Basic Economics

by Thomas Sowell

  EXPLOITATION

  Usually those who decry “exploitation” make no serious attempt to define it, so the word is often used simply to condemn either prices that are higher than the observer would like to see or wages lower than the observer would like to see. There would be no basis for objecting to this word if it were understood by all that it is simply a statement about someone’s internal emotional reactions, rather than being presented as a statement about some fact in the external world. We have seen in Chapter 4 how higher prices charged by stores in low-income neighborhoods have been called “exploitation” when in fact there are many economic factors which account for these higher prices, often charged by local stores that are struggling to survive, rather than stores making unusually high profits. Similarly, we have seen in Chapter 10 some of the factors behind low pay for Third World workers whom many regard as being “exploited” because they are not paid what workers in more prosperous countries are paid.

  The general idea behind “exploitation” theories is that some people are somehow able to receive more than enough money to compensate for their contributions to the production and distribution of output, by either charging more than is necessary to consumers or paying less than is necessary to employees. In some circumstances, this is in fact possible. But we need to examine those circumstances—and to see when such circumstances exist or do not exist in the real world.

  As we have seen in earlier chapters, earning a rate of return on investment that is greater than what is required to compensate people for their risks and contributions to output is virtually guaranteed to attract other people who wish to share in this bounty by either investing in existing firms or setting up their own new firms. This in turn virtually guarantees that the above-average rate of return will be driven back down by the increased competition caused by expanded investment and production whether by existing firms or by new firms. Only where there is some way to prevent this new competition can the above-average earnings on investment persist.

  Governments are among the most common and most effective barriers to the entry of new competition. During the Second World War, the British colonial government in West Africa imposed a wide range of wartime controls over production and trade, as also happened within Britain itself. This was the result, as reported by an economist on the scene in West Africa:

  During the period of trade controls profits were much larger than were necessary to secure the services of the traders. Over this period of great prosperity the effective bar to the entry of new firms reserved the very large profits for those already in the trade.{423}

  This was not peculiar to Africa or to the British colonial government there. The Civil Aeronautics Board and the Interstate Commerce Commission in the United States have been among the many government agencies, at both the national and local levels, which have restricted the number of firms or individuals allowed to enter various occupations and industries. In fact, governments around the world have at various times and places restricted how many people, and which people, would be allowed to engage in particular occupations or to establish firms in particular industries. This was even more common in past centuries, when kings often conferred monopoly rights on particular individuals or enterprises to engage in the production of salt or wine or many other commodities, sometimes as a matter of generosity to royal favorites and often because the right to a monopoly was purchased for cash.

  The purpose or the net effect of barriers to entry has been a persistence of a level of earnings higher than that which would exist under free market competition and higher than necessary to attract the resources required. This could legitimately be considered “exploitation” of the consumers, since it is a payment over and beyond what is necessary to cause people to supply the product or service in question. However, higher earnings than would exist under free market competition do not always or necessarily mean that these earnings are higher than earnings in competitive industries. Sometimes inefficient firms are able to survive under government protection when such firms would not survive in the competition of a free market. Therefore even modest rates of return received by such inefficient firms still represent consumers being forced to pay more money than necessary in a free market, where more efficient firms would produce a larger share of the industry’s output, while driving the less efficient firms out of business by offering lower prices.

  While such situations could legitimately be called exploitation—defined as prices higher than necessary to supply the goods or services in question—these are not usually the kinds of situations which provoke that label. It would also be legitimate to describe as exploitation a situation where people are paid less for their work than they would receive in a free market or less than the amount necessary to attract a continuing supply of people with their levels of skills, experience, and talents. However, such situations are far more likely to involve people with high skills and high incomes than people with low skills and low incomes.

  Where exploitation is defined as the difference between the wealth that an individual creates and the amount that individual is paid, then Babe Ruth may well have been the most exploited individual of all time. Not only was Yankee Stadium “the house that Ruth built,” the whole Yankee dynasty was built on the exploits of Babe Ruth. Before he joined the team, the New York Yankees had never won a pennant, much less a World Series, and they had no ballpark of their own, playing their games in the New York Giants’ ballpark when the Giants were on the road. Ruth’s exploits drew huge crowds, and the huge gate receipts provided the financial foundation on which the Yankees built teams that dominated baseball for decades.

  Ruth’s top salary of $80,000 a year—even at 1932 prices—did not begin to cover the financial difference that he made to the team. But the exclusive, career-long contracts of that era meant that the Yankees did not have to bid for Babe Ruth’s services against the other teams who would have paid handsomely to have him in their lineups. Here, as elsewhere, the prevention of competition is essential to exploitation. It is also worth noting that, while the Yankees could exploit Babe Ruth, they could not exploit the unskilled workers who swept the floors in Yankee Stadium, because these workers could have gotten jobs sweeping floors in innumerable offices, factories or homes, so there was no way for them to be paid less than comparable workers received elsewhere.

  In some situations, people in a given occupation may be paid less currently than the rate of pay necessary to continue to attract a sufficient supply of qualified people to that occupation. Doctors, for example, have already invested huge sums of money in getting an education in expensive medical schools, in addition to an investment in the form of foregone earnings during several years of college and medical school, followed by low pay as interns before finally becoming fully qualified to conduct their own independent medical practice. Under a government-run medical system the government can at any given time set medical salary scales, or pay scales for particular medical treatments, which are not sufficient to continue to attract as many people of the same qualifications into the medical profession in the future.

  In the meantime, however, existing doctors have little choice but to accept what the government authorizes, if the government either pays all medical bills or hires all doctors. Seldom will there be alternative professions which existing doctors can enter to earn better pay, because becoming a lawyer or an engineer would require yet another costly investment in education and training. Therefore most doctors seldom have realistic alternatives available and are unlikely to become truck drivers or carpenters, just because they would not have gone into the medical profession if they had known in advance what the actual level of compensation would turn out to be.

  Low-paid workers can also be exploited in circumstances where they are unable to move, or where the cost of moving would be high, whether because of transportation costs or because they live in government-subsidized housing that they would lose if they moved somewhere else, where they would have to pay market
prices for a home or an apartment, at least while being on waiting lists for government-subsidized housing at their new location. In centuries past, slaves could of course be exploited because they were held by force. Indentured servants or contract laborers, especially those working overseas, likewise had high costs of moving, and so could be exploited in the short run. However, many very low-paid contract workers chose to sign up for another period of work at jobs whose pay and working conditions they already knew about from personal experience, clearly indicating that—however low their pay and however bad their working conditions—these were sufficient to attract them into this occupation. Here the explanation was less likely to be exploitation than a lack of better alternatives or the skills to qualify for better alternatives.

  Where there is only one employer for a particular kind of labor, then of course that employer can set pay scales which are lower than what is required to attract new people into that occupation. But this is more likely to happen to highly specialized and skilled people, such as astronauts, rather than to unskilled workers, since unskilled workers are employed by a wide variety of businesses, government agencies, and even private individuals. In the era before modern transportation was widespread, local labor markets might be isolated and a given employer might be the only employer available for many local people in particular occupations. But the spread of low-cost transportation has made such situations much rarer than in the past.

  Once we see that barriers to entry or exit—the latter absolute in the case of slaves or expensive in the case of exit for doctors or for people living in local subsidized housing, for example—are key, then the term exploitation often legitimately applies to people very different from those to whom this term is usually applied. It would also apply to businesses which have invested large amounts of fixed and hard to remove capital at a particular location. A company that builds a hydroelectric dam, for example, cannot move that dam elsewhere if the local government doubles or triples its tax rates or requires the company to pay much higher wage rates to its workers than similar workers receive elsewhere in a free market. In the long run, however, fewer businesses tend to invest in places where the political climate produces such results—the exit of many businesses from California being a striking example—but those who have already invested in such places have little recourse but to accept a lower rate of return there.

  Whether the term “exploitation” applies or does not apply to a particular situation is not simply a matter of semantics. Different consequences follow when policies are based on a belief that is false instead of beliefs that are true. Imposing price controls to prevent consumers from being “exploited” or minimum wage laws to prevent workers from being “exploited” can make matters worse for consumers or workers if in fact neither is being exploited, as already shown in Chapters 3 and 11. Where a given employer, or a small set of employers operating in collusion, constitute a local cartel in hiring certain kinds of workers, then that cartel can pay lower salaries, and in these circumstances a government-imposed increase in salary may—within limits—not result in workers losing their jobs, as would tend to happen with an imposed minimum wage in what would otherwise be a competitive market. But such situations are very rare and such employer cartels are hard to maintain, as indicated by the collapsing employer cartels in the postbellum South and in nineteenth-century California.

  The tendency to regard low-paid workers as exploited is understandable as a desire to seek a remedy in moral or political crusades to right a wrong. But, as noted economist Henry Hazlitt said, years ago:

  The real problem of poverty is not a problem of “distribution” but of production. The poor are poor not because something is being withheld from them but because, for whatever reason, they are not producing enough.{424}

  This does not make poverty any less of a problem but it makes a solution more difficult, less certain and more time-consuming, as well as requiring the cooperation of those in poverty, in addition to others who may wish to help them, but who cannot solve the problem without such cooperation. The poor themselves may not be to blame because their poverty may be due to many factors beyond their control—including the past, which is beyond anyone’s control today. Some of those circumstances will be dealt with in Chapter 23.

  Job Security

  Virtually every modern industrial nation has faced issues of job security, whether they have faced these issues realistically or unrealistically, successfully or unsuccessfully. In some countries—France, Germany, India, and South Africa, for example—job security laws make it difficult and costly for a private employer to fire anyone. Labor unions try to have job security policies in many industries and in many countries around the world. Teachers’ unions in the United States are so successful at this that it can easily cost a school district tens of thousands of dollars—or more than a hundred thousand in some places—to fire just one teacher, even if that teacher is grossly incompetent.

  The obvious purpose of job security laws is to reduce unemployment but that is very different from saying that this is the actual effect of such laws. Countries with strong job security laws typically do not have lower unemployment rates, but instead have higher unemployment rates, than countries without widespread job protection laws. In France, which has some of Europe’s strongest job security laws, double-digit unemployment rates are not uncommon. But in the United States, Americans become alarmed when the unemployment rate approaches such a level. In South Africa, the government itself has admitted that its rigid job protection laws have had “unintended consequences,” among them an unemployment rate that has remained around 25 percent for years, peaking at 31 percent in 2002. As the British magazine The Economist put it: “Firing is such a costly headache that many prefer not to hire in the first place.”{425} This consequence is by no means unique to South Africa.

  The very thing that makes a modern industrial society so efficient and so effective in raising living standards—the constant quest for newer and better ways of getting work done and more goods produced—makes it impossible to keep on having the same workers doing the same jobs in the same way. For example, back at the beginning of the twentieth century, the United States had about 10 million farmers and farm laborers to feed a population of 76 million people. By the end of the twentieth century, there were fewer than one-fifth this many farmers and farm laborers, feeding a population more than three times as large. Yet, far from having less food, Americans’ biggest problems now included obesity and trying to find export markets for their surplus agricultural produce. All this was made possible because farming became a radically different enterprise, using machinery, chemicals and methods unheard of when the century began—and requiring the labor of far fewer people.

  There were no job security laws to keep workers in agriculture, where they were now superfluous, so they went by the millions into industry, where they added greatly to the national output. Farming is of course not the only sector of the economy to be revolutionized during the twentieth century. Whole new industries sprang up, such as aviation and computers, and even old industries like retailing have seen radical changes in which companies and which business methods have survived. More than 17 million workers in the United States lost their jobs between 1990 and 1995.{426} But there were never 17 million Americans unemployed at any given time during that period, nor anything close to that. In fact, the unemployment rate in the United States fell to its lowest point in years during the 1990s. Americans were moving from one job to another, rather than relying on job security in one place. The average American has nine jobs between the ages of 18 and 34.{427}

  In Europe, where job security laws and practices are much stronger than in the United States, jobs have in fact been harder to come by. During the decade of the 1990s, the United States created jobs at triple the rate of industrial nations in Europe.{428} In the private sector, Europe actually lost jobs, and only its increased government employment led to any net gain at all. This should not be surprising.
Job security laws make it more expensive to hire workers—and, like anything else that is made more expensive, labor is less in demand at a higher price than at a lower price. Job security policies save the jobs of existing workers, but at the cost of reducing the flexibility and efficiency of the economy as a whole, thereby inhibiting production of the wealth needed for the creation of new jobs for other workers.

  Because job security laws make it risky for private enterprises to hire new workers, during periods of rising demand for their products existing employees may be worked overtime instead, or capital may be substituted for labor, such as using huge buses instead of hiring more drivers for more regular-sized buses. However it is done, increased substitution of capital for labor leaves other workers unemployed. For the working population as a whole, there may be no net increase in job security but instead a concentration of the insecurity on those who happen to be on the outside looking in, especially younger workers entering the labor force or women seeking to re-enter the labor force after taking time out to raise children.

  The connection between job security laws and unemployment has been understood by some officials but apparently not by much of the public, including the educated public. When France tried to deal with its high youth unemployment rate of 23 percent by easing its stringent job security laws for people on their first job, students at the Sorbonne and other French universities rioted in Paris and other cities across the country in 2006.{429}

  OCCUPATIONAL LICENSING

  Job security laws and minimum wage laws are just some of the ways in which government intervention in labor markets makes those markets differ from what they would be under free competition. Among the other ways that government intervention changes labor markets are laws requiring a government-issued license to engage in some occupations. One cannot be a physician or an attorney without a license, for the obvious reason that people without the requisite training and skill would be perpetrating a dangerous fraud if they sought to practice in these professions. However, once the government has a rationale for exercising a particular power, that power can be extended to other circumstances far removed from that rationale. That has long been the history of occupational licensing.