New Solutions to the Knowledge Problem?

In teaching my students the foundations of the capitalist system each fall, I often begin my course with Hayek’s most famous (and possibly most important) essay “The Use of Knowledge in Society.”  In this article, Hayek makes possibly the two most important points in understanding how and why free markets are the only means to efficiently allocate resources:

  1. It is impossible for any individual or group to possess complete knowledge of all the information necessary to determine how and where resources should be used.
  2. Yet, there must be some means in place to aggregate all this knowledge in order to then communicate how resources should be used.

So, all this dispersed knowledge is necessary to determine how resources should be used but there is no individual or group that can attain complete knowledge.

Some would argue that we simply need to employ smarter mathematical algorithms, use more computing power, and certainly we can determine the use of all resources.  That was the problem with the Soviet system, Stalin simply needed computers to determine how to manage his Marxist experiment.

Hayek goes on to explain that the knowledge needed is dispersed among millions and millions of individuals, and this knowledge is unique to people all over the world.  No individuals or computers could instantly and constantly gather the information needed to determine how many iPhones to produce each day, or how many acres of wheat to grow each year, or how many tons of steel to produce, or how many boxes of Cheerios to manufacture, etc.  Additionally, this knowledge is necessary to determine if copper should be used to produce pipes for plumbing or wiring for electronic components.

Thus, there are no “new” solutions to this knowledge problem that Hayek wrote about in 1945.  Even with all the computing power in the world, and all the sophisticated mathematical models a price system is the only means by which this dispersed knowledge, necessary to communicate how resources are to be used, is aggregated.  Free and unregulated prices are the only mechanism which can communicate the correct information to both producers and consumers throughout the world.

Hayek’s writing is as true today as it ever was.

North Carolina and Small Business Friendliness

Depending on the way it is measured, at least half of all workers are employed by small business and these firms account for two-thirds of all net new jobs. Thus, incentivizing the growth and proliferation of small businesses should be a key component of any state’s economic growth policy. Unfortunately, according to a new study by Thumbtack and the Kauffman Foundation North Carolina ranks the worst in the Southeast (Florida has the same ranking but beats North Carolina with many tax advantages).

The North Carolina legislature has made some improvements on easing some taxes and licensing, but many regulations and tax hurdles remain.  When each state that touches your border has a friendlier environment for small business development, there is cause for concern and those in Raleigh should take notice.

Inequality and Polarization

French economist Thomas Piketty has a new book that has captured the headlines.  He calls for a global tax on wealth to “solve” the problem of inequality brought about by capitalism.

Ben Domenech provides advice on how to approach the inequality issue that so many argue is simply an income problem that can be handled with more forced transfers.

Mobility and Income (Inequality part two)

Matthew O’Brien of the Atlantic reviews a recent study by a group of Harvard and UC Berkley economists on intergenerational mobility in the United States.  The core finding from this research is that the ability for someone to move up the social scale in the United States (i.e. moving from the bottom twenty percent of households to the top twenty percent), is geographically limiting (and especially limiting in the South).  Specifically O’Brien summarizes:

“Kids born into the bottom 20 percent of households, for example, have a 12.9 percent chance of reaching the top 20 percent if they live in San Jose. That’s about as high as it is in the highest mobility countries. But kids born in Charlotte only have a 4.4 percent chance of moving from the bottom to the top 20 percent. That’s worse than any developed country we have numbers for.”

Thus, what matters for future income potential is not only where your family lands on the economic spectrum, but also where your family is living.  This may seem obvious due to the varying economic conditions around the country; but, tax differences, schools, labor markets, manufacturing jobs, etc., do not appear to make a significant difference.  So what does matter?

Again, O’Brien highlights several points the researchers find that help explain the geographic mobility differences across states and regions and one point stands out:

Family Structure. Forget race, forget jobs, forget schools, forget churches, forget neighborhoods, and forget the top 1—or maybe 10—percent. Nothing matters more for moving up than who raises you. Or, in econospeak, nothing correlates with upward mobility more than the number of single parents, divorcees, and married couples. The cliché is true: Kids do best in stable, two-parent homes.”

I recently wrote about the economic costs of the changing family structure in North Carolina.  It’s no surprise that kids have the best future possibilities if they remain in traditional two-parent families.  Statewide divorce rates certainly don’t explain all the difference in mobility between San Jose and Charlotte, but North Carolina’s divorce rate is 25% higher than the rate in California.  O’Brien rightly notes that redistribution policies will not solve the economic mobility problem faced by many North Carolinians, but it is also not simply about better schools or more jobs or an increase in the minimum wage.  Policymakers would do well to address issues that impact family structure, like education and incentives for marriage and the importance of raising children in a traditional family structure.  This leads to less crime, less mental illness, and greater academic achievement, which are all key variables in economic mobility.

Inequality – The State of the Union

President Obama has recently claimed, and reiterated in his state of the union address, that income inequality is the defining problem of our time.  Inequality is more harmful to humanity than terrorism, tyrannical governance, nuclear proliferation, disease, etc.  Yet, even if we agree with Mr. Obama the questions of why there is such inequality and how to create more income equality (assuming this is the goal) seem to be lost on the president.  In fact, Mr. Obama must know that his “solutions” to this problem have much political weight but little hope of a practical impact.

Why is there so much inequality?  Depending on who you ask, the answer is typically some version of the following: Individuals can attain higher incomes via hard work and productivity yet many others don’t have the knowledge or skills to do so, and this is the way it should be OR there is not enough income redistribution.  The U.S. is going to have wealthy people and poor people (no one disputes this), but the question is should government do more to close the gap between these two groups.  If you look at all the developed countries in the world that have more equality than the U.S., they are mainly concentrated in Europe and they all have significant redistribution programs in place.

The irony here is that in the president’s state of the union address this week, despite all the talk about working and work ethic, his solutions to inequality are impotent to actually make a difference.  What’s more, income inequality is not the same as poverty (which he seems to conflate).  Many countries have more income equality than the U.S., but overall they are much poorer.

Yet, even if the President believes we must close the gap so that incomes (he is not claiming wealth should be more equal) are more equal, will his proposals have any affect?  Raising the minimum wage will impact a tiny portion of the labor market.  Extending unemployment benefits will not even make a dent income inequality, and the modest increase in taxes on the rich proposed by the president will lower their income by a few percent.  Mr. Obama seeks to pray on zero-sum thinking.  If one person has a higher income than someone else must earn less, so it is only fair to take from those who have more and give to those who have less.  This is a fundamental economic fallacy that unfortunately many believe.  Wealth is not static, and people who earn high incomes are often creating new wealth.

Maybe the president should focus his attention on how the government can incentivize job growth and not income equalization.  It should be clear to the Obama administration, that without a job Americans have no hope in attaining a more equal income.

The (Un)Intended Consequences of Healthcare

It looks like the Obama administration knew that many Americans would not be able to keep their current health coverage if they purchase insurance on their own (and not through an employer).  Is this a surprise?  It is hard to imagine that a massive government program that is attempting to combine a market-based insurance system with a government mandate would be able to properly calculate the price of a policy.  The government has no choice (because it lacks the information necessary) but to price an insurance policy by some arbitrary means.  Given your income level, number of dependents, net worth, etc. your should pay X for health insurance.  Also, it is impossible for the government to set the price and  allow you to properly value your own heath risk.

Consequently, you have a system that penalizes the health conscious middle-income earner because he must subsidize the a category of individuals in the Obamacare “calculation” that are paying less and are likely less healthy.

The government cannot engage in market calculation.  There is too much information known only to the individual and his unique circumstances, and when the government sets the price (or at least mandates a certain range of coverage and prices) the result a gross misallocation of resources.

Maybe this is what the Obama administration intended?  Some have said this will move the American system closer to a fully government-run system eliminating private insurance all together.  Whether this is true or not, the current system is likely to collapse under its own dysfunction.

Wal-Mart and Lower Wages

Megan McArdle writes about the connection to wages and productivity, and markets.

When comparing Wal-Mart wages to those of Costco employees, the business model explains, in large part, why workers at the world’s largest retailer earn a much lower hourly rate.

A similar story will likely explain much of the difference in wages between McDonald’s employees and those at other retailers.