Twenty More British Power Suppliers at Risk of Bankruptcy due to Regulatory Price Caps; Press Calls it "Deregulation"

Click here to read the original Cautious Optimism Facebook post with comments

2 MIN READ - Last week the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff reported that the twelfth British retail gas/power supplier since September had failed under the weight of rising wholesale energy prices.

What makes Britain more crisis-prone is that its power regulator Ofgem (Office of Gas and Electricity Markets) allows wholesale prices to rise or fall without limit but caps retail rates, restricting private power suppliers from passing higher natural gas/power generating costs on to customers. Hence in the midst of the energy crisis suppliers are paying a lot more to produce electricity but aren't allowed to charge more to deliver it.

The Correspondent also compared Britain’s problem to California’s 2000 electricity crisis when the state government also allowed wholesale energy prices to rise with the market and also strictly capped retail rates, spawning widespread blackouts, forcing power giant PG&E into bankruptcy and nearly bringing down Southern California Edison save a last minute rescue package from Sacramento.

You can read more details of California’s failed electricity experiment at:

http://www.cautiouseconomics.com/2021/10/energy-16.html

At the time the Correspondent predicted British left-wingers would call their price-capped power crisis “deregulation” and “free market capitalism” just as Californians have mislabeled their own disaster for over 20 years.

Well the verdict is still out on the left-wingers, but not for the press (then again, the latter has become just a genus of the former's larger family). Reuters is now reporting twenty more British suppliers are teetering on bankruptcy while referring to the bizarre price-capping arrangement as “deregulation.”

("Britain faces 'massacre' of 20 more bust energy suppliers, Scottish Power says": Reuters)

https://www.reuters.com/business/energy/energy-market-massacre-looms-britain-scottish-power-chief-says-2021-10-21

Two passages from the story:

“Britain's energy market faces an absolute massacre that could force at least 20 suppliers into bankruptcy in the next month alone unless the government reviews the energy price cap, Scottish Power Chief Executive Keith Anderson said on Thursday…”

"...We are now going to start seeing some relatively well-run, good, commercially sound businesses going bankrupt because they just can't pass the cost of the product through to customers."

And written in the middle of literally eight mentions of the price cap and price regulator:

“The soaring natural gas prices have strained Britain's retail energy markets to breaking point, putting into question 30 years of energy deregulation which began in 1989 under then-Prime Minister Margaret Thatcher.”

Which leads the Correspondent to ask a reasonable question: “What do the Reuters editor’s desk and journalism schools think the definition of ‘deregulation’ is?” Because evidently their dictionary defines it as “anything that goes wrong in a government-controlled marketplace.”

Call me old-fashioned, but I always thought “deregulation” meant “no government interference in the economy” which definitely includes "no price controls."

At minimum Reuters could describe Britain's power market as "retail-regulated" or "partially regulated," but then my generation probably isn’t woke enough to understand.

In case you can’t get past the Reuters paywall Yahoo! has rerun the story at:

https://www.yahoo.com/news/uk-faces-energy-massacre-20-064856528.html

Rising Inflation and Just One Possible Alternative Theory to "Supply Chain Issues"

 Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff has seen no shortage of what appears to be coordinated news headlines pinning recent elevated price inflation on "supply chain issues."

Well he’d like to offer a small alternative theory via this simple chart from the Federal Reserve:

There are 35% more dollars circulating in the U.S. economy than there were 19 months ago.

Actually, the Correspondent has written in more detail on the money supply factor in a previous entry (see below) but is also growing tired of the media chanting presumptively that the "supply chain" theory is the only explanation.

Does anyone think a 35% increase in the M2 money supply and the Fed's unwillingness to-date to restrain its continued growth might be relevant enough to warrant just a little media mention? 

Or has the money supply become the economic equivalent of Hunter Biden's laptop?

ps. Since Facebook only allows one photo per post, please check these additional charts/URL's for money supply aggregates in Canada, the United Kingdom, and the Eurozone. The press blames “supply chain issues” for global price pressures, but does anyone see anything else in common in all these places?

Canada:

UK:

Eurozone:

Britain’s 2000 California Energy Crisis

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff uncovers key parallels between California's 2000 electrical power crisis and Great Britain's current one.

Britain’s third gas/electricity supplier has failed this week, the twelfth since September, leaving its assets in the hands of U.K. power regulator Ofgem (Office of Gas and Electricity Markets) to take over and determine the failed operator's final disposition.

Read details at:

https://www.yahoo.com/now/daligas-becomes-third-uk-energy-143859141.html

However this string of bankruptcies isn’t due simply to rising energy prices. The USA and Canada have had multiple energy price spikes over the last two decades (2000, 2005, 2008, 2010-2014) and they’ve never precipitated waves of mass bankruptcies among utilities.

Except in California in 2000-2001.

Twenty years later the U.K. is undergoing the same purge for similar reasons. To understand why it helps to revisit California’s 2000-2001 power crisis for a moment.

(Note: Although the U.K. is technically Great Britain plus Northern Ireland I will use the two names interchangeably in this article. British readers please accept my apologies for the technical error.)

PARALLELS

Older CO readers may remember news headlines about rolling blackouts in California two decades ago plus subplots about the bankruptcy of power giant PG&E (yes, another one) and the near-bankruptcy of Southern California Edison which was only saved at the last minute by a rescue deal with the state government.

So why were there blackouts and utility bankruptcies throughout California while the rest of the USA, which also experienced higher prices, was relatively calm?

The reason lies with California’s unique electricity regulations.

A major electrical power reform negotiated between Republican Governor Pete Wilson and the Democratic legislature was enacted in 1996 (the late 1990’s was a period of historically low energy prices). Among the major provisions of the regulations were:

1. Wholesale energy and power rates paid by California utilities were to be deregulated, allowing prices to move freely.

2. Retail prices charged by California utilities were to be capped by regulators, strictly limiting their ability to raise rates.

Already some readers might be able to see the problem this would inevitably create. So long as diesel, natural gas, or wholesale electricity prices remained low, retail price caps wouldn’t pose a problem. But the moment energy prices spiked, California utilities would have to pay spot prices on the open market but would be legally prohibited from passing those higher costs on to customers, generating huge financial losses.

Worsening matters is simple microeconomics. When demand for a commodity like power exceeds supply, a rising price encourages conservation and discourages waste by consumers. But given that state regulators wouldn’t allow rate hikes at precisely the moment they were most needed—when a critical supply-demand imbalance appeared—customers would have no incentive to alter their consumption behavior. Hence, rolling blackouts.

In what the Correspondent views as a sick and uninformed joke these reforms were called, and remain called to this day, “energy deregulation." And when the inevitable crisis struck, California liberals blamed and still blame the disaster even today on “free market capitalism.”

Which brings us back to the U.K.

Recently failed power supplier Daligas released a statement citing “unprecedented energy market conditions, the record high wholesale prices and the current energy cap set by the industry regulator Ofgem” for their inability to continue operating as a going concern.

Reuters has also reported that “Many British energy firms, often supplying both gas and electricity to homes and businesses, have struggled with soaring wholesale energy costs because of the regulator's price caps, which limits how much of the price rise they can pass on.”

Sounds just like California in 2000.

Hopefully Ofgem will allow U.K. energy suppliers to raise rates higher (and soon) allowing them to save themselves from bankruptcy, but the Economics Correspondent suspects British socialists and left-wingers are already blaming “free market capitalism” and “deregulation” for their nation’s power woes. And just like California, they’ll probably keep blaming "capitalism and deregulation" twenty years from now too.

Keep reading if you’d like to learn more absurdities about California’s power “deregulation.”

2000: YET MORE CALIFORNIA DYSFUNCTION

Another bizarre “deregulation” that California imposed on its suppliers was a ban on wholesale price hedging, a tool that utilities—along with airlines, oil and gas producers, and a slew of other industries vulnerable to rapid changes in commodity pricing— routinely use to protect themselves from price volatility .

California utilities wanted to buy long-term contracts locking in wholesale energy prices to reduce the impact of potentially skyrocketing rates. But the Sacramento legislature, in its infinite wisdom, made hedging illegal. 

The reasoning? If utilities locked in wholesale rates while they were low and then charged a higher, regulated retail rate, they might make more profit than the government considered acceptable. And we all know “too much profit” is a capital offense that must be prevented at all costs in California.

Well the legislature did prevent it, and at dear cost indeed.

When energy prices spiked in 2000 California suppliers were forced to pay high prices on the spot market which, again, they were forbidden from passing on to their customers. Once natural gas and diesel rates became prohibitively high California suppliers attempted to buy power from out-of-state but, legally restricted from locking in prices with hedging, found themselves forced to pay high spot market rates there too.

Some Californians love to dismiss the hedging prohibitions and blame energy traders like Enron for “market manipulation.” And it is true that when demand and prices started to rise Enron traders used clever strategies to charge even higher prices. One famous example is Enron overbooked a critical transmission line that connected the state’s northern and southern power grids, creating a bottleneck for power distribution which allowed it to charge even more to move power from one half of the state to the other.

What critics don’t mention is that a letter from an Enron whistleblower to Barbara Boxer’s office revealed that “There is a single connection between northern and southern California's power grids. I heard that Enron traders purposely overbooked that line, then caused others to need it. Next, by California's free-market rules, Enron was allowed to price-gouge at will.”

Well sure, when there’s only a single connection serving as transmission corridor between two population centers of 15 million and 23 million people it’s a lot easier for a canny firm to clog it up, create bottlenecks, and price gouge than when there are several connections. 

And whose brilliant idea was it to allow only a single transmission line (when private suppliers had applied for years to construct additional ones)? California's regulator, the Public Utilities Commission.

Imagine airports in New York and Los Angeles, each with multiple runways and 100+ gates, but the Department of Transportation limits the number of slots (allowed landings) to just two per airport per day. One firm can more easily buy up huge "market share" and create scarcity/higher prices than if the government permitted the literally thousands of slots it does at those two airports today. 

As further evidence, in 2000 other states had also enacted varying degrees of power deregulation, and Enron and other greedy energy traders were operating throughout. Yet only California suffered from statewide rolling blackouts and the failure or near failure of giant utilities that served over 30 million people.

Finally, as suppliers fell into crisis or conservatorship, California’s Democratic Governor Gray Davis invoked emergency powers authorizing the state government to buy electricity on behalf of private utilities to stop the blackouts.

Ironically Davis, who had previously championed restricting private suppliers from hedging on wholesale prices, granted himself the freedom to do exactly that. Evidently it’s OK for the government to use everyday market tools to limit its losses but not the private sector.

And in a follow-up act of astonishing stupidity Davis immediately signed long-term contracts with out-of-state providers, locking in natural gas and electric power at astronomically high prices. Now California government was committed to paying a crisis premium for years.

When the crisis abated shortly after and wholesale prices fell, Davis tried to renege on his hedging contracts and demanded suppliers accept lower payments from the state. Wholesalers obviously refused, holding him to the terms of the hedging contracts he had voluntarily entered into.

California’s Treasurer warned Davis that overpaying billions of dollars for electricity was blowing a hole in the state budget, and the state filed suit against suppliers for lower rates, but the Economics Correspondent doesn’t recall the final court ruling.

However Alaska Republican Senator Lisa Murkowksi confirmed this story in her statement during Congressional hearings on the crisis:

“The State of California signed billions of dollars of long-term power supply contracts on behalf of the investor-owned utilities. Keep in mind that the State prevented the IOU's from long-term contracts in the first place.”

“When the State signed contracts, when they proved to be far above the market, putting California taxpayers on the hook for billions of dollars, guess what happened? Well, we see that in the paper as Governor Davis proclaims his predicament. California, according to Governor Davis, is trying to abrogate the contracts and place the blame on industry, not just Enron.”

In the end, the electric power debacle, combined with his attempt to fill the state budget shortfall by imposing $1,000+ annual car registration renewal fees, brought about the fall of Gray Davis. A successful recall effort was launched resulting in the election of Arnold Schwarzenegger as new state governor.

Larry Summers Slams Woke Fed for Risking Losing Control of Inflation

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff agrees with the mantra "When you're right, you're right. Even if you're an overrated New Keynesian economist."

Summers was also pretty good warning in March that the pork-laden $1.9 trillion Biden "Covid rescue package" (over $1 trillion of which had nothing to do with Covid, unemployment, or stimulus checks) would elevate inflation risks.

His list of problems today is also very good except for "excess household savings" which is not the problem... at all.

"Former Treasury Secretary Lawrence Summers castigated monetary policy makers in the U.S. and elsewhere for paying too much attention to social issues and not enough to the biggest risk to inflation since the 1970s."

“We have a generation of central bankers who are defining themselves by their wokeness,” Summers, who is now a professor at Harvard University, said on Wednesday. “They’re defining themselves by how socially concerned they are.”"

<snip>

"Summers ticked off a number of reasons for what he called his “very considerable concern,” including ultra-lax monetary policy, surging house prices, a big federal budget deficit and excess household savings."

https://www.bloomberg.com/news/articles/2021-10-13/summers-slams-woke-fed-for-risking-losing-control-of-inflation

If you can't get past the Bloomberg paywall a Google cached URL with free access is available at:

https://webcache.googleusercontent.com/search?q=cache:RlFJT3XWAPEJ:https://www.bloomberg.com/news/articles/2021-10-13/summers-slams-woke-fed-for-risking-losing-control-of-inflation+&cd=1&hl=en&ct=clnk&gl=us

Minimum Wage Fallacies and Economics: “If wages had kept pace with productivity gains since 1968 the current minimum wage would be more than $24 an hour” (Part 2 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

Robert Reich: “If wages had kept pace with productivity gains over the last 50 years the minimum wage would be $24 an hour.”

Cautious Optimism Economics Correspondent: "Former Labor Secretary Robert Reich, who has an Oxford degree in ‘Philosophy, Politics, and Economics,' is conflating average productivity gains with minimum wage productivity gains—perhaps deliberately.”

(Productivity gains in select industries, 1987-2019)

-Wired Telecommunications: +231%

-Electric Power Generation, Transmission and Distribution: +150%

-Commercial Banking: +143%

-Food Services and Drinking Places: +17%

(source: U.S. Bureau of Labor Services)

=====

6 MIN READ - In Part 1 of this series we reviewed the gigantic fallacy propagated by Robert Reich, Elizabeth Warren, and some left-wing economists that nominal workers’ wages must always be raised in tandem with productivity increases.

In fact throughout the 300 year history of capitalism the lion’s share of productivity increases has been passed on to workers in the form of lower real prices for more goods and services of increasing technological sophistication (ie. dramatically higher living standards).

Which is why the average laborer of the mid-19th century lived in a one room wooden shack with a dirt floor while today’s average laborer, who works fewer hours in more comfortable settings, has a climate controlled house or apartment with modern appliances, a car, closets full of clothes, HDTV, smartphones, and can buy pretty much anything they want in a Walmart—even as most products inside a Walmart didn’t even exist in the mid-19th century.

For those who have not read it in detail yet, the Economics Correspondent recommends reviewing Part 1 at:

http://www.cautiouseconomics.com/2021/10/microeconomics15.html

However the errors don’t end there. We’ll now cover two more equally uninformed mistakes on part of the “minimum wage has to keep up with productivity” crowd.

AVERAGE PRODUCTIVITY VS MINIMUM WAGE PRODUCTIVITY

When Reich and Warren cite productivity increases going back to 1968, they’re referring to average productivity across all workers and all sectors, lumping fast food workers together with stockbrokers, airline pilots, and computer programmers.

But average productivity gains are not the same as minimum wage productivity gains, and multiple analyses of minimum wage workers have revealed those jobs haven’t seen that much progress in productivity over the decades—a big reason why they still pay so little in the first place.

According to the Bureau of Labor Services, certain jobs that intensively use software or telecommunications have seen triple-digit productivity gains going back to 1987—the first year available in the dataset. The proliferation of computers has made, say, accountants and financial workers much more productive since they can use spreadsheets, databases, and shared server storage to track vastly more information than before instead of using pen, paper, hand calculators, and endless file cabinets.

Which is also part of the reason not only computer prices, but also industries that rely heavily on computers such as stock brokerages and airlines, have delivered enormous real price reductions for consumers.

But how many more burgers does a McDonalds worker grill today than in 1987 due to new technology? Maybe drive through windows, wireless headsets, and those S/M/L one-touch drink machines have made fast food workers slightly more productive, but the gains haven’t been anywhere near the scale of other industries where both productivity and pay have risen and real prices have fallen faster.

In fact analyzing those Bureau of Labor Services tables from 1987 to 2019, we can see productivity gains in industries that employ lots of minimum wage workers (restaurants, grocery stores) severely lag those in other, higher skilled industries:

(Productivity gains in select industries: 1987-2019)

-Commercial Banking: +143%

-Electric Power Generation, Transmission and Distribution: +150%

-Air Transportation: +161%

-Wired Telecommunications: +231%

-Publishing (non-Internet): +282%

-Computer and Electronics Manufacturing: +1,139%

…and industries that employ many minimum wage workers?

-Food Services and Drinking Places: +17%

-Grocery Stores: +20%

Source: https://data.bls.gov/cgi-bin/surveymost?ip

The BLS didn't provide productivity increases for custodial or janitorial services but the Economics Correspondent wagers they haven't risen by leaps and bounds either.

Once again Reich and Warren are revealed peddling fantasies, this time by simple math. If minimum wage kept up with productivity gains for fast food workers (not with average productivity across all sectors) it wouldn't be anywhere close to $24 per-hour but rather something, well... not much higher than $7.25.

WHO TO THANK FOR CAPITAL?

The last fallacy we'll discuss is not rooted so much in statistical error as political economy.

Higher productivity, we’ve already established, derives nearly entirely from more efficient capital tools and machines. Worker skills and training are an input too, albeit a smaller one, but most companies also pay for workers to divert time away from immediate production to attend training on new capital equipment.

So back to capital tools, an airline pilot’s labor has become far more productive over 100 years not because he drags 340 passengers by hand from one continent to another twice as fast but rather because today he operates a $375 million commercial 777-300ER airliner instead of a Sopwith Camel.

The construction crane operator is more productive not because he carries half-ton steel beams on his back to the top of a 20-story building but because he has a multimillion dollar crane at his disposal.

Even Henry Ford’s autoworkers needed a factory assembly line before they could assemble a Model-T with 1.5 man-hours of labor instead of the original twelve.

So who provides the commercial jet to the pilot, the construction crane to the operator, and the assembly line factory to the auto worker? Do the pilot, crane operator, and assembly line worker provide the capital machines? Or risk hundreds of millions or billions of their own dollars?

Of course not. They show up to their first day on the job and ask the company: “Where’s that plane I’m supposed to fly?” or “Bring me that crane you want me to lift steel beams with” or “Point me to the factory floor you want me to work on.”

The Economics Correspondent is no different. He shows up at his daytime job and asks "Where's the multimillion dollar telecommunications system you want me to configure?"

It’s just expected—particularly by Elizabeth Warren and Robert Reich—that the company is supposed to drum up the money, investment, and risk to provide advanced capital tools for their workers.

So it’s no surprise that when a new multimillion dollar capital machine makes a worker 15% more productive than the old capital machine, not all of the gains will be transferred to the worker’s bank account.

Who is primarily responsible for the 15% growth in productivity? The savers/investors who sacrificed, deferred their immediate consumption, and risked their savings, and to a lesser extent financial intermediaries and the management who acquired, delegated, and placed the capital tools at the worker’s disposal. 

The increased productivity bonus is just naturally more likely to go into their pockets than the worker’s. 

Besides, savers and investors need to at minimum recoup their initial investment or they stop investing.

Sounds like a depressingly bad deal for workers doesn’t it?

Well the good news is in reality capitalism actually gives workers a far better deal than what we just described.

Over the longer-term workers win too in the form of a wider variety of products at lower and lower real prices. 

For example, as the cost to manufacture a computer in 1980 fell from over $3,000 (2021 dollars) in 1980 to a couple of hundred dollars today, firms didn’t just leave the price fixed at $3,000+ for four decades and hoard $2,800 in profit for themselves while their costs relentlessly fell. Rather due to competition computer prices fell too. In fact profit margins actually shrank as computers became commoditized leading to narrowing profits for computer manufacturers while consumers raked up nearly all the gains.

Under capitalism the big winners have been the consumers who are typically also the workers.

Also under capitalism there's nothing stopping workers from claiming a greater share in the productivity gains by deferring their own consumption and buying corporate bonds or shares of stock—right alongside all the other investors who risk their savings to raise the workers' productivity every day.

In fact many workers already do so by participating in their 401k, pension, and individual retirement plans. Social Security? Not so much as virtually no Social Security taxes are directed into productivity enhancing capital investments.

And going beyond falling computer prices and considering every other product and service in the economy, the median income worker of today lives in most respects better than John D. Rockefeller—the richest American ever as a share of national GDP—did running Standard Oil in the 1870’s.

While Rockefeller, as company president and managerial genius, definitely got paid more than his workers, in the long run the relentless rise in capital productivity has allowed today’s worker to enjoy everyday conveniences that Rockefeller couldn’t dream of in his business days: air conditioning, air travel, television, automobiles (OK Rockefeller did get to drive in his old age but even today’s cars are far safer, faster, quieter, and more comfortable), ibuprofen, remote control, antibiotics, Internet and smartphones, ride lawn mowers, microwave ovens, carbon race bicycles with GPS (a Correspondent favorite)… the list is endless.

Even in recent history, a kid in Ghana with a smartphone has instant access to more information than President Bill Clinton could retrieve from the Oval Office just 25 years ago.

That’s the bonus that capitalism bestows upon everyone, particularly the masses of workers. 

But Elizabeth Warren and Robert Reich still think if every dollar of every productivity increase isn't diverted exclusively to workers then a capital crime has been committed.

ps. For Marxists the labor theory of value argues capital tools and machines are not provided by investors and businessmen because the tools themselves are built by workers. Or that to the extent the tools are built with other tools then the previous generations of tools are also built by workers. 

Therefore under Marxism investors and capitalists, who provide no labor in the increasingly capital-intensive process, deserve no credit for the rising productivity of the workforce, are simply parasites extracting an undeserved income, and deserve to be violently overthrown in a communist revolution.

This theory has been refuted over and over by economists of all schools (except the Marxists of course) and the Correspondent will write about it in more detail one day when he delivers a series on Marxism and communism.

Venezuela Shaves Six More Zeroes off the Bolivar Bringing Total to Fourteen Since 2007

Click here to read the original Cautious Optimism Facebook post with comments

Back in May the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff posted an update reporting that Venezuela had launched a new 1 million bolivar (BsS) banknote worth less than 50 U.S. cents at the time. 

However the 1 million bolivar note was really a 100 trillion bolivar note when accounting for two monetary reconversions in 2007 and 2018 when the socialist regime shaved three and five zeroes respectively off the original bolivar (Bs) and succeeding bolivar fuerte (BsF) to launch the reformed 2018 bolivar soberano (BsS) which has circulated within Venezuela until today.

But as of October 1st Venezuelans will see every one million of their old BsS bolivars converted into a single “bolivar digital” (BsD) worth about 25 U.S. cents.

Incredibly, this means that the successive Hugo Chavez and Nicolas Maduro regimes have shaved a total of fourteen zeroes off the original currency meaning 100 trillion 2007 Chavez-era bolivars can buy you just one new bolivar digital worth 25 cents, an inflation of one trillion percent over fourteen years setting aside the USD conversion rate of one Bs vs one BsD.

To put it in further perspective, Venezuela's official GDP in 2007 was 66 trillion Bs using the original bolivar. Using the more reliable black market exchange rate the entire Venezuelan economy in 2007 has been debased to about a quarter of a U.S. cent.

Or placed in more reliable U.S. terms if you held the entire United States GDP estimated at $22.7 trillion for 2021, by the time the Venezuelan central bank finished with you your fortune would be worth 23 cents or almost enough for two slices of Wonder Bread at Walmart.

As bad as inflation is getting in the USA, it’s no surprise that Venezuela is becoming highly dollarized with everyday citizens using U.S. dollars, Colombian pesos, euros, and Bitcoin to conduct daily private transactions. Even at the current annualized 5.25% U.S. inflation rate a million dollar nest egg would still be worth $489,000 at the end of 14 years as opposed to about 0.000001 cents (1/one millionth of one cent) in Caracas.

Read Reuters article at:

https://www.reuters.com/world/americas/venezuela-subtract-six-zeros-currency-second-overhaul-three-years-2021-10-01

Minimum Wage Fallacies and Economics: “If wages had kept pace with productivity gains since 1968 the current minimum wage would be more than $24 an hour” (Part 1 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

8 MIN READ - CO invites you to explore the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff’s accounting of minimum wage fumbles by Elizabeth Warren and Robert Reich…

Senator Elizabeth Warren (2013): “If wages had kept pace with productivity gains since 1968 the current minimum wage would be more than $22 an hour. With a minimum wage of $7.25 an hour, what happened to the other $14.75? It sure didn't go to the worker."

Cautious Optimism Economics Correspondent: “Under capitalism the lion’s share of unparalleled productivity gains, induced by centuries of relentless and continuous investment in better capital tools and machines, has been transferred to consumers in the form of lower real prices for vastly more goods and services of greater quality and sophistication. And in contrast to all of human history prior to capitalism, today's working masses are the primary buyers of the goods they produce.”

It seems after winning “Fight for $15” victories in many blue states, some liberal public figures are already complaining it’s not enough and demanding $24 an hour instead.

While on the surface this idea seems like a guaranteed way to close more small businesses and force even large ones to retreat into downsizing, “Inequality for All” author Robert Reich, far-left economist Dean Baker, and Senator Elizabeth Warren claim they’ve found the economic open sesame that will make it work.

To them, it will work today because it did fifty years ago. As Reich recently tweeted: “If wages had kept pace with productivity gains over the last 50 years, the minimum wage would be $24 an hour.”

This “minimum wage should keep up with productivity” argument has been very effective at convincing sympathetic left-wingers everywhere that workers are being ripped off for not receiving larger paychecks consummate with all the past’s productivity gains. And there’s been no shortage of online commenters parroting the soundbite to “prove” there will be no negative repercussions to evening the playing field with a massive pay hike.

But the productivity argument is rooted in elementary fallacies that anyone with a reasonable economics background can recognize. We’ll focus on the most glaring error in this column before covering two more in the next installment.

PRODUCTIVITY REALLY (REALLY) MATTERS

First, let’s establish where Reich, Baker, and Warren are on the right track: Higher productivity is not only an effective way to raise long-term wages, it’s the only way to raise long-term standards of living.

Even Paul Krugman saved the broken-clock theory in 1994 when he wrote:

“Productivity isn’t everything, but, in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

Amen. In most countries, and particularly western nations, standards of living for workers have risen from primitive, pre-industrial conditions to modern comforts and plenty due to each worker producing vastly more output per labor-hour.

And the key to producing multiples more and higher quality goods and services than before lies not in toiling harder, but with the employment of more efficient and technologically sophisticated capital tools and machines. In fact, far from laboring harder, capital machines have moved workers of 150 years ago away from manual labor under the blazing sun from dawn to dusk into air-conditioned office buildings working behind a desk or on climate-controlled factory floors.

Today’s worker labors much more easily and for shorter hours than his 19th century predecessors, and enjoys a vastly higher standard of living, because capital tools and machines do so much more of the work for him.

The examples are countless, but just consider the first of two: one American farmer using a contemporary air conditioned, cabin-pressurized combine with modern fertilizers, irrigation methods, insecticides, and genetically modified seeds can produce as much food as 5,000 farmers using their bare hands and primitive tools in the underdeveloped world.

It’s that kind of productivity-enhancing capital machinery that allows the American farmer to afford a multibedroom house with two trucks, appliances, cable TV, and a first world standard of living while lack of capital keeps third world farmers destitute in mud huts.

Another, which CO discussed a few months ago, is Henry Ford’s factory assembly line. Introduced in 1913, the assembly line allowed Ford to reduce the number of man hours required to assemble a car from 12 to 1.5, an eightfold savings although he still had to pay for physical inputs.

The full list is endless. From bulldozers to forklifts, commercial jumbo jets to mile-long freight trains, floating oil rigs to semiconductor fabrication plants, or steel mills to mega-container ships, human workers rely on advanced capital tools and machines to produce vastly more goods and services than their machine-deficient ancestors.

MOTHER OF ALL PRODUCTIVITY FALLACIES

After that Warren, Reich & Company-brand logic goes off the rails.

The argument continues that with each increase in worker productivity the workers themselves are being screwed over if the productivity gains don’t go straight into their pockets as higher salaries.

To which anyone who understands capital economics would reply: “So what? It’s always been that way.”

Throughout the entire 300+ year history of capitalism the benefits of higher productivity through machines have never gone exclusively to the workers, nor to the bosses, nor to the investors. Throughout the centuries, as well as from 1968 to 2021, companies have nearly always passed on the lion’s share of productivity gains to consumers in the form of lower real prices.

And the main consumers of economic output in capitalist economies are the workers themselves.

We just mentioned Henry Ford reduced his cost of labor by 87.5% through productivity-boosting capital investment. Did he keep the 87.5% savings all for himself? Did he give it all to investors? Did he give it all to the workers?

No, no, and no. Ford did give his workers a raise to keep them from leaving what became more monotonous assembly line jobs, but it wasn’t a 700% raise. He did give himself a bonus. And the shareholders did gain from Ford’s bottom line improving.

But the biggest beneficiaries were buyers of cars. Ford, employing other cost-saving processes and equipment along the way, eventually lowered the price of the Model-T from $800 in 1908 to $300 in 1925 ($146 in 1908 dollars) for a real price reduction of 82%.

John D. Rockefeller used his managerial genius to produce refined kerosene for a fraction of its previous cost. But he didn't hoard all the savings for himself, his investors, or even the workers. Instead, he raised the quality and lowered the price of kerosene by 88% over a period of 25 years, a bonanza to anyone who had previously spent their evenings in pitch black darkness.

To the extent Ford and Rockefeller’s workers consumed the same goods they helped produce, they did keep some of the productivity gains for themselves too just by saving money on a Model-T or refined petroleum. But Reich and Warren would still complain they were still being shortchanged since they saved on only two purchases.

Wrong again. The history of capitalism records virtually every industry has found ways to increase productivity over the centuries. Those companies that have refused have gone out of business, shunned by consumers and replaced by more innovative firms. It’s not just Ford and Standard Oil but all companies everywhere, then and now, increasing productivity and passing most of the savings on in the form of lower real prices.

And workers have benefited tremendously since they themselves are the primary consumers of those products—even if they don’t see it in the form of a nominal dollar raise.

It’s why a dozen eggs—which cost 61 cents in 1919 and would cost $9.29 today if adjusted for inflation—instead costs about $1.28 at Walmart (2019), a real savings of 86%. Everyone who eats eggs, including the chicken farm workers, has shared in the benefits of higher productivity.

It’s also why a one-way Boston-Los Angeles flight in 1940 cost passengers $4,788 in 2021 dollars, took 15 hours and twelve stops to complete while you shivered in the frigid passenger cabin, but today takes only six hours for $99 on Spirit Airlines.

Or since adjusting for inflation makes calculations more complicated, why don't we just measure the number of man hours of labor required by the average worker to purchase everyday items?

-In 1950 it took 6 minutes of work to earn the purchasing power to buy a loaf of bread. By 2000 it took 3.5 minutes.

-In 1950 it took 21 minutes of work to purchase a dozen oranges. By 2000 it took 9 minutes.

-In 1902 it took nearly three weeks (110 hours) of work to purchase 100 kilowatt-hours of electricity. By 1950 it took 2 hours. By 2000 it took 24 minutes. In 2021 it has actually climbed back to 25 minutes (thanks to government green energy, wind, and solar mandates).

-Going back even further, in 1900 it took nearly 3 hours of work to purchase a three-pound chicken. In 1950 it took 71 minutes. In 2000 it took 24 minutes.

-In 1900 it took 9 hours of work to purchase a pair of blue jeans. By 1950 it took 4 hours. By 2000 it took 3 hours, and by 2020 under 2.5 hours.

-In 1900 the typical American family spent almost half their household budget on food, by 1950 it was under 30%, and today it’s about 10.5% which includes far more “eating out” than Americans did in 1900.

-And in 1900 it didn’t matter how many hours you worked, you couldn’t have a television because it didn’t exist. By 1954 you could buy a 15” color Westinghouse TV with one or two channels for $12,700 in 2021 dollars. In 2021 you can get a 50” 4K HDTV for $480 along with countless channels DVD, DVR, and other gadgets.

(thanks to economic historian Thomas E. Woods for some of these examples)

Incidentally there are three notable exceptions to this trend where real prices are skyrocketing instead of falling: housing, healthcare, and college education. And uncoincidentally these three sectors are the target of the most government interference, regulation, control, and subsidies. There is a direct causal effect of government interference driving the prices of these goods up faster than inflation, but the Correspondent doesn’t have room in this column to give that subject the time it deserves.

WHAT IF WE DO IT REICH’S WAY?

Finally, if Robert Reich and Elizabeth Warren wanted to dig themselves a deeper hole they could insist worker pay must keep up with productivity gains on a 1-to-1 basis, meaning all savings go into higher paychecks and nothing to consumers, managers, or investors.

Well that might make liberals feel good for a few minutes, but then we’d have to go back to $4,788 for a one-way cross-country flight, $12,000 for a television or, even as recently as 1980, $2,718 (in 2020 dollars) for a single CD-player. There would be no other choice, because paying every dollar in productivity-induced savings to workers would prevent real prices from falling.

And, to quote a favorite epithet of liberals that they also don’t understand, that’s what an economy with no "trickle-down" will really look like.

And one last thing: If investors and executives get no share of the productivity gains, well you can expect the progress of the last 300 years to grind to a halt since it’s investors who fund the next generation of capital tools and machines and executives who manage their deployment. Tell them they get no profits other than lower-priced eggs and watch investment capital and managerial acumen dry up much like it has in Venezuela, Cuba, and North Korea.

We’ll cover two more fallacies swirling around Robert Reich and Elizabeth Warren in the concluding segment.