WHEN ARE WE EVER GOING TO LEARN THAT FREE MARKET
CAPITALISM, SO LONG AS IT IS COMPETITIVE, IS THE BEST POSSIBLE ECONOMIC SYSTEM
TO ACHIEVE THE ECONOMIC WELFARE OF ITS CITIZENS?
A TALE OF TWO ECONOMIC
POLICIES, a confused and ill-conceived
pattern of INCOME REDISTRIBUTION VERSUS ECONOMIC welfare and GROWTH: A NON-IDEOLOGICAL ECONOMIC ANALYSIS
Twentieth Century should have taught the World a lesson. Fascism, whether of the Nazi stripe in
Germany or other varieties such as that of Italy, failed miserably. Socialism, especially of the communist
variety, ran a dead heat with Fascism for the most miserable failures. Given the hackneyed behavior currently being
manifested by Vladdy Putin, who seems to strive to be part Josef Stalin and
part Peter the Great, is pursuing a path taken by Adolph Hitler just preceding WWII.
Georgia and the Crimea have replaced Austria
and the Sudetenland, but the new bully on the street is just warming up. Déjà vu!
Why the kudos
for free market capitalism? That praise
only fits if it is of the competitive variety and not a first cousin to fascism
owing to a lack of sufficient competition; or the Invisible Hand, as Adam Smith
called it in his Wealth of Nations. As
we have examined on several occasions in newsletters on this website and its
archive for less recent issues, the end game or limiting case for competitive
free market capitalism is the achievement of the theoretical economic welfare conditions
of efficiency and equity on the microeconomic level, and high employment (or
the natural rate of employment) and a reasonable degree of price level
stability on the macroeconomic level. To
fully achieve these goals or conditions of theoretical welfare economics, perfect
competition must prevail in all markets, both the product markets for goods and
services and the productive resource markets for labor, debt and equity
capital, entrepreneurship and land.
the Light from the Heat: an analysis of the income distribution and the endless
clamor for its redistribution; the whys, wherefores, and implications February
these end game conditions of all markets being perfectly competitive and in
long-term equilibrium never exist so we have to think in terms of a spectrum
with the ‘ideal’ economic setting at one end and at the opposite end, markets
that are monopolistic on the sellers’ side and/or monopsonistic on the buyers’
side. The effects of this latter case, or
end game that also never exists, where monopoly power dominates would be a gravely
excessively unequal income distribution that benefits the top decile or
quintile or so of that income distribution and leaving the rest far worse off
than if significant competition was otherwise present in all of the
markets. This latter case where monopoly
or monopsony power dominates the markets, would reflect a politically
unacceptable degree of income inequality and a grievous degree of failure to
achieve the goal of equity as compared to the former case where vigorous
competition in all markets prevails.
In other newsletters
and in papers presented at conferences, the author of this issue of this newsletter
has pointed out that a sizeable portion of the economy falls short of the ideal
or limiting case of vigorous competition.
Given the size of the market and technologies available, cost structures
cause some markets to fall into the category of natural monopolies and others,
natural oligopolies. In some markets,
there is the presence of externalities: cost external to the firm and benefits
– not directly reflected in gains to the buyers, but present to society as a
whole. Some markets are unable to exclude the non-payers who become what are
termed ‘free-riders’, those refusing to fully reveal their preferences but
nonetheless enjoying the benefits from the production of the good or service.
To the extent that such conditions exist, the economy operates more distantly
from the limiting case that results in the full achievement of the theoretical
economic welfare conditions. In an
optimal sense, some markets overproduce and some under-produce, thus lowering
the material standard of living, violating the welfare conditions of efficiency
as well as equity. In reality, these
markets can change from more – to less competition and likewise from less – to more
competition. The beer brewing industry
is one such example and the production stage of electric power is another such
example. In years past, the former led to
less competition and the latter to more competition. Many other examples abound on the dynamic
landscape of market structures, both in the markets for goods and services and
for productive resources such as labor and capital.
To sum up,
the lack of significant competition in markets results in a significant
reduction in the per capita (individual) level of income and production, that
is a failure to achieve the microeconomic welfare condition of efficiency. As a result, our economy falls far short of
the material standard of living that could be achievable given our stock of
productive resources and the currently available level of technology. The economy would be operating within its
production possibility frontier.
The way to
minimize the problems in markets characterized as natural monopolies and
oligopolies is to vigilantly enforce the anti- trust legislation to minimize as
far as possible the wielding of monopoly power by suppliers in both product
markets such as crude oil and productive resource markets such as for labor,
capital and entrepreneurship. The effective enforcement of anti-trust laws
is not anti-capitalistic but is necessary to bring economic activity closer to
the full achievement for its citizens of the potential welfare a capitalistic
economic system is capable of delivering.
We can see the failure of free market capitalism to achieve equity and
efficiency in the highly cartelized markets for crude oil and its refined
downstream derivative products such as gasoline. We can see the movement toward equity and
efficiency as fracking restores some of the lost competition in the market for
crude oil and especially for natural gas thanks to the growing importance of shale
fields such as Marcellus, Eagle Ford and Bakken. Big oil such as OPEC and its fellow travelers
in the re-cartelized American segment of the oil industry are already crying as
the recent comment by a Saudi Arabian Prince proclaims.
to data from the U.S. Energy Information Administration (EIA), fracking (and
horizontal drilling) has resulted in the United States becoming (in 2010) the
world’s largest natural gas producer.
Also, in October 2013, domestic oil production surpassed the amount of
oil imported into the United States for the first time since 1995.”
oil by rail costs an average $10 per barrel to $15 per barrel nationwide, up to
three times more expensive than the $5 per barrel it costs to move oil by
pipeline, according to estimates from Wolfe Trahan, a New York City-based
research firm that focuses on freight transportation costs.”
the biggest railway mover of U.S. crude, transporting one-third of Bakken oil
production alone with unit trains carrying up to 85,000 barrels of oil. The
company's carloadings of crude oil and petroleum products increased 60% during
the first six months of 2012.”
of environmentalists, especially of the non-scientific stripe, supports the
wailing of the Big Oil banditos as they fear the loss of control of the supply
in these markets will result in a loss of a considerable portion of their huge
surplus profits. In a more narrow sense,
the owners of railroads fight pipelines and the loss of the very profitable
transport of petroleum products to refineries and retail markets over the
existing railroad networks. You can fill
in the blanks and connect the dots without much difficulty! Greed and ignorance is a dangerous tandem to
any well- functioning economy and as a result the loss of economic welfare of
also see the failure to achieve high employment as Employment Reports over the
past few years have shown clearly. The
decline of competition introduces downward price rigidity in such markets and
causes a twin bias toward intermittent periods of recessions and episodes of
unacceptable high inflation rates.
bellwether that we’ve been looking at is the Labor Force Participation
Rate. This measure from the Civilian
Population Survey compares the Civilian Labor Force (Employed + Unemployed)
with the Civilian Noninstitutional Population. While the historic measure throughout the last
decade (2000-2010) was around 66%, the December reading of 62.8% was the lowest
since March 1978.”
unions can have the same effect as do business cartels. By reducing supply and through collective
bargaining, they can achieve an above equilibrium labor compensation rates for
its members. In the long-run this triggers
the substitution affect as more capital intensive technologies replace labor
intensive technologies. Accelerated automation
can be clearly seen in modern factories and seaports.
the passage of a definitely not so affordable, Affordable Health Act, referred
to as Obamacare, has added to the economic malaise facing our nation. Uncertainty undermines the ability to make
rational choices. It is an awkward and
excessively costly attempt at addressing excessive inequality in the income
distribution of the U.S. of A. It is to
a clarification of this issue of income inequality that our analysis now turns.
questions to the critics of the American economy who continually demand a
lessening of the inequality in the income distribution.
What constitutes excessive inequality
and what are its causes?
What should be the tax rate
structure to address the problem of excessive income inequality?
Much of the time you will hear
some incoherent mumbling at best and silence at worst.
certainly is an excessively unequal income distribution as many oligarchs agree
all the way to the banks to invest their huge and excessive reward as
productive resources. While not exactly
oligarchs, members of some labor unions are included in this group. The rise of the phenomenon called ‘sticker
shock’ is a result of the few wielding monopoly power over the many.
begin our analysis by first examining the economic welfare condition of
equity. As we shall see, equity is not
equality. In fact, complete equality
would be inequitable! The limiting case
of perfectly competitive product and productive resource markets in long- term equilibrium
would bring about equity.
perfectly competitive markets in long-term equilibrium, the productive
resources laborers, debt and equity capitalists, entrepreneurs, and owners of
land (which consists of natural resources and earthly space), receive their
opportunity costs. They would receive
just what it takes as a reward or income to bid them away from their next best competitive employment, no more and no
less. There would be no economic rent
paid them. Economic rent or its modern
vernacular equivalent, producer surplus, is the measure of a productive
resource’s reward in excess of its opportunity cost and the cause of an
excessively unequal income distribution that dominates the political debate
markets are perfectly competitive and in long-term equilibrium, the result is
that the buyer pay the lowest price possible consistent with the need to reward
all productive resources engaged in the production of the good or service in
question, their opportunity cost, no more and no less. The result is that the consumer surplus is
If you study the graph immediately
above this paragraph, explaining what a cartel such as OPEC does in order to
increase the price, you will notice several things. First, note the
triangle (for straight line demand curves) with its base as the perpendicular
line from the price axis (Segment
AB). Next, the line segment
of the demand curve from where it meets the supply curve up to the price axis
(segment BC). Lastly, we have the price axis down to the equilibrium
price (segment CA). This is what is referred to as consumer surplus when
the price is $50 per barrel. The buyers or consumers in this case, expend
an amount equal to price of $50 per barrel times quantity demanded of 20
million barrels or $1,000,000,000 or 1 billion dollars. This is also the
total revenue going to the firm. This revenue will then be used to pay
all expenses with the remaining revenue being called profit, in an accounting
sense. The triangle we have called the consumer surplus represents an
estimate of additional expenditures the consumers would have paid if they had
to in order to acquire the equilibrium quantity of 20 million barrels. In
our example, the original consumer surplus is one half of [$135 -$50] or $85
times 20 million barrels or $1.7 billion.
Some of the potential
revenue represented by the consumer surplus could be expropriated by the firm
using a technique called price discrimination.
A simpler tactic would be reducing the supply and driving up the price
to everyone. If the firm is not able to
do so, the consumer surplus stays with the consumers. Note: in this
example, OPEC raised the price from $50/barrel for crude oil to $70/barrel of
crude oil by reducing the supply from supply 1 to supply 2. The consumer surplus would shrink
significantly – the consumer would pay more, receive less. The loss of the
consumer surplus is equal to the increase in the producer surplus of [$70-$50]
or $20 times 15 million barrels or $300 million plus the dead weight loss of
one-half of ($20 times 5 million barrels) or $50 million. The total loss of consumer surplus would equal
the sum of the two or $350 million.
There are further implications of deadweight loss, (deadweight loss:
neither the consumer, nor the producer receives this portion of the former
consumer surplus; the result is loss of surplus value). Should we desire
to see the effect of increased competition, assume a major new oil field came
into production thus increasing the supply of oil from supply 2 to supply
Now reverse the
direction of the changes. The producer
surplus would decrease and the deadweight loss in this case would go to zero. The consumer surplus would increase by the sum
of the decrease in the producer surplus plus the decrease in the dead weight
This has income
distribution implications. Everyone is a consumer! Not everyone is
a productive resource nor does each of the productive resources possess the
same quality and quantity of resources. To the extent the economic rent
or surplus rewards (in excess of opportunity costs*) is shifted to the
consumer surplus by an increase in competitive pressures in the market, the
income distribution of individuals and households will be less unequal than it would have been had the
productive resources retained the surplus.
Thus the increase in competition resulted in a greater conformity to the
condition of equity and as we argue, greater conformity to commutative justice.
This is the compensation that a productive resource (e.g., labor is both the
resource and the individual) could earn in its next best COMPETITIVE alternative
employment. Remember that the productive
resources include not only labor, but debt and equity capital, entrepreneurship
and natural resources and space – the latter is usually referred to as land. Included in opportunity cost is what is referred
to as ‘normal’ profits; again, this refers to the resource just receiving
enough compensation to keep it from moving to its next best competitive
everyone is a consumer while only some of society supplies productive resources,
as markets become more competitive, the consumer surplus increases relative to
the producer surplus thus reducing the excessive inequality in the income
distribution. On the other hand, as
competition in markets decreases, the producer surplus increases (economic rent
or excess reward to productive resources increases) relative to the consumer
surplus and this increase the excessive inequality in the income distribution.
markets do this without the need for income redistribution policies that
history has shown can damage the average citizen’s standard of living and slow
the rate of economic growth of the economy as a whole.
the far left are to some extent ideologically blinded to the producer surplus
or economic rent going to labor as labor markets some of which have been
cartelized by unionization and some of the non-essential aspects of
the far right are to some extent ideologically blinded to the surplus rewards
or producer surplus (economic rent) going to entrepreneurs and equity
capitalists due to the lack of sufficient competition.
competition in all markets, move the income distribution toward the achievement
of the theoretical economic welfare condition of equity while declining
competition in markets increases excessive income inequality and moves the
economy further away from the achievement of the economic welfare condition of
field of social ethics, increasing competition brings the economy closer to the
achievement of subsidiarity and the movement toward equity promotes solidarity
among the members of society.
greater the degree of competition in the markets of an economy, the less is the
need for income redistribution policies.
Since such economic policies are incapable of defining clearly the
equitable income distribution and tax and transfer of income pursuant to that
determination, such policies are fraught with danger to the other economic
welfare goals of efficiency, high employment, and a reasonable degree of price
to explain the economic malaise around the World including the U.S. of A. Several consecutive years of relatively slow
economic growth give clear evidence of this dilemma.
failing to achieve efficiency causes the economy to operate within its
production possibility frontier or curve, so does excessive unemployment, or
operating at a level of production that is less than that which is commensurate
with the natural level of employment. The cause of this shortfall in respect to
the natural rate of employment is due to the labor market not being able to be
truly cleared due to the lack of sufficient competition.
appears, curiously enough, that there is nowhere in the literature a complete
and concise nonmathematical treatment of the problem of welfare maximization in
its "new welfare economics" aspects. It is the purpose of this
exposition to fill this gap for the simplest statical and stationary