members of the Union who benefit from catching-up phenomena. France is lucky to be growing at just over 2 percent p.a. at present, and Germany at half that rate. Neither country’s government seems willing to tell its public the stark truth (as Margaret Thatcher told the British after 1979) that without scrapping much of the “model,” things cannot get better. France’s political leaders, in particular, will do almost anything to appease any sectional interest that shouts “boo!” at them. It is now an open secret that both Germany and France are in decline. They are very much the Two Sick Men of Europe.
Hereby hangs the second, and more novel, feature of their much touted “model.” Any society that is failing and feels its own decline badly needs to reassure itself. Like the Arab societies that have so signally failed and now swear by Islamic values while hating and denigrating the Western civilizations by whose standards they have failed, Germany and France are beginning to talk of their different value system and are showing a violent antipathy to the liberal, Anglo-American civilization that is leaving them behind. “Liberalism” (in the classical sense as it is used outside the U.S.) is now a hate word, almost an obscenity in France, and not much better in Germany. The more Germany and France feel that liberalism and America function while they do not, the more convinced they are that the “European model” is far superior.
Opponents of the new European “constitution” oppose it because it fails to order, by force of law, a “really social” Europe. They would like it to impose stricter labor laws and more generous welfare provisions all over the Union so as to protect the Franco-German center from “social dumping.”
Bitter political adversaries in the two Sick Men countries are equally eager to preserve the “European social model” from the largely imaginary liberal menace, seemingly quite oblivious to the total failure of the “model” to produce the blessings it is supposed to bring. The detached observer must rub his eyes to believe what he sees. Medieval friars and nuns who wore hair shirts knew what they were doing; they were making a down payment on a place in heaven and the torture was worth it. But the hair shirt of the “European social model” tortures the societies that were naive enough to fall for it, without the torture buying them anything beyond false pride. It is a case of sociomasochism where, however, the masochist is not even drawing much perverse enjoyment from the pain it inflicts on himself.
Worse still, the pain hurts most of all the very working class whose well-being the model is meant to promote. Near-stagnant economies with chronic unemployment in the 10 percent range not only demoralize the unemployed themselves. They also undermine the bargaining power of those still employed, and desperately clinging to their jobs. In private industry, management now has the upper hand and can in some cases even impose longer hours, changed work methods, and wage freezes that would have been unthinkable when unemployment was at only 5-6 percent.
It is only in the public sector that labor can still make demands and use the strike weapon. In Germany, where union membership is about 22 percent of the employed labor force, the unions still have some influence in the private sector. In France, with union membership at 7-8 percent, almost entirely in the public sector, the only union presence in the private sector is the paid union official, maintained there by the grace of the labor code and generous government support. It is hard to believe but perfectly true that unions in France no longer ask for higher wages in the private sector by going to the management. They go to the government instead, asking it to tell “big business” to increase wages.
Both governments try to please labor by “job protection” measures of Byzantine complexity. They make dismissal very difficult and expensive, hence hiring new employees very risky. The logical consequence is that net job creation has come to a complete halt. Without “job protection,” one could expect to gain around 300,000 net new jobs annually in Germany and 200,000 in France. Losing this is like putting an extra wrinkle in the hair shirt. Sociomasochism is made more intense. However, smoothing out the wrinkle in the hair shirt by dismantling the more absurd aspects of “job protection” would be a surrender to “liberal heartlessness.”
Sociomasochism is more complicated than common or garden-variety masochism. A sociomasochist society refuses to admit that it is being tortured, and fails to see that the pain is of its own doing. Rather than recognizing its own foolishness, it convinces itself that if it took off the hair shirt, it would feel the cold on its naked torso. Perhaps we may hope that once the air is clear of inane debates about a no less inane new “constitution,” Germany and France can be reminded that the hair shirt is not the only kind of shirt one can wear.
SHALL WE BORROW FROM THE CHILDREN?*
“Tax and spend” is the usual charge levied against democratic governments seeking popular support by dipping into the pork barrel. “Spend and tax” would be more accurate. The typical pattern is for expenditure on worthy and less worthy programs to rise first, with revenue seldom if ever catching up. The money never runs out, for unlike households, the government can always borrow whatever it needs to cover the deficit, almost regardless of how large it is. It owns a sort of widow’s curse whose magic lies in the state’s power to raise the taxes in the future that it has no stomach to raise in the present. The day of reckoning need never come, for old borrowing is always refinanced from new borrowing. The debt-to-income ratio must not get out of hand, but in actual fact the markets tolerate high ratios for unsecured government borrowing, whilst they would demand individual debtors to put up some security.
In the nineteenth century, with Victorian probity permeating both ethics and economics, public deficits were felt to be perilous, and running them systematically a short route to ruin. Modern public-finance theory has reduced these fears to the status of a superstition, knocking down one barrier to the steady rise in the share of the national income absorbed by state spending. Perhaps enlightenment is not always the unmixed blessing that we unthinkingly take it to be.
However, there subsists in the public mind a faint unease about budget deficits. While no longer believing that a state that gets ever deeper into debt will finish by going bankrupt, many sensible people are worried about the propriety of the government doing something on behalf of its citizens that it would be imprudent if not downright wrong for the citizens to do for themselves. It is worth looking more closely at the mainsprings of this unease.
For believers in the freedom of contract, there is no objection in principle to willing borrowers selling bonds to willing lenders; any transaction between consenting adults deserves the presumption of being an improvement in well-being. Good reasons must be advanced to show that this is not the case.
What effectively shatters this presumption is that public borrowing that is never repaid, but is constantly rolled over and keeps swelling in volume, is not a transaction between consenting adults. With only a mild recourse to metaphor, we could represent it as a transaction in which consenting adults borrow from their children and their children’s children who do not consent and could not do so, especially if they are not yet born.
While this undoubtedly deprives deficit financing of liberal credentials, there is no need for moral alarm bells to ring too shrilly about it. It is not the only, nor the gravest, instance of the present generation mortgaging the interests of their descendants. In this particular instance, though, it is doing so not out of sheer selfishness or carelessness, but as the somewhat incoherent, self-contradictory act of a split personality. Its public persona is doing one thing, its private one the opposite.
The great majority of private individuals achieve some positive saving over their lifetime, the ratio of saving to personal income averaging from 2-3 percent to near 20 percent from country to country and year to year. The ratio is highest for individuals near the peak of their earning power and declines in old age, but it seems to be a near-universal aspiration, not confined to people who have children, to leave more at the end of one’s life than one was given at its start. Dissaving via cumulative budget deficits runs counter to this objective. It consumes resources now which would otherwise have been available for future consumption. To add insult to injury, this preemptive move is not costless. Its cost, the debt interest which reflects the present generation’s time preference, will be paid mostly by our descendants through the indefinite future.
Governments buy support by spending money, not by siphoning it away in taxes. Spending now and deferring the matching taxes to an indefinite future is dictated by the most elementary political know-how, and it should not surprise or shock anyone to see it happen again and again, especially when elections approach and politicians start getting desperate. They are not wicked, they are just playing by the democratic rules. That the electorate is quite content with these rules, or at least does not try to alter them, is perhaps more difficult to explain.1 It may be that the bulk of the electorate just does not see the connection and cannot be bothered to think about it. Public choice theory has several other, less simple explanations for the contrast between collective and private behavior. Whatever the reason, they are mutually contradictory and the economic and social consequences are fairly weighty.
The deficit-and-public-debt problem shows up to varying degrees in the USA and most European countries, and very acutely in Japan. The U.S. has tried to stem it by placing a ceiling on the federal debt, a measure whose only effect is to oblige the Congress to raise the debt ceiling every time the rising debt catches up with it. Japan has so far not done anything systematic to control the debt. In Europe, fiscal histories and outlooks differ widely between countries. The twelve states that have adopted the euro have understood that a common currency combined with widely divergent fiscal regimes could give rise to dangerous and unfair free-riding. To forestall this, in the Maastricht treaty founding the currency union they accepted the obligation to keep the national debt under 60 percent and the budget deficit under 3 percent of national income (GNP).
As was obvious from the outset, the treaty obligation is proving un-enforceable. France showed no embarrassment in declaring, almost in so many words, that it will reduce its deficit to the Maastricht limit when it finds it convenient to do so. Less arrogantly, Germany is following much the same course. Only poor little Portugal is scrambling to obey the treaty, for what will not be enforced against big states may be enforced against small ones.
However, it is instructive to see what would happen if euro-zone countries were strictly to stick to the 3 percent limit year in, year out, not deviating from it in either direction. Let us suppose, counterfactually, that they all start with a national debt at 60 percent of GNP. (This limit is in the treaty but carries no sanction.)
What happens under this hypothesis as we move over time depends primarily on the average rate of growth of GNP. Assuming that the zone as a whole achieves growth at 2 percent a year looks optimistic from the perspective of the dismal present, but should be feasible with only reasonable luck. Consider a ten-year time span—not a long time for a currency union. At the end of Year 1, GNP rises from 100 to 102 and the national debt from 60 to 63. At the end of Year 10, GNP is at 122. The national debt rises to 93, which amounts to 76.4 percent of GNP. The longer the period considered, the more glaring becomes the effect of the growth of the debt being faster than the growth of national income.
It would seem, then, that unless economic growth were much faster than we can realistically expect in a zone of welfare states, even durable obedience to some such self-denying ordinance as the Maastricht treaty cannot guarantee long-run equilibrium. Regardless of questions of morality, economic realities alone tell us that “borrowing from the children” had better not become a steady habit.
The tail end of the twentieth century and the beginning of the twenty-first have been exceptionally kind to both capital and labor, but kinder to capital than to labor. Overall economic growth, apart from some sluggishness in continental Europe and Japan and violent but brief upsets in Southeast Asia and Russia in 1998, went on more briskly and for longer than at any other time in known history. While the rise from poverty was the most spectacular in China and India, even such hitherto unpromising areas as black Africa and much of Latin America began to share in the benefits of freer trade, relative peace, and the rudiments of the rule of law.
Within an expanding world income, profits rose markedly faster than wages, so that the relative share of labor declined fairly continuously. This shift in relative shares concerned labor as a whole, and must not be confused with the quite different shift within total labor income in favor of those with higher skills. In fact, separately from the faster rise of profits than of wages, there was a widening of wage differentials, most pronouncedly favoring managerial, accounting, and legal work and computing skills. Unskilled labor and labor using old, established technologies lagged behind. The net effect for labor incomes was a relative loss compared to the income accruing to capital. The era is widely perceived to be one of high profits, low pay.
There was and still is much aggrieved feeling about this by the blue-collar, the casual, and the part-time workers in the Western world, which is understandable enough, and much righteous indignation by socialists of all hues, which is only to be expected. The more muddleheaded blame the IMF, the World Trade Organization, “unbridled” liberalism, greedy multinationals, and the “dictatorship of the market.” It is fruitless to argue with them; if you do, they win by talking faster and louder. More reasoned inquiry about the cause of low pay in the midst of unparalleled prosperity focuses on two major trends, one in trade, the other in technology. The present paper sets equal store by a third. That trend is less widely understood than the first two, but worth close attention for that very reason. It is the rising ideology and the attendant legal machinery of job protection.
The diagnosis that freer trade favors capital more than it does labor runs roughly thus. In a more or less closed economy, capital formation raises the marginal product of labor and leads to higher demand for it. Since the labor force is limited, the wage rate will quickly catch up with the marginal product. As employment approaches the over-full level, labor’s marginal product may indeed fall, for lower-quality workers are employed, labor discipline slackens, and shirking and dawdling involve less risk of sanction. The share of wages in total factor income reaches a maximum. As it now pays to substitute cheap capital for dear labor, the marginal product of capital recovers and capital formation is stimulated. The relative shares of the two factors of production swing back in favor of capital, until capital reaches a maximum and the pendulum starts to swing back toward labor. For decades at a time, the relative shares of capital and labor may change only a few percentage points either way, for the pendulum need swing only a little in favor of one factor of production before it is quickly pulled back in favor of the other. A more or less fixed, inelastic supply of labor is the great stabilizer of this distributive machine.
When such an economy is opened up to the wide world, what happens depends on what the world is like, notably in terms of its factor endowments. Its stock of capital and its supply of labor are the decisive determinants of how freer trade affects income distribution.
In our age, Europe and North America have opened up, first and foremost, to two very large areas in China and India with a huge rural population with no opportunity to deploy its productive potential but eager to do so, and a low stock of capital. As obstacles to trade were partly dismantled and transport costs shrank, the demand for labor of Western capital met, not the limited supply of labor hitherto available to it in the Western world, but the seemingly unlimited supply of Chinese and Indian peasants flocking from rural misery to slightly less miserable urban work. They did not physically move to Europe and North America; the garments, plastic toys, components, electronic subassemblies and gadgetry (and no doubt soon complex, highly sophisticated equipment, too) incorporating Asian labor did all the moving from East to West that was necessary to simulate the conditions of an almost infinitely elastic labor supply in the West. Delocalization of production from West to East, painful to its direct victims and politically poisonous, created more protectionist emotion than its tangible effects might have warranted, but it certainly added to the general sentiment that blue-collar workers in advanced countries were getting a raw deal at the hands of ruthless, greedy bosses trying to please ruthless, greedy financiers. Some of the measures proposed in all seriousness to stop delocalization and curb greedy finance could match Bastiat’s famed virtual railway for silliness.
Under these conditions, as capital accumulation proceeds vigorously in response to the marginal product of capital staying high or rising, the demand for labor increases but the price paid for labor—the price of T-shirts, jeans, plastic articles, consumer electronics—does not increase. In the Western world, the pendulum is not swinging back in favor of labor. Wages in “old” industries lag behind overall income growth and even more so behind profits, even as wages in China and India rise fast as they catch up with the sharply increased productivity of urban compared with rural work. The process leads to convergence of factor prices between West and East, though their actual equalization is no doubt very far off. Meanwhile, in the West “globalization” is blamed, reasonably enough, for low pay.
Economists worth their salt have a more than merely intellectual commitment to free trade, and regard protectionist arguments with no more sympathy than Vatican prelates regard liberation theology. It is in part their subconscious disgust for findings capable of being turned against free trade (such as those detecting some ill effects from “globalization”) that induces many economists to reject the thesis of “globalization” being the root cause of low pay. They are only too ready to ascribe it to technological change instead (and are supported in this stand by recent studies done at the OECD that minimize the role of Asian exports produced by cheap Asian labor and stress the effect of information technology).
When we hear the words “technological progress,” we almost automatically couple them with the words “labor-saving.” Indeed, if technological change is progressive, we should expect it to enable a given output to be produced with less labor, or more output produced with no more labor. We have the mental picture of a little man pushing a wheelbarrow filled with earth and next to it a great yellow earthmoving monster driven by another little man doing what it would take a hundred wheelbarrow-pushers to do.
If it is the case that technological progress is intrinsically labor-saving, then one should expect it to be reflected in a lower marginal product of labor (not to be confused with “labor productivity,” which is total output divided by the number of workers engaged in producing it, and includes the contribution to output of capital as well as of labor) or a higher marginal product of capital. It would explain why the share of capital in total income increases more than the share of labor.
But it is quite wrong to suppose that technological progress is typically, or even predominantly, labor-saving. Those who tacitly assume that it is typically labor-saving nowadays have information technology in mind. However, if you reflect that a few decades ago a mainframe computer would fill a good-sized room and cost many times its handy-sized contemporary equivalent, it will dawn on you that even information technology can be capital-saving. In fact, changes in production equipment can go either way and indeed both ways at the same time, though labor-saving may be more characteristic of it.
Apart from fixed equipment, though, much of the rest of capital employed in the production process is more likely to be hospitable to capital-saving than to labor-saving technology. Two kinds of capital are involved: work-in-progress and goods in transit.
Work-in-progress tied up in producing a given volume of output can be reduced by using statistical probability to estimate the need for various inputs at various times, and by more precise and reliable delivery schedules of materials and parts thanks to advances in logistics. The “just-in-time” methods made famous by Japanese car manufacturers are but a prominent example of a much wider phenomenon that has vastly reduced the amount of capital absorbed in work-in-progress.
Probably more important by a great deal is the effect of advancing transport technology on the volume of both raw materials and finished goods in transit. Depending on the geographical structure of commerce, all goods travel a greater or lesser distance between final seller (the farmer, miner, lumberman, or manufacturer) and final buyer (the consumer). If the average good spends three months in transit on road, rail, and sea and in warehouses and depots, the transit function absorbs a volume of capital equal to 25 percent of physical (goods only) GDP. If advances in transport technology cut average transit time to one month, the capital requirement shrinks from 25 to 8 percent of physical GDP.
These figures, of course, have not the remotest pretension to accuracy, yet may be near enough to reality to illustrate the vast effect that technology is liable to exert in a capital-saving direction. If the numbers are anywhere near reality, the belief that technological progress is intrinsically labor-saving must be at least suspended. As a consequence, it can hardly serve as the most important and most probable explanation of low pay, for capital-saving would, if anything, raise wages.
Neoclassical economics teaches that in large-number interactions where many agents deal with one another, and all or most act so as to maximize some entity that can be represented by “the measuring rod of money,” capital and labor will each earn their marginal product. It will be only just worthwhile to employ the last unit of capital at the going rate of interest and the last unit of labor at the going wage rate.
There are two standard objections to this theorem. One is that it works only under diminishing or constant returns to scale, but breaks down under conditions of increasing returns, where paying capital and labor the values of their marginal products would require more than the total product available. The other, close to socialist doctrine, is that it is impossible to identify the marginal product of a particular unit of capital or labor, for all product is social and must be imputed to society as a whole. Therefore society alone is entitled to decide how capital and labor are remunerated. I shall pass by these two objections. A third seems to me more interesting.
Let us admit that in a static economy, which reproduces itself without any change from one day to the next, a firm can both ascertain the marginal product of its labor force and know that tomorrow and the next day it will be the same as today. In that case it will hire labor if its marginal product is higher than the wage rate, and fire it if it is lower.
In a dynamic setting that keeps changing in all kinds of ways, the firm cannot rationally rely on current experience alone. It needs to form expectations about what the marginal product of its staff will be at future dates. These expectations, though obviously unreliable, are still the best guide the firm has as to whether it should hire, fire, or do nothing. They form a probability distribution, some values of it lying above the going wage rate, others lying below it. Basic decision theory suggests that if the mathematical expectation (“certainty equivalent”) is lower than the wage rate, the firm should “restructure,” “outsource,” “delocalize,” or otherwise contrive to fire some of its workers, lifting the marginal product of the remaining staff.
However, in an economy with freedom of contract, this decision “model” rests on false premises. Suppose that as the future rolls on, times turn out good and the firm’s best expectations prove to have been right. The marginal product is comfortably above the wage rate. It would have been right to hire more labor. Suppose, however, that the firm did not do so, because it was frightened off by the unfavorable half of its expectations, which pulled the “certainty equivalent” down to, or below, the actual wage rate. Now this would have been a rather foolish way to act, for if the firm had hired more labor and found that this did not in fact pay, for times turned out to be bad, it could have without much ado fired those it had hired and suffer little loss; while if it never hired the extra labor and times have in fact turned out to be good, it would suffer an opportunity loss. To rectify its mistake, it could at best belatedly scramble and hire the labor left over by its less timid competitors, while at worst it would miss the chance the good times have offered. Therefore the right decision would have been to hire the extra labor to start with.
The logic of this argument tells us clearly enough that under complete contractual freedom where labor can be hired or fired subject only to the agreed terms of the employment contract, and the length of notice is freely negotiated between employer and employee, there will be a distinct “speculative” incentive for firms to expand. Evidently, if enough firms respond to this biased incentive, it will prove to be a self-fulfilling prophecy. The expansion of many will justify the expansion of each. Subject only to the proverbial slip between cup and lip, expectations held with some, albeit limited probability that times will be good could succeed to bring about full employment and good times.
It needs no great analytical acumen to see that when freedom of contract is suppressed and job protection of some stringency is put in its place, the above argument is turned on its head. If firing workers is made excessively costly, requiring a long-drawn juridical process, or becomes impossible unless justified by manifest problems of the employer’s solvency, the unfavorable half of the probability distribution of future marginal products becomes menacingly relevant, for once it hires them, the firm has to carry its workers almost indefinitely, whether or not it pays to do so. The “speculative” incentive is not to hire, perhaps even not to replace staff lost by natural attrition. A powerful bias toward unemployment is created, and reinforces itself in the manner of self-fulfilling expectations.
As the inexorable force of politics by majority rule continues to strengthen job protection by both labor legislation and the pressure of public opinion, the firm must come to regard its wage bill as becoming dangerously like a fixed cost which it is only prudent to keep lower than would be profitable if it were a truly variable cost. Unemployment, the bias that job protection imparts to the firm’s expectations of probable future outcomes, and the loss of labor’s bargaining power, all combine to keep wages low. Job protection is certainly not the only or even probably the most important reason for the least well-off getting the worst deal in the present era of burgeoning growth and economic serenity. But it is a cause that was meant to have exactly the opposite effect and that it would be fully within political society’s power to remove if only its perversity were more widely understood.
FREEDOM TO STRIKE OR RIGHT TO STRIKE?*
Keep using the same word for two different meanings, and after a while the effect on public attitudes can become momentous.
The freedom to strike and the right to strike mean two different things, just as freedom and right mean two different things. Failure to distinguish between them generates a confused understanding of what is at stake. The confusion facilitates public acquiesence in practices that have two deep vices. They clearly violate the freedoms and rights of the passive victims of these practices, and they can lead to costly and painful breakdowns in the functioning of entire societies unless one party to some pending negotiation bows to the will of the other.
The more advanced and complex a civilization, the more vulnerable it becomes to certain, often very small, groups that are thought to be exercising their “rights” when they interfere with the liberties of others in order to get their way. The current strike of truck drivers in France, the second in two years to involve the blockade of crossroads, fuel and other merchandise depots, and cross-border goods traffic by road, is a case in point. The last one is estimated to have cost 0.4 percent of gross national product. Whatever the present one will cost is too much for France, whose chronic unemployment problem renders it more vulnerable than most to such blows. Yet French public opinion accepts that what the lorry drivers are doing is the exercise of the right to strike.
The dividing line between a freedom and a right is crystal clear and there is little excuse for the sloppy usage that confounds the two. A person is free to perform an act, and therefore to engage in a practice involving such acts, if no other person has a sufficiently strong cause to object to it. To reduce the scope for subjective argument about what is a sufficient cause, society has evolved conventions. These are widely accepted, and in some cases have been formalized and elaborated into laws. A free act, then, is one that no one else has a right to stop.
A right, in sharp contrast, enables one person to require another to perform some act, or to stop performing some other act. I am free to enter or leave my house as I please. However, if I have rented it, the tenant can require me to let him have the keys and stop me from entering it except as authorized in the rental agreement. He has rights and I have obligations which I must fulfill if he chooses to exercise his rights.
The freedom to strike means that there is no sufficient cause for one person, or indeed for society as a whole or its supposed representative, the government, to stop another person (or group) from withholding its labor. When there is a sufficient cause—the maintenance of certain public services and valid employment contracts may count as sufficient—there is no freedom to strike. Otherwise, however, it is generally taken as incompatible with our civilization to force someone to work or punish him if he will not.
The right to strike goes further than the freedom to strike. But how much further? It involves some degree of legitimate power over what others must, or may not, do. The problem is precisely the degree of this power, and it is a very slippery slope. The right to station pickets at factory gates, who should be able peacefully to explain to would-be strikebreakers that it is wrong to be a blackleg, is a small degree of power. How could one object to it on the grounds that it requires the strikebreaker to listen to the strikers? From here, however, very small steps lead to increasingly more robust forms of exercising the “right” to strike. From moral suasion to covert intimidation, overt threats, and secondary picketing of employers not party to a dispute, the slippery slope eventually leads to violent interference with the free conduct of the daily life of ordinary citizens and to blackmailing the government to give the strikers what they cannot get by the mere threat of withholding their labor.
The tragedy is that society usually will not meet such violence with violence because public opinion, especially its literate and idealistic half, would think it wrong to do so. It considers the right to strike as almost sacred because it confuses it with the freedom to strike, and it interprets that right as obliging innocent third parties obediently to submit to whatever the strikers need to make their strike successful.
[* ]First published as part 1, “The Inequality Machine,” and part 2, “Indecent Earnings,” of “The Capitalism They Hate,” by Liberty Fund, Inc., at www.econlib.org on February 5, 2007, and March 5, 2007. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on June 5, 2006. Reprinted by permission.
[* ]First published as “‘Bread and Circuses’ in the Modern Welfare State: Is the Worm Finally Turning?” by Liberty Fund, Inc., at www.econ.lib.org on August 2, 2004. Reprinted by premission.
[* ]First published as part 2 of “Economic Theories and Social Justice,” by Liberty Fund, Inc., at www.econlib.org on June 7, 2004. Reprinted by permission.
[1. ]As the Italian economist and statesman Antonio Martino once put it, this is now a minority opinion voiced by few outside Pyongyang and Cambridge, Massachusetts.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on May 15, 2003. Reprinted by permission.
[* ]First published as “Socio-Masochism: How Germany and France, the Sick Men of Europe, Torture Themselves,” by Liberty Fund, Inc., at www.econlib.org on June 6, 2005. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on November 3, 2003. Reprinted by permission.
[1. ]A well-known theory (Robert J. Barro, “Are Government Bonds Net Wealth?” Journal of Political Economy 82 (1974): 1095-1117) asserts that households knowingly compensate for a rise in government debt by increased saving, because they anticipate a rise in future taxes they (or their descendants) will have to meet. The theory would seem to reconcile the apparent contradiction between public borrowing and private saving.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on July 2, 2007. Reprinted by permission.
[* ]First published in the Wall Street Journal Europe, November 4, 1997. Reprinted by permission.