Art Carden on Price Theory & Its Discontents
2022-05-02 · Guest: Art Carden (Professor of Economics at Samford University) · 52:30
The Role of Prices in Free Markets
Bob Zadek and economist Art Carden discuss the fundamental role of prices in a free market, arguing that prices are the most accurate form of information for coordinating human action. They explore how government interventions like rent control, minimum wage, and price gouging laws distort these signals, leading to waste, shortages, and unintended social consequences.
Topics: Price Theory, Free Markets, Rent Control, Minimum Wage, Price Gouging, Economic Waste, Profit and Loss, Information Problems
Speakers:
- Bob Zadek: Host
- Art Carden: Professor of Economics at Samford University and Senior Fellow at AIER
- Milton Friedman: Economist (archival clip)
- Phil Donahue: Talk show host (archival clip)
Introduction to Price Theory [00:00]
Voiceover: You’re listening to the Bob Zadek Show, a full hour of libertarian discussion with the smartest guests on radio. Live, spontaneous, and thoughtful, it’s the show of ideas, not attitude. And your calls are welcome at 424-BOB-SHOW. Now, your host, Bob Zadek.
Bob Zadek: Hello, everyone. Welcome to the Bob Zadek Show, the longest-running libertarian show on all of AM radio. There is so much misunderstanding in this country about what exactly free markets are all about. We see that with price gouging, rent control, with greed—one of my favorite economic concepts. You think it’s an emotion? No, it is a concept of bedrock free market economics.
We will be visiting free markets and discussing the core principle of it all, the root drive to free markets, which is the role of price in our daily life. Not only is price the purest and most ultimate truth if it is the result of a free market, it is the most small-d democratic way for every participant in a market society—from the spender living on the tightest budget on the planet to the billionaire—all of us participate in a market economy.
With so much being written about suppressing the vote, encouraging the vote, the ultimate vote, the most important vote, the most personal vote, and the vote we exercise hundreds of times a day is the vote we use when we buy or sell anything. So the more pure price information we have, the purer our economic democracy is. Price is so misunderstood.
I have asked our guest this morning, Art Carden, to join us to explain to us with a level of clarity that I have never seen before. Art writes for AIER, the American Institute of Economic Research, and he wrote an essay on price that made everything so clear. He was going to help me explain why free market economics, why unfettered price setting without government interference, is crucial to all of our lives. Art is a professor of economics at Samford University’s Brock School of Business. He’s a senior fellow with the American Institute for Economic Research and at the Fraser Institute. Art is here to help me explain the role of price and free markets in our lives and how without it, neither our economic system nor no other economic system on earth can possibly function.
Now, you wrote about price in the context of price being—these are my words, not yours—the ultimate truth and maybe modified by economic truth. So tell me about the price of something, whether it’s wages or goods or services, and what it has to do with truth.
Markets as a “World of Truth” [03:30]
Art Carden: So the economist Tim Harford wrote this great book in 2008 called The Undercover Economist. In it, he referred to competitive markets as a “world of truth.” This has stuck with me since I taught this book 14 years ago. The things that he points out are that prices, when they’re set in competitive markets, ensure that we produce the right stuff, we produce it the right way, it goes to the right people, and we make it in the right proportions. It’s right in so far as in a competitive market, we’re not wasting any resources.
That’s the point that I would want to double underline: in a competitive market, we’re not wasting any resources. Furthermore, I would triple underline the fact that in a competitive market, we’re not leaving any money on the table either. Every mutually beneficial exchange that can be made gets made in a competitive market. If we want to be strictly utilitarian about it, when you take an economics class, you learn that it maximizes the sum of consumer and producer surplus. In short, it makes the world as well-off as it can possibly be.
Defining Economic Waste [05:00]
Bob Zadek: Now, when you say “makes the world as best as it can possibly be” and “it results in minimal or actually no waste,” what did you mean by waste? When is something wasted, as you use the phrase? There’s lots of examples in your writing and in books that you and I have read, and the classic example about the baker building a bake shop and selecting the ingredients. When is something wasted and when is it not wasted?
Art Carden: Something is wasted when we use more of it than we need to. Think about say something like an aluminum can. We are wasting resources if we’re using more aluminum than is in some sense absolutely necessary. We’re wasting resources if we’re using more lacquer than is absolutely necessary. We’re wasting resources when we’re not producing stuff at the absolute minimum possible cost.
Now, the thing that a lot of people confuse is that minimizing cost means producing cheap, crappy stuff. That’s not true. It’s not about producing cheap, crappy stuff for which you don’t pay a whole lot of money; it’s about producing a good of a given quality, like this can of sparkling water that I’m holding right now, at the minimum possible cost. Because if anybody is using more aluminum than they need, if they’re using more lacquer than they need, if they’re using more labor than they need, then that means we’re giving up all of the things that we could have gotten with that aluminum, with that lacquer, with that labor. We’re wasting it in that there are benefits that we could have gotten that we are not getting because we’re using too much labor and too many resources to produce cans of sparkling water.
Now, that might not sound like it’s any huge deal, but you pick anything that really matters in life, like health or your family or you love the arts or what have you—all of these things are very highly correlated with per capita income. We need real resources in order to produce them. So if we’re wasting resources producing sparkling water at too high a cost, that means fewer tickets to the opera.
The Myth of Greed in Price Setting [08:50]
Bob Zadek: And when you say waste, I guess the issue is how does one know when they are wasting something? While waste is for sure a negative word, we don’t know if we are wasting anything unless we know—waste in the abstract, the concept can’t be explained. Waste means, as it did in your example, a choice between two things.
I’ll give a really clear example. You have an hour of your time. The question is, how do you spend that hour of your time? Let’s be specific. You have two people who want to buy an hour of your time, and you like them equally. You have to decide what’s the best use of that hour. To whom should you give that hour? The answer is so obvious: the one who will pay you the most.
But then it gets modified a bit by one individual might be paying you more, but that task is more hazardous, so you will build that in as a non-economic consideration. In other words, you try to convert apples to apples, and the only way to decide is by price. Thus you have a choice to make, a choice which cannot be made without knowing the price. First of all, Art, build on that concept of price and then explain about price established by the free market versus price established by fiat and examples of that if you would.
Art Carden: So most people subscribe to the “producers are mean” theory of prices and the “employers are mean” theory of wages. They think that the price of gas, for example, is set based on how greedy the gas station owners are when they wake up in the morning. That’s not at all what happens. Prices are the products of human action, but they’re not the products of human design. That phrase comes from one of Adam Smith’s contemporaries, Adam Ferguson. They’re unintended consequences of people pursuing their own interests.
Very importantly, prices are indispensable guides that help us know whether we are stewarding our resources well or stewarding our resources wastefully. Who will pay me the most for an hour of my time is a pretty good guide to what is the most socially valuable use of my time. The way that I tell my students, I say that it’s informative, it’s not decisive. There are some things I’m sure that people would pay me a lot of money to do that I wouldn’t do—commit murder, for example. But prices give us the best estimate of the alternative uses of a resource—someone’s time, like a pound of aluminum, like an ounce of gold, so on and so forth. So we know, first of all, what we’re giving up, and we also know, if we can compare prices, what is the highest-valued use of a particular resource—again, whether it be our time, whether it be a pound of aluminum, whether it be a laptop, whether it be anything.
Bob Zadek: You mentioned the misperception that employers are greedy because they don’t choose to pay their workers enough, producers are greedy because they overcharge—a concept that has no meaning whatsoever. I’ll explain what I mean. Because producers overcharge—but that cannot be, because price is what a producer wants for its product. It’s aspirational. It’s the hoped-for price, it’s not the price. No one gets to set a price unilaterally. The price is zero unless somebody is willing to pay that price. In which case, the person paying the price has decided it is as beneficial to the buyer as it is to the seller. Thus, what has happened is two people have been viciously greedy: the buyer, who is determined to not pay one penny more than it has set in its own mind for goods, and the seller has said, “I’m not selling it for one penny less.” When those two lines cross, both parties get what they want and they’re better off.
In that simple example, who was more greedy? The buyer who refused to pay more than the seller wanted—“Here, I’m feeling generous today”—or the seller who refused to sell for one penny less? It’s an absolute tie. So without greed, we’ll all die of starvation, as Adam Smith taught us in that wonderful story about—it is not for the generosity of the butcher and the baker. Many of you have heard that. Build upon that concept of the total absence of greed in a free market. And along the way, Art, because it’s so important and we have to clear up so much confusion, when you do, weave in the evils of price gouging regulation, because that is a profound misunderstanding that has public support, but it’s destructive on the public who those statutes try to protect.
The Problem with Price Gouging Laws [13:00]
Art Carden: There’s a lot there. Let’s start with the Adam Smith story, which is near the very beginning of The Wealth of Nations. Smith writes that it is not from the benevolence of the butcher, the baker, the brewer that we expect our dinner, but from their regard to their own interest. A lot of people see this as an apology for the worst kinds of dispositions, like the sorts of ways we teach our children not to be—completely self-absorbed. But I think Smith’s message fundamentally is to the people who are standing on the sidelines harping about the prices and saying, “That’s not fair, that’s not fair, that’s not fair.” It’s effectively saying, “Get over yourself.”
The butcher, the baker, the brewer—they’ve got their own families, they’ve got their own responsibilities, they’ve got their own churches, they’ve got their own health issues. They’ve got all of their own stuff to take care of. It is presumptuous of someone to come into the baker shop and demand to be fed at the baker’s expense, given again that the baker’s got his own stuff to worry about. I think about this again in the context of children. I’ve got three kids, age 13, 11, and 9. It would be the height of presumption for me to go into somebody else’s house and expect them to feed my children before they feed their own.
So there’s a certain beauty in this market relationship—call it greed if you want to—but there’s a certain beauty in the cooperation that happens in markets because the butcher, the baker, and the brewer are able to help me raise my family by providing me with beer and beef, and I’m able to help them raise their families by providing students at Samford University with economics lectures and readers around the world with economics articles, which I trade for money and then can give to the butcher, the baker, and the brewer.
There’s a really great clip on YouTube of Milton Friedman on the Phil Donahue show where Donahue is talking about greed and Milton Friedman says, “Well, who’s greedy? It’s always the other guy who’s greedy. None of us are greedy.” I think about this with respect to someone’s role as an employee. I know maybe two people in my life who’ve ever turned down a raise. My guess is that among the listeners, you’re probably not going to think of many people who’ve ever turned down a raise, saying, “Ah, you know, you’re paying me enough. I’m going to forego this raise.” And it’s also pretty rare to see someone go into a grocery store or a video store or anywhere and say, “Oh, this price is too low. I’m going to pay a little bit extra for it.” Maybe they do that at the farmers market or whatever, or they tip extra during COVID because they want to encourage people to work or what have you. But generally, people are not going to pay more than they absolutely have to, and they’re not going to accept less than they’re absolutely willing to accept. Again, in both of those cases, they’re being “greedy”—they’re pursuing their own interests, but in a way that ultimately helps the people with whom they’re able to cooperate.
So you mentioned the evils of price gouging regulation. What is price gouging? How is it described in the public? Because you point out in your writing about the role of good intentions. It’s a wonderful opportunity for you to weave the role of intentions into the public policy issue involving price regulation in general. But we are focusing specifically now on alleged price gouging regulation.
Art Carden: I tell my students: incentives matter, institutions matter, intentions don’t matter. Indeed, we live in a world where we give ourselves far too much credit for meaning well. I teach at a private Christian school in Alabama and, you know, it does the sort of things that private Christian schools do—our students go on mission trips and various other things. We do things to try to help people, and I’m surrounded here in Birmingham by people who are trying to help people. But it’s not always clear necessarily that they’re getting what they want.
This is one of the things that just blows my mind every time I teach an introductory economics class. Often, the things that we do in the name of helping people actually, in the long run, make them worse off. So we’re hurting exactly the people that we’re trying to help. And here’s the sort of perverse thing: then we’re patting ourselves on the back for it.
Price gouging legislation is like this. “Price gouging” is a lovely term because it doesn’t actually mean anything. It’s a form of price control. So there are price ceilings where a government might say, “Okay, the maximum price of gas is $5 a gallon. Thou shalt not charge more than $5 a gallon.” Okay, that’s a hard price control. A price gouging law is something that’s much, much more nebulous. It usually happens in the wake of a natural disaster or something like that. The way that a lot of price gouging statutes are worded, they’ll say something like “prohibited from charging more than 20% above wholesale price” or “it’s to punish unreasonable and unconscionable increases in the prices of gas and water and all sorts of emergency goods and things like that.” And of course, the big question is, “Okay, according to whose reason and according to whose conscience?” It’s not to sound cliché, but it’s very Kafkaesque because it’s not really clear what the crime is. It’s very messy. When people get prosecuted for price gouging, it’s just this very squishy space where people just say, “Okay, you’ve done something wrong.”
The problem with price gouging laws is the same as the problem with any binding price ceiling. By preventing the price from rising, you’re creating a shortage. Every time I look at pictures of, say, New Orleans, Louisiana after Hurricane Katrina, or Houston after Hurricane Harvey, people lined up down the block waiting for gas or something—the storm didn’t cause that. The price control, the price gouging law, is what caused that. Rising prices send two signals. They send a signal to people who would demand gas to say, “You need to consume less. Think twice about taking that next trip. Think twice about going to two different grocery stores.” And then furthermore, they send an important signal to potential suppliers saying, “Hey, gas is really valuable now in New Orleans or Houston or somewhere like that. You get an extra reward if you bring gas over here.”
Prices as Information Signals [18:13]
Art Carden: One of the things again that I think is beautiful about it is prices transmit information. They transmit valuable and important information about what’s going on on the ground. Someone who has no idea what’s happening can nonetheless respond appropriately to what’s happening because they get that information from prices.
Let’s suppose something weird happening in California right now. Let’s go with a drought. Okay, so there’s a drought in California, which if there was a free market in water, that would mean higher water prices. If there were higher water prices in California, potential water suppliers would notice that they could probably earn more selling water in California than they could earn selling water in Alabama. I might have no idea what’s going on in California; I just see my water bill going up and I take shorter showers. So again, this is one of the beautiful things—and I use the word “beautiful” intentionally—about the price mechanism, because it helps me, who frankly has no idea what’s going on in California with respect to the drought, help all of you guys, even though I may not necessarily know it.
The Mispricing of Water [20:13]
Bob Zadek: And although obviously economic policy didn’t cause the drought, it did cause the lack of cure for the drought. Because if prices were permitted to tell the truth—the theme of this morning’s show—if people were told water has become very valuable there, then anybody who could practically do it would go out of their way, would spend their time not at their regular job, not playing golf, because now an hour of their time became far more valuable if they move water to California. Thus, it doesn’t take government and National Guard to force people to fix the problem. Price sends out a message. Price is like a loudspeaker. Anybody with water, you can exploit your access to water and further your self-interest. And you know what happens along the way? The people who want the water get it.
So notice the theme: everybody is better off. The supplier of the water is better off; they made some money. The purchaser of the water is better off because they got water, which without the premium price, nobody would bother—except for the Red Cross—to move water and take their own time to fix somebody else’s problem. So price is telling the truth about the value of water. When the government sets the price, whether it’s with anti-price gouging legislation, the government is saying, “We compel you to lie,” and “We compel you to undervalue a commodity or a unit of labor.” We compel you not to tell the truth on what something is really worth.
Think of all the decisions we make in our life where we make the decision based upon what we believe to be the relative value. Imagine trying to decide anything—what food to buy, how to spend your time, what commodities to purchase—how would you possibly make a decision without knowing the relative value? The beauty of it—and I’ll ask Art to expand upon this—is that the choice is either value is set by the entire planet of strangers acting in their self-interest, and that produces the absolute true value of something, versus somebody in Washington who determines the value with one seven-billionth of the information. Because seven billion people acting in their self-interest will produce the exact, to the tenth of a cent, value of everything on earth—time and labor—as opposed to it being done by fiat, which is the opposite of a free market economy.
Art Carden: Water is a horrible example for this because of the way that water prices are regulated. But in light of what you just said, water is actually the perfect example for this because of how water prices are regulated. Water prices are not really set by a free market, and that gives people overwhelming incentives to use water wastefully, to not conserve it. Many people object to pricing water on moral grounds. They think that water is a human right. Maybe there’s an argument for at least a certain amount. But the value of a unit of water is the value we place on its next best use. And there’s a lot of water out there. So the next best use of a gallon of water might be a longer shower, or it might be washing my car, or it might be something else.
If we allow the market to set the price of water, then again, people like me sitting in Alabama can adjust to drought conditions in California without knowing that there’s a drought because we see our water bill going up by a little bit. For example, I’ve got a cup of cold coffee sitting in the kitchen. If the price of water were set by free markets and the water bill went up a little bit, I’d be much more likely to either drink that coffee cold or nuke it in the microwave than to dump it out and make a fresh cup of coffee. So these are the ways that people who are remote from the situation can, without necessarily knowing what they’re doing, adjust to on-the-ground conditions in, again, say California.
Something a lot of people might reply is, “Yeah, the average person isn’t going to drink a cup of cold coffee because their water bill goes up a teeny bit.” And that might be true, but the marginal person—there’s somebody out there who will save eight fluid ounces of water or a gallon of water because their water bill went up by five cents or ten cents or fifteen cents or twenty cents. And again, this is the market price telling us the truth about where water is most urgently wanted.
The Destructive Nature of Rent Control [29:00]
Bob Zadek: We come back to a word that you used early in the broadcast: the word “waste.” It’s perfect to discuss water because to most people, since no one has any idea what water is worth, it therefore is presumed to be free. Now, I leave the faucet running in the kitchen and my wife might say to me, hopefully with great affection, “You’re wasting water. Turn off the spigot.” And I have said to her, smugly armed with Economics 101 that I took in college, “No, I am not wasting water at all. It’s my water. I can do what I want with it. And if it makes me happy to make my kitchen sound like a babbling brook, that’s up to me. I cannot be wasting water because I own the water.”
I could buy food in the supermarket and throw it away. I’m not wasting food; it’s my food. I can do what I want with it, and the concept of waste doesn’t apply. But once things have a market price like water, now I get it. I am wasting money. I’m not wasting water—it’s my water—but now there is a relationship between the cost of the water and my well-being, and my behavior just changes. So without knowing the price of something, the concept of waste doesn’t get into the conversation at all. And that’s why waste is an important concept in discussing price, because price is what adjusts behavior to the truth of how much something actually costs.
Art Carden: Yeah, that’s a very good point. When we think about wasting a resource, if a price is too low—so if we hold the price of water way too low—then that gives people incentives to waste it. Or in other words, it gives people incentives to use too much of it. And by “too much,” basically we mean that the value of what we get with that additional gallon of water is lower than the value of the best alternative use of that gallon of water.
Again, thinking about the California drought, I have very weak incentives to use water wisely, prudently, extremely judiciously because the price is extremely low. And maybe I take a longer shower tonight and I use five extra gallons of water that in a free market would have been used to produce almonds or something in California. The value of the almonds is higher than the value that I get from spending an additional five gallons of water washing myself. But I don’t get that message because the price doesn’t transmit it. We don’t let the price transmit it.
Going back, Art, to your very important discussion of intentions. When government does something like rent control—now, I know all the hairs on the back of your neck are automatically straight out, Art. I know that. I apologize for causing you discomfort by raising a subject as painful as rent control. But look at the intention. The intention is to make sure that the voters can afford to live where they want to live. The intention is pure. But the problem is the cost of housing. Explain with the role of price how the cure is what causes the problem to begin with. In other words, as you hinted at earlier, how playing with the price—and rent control is a wonderful example. It’s been observed that the most efficient way to destroy a city other than by bombing it is to impose rent control. And that’ll do without the muss and without the fuss and the bother and the noise. So help us understand that dynamic, although this is by no means a housing show, but of course a housing shortage is an economic concept. So explain to us how by messing with the price, rent control is simply price control.
Art Carden: Rent control takes a housing crisis and it makes it worse. In fact, actually, rent control in a lot of ways creates housing crises. I’ve said before, I would love to live in San Francisco. The only problem is if I were to move to San Francisco, I’d probably have to pay $4,000 a month to live in your closet. The price of housing in San Francisco is simply astronomical. And that’s true, first of all, because it’s prohibitively costly to build new housing in San Francisco. And second, and paradoxically, it’s because of rules in a lot of San Francisco and a lot of places around San Francisco making it hard to charge market prices for “low-income housing.”
So if you impose a rent control on low-income housing, in the very, very short run, you might help some people. In the long run, however, people might take that housing and convert it into something else—turn it into condominiums or something. You mentioned the bombing point, and Assar Lindbeck, a Swedish economist, said exactly that: rent control is the fastest way to destroy a city short of bombing it. In part because when you have rent control, landlords have hardly any incentive to maintain their property. Why? Because if your toilet’s broken and you call and complain, rent control has created a housing shortage. There are more units of housing demanded than there are units of housing supplied. And if you don’t like living in the apartment with the busted toilet, there’s somebody else, the next person on the list, who would probably be willing to do so.
Rent control makes it relatively more attractive to build luxury housing, which is not going to have the same price regulations that “low-income housing” is likely to have. If I could make $10 million building luxury condominiums or $11 million, say, building low-income housing, I would build low-income housing. If, however, I can make $10 million building luxury condominiums but now, due to price controls, could only make $9 million building low-income housing, then I’m going to go with luxury condominiums rather than housing. This is an example of a policy that people support usually out of the purest of motives. But I think we as a society need to quit giving ourselves so much credit for merely meaning well. The fact that you’re sincere is not going to put a roof over the head of the homeless guy on the street. You actually need to build housing for that.
Profit and Loss as Social Signals [33:48]
Bob Zadek: The stories are legion in rent control communities. An older couple who are empty nesters who are living in a three-bedroom apartment, and they can’t afford to leave because it’s rent-controlled. And if they leave, they go into higher-rent housing, and therefore they stay, which means they’re using three bedrooms to store groceries—wasting the space because the market is not permitted to send a message as to what it is worth. The mere fact of rent control causes it to be wasted. So again, it sends the wrong message.
Now, in your writing, you also explained the role of profit. In much of the entertainment world, in books and movies, competition is dreaded. Instead, it should make us delighted that such competition exists. If people understood competition, they would never modify it by “cutthroat.” Or if they did, “cutthroat” would be a feature, not a bug. Because what are businesses competing for? They’re competing for the right to give us what we want at the lowest price. Doesn’t it give everybody goosebumps to think that some of the smartest minds on the planet spend their entire life figuring out how to make us happy? Art, please help me explain that if you would.
Art Carden: There are few things that are as poorly understood as profits and losses. My holy discontent in the world is to try to help people understand what profits are, what losses are, and why earning a profit is in fact honorable. I’m the author, with Deirdre McCloskey, of Leave Me Alone and I’ll Make You Rich: How the Bourgeois Deal Enriched the World.
Bob Zadek: I love that book. I love it.
Art Carden: Thank you, thank you, thank you. A lot of people think that profits happen because somebody did somebody wrong. A company earns profits because they underpay their employees or they overcharge their customers or something like that. And that’s not how profits and losses work. A profit is a residual income. You have contractual income where an enterprise has to pay labor, they have to pay rent, they have to pay interest on loans—these are contractual incomes they have to pay out. Anything that’s left over, they get to keep.
That profit is a reward for choosing wisely. It’s the world’s way of saying, “Do more of the thing that you have earned a profit doing.” If you earn a loss, on the other hand, that’s the world’s way of telling you that you’re wasting resources, that you need to do something else. So this evening, my wife is out of town, so the kids and I are getting takeout from one of our favorite Chinese restaurants here in Birmingham, and we’re going to watch a movie and it’s going to be great and wonderful and all family-ish. The restaurant that we’re going to order from is competing with every other restaurant in town—not just every other Chinese restaurant in town, but literally every other restaurant in town for the opportunity to feed us, which is unbelievable. Which I think is really fantastic. They’re competing with each other for the opportunity to feed us.
And very importantly, we are competing with everybody else in the Birmingham area for the opportunity to be fed. This doesn’t create any social chaos necessarily; rather, it creates social order and social harmony because we’re able to come together and, again, make one another better off through voluntary exchange. If the restaurant we’re ordering from is making money, if they’re earning a profit, that’s the world’s way of clapping for them. The invisible hand clapping for them, patting them on the back, saying, “Do more of that.” Profits, again, are valuable signals telling us “do more of this.” Losses are valuable signals telling us “do less of that.” And very importantly, again, profits come from entrepreneurs and managers exercising good judgment, not from exploitation.
Minimum Wage and Market Distortions [42:17]
Bob Zadek: Most importantly, price is the only information, the only truth that we must have to make any decision in life. Making a decision obviously means making a choice. You have taste buds; you might be in the mood for Chinese food or pizza. That’s dictated by preference and taste and whim. But how do you decide any other decision in life? Where to live, what to buy, what to do with your career, whether to change jobs? You have to know the alternative. And in the alternative, the economic component, it always comes down to that because that’s the common denominator. Sometimes we have to convert—well, the climate, how much is that worth? That’s a personal decision. But if price were not in the equation, you couldn’t possibly make the decision.
Price tells you what you could reasonably expect and not be cheated to sell something for or to buy something for. It’s the information you have to have to make any decision. Because if you had the potential to be a talented sports figure, but if sports figures were by fiat paid no more than an office worker, you might say, “Well, it’s easier to be an office worker,” and “I will waste my skill because it’s not worth anything anymore.” And there again is Art’s waste.
Therefore, having established as Art does that price is the truth we need to make decisions in life, now we get to understanding that if price equals truth, as Art explained, that means to the extent that government messes with the price, it is interjecting falsehood into a market, which must result in people making wrong decisions. Therefore, Art, give us—we’ve discussed rent control briefly, we’ve discussed the fact that water is subsidized and never reaches its true price. Water is astonishing. Why we are not paying the market price for water in this country is astonishing. Yet droughts are all over the place, and yet there’s a natural component, but there’s a man-made component. Because if people had to pay the true value of water, Californians would be charged more, as Art explained, they’d use less, and if it’s not fixed, at least it’s mitigated. So just so our audience can be alert to all of the areas where government, with good intentions, is messing with the price and therefore adding falsehood into the market and distorting decisions, give us some other examples if you would, so we the listeners and the consumers can be alert to these imposed falsehoods into the marketplace.
Art Carden: I’ll give you one specifically that I benefit from a lot and that probably a lot of the listeners benefit from a lot, and that is the mortgage interest tax deduction. So I got a notification from Mint earlier today saying that our tax refund had been deposited. The mortgage interest tax deduction, which allows people like me to write off of our taxes the interest we’re paying on mortgage loans, saves us enormous amounts of money in taxes, which is great, but it also distorts the price of housing. A special tax break for owning versus renting means that now owner-occupied houses are a lot more expensive than they would otherwise be, and people are living in probably bigger houses than they would if they couldn’t write off the mortgage interest and if tax rates were just lower. So for example, about a year and a half ago, we moved to a different part of Birmingham. We live in a larger house now. We’re able to do that in part because we can write off the mortgage interest. We had to pay so much for the house in part because we can write off the mortgage interest and that was capitalized into the sale price of the home. But without that distortion, we probably would have made a different choice.
Bob Zadek: We should mention also maybe the mother of all price distortions with, again, good intentions, horrible results: minimum wage laws. Classic. Good intentions gets people elected but damages the very population it’s supposed to protect.
Art Carden: First, minimum wages do not have their origins in good intentions.
Bob Zadek: It was racial in the Great Migration from the South to the North.
Art Carden: Yeah. So in the late 19th century, early 20th century, when a lot of US states are passing minimum wage laws, to our eternal discredit, the leaders of the economics profession were cheering this on. People looked and said, “If you impose these minimum wages on this market, then that’s going to reduce employment.” And some people said, “Yeah, that’s a great thing because if we reduce employment, that means those swarthy immigrants over there aren’t going to be able to work as much, so they’re not going to be able to reproduce as much. Those people with darker skin than mine aren’t going to be able to work as much, aren’t going to be able to reproduce as much. Those people with eyes that are shaped a little bit different from mine from the other side of the Pacific, they’re not going to be able to work as much, they’re not going to be able to reproduce as much.” And I paraphrase one of the terms they used: “They’re not going to debauch the gene pool.”
So this is like horribly, absurdly, awfully racist stuff. They’re saying, “Oh yeah, we want that unemployment because the people who are unemployed are genetically inferior to folks who look like me.” We see this kind of everywhere minimum wages have been imposed. I’ve been doing a lot of work on institutions and an economist named William Harold Hutt, who spent most of his career in South Africa. And the South African color bar, most of apartheid, was aimed specifically at shutting black labor out of skilled occupations to the benefit of highly unionized white labor. People are claiming that Elon Musk was a beneficiary of apartheid in some sense. And first, from what I understand, that’s not true. But second, the beneficiaries of apartheid would have been the white workers who were shielded from competition, not the mine owners necessarily. And this is ultimately to the long-run detriment of everybody.
Now, of course, everybody when they support minimum wages, they do it with good intentions. But this increases the amount of labor people are willing to supply while reducing the amount of labor that firms demand. That creates unemployment. And also, very importantly, it distorts a lot of the ways that people compete for these now artificially scarce jobs.
Bob Zadek: Take the classic example of the cashier at a fast-food restaurant, low-skilled, the classic entry-level job. That job is worth what that worker’s contribution to profits is—pretty low. Therefore, you cannot pay a worker a lot if their contribution to profits is very low. So now, if you’re required to pay for that task $15 an hour, your choice is: hire an uneducated teenager or a retired college professor who’s tired of sitting around the house and who’s erudite. Well, you’ve got to pay $15 anyway, might as well get the college professor and underpay that person rather than overpay the employee who’s only worth $6 an hour. The employee who’s only worth $6 an hour doesn’t get to sell the services even though that employee is willing to get the, air quotes, “market value” of $6. That employee says, “I’m willing to do it. It’s worth it to me to get started.” And that now is a crime. That is the mother of all examples of the government using statute books to establish by fiat rather than by market the value of services. So we end up underpaying the college professor or overpaying the teenager—a waste on either side of that.
As to prices, are we at all going in the right direction? Are there examples of societies that get it more than us? Because after all, “free markets” has the word “free” in it. We get to vote 100,000 times a day about what behavior we endorse, what’s making us happiest. Is there one example that we might look to, besides maybe Estonia, that we ought to look to in the closing seconds of our show as being an example of more economic freedom than we experience?
Art Carden: I’ll just use one specific example in the United States, and that is my home state of Alabama, where one thing we have going for us—and this is going to sound perverse to a lot of people—one thing we have going for us is we don’t have a state-level minimum wage that is higher than the federal minimum of $7.25 an hour. Ergo, if you are of relatively low skill in Alabama, it’s easier to find a job. What you mentioned earlier is an example of something that we call labor-labor substitution. At the school I teach at, most of my students are relatively affluent, and I’ll ask, “How many of you have a job?” and some hands will go up. I say, “How many of you would start looking for a job now if you could earn $15 an hour?” and a few more hands go up. And what happens is that that draws into the labor market my relatively high-productivity college students who frankly probably don’t need the money that much, and then they crowd out people with, say, poor educations or from different backgrounds or things like that. If we want to talk about rules and laws creating structural racism, the way we regulate the labor market, I would argue, is a pretty good candidate for a phrase like that.
Milton Friedman on Greed [50:17]
Bob Zadek: So we can only hope that government does not continue to spread misinformation, fake news, and falsehoods through the guise of good intentions and messing with the free market. Let all prices of all goods and services reach their natural free market level. And if it ends up that certain people can’t afford what we think they ought to have, we do that through the political process of giving them the money so they can pay what something is worth. That way, there are no victims, the market is 100% truthful, everything becomes more efficient, everything becomes cheaper. And I close by saying, Art, you were a bully. You forced me to try to compare free market Alabama with California, and so I have no defense. So in that debate, you win. Art, thank you so much.
Art Carden: That’s only one margin. We have better weather. Thank you so much for helping me explain to all of our friends out there why unfettered free market pricing is the source of all truth and why government finds an outlet for its good intentions by harming those who it presumably loves. Thank you so much, Art, for your time this weekend morning, and thank you to all of my friends out there for sharing a little bit of your time with us this morning. So long and have a good weekend.
Phil Donahue: When you see around the globe the maldistribution of wealth, the desperate plight of millions of people in underdeveloped countries, when you see so few haves and so many have-nots, when you see the greed and the concentration of power, did you ever have a moment of doubt about capitalism and whether greed’s a good idea to run on?
Milton Friedman: Well, first of all, tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course, none of us are greedy; it’s only the other fellow who’s greedy. The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty you’re talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kinds of societies that depart from that. So that the record of history is absolutely crystal clear: that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.
Phil Donahue: But it seems to reward not virtue as much as ability to manipulate the system.
Milton Friedman: And what does reward virtue? You think the communist commissar rewards virtue? You think a Hitler rewards virtue? You think—excuse me, if you’ll pardon me—do you think American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of their political clout? Is it really true that political self-interest is nobler somehow than economic self-interest? You know, I think you’re taking a lot of things for granted. And just tell me where in the world you find these angels who are going to organize society for us? Well, I don’t even trust you to do that.