Invisible Unemployment

When governments get involved in any activity to create jobs or to create employment, they are also getting involved in the business of creating unemployment. However, the unemployment they are creating is the factor that most people do not consider. Hence, the idea of invisible unemployment.

Many people believe that money spent by the government to fund projects that ultimately require workers to be hired to fulfill the completion of those projects is good business for the government to be involved in. A superficial review of the situation may cause one to think that this use of funds can only help the economy, because the wages provided to each worker will ultimately be spent in the economy, and therefore provide a healthy boost to the economy. After all, the best thing a consumer can do for the economy is to spend money in the economy. In terms of it being “good business”, it goes without saying that most people believe that providing jobs by any means is a worthy endeavor for the government.

Furthermore, if people who are otherwise unemployed can become employed using funds that are already on hand with the government, then that seems like a winning proposition. Using this logic, this can not only be a positive endeavor for the government in terms of individuals being able to earn a wage but also for the other previously employed individuals and businesses, as they can only benefit from a stronger economy.

There are at least two problems with this idea. First, one of the most foundational ideas to understand about government revenue and spending is that whatever funds the government acquires to spend (in this case, to employ people) must first come out of the economy, in the form of taxes. Generally speaking, the government does not manufacture products nor provide services that in turn produce revenue (profits) from the natural working of the economy. There are some exceptions, but by in large, their revenue is acquired in the form of taxes (taking funds from consumers that would otherwise be used in the economy).

In a scenario where a business operates in the free market, the business obtains its funds from the business owner’s own capital, other investor’s capital or other funds that have been “saved” from previous market activities in order to start the business. The business, using its own funds, begins making products and using its own resources, employs people to assist them in carrying out the function of the business. If all goes well, the business will spend less money to make the product than it earns for selling the product and will make a profit, thus allowing them to continue the business and to continuing employing people. Notice, that in this rather simple illustration, the business obtained its capital privately, without having to take money out of the economy to ultimately employ people (provide employment).

On the other hand, in the scenario where the government starts a project (business), the funds used to start that venture or project that will ultimately require people to be hired must first be taken out of the economy. When I say these funds are “taken out of the economy”, I mean that the only way for the government to obtain funds to start these projects is to take the funds from its citizens in the form of taxation. The same $100 dollars that the government takes from an auto mechanic in taxes to fund the project, is the same $100 that will not be spent in the economy by that individual.

To get at the heart of my argument that government creates unemployment by using their projects to create employment, consider this. That $100 that was taken from the auto mechanic in taxes can no longer be used to buy a new toaster that his wife wanted. It cannot be used to buy the shirt and tie that he needed for a interview at another auto shop. These funds taken out of the control and use of the auto mechanic create “unemployment” on the backside of the equation.

And that gets us to the second problem. Whenever these arguments are made, only one side of the equation is really ever considered. Everyone loves to hear the stories of the government creating jobs for those people who otherwise would be out of work. The stories of people regaining their self-esteem, being given a chance to provide for their family and the other countless instances of goodwill are very nice to hear about. If we could consider the number of toaster manufacturing workers and garment manufacturing workers that are not employed because the government had to take the funds away from the consumer that would have employed those workers who would have benefited from the consumer’s funds, then we would have a fuller picture of the offset of job creation in this scenario. We all can see the actual outcome of actual jobs created by government because we can read the stories and see the news reports and perhaps even see our friends and neighbors benefit from them. But, we don’t see the jobs that will never be created because the government took away the opportunity for those jobs to even exist. And this is what I mean by “invisible unemployment”.

So, what we are really dealing with here is a net zero proposition. For all of the jobs that are “created” by government, there are an equal amount of jobs never created, or “lost”, because of the missed opportunity to employ people in the first place.

Note: This idea of “invisible unemployment” is further explained in a similar fashion with the timeless analogy of the “The Broken Window” in Henry Hazlitt’s book “Economics in One Lesson”. Economics in One Lesson

Tell me what you think.

Audio version:

Briefs: The Economics of Pokemon®

Pokemon® is a game that I know little about. My six year old son, however knows a lot about it and talks frequently about the phenomenon of rare Pokemon® cards. He kept talking about how these rare cards cost a lot of money. I seized the opportunity to teach him his first lesson on economics: the basic lesson on price, using the principles of supply and demand. I first asked him he knew why these rare cards cost so much money (as if I expected him to say yes). He obviously said that he did not know why and so I proceeded to explain why.

I explained to him that the price of anything (in this case the price of rare Pokemon® cards) is controlled by the how much of it is available to buy (supply) and number of people who want to buy it (demand). This, of course assumes that we are operating in a free market economy. When there are a lot of people that want to buy something of which there is little supply of, the price will tend to increase and that something will eventually be considered to be “expensive”. Conversely, if there are a few people want something that there is a great abundance of, the price will decrease and that something will eventually be considered to be “inexpensive” or even “cheap”. Rare Pokemon® cards (and anything desired that is considered rare) fall into the category of something many people want of which there is little of. In this case desired rare items, people are willing to pay more for something that there is little supply of, because they know that they are competing with a lot of other people that want the same limited amount of the desired items. People who are selling the items know this and are incentivized to sell the items for an increased price. This is the reason why rare items are generally expensive in price. Consumers and their free choices determine the price of items.

It’s not too difficult to understand this idea and how the price of something is affected by supply and demand. This applies not only to rare Pokemon® cards, but also to virtually every good and service that is not regulated by governments and organizations. Even my six year old gets it now…I think.

Scarce Resources, which have Alternative Uses

One of the most fundamental axioms to understand about economics is that resources are scarce. This means that there is no infinite abundance of resources in any market. There is only a limited amount (no matter how large that amount is) of any resource used to manufacture all goods and provide all services. There is nothing that is infinitely available and ready for our disposal. This truth explains why people have to make economic decisions and make other arrangements in response to the scarcity of these resources. In addition to resources being scarce, they also have alternative uses, which adds to the need to make wise economic decisions, lest there be waste. These ideas of scarcity and alternative usage is why the great economist Thomas Sowell himself defines economics as the study of scarce resources, which have alternative uses.

When I talk about scarcity, it is in the attempt to explain that of all the abundant raw materials, manufactured products or natural resources that are available on a world-wide scale, there is still some finite amount that can be used up until there is no more. This is scarcity on a macro level (globally). To further the point, if scarcity exists on a macro level, then it obviously exists on a micro level (locally). Because there is only a limited amount of all resources, human beings are forced into making wise economic decisions, both in manufacturing (on the supply side) and in consumption (on the demand side).

Take the example of trees. On a world-wide scale, trees are very abundant. No time soon is the world going to run out tress as a natural resource. However, if man were to begin a large-scale, world-wide effort in manufacturing that required a lot of wood in the process, it may eventually dwindle the supply of trees to a point that would affect the global access to this natural resource. For the foreseeable future, that is not likely to happen. On the other hand, this is likely to happen on a local scale. While there may be an abundance of trees globally, there are places in the world where trees are very scarce.

Take another example. Let’s say there is a small town and in that small town there is a small forest of trees that is currently not in use, other than to be enjoyed by the community in the form of camping and other recreational uses. The mayor of that small town understands that these are the only trees that the town “owns” and that they need to be very prudent about how they “use” these trees. You can start to see how scarcity is already a factor to be reckoned with. The mayor and most of the citizens of that town know that these trees are important, even if nothing is done with them at all. They are already being used and the economic decision may very well be just to keep using them as they are currently being used.

Along comes a man who proposed that the town use some of the trees that it already owns to construct a pavilion to enhance the recreational enjoyment of the forest area. Now, the mayor is presented with another economic decision that he and the citizens will need make prudently, because there is trade-off to be considered in this situation. If the trees are used for the pavilion project, then there are less trees available for the original recreational purpose. And it is because of the fact that the trees are not infinitely available for their disposal that this decision is necessary. The trees are scarce, in the sense that if they keep continuing to use them up, there will no longer be any trees at all for their use (short of planting new trees for use decades later).

As you can image, there are a number of decisions that can be made here by the mayor and the citizens. They may decide to do nothing at all, because they enjoy the trees more than they would enjoy the pavilion without the missing trees, knowing that they do not have an infinite amount of trees at their disposal and preserving the trees seem more important to them. Another economic decision that they can make is to go forward with the construction, because the added recreational opportunity of the pavilion is enough to make up for the missing trees, understanding the idea of scarcity. And maybe another decision that they can make is to keep the trees that they have and build the pavilion anyways. This economic decision would require buying wood from other sources (another town, perhaps) and using funds that they would otherwise be used for other purposes.

No matter the decision, each one involves factoring in the fact that the resources in question are not infinite and therefore, requires wisdom to avoid waste. After all, if the town had an infinite number of trees at its disposal, then each decision could be made strictly on the basis of preference. This is hardly, if never the case because of the idea of scarcity.

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The Benefits of the Free Market


Free markets are somewhat of an enigma to some people and are even looked at by others as a threat to our current society. Some people have the idea that free markets are markets where companies can go un-checked and are free to take advantage of consumers for their own benefit. This view is one that assumes that companies are the ones “holding all the cards” in these markets. However, that is not the case at all. In fact, it is just the opposite. Additionally and contrary to the idea that free markets are a threat, they are what affords our society the high standard of living that we currently enjoy. It is also free markets that are responsible for the innovation that we continually see and for all of the advancements in technology, medicine, and every other industry that we could think of. Let’s look at a few of the benefits of the free market.

Demand Drives Supply
In a free market scenario, supply and demand forces dictate economic results. More specifically, it is demand (the consumers) that really dictates economic results, because demand is what drives supply. And manufacturers (supply) will “react to the market” in the form of responding to demand and manufacture the demanded products. Companies will only manufacture goods that consumers want and are able to buy, as long as it is economically viable (meaning, they can make a profit that will allow them to continue manufacturing the wanted good). They will not manufacture a good that customers do not want and are unwilling to buy.

In a free market, competition exists (naturally) also as a way to benefit the consumer in terms of quality of goods. Because consumers (demand) are the driving force in the free market, and manufacturers are competing with others for the same consumers, manufacturers have an incentive to use technology in a way that continually enhances existing products. They are always in the business of making their product more attractive to the consumer to purchase. We see that in

Better products
The competition that is naturally generated in the free market between manufacturers in the same industry also leads to better products for the consumer. The same reason that manufacturers have an incentive to work efficiently and prices their products at competitive prices is the same reason why they have the incentive to innovate their products, or create other products that are better.

Rations Prevented
In a market that is not purely free, there is always the danger of product shortages or even the need for rationing, especially in regard to essential products. For example, in times of fuel shortages, you will inevitably see consumers “stocking up” on gasoline, topping off their tanks in order to prevent the situation where the next time they need gas, they will be unable to find any (because everyone else it topping off and stocking up). Many states have laws which prevent businesses to increase their prices at a level politicians feel would be “unfairly” charge consumers in an emergency situation (price gouging). The fact of the matter is that if the free market were to be allowed to dictate the price, the law of supply and demand would take over and would allow for a more tapered shortage, and more availability to more consumers.

I will discuss more benefits of the free markets in future articles.

Please comment and discuss.

Is the Affordable Care Act affordable?

Affordable Care Act

As the debate rolls on about the Affordable Care Act (ACA), there are some fundamental problems with the legislation that causes it, at its foundation, to be contrary to what its name desires to achieve. Instead of working to reduce healthcare costs, if nothing changes, it will prove to keep healthcare costs higher in the long run. The problem comes in the form of fundamental supply and demand.

First, I am not concerned in this article in getting involved in the discussion of why there are a limited amount of suppliers. We can look at that topic at another time. As we see the market reacting to this legislation, we see more and more healthcare providers opting out of participating in this program. I will explain how this decrease in service participation will affect cost in the long run. Second, the word “affordable” is very subjective and changes from person to person. Instead of debating whether or not healthcare services will be more affordable under the ACA, I will address how prices will be affected. Each individual will determine on their own whether or not the services are affordable or not.

In a free market, price (cost) is affected by certain factors, namely supply and demand. Assuming the demand for a product (or service) remains unchanged (constant), if the supply of that product decreases, the law of supply and demand tells us that the price of the product will eventually increase. And that’s easy to understand. When the amount of stuff consumers want to buy decreases, and the number of people that wanted to buy the same stuff does not change (demand remains constant), then those people (consumers) will be willing to pay a little more than they were previously willing to pay, when the product was more readily available. Manufacturers know this and more than willing to increase their price to accommodate the change in the supply as it relates to the unchanged demand.

Apply this to the ACA. The ACA seems to be heading towards reduced amount of doctors and healthcare providers being willing to “supply” their healthcare to the growing number of “wanters” (patients) that desire the same healthcare. As the supply of providers continues to decrease, assuming the number of patients at least stays the same or increases (which is very likely), the more those healthcare services will cost. That is, unless the government intervenes once again to put controls on certain, if not all prices for the healthcare. If that happens, there will prove to be some dangerous consequences in that scenario (read my article on The Danger of Price Controls).

The word or idea of “supply” in this scenario can also be explained by using the word “competition”, as they are closely related. You see, when there are two or more suppliers supplying the same or similar product to a set of consumers (“wanters”), then that is what causes the phenomenon of competition. The more the suppliers, the more the competition, and the better off the consumers become. In a competitive market (a lot of suppliers supplying the same or similar products), a decrease in price will naturally occur, without any government intervention to control prices. Let’s explain this in basic terms.

Let’s say you have one company that manufactures latex gloves for the entire medical industry. Now, if that were true, then that company could literally charge just about any price to its customers for latex gloves. This company knows that the customer has no other option but to buy latex gloves from them and as such, the company has no incentive to sell the latex gloves at a lower price. This is not a good situation for the customers. Enter in another company that manufactures the same, or similar latex gloves. To incentivize the existing consumers to buy from their company, this second company prices their latex gloves a little lower to attract business. When this happens, the first company becomes aware of this development and is then forced (by natural and fair competition) to reduce their price to a price that is closer, if not lower than what the second company charges. The first company (by the effect of competition) now has an incentive to lower their price of latex gloves. This can only be good for the customer. Now, these two companies could get together and agree to keep their prices the same, or similar in order to keep their desired share of customers. Despite being illegal to do this, you see how this cannot be good for the customer.

Enter in a third company that manufactures the same latex gloves and is uninterested in “fixing prices”, as the first two companies are. They set their price lower than the “fixed price” (but at a price that still provides a profit) to incentivize the existing consumers to buy latex gloves from their company. Again, you see how this can only good for the customer. This could go on and on until you have several companies competing for the same number of customers, driving the price lower and lower, ultimately to the benefit of the customer. And this happens naturally in free market, without any legislation to control prices.

Another by-product of competition in the free market is that is creates an incentive for the manufacturers to improve the quality of the product. Using the previous example, when there are several companies that are manufacturing latex gloves and they are competing for the same customers, it is not only in their interest to lower the price as much as they can (and still produce a profit) but also to make their product better, and more desirable. Not only does a lower-priced product (that is similar in quality to the other manufacturer’s product) cause customers to buy a company’s product, but a better quality product at even a higher price will cause some customers to buy their product.

Now let’s circle back around to the ACA. Again, I’m not interested in getting involved in the discussion about why there are a limited amount of suppliers of healthcare services as related to this legislation. That is another topic altogether. But, as we can see in the example of the latex gloves, a limited number of suppliers of products (in this case, services) will ultimately serve to keep the cost of healthcare high and reduce the quality over time. As in the example of the latex gloves, when there are a small number of suppliers of healthcare services, the incentive for those providers to reduce their costs (by the natural effect of competition) is reduced, in relation to what it would be if there were several suppliers involved. The incentive for these service providers to be efficient and to increase the quality of the healthcare that they provide is also reduced.

Many suppliers leads to more competition, which leads to lower customer prices, which leads to better quality of service and increased efficiency.

Please comment.

The Danger of Price Control


Price control is something that may sound like great idea on the surface. Why not set prices on essential products and services (gas, food, electricity, etc.) at a level that is “affordable” to the average consumer? As with many naive ideas, there come some fundamental problems. And this idea is no different.

In a free market, prices are determined by the market activities (the functioning components of the market activities are price, supply and demand). In the basic idea of supply and demand, companies try to set the price of a particular product that they are selling at an amount that will cause consumers to buy the product at the same rate of production. If the price of the product is set too high (a price higher than the consumer is willing to part way with their money acquire the product), then fewer consumers will buy the product, leaving a surplus of products not sold. If the price is set too low, then more consumers will be willing to buy the product than is able to be supplied, and thus causing a shortage.

Companies selling products are always trying to set the price on their product at an amount where supply and demand are equal. In other words, companies want to produce the exact amount of products that consumers will buy, no more, no less. That makes sense, doesn’t it? But we know, in reality that hardly ever happens. In theory, if a company could know at exactly what price to sell their product in order to attract consumers to buy the exact amount of their product that they produced (supplied), then there would be no need for companies to have any overstock or any other surplus goods held in inventory. This is the concept of supply and demand equilibrium. Embedded into the price that is being considered is the amount of profit that the producer of the product will make for each item sold.

Now, when one of the functioning components of the market, by law and legislation, are not able to operate freely (meaning, freely able to be affected by market activities), the other components will be affected. Again, the three fundamental components or factors are price, supply and demand. And when you affect one third of the equation, things will change drastically…and change quickly. When supply is artificially constrained (i.e. government legislation demands that only a certain amount of a particular good can be available to the market), then price is affected (artificially made to increase). For example, when the countries that we import oil from (to produce gasoline) put caps on the amount of oil they will supply to the world, the price of that oil will increase, assuming no change in demand for that oil. That makes sense, right? Because there are a lot of companies in the world that want and need that oil to produce the gasoline to satisfy their particular set of consumers that desire to fill their vehicles up with gasoline (and in this example, the supply of that oil is limited). These companies are willing to pay more for that oil because there are other companies trying to buy the same, limited amount that is being supplied. But, they can only pay an increased amount up at a certain point. They cannot pay just any amount. They can only pay an amount up to the point that it ceases to become cost-effective.

That brings us to another side of the coin. When governments artificially constrain prices, we get a similar affect. When prices, by law and legislation, are fixed at a certain amount, the product being sold does not magically become cheaper to produce. No, in fact, it will at the very least be more expensive to produce. And maybe the product will become even impossible to produce in the long run, because the amount of money that is required to produce the good (labor, materials, etc.) may exceed the amount that the company is allowed, by law and legislation, to charge a consumer to buy (price). At that point in time, there is no reason or incentive for the company to continue to produce a product that they will only lose money on. And eventually, if nothing changes in terms of the control on the price, the product will become unavailable because companies will have no reason (or incentive), by means of a profit, to produce it.

We see this phenomenon in many facets of life, when governments have tried to control the price of a good or service in the private sector of business, only to see either the quality dwindle or the quantity disappear. We see it in rent controlled housing, where the quality of the housing deteriorates. Again, if the landlord can only charge a certain amount of rent, by law or legislation, it limits the amount of resources he can spend to maintain the property, given all of the other operating expenses involved in leasing the apartments (wages to property manager, property taxes, etc). We have also seen the effects of price control in the medical industry, where governments have capped the price on certain medicines, only to make the medicine eventually unavailable because the manufacturers cannot afford to produce the medicine at the controlled price, and still make a profit.

As we look at the idea of price control, we see that there are many unintended consequences. More specifically, we eventually see the complete opposite effect of the intended outcome. While the outcome of price control is to provide goods and services to consumers that would otherwise not be able to afford them, if the price is allowed to be controlled for too long, those very goods will eventually be unavailable altogether because they would cease being produced.

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