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Intellectuals and Economics
Thomas Sowell has just written his third book in a year, Intellectuals and Society, and America's foremost economist and contemporary philosopher has again given IBD permission to publish excerpts.

The new book is a study of what intellectuals do, why they do it the way they do and — most important —their effects on society. ...

...Despite the verbal virtuosity involved in creating a vivid vision of profits as having been clawed out of the guts of society, neither Steinbeck nor most other intellectuals have bothered to demonstrate how society has been made poorer by the activities of Carnegie, Ford or Rockefeller, for example — all three of whom (and many others) made fortunes by reducing the prices of their products below the prices of competing products.

Lower prices made these products affordable to more people, simultaneously increasing those people's standard of living and creating fortunes for sellers who greatly expanded the numbers of their customers. In short, this was a process in which wealth was created, not a process by which some could get rich only by making others poorer.

Nevertheless, negative images of market processes have been evoked with such phrases as "robber barons" and "economic royalists" — without answering such obvious questions as "Just who did the robber barons rob when they lowered their prices?" or "How is earning money, often starting from modest circumstances (or even poverty-stricken circumstances in the case of J.C. Penney and F.W. Woolworth) the same as simply inheriting wealth and power like royalty?"...

...Implicit in many criticisms of market processes by intellectuals is the assumption that these are zero-sum processes, in which what is gained by some is lost by others. Seldom is this assumption spelled out but, without it, much of what is spelled out would have no basis...

...In terms of statistical categories, it is indeed true that both the amount of income and the proportion of all income received by those in the top 20% bracket have risen over the years, widening the gap between the top and bottom quintiles.

But Internal Revenue Service data following specific individuals over time show that, in terms of people, the incomes of those particular taxpayers who were in the bottom 20% in income in 1996 rose 91% by 2005, while the incomes of those particular taxpayers who were in the top 20% in 1996 rose by only 10% by 2005 — and those in the top 5% and top 1% actually declined.

While it might seem as if both these radically different sets of statistics cannot be true at the same time, what makes them mutually compatible is that flesh-and-blood human beings move from one statistical category to another over time.

...More than three-quarters of those working Americans whose incomes were in the bottom 20% in 1975 were also in the top 40% of income earners at some point by 1991.

Only 5% of those who were initially in the bottom quintile were still there in 1991, while 29% of those who were initially at the bottom quintile had risen to the top quintile. Yet verbal virtuosity has transformed a transient cohort in a given statistical category into an enduring class called "the poor."...

...According to the Internal Revenue Service: "Among those with the very highest income in 1996 — the top 1/100 of 1% — only 25% remained in this group in 2005." If these were genuinely super-rich people, it is hard to explain why three-quarters of them would no longer be in that category a decade later....

...Meanwhile, real per capita income rose by 122% over that same span, from 1967 to 2005. When a more than doubling of income is called "stagnation," that is one of the many feats of verbal virtuosity.

The reason for the large discrepancy between growth rate trends in household income and growth rate trends in individual income is very straightforward: The number of persons per household has been declining over the years.

As of 1966, for example, the U.S. Bureau of the Census reported that the number of households was increasing faster than the number of people and concluded:

"The main reason for the more rapid rate of household formation is the increased tendency, particularly among unrelated individuals, to maintain their own homes or apartments rather than live with relatives or move into existing households as roomers, lodgers, and so forth." Increasing individual incomes made this possible.

Despite such obvious and mundane facts, household or family income statistics continue to be widely cited in the media and in academia — and per capita income statistics widely ignored, despite the fact that households are variable in size, while per capita income always refers to the income of one person. However, the statistics that the intelligentsia keep citing are much more consistent with their vision of America than the statistics they keep ignoring....

...Just as household statistics understate the rise in the American standard of living over time, they overstate the degree of income inequality, since lower-income households tend to have fewer people than upper-income households. While there are 39 million people in households whose incomes are in the bottom 20%, there are 64 million people in households whose incomes are in the top 20%....

...As of 2001, three-quarters of Americans with incomes below the official poverty level had air-conditioning (which only one-third of Americans had in 1971), 97% had color television (which fewer than half of Americans had in 1971), 73% owned a microwave oven (which fewer than 1% of Americans had in 1971) and 98% of "the poor" had either a videocassette recorder or a DVD player (which no one had in 1971). In addition, 72% of "the poor" owned a motor vehicle....

...In the real world, the situation is quite different. In a market economy, most people receive income as a result of what they produce, supplying other people with some goods or services that those people want, even if that service is only labor. Each recipient of these goods and services pays according to the value which that particular recipient puts on what is received, choosing among alternative suppliers to find the best combination of price and quality — both as judged by the individual who is paying.

This mundane, utilitarian process is quite different from the vision of "income distribution" projected by those among the intelligentsia who invest that vision with moral angst. If there really were some pre-existing body of income or wealth, produced somehow — manna from heaven, as it were — then there would of course be a moral question as to how large a share each member of society should receive....

...Among the underlying realities in many low-income neighborhoods are higher rates of crime, vandalism and violence, as well as a lack of the economic prerequisites for the economies of scale which enable big chain stores to charge lower prices and make profits on higher rates of inventory turnover in more affluent neighborhoods.

But such mundane considerations do not present intellectuals with either an opportunity to display their special kind of knowledge or an opportunity to display their presumptions of superior virtue by condemning others.

If stores in low-income neighborhoods were in fact making higher rates of profit on their investments, it would be hard to explain why national store chains and many other businesses avoid locating in such places, which are often painfully lacking in many businesses that are common in more affluent neighborhoods....

...The economic consequences of government intervention to limit the annual interest rate can be seen in a number of states where such limits have been imposed. After Oregon imposed a limit of 36% annual interest, three-quarters of its "payday loan" businesses closed down.

Nor is it hard to see why — if one bothers to look at facts. At a 36% limit on the annual interest rate, the $15 in interest charged for every $100 lent would be reduced to less than $1.50 for a loan payable in two weeks — an amount not likely to cover even the cost of processing the loan, much less the risks of making the loan....

...If, at a given time, three-quarters of the consumers prefer to buy the Acme brand of widgets to any other brand, then Acme Inc. will be said to "control" three-quarters of the market, even though consumers control 100% of the market, since they can switch to another brand of widgets tomorrow if someone else comes up with a better widget, or stop buying widgets altogether if a new product comes along that makes widgets obsolete....

...By saying that businesses have "power" because they have "control" of their markets, this verbal virtuosity opens the way to saying that government needs to exercise its "countervailing power" (John Kenneth Galbraith's phrase) in order to protect the public.

Despite the verbal parallels, government power is in fact power, since individuals do not have a free choice as to whether to obey government laws and regulations, while consumers are free to ignore the products marketed by even the biggest and supposedly most "powerful" corporations in the world. There are people who have never set foot in a Wal-Mart store and there is nothing that Wal-Mart can do about it, despite being the world's largest retailer....

...Far from leading to higher prices, this was an era of falling prices charged by these larger businesses, whose size created economies of scale, which meant lower production costs that let them profit from lower prices, thereby expanding their sales.

Crude oil, which sold for $12 to $16 a barrel in 1860, sold for less than $1 a barrel in every year from 1879 to 1900. Railroad freight costs fell by 54% between 1873 and 1887. The price of steel rails fell from $68 in 1880 to $32 in 1890. The prices of sugar, lead and zinc all fell during this period.

Henry Ford pioneered in mass production methods and had some of the highest paid workers of his day — decades before the industry was unionized — and the lowest priced cars, notably the legendary Model T, which made the car no longer a luxury confined to the wealthy.

But none of these plain facts prevailed against the vision of the Progressive era intelligentsia, who in this case included President Theodore Roosevelt. His administration launched antitrust prosecutions against some of the biggest price cutters, including Standard Oil and the Great Northern Railroad.

Roosevelt sought the power, in his words, to "control and regulate all big combinations." He declared that "of all forms of tyranny the least attractive and the most vulgar is the tyranny of mere wealth, the tyranny of a plutocracy."

No doubt it was true, as TR said, that Standard Oil created "enormous fortunes" for its owners "at the expense of business rivals," but it is questionable whether consumers who paid lower prices for oil felt that they were victims of a tyranny....

...While unemployment went up in the wake of the stock market crash, it never went as high as 10% for any month during the 12 months following that crash in October 1929. But the unemployment rate in the wake of subsequent government interventions in the economy never fell below 20% for any month over a period of 35 consecutive months.

In short, though the stock market crash has been conceived of as the "problem" and government intervention as the "solution," in reality the unemployment rate following the economic problem was less than half of the unemployment rate following the political solution....

...In the wake of these tariffs, unemployment rose far more dramatically than in the wake of the stock market crash. The unemployment rate stood at 6.3% in June 1930 — eight months after the stock market crash — when the Smoot-Hawley tariffs were passed. A year later, the unemployment rate was 15% — and a year after that it was 25.8%.

All of this unemployment need not be attributed to the tariffs, but the point is that the tariffs were supposed to reduce unemployment. The unemployment rate was already trending generally downward for several months when the Smoot-Hawley bill was passed, a trend that reversed itself just five months after the new tariffs went into effect....