Hayek on Equality

Inequality is one of the hot topics in economics and politics today.  Thomas Piketty’s bookCapital in the Twenty-First Century, has taken the economics field by storm by documenting rising income inequality using national income data across countries and years. Piketty is a French economist who sold over 80,000 copies in France, but has well-surpassed that number in America. His book has been on the NY Times Best Seller list for 19 weeks and counting, which speaks to the fact that people care about this topic. Inequality by other means, such as marriage inequality, continues to be debated in state and federal courts, while racial inequality with police and police force, as exemplified by the incident surrounding Ferguson, Missouri, is a highly contested issue right now.  With such an important focus on inequality in society today, I want to explore Hayek’s point about inequality:

 

“From the fact that people are very different it follows that, if we treat them equally, the result must be inequality in their actual position, and that the only way to place them in an equal position would be to treat them differently. Equality before the law and material equality are therefore not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time” – Friedrich Hayek, The Constitution of Liberty

 

Marriage and racial inequality with police force is an equality issue before the law, while income inequality is material inequality.  If we treat income inequality as an issue that needs to be fixed by law then the only way to do that is to have unequal laws since people are different. So, we would be fixing income inequality by creating inequality… in the law. With marriage and racial inequality, equality before the law is wanted, but if we treat this problem as one that should be fixed by material equality then we will necessarily create unequal laws to do so. As a society we must choose–equality in law or material equality. What would you choose?

Economic Inequality and Relative Deprivation

[In progressing economies] poverty has…become a relative rather than an absolute concept. This does not make it less bitter. Although in an advanced society the unsatisfied wants are usually no longer physical needs but the results of civilization, it is still true that at each stage some of the things most people desire can be provided only for a few and can be made accessible to all only by further progress. Most of what we strive for are things we want because others already have them.

Friedrich Hayek, The Constitution of Liberty, 1960, 98.

 

A.K.

People Talk With Their Feet, Why Not Listen?

One of my colleagues just posted yesterday about federal subsidies for cities that are failing. He questions why the federal government props up cities that have been in a population decline and lists which cities made the “Most populated cities” list in 1950 and then again in 2013. Detroit, Cleveland and Washington D.C. among others no longer make the top 15. He studies cities and, in particular, the changing demographics of cities over time, so his work on this subject is very interesting.

 

In particular, he makes a great point about cities not having a right to be large and prosperous:

 “Cities like Cleveland and St. Louis used to be relatively large and well off while cities like Columbus, OH and Austin, TX were small and relatively poorer. Today that is flipped, but that does not mean that the federal government should attempt to put things back the way they were; no city has a right to be large and prosperous.”

 

This sounds correct, but in reality I am not so sure that cities, or the people who live in them, believe they have a right to grow and create wealth. As mentioned in his blog, cities rise and fall for numerous reasons such as businesses leave for a cheaper location, better parks and recreation, better hospitals, tax structures of local governments and zoning policies. So, is it not that cities lobby for federal financial assistance to overhaul tax structures, fix ill-maintained parks and create better hospitals and then are awarded federal dollars? Or is it that they are envious of prosperous cities like New York and they feel like they have a right to be like NYC without actually moving its entire population to New York?  I would think that it would be the former, although, additional dollars for failing cities rarely helps fix tax structures, bad government or parks. An alternative option would be that the government is worried about socio-economic implications with a declining population since the rich are more mobile, while poorer members of society do not have the means to relocate to find a better job, better neighborhood or school for their kids. However, if the government set up performance-based federal money, I think the decision to give more federal dollars to some cities would change.

The federal government has been handing money to one declining city, Detroit, since the 1960s by means of more subsidies and propping up their large automobile industry. Forty years later, Detroit still has issues, while they continue to receive government money.  If the federal government believed that population trends are any indication for future growth there should be no reason for an increase in federal dollars. People talk by ways of their feet and the government should listen.

 

 

Wage Rate Regulation at Different Scales

Readers know I like a good graphic and I love state by state comparisons. Here’s a nifty little state by state comparison of wage rate regulation in the U.S.:

Minimum Wage Legislation by state

Of course, the federal minimum has been set at $7.25 since 2009, and the Obama Administration is contemplating an increase to $10.10. Moreover, cities can get in on the action as well. Danielle and I commented on Seattle’s wage experiment here and here. On that latter score, I stumbled across some friendly-fire skepticism on the wisdom not of raising the minimum but of a city raising it much higher than its surrounding community. Former Labor Department and current Brookings Institution economist Gary Burtless asks us to

Consider a business that mainly sells low-cost, fast-food meals. If it must pay $15 an hour to its low-wage employees, while its competitors less than a mile away are only required to pay $10 an hour, the companies outside Seattle can charge lower prices to their customers for shakes, burgers, and fries, and yet still make a profit. The lower cost establishments can capture a larger percentage of the local fast-food trade, reducing fast-food sales inside Seattle’s city limits. The same is true of the goods and services sold by laundry and dry cleaning establishments, inexpensive motels, and other businesses that depend on low-wage workers to stay competitive. The labor cost disadvantage caused by a higher minimum wage can hurt low-wage employment in Seattle and possibly reduce the value of some of the city’s commercial real estate.

To the extent that consumers have the option of buying goods or services from companies that are not required to pay a higher minimum wage, some of the hoped-for gains from a higher minimum wage will be lost. When customers can conveniently buy products or services from firms that face lower labor costs, the new businesses that they patronize will grow and the old, high-cost businesses they abandon will shrink. Low-wage workers may earn higher wages inside the Seattle city limits, but their employment opportunities in Seattle may shrink.

Read Burtless piece in its entirety here.

A.K.

Take a TIP Before They Vanish: New Minimum Wage Law

As A.K. mentioned in his earlier post, Seattle bumped up the minimum wage to $15 which has caused quite the firestorm in media.  Washington State previously had one of the highest minimum wages at $9.32/hour, much higher than the federal minimum wage of $7.25 which was last passed in 2009.

One interesting piece of this legislation is that ALL tipped and non-tipped workers will have to be paid $15/hour or more starting in 5 years! Waiters and waitresses, who approximately receive $2-$3/hour and tips to supplement their base minimum wage pay, will be included in the new law.

Minimum wage for tipped employees has been stagnate at  $2.13 since 1991, with federal legislation requiring that employers are supposed to make up the difference if tips do not equate to the legal minimum wage. Some workers will have employers boosting their wages when nights are slow (as required by law), whereas others make well over minimum wage on good nights. President Obama in his plan to change the federal minimum wage to $10.10 by 2015 also pushed for the tipped minimum wage to be 70% of the full wage. Congress has fought this legislation, but that does not mean states, like Washington, have not already started to enact these changes.

This leaves a few questions to ponder: Would people stop tipping with salaried waitresses and waiters? Will the quality of service at a restaurant decrease? Will food prices rise? Here are some potential issues that I see:

 

More Tasks Could be Automated Leading to Job Loss

Tasks like ordering could be automated to I-Pads on each table with a button to press when a server must be present for a specific question.  Bolt Burgers, in Washington D.C., already has a pretty impressive ordering system that is fully automated which allows you to choose from 25 potential toppings. However, automated tasks are also being brought to quality restaurants in Palo Alto, such as Calafia run by Rajat Suri.

“It costs about a dollar a day per table, it can even go lower depending on if you have sponsors involved because all the alcohol companies want to get involved,” Suri says. “For that, they get about $6 a day per tablet in increased sales. That’s extra desserts, appetizers, drinks. They get about another $5 in extra table turns. If you can fit in one more table per night, that’s worth a lot of money. And some restaurants, though not Calafia, get about $4, $5 extra because they choose to save labor.”

This restaurant device, called the Presto, was designed to engage younger generations who desire all things digital. With new minimum wage laws for tipped employees they may become a cheap alternative to hired labor.

presto_615

A Decrease In Hours and Quality of Food Service

Even without automated systems, jobs could be cut and workload increased at restaurants. If servers are still desired by consumers and restaurateurs cannot afford to pay 6 employees all $15/hour then perhaps only 2-3 workers will remain employed. As one restaurateur in Virginia stated, higher wages will “minimize the need for staff”.

With fewer servers, each server will take on more tables and service could slow down. The Boston Globe reports that “diners doled out some $40 billion in gratuities in 2012” which may shrink with a decline in service. Further, customers may not feel as compelled to make up for low wages with an increase in hourly pay to $15/hour.

 

Cost of Food Increases and Restaurant Expansion

As Alan Greenblatt points out, “Consumers can be sensitive to price changes” and when eating out, most meals cost more when they are waited on by servers. Nancy Laird, owner of a high-end restaurant in New Jersey, stated:

“If this minimum wage is raised, we will have to raise prices. We will of course meet some customer resistance and because of customer resistance we will have fewer revenues and thus fewer employees.”

Laird’s explains how a snowball effect that can happen. If consumers stop eating at restaurants due to an increase in prices, restaurants may lower prices to encourage food sales, but supplement the increased costs with lay-offs of servers.

A New Jersey businessman from the same article, whose company owns 40 Applebees and 7 other restaurants, said an increase in tipped server wages would be “devastating” and would force his company to reconsider expanding in New Jersey. “Labor costs are huge dollars to a restaurant operator”.

 

Less “Freebies” for All

In a city like San Francisco, where there is a large restaurant scene, restaurants are choosing to skimp on the extras such as nice tablecloths and bread and butter for consumers. When asked about the new laws increasing wages for servers in San Francisco one restaurateur stated:

“It’s very, very expensive to run any sort of restaurant in San Francisco,” says Patricia Unterman, a longtime restaurateur and food critic in the city. “The cost of doing business here, especially for labor-intensive operations like restaurants, almost doesn’t pencil out.”

There are fewer benefits for servers and employees who receive the increase in wages, too. SeaTac, which is a city in Washington that already has seen the $15/hour wage increase start at the beginning of the year, has employees less than pleased at the new law. Tim Worstall from Forbes writes about a conversation one had with a SeaTac employee:

‘“Are you happy with the $15 wage?” I asked the full-time cleaning lady.

“It sounds good, but it’s not good,” the woman said.

“Why?” I asked.

“I lost my 401k, health insurance, paid holiday, and vacation,” she responded. “No more free food,” she added.

The hotel used to feed her. Now, she has to bring her own food. Also, no overtime, she said. She used to work extra hours and received overtime pay.

What else? I asked.

“I have to pay for parking,” she said.

I then asked the part-time waitress, who was part of the catering staff.

“Yes, I’ve got $15 an hour, but all my tips are now much less,” she said. Before the new wage law was implemented, her hourly wage was $7. But her tips added to more than $15 an hour. Yes, she used to receive free food and parking. Now, she has to bring her own food and pay for parking.’

 

Minimum wage laws, especially this particular law designated for servers, may have the right intent—to give workers more money, but in reality there are adverse effects that occur to offset or even outweigh any potential gain. Businesses do not just take money from top management and give it to waitresses and waiters. Instead, changes will occur in terms of employment numbers, quality of service, tips that customers willfully give, prices of food for customers, number of new restaurant job openings and amenities such as free parking or food during shifts. When a new legislation is enacted, the effect usually is less mild than imagined. There is a ripple effect that occurs that can leave workers worse off than the legislation originally intended.

Is “Fair Trade Coffee” Really Fair? A Lesson in Supply & Demand

At church a Sunday ago I was given a brochure to attend a community service event where “we can buy fair trade coffee to benefit those in Africa”. Immediately I shook my head and said there is a better way to increase welfare. This topic is really important to understand, because many organizations try pushing “fair trade” products yet it is not the most efficient way of increasing public welfare.

First , according to fairtradeusa.org, fair trade is,

“products…from farmers and workers who are justly compensated”.

To show that fair trade products are not an efficient means of redistribution, teaching a lesson about markets, particularly an Econ 101 lesson on supply and demand, will be helpful. In a free society, and by this I mean one in which people are not slaves and do not have to produce goods for an owner/dictator, workers can choose whether or not to sell their products to others in exchange for money to buy goods and services.  This is  best explained with an example. So for example, Mark has a coffee plant and processes the beans to make 36 bags of coffee each day. Now, he can choose to drink an insane amount of coffee each day or he can choose to sell it to others who may want coffee. In exchange for Mark selling coffee at $3/bag, Mark may buy beef or milk from someone else. Mark is not forced to sell coffee at $3/bag, but rather that is the price that the coffee market is in equilibrium.

Let’s look at the linear supply and demand graphs below to fully understand what is going on here. Mark chooses to supply coffee at the local farmer market in town. It may cost him $0.50 to make a bag of coffee, but Mark, like most normal-minded workers, would love to get the maximum amount of money in exchange for the bag of coffee. The supply curve represents Mark’s willingness to supply coffee at desired prices. At a price of $1, Mark is only willing to sell 6 bags of coffee; at a price of $2 Mark is willing to sell $12 bags of coffee and so on. At higher prices, Mark is more willing to sell his coffee beans and not save them or consume them himself.

 fairtrade

On the demand side of things, people who attend the local farmer’s market want to buy coffee, but would prefer to do so at the cheapest price possible. The cheaper they pay for coffee, the more money they have to spend on other products they want. The demand curve represents consumer’s willingness to pay at desired prices for bags of coffee. At a price of $5, consumers only want to buy 6 bags of coffee. At a price of $4, consumers want to buy 12 bags of coffee and so on. Consumers would really be happy to buy coffee at $1/bag, however Mark would not be happy to sell it for such a low price. The intersection of supply and demand gives us market equilibrium, which is the price that no one else has an incentive to alter the price or quantity. Equilibrium in this case is P*=$3/bag of coffee and Q*=18 bags of coffee are sold.

Now, let us say that there is an argument for “fair trade” and by this I mean pay farmers, like “poor” old Mark more money for coffee. Let’s say that a church group goes in and decides to pay Mark $4 for coffee, as opposed to the market price of $3. If this is the case then at $4, Mark is willing to supply 24 bags of coffee, but consumers are only willing to buy 12 bags of coffee. There is excess supply in the market (when supply > demand). What this means is that Mark is willing to supply more than what people want at $4/bag. To get rid of the extra bags of coffee on the shelves, consumers have to buy more coffee. Since we cannot force consumers to buy more coffee, the only way consumers are encouraged to buy the excess 12 bags of coffee (24 bags supplied, 12 demanded) is if the price drops. However, the price cannot drop to $2, because if it does than there is excess demand (demand > supply) in the market.   Consumers want to buy 24 bags of coffee, but Mark is only willing to put 12 bags on the shelf! In fact, at this price a line may start to form to buy coffee. If there are so many people willing to buy coffee, Mark will raise his price until some consumers drop out of line such that there is no more shortage of coffee. Exactly what is demanded is what is sold at the market-clearing price, or equilibrium price. A price other than equilibrium is not stable such that there will be pressure to alter the price up or down depending on excess supply or demand.

We measure welfare simply by a concept called consumer and producer surplus. At a price of $3 and 18 bags of coffee sold, consumer surplus is the triangle from $6 to $3 and 18 bags of coffee (represented by the red triangle, or triangle A). Consumer surplus is thus ($6-$3)*0.5*18= 27. Producer surplus is represented by the black triangle, or triangle B, and is ($3-$0)*0.5*18= 27. Now, if we go back to the fair trade example, where coffee is told to be sold at $4/bag, consumer surplus would be ($6-$4)*0.5*12= 12; while producer surplus would now be ($2-$0)*0.5*12+ ($4-$2)*12= 36. Here we can see that total surplus has gone down. Originally consumer surplus + producer surplus= $54, but now it only equals $48. This is because we have deadweight loss. Deadweight loss is the consumer surplus we lost out by setting a price higher than what market equilibrium in a free market would be, or $54-$48. Consumers are made “worse off” such that they get less surplus with a higher price and are unable to buy as much coffee beans, while Mark gains more surplus.

So, in reality “fair trade” is not really fair at all…at least for consumers. However, if the intent of fair trade coffee (or other products) is to make the farmer better off than perhaps it will and  in this case it did. But, it isn’t efficient! In the fair trade example above, Mark gains $9 while consumers lose $15 worth of surplus. $6 of surplus is deadweight loss and thus no one receives this money. If instead the price was at market equilibrium, then Mark receives $27 and consumers receive $27 of surplus. Consumers could then donate to give Mark the same extra $9 (thus leaving $36 for Mark and now $18 for consumers in surplus). In this example, Mark is just as well off as with fair trade coffee and consumers are better off! There is no deadweight loss, consumers can buy more bags of coffee and pay a lower price! This to me seems like a more efficient way to redistribute money than setting what is like a price floor via a fair trade platform.

To give a bit more background on the fair trade movement in recent year. The founding of Fairtrade International occurred in 1997 with a goal to give “producers in developing nations a minimum price—a safety net to cushion farmers and producers against market fluctuations—as well as a premium, a separate payment (for example, 20 cents per pound for coffee) that workers and farmers can invest in environmental, educational or infrastructure projects.”

This safety net, however, comes at a cost. Besides the, now obvious, decrease in consumer surplus and increased costs to consumers what else is the problem with fair trade?

  1.  Fair trade does not help out the world’s poorest countries. “We might think of sub-Saharan subsistence economies when we think of fair trade, but the biggest recipient of fair trade subsidy is actually Mexico. Mexico is the biggest producer of fair trade coffee with about 23% market share.” Roughly 200 of 300 fair trade coffee producers are located in South America or the Caribbean. 
  2. There is a question about how much of this extra price actually goes into the hands of farmers or whether there is an institutional cut before farmers see any increase. A George Mason policy series study shows that after paying a fair trade co-operate program and its employees, farmers may only seek to make an extra 5 cents.
  3. Farmers outside of fair trade product networks stand at a disadvantage or those who use the fair trade product as an intermediate good. Fair trade encourages producing more in one industry at the expense of another when there can be better uses of employee time than coffee production.

To be clear, economic inequality between third-world farmers and CEOS on Wall Street is large and concerning to many. However, demanding reallocation of resources by inefficient means is not the best or fairest solution.

A great quote by Gene Callahan at FEE sums this up great,

“The belief that any group with power – government officials, economic experts, or social activists – can establish a price that’s “fairer” or “more just” than the actual market price is a fallacy that bedeviled communism for decades and it’s bedeviling the fair-trade movement today.”