URGENT: MAKE A CARBON TAX PART OF CLIMATE CHANGE POLICY NOW

         The latest UN annual report on climate change issues the sternest warning yet that climate change due to human activity is accelerating. This series of reports has triggered two types of responses. The first type calls for government command and control measures that would phase out all fossil fuel-based energy by 2030; this has gained a great deal of attention with the introduction of the Green New Deal.  The second favors the carbon tax, a pro-market approach that would use price incentives to induce market participants to reduce their greenhouse gas emissions. Both strategies will be needed, but the carbon tax is misunderstood and needs further explanation. 

   The atmosphere is a “common access resource.” Consequently, an unregulated “free market” does not require payment when polluters emit CO2 into the atmosphere.  They have an incentive to save abatement costs by using the atmosphere as a free disposal site.  The implementation of a tax per unit of carbon emitted into the atmosphere would insert the missing price per unit of CO2 emission. Profit-seeking firms would be incentivized to direct their engineers and scientists to seek emission-reducing methods that are cheaper than paying the tax.

 Reducing carbon emissions costs money. In an unregulated "free" market, a firm that voluntarily incurs abatement costs places itself at a competitive disadvantage relative to competitors that do not abate their emissions.   The carbon tax applied to all emitters levels the playing field by eliminating the emitters’ advantage:  without the carbon tax, a firm can gain a competitive advantage by emitting more carbon; with the carbon tax, a firm can gain a competitive advantage by emitting less carbon.  

 As the carbon tax is passed on to consumers, they will perceive a change in the relative prices of different energy sources. For example, due to coal's relatively high carbon content per unit of energy, the carbon tax for coal would be roughly twice that for natural gas, providing coal users with a strong incentive to switch to gas. Energy buyers would perceive even lower relative prices for non-fossil energy, like wind and solar, provided they can work around natural interruptions of those sources.  

The Bipartisan Approach

Recognition of the potential of this tax to curtail climate-altering CO2 emissions is growing, and support for it is gaining ground on both sides of the aisle. Recently, Senators Whitehouse (D-RI) and Schatz (D-HI) proposed charging polluters $49 per ton for their carbon emissions. Meanwhile, the Climate Leadership Council (CLC),  a "conservative" organization,  endorsed a fee of $40 per ton. 

This measure would generate considerable revenues (e.g., the CBO estimates that the Whitehouse/Schatz proposal would generate over $2 trillion per decade).  The money could be spent partially offsetting the increase in the national debt resulting from the 2017 recent debt-financed tax cut. Or, the money could be spent to beef up safety net programs for the poor, shore up the national retirement and health programs, and fix the nation’s crumbling infrastructure. Or, it could be spent on speeding up the development of alternatives to fossil fuels. After all, if the scientists are right, we need to make up for lost time.  Finally, the CLC has proposed that the money could be returned to the public in the form of an equal per-person “citizen dividend.” At $40 per ton, that annual dividend is estimated at roughly $2,000 per family of four.  

The Carbon Tax Complements Other Government Regulation.

 Many “small government conservatives,” who recognize the need to reduce CO2 emissions, over-estimate the effectiveness of a “free-market solution” offered by the carbon tax. It has great appeal for them because, as a complement to market forces, they regard it as a substitute for the "heavy hand" of government command and control actions (quotas, bans, equipment requirements, measurement techniques, inspections, and compliance rules that restrict managerial prerogatives). However, while a carbon tax reduces the scope of the required regulatory oversight, it does not eliminate the role for regulation.  The regulatory authorities still will be required to continually monitor carbon emissions to determine how high to set the tax - the higher the tax, the lower the emissions. Moreover, the government must also monitor compliance. So, while the carbon tax creates compatible incentives to reduce emissions, it is not sufficient to absolve the government of all its responsibilities.  

The Carbon Tax is a Start on Net Zero CO2 Emissions by 2050

 According to the CLC, such a hefty tax would induce investment in abatement methods that would keep our emissions far below the 2030 target levels agreed to in the Paris accords. That would be a good start on the "net zero" by 2050,   regarded by scientists as a necessary condition to keep global temperature increase to 2°C. So the carbon tax is a good component in the large set of proposals that must work to re-organize the incentives of 340 million ideologically mixed citizens. The carbon tax gives all decision-makers an incentive to act in ways that save the planet, even if that is no part of their intent.

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

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Roe v. Wade Repeal: Predicted Economic Impact on Women and Families

         On May 10th, in her testimony before the Senate Banking Committee, Treasury Secretary Janet Yellen stated,  “I believe that eliminating the right of women to make decisions about when and whether to have children would have very damaging effects on the economy and would set women back decades.”  She predicted that the labor force participation of women would fall, that their incomes would fall, and that their career paths would be delimited. Committee-member  Senator Scott (R-SC) responded by labeling her analysis "callous." He spoke over her while she was talking, smothering her response: "... that's the truth."     A few days later,  Scott posted an opinion piece in the Washington Post stating that his extremely hard-working single mother had raised her children while working multiple jobs (which would seem to buttress Yellen’s argument, not his). [1]

         Economists have produced a large body of economic research on the relationship between abortion access and the economic status of women. An excellent place to initiate study of the topic appeared on November 30, 2021, on the Brookings Institution website, entitled  "What can economic research tell us about the effect of abortion access on women's lives? [2]" by two economists, Professor Caitlin Myers of Middlebury College and economist Morgan Welch of the Brookings Institution. They point out that in their plea before the Supreme Court to overturn Roe v. Wade, the State of Mississippi asserts “there is simply no causal link between the availability of abortion and the capacity of women to act in society” and hence no reason to believe that abortion access has shaped “the ability of women to participate equally in the economic and social life of the Nation.”  In strong disagreement, 154 distinguished economists provide hard evidence in their September 20, 2021 amicus brief ("friend of the court brief")[3].

The amicus brief is rather long, but a few samples of the findings can be summarized here. From page 10: ”For young women, the estimated reduction in birth rates due to abortion legalization was three times as much as that of all women. Legalization of abortion, together with policies specifically granting young women the ability to obtain an abortion without parental consent, reduced teen motherhood by 34% and reduced teen marriage by 20%.”

Several findings appear on Page 14, which can be summarized: Abortion legalization has shaped families and the circumstances into which children are born, reducing the number of children who lived in single-parent households, lived in poverty, received welfare and social services, suffered child neglect and abuse. Moreover, children in those families with abortion access had increasing rates of college graduation. 

And, from page 23: “Approximately 49% of women who seek abortions are poor, 75% are low income, 59% already have children, and 55% report a recent disruptive life event such as the death of a close friend or family member, job loss, the termination of a relationship with a partner, or overdue rent or mortgage obligations.”

              Because the amicus brief was submitted in mid-September,  the justices and their interns had two months to consider the arguments and evidence presented in it.  But during those oral arguments in December, Chief Justice Roberts interrupted the presentation of the economic evidence and waved it off as irrelevant. Furthermore, in the famously-leaked draft opinion written by Justice Alito, there is no evidence that the economics studies detailed in the amicus brief were taken into consideration, or even read. Evidently, the predictable economic consequences of the court's decision are not considered a part of the decision-making process.[4]  

 

[1] (https://www.washingtonpost.com/opinions/2022/05/17/tim-scott-abortion-single-black-mothers-economic-problems/)

[2] (https://www.brookings.edu/research/what-can-economic-research-tell-us-about-the-effect-of-abortion-access-on-womens-lives/)

[3] (https://www.supremecourt.gov/ DocketPDF/19/19-1392/193084/20210920175559884_19-392bsacEconomists.pdf).

[4] Anyone wishing to pursue this topic further would be well served by first reading the Myers/Welch article in Brookings before reading the wealth of information and references contained in the economists' amicus brief.  

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

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A FIRST LOOK AT MARKETS AND POLICY

    A FIRST LOOK AT MARKETS AND POLICY[1]

         To foster the economic prosperity of a society of 330 million people, the US relies on both a market system and different levels of representative government.  Often public policy questions center on the proper role of government in complementing market activity, and when to let the market self-regulate.  Contemporary headliner examples include whether to control or end the use of fossil fuels; or to regulate health insurance markets or nationalize that service; or to subsidize higher education tuition versus enabling students to finance their education through long-term borrowing.   Questions of this type are inherently political questions, often accompanied by great polarization, angst, and concern over election outcomes.

        Advancement of public discourse about economics requires a common "language," i.e., an understanding of what people mean when they use key economic terms and concepts.  Of particular concern is the frequent use of the misunderstood term: "free markets," a term at odds with core economic analysis of markets.  

        The powerful forces of markets can be used to complement the regulation of utilities such as electricity, natural gas, and cable TV; to guide the construction and operation of infrastructure projects such as streets, roads, bridges, and airline flight paths; and to modulate climate change.  Examples such as these, and many more, show the importance of economic understanding in the development of public policy and in the evaluation of politicians at election time.

       Although every societal problem has a significant economic component, Democrats seem disinclined to use economics in their policy development and public discourse, preferring to frame issues with vague references to fairness and justice.  Meanwhile, self-branded conservatives invoke with gusto the verisimilitude of economics, confidently asserting that economic goals of growth and prosperity can be met within a robust market system that is free of government intervention.   In their telling, "free markets" are self-regulating,  serving the public better than if the government were to intervene.   

Model-Building in Economic Education

   In contrast to contemporary liberals and conservatives, economists are more cautiously analytical in determining whether and how markets can serve the public interest.   Economists introduce economics through the  "competitive market model," a composite of principles describing the conditions required for a market to help society improve its economic well-being despite Nature's scarce resources.

 Profit and Loss

   The process of competition coordinates myriad choices. When buyers can choose among a large number of sellers, those sellers are incentivized to provide goods and services of reliable quality, durability and price. Price is determined by the interplay between sellers’ supply and the buyers’ demand for goods and services.  Investors enter an industry when profits can be expected, and exit to avoid expected losses. Price is forced down by entry or up by exit, until a "Goldilocks" price level is reached at which shortages and surpluses are eliminated: at that price the amount buyers want to buy equals the amount sellers want to sell.  

 

The most surprising and counter-intuitive result from this model is that each of the competitors intends to improve their own profit but the process of competition transforms that intent into a greater quantity and lower price for the benefit of buyers.   This was first proposed by Adam Smith: self-interested profit-seekers  guided by the process of competition – – "as if by an invisible hand" -- to serve the public interest "even though that is no part of their intent."   Smith referred to this as a “system of natural liberty.” 

   This competitive market outcome requires key preconditions, including a large number of independent sellers as well as well-informed buyers.  Economists beginning with Smith have warned against over-reliance on the beneficent outcome of competitive markets without regard to these preconditions. He emphasized the incentive for individual sellers to attempt anti-competitive efforts:   "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."  For example, if firms obstruct the process of competition by forming cartels -- i.e.,  agreements among competitors to reduce total output to force prices up --  consumers are denied the benefits of competition, such as reasonable prices for drugs or gasoline or meat.

Further Toward Realism: Competitive Markets Require Rules Set by Government

   Markets cannot function free of government. Instead, they require certain foundations provided by government, including rule of contract law, property rights law, ownership rights law, and other sectors of the law that form the “rules of the game.”  Because mutually beneficial exchange is central to the functioning of the competitive market, tradable ownership rights must be created and protected.  Although these legal systems are prerequisites for markets to function, they are a public responsibility; markets cannot provide them. 

Another implication of the model that becomes explicit in practice: for the competitive process to serve the public interest, exchanges must be mutually beneficial to all parties affected by the transaction.  Consequently, all costs must be borne by buyers or sellers or shared between them, not shed to "third parties" external to the market's buyer-seller transactions. An example of such external costs would be an agreement between buyers and sellers that imposes noise, or danger, or the sight of ghastly architecture onto people who are not parties to the arrangement.  

"Free Markets" versus Economics   

       The term "free market" is used very frequently in public discourse, particularly by people who brand themselves "conservative," and whose all-purpose policy prescription is tax cuts and deregulation.   When the word "free" is affixed to "market" it conveys a market that is free of government involvement in its operation.    

       Because the economics profession has devoted a great deal of attention to the benefits of competition, "free markets" are often conflated with "competitive markets."  This is a mistake; they are very different concepts.    Economists frame economic problems as seeking ways to improve economic well-being by overcoming some of Nature's constraints on resources -- land, labor, capital equipment, and time.   In that conception, economic freedom rises or falls depending upon whether the society's access to resources increases or decreases, whether that involves government or not.    

Fossil Fuel Freedom?

       The competitive market model not only lays out the preconditions for market efficiency, but it also pinpoints possible remedies when those preconditions are not met.   That is, if those missing pieces can be provided through regulation, then economic freedom rises even though the market is less free from government.  For instance, as the competitive model shows, the market will tend to ignore external costs of the use of fossil fuels (i.e., pollution, emission of heat-trapping gas), and consequently underprice and, thereby, encourage overuse of those fuels.    To correct for the too-low price of fossil fuels, economists recommend implementation of a carbon tax to force buyers and sellers to factor in the external costs to their decision-making. With that correction, economic efficiency rises because of, not in spite of, increased government involvement.  While the market will be less free, economic performance and economic freedom improve.   This example and many more show the inherent contradiction between free-market concepts and the peer-reviewed findings of the economics profession.  

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

[1] This is the first of several articles on markets and public policy, written with the conviction that misunderstanding of this concept, deepened by dis-information from economic opportunists, is central to the polarization facing the nation.  

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THE ROLE OF STUDENT BORROWING IN COLLEGE FINANCE

         The college education is an exploration of the amazing achievements of the human race as well as enabling students to discover their own talent and passion within a galaxy of opportunity.  It is an expensive endeavor; borrowing from the student loan program is an essential part of the strategy to maximize the value of the educational asset.   This is the first of two essays on student loans for the Grassroots North Shore.  It focuses on ways to make high-valued use of student borrowing.    The second essay will present a two-part plan to improve the market for student loans to reduce the burden of repayment. 

         A college education is a costly service and must be paid for somehow.  Students do not pay full cost; in addition to the student share of cost, the remainder is split between state and federal support of higher education,  as well as fund-raising and yield on endowment.   While the total cost of an education has gone up at about the rate of inflation, the state share of the cost has gone down, requiring the share of cost paid by the students to rise faster than inflation.

         45.5 million college students and graduates have built up $1.75 trillion in student loan debt.   It is not uncommon for individual graduates to have ten or twenty thousand dollars of indebtedness,  in some cases much more. Hefty monthly payment obligations begin soon after graduation.  Proposals to ease this burden include making tuition "free" and canceling some or all of the debt already accumulated. 

          Free tuition and student loan cancellation would constitute a  transfer of costs from the student share to taxpayers.  Taxpayers are already under strain, saddled with the cost of public health, prisons, pensions, and the trillions of dollars of debt inherent in neglected infrastructure. Students are under strain, too,  which makes the student loan issue one of the more nettlesome of the prominent issues facing the nation and its voters.

Does Borrowing Make a Borrower Worse Off?

            The math boils down to this:  if  borrowed money is invested in an asset with a rate of return greater than the rate of interest on the borrowed money, the borrower becomes better off financially; if the rate of return is less than the rate of interest on the borrowed money, the borrower becomes worse off.[1]   

         Put more simply: if the borrowed money is invested in a way that enhances ability to repay, the borrower's financial position improves over time.     If a student borrows money to buy the time needed to build an educational asset that will not only be personally rewarding but will also enable a net economic gain after loan repayment.[2]  However,  students who borrow money for college and then earn low grades will not add much to ability to repay. 

Should Low-income Students  Borrow Less or More than Middle-income Students?

          Borrowing does not make poor students poor; they are already poor. Poverty is the problem to be solved; for many poor students, a rigorous college education is a way to solve that problem. A well-regulated student loan program enables the poor students to earn the same degree as the higher income student who doesn't have to borrow from the student loan program.   

 Strategies for Growing the Net Benefits of College 

         Targeted high school preparation can reduce college costs and grow the benefits.   First up:  computer skills.   College is high-tech these days in virtually all disciplines across campus,  from science and engineering to social science, humanities, and fine arts.      Textbooks come with ancillaries such as websites,  electronic problem sets,  video clips, and tutorials.  Similarly, modern technology enhances communication with professors, teaching assistance, and other students.   The high school years are a good time to enhance computer skills.  

         Second: English and math are the languages central to the study of the wide range of knowledge available for guided study in college. The non-routine projects required during a rigorous college education require skill in writing,  revising, and editing essays as well as the intricate strategies for math problem-solving.   High school elective courses that require expository writing and word problems in math help prepare. 

The Danger of Borrowing Too Little

          Working at low-paying jobs that consume a lot of time and energy could be counterproductive.  Often the time would be better spent in pursuing high grades in a rigorous education, even though that path might require additional borrowing.    When prepared and mature enough,  students should borrow to buy the time needed to earn high grades.   

The Double Major Option

         As Payscale.com reports, some college majors have a higher lifetime financial pay-off than others.      Students whose passions are enlivened by a major with little likelihood of financial payoff might combine that interest with a more financially promising second major. For example, one of the high-paying engineering majors, or business finance or economics could combine with social science or humanities major. Such combined study can fulfill both intellectual interest and financial security, including the ability to repay student loans.  

         Education is a lifetime asset of greater value than any other. Borrowing enables students to enhance that value.  The next essay in this series includes suggestions for improving the loan repayment formulas to reduce the repayment burden so that students can more fully enjoy the benefits of their asset.     

 

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

  

 

[1] Private sector banking industry requires borrowers to pledge guarantees to the bank, called "collateral," of assets that the bank can take possession of should the borrower default on repayments. Federal student loan guarantees substitute for that collateral, and direct federal loans do not require collateral.

 

[2] See Payscale.com for data on the returns to college by type of degree and major course of study.

 

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EASING THE BURDEN OF STUDENT LOAN REPAYMENT

EASING THE BURDEN OF STUDENT LOAN REPAYMENT

 College students face rising costs in two ways:  first, tuition has risen as states have cut back on their support of higher education. Second, the number and frequency of course offerings have been reduced, increasing the time to graduation, which further adds to the student's total cost of education. In response, many students  take out large loans and/or work long hours at low wages in the hope of building an educational asset of incalculable value that will last a lifetime. Various relief measures have been proposed, including  “free college tuition” and student loan debt forgiveness.

Two-part Plan       

                Here's a plan targeted to the two trends that have imposed the greater repayment burden:  the government/taxpayer share of higher education costs as well as the student loan repayment schedules.

 Part I: Government/taxpayer Share

             Taxes are already high; we cannot expect the taxpayer share of college tuition costs to be returned to 80% -- last seen in the 1970s --  let alone 100%, or  “free college.”   Since college graduates will, on average, eventually earn more than today’s average taxpayer, a free college education would involve a transfer from the average working person to those who will eventually be financially better off.   Still, society at large does benefit from an educated populace, so the first part of the plan is a compromise taxpayer share of 50%.  

Part II: Reformed Loan Repayment Schedule

             To reduce the loan repayment burden,  student loans should be spread over the earning years,  a term of 30 to 40 years. As with other long-lived assets, such as houses and commercial buildings,  the student loan term would reflect  the life of the asset.

            In addition, the annual dollar amount of the repayment should be capped at some low percentage of the graduate’s annual income -- e.g., 5%.  With such a cap,  the dollar amount would rise and fall with income until the debt is repaid in full, including interest. Because the years just after graduation are often low-income years (especially for students graduating during a recession or a slow national job-market recovery), the loan repayment burden is most pronounced during those years.  A fixed percentage rather than a fixed monthly dollar amount would bring the pattern of repayment in line with the graduate’s pattern of earned income.

 

To see how this would work, consider a recent college graduate whose first job pays $36,000 per year. The student loan repayment would be capped at 5%, or $1800 per year,  $150 per month. If after a time the student's income would rise to, say, $50,000, the cap would rise to $2500 per year or $208 per month. Of course, different percentage caps could be agreed-upon: if the cap were 3% of annual income, the yearly payment based on $36,000 per year income would be $1080, or, $90 per month.  With such a fixed percentage cap formula in place, the repayment would fall automatically for the graduate who suffers a period of lower pay or even unemployment.   

To assure a high repayment compliance,  the loan should be collected by the federal internal revenue service; repayment would simply become part of paying taxes, which are not  dischargeable in bankruptcy. 

                A properly designed loan system would enable college students to focus on maximizing the value of their educational asset, studying more hours per week, taking more rigorous courses and majors, and graduating sooner with higher grades.   Their capacity to repay the loan would be increased by an enhanced learning experience and earlier entry into their chosen career path. College is a long-lived asset; both society and the students gain when we treat it that way.         

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HITTING BACK WHEN CHARGED WITH “SOCIALISM”

It's that season again: Republicans are claiming that  Democratic Party office-seekers have taken a “hard left turn” toward socialism. This gambit evokes powerful negative imagery: economic failure, soup and bread lines,  the suppression of individual initiative and innovation, and gulags for those who complain.  This rhetorical device distracts from the difficult issues facing the public, as well as deflects responsibility for resolving those issues.  The best defense is a quick pivot to offense, incorporating mainstream economics in the response. Consider a few  examples:

Economic Issues of Great Concern to Voters

 Many of today’s concerns (health insurance, infrastructure, climate) derive from the failure of the market sector to perform well (often dubbed "market failure") or from the failure of the government sector to perform the functions assigned to it (similarly dubbed "government failure"). As the socialist label is tossed around, both voters and pundits must keep in mind a guiding economic principle: capitalism requires efficient provision of public assets that private markets will not provide. Moreover, because capitalism requires a well-functioning public sector, it is crazy to call public investments "socialism."   

 We do not face a choice between capitalism and socialism: all capitalist economies are “mixed economies” in which a large number of activities are directed by private market forces while others are directed by government forces. In those sectors where market direction is chosen, profit-seeking private firms will compete to provide those goods and services that can be owned by individuals and bought and sold on markets. In those sectors in which government direction is chosen, the means of production will be owned collectively and directed by bureaucracy and elections and paid for with taxes and user charges.  

Because capitalism is such a successful wealth-producing system, the American presumption is that goods and services are best directed by market forces rather than through government direction. However, the challenge for modern society is not to choose markets in all sectors of the economy versus government ownership of the means of production in all sectors. Instead, it is to determine task-by-task, sector-by-sector, whether private enterprise markets or a well-chosen level of government would be the better allocator of resources within each sector.  In transportation, for example, while roads and bridges are built and maintained by government, the cars driven over them are produced by private enterprise

 Two types of error can be made: Type I is the error of implementing government ownership of the means of production in a sector that would be better served by market forces. Type II is the error of relying on markets when government ownership of the means of production would serve society better. Steady improvement of an economy’s performance depends on avoiding both types of error. 

Hitting Back When Hit with the Charge of “Socialism”

          Candidates can use well-accepted economics to hit back sharply when confronted with a charge of socialism, with responses such as these:

On Deteriorating Roads … “We are plagued with terrible road conditions that increase costs for commuters and business firms.  Fixing roads requires a collective initiative. … and money. To pay for the roads, we need user fees to require that those who use the roads pay for them. For now, that means raising fuel taxes; as technology improves so will better ways to impose user charges. It is ridiculous to apply the term "socialism" to investments in roads and the user charges to pay for them; roads provided publicly are essential for capitalism to thrive, and user charges employ one of the hallmarks of markets, which is using prices to require users to pay for what they use.” 

On Health Insurance … “My opponent claims that the Affordable Care Act will lead to socialized medicine. Not true: as shown by the Heritage Foundation, a pro-market think tank, market insurance alternatives that are unregulated cannot provide universal health insurance coverage. Why not? Competition would force insurers to charge experience-rated premiums, i.e., charging higher premiums to higher-risk policy-holders. Low-income people, and those with pre-existing conditions, would be priced out of the insurance market and lose access to basic medical care.” 

On Greenhouse Gas Emissions … “An important first step in addressing the climate threat is to recognize that the current cost of emitting carbon is too low; polluters use the atmosphere as a low-cost waste dump. Consequently, polluters are encouraged to overproduce and underprice their products.   To re-direct those market forces toward reducing carbon emissions, we should follow the advice of the Climate Leadership Committee and implement a carbon tax of $40 per ton of carbon emitted, which will generate a $2,000 per taxpayer rebate.   My opponent calls this socialism. Ridiculous. The carbon tax is an example of how to use market forces to reduce global warming pollution to sustainable levels."   

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

 

 

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The Essential-Worker Paradox

       Ordinarily, the contribution of sanitation workers, store-shelf stockers, bus drivers, delivery people, emergency medical technicians, childcare providers, and many others, are routine, unnoticed, and taken for granted. During the covid pandemic, however, the general public became acutely aware of their dependence on these essential workers. But if their value is so high, why is their pay so low?

 The Diamond-Water Paradox

The quandary of value versus market-determined price has a long history in economics.    250 years ago Adam Smith, founder of modern economics, examined the logic of the problem when he posed the Diamond-Water Paradox: Why does water, essential for life itself, sell for a low price, while gem diamonds, mere adornments, sell for a  high price? Smith never solved the riddle; it was not until 1816 that David Ricardo observed that this is not a paradox at all; price and value are very different economic concepts.   He explained that the value of water in its use —  especially the life-sustaining uses —  is greater than its price in market exchange. In fact, the two measures can move in opposite directions:  the greater the abundance of water the greater its value in use but the lower its market price.

  Applying Ricardo’s logic to labor: wages paid do not measure the total value of what workers produce any more than the price of water measures the value of water in its many uses. Just as the market price of water lies far below the total value of water, the wages of essential workers under-represent the value of their work. 

The Market Distributes Surplus Value Upward

       When goods and services are bought and sold in the market system, those exchanges generate surpluses, defined as the excess of value over price.  The surplus value resides in the work product, not the wage.  Those with more disposable income can purchase more goods and services, and, in turn, acquire more of the associated surpluses; those who are paid less are constrained to buy less and so acquire less of the surplus.   Therefore, because the surpluses are enjoyed by those who own the work product and are not included in the market wages paid to the workers, the market forces will redistribute the surpluses to the higher-income people who can afford to buy more of that work product.  

       Although market-determined wages do not measure the contribution of labor to national wealth, markets do perform a very important “allocative” function in the labor market: they equate “supply and demand.”  That is, the market wages are determined at the level where the quantity of labor that employers want to employ equals the quantity of labor that workers want to offer.  

Sharing the Surpluses.

A society that recognizes the mismatch between wages and value of work-product commonly wishes to supplement the low incomes of essential workers, either in kind or with money payments.  One way is to use progressive income tax revenue to provide public goods of benefit to those workers, such as education, health insurance, transportation, and enabling them to vote in minutes rather than hours. Most Americans, certainly most of the essential workers, rely on these public resources for their health, safety, education of their children, and other social investments and risk-sharing insurances.  Such a redistribution requires a political role in mediating market forces through a democratically-elected representative government.

A second way is to use general taxes to finance wage supplements. Such staunch adherents of market economics as Milton Friedman and Ronald Reagan advocated using the tax system to supplement low-wage work. During the Reagan administration, this redistribution was implemented through the “Earned Income Tax Credit,” which reversed the flow of taxes for low-income workers: instead of paying into the tax system, these workers would receive wage-supplement payments from the tax system. These wage supplements could take the form of bonus payments paid to emergency health workers as “hazardous duty pay,” or even universal basic income, core support for low-income citizens.

Such redistribution uses market forces to offset some of the upward distribution of surpluses inherent in labor-market transactions.  Markets are great producers of wealth through the coordination of incentives, but political intervention is needed to distribute the wealth more in line with individual contributions to the total. 

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

 

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CAPITALISM REQUIRES A WELL-FUNCTIONING PUBLIC SECTOR

          In this campaign year, much of the time will be occupied by discussions of the huge cost of President Biden's infrastructure packages. It will be called fiscally irresponsible; some will call it "socialism."       Now is a good time to bring up two points. The first is the impact of infrastructure on both productivity and cost within market activities.  That is, the synergy of infrastructure and the functioning of the market system.     

         Second, the charge of socialism will be a reliable Republican campaign smear tactic. When applied to infrastructure spending, the accusation reveals a special case of economic ignorance because capitalism requires a well-functioning public sector.   It is also laughably ignorant since it violates not just economic logic but fundamental logic as well.  

The Market System Requires Public Sector Infrastructure.

         There are certain things that provide benefits to society and enhance the market system that the market system does not have the financial incentives to provide for itself. Among these are hard infrastructure assets; i.e., streets, roads, bridges, sewer systems, water systems, broadband, etc. These are assets that can be invested in during one period of time in order to produce public (and private sector) benefits in many future periods of time. All of these assets add to labor productivity in the marketplace.[1]

         The cost of market activity tends to rise and fall inversely related to the rise and fall of productivity. This has two major impacts. First, when productivity rises and costs fall, the cost of doing business within the state of Wisconsin falls. As a result, the competitiveness of Wisconsin to attract more business increases. 

         Secondly, increasing productivity is one component of the never-ending battle with price inflation. When productivity grows, it is reflected in slower-growing producer prices.  In turn, lower producer prices will -- after a time lag of a few months --  be reflected in slower-growing consumer prices.

Wisconsin’s Hard Infrastructure Report Card

          The American Society of Civil Engineers provides a report card for each of the states, and Wisconsin is not doing well. Some of the state's more prominent public assets are getting terrible grades. For instance, bridges are assigned a grade of C+, which means terrible road surfaces, time-wasting lane closures as well as occasional closures of entire bridges.  Because bridges are usually built in places where there are no nearby alternative routes, these lane and bridge closures impose gigantic time costs on commuters and freight haulers.

 

         Drinking water earns a C- grade -- and that's an average:  in some municipalities, the residents have to use boiled or bottled water. Ports earned a C+; how is Wisconsin supposed to move heavy manufactured goods to the world through Great Lakes Ports that are not in good working order? 

         Roads in Wisconsin earn a D+.  Prominent economist Lawrence Summers has estimated that roads in such poor condition cost car owners more in repair bills than it would cost to fix the roads; such is the idiocy of long-term neglect!

The Charge of Socialism

         There is an election coming up in November and the opposition ads have already begun to label government expenditures on infrastructure as "socialism." Advocates of spending on these productivity-enhancing assets should get ready for this onslaught.  It is an absolutely ridiculous charge because capitalism requires a well-functioning public sector that includes roads and bridges.

         Case in point: Interstate 43 from the City of Milwaukee to Green Bay is in terrible shape. North of the city, and well into the next county,  this is a commuter route,  congested at every rush hour and often in between. This 10-mile stretch is in a D+ condition and an additional lane has been called for the past 20 years.   All of this is underway right now. Time costs will fall and smooth surfaces will increasingly greet electric cars and electric buses and vans for commuters as internal combustion vehicles are replaced. Those buses and vans will enable city residents to take jobs north of the city, where there are many advanced manufacturing and other state-of-the-art employers providing jobs with the promise of upward mobility.  This is a win-win for our employers, our citizens, and Wisconsin.

 The Socialism Smear Violates Logic 101

             The logic is simply stated:  socialists advocate government ownership of the means of production, therefore advocates of government ownership of means of production are socialists.  It's as if repairing a road or a sewer system is a mile down the road to serfdom where gulags await those who complain.

          This logical fallacy is known as "affirming the converse."  Students are warned to avoid this fallacy in formal logic courses, and students in good geometry classes encounter it in high school.  Affirming the Converse is so absurd that the fallacy is often explained with derisive examples,  such as Green Bay Packers are all strong men;  therefore all strong men are Green Bay Packers.  Or: all dogs are mammals; therefore, all mammals are dogs.  Still, the rhetorical ploy is used all the time by faux conservatives, basically because they know they can get away with it unchallenged by their opposition and by journalists.  

         This charge of socialism is an exercise in economic ignorance that would be comical if it were not so damaging to the nation, the localities where the infrastructure would be built,  and the wages and working conditions of the people who would do the building. The infrastructure is a public responsibility because only the public can earn a cost-beneficial return on investment in these public goods.  Hard-working and skilled workers are ready to bring the infrastructure report card up to straight A's, and earn family-supporting incomes while doing it.    

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

        

 

[1] Topics for future essays in this series:  investments in people, such as the child tax credit, subsidized college tuition, nutrition programs, etc, which, like infrastructure,  also raise productivity.  

 

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EFFICIENT GOVERNMENT IS OFTEN COUNTER-INTUITIVE

In every election cycle, some of the candidates running for national office claim they are running against Washington. They claim that only people with their particular life experiences have the transferable skills to free the country from an alleged mess created by career politicians.  Consider the Republican primary race to succeed retiring Senator Rob Portman of Ohio.   Josh Mandel, who served as Ohio Treasurer and served honorably in Afghanistan,  assures us that when he gets to Washington he will not only "drain the swamp" but also "blow up the swamp."  Another contender for that Senate office is prominent businessman Mike Gibbons who asserts his comparative advantage is great business acumen honed in the private sector.  Consider, too, Wisconsin's Senator Johnson, currently running for a third term, who often touts his business experience and his accounting training as giving him essential insights into the importance of shrinking the government.   

Should  Government Be Run Like a Business?

The frequently-heard assertion from office-seekers who lack public-sector experience is that government should be run like a business;  if it were,  the U.S. would be solvent, more efficient, and more prosperous.  Along with this misconception goes its corollary: private sector CEOs are “job creators” and government is a job killer. As with many trivializations in economics, this one resonates well with the public but it is dangerously wrong.

The reason this is wrong is derived directly from the free-market model, a  concept initially proposed by Adam Smith and rigorously developed since. The model is routinely taught in economics classes and business school prerequisite classes and shows that the public interest is served best by competition among firms and their investors, even though the public interest is not part of the decision maker's motivation. But it also shows that when the pre-conditions for competition do not exist, market efficiency requires intervention by government.  Economic activity, including job creation, requires a great confluence of inputs as well as coordination of the public and private sectors.  The private sector firm is necessary for most of the jobs created, but it is not sufficient.  Public goods (roads, schools, universities, courts, and law enforcement), paid for with taxes, are essential components of successful job creation efforts.  Moreover, government often has to promote the process of competition, as well as ward off recession and high unemployment.

The Private and Public Sectors are Complements

The economy is not a large version of a business firm. Managing an economy requires a more comprehensive economic model than the one followed in managing a firm.  A firm is a small piece of a very large puzzle. To manage a firm, CEOs employ "microeconomic" reasoning to guide all aspects of their puzzle piece: e.g., financing, marketing, and operating decisions.    By contrast, managing an economy requires an understanding of macroeconomics, which focuses on the aggregate behavior of firms in the economy, i.e., how all the puzzle pieces fit together.  For example, a properly-run government will counter the business cycle by dampening an expansion to control inflation and softening a downturn to limit unemployment. A properly run business firm, even a very large one, cannot hope to modulate economy-wide swings and instead must accept its limited role within the economy.   

Consider the different strategies pursued by firms and governments during recessions.      Firms suffer reduced demand for their products and services. Consequently, to survive a recession and prepare for better times, a firm has a strong incentive to contract.  But business leaders who "tighten their belts" during recessions often have a hard time understanding why the government orders a bigger belt.  Economic activity encompasses four categories of spending: consumption, private sector investment, net exports, and government. In the disastrous recession of 2008, the first three of these categories declined.  Mark Zandi, chief economist at Moody's Analytics, estimated that, if the government had also tightened its belt, unemployment would have risen to 15 percent.  Instead, it peaked at the still-terrible rate of 9.5 percent.  In other words, the recession would have been much worse had it not been for government intervention. 

Similarly, in 2020, during the pandemic and prior to the successful distribution of a vaccine, many businesses were shutting down due to collapsing demand and, in many cases, were forced to shut down by government order. As the economy lost 21 million jobs in a month and a half, the federal government frantically borrowed and spent $3.1 trillion in just one year. This counter-cyclical spending shored up businesses and households which otherwise would have been lost.

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

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NO SENATOR JOHNSON: SOCIAL SECURITY IS NOT A PONZI SCHEME

               Senator Ron Johnson recently told a group of donors that Social Security should be privatized because “it is a Ponzi scheme and the bonds in the Social Security Trust Fund are worthless.” In doing so, he demonstrates his misunderstanding of  Social Security and of Ponzi schemes. 

            A Ponzi scheme sets up a fund and attracts investors who buy shares of that fund on the promise of very high returns on their investment.  But there are no real resources backing up the fund, nor is there a reasonable-risk venture such as car production,  or a medical technology invention.  Instead, there is simply a sequence of investors in the fund, with early investors gaining a return via payments out of the fund financed by the payments into the fund by later investors.   As the high returns get paid, the news travels fast, and more and more investors gleefully invest. As long as each successive group of investors is sufficiently larger than the preceding group, the promised returns can continue to be paid, and, of course, the scheme organizers reap huge profits as well. Eventually, however, the laws of arithmetic catch up with the Ponzi scheme.  It becomes impossible for each succeeding investor group to be larger than the preceding group; the investor returns collapse, disappointed investors sue the scheme organizers, and, as in the cases of Bernie Madoff and Charles Ponzi, the organizers serve prison terms.

 By contrast, Social Security is remarkably solvent; the system is going strong after 80 years, never having missed a payment. It is an insurance program backed by real resources, i.e., the taxes paid by current workers as well as the bond fund to be explained shortly. Most workers are required to participate by paying a payroll tax as their contribution to insure against poverty in their old age. It is designed as a “pay-as-you-go” system: current workers pay for current retirees with the expectation that, when they reach the age of eligibility,  future workers will pay their Social Security benefits. This can be reasonably expected because over the decades each generation has added to and passed on the physical and knowledge capital of the nation. As a result worker productivity per hour has been increasing at a rate of roughly 1.5% annually. The immense value of this transfer of productivity from old to young enables younger workers to produce the national income out of which the old take their piece. There is no similar reciprocity in a Ponzi scheme.

            Such pay-as-you-go systems are stable if each succeeding generation has a bit higher total productivity than the preceding one.  Even though productivity per worker is rising, stability of an intergenerational financing of the Social Security system is hard to achieve when one generation is much smaller in number than the preceding one. Just such a problem was created when the baby boomers numbered 77 million and the subsequent generation numbered only 47 million. In 1985, when President Reagan foresaw the problem Social Security would face by 2012 when the boomers would begin to retire, he augmented the original pay-as-you-go design by increasing the payroll tax rate.  This forced the boomers to add savings of their own to the payroll taxes they were already paying.    

            To understand the Reagan plan, we must follow both cash and bonds. Beginning in 1985, the increase in the payroll tax rate drove receipts above payments of retiree benefits, the difference generating a surplus. These surplus dollars were invested in a "Trust Fund," a reserve of special-issue US Treasury bonds that can only be traded between the US Treasury and the Social Security Administration. During the years that Social Security holds these bonds, Treasury has the corresponding cash, a chance to boost national economic growth by investing in assets like roads, bridges, broadband, and port facilities.  Whenever payroll tax revenue is insufficient to pay scheduled retirement benefits, either due to the large number of retirees or setbacks such as the Great Recession of 2008-09 or the COVID-19 crisis of 2020, the bonds can be cashed in to add to the payroll tax.  Contrary to Senator Johnson's misunderstanding, the bonds are definitely not worthless; they represent money loaned to the general public by boomers during their work years to be repaid later during the boomers’ retirement years.  If the bonds were worthless, then the Reagan plan would have been massive theft. Fortunately, Ronald Reagan was no Charles Ponzi!

            In the original 1985 plan, the payroll tax rate was calibrated so that the bonds would run out around 2060 after all but the most persistent boomers will have passed on. However, the combination of slower-than-projected economic growth plus the blessing of longer life will exhaust the bond fund around 2034. At that point, the payroll tax revenue will be about 79 percent of what is required for scheduled benefits. Consequently, just like a private insurance plan adjusts to changing demographics and returns on endowment, adjustments will be required to Social Security.  Phasing in small changes, such as an increase in the eligibility age and raising the top end of the taxable income range, will make up for the shortfall.  

  Social Security is not a one-way transfer of funds from workers to retirees. Rather, it is a program that recognizes the reciprocity between generations. In a market system, with well-functioning capital markets, each generation’s productivity is enhanced by the efforts of preceding generations, and each generation pays a part of that increased productivity in the form of retirement benefits for the generation that made it possible.  The young pay the old out of enhanced productivity made possible by the old when they were young. 

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.

 

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