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Archive for April, 2010

 

     In Part II we move beyond defining the middle-class to an emphasis on understanding the middle-class from an economic point of view. If one is successful in comprehending the relationship between the middle class and economic principles, one will begin to see the folly, if not absurdity, of Robin Hood Politics. 

 THE IMPORTANCE OF UNDERSTANDING ECONOMICS

      First off, a brief review of economics is necessary for the reader. To know what economics is, one must first know what an economy is. If society had unlimited abundance there would be no scarcity. The world has never known unlimited abundance. Without scarcity, there is no need to economize—and therefore no economics. Now—a definition of Economics.

 Economics is the study of the use of scarce resources which have alternative uses.

      What does “scarce” mean?  It means, quite simply, that people want more than there is. Many people, including well educated individuals, grossly misunderstand the implications of scarcity. Back in 1999 the New York Times laid out the economic woes and worries of middle-class Americans—one of the most affluent groups of human beings ever to inhabit the planet. 

      Although the story included a picture of a middle-class family in their own swimming pool, the main headline said: “The American Middle, Just Getting By.”  In essence, there is a great chasm between middle-class expectations and the reality of economics.  Said another way, middle-class Americans’ desires exceed what they can comfortably afford, even though what they already have would be considered unbelievable prosperity by people in many other countries around the world—or even by earlier generations of Americans.

     To look upon the middle-class in America as some sort of financial social victim is outright stupid, naïve, and a highly misplaced prejudice that fans the flames of social class bigotry everywhere. Some view the middle-class as burdened by budgeting and struggling just to make ends meet. If real budgeting is the norm among the middle-class, one can’t tell by the facts. Budgeting is not a real constraint on the middle-class. I find it hard to accept when it was the middle-class the last 30 years who chalked up astronomical credit card debt, were suckered into buying homes they couldn’t afford, and who spent money like there was no tomorrow, and whose saving accounts were drier than a Sahara desert dune. Frugality, except among the most diligent, is not the general way of the middle-class.

      It is not something as man-made as a budget that constrains them: Reality constrains them (or should). There has never been enough to satisfy everyone completely. That is the real constraint. That is what scarcity means.    

      Most people are savvy enough to understand, as an economic principle, the concept of Supply and Demand. In general, when supply increases, the cost per unit of a product or service (labor and material costs) usually declines. When demand increases, prices usually rise in response to the demand. Sometimes the supply side can’t respond to demand no matter how great, for example where there is not an unlimited supply of beach-front properties along our nation’s coastline.

     Other times supply can increase at a greater speed as when assembly lines go into high gear to put more automobiles on lots. However, sometimes prices can remain exceptionally high even when demand can only be met by a few buyers. For example, rare gems and diamonds, or a Van Gogh painting may be desired by everyone, but afforded by only a few. Because there is only a finite amount of precious art objects or rare jewelry, supply rather than demand is in the driver’s seat where higher prices are concerned.

     However, 99.999% of all businesses can make more money if they keep prices lower and try to attract a larger volume of consumers. For example, food, energy, utilities, common household products all generate large volumes of customers but scarcity is the controlling factor when coupled with demand. For example, energy prices can fluctuate considerably in extremely cold regions of the country with high demand compared to warmer areas of the country where the demand is less.  Many people, including myself, have long considered prices as something that thwarts one from getting the things they want. This is because most of us have never really understood the economic function of prices.

     So, what are prices and how do they function? Is there anything in this mechanism of pricing (no matter how suppressing it might be) that tells one that he is somehow deserving of his neighbor’s larger income? [I don’t think so, folks!]  In all of this, you should endeavor to understand the underlying principle of supply and demand, and its relationship to fluctuating prices. In this way you’ll be able to see that prices are like signals or bits of information. They simply measure the barometer of resources, whether scarce or abundant, and translate that state of scarcity or abundance into prices.

 In all that follows I wish I could take credit for the examples and economic principles and insights involved. Instead, all the credit goes to the famous and distinguished economist and writer—Thomas Sowell. A short bio of Dr. Sowell follows his contribution to the issues I have raised.

 DR. THOMAS SOWELL’S CONTRIBUTION

       In a market economy, prices play a crucial role in determining how much of each resource gets used where (remember, scarce items with alternative uses). Many people see prices as simply obstacles to their getting the things they want. Those who like to live in a beach-front home, for example, may abandon such plans when they discover how expensive beach-front property is.

      But high prices are not the reason most middle-class individuals cannot all live on the beach front. On the contrary, the inherent reality is that there are not nearly enough beach-front homes to go around, and prices are just a way of conveying that underlying reality. When many people bid for a relatively few homes, these homes become very expensive because of supply and demand. But it is not the prices that cause the scarcity, which would exist under whatever other social arrangement was used instead of prices.

      If the government were to come up with a “plan” for “universal access” to beach-front homes and put “caps” on the prices that could be charged for such property, that would not change the underlying reality of the ratio of people to beach-front land. With a given population and a given amount of beach-front property, rationing without prices would have to take place by bureaucratic fiat, political favoritism, or random chance—but the rationing would still have to take place.

      Even if Congress or the Supreme Court were to decree that beach-front homes were a “basic right” of all Americans—that would still not change the underlying reality in the slightest. Prices are like messengers conveying news—sometimes bad news, in the case of beach-front property desired by far more people than can possibly live at the beach, but often good news. For example, computers have been getting both cheaper and better at a very rapid rate, as a result of technological ingenuity.

     Prices not only guide consumers, they guide producers as well. When all is said and done, producers cannot know what millions of different consumers want. All that the automobile manufacturer, for example, knows is that when they produce cars with a certain combination of features, they can sell these cars for a profit that covers their production costs and leaves them a profit. But when they manufacture cars with a different combination of features, they don’t sell as well.   

      Persistent source of confusion surrounding the term “middle class” derives from the fact that members of the middle class, as defined by sociologists, do not fall in the middle of a society’s income distribution. Instead, members of the middle class tend to have relatively high incomes compared to others in their societies. Thus, people who fall in the middle of their own societies’ status hierarchies are typically not, in fact, “middle class” as defined by sociologists. As a result, intuitive colloquial and journalistic usage of the term has come to diverge substantially from its strictly sociological usage.

 WAGES, PRICES AND ECONOMIC PROSPERITY

      Wages and salaries serve the same economic purpose as other prices—that is, they guide the utilization of scarce resources which have alternative uses. Yet because these scarce resources are human beings, we tend to look upon wages and salaries differently. Often we ask questions that are quite emotionally powerful, even if they are logically meaningless. For example: Are the wages “fair?” Are the workers “exploited?” Is this a “living wage”?

      Such questions seldom get asked about the prices of inanimate things, such as a can of peas or a share of stock in General Motors (except out of frustration when trying to buy something expensive such as an automobile or a home one can’t afford). But people are believed to be entitled to pay that is “fair,” even if no one can define what that means. “Exploitation” and “a living wage” are likewise emotionally powerful expressions without concrete meanings. If a worker is living, how can he be receiving less than “ a living wage”—unless as some have said thoughtlessly, “living below subsistence”?

      No one likes to see fellow human beings living in poverty or squalor, and many are prepared to do something about it, as shown by the vast billions of dollars that Americans donate to a wide range of charities every year, on top of the additional billions spent by federal, state, and local governments in an attempt to better the condition of less fortunate people. These socially important activities occur alongside an economy coordinated by prices, but the two things serve different purposes.

     Attempts to make prices, including the prices of people’s labor and talents, be somethimg other than signals to guide resources to their most valued uses, make those prices less effective for their basic purpose, on which the prosperity of the whole society depends.

     Ultimately, it is economic prosperity that makes it possible for hundreds of billions of dollars to br devoted to helping the less fortunate. It is also economic prosperity which allows people born into poverty to rise to economic heights undreamed of by their parents or perhaps even by themselves.

INCOME DISTRIBUTION—WHAT’S IT REALLY ALL ABOUT?

      Nothing is more straightforward and easy to understand than the fact that people can earn more than others, for a variety of reasons. Some people are simply older than others, for example, and their additional years have given them opportunities to acquire more experience, skills, formal education and on-the-job training—all of which allows them to do a given job more efficiently or to take on more complicated jobs that would be overwhelming for a beginner or for someone with limited experience or training.

     With the passing years, older individuals may also become more knowledgeable about job opportunities, while more other people may become aware of them and their abilities. These and other commonsense reasons for income differences among individuals are often lost sight of in abstract discussions of the ambiguous term “income distribution.”

      Most income is of course not distributed at all, in the sense in which newspapers, milk, or Social Security checks are distributed from some central place. Most income is distributed only in the statistical sense in which there is a distribution of heights in a population—some people being 5 foot 4 inches tall, others 6 foot 2 inches, etc.—but none of these heights were sent out from some central location.

     Yet, it is all too common to read journalists and others discussing how “society” distributes its income, rather than saying in plain English that some people make more money than others. More is involved than a misleading metaphor. Often the very units in which income differences are discussed are as misleading as the metaphor. Family income or household income are not like individual income.

     An individual always means the same thing—one person—but the sizes of families and households differ substantially from one time period to another, from one racial or ethnic group to another, and from one income bracket to another. For example, there are 39 million people in the bottom 20 percent of households, but 64 million people in the top 20 percent of households.

      These differences in  the sizes of families and households are not incidental. They radically change the meaning of income distribution statistics that are thrown around in the media and in politics. For example, real income per American household rose only 6 percent over the entire period from 1969 to 1996, but real per capita income rose 51 percent over the same period. The average size of families and households were simply declining, so that smaller househokds were now earning about the same as larger households had earned a generation earlier.  

     As so often happens, the facts are not complicated, but misunderstandings abound nevertheless. A Washington Post writer, for exanple, declared in 1998 that “the incomes of most American households have remained stubbornly flat over the last three decades.” It would be more accurate to say that some writers have remained stubbornly blind to economic facts. When two people in the one household today earn the same total of money that three people were earning in that household in the past, that is a 50 percent increase in income per person—even when household income remains the same. 

      It is equally misleading to compare high-income families or households with low income families and households. There are more people per family in upper-income families compared to low-income families—and more of these people work. That is part of the reason for some families having higher incomes than others. It is not uncommon for families in the top 20 percent of income-earners to supply several times as many man-hours of work per week per year as families in the bottom 20 percent. Many of the latter work very little or not at all, whether due to illness, retirement, single mothers raising children on welfare, or for other reasons. Yet plain facts like these are often omitted by those who write or speak of how “society” unequally or unfairly “distributes” its income. A closer look at these households reveals that those in the top quintile contain more than 40 million people of working age—18 to 64 years of age—while the bottom quintile contains fewer than 20 million prople in such age brackets.

     Perhaps the most radical difference between individual and family or household statistics are those used in comparing different American racial or ethnic groups. For example, real income per black household rose only 7 percent in the two decades from 1967 to 1988, but real per capita income among blacks rose 81 percebt over those very same years. Average black household size was simply declining during these decades, so that a substantial increase in real income per person appeared statistically as a triviality small increase per household. Moreover, because black household size was declining more sharply than white household size, black incomes appeared to be falling behind white incomes when household statistics were used, but were in fact rising faster than white incomes when individual statistics are examined.    

     For both blacks and whites, rising prosperity was one reason for more people to be able to go set up their own individual households, instead of continuing to live with parents or as roomers or by sharing an apartment with a roommate. Yet these consequences of prosperity generate household statistics that are widely used to suggest that there has been no real economic progress.

     Among individuals in the general population, age makes a big difference in income—and a huge difference in wealth. Inexperienced young people beginning their careers in their twenties sekdom make as much money as their parents who are in their forties and fifties. Having just begun to work, these younger workers are usually not as valuable as older and more experienced people. Having just begun to save, they are more likely to have much less money in the bank or in a pension fund, as compared to their parents, who have been saving for decades and acqutring other assets for decades.

     Although people in the top income brackets and the bottom income brackets—the “rich” and the “poor,” as they are commonly called—may be discussed as if they were different classes of people, often they are the very same people at different stages of their lives. An absolute majority of the people in the bottom 20 percent in income in 1975 were also in the top 20 percent at some point over the next 17 years.

      This is not surprising. After 17 years, people usually have had 17 years more experience, perhaps including on-the-job training or formal education. It would be surprising if they were not able to earn more money as a result. It is not uncommon for most of the people in the top 5 percent of income earners to be 45 years old and up.

     Although people in the upper income brackets are often characterized as “rich,” in reality a family or household can reach the top 10 percent with incomes that fall far short of what truly wealthy people make. As of 1998, a household income of $75,000 a year was enough to put the people in that household in the top 10 percent. A couple making $38,000 each hardly seems like “the rich.” Even the top 5 percent of households could be reached with a combined income of  $133,000—comfortable, but hardly in the same categories as millionaires and billionaires.

     Even people in the top one percent in wealth bear little resemblance to “the idle rich” conjured up in popular legend or ideological rhetoric. The average person in the top one percent works 52 hours a week. At the other end of the scale, more than half of all those in the bottom 20 percent do not have a full-time job.

      Another common statistical illusion comes from determining whether “inequality” is increasing or decreasing by comparing the incomes of those in the top 20 percent with the incomes of those in the bottom 20 percent. Nothing is easier to find than media and academic proclomations that the difference between incomes in these top and bottom brackets has grown wider over the years. Even when the changes are only of a few percentage points, there may be much hand-wringing and moral indignation. However, if our concern is not with statistical categories but with flesh-and-blood human beings, then we must focus not on brackets but on the people who are constantly moving in and out of those brackets.

      Fewer than 3 percent of those in the bottom 20 percent in 1975 were still there in 1991, while 39 percent of them were now in the top 20 percent. Most of “the poor” of the 1970s had reached higher income levels in the 1990s than most of the whole American population had in the 1970s. To compare the current incomes of these now “rich” people  with the incomes of the currently “poor” ignores the likelihood that todays “poor” will continue to repeat the pattern and be even more prosperous in 2010 than our current top 20 percent are today.[Parenthetically, I’d like to point out that Dr. Sowell’s book, Basic Economics—A Citizen’s Guide to the Economy, was copyrighted in 2000.]  

     Time has an even stronger effect on the accumulation of wealth. The average amount of wealth held by people in the older age brackets is usually several times the amount held by people in their twenties. But these are not the enduring economic differences we usually have in mind when we talk about classes.

     People in their forties and fifties are not a different class from people in their twenties, because all forty-year-olds were once twenty-year-olds and all twenty-year-olds are going to be forty-year-olds, unless they die prematurely. Not only are most uf them likely to be both “rich” and “poor” at different stages of their lives, even at a given moment many of the low-income people are the children of high-income people—and their heirs.

     Genuinely rich and genuinely poor people exist—people who are going to be living in luxury or poverty all their lives—but they are much rarer than gross income statistics would suggest, when these statistics are not broken down by age. The turnover was huge in all income brackets in just 17 yrars, less than half of most people’s working life.

      Just as most American “poor” do not stay poor, so most rich Americans were not born rich but only achieved wealth at some point in their own lifetimes. Moreover, the genuinely rich are nearly as rare as the genuinely poor. Even if we take a million dollars in net worth as our criterion for being rich, only about 3.5 percent of Americans are at that level at a given time. This is in fact a fairly modest level, given that net worth counts everything from household goods and clothing to the total amount of money in an individual’s pension fund. Nevertheless, the genuinely rich and the genuinely poor, put together, add up to less than 7 percent of the American people, even though political rhetoric might suggest that we are all either “haves” or “have nots.”

      While, in some senses, those who are called “the poor” are not as badly off as instantaneous statistics might suggest, in other respeccts they are worse off. They must often pay higher prices for inferior goods and services because there are higher costs of delivering those goods and services to low-income neighborhoods. A suburban supermarket has lower costs of delivering groceries to its customers than does a typical neighborhood store in the inner city, and that translates into higher prices charged to low-income customers than to high-income customers. Similarly, banks serving middle-class people have lower costs per transaction than institutions serving people in poverty, such as pawnshops or check-cashing agencies. It does not cost a hundred times as much to process a $5,000 loan to an affluent person as it does to make a $50 loan to someone in poverty.

     Cashing a check for an affluent person whose employment and credit history is known to the bank, and who has had an account in the bank for years, is much less risky than cashing a check for someone who walks off the street into a check-cashing agency in a low-income neighborhood and who probably does not have a bank account or perhaps even a permanent job. Thus affluent people have their checks cashed free of charge in their banks and receive bank loans at a lower interest rate than those charged the poor by pawn shops or other sources of credit that will take a chance on them. Being poor is expensive. Fortunately, most Americans do not remain poor very long.

 DR. THOMAS SOWELL’S BIOGRAPHY

      Thomas Sowell was born in North Carolina and grew up in Harlem. As with many others in his neighborhood, Thomas Sowell left home early and did not finish high school. The next few years were difficult ones, but eventually he joined the Marine Corps and became a photographer in the Korean War. After leaving the service, Thomas Sowell entered Harvard University, worked a part-time job as a photographer and studied the science that would become his passion and profession: economics.  

     After graduating magna cum laude from Harvard University (1958), Thomas Sowell went on to receive his master’s in economics from Columbia University (1959) and a doctorate in economics from the University of Chicago (1968).

     In the early ’60s, Sowell held jobs as an economist with the Department of Labor and AT&T. But his real interest was in teaching and scholarship. In 1965, at Cornell University, Sowell began the first of many professorships. Thomas Sowell’s other teaching assignments include Rutgers University, Amherst College, Brandeis University and the University of California at Los Angeles, where he taught in the early ’70s and also from 1984 to 1989.

     Thomas Sowell has published a large volume of writing. His dozen books, as well as numerous articles and essays, cover a wide range of topics, from classic economic theory to judicial activism, from civil rights to choosing the right college. Moreover, much of his writing is considered ground-breaking — work that will outlive the great majority of scholarship done today.

     Though Thomas Sowell had been a regular contributor to newspapers in the late ’70s and early ’80s, he did not begin his career as a newspaper columnist until 1984.       George F. Will’s writing, says Sowell, proved to him that someone could say something of substance in so short a space (750 words). And besides, writing for the general public enables him to address the heart of issues without the smoke and mirrors that so often accompany academic writing.

     In 1990, he won the prestigious Francis Boyer Award, presented by The American Enterprise Institute. Currently, Thomas Sowell is a senior fellow at the Hoover Institute in Stanford, Calif.

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