Consumer Spending Doesn’t Drive the Economy, Investment Does
Foundation for Economic Education
May 17, 2010
“Consumer spending makes up more than 70 percent of the economy, and it usually drives growth during economic recoveries.” –“Consumers Give Boost to Economy,” New York Times, May 1
Every quarter, when the government releases its latest GDP figures, we hear the familiar refrain:
“What the consumer does is vital for economic growth.”
“If the consumer starts saving and stops spending, we’re in big trouble.”
“Consumer spending accounts for 70 percent of the economy.”
The latter “fact” is repeated regularly in the news reports from the Associated Press, the Wall Street Journal, and the New York Times.
The truth is that consumer spending does not account for 70 percent of economic activity and is not the mainstay of the U. S. economy. Investment is! Business spending on capital goods, new technology, entrepreneurship, and productivity are more significant than consumer spending in sustaining the economy and a higher standard of living. In the business cycle, production and investment lead the economy into and out of a recession; retail demand is the most stable component of economic activity.
Granted, personal consumption expenditures represent 70 percent of gross domestic product, but journalists should know from Econ 101 that GDP only measures the value of final output. It deliberately leaves out a big chunk of the economy — intermediate production or goods-in-process at the commodity, manufacturing, and wholesale stages — to avoid double counting. I calculated total spending (sales or receipts) in the economy at all stages to be more than double GDP (using gross business receipts compiled annually by the IRS). By this measure — which I have dubbed gross domestic expenditures, or GDE — consumption represents only about 30 percent of the economy, while business investment (including intermediate output) represents over 50 percent.
Thus the truth is just the opposite: Consumer spending is the effect, not the cause, of a productive healthy economy.
The Importance of Say’s Law
This truth prevails in the marketplace: It’s supply — not demand — that drives the economy. Savings, productivity, and technological advances are the keys to economic growth. This principle was discovered and developed by the brilliant French economist Jean-Baptiste Say in the early nineteenth century and is known as Say’s law. In fact, he invented the word “entrepreneur” to describe the primary catalyst of economic performance.
Is retail sales a leading economic indicator? Each month the Conference Board releases its Leading Economic Indicators for the United States and nine other countries. The ten U.S. leading indicators are:
- manufacturers’ new orders
- building permits
- unemployment claims
- average weekly manufacturing hours
- real money supply
- stock prices
- the yield curve
- new orders for nondefense capital goods
- vender performance
- index of consumer expectations
As you can see, almost all of the indicators are linked to the early stages of production and business activity.
Misleading Consumer Confidence Index
What about the Consumer Confidence Index that the media highlights every month? It turns out that the title is misleading. The questions asked consumers are more about business conditions than spending attitudes. Here are the questions consumers are asked to determine their “expectations”:
- Are current business conditions good, bad, or normal?
- Do you expect business conditions to be good, bad, or normal over the next six months?
- Are jobs currently plentiful, not so plentiful, or hard to get?
- Do you expect jobs to be more plentiful, not so plentiful, or hard to get over the next six months?
- Do you plan to buy a new/used automobile/home/major appliance [note: these are all durable consumer goods, not unlike durable capital goods] within the next six months?
- Are you planning a U.S. or foreign vacation within the next six months?
In other words, the much-touted “consumer” confidence index is more a forecast by consumers for business, employment, and durable goods than “retail sales” and consumer spending. It does not ask any questions about food, clothing, entertainment, and other short-term buying, because these expenditures seldom change from month to month.
The reality is that business and investment spending are the true leading indicators of the economy and the stock market. If you want to know where the stock market is headed, forget about consumer spending and retail sales figures. Look to manufacturing, capital expenditures, corporate profits, and productivity gains.
Beware of Keynes’s Law
The reason we hear so much about the consumer is because the media and political pundits still live under the spell of Keynesian economics, which teaches that demand creates supply. Keynes’s law is just the opposite of Say’s law (supply creates demand). According to Keynesians, consumer spending drives the economy and saving is bad when the economy is in a short-term contraction.
In reality, increased savings can actually stimulate the economy, even if consumer spending is anemic. A recent study by the St. Louis Fed concluded that in the short run, “a higher saving rate in the current quarter is associated with faster (not slower) economic growth in the current and next few quarters” (Daniel L. Thornton, “Personal Saving and Economic Growth,” Economic Synopses, St. Louis Fed, December 17, 2009).
How is this possible? When people save more, interest rates fall and business can afford to replace their old equipment with new tools, spend more on research and development, or develop new production processes. So while consumer spending may stay low, business spending can pick up the slack. Remember, in a dynamic economy the decision by businesses to spend more investment funds and hire more workers is a function of both current consumer demand and future consumer demand. And don’t forget, during a recession corporate profits often recover first, without an increase in customer demand, because companies can boost profits by cutting costs and downsizing.
In the long run new business strategies and spending patterns increase productivity and lower prices to consumers, which in turns means the consumers’ purchasing power increases. As the St. Louis Fed concludes, “A higher saving rate does mean less consumption [in the short run], but it could also result in more capital investment and, ultimately, a higher rate of economic growth…. [T]he growth rate of real GDP has been higher on average when the personal saving rate is rising than when it is falling.”
Granted, the ultimate function of business activity and entrepreneurship is to fulfill the needs of consumers, and the most successful firms are those that satisfy their customers. But more important, who discovers the new, improved products that consumers desire? Who is the catalyst that determines the quantity, quality, and variety of goods and services? Did the consumer come up with the idea of personal computers, SUVs, fax machines, cell phones, the Internet, and the iPhone? No, these technological breakthroughs came from the genius of creative entrepreneurs and the savers/capitalists who funded their inventions.
A Year at FEE
by Mark Skousen
Is the sun setting on the world’s oldest freedom organization?
The Foundation for Economic Education (FEE) is often called “America’s oldest freedom organization.” It predates the Institute for Humane Studies, the Cato Institute, and the Libertarian Party; its monthly magazine The Freeman (now Ideas on Liberty), was published for years before Reason or Liberty began publication. FEE was founded in 1946 by Leonard Read, a libertarian businessman and prolific writer most famous for his book Anything That’s Peaceful and his essay “I, Pencil.” For almost 60 years, the Foundation has been located in a 35-room mansion on a five-acre estate in Irvington-on-Hudson, just 20 miles north of Manhattan. Through its books, student seminars, and The Freeman, FEE has been associated with some of the biggest names in the freedom movement: Ayn Rand, Ludwig von Mises, Henry Hazlitt, and Milton Friedman, among others. Even Ronald Reagan, John Wayne, and Lawrence Welk wrote letters of support to Read. (Go to www.FEE.org for a delightful color photograph of Ronald Reagan reading The Freeman, while his wife, Nancy, rests on his shoulder.)
Yet since the passing of its founder in 1983, FEE has fallen into obscurity while the Cato Institute, the Heritage Foundation, and Hillsdale College have become household names. It has struggled to survive financially and The Freeman has dropped to only 5,000 paid subscribers. A series of presidents, including Hans Sennholz and Donald Boudreaux (now chairman of the economics department at George Mason University), worked hard to resurrect the glory years of FEE. Their efforts were valiant. But despite these valiant efforts, when I became president of FEE in August, 2001, many of my friends in politics and finance had never heard of it.
So now it was my turn to take on the challenge of resurrecting FEE. I thought my background had prepared me well. I hold a Ph.D. in economics from George Washington University. I’ve been a professor of economics and finance at Rollins College for 16 years. I’ve edited a very successful investment newsletter and spoken on economics and liberty to a wide variety of audiences. Having written over a dozen books, including three textbooks, The Structure of Production, Economic Logic, and The Making of Modern Economics, I felt it was time to focus my efforts on spreading the word.
And I had a long experience with FEE. I have been an avid reader of The Freeman since the 60s, a columnist since 1994, and a financial supporter of FEE. I knew Leonard Read and have lectured at the FEE mansion many times over the past two decades. FEE published my Ph.D. dissertation, Economics of a Pure Gold Standard, in 1988 and a pamphlet, What Every Investor Should Know About Austrian Economics and the Hard Money Movement, in 1995. For many years, I have recommended FEE in my investment newsletter, Forecasts & Strategies as the one organization worthy of a tax-deductible contribution. Most importantly, economic education has always been as much my passion as the world of investing.
So when Gary North, a longtime FEE supporter, urged me to apply for the job as president in early 2001, I jumped at the opportunity. When the FEE board approved my name, our family suddenly dropped our easygoing lifestyle in Florida and moved to New York, with less than a month’s notice.
FEE has fallen into obscurity while the Cato Institute, the Heritage Foundation, and Hillsdale College have become household names.
I immediately went to work to restore the glory days of FEE, telling the board that my plan was to think big and make FEE a household name. I read everything I could about FEE, including Leonard Read’s private diaries and essays. My wife, Jo Ann, and I worked twelve-hour days, including weekends, to turn a candlestick (Leonard Read’s favorite symbol of liberty) into a lighthouse. I paid my respects to Andrew Carnegie, the legendary financier buried a few miles away in Sleepy Hollow Cemetery, by following his advice to “attract attention.” The first thing I did upon arriving was to replace the 50-year-old sign at the Broadway entrance with an impressive new sign. Here are some of the other FEE accomplishments in my first year:
• We acquired Laissez Faire Books, the largest distributor of books on liberty in the world.
• We created the annual Leonard E. Read Book Award for Excellence in Economic Education.
• We publicized FEE by obtaining complimentary exhibit booths at the Money Shows and other major investment conferences around the country.
• We created the James U. Blanchard III Memorial Scholarship Fund to finance scholarships for needy international students to attend FEE seminars. We raised over $60,000 in our first year and eight international students were recipients of the Blanchard scholarships this summer.
• We updated our primary website, www.FEE.org, and created a daily news service, www.FEEnews.org, with Ron Holland as editor. He did a terrific job and FEE won an award for this new daily news service. This past summer, FEE.org was averaging 30,000 new visitors each month — not “hits,” visitors.
• We dramatically expanded our high school and college outreach program, with Dinesh D’Souza serving as our spokesman on college campuses, and Greg Rehmke expanding his debate program into the homeschool arena.
• We invited Nobel Prize economist Milton Friedman to write an article for Ideas on Liberty (a first).
The FEE National Convention: First Time on Nationwide TV
Perhaps our greatest achievement was the FEE National Convention (“FEE Fest”) at Las Vegas in early May. It put FEE on the map and people are still talking about it. We attracted nearly 900 paid attendees, 100 exhibitors, and 80 speakers (including Ben Stein, Charles Murray, Ron Paul, Nathaniel Branden, and Dinesh D’Souza). FEE Fest was co-sponsored by Reason Foundation, Heritage Foundation, Young America’s Foundation, Institute for Humane Studies, Leadership Institute, Goldwater Institute, Liberty magazine, and dozens of other freedom organizations. Our seminar director, Tami Holland, put together this program in only four months and Kim Githler, president of the Money Show, was able to negotiate a contract with Bally’s/Paris Resort Hotels without requiring a minimum deposit (thus minimizing our risk). We made some money — $14,000 — on the convention, but more importantly, we made FEE visible for the first time in decades, and introduced hundreds of people to free-market economics in the course of three wonderful days. “I feel an electricity that I have not felt in many years among libertarian gatherings,” commented Nathaniel Branden. We received extremely favorable comments from attendees, and even today people write us to ask when the next FEE convention will be.
As a result of the convention, FEE appeared on nationwide television for the first time when C-SPAN Book TV taped speeches by Dinesh D’Souza, Harry Browne, Michael Ledeen, Charles Murray, Tom DiLorenzo, and me. C-SPAN Book TV broadcast these speeches from the FEE convention repeatedly from May until November. C-SPAN was so impressed with the FEE convention that they wanted to bring two crews to the next one.
As an added benefit of the convention, FEE acquired two new prestigious toll-free numbers, 1-800-USA-1776 and 1-888-USA-1776. These numbers — previously owned by the U.S. Bicentennial Commission — were valued by an independent media consultant conservatively at $400,000. The toll-free numbers were donated by Terry Easton, a telecommunications expert who attended the FEE convention and was so impressed with the “new” FEE that he offered to help FEE financially in many other ways.
FEE Summer Seminars: “You Changed My Life”
The FEE convention also led to the doubling of student/teacher seminars. We sold out all of our student seminars this past summer and even had to add an additional seminar because of higher demand. Over 175 students attended. One major supporter who attended the FEE convention was so pleased that he more than doubled the number of scholarships he awarded to FEE summer seminars.
In addition, we made money on all our seminars this summer (a first). We cut costs by using staffers and trustees to teach. My wife, Jo Ann, and the staff prepared 3,200 meals in the FEE kitchen, thus saving thousands of dollars. But the best part was the response of the students. (One student wrote me, “I will be forever grateful to FEE for making this life-changing event possible. It was one of the most enjoyable and productive weeks in my life.”) Of all the things we did in 2002, the student seminars were the most rewarding.
My Most Controversial Decision: Inviting Rudy Giuliani to Speak
Every year FEE plans a fall dinner in October for trustees and supporters. My goal was to put FEE on a national pedestal, so I invited the #1 speaker in America, former mayor Rudy Giuliani, to be the keynote speaker. I didn’t think this choice would be out of character, since past speakers have included Lady Margaret Thatcher, Bill O’Reilly, and Paul Gigot (new editorial page editor of The Wall Street Journal). Although not a libertarian, Giuliani had almost singlehandedly transformed the world’s most powerful city from a stifling, dirty, dangerous metropolis into a thriving, safe, and clean city. Giuliani proudly points to the recommendations of the Manhattan Institute, a free-market think tank, as having influenced his decision to cut taxes, privatize, and deregulate the city’s economy. And few questioned his leadership during the terrible days after the terrorist attacks in September, 2001. I probably would not have moved to New York if Giuliani hadn’t been mayor, because the New York of ten years ago simply wasn’t safe or inviting.
In my mind, the biggest risk was financial — Giuliani gets a high honorarium and we had reserved the big ballroom at the New York Hilton. My goal was to attract the largest gathering of freedom lovers in New York history and to let them know that FEE was the place to learn more. Kim Githler again came to our aid by co-sponsoring the event and negotiating excellent terms with the Hilton. The chances of getting Giuliani were slim, however, since he turns down nine out of every ten requests. But everything fell into place when Giuliani accepted my invitation. And John Stossel of ABC News graciously agreed to be Master of Ceremonies for the event. Talk about a one-two punch! I quickly arranged pledges from supporters to buy patron tables to cover the cost of Giuliani’s honorarium, and Tami Holland went to work selling tickets. Everything was set for a spectacular extravaganza that would elevate FEE to national prominence.
However, I failed to take into account one thing — the extreme reaction of some libertarians around the country to my choice of Rudy Giuliani as a speaker at a FEE event. Many were outraged that I would select a “fascist” and a “thug” who “represents everything inimical to what FEE stands for,” to quote some of the more colorful lines from libertarians on the Internet. I was attracting attention, all right, but not the kind I was expecting. I countered by explaining that the Liberty Banquet was not an endorsement of Giuliani’s political record, but an outreach program. We wanted the general public to become familiar with FEE as the best source of sound economics, and what better way to attract the public than to invite America’s hero after Sept.11? Thousands of investors and business people didn’t know FEE from Adam, but they knew Giuliani, and by coming to a banquet with America’s mayor as speaker, they would be introduced to a powerful new organization that could change their lives forever.
The only way we are going to make a difference in this world is if we reach out to people who don’t yet agree with us. Sound economics is too important to leave only to libertarians! Henry Grady Weaver wrote in a FEE pamphlet: “I [already] believe in free enterprise. Explain it to those who don’t, not to me.” Amen!
I didn’t think choosing Rudy Giuliani to speak would be out of character, since past speakers have included Lady Margaret Thatcher, Bill O’Reilly, and Paul Gigot.
It didn’t seem to matter that John Stossel, a true libertarian hero, was willing to appear on stage with Giuliani, or that Giuliani had done wonders to restore the value of life, liberty, and property (the libertarian trinity) in the city of New York. I was amazed how closed-minded my libertarian friends were to Giuliani’s positive contributions. “It’s like inviting the devil to church,” accused John Pugsley. My response: “I already did that when I invited Doug Casey to speak at the FEE National Convention on Sunday, May 5.” Many Christian libertarians, including me, were offended by Doug’s attack on Christianity, but I was willing to listen to his opinions. I wish libertarians could be more tolerant and open-minded, more willing to have a dialogue with those whose views differ from their own. As Ben Stein, our keynote speaker at the FEE convention, said, “It’s funny how libertarians are so controlling.” (I was criticized for inviting Ben Stein, too, because he wasn’t a pure libertarian.)
Ironically, another organization, Washington Policy Center, dedicated to “advancing limited government and free markets,” promoted their own banquet in Seattle two weeks before ours. The keynote speaker? Rudy Giuliani. They had over 850 attendees in a very successful outreach program.
It was during this ongoing debate over Giuliani that I received a startling telephone call from the chairman of the FEE board. He said the executive committee had met and decided to ask for my resignation. He did not go into details, aside from saying the board did not share my grand vision for FEE. He cancelled the Liberty Banquet and all future FEE national conventions.
I must admit that this move was the most shocking and disappointing event I’ve ever experienced in the freedom movement, and it came at a time when FEE was on the verge of once again making a real impact. Over the past ten years my wife and I had put our hearts and souls, as well as a good deal of money and reputation, into FEE and then it ended like this! It seemed unfair to us and destructive to FEE’s future. I have no doubt that the board members are good people and well-intentioned supporters of liberty. They volunteer their time, donate funds, and attend board meetings without compensation. Several board members were quite supportive of my presidency and wrote letters on my behalf. But I did not want to cause further controversy by fighting a divided board, so I agreed to resign. I still feel a great sadness about this.
Looking back, I made lots of mistakes as president, things I would do differently if I had the benefit of hind-sight. I would have worked more closely with the board and spent more time raising money. I probably tried to do too much too soon. But I think we did some things right and, in large measure, fulfilled the mandate I was given.
When I became FEE’s president, the organization was coming off a difficult year financially and charitable giving was plummeting across the country. I am pleased that in the six months before I was asked to resign, FEE’s revenues were up 30% and contributions were up 20%. And I am proud of the FEE convention and the student seminars.
When I was asked for my resignation, it was the most shocking and disappointing event I’ve ever experienced in the freedom movement, and it came at a time when FEE was on the verge of once again making a real impact.
After the executive committee cancelled the fall dinner, I was worried about the financial burden the cancellation of the Liberty Banquet would put on FEE, since it would still have the expense of honoring Giuliani’s contract while returning the patron table donations. So with the help of my publisher, Tom Phillips, and Kim Githler of the Money Show, we resurrected the Liberty Banquet and it went off on schedule Oct. 25 at the New York Hilton. It had lost momentum after the initial cancellation and a three-week delay in sending out the major promotions, but we still managed to attract 250 paid attendees. Rudy Giuliani was the perfect gentleman and quite a few libertarians gave him a standing ovation.
Jo Ann and I have appreciated the many letters and emails of support we have received during this difficult period. I continue to teach on college campuses, write my investment letter, speak at conferences, and author books. Instead of writing a column for Ideas on Liberty, I am now a contributor to Liberty magazine. I have my free time back but, to paraphrase John Maynard Keynes, I’d rather be the slave of some great cause.
Jo Ann and I will persevere, but what about America’s oldest freedom organization? An aggressive new FEE is unlikely under the current board. The new toll-free numbers have been returned to Terry Easton (upon his request), the daily news service is dormant, and the Blanchard Scholarship Fund is looking for a new home. There’s talk among a few board members of selling the FEE mansion and distributing the assets of FEE to other freedom organizations. Such an action would be most unfortunate. As one FEE supporter wrote, “it would be a crime to discontinue FEE since it was the first free-market foundation preaching in the wilderness to the business community which was then plagued with Keynes’ dogmas.”
FEE deserves to survive and prosper. Many organizations do a fine job of lobbying in Washington, researching public policies, supporting important libertarian scholarship, and fighting the enemies of freedom. But only one organization is dedicated solely to educating students, teachers, businesspeople, and citizens on the principles of free markets and sound money. And, if there’s anything the world needs desperately, it’s a strong dose of sound economics and an enthusiastic FEE. Jo Ann and I sincerely hope FEE can regain its influence.
When the Founding Fathers signed the Constitution of the United States in 1787, Benjamin Franklin, looking toward the half-sun carved on the back of the president’s chair, observed, “I have often in the course of the session, looked at that [chair] behind the president without being able to tell whether it was rising or setting. But now at length I have the happiness to know that it is a rising and not a setting sun.”
In a similar vein, as I was leaving FEE at the end of my presidency, I stood before the large portrait of Leonard E. Read located above the mantel in the living room of the FEE mansion and wondered whether Len was smiling or sad. I think that, for a year at least, he was smiling.
From Poverty to Riches: Is There a Magic Elixir?
From The President’s Desk
Published in Ideas on Liberty
by Mark Skousen
“The problem of making poor countries rich was much more difficult than we thought.”
—William Easterly, World Bank1
“If there is one formula for our success, it was that we were constantly studying how to make things work, or how to make them work better.”
—Lee Kuan Yew, former Prime Minister, Singapore2
William Easterly has spent his entire adult life working for the World Bank, living in the Third World, and helping poor countries develop into rich countries. You would think he would severely lecture the World Bank and his fellow economists about the dumb policies governments have pursued.
Instead, Easterly throws his hands in the air and offers no clues to the “elusive” quest for growth. He confirms a few economic truths, such as “incentives matter” and “government can kill growth,” but ultimately he thinks luck has as much to do with it as anything. “There are no magic elixirs,” he sighs. The almighty empirical evidence solemnly declares it. Foreign aid doesn’t work. Foreign investment doesn’t work. High savings don’t work. Investment in machinery doesn’t work. Education doesn’t work. Technology doesn’t work. Tax cuts don’t work. All have failed to live up to expectations. It’s time for the economist to be humbled: “It’s very, very hard to predict success in sports, music, and politics—as well as in economics.”3
Over the years I have witnessed a split in the economics profession. Some adhere to the view that we live in an Age of Ignorance; that we know very little about how the world economy really operates and what government policies should be pursued. They are in large measure armchair critics and doubting Thomases.4 Others believe we live in an Age of Enlightenment; that despite maddening uncertainties about the marketplace, we do know with some assurance how a freely competitive market economy works and we have learned a great deal about what governments should and should not do. It is sad commentary to see that despite his honesty, Easterly, a seasoned veteran in the war on world poverty, tends to fall into the former category. He certainly lost an opportunity to clear the air and reveal the root causes and cures of poverty.
Singapore’s Economic Miracle
Perhaps one reason Easterly’s story ends in tragedy is that he apparently spent too much time in failed economies and not enough time in successful ones. I notice that his book says almost nothing about Chile, the economic model of Latin America, or the Four Tigers—Hong Kong, Korea, Taiwan, and Singapore.
Contrast Easterly’s confused story with Lee Kuan Yew’s autobiographical account of Singapore. Lee became president of the tiny, poverty-stricken British colony after it was granted independence in 1965. In one generation, he oversaw its transformation into an Asian giant with the world’s number-one airline, best airport, busiest port of trade, and the world’s fourth-largest per capita real income.
How did this economic miracle happen?
First, Lee offered real leadership. He was a seminal figure in Asia who accomplished extraordinary things. He built an army from scratch, won over the unions, and destroyed the communists after the British left a vacuum. Despite strong opposition, he insisted on making English one of four official spoken languages, knowing it was fast becoming the language of international business. Singapore, like other Southeast Asian countries, was known for its nepotism, favoritism, and covert corruption; Lee cleaned up the courts, police, and immigration and customs offices. Today Singapore is ranked as the least corrupt country in Asia. Singapore was also dirty, so Lee began a “clean and green” campaign. Rivers, canals, and drains were cleaned up and millions of trees, palms, and shrubs were planted.
The Lee government tore down dilapidated shacks and replaced them with high-rise apartments. He imposed law and order by demanding severe sentences for murder and other crimes. Today Singapore ranks no. 1 in the world for security. To reduce traffic congestion, a huge problem in Asian cities, Singapore built an underground subway system, and imposed an electronic road-pricing program. Every vehicle has a “smart card” on its windshield, and the toll amount varies with the road used and the time of day. During rush hour, the price goes up. “Since the amount people pay now depends upon how much they use the roads, the optimum number of cars can be owned with the minimum of congestion.”5 A sound economic principle!
Lee rejected Soviet-style central planning and domestic heavy industry, although he did target certain industries for development. He focused on a two-pronged plan to advance Singapore: First, his government encouraged domestic industry to leap over their neighbors and link up with the developed world of America, Europe, and Japan, and tried to attract their manufacturers to produce in Singapore. Second, Lee wished to create a First World oasis in the Third World by establishing top standards in security, health, education, communications, and transportation, and a government offering a stable currency, low taxes, and free trade. Singapore would become a “base camp” for multinational corporations from around the world. And, after years of effort, it worked.
Under Lee’s brilliant leadership, Singapore has advanced far beyond anyone’s dreams. Yet we cannot ignore his mistakes—his paternalistic strong-arm tactics, his interventionist targeting of industries, his forced saving programs, his denial of a free press, and his excessive punishments for certain crimes. It will be interesting to see how Singapore performs, both as a people and economy, after Lee Kuan Yew is gone. We can only hope that economic freedom will lead to political liberty.
1. William Easterly, The Elusive Quest for Growth (Cambridge, Mass.: MIT Press, 2001), p. 291.
2. Lee Kuan Yew, From Third World to First: The Singapore Story, 1965–2000 (New York: Harper Collins, 2000), p. 687.
3. Easterly, p. 208. Despite Easterly’s failure to come to any clear conclusions, his book offers an honest and often entertaining appraisal of development literature.
4. See my columns, “Is This the Age of Ignorance—or Enlightenment?,” June 1994; “European Unemployment: The Age of Ignorance, Part II,” January 1995; and “The Age of Confusion,” August 1995.
5. Lee, p. 206.
Mark Skousen is president of FEE.
A Painless Way to Triple Your Savings
From The President’s Desk
Published in Ideas on Liberty
by Mark Skousen
“The human mind is charming in its unreasonableness, its inveterate prejudices, and its waywardness and unpredictability.”
“Behavioral” finance is the hot new field in the rapidly growing “imperial” science of economics. Consider the titles of recent books on the subject: Irrational Exuberance by Robert Shiller of Yale University, who correctly warned investors that the bull market on Wall Street in 2000 was not sustainable, and Why Smart People Make Big Money Mistakes by Gary Belsky and Thomas Gilovich.
Essentially, these writers take issue with a fundamental principle of economics—the concept of “rational” predictable behavior. They argue that investors, consumers, and business people don’t always act according to the “rational economic man” standard, but instead suffer from overconfidence, overreaction, fear, greed, herding instincts, and other “animal spirits,” to use John Maynard Keynes’s term.2
Their basic thesis is that people make mistakes all the time. Too many individuals overspend and get into trouble with credit; they don’t save enough for retirement; they buy stocks at the top and sell at the bottom; they fail to prepare a will. Economic failure, stupidity, and incompetence are common to human nature. As Ludwig von Mises notes, “To make mistakes in pursuing one’s ends is a widespread human weakness.”3
Fortunately, the market has a built-in mechanism to minimize mistakes and entrepreneurial error. The market penalizes mistakes and rewards correct behavior (witness how well business responded to the Y2K threat in the late 1990s). As Israel Kirzner states, “Pure profit opportunities exist whenever error occurs.”4
But the new behavioral economists go beyond the standard market approach. They argue that new institutional measures can be introduced to minimize error and misjudgments, without involving the government.
At the American Economic Association meetings in Atlanta in January 2002, Richard Thaler of the University of Chicago presented a paper on his “SMART” savings plan, which is being tested by five corporations in the Chicago area. Thaler, author of The Winner’s Curse and a pioneer in behavioral economics, has developed a new institutional method to increase workers’ savings rates. Thaler noted that the average workers’ savings rates are painfully low. I blame the low rate on high withholding taxes, but Thaler suggested that part of the problem is the way retirement programs are administered. He convinced these corporations to adopt his plan to have their employees enroll in an “automatic” investment 401(k) plan. Most corporations treat 401(k) plans as a voluntary program and, as a result, only half choose to sign up. In Thaler’s plan, employees are automatically invested in 401(k) plans unless they choose to opt out.
Result? Instead of 49 percent signing up (as they do in a typical corporate investment plan), 86 percent participate.
In addition, Thaler has participating employees automatically invest most of any pay increase in higher contributions to their 401(k) plans, so they never see their paychecks decline, even though their 401(k) plans are increasing. Consequently, employees under this SMART plan have seen their average savings rate increase from 3 to 11 percent.
Robert Shiller was a discussant at the session and rightly called Thaler’s plan “brilliant.” I agree. Having authored several investment books advocating “automatic investing” and dollar-cost-averaging plans,5 I applaud Professor Thaler for taking the concept of automatic investing to a new level. If companies everywhere adopt his plan, it could indeed revolutionize the world and lead not only to a much more secure retirement for workers but to a higher saving and investment rate. The result could be a higher economic growth and standard of living throughout the world.
Most important, Thaler’s plan is a private-sector initiative and does not require government intervention. In short, through innovative management techniques and education, individuals can solve their own financial and business problems without the help of the state.
1. Lin Yutang, The Importance of Living (New York: John Day Company, 1937), p. 57.
2. References to “animal spirits” and “waves of irrational psychology” can be found in John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Macmillan, 1973 ), pp. 161–62.
3. Ludwig von Mises, Theory and History (New Haven: Yale University Press, 1957), p. 268. However, Mises refuses to call bad decisions “irrational.” He states, “Error, inefficiency, and failure must not be confused with irrationality. He who shoots wants, as a rule, to hit the mark. If he misses it, he is not ‘irrational’ he is a poor marksman.”
4. Israel M. Kirzner, “Economics and Error” in Perception, Opportunity, and Profit (Chicago: University of Chicago Press, 1979), p. 135.
5. Mark and Jo Ann Skousen, High Finance on a Low Budget (Chicago: Dearborn, 1993) and Mark Skousen’s 30-Day Plan for Financial Independence (Washington, D.C.: Regnery, 1995).
Mark Skousen is president of FEE.
One Capitalist’s Advice: Attract Attention!
From the President’s Desk
Ideas on Liberty
by Mark Skousen
“Individualism, private property, the law of accumulation of wealth, and the law of competition . . . are the highest result of human experience, the soil in which society, so far, has produced the best fruit.” —ANDREW CARNEGIE’
A few days after my move to New York, I paid my respects to an icon of capitalism, Andrew Carnegie (1835-1919), whose tombstone is appropriately located only a few miles up from FEE headquarters, in Sleepy Hollow Cemetery. In three ways, Carnegie reflects the spirit of FEE—he was a fierce defender of free-enterprise capitalism; he gave generously to good causes; and he worked hard for the cause of world peace and democracy. All three are in short supply in today’s uncertain world of regulatory state capitalism, welfarism, and terrorism.
As a joint creator (along with J. P. Morgan) of U.S. Steel, the first billion-dollar corporation in the world, Carnegie was a successful entrepreneur who benefited humanity by offering cheaper and better steel with which to build a modern world. He would reject the “robber baron” title. Capitalism was not a device to enrich the rich at the expense of the poor, as the Marxists contend; “Capitalism,” he said, “is about turning luxuries into necessities.” He started out as a poor Scottish immigrant, a classic Horatio Alger hero. He liked to be different; his favorite advice to young men was, “Attract attention.”
For Carnegie, there were in the world other values than those of the business culture: he loved books, and became friends with intellectuals, writers, and statesmen such as Herbert Spencer, Mark Twain, and William Gladstone. He was intensely competitive, even glorying in beating his friends in golf. In business, he drove down the cost of steel, even as he improved the quality. “Cheaper and better” became the American way. “Watch the costs, and the profits will take care of themselves,” he explained.2 He made no apologies for his ruthless competitive spirit, which he justified as a Darwinian form of “survival of the fittest” and as a fulfillment of Jesus’ parable of the talents. Like an old-fashioned Hank Rearden in Ayn Rand’s novel Atlas Shrugged, Carnegie wasn’t merely an apologist for anarchic individualism; he was its celebrant.
Carnegie objected strenuously to the “progressives” who favored socialism and communism over individualism. “To those who propose to substitute Communism for this intense Individualism, the answer therefore is: The race has tried that. All progress from that barbarous day to the present time has resulted from its displacement.”3
“The Man Who Dies Rich Dies Disgraced”
Following his retirement in 1901, the Man of Steel did not live it up with ostentatious mansions, limousines, and hundred-dollar cigars, which Thorstein Veblen labeled “conspicuous consumption” of the idle rich. Carnegie spoke of the millionaire’s duty to live a “modest” lifestyle, shunning extravagant living and administering his wealth for the benefit of the community. To do otherwise, he warned, would encourage an age of envy and invite socialistic legislation attacking the rich through progressive taxation and other onerous anti-business regulations.
Carnegie practiced what he preached, giving away over $350 million in his lifetime. One of his first acts after U.S. Steel went public was to put $5 million into a pension and benefit plan for his workers. He was careful in his philanthropy, avoiding at all costs “indiscriminate charity.” He disdained the conventional practice of accumulating wealth solely to be bequeathed to heirs, which he regarded as “sterile” and even “perverse” if it resulted in profligate living. Instead, he spent millions building 2,811 public libraries, donating 7,689 organs to churches, and establishing Carnegie Hall in New York and the Carnegie Institution in Washington. He financed technical training at the Carnegie Institute of Technology and established a pension fund for teachers through the Carnegie Foundation for the Advancement of Teaching. I cannot help but think that were he alive today, he would be a major donor to FEE!
Finally, Carnegie devoted the rest of his life to promoting world peace and democracy. He was convinced that the United States surpassed Europe economically in part because Europe was constantly embroiled in wars with its neighbors while the United States largely avoided such conflicts. He campaigned against imperialistic entanglements with other nations and in favor of peaceful arbitration as a means to end conflicts. He was a passionate believer in democracy, universal suffrage, and equality of opportunity through free public education. But he opposed equality of property or ability, and argued that all citizens had the right to choose their own occupation and had the right to earn income in any amount and spend it as they wished. He expressed distaste for royalty, aristocracy, and any form of state religion.
The Spirit of Andrew Carnegie Lives at FEE
Today I am happy to report that the world has a goodly share of modern-day Andrew Carnegies. As the new president of FEE, I have had the pleasure of becoming aware of these unique men and women of the business world who have not only added value to the global economy through their entrepreneurial efforts, but have sacrificed time and money to promote FEE and its mission. For example, last week Larry Reed, president of the Mackinac Center for Public Policy and a FEE trustee, told me about a FEE donor who spent half his life sponsoring FEE seminars on free-market economics in his hometown, often at considerable personal sacrifice of time and financial resources. Another individual, on hearing that a FEE student seminar might have to be canceled due to a lack of attendees, arranged for several dozen students to attend. The seminar turned out to be a great success. Hundreds of other FEE supporters have arranged conferences, raised funds, and distributed copies of Ideas on Liberty to their friends and acquaintances. And with your help we are planning many new programs to spread the gospel of FEE and to “attract attention,” as Andrew Carnegie would advise.
When barbaric terrorists destroyed the Twin Towers at the World Trade Center a symbol of global capitalism and individual creativity, and built with Carnegie steel—I was heartened to read how thousands of private business leaders stepped forward and provided $200 million in financial aid to rebuild the area. I salute them for being living examples of FEE’s gospel of peace, prosperity, and freedom.
1. Andrew Carnegie, The Gospel of Wealth and Other Timely Essays (Cambridge: Harvard University Press, 1962 ). p. 19.
2. Michael Kiepper and Robert Gunther, “Andrew Carnegie,” in The Wealthy 100 (New York: Carol Publishing Group. 1996). p. 31.
3. Carnegie, p. 18.
Where Are the Best Schools in Austrian Economics?
Ideas On Liberty
Economics on Trial
by Mark Skousen
“We must raise and train an army of fighters for freedom.”
—F. A. Hayek
Frequently students or parents approach me at investment or economics conferences with the question, “Can you recommend an undergraduate or graduate program in free-market economics?” With the explosive interest in a degree in economics, it’s imperative that students get a topnotch education.* In my experience, if students aren’t exposed early to the principles of Adam Smith and Ludwig von Mises, it is often difficult for them to shed the philosophies of John Maynard Keynes, Karl Marx, and other interventionsts later on.
Here in the United States most colleges and universities have a goodly number of “neoclassical” economists with a free-market bent. (There are a number of “free market” colleges and universities in Latin America, Europe, and Asia, a topic I shall pursue in a future column.) The American schools include the University of Virginia; the University of California, Los Angeles (UCLA); Florida State University; and the University of Chicago. However, anyone pursuing a degree in economics from these institutions will need to be well-versed in advanced mathematics in order to understand the professional language. As New York University Professor Mario Rizzo wrote me, “Contemporary economics has become a branch of applied mathematics.”
Graduate Schools in Austrian Economics
Fortunately, there’s a growing number of schools that specialize in Austrian economics. The best-known program is located at New York University, ranked as one of the top 20 economics departments in the country. The Austrian Economics Program, under the tutelage of Israel Kirzner, David Harper, and Rizzo, has been functioning at NYU since the days of Mises. The Austrian course work attracts students from around the world.
NYU also offers a weekly Austrian Economics Colloquium and an annual summer course held at FEE. (Go to www.econ.nyu.edu/dept/austrian.) However, it should be noted that the NYU program is small, and most of the teachers there are non-Austrian.
George Mason University (in northern Virginia) is also attracting undergraduate and graduate students who want to specialize in Austrian economics, although Professor Peter Boettke, who also edits The Review of Austrian Economics, says that “what makes GMU particularly attractive are its affiliated fields of Public Choice, history of thought, and constitutional economics.” Boettke and Karen Vaughn teach the Austrian theory of the market process; Richard Wagner offers a course in institutional economics; and Walter Williams serves as chairman of the department. (Go to www.gmu.edu/departments/economics.) The Institute for Humane Studies is also located at GMU (www.theihs.org).
Another graduate Austrian program that is gaining prominence is at Walsh College of Accountancy and Business Administration in Troy, Michigan (near Detroit). Walsh College (www.walshcol.edu) specializes in business degrees—in marketing, management, finance, and economics. Under the direction of Harry Veryser, the school now offers a two-year bachelor’s degree and a master’s degree in economics. The entire faculty consists of free-market economists, with a special emphasis on Austrian economics. Students are assigned books and readings by Mises, Hayek, Henry Hazlitt, Wilhelm Ropke, Paul Heyne, and me, among others. Walsh’s program is impressive.
The Expanding Austrian Universe
With the Ludwig von Mises Institute (www.mises.org) next door, Auburn University (www.auburn.edu/business/economics) has attracted a large number of students over the years. The most prominent Austrian economist on campus is Roger Garrison, author of the new advanced macro text Time and Money. Garrison teaches the main course in macroeconomics. (Leland Yeager, former Ludwig von Mises Professor of Economics at Auburn, is now retired.) Unfortunately, Auburn recently discontinued its Ph.D. program. There are a goodly number of colleges offering solid undergraduate courses. Two mainstays are Hillsdale College in Michigan and Grove City College, near Pittsburgh. Grove City College (www.gcc.edu) no longer has Hans Sennholz as chairman of the department, but Hans indicates that the school is still free-market oriented, and John Moore, the president, is an economist. Hillsdale College (www.hillsdale.edu/dept/economics) has several free-market professors, the most well-known being Richard Ebeling, who runs the annual Ludwig von Mises lecture series. Hillsdale also houses the Mises library.
I should also mention Northwood University, an associate- or full-degree business school with campuses in Midland, Michigan; West Palm Beach, Florida; and Cedar Hill, Texas. Founded by Gary Stauffer and Arthur Turner in 1958, Northwood stresses free-market and Austrian economics. (Go to www.northwood.edu.)
In California, there are two universities with an Austrian bent. Santa Clara University, under the guidance of Daniel Klein, offers the Civil Society Institute (www.scu.edu/csi), which involves a weekly colloquium, lectures series, and “coffeehouse” for libertarian ideas. Other prominent members of the faculty are Laurence Iannaccone, Henry Demmert, Fred Foldvary, and David Friedman. Charles Baird, labor economist and Ideas on Liberty columnist, is the co-chairman of the department at California State University at Hayward (www.sbe.csuhayward.edu) and director of the Smith Center for Private Enterprise Studies. According to Baird, half the tenure-track economists there are “unabashedly free-market.”
Lawrence H. White, a specialist in free banking, was recently appointed the first F A. Hayek Professor of Economic History at University of Missouri-St. Louis (www.umsl.edu/divisions/artscience/economics). According to his colleague David C. Rose, “a number of economists are either outright Austrian or are very sympathetic to the Austrian school and free market ideals.”
If you want year-round sunshine, you can always come to central Florida and take one of my courses in investments, history of thought, or Austrian economics at Rollins College in Winter Park, Florida (near Orlando). (See www.rollins.edu.)
Austriae est imperare orbi universo!
*See Jon E. Hilsenrath, “In Hot Pursuit of Economics Ph.D.s—Short Supply and Big Demand Mean Young Graduates Are Courted Like Royalty,” Wall Street Journal, February 20, 2001, p. B1.
Pulling Down the Keynesian Cross
Ideas On Liberty
Economics on Trial
by Mark Skousen
“The circle had come right round; it was as though Keynes had never been.”
“Textbooks have to be rewritten in the aftermath of each scientific revolution.”
-Thomas S. Kuhn2
In his third and final volume on John Maynard Keynes, Robert Skidelsky comes to the shocking conclusion that the Keynesian revolution was temporary, that Keynes’s General Theory was really only a “special” case, and that “free market liberalism” has ultimately triumphed. This is all the more amazing given that Lord Skidelsky has spent the past 20 years of his professional career studying Keynes and resides in Keynes’s old estate, Tilton House. Few scholars would have the guts to repudiate the theory of the man they adore.
It’s even tougher for old dogs to learn new tricks, and that refrain applies to Paul Samuelson, the “American Keynes” who introduced millions of students to the “new economics” of the master. He continues to hang his hat on the Keynesian cross, even as he publishes the 17th edition of his world-famous textbook. The pedagogical paradigm keeps shifting further toward the classical model of Adam Smith, and as each edition of Economics moves in that direction, Samuelson resists the change. He cites his mentor more than any other economist; only Keynes, not Adam Smith or Milton Friedman, is measured as a “many-sided genius.” His textbook still begins macroeconomics with the Keynesian model, even though most other textbook writers have adopted Greg Mankiw’s method of starting with the long-run classical model.3 According to Samuelson, Adam Smith’s invisible-hand doctrine-that laissez-faire behavior maximizes social welfare-“holds only under very limited conditions.”4 On the final page (755) of his massive textbook, he renders “two cheers to the market, but not three.”
Two Cheers for Hayek and Friedman
Having reviewed all 17 editions of Samuelson’s magnum opus, I conclude that his textbook has gradually shifted, albeit grudgingly, from one cheer to two cheers for the market. Much of this improvement is due to Yale’s Bill Nordhaus, his co-author since 1985. (He writes the entire text now, which Samuelson then reviews.)
What’s new about the latest edition? More free-market economists are cited, including Julian Simon, Ronald Coase, James Buchanan, Arthur Laffer, Robert Mundell, and Gary Becker. Samuelson and Nordhaus devote an entire page (41) to F.A. Hayek and Milton Friedman, “guardians of economic freedom.” They recommend Hayek’s The Road to Serfdom and Friedman’s Capitalism and Freedom, saying, “All thoughtful economists should study his arguments carefully.”
In chapter 2, “Markets and Government in a Modern Economy,” the authors highlight the benefits of globalization and the importance of property rights, noting that Russia and other former communist nations have suffered because of a failure to enforce “the legal framework.”
They also add an entire new page on the issue of lighthouses as public goods. For years Samuelson used the lighthouse as a prime example of market failure; only government could build and operate lighthouses. Several years ago I chided Samuelson for ignoring Ronald Coase’s famous essay, “The Lighthouse in Economics,” which proved that the Trinity House and other lighthouses in England were built and owned by private firms that imposed tolls on ships docking at nearby ports.5
Now, finally, Samuelson and Nordhaus have responded to Coase’s challenge in the 17th edition (pp. 37—38). They admit that privately operated lighthouses existed in England, but then point to the east coast of Florida as a case where “there were no lighthouses until 1825, and no private-sector lighthouses were ever built in this area.” According to Nordhaus, the only response to shipwrecks was a thriving private “wrecking” industry that charged high fees for “saving lives and cargo.” Nordhaus goes on to note that lighthouses have become obsolete, replaced by the satellite-based Global Positioning System, a service provided by the government.
In sum, the paradigm in economics has definitely shifted from Keynesianism to classical economics, but the case for complete laissez faire is still raging in the halls of academia.
1. Robert Skidelsky, John Maynard Keynes: Fighting for Britain, 1937-1946 (London: Macmillan, 2000), p. 506.
2. Thomas S. Kuhn, The Structure of Scientific Revolutions, 2d ed. (Chicago: University of Chicago Press, 1970), p. 137.
3. See N. Gregory Mankiw, Principles of Economics, 2d ed. (Ft. Worth, Tex.: Harcourt College Publishers, 2001). I still regard Roy J. Ruffin and Paul R.Gregory, Principles of Economics, 7th ed. (Boston: Addison Wesley Longman, 2001) as the best mainstream textbook on the market today.
4. Paul A. Samuelson and William D. Nordhaus, Economics, 17th ed. (New York: McGraw-Hill Higher Education, 2001), p. 325.
5. Mark Skousen, “The Perseverance of Paul Samuelson’s Economics,” Journal of Economic Perspectives, Spring 1997, p. 145. Coase’s article appeared in the Journal of Law and Economics, October 1974, pp.357-76.
It All Started with Adam
Ideas On Liberty
Economics on Trial
by Mark Skousen
Adam Smith, that is. Having just completed writing a history of economics,1 I have concluded that, despite the protestations of Murray Rothbard and other detractors, the eighteenth-century moral philosopher and celebrated author of The Wealth of Nations deserves to be named the founding father of modern economics.
The reason: Adam Smith is the first major figure to articulate in a profound way what has become known as the first fundamental theorem of welfare economics: that the invisible hand of competition automatically transforms self-interest into the common good. George Stigler rightly labels Smith’s model of laissez-faire capitalism (Smith never used the phrase) the “crown jewel” of The Wealth of Nations and “the most important substantive proposition in all of economics.” He states, “Smith had one overwhelmingly important triumph: he put into the center of economics the systematic analysis of the behavior of individuals pursuing their self-interests under conditions of competition.”2
In short, Smith’s thesis is that a “system of natural liberty,” an economic system that allows individuals to pursue their own self-interest under conditions of competition and common law, would be a self-regulating and highly prosperous economy. Eliminating restrictions on prices, labor, and trade meant that universal prosperity could be maximized through lower prices, higher wages, and better products. Smith assured the reader that his model would result in “universal opulence which extends itself to the lowest ranks of the people.”3
Indeed it has. Published in 1776, The Wealth of Nations was the intellectual shot heard around the world, a declaration of economic independence to go along with Thomas Jefferson’s declaration of political independence. It was no accident that the industrial revolution and sharply higher economic growth began in earnest shortly after its publication. As Ludwig von Mises declares, “It paved the way for the unprecedented achievements of laissez-faire capitalism.”4
For or Against Smith
The most amazing discovery I made in researching and writing over the past three years is that every major economic figure—whether Marx, Mises, Keynes, or Friedman—could be judged by his support of or opposition to Adam Smith’s invisible-hand doctrine. Karl Marx, Thorstein Veblen, John Maynard Keynes, and even British disciples Thomas Robert Malthus and David Ricardo denigrated Adam Smith’s classical model of capitalism, while Alfred Marshall, Irving Fisher, Ludwig von Mises, and Milton Friedman, among others, remodeled and improved on Smithian economics.
For example, Keynes is unsympathetic to Adam Smith’s worldview. “It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. . . . Nor is it true that self-interest generally is enlightening. . . . Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately.”5 The basic thesis of Keynes’s magnum opus, The General Theory of Employment, Interest, and Money (1936), is that laissez-faire capitalism is inherently unstable and requires heavy state intervention to survive. Keynesian disciple Paul Samuelson correctly understood the true meaning of Keynes: “With respect to the level of total purchasing power and employment, Keynes denies that there is an invisible hand channeling the self-centered action of each individual to the social optimum.”6 Thus, I conclude that Keynesian economics, rather than its savior, is an enemy of Adam Smith’s system of natural liberty.
Karl Marx went even further. Instead of creating a system of natural liberty, Marx set out to destroy it. Modern-day Marxist John Roemer agrees. The “main difference” between Smith and Marx is: “Smith argues that the individual’s pursuit of self-interest would lead to an outcome beneficial to all, whereas Marx argued that the pursuit of self-interest would lead to anarchy, crisis, and the dissolution of the private property-based system itself. . . . Smith spoke of the invisible hand guiding individual, self-interested agents to perform those actions that would be, despite their lack of concern for such an outcome, socially optimal; for Marxism the simile is the iron fist of competition, pulverizing the workers and making them worse off than they would be in another feasible system, namely, one based on the social or public ownership of property.”7
Adam Smith as a Heroic Figure
By measuring economists against a single standard, Adam Smith’s invisible-hand doctrine, I found a fresh way to unite the history of economic thought. Virtually all previous histories of economics, including Robert Heilbroner’s popular work, The Worldly Philosophers, present the story of economics as one conflicting idea after another without resolution or a running thread of truth. This hodgepodge approach to history leaves the reader confused and unable to separate the wheat from the chaff.
My approach places Adam Smith and his system of natural liberty at the center of the discipline. Think of it as a story of high drama with a singular heroic figure. Adam Smith and his classical model face one battle after another against the mercantilists, socialists, and other enemies of liberty. Sometimes even his “dismal” disciples (Malthus, Ricardo, and Mill) wound him. Marx and the radical socialists attack him with a vengeance and leave him for dead, only to have him resuscitated by the leaders of the marginalist revolution (Menger, Jevons, and Walras) and raised up to become the inspiration of a whole new science.
But the “neo-classical” model of capitalism faced its greatest threat from the Keynesian revolution during the Great Depression and the postwar era. Fortunately, the story has a good ending. Through the untiring efforts of free-market advocates, especially Milton Friedman and F. A. Hayek, Adam Smith’s model of capitalism is re-established and in the end triumphs. As Milton Friedman proclaims, “To judge from the climate of opinion, we have won the war of ideas. Everyone-left or right-talks about the virtues of markets, private property, competition, and limited government.”8
Long live Adam Smith!
1. The Making of Modern Economics (Annonk, N.Y.: M. E. Sharpe Publishers, 2001).
2. George Stigler, “The Successes and Failures of Professor Smith,” Journal of Political Economy, December 1976, p. 1201.
3. Adam Smith, The Wealth of Nations (New York: Modern Library, 1965 ), p. 11.
4. Ludwig von Mises, “Why Read Adam Smith Today,” in The Wealth of Nations Washington, D.C.: Regnery, 1998), p. xi.
5. John Maynard Keynes, “The End of Laissez-Faire,” Essays in Persuasion (New York: Norton, 1963 ), p. 312. Keynes’s speech was given in 1926, a full decade before The General Theory came out.
6. Paul A. Samuelson, “Lord Keynes and the General Theory,” The New Economics, ed. Seymour Harris (New York: Knopf, 1947), p.151.
7. John E. Roemer, Free to Lose (Cambridge, Mass.: Harvard University Press, 1988), pp. 2-3. Note the title, imitative, albeit negatively, of Milton and Rose Friedman’s popular Free to Choose (New York: Harcourt Brace Jovanovich, 1980).
8. Milton and Rose Friedman, Two Lucky People (Chicago: University of Chicago Press, 1998), p. 582.
Social Security Reform: Lessons from the Private Sector
IDEAS ON LIBERTY
Economics on Trial
by Mark Skousen
“Of all social institutions, business is the only one created for the express purpose of making and managing change. Government is a poor manager.”
—Peter F. Drucker 1
In the ongoing debate over the privatization of Social Security, one story has been over-looked: The private business sector in the United States has already faced the pension-fund problem and resolved it.
Here’s what happened. After World War II, major U.S. companies added generous pension plans to their employee-benefit programs. These “defined benefit” plans largely imitated the federal government’s Social Security plan. Companies matched employees’ contributions; the money was pooled into a large investment trust fund managed by company officials; and a monthly retirement income was projected for all employees when they retired at 65.
Management guru Peter F. Drucker was one of the first visionaries to recognize the impact of this “unseen revolution,” which he called “pension fund socialism” because this Social Security look-alike was capturing a growing share of investment capital in the United States.2 Drucker estimated that by the early 1990s, 50 percent of all stocks and bonds were controlled by pension-fund administrators.
But Drucker (who doesn’t miss much) failed to foresee a new revolution in corporate pensions—the rapid shift toward individualized “denned contribution” plans, especially 401(k) plans. Corporate executives recognized serious difficulties with their traditional “defined benefit” plans, problems Social Security faces today. Corporations confronted huge unfunded liabilities as retirees lived longer and managers invested too conservatively in government bonds and blue-chip “old economy” stocks. Newer employees were also angered when they changed jobs or were laid off and didn’t have the required “vested” years to receive benefits from the company pension plan. Unlike Social Security, most corporate plans were not transferable. The Employment Retirement Income Security Act (ERISA), passed in 1974, imposed regulations on the industry in an attempt to protect pension rights, but the headaches, red tape, and lawsuits grew during an era of downsizing, job mobility, and longer life expectancies.
The New Solution: Individualized 401(k) Plans
The new corporate solution was a spin-off of another legislative invention—the Individual Retirement Account (IRA). The 401(k) rapidly became the business pension of choice, and there is no turning back. These “defined contribution” plans solve all the headaches facing traditional corporate “defined benefit” plans. Under 401(k) plans, employees, not company officials, control their own investments (by choosing among a variety of no-load mutual funds). Corporations no longer face unfunded liabilities because there is no guaranteed projected benefit. And workers and executives have complete mobility; they can move their 401(k) savings to a new employer or roll them over into an IRA.
According to recent U.S. Labor Department statistics, there are about nine times more defined-contribution plans than defined-benefit plans. Almost all of the major Fortune 500 companies have switched to defined-contribution plans or hybrid “cash-balance” plans. Companies that still operate old plans include General Motors, Procter and Gamble, Delta Airlines, and the New York Times Company. IBM, a company that once guaranteed life-time employment, switched to a “cash-balance” plan two years ago, giving its 100,000 employees individual retirement accounts they can take with them in a lump-sum if they leave the company before retirement (long-service workers are still eligible for IBM’s old defined-benefit plan). But virtually all “new economy” companies, such as Microsoft, AOL, and Home Depot, offer 40 l(k) plans only.
Why Social Security Needs Reform
Congress could learn a great deal studying the changes corporate America has made in pension-fund reform. In fact, Social Security is in a worse position than most corporate plans were. Since less than a fourth of all contributions go into the Social Security “trust fund,” the government program is more a pay- as-you-go system than a defined-benefit plan, where most of the funds go into a corporate managed trust fund. As a result, the unfunded liability, or payroll-tax shortfall, exceeds $20 trillion over the next 75 years. To pay for so many current recipients, Congress has had to raise taxes repeatedly to a burdensome 12.4 percent of wages, and payroll taxes will need to be raised another 50 percent by the year 2015 to cover the growing shortfall.3 Few corporate plans require such high contribution levels.
Moreover, the Social Security trust fund is poorly managed, so much so that experts indicate that the annual return on Social Security is 3.5 percent for single-earner couples and only 1.8 percent for two-earner couples and single taxpayers.4
Clearly, converting Social Security into personal investment accounts would be a step in the right direction, a policy change already achieved in Chile and other nations. Unfortunately, government—unlike business—is not prone to innovation. As Drucker notes, “Government can gain greater girth and more weight, but it cannot gain strength or intelligence.”
1. Peter F. Drucker, “The Sickness of Government,” in The Age of Discontinuity (New York: Harper, 1969), pp. 229, 236.
2. Peter F. Drucker, The Unseen Revolution: How Pension Fund Socialism Came to America (New York; Harper & Row, 1976). This book was reprinted with a new introduction as The Pension Fund Revolution (New Brunswick, N.J.: Transaction, 1996).
3. Andrew G. Biggs, “Social Security: Is It a Crisis that Doesn’t Exist?” Cato Social Security Privatization Report 21 (www.cato.org), October 5, 2000, p. 3.
4. Ibid., p. 32.
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