Friday, March 03, 2006

Voluntary Transactions in a Free Market

When we speak of market transactions as being voluntary in a free market we are saying that the use, or threatened use, of physical force is not being applied to either of the two participants in the transaction in order to make them enter into that transaction. Unfortunate or unpleasant circumstances may leave a person with little or no choice as to whether or not to enter into the transaction but this is not the same as one of the participants or his/her agents threatening force to complete the transaction.

For instance, going to the dentist to have a cavity in one of my teeth filled is not something that I look forward to having done and it is certainly not something for which I enjoy spending my money. In fact I take steps to try to prevent cavities so as not to have to enter into such transactions. When I do get a cavity I have the choice of either paying to have it treated or living with the pain and knowledge that I will eventually lose the tooth or worse. So I go to the dentist and part with my money knowing that paying for the treatment is the better of two unpleasant and unwanted choices. Even though I view my choice as being the lesser of two evils I still freely choose to pay to have the cavity filled.

This is different from the dentist deciding that, because cavities are not healthy, people must be made to have them filled. To do this the dentist forces his/her patients at gunpoint to come in and pay to have their cavities treated. Whether the dentist personally confronts the patients or has an agent do the threatening, the use, or threat, of force by the other party to the transaction means that this is no longer a voluntary decision on the part of the other party to the transaction. The same would be true if the dentist, rather than personally threatening the patients or hiring others to do the threatening got the government to make it illegal for people not to have their cavities treated and used the police to force people obtain treatment. (While it may seem like a no brainer to have one's cavities treated, a person could choose to live with the discomfort of a bad tooth if treating the tooth meant using money that was needed for something more important to them such as to purchase life saving medication for a loved one.)

The above example would be the same if it was the patient that threatened or used force against the dentist to fill a cavity at a price lower than what the dentist wanted to charge. Getting laws passed to limit what a dentist could charge to fill a cavity (and enforcing it with fines or prison if they insisted on charging a higher fee) would also be an example of force to make one party in the transaction participate unwillingly.

Circumstances are not always good and many economic decisions are made on the basis of choosing the lesser of two undesirable choices. But so long as we are free of man-made force and allowed to make the choice on the basis of the environmental obstacles alone, the choice is voluntary.

Thursday, March 02, 2006

What Will Happen when the Boomer Generation Retires?

After doing the assignment and take home test for section two of the telecourse, which dealt with the Philips Curve and Inflation, a student asked if the coming retirement of the Boomer generation (of which I am a member) would be inflationary.

The simple answer to this is yes, as the removal of such a large section of the population from the workforce would result in a noticeable reduction in the labor force and decline in production of goods and services. Further, with their income from Social Security, pensions, 401(k) plans and IRAs, this large group, who would not be producing, would still be exerting significant demand for goods and services. The same amount of money chasing a reduced amount of goods and services would be inflationary as prices rose in response to people bidding up the prices of the shrinking supply of goods and services.

Having said that, do I think that this will happen? My answer to this is no. There are four reasons why I don't think that, other things being equal, the pending retirement of the Boomer generation will be inflationary.

The first reason is the fact that, based upon both the past actions of this generation and present indications, a large number of these people will not be retiring. Many of the members of the Boomer generation do not have sufficient savings to be able to afford retirement. A number of these absolutely cannot afford to retire and others cannot afford to retire and maintain the life styles they are accustomed to living. Many others, including me, have indicated that they have no interest in stopping working. These people do not want to leave an active life of productive work and spend the rest of their days in idle leisure. Not only is the prospect of doing noting not attractive to these people, but both scientific studies and our own observations of our parents' and grandparents' as they aged have shown that people who remain active and productive tend to be healthier and live longer than those who simply stop working all together. Anyone who doubts this should take a trip down to Green Valley during the winter to visit the Green Valley Computer Club. This is a large active group of older people who volunteer as much as 40 or more hours per week running a computer training operation that rivals anything that Pima Community College offers in this area. I was invited to address this group a few years ago and was impressed by what this group, most of whom appeared to be in their late sixties or early seventies was doing. I was dumbfounded when I learned that most of the leaders who were showing me around were really in their late eighties and early nineties!

The second reason I feel that the pending retirement of the Boomer generation will not be inflationary is the global economy. While nations with advanced (in terms of economic development) economies - the U.S., Canada, Australia, Western Europe and Japan - have aging populations, the populations of the emerging economies of Asia, Latin America, the Middle East and Africa are disproportionately young.

Outsourcing, or the shifting of work from one nation to another, is already an established practice for other reasons. The gaps in the workforce caused by the retirement of large numbers of people in countries like the U.S. can be offset by shifting the work to places like Asia or Latin America who have the population to do the work. Americans have the money to purchase the goods and these countries have the workers to produce the goods.

The third reason for being confident that the possible exit of large numbers of workers from income producing work in the U.S. due to retirement will not be inflationary is immigration. Again, aging populations in the U.S. and other economically advanced nations is offset by disproportionate numbers of younger workers in the developing nations. Immigrants are not just poor peasants from Mexico or Central America coming here to take low wage jobs that require few skills. Instead, they include people at all levels. Rupert Murdoch, the owner of the Fox media empire is an immigrant. Last week's Wall Street Journal had an article about how as President Bush was finding an ally in the new Prime Minister of India, a leading critic of the President was the daughter of that same Prime Minister. However, she was not a foreign critic of the President but rather the leader of an American Civil Liberties Union (ACLU) team fighting the Bush Administration in court over their handling of prisoners in Guantanamo. Her father may be the Prime Minister of India, but she is a Yale educated lawyer, member of the American Bar, living and working in the U.S. and married to an American citizen (the article did not indicate whether she was a citizen or simply a legal resident). The fact is, the U.S. is a relatively open nation which offers great opportunity and this attracts people from all over the world. The U.S. has always been a nation with a shortage of labor and from the early days when we were still just a string of British colonies along the Atlantic coast we have relied on immigration to provide the labor need to build the country.

Finally, we have capital and technology. Capital is expensive and, other things being equal, it is less expensive to use labor rather than capital. But when labor is in short supply (as it has been throughout most of America's history) business is forced to invest in capital. Critics constantly bemoan the decline of the manufacturing sector in the U.S. But we are still a major producer of manufactured goods and our output of these goods is increasing rather than decreasing. Manufacturing is as large as ever in the U.S., it is just that: 1) other sectors are growing as well so the proportion of the economy devoted to manufacturing is declining; and, 2) due to automation, the number of jobs in manufacturing are declining. Today, production processes that used to employ dozens now employ a half a dozen or less aided by robots and other automated equipment. The exit of the Boomers, if it occurs, will be further incentive to invest more in capital and technology to make up for their loss.

Contrary to Luddite mythology, automation and advancing technology creates rather than destroys jobs. Ceteris paribus, automation enables business to continue to expand without having to increase labor proportionately. The main reason why business invests in more capital rather than labor is that the needed labor is not available. When the labor needed is already fully employed the only way for one company to expand is to bid workers away from another company – this results in an upward spiral in labor costs, which is inflationary, without a corresponding increase in output. Increased capital investment solves this problem in two ways: 1) it makes each existing worker more productive by allowing them to produce more in the same amount of time with the same or less effort; and, 2) it increases the pool of labor by enabling people who lack the physical and/or intellectual capabilities to do the job under the previous conditions to now do the job. For example, think of physical labor such as road building. If done with a pick and shovel the work is not only slow but the jobs can only be done by people who are physically strong. Bring in motorized earth moving equipment and not only can one worker now move as much dirt as a dozen or more using picks and shovels, but the person driving a piece of heavy equipment does not have to meet the same demanding physical standards, thus allowing employers a larger pool from which to hire. Early in my banking career I designed an automated system for doing the paperwork needed to process mortgage loans. Prior to the computer system this job required excellent typing skills as well as years of experience in order to know which documents to prepare for a given loan and how to prepare them. Increasing demands for home mortgage loans and increased complexity due to new government regulations put great pressure on the industry to expand but the cost of recruiting experienced labor from our competitors was prohibitive. With the system I designed it took about the same amount of time to produce a loan package. However, instead of 40 to 60 words per minute typing skills I could use people who typed at 18 to20 wpm. Instead of some post secondary education and ten years or so of experience, the new system allowed us to hire people right out of high school, train and have them producing mortgage loan packages within two weeks. We were thus able to increase our loans without driving up our wage costs.

It should be noted that most Boomers put off having children until they were in their late thirties or early forties. By deferring the start of their families for about twenty years we, in effect skipped a generation (it takes about 20 years for a new generation to reach adulthood). The so called baby bust refers to the roughly twenty year period when most of the boomer generation were not having children which resulted in the generation that immediately followed us being very small. Our own children are now reaching adulthood just as we are getting ready to retire. This generation is as large as the Boomer generation but, since it is just coming of age and beginning to enter the labor market, it has not had time to acquire the skills and experience needed to enable it to replace us in the workforce. However, technology could make up for much of the experience and skills that our children lack thereby enabling them to replace, to some extent, the retiring Boomers.

All of the above factors will come into play as individuals and individual businesses adjust to changing conditions. I am confident that, if left to itself, the market will adjust and the transition will be relatively smooth. The chattering classes, of course, will be devoting ever increasing amounts of time to worrying about this perceived problem over the coming years. However, anyone who feels the temptation to succumb to their doom and gloom predictions, should go to their local library or the internet and search out magazine and newspaper articles from the 1930s dealing with the perceived demographic crises of those years. Due to the Depression and other factors, the birthrate had dropped noticeably giving rise to fears that there would be too few people in coming years to do the work necessary to keep society going. That generation went on to push the economy to new highs and, at the same time, produce the Boomer generation.

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