Tuesday, March 1, 2011

Employment, Mental Models and Killing the Goose

I know you will all be shocked, shocked, to discover that I was particularly excited by chapter 8. I don't think it contains the same kind of foundational insights as other chapters (e.g. knowledge problem, responsibility, the value of liberty, etc.), but I find it to be -- finally! -- one of the rare practical illustrations in a brilliant but overly theoretical book.

First, then, I want to comment on the problem of the employed v. entrepreneurs (in combination with the franchise). Hayek points to an important problem in mental models, and one that ties in with his thoughts on responsibility. Indeed, most people who are employed simply lack a sense of where the money comes from, and come to view their job as an entitlement, rather than an opportunity to create value -- and their salary as automatic, as opposed to a reward for the value they create. In Hayek's language, most people are "largely unaware of the kinds of problems and views that determine the relations between the separate units within which they work" (121) and have "little knowledge of the responsibilities of those who control resources and who must concern themselves constantly with new arrangements and combinations" (122). Think back to responsibility and freedom...

In the non-profit world, I understood this only when I worked in fundraising, as program officers tend to have a sense that there exists a pot of money from which to draw, but the fundraiser knows the money must be raised. In a more direct market sense, think of an associate lawyer at a law firm. Take the example of an associate billing, say 1,500 to 2,000 hours/year, at a billing rate of $200/hour, which represents $300k to $400k of income for the firm. Yet the associate will make (typically) only about $150k per year in salary. "Exploitation!" "Unfair!" cries the associate. But... think about this... the firm is paying, out of what the associate is billing, for overhead (rent, telephones, HVAC), health insurance, secretarial services, paralegals, insurance, partners for mentoring -- and, perhaps most importantly, partners who go out and make rain, i.e. get clients. A law school graduate is perfectly welcome to hang his own shingle and look for clients, but good luck making that kind of money immediately! I have a friend who is now established as a lawyer. After working for a few years as an associate, he took out big loans to open his own law firm. For about the first five years, his employees (associates) made more money than he did, because they were paid a guaranteed salary and he kept the profit (which was minimal, and sometimes negative) after paying his bills and his employees.

Perhaps people in specific professions have a sense of this, but I think most people don't, and come to see their jobs as a responsiblity to punch in, put in eight hours, punch out, and do a decent job in between -- but not necessarily create value. I am reminded of this sometimes when I consider that I have an average of 30 students/class, each of which is paying about $20,000/year in tuition, or $4,000/class if you assume five classes/semester. I certainly don't make $120,000/year for each class that I teach. However, I'm grateful that I can spend my working hours reading, researching, and preparing lectures, rather than having to find students and a building in which to teach them... and face certain semesters where I have many students and make tons of money, and other semesters where I have but a handful of students and can't pay my mortgage. I like having a steady monthly paycheck. Check out Adam Smith's writings on alternate models for professor remuneration if you're interested.


First, I think the employed-voter combination is troublesome, as Hayek points out, because most people don't understand where the wealth comes from that allows them to have a job... and vote accordingly.

Second, a consequence can be taxation of wealth. "Unfair!" they scream. But where does wealth go, and what does wealth do? Well, I doubt many of "the rich" like to swim in pools full of dollar bills, like Scrooge McDuck. Instead, the money goes to consumption (which creates jobs, even if the consumption itself is "wasteful" or "ridiculous" or "ostentatious" -- and frankly, it probably often is, if by my subjective standards); or it goes to investment. "What?" The rich will get richer by investing?" Sure they will! By investing in the economy and making jobs. Check out Mandeville's "Fable of the Bees" on private vices and public virtues." Check out also Frederic Bastiat, generally on "what is seen and what is not seen" and specifically on "frugality and luxury", http://bastiat.org/en/twisatwins.html#frugality_luxury

Third, what of waste? Yes, it's troublesome, and the human in me (as opposed to the economist... check out Deirdre McCloskey's _How to Be Human, Though an Economist_) recoils at the thought of parallel poverty of the many and waste of the few. But... what of the benefits of "waste" (consumption and investment)? Who gets to determine what is waste anyway (back to the knowledge problem)? And what of the unintended consequences of social engineering that violate the knowledge problem (next paragraph?). Hayek has a nice solution, in the form of non-coercive shame like "admiration for the moral tradition that frowns upon idleness where it means lack of purposeful occupation" (127). Even taking the above into consideration, shame lacks the unintended consequences of coercive engineering.

Fourth, on coercive engineering... Again, the market isn't perfect. How could it be? It's made up of fallible humans, who all suffer from a knowledge problem. But let's compare market failure to government failure, rather than comparing the market to some idealized, stylized, fictional Nirvana, then run off to declare that we need government intervention to solve market failure without looking at the shortcomings of coercive intervention. The market may not be perfect, and it may generate outcomes with which we are not comfortable, like income inequality (btw, check out the writings of Gerald Scully, e.g. _Constitutional Environments and Economic Growth_ who shows that income inequality is LESS in freer countries!)... or like poverty side-by-side with wealth. But let's be careful about engineering outcomes that we would prefer. My grad school professor Pete Boettke of George Mason University talked about the analogy of the superhighway of development for post-communist countries. While it would be tempting to take early exits by redistributing income, such myopic considerations would ultimately kill the goose that lays the golden eggs and prevent growth and development... thus preventing the very help to the poor that we're trying to offer. Let us not forget both history and geography. Historically, the poor today and in the 19th century have an awful situation compared to the rich... but not compared to the poor, or to the mass of humanity before the industrial revolution. Geographically, the poor in free societies (those very people who suffer from income inequality) have a hard time compared to the rich, but are doing remarkably well compared to the mass lot of humanity. Last I looked, 50% of humanity was living of $2/day (or roughly $750/year). That's the real problem, and the consequence of interventionism. Compare that to the poor in the US, earning $10k, $15k, $20k/year. Not easy. And we can do better (let's start by cutting welfare programs, regulations and other impediments to growth). But 13 to 25x better than half of humanity... and better rule of law, treatment by police, sanitation, access to courts, etc. Not optimal, and more work to be done (non-coercively, of course, through charitable associations and civil society, outside the growth-stunting effects of government intervention and coercion). But still better.

To finish, then, in Hayek's words:

To prevent some from enjoying certain advantages first may well prevent the rest of us from every enjoying them. If through envy we we make certain exceptional kinds of life impossible, we shall all in the end suffer material and spiritual impoverishment. Nor can we eliminate the unpleasant manifestations of individual success wihtout destroying at the same time those forces which make advance possible. One may share to the full the distate for the ostentation, the bad taste, and the wastefulness of the new rich and yet recognize that, if we were to prevent all that we disliked, the unforeseen good things that might thus be prevented would probably outweigh the bad.

Thanks, Professor Hayek, for encouraging us to be cautious and humble: "A world in which the majority could prevent the appearance of all that they did not like would be a stagnant and probably a declining world." (130)

So the next time I have an extra $200 in disposable income, I'm going to donate $100 to charity, and spend $100 on a nice bottle of vintage champagne... and wonder if I shouldn't feel guilty for being inefficient about donating $100, when I could have spent it on goods or services, no matter how ostentatious, luxurious or wasteful, and thereby help create economic activty, jobs, and growth....

I became an economist, and a libertarian, because I became convinced that the market can feed the poor. I am outraged and shocked and saddened by poverty. But I still believe that markets will do a better (not perfect) job of feeding the poor than will coercive statist inverventionsim.

Perhaps I am a bleeding heart libertarian? Perhaps Hayek was also?

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