Given the recent Supreme Court decision in Janus v. AFSCME, the public sector union case, I thought it worth explaining why labor unions are so important aside from the usual explanations given.
In 1956, Richard Lipsey and Kelvin Lancaster, developed the Theory of Second Best for the Walrasian model. They demonstrated in their paper that when one optimality condition cannot be satisfied, manipulating other variables away from optimum can create a second best outcome in an economic model. In other words, if one market distortion cannot be removed, then a second best equilibrium can be achieved by imposing a second market distortion. The Theory of Second Best can explain why labor unions are not distortionary, but counter distortionary to the general state of the labor market.
If you have taken an introductory economics course, you might be vaguely familiar with the argument that unions create a distortion to the economy. By unions demanding higher compensation above the equilibrium wage, the union creates a surplus of labor since labor demand at the higher wage is lower than the equilibrium wage. The problem with this argument is it assumes a perfectly competitive labor market. The reality is that in most labor markets have significant imperfections. Labor market frictions are pervasive. Regional monopolies are pervasive creating monopsony markets for certain labor skills (if you are unfamiliar with the concept of monopsony, I have written about it before here). Even while certain regions encompass enclaves of industry, differentiation between firms can produce inadequate alternatives based on individual preferences. Commuting distances and tenure benefits create disincentives to move between jobs. Imperfect information between firms and workers is also a crucial assumption of the perfectly competitive market, yet we know perfect information is not possible, nor even desirable to both parties. All of these market imperfections give firms a non-negligible influence over wages; evidenced by the fact that real wage earnings have been stagnant since the 1970s.
The natural state of the labor market is a distorted state which carries with a less than social optimal equilibrium. The market imperfections are not easily corrected or removed. Technology may reduce search frictions by increasing the probability of matches through online job search sites, but fixing geographical distances, compensating differentials, and reducing the monopolies requires structural adjustment to the economy that come at no small cost. This is why unions are so important. They were created in response to these imperfections which gave firms undue influence over wages. Unions become a countervailing force to the monopsony power of firms.
The decision in Janus of course has dealt a significant blow to financing of public sector unions. For those that don’t know—which is understandable given our crazy news cycle these days—this Supreme Court overturned 41 year old precedent set in Abood v. Detroit Board of Education (1977) which permitted unions to charge an “agency fee”. Agency fee was a compromise the court made for non-union employees who may have disapproved or did not want to contribute to the political activities of unions, but nonetheless enjoyed the compensation gains earned from union bargaining activity. Since non-union employees were only paying for bargaining activity, agency fees were less than actual union dues. The arrangement seems to have worked pretty well for over 40 years until Janus, which ruled that agency fees were unconstitutional. This puts unions, whose influence and power have already been diminished considerable over the last couple decades, between a rock and a hard place. The law of the land is that unions still have to represent all employees of a company, state, or municipal government. However, it can no longer charge the agency fee, which will create free riders, and unions will now have to divert funds into union member recruitment and retention. There is no question it’s a significant blow in the short-term, but there is an argument to be made that it could make unions stronger in time. Only time will tell. And it’s imperative that they do because unions are crucial the balance of power between monopolies and labor, and the theory of second best explains why.
Don’t overreact to the cost of producing pennies, the business of minting coins is still quite profitable
Vox Media has an interesting YouTube video floating around on Facebook about pennies (see below). If you haven’t seen it, you have probably heard a take on the theme: pennies are useless and cost the government more money to make them than they are worth ($0.0107 per penny). While this is true, one might be misled into believing that the government is somehow losing millions of dollars from the manufacturing of the currency, but it’s not when you factor in the rest of coins and bills the U.S. produces into the equation.
In monetary economics, there is a concept called “seigniorage”; which dates back to the Middle Ages from Old French seigneuriage “right of the lord (seigneur) to mint money”. Seigniorage is generally defined as the net revenue or profit, if you will, from the face value of the coinage or token minted minus the cost of production and maintenance. For example, the cost of producing a dollar bill is a couple cents (say $0.05), so the rest of the value generated by producing a dollar bill ($0.95) counts as revenue to the treasury. So even though it costs $0.0107 to make a penny, the treasury is not losing money when you factor in the combined seigniorage revenue from all the coins and bills produced into circulation; it’s still a huge positive net revenue. In 2016, in fact, the U.S. Mint reported seigniorage net income of $668.5 million before protection costs.
So while it’s true that pennies cost, and maybe they are useless, it’s not really a big deal to keep them either. By getting rid of them, it would simply increase the net revenue to the treasury. Personally, I would be fine with getting rid of them, and it would not be an issue as many countries have already done it such as Canada and Australia. But let’s not overreact to the cost of producing them when you consider how much seigniorage revenue is still gained from producing $5, $10 bills, $20 bills, etc.
I often get into debates online with generally smart people about the inefficiencies of socialism often revolving around the planned economy of the Soviet Union. I have argued elsewhere that the Soviet Union was not really socialist (so I'll avoid addressing that myth here). The most important point to get across to people is that central planning and state ownership of the means of production are not necessary conditions for a socialist economy. My own preference is a market socialist economy, one in which the majority of firms are worker-owned cooperatives or consumer cooperatives. However, although I agree that highly centralized planned economies have significant drawbacks (mainly principle-agent problems, incentive problems, and information problems), I disagree that planning is inherently less efficient than market economies (I'll explain why in a bit). The problem with the way in which people approach the debate is often from the stand point of the superior optimality and efficiency of markets. However, the problem with this approach is that the software running in the background is the neoclassical model.
This has also been generally the approach by Western economists in the comparative systems literature. The primary aim of the neoclassical approach to comparative systems has been to demonstrate the irrationality and inferiority of the planned economic system to that of the Walrasian competitive market system. The competitive market system is regarded by neoclassicals as producing the most efficient allocation of resources through the interaction of self-interested actors in voluntary exchange pursuant to the goal of profit and utility maximization. The achievement of the most efficient allocation of resources is considered “optimal”. However, the neoclassical definition of optimality is based on a fictional model of the economy, and has never been applicable to real world capitalism.
The key claim of the neoclassical model is that prices carry all the information needed for agents in a competitive market economy to make rational allocation decisions. In theory, competitive markets achieve optimal efficiency at the equilibrium between demand and supply. When equilibrium is achieved, markets are said to be in Pareto optimum, a state in which any reallocation would only make someone else worse off.
In the Walrasian model, Pareto optimality can be proven mathematically, but only under very restrictive assumptions.
The moment we relax any of these assumptions, the model falls apart. And so the Walrasian model has never been applicable to real world capitalism. The fact of the matter is in real world capitalist systems, economies of scale are widespread, there is asymmetric information between consumers and producers, and imperfect competition exists to some degree in nearly all markets. Thus the assumptions noted above are wholly unreasonable to infer any sort of dynamically stable equilibrium exists. The implications of this is that prices in market systems do not actually carry the information claimed by Friedrich Hayek (1945) and others.
In the real world, markets exhibit a fair amount of inefficient allocation resources resulting in significant rents, and overproduction of goods indicated by excess inventories (e.g. cheese glut, food waste, etc.). Underproduction in modern capitalist economies is rare, but less perceived due to the veil of price rationing which prices the poor out of the market (e.g. 12.2% of Americans are uninsured, 1 in 8 Americans experience food insecurity). The most significant indication of market inefficiency is unemployment. Some of these inefficiencies are related to government intervention, but many people put the chicken before the egg forgetting that government regulation comes about due to the preexistence of market failure. Despite the inefficiencies of the market economy, capitalist systems appear to be fairly stable (when maniac politicians are not actively attempting to dismantle them), but that stability is due to the institutional features of those systems.
A more realistic conception then of the strengths of capitalist systems is that the profit motive drives competition to keep costs and prices low in an effort to gain market share. Capitalist firms seek out what consumers want, and consumers communicate their demand through consumption. Capitalism has been able to achieve rapid technological innovation, accumulation, increasing consumption and living standards over time. And while capitalism has historically allowed a significant level of agent sovereignty in both consumption and enterprise, it has come at the cost of inegalitarian privileges and influence of a relatively small and wealthy capitalist class.
The defining characteristics of capitalism—production for profit, competition, and wage-labor—are qualitatively different from that of socialism which seeks to build an economy and society based on production for use, cooperation, meaningful labor, and human development. It makes little sense to evaluate these systems on any notion of Pareto optimality, particularly when that notion has little basis in reality. A more appropriate comparative analysis would be on the basis of performance and outcomes in accordance with the goals and values of the system in question.
Socialist systems also have qualitatively different values than capitalist systems. Capitalists systems value self-interest, competition, profit maximization, capital accumulation, protection of private property, access to wage labor, and growth. A socialist economy, on the other hand, values cooperation, meaningful labor, a non-commodity society, and human control over social evolution. To appropriately evaluate system design, an analyst should determine how well the system embodies these values. This does not mean comparative analysts have no means of comparison. Legitimate areas of comparison depend on the goals of the system. Advocates of capitalism generally defend its ability to increase average living standards overtime, stability of the system, and capacity for innovation and technological progress. Additional areas of comparison which have come to be important are income distribution, full employment, and environmental protection.
The neoclassical notions of efficiency or optimality are not a legitimate area of comparison between capitalist and socialist systems as both have forms of waste. Instead, a better question is whether a socialist economy can utilize its resources to produce what is valued at costs acceptable to society.
There are many underlying factors which contributed to both the financial crisis and the Great Recession. The trigger of crisis and recession begins with the burst of the housing bubble in mid-2007. As subprime mortgage default rates began to accelerate, overly leveraged financial institutions holding risky products such as mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) triggered a crisis of asset devaluation. Financial institutions holding both MBSs and CDOs and financial derivative products such as default swaps took a double hit inducing a liquidity crisis and immediate default risk.
According to Crotty (2008), there are two major underlying causes which led to the financial crisis. The underlying causes are as follows: The first was bad theories such as the efficient financial market theory, and, generally, New Classical Macroeconomics. Such theories made assumptions at odds with the real world. For example, efficient market theory included assumptions such as: a) investors can determine the true distribution of risk; b) liquidity is never a problem; c) markets maintain stable equilibrium; d) default is rare; e) agent borrowing is limitless at risk-free interest rates. All of these assumptions turned out to be false. The second underlying cause was the “New Financial Architecture” which primarily consisted of flawed institutions and erroneous practices related to aggressive risk taking, over leveraging, and light government regulation. These practices inevitably led to
stimulated aggressive risk taking (not perceived as risky), pushed some security prices to unsustainable levels, dramatically raised systemic leverage and thus, to use Minsky’s phrase, financial fragility (the vulnerability of the financial system to problems that appear anywhere within it), and facilitated the creation of unprecedented financial market complexity and opaqueness. They also led to a secular rise in the size of financial markets relative to the rest of the economy, and created the preconditions for a global financial crisis (Crotty, 2008).
Once the crisis was underway, a liquidity trap ensued. Despite the federal funds rate being dropped nearly to zero, credit dried up in the interbank market requiring intervention from the Federal Reserve to facilitate loans and buyouts. Credit also dried up for the non-corporate business sector, which included smaller businesses despite banks sitting on large sums of cash and reserves unwilling to risk making bad loans (Pollin, 2012).
Businesses and financial firms were not the only ones who were overleveraged, households also became debt constrained. From 2000-2006, households experienced a sharp rise in debt primarily due to new borrowing (95 percent of which was comprised of mortgage debt), but also in part due to a rise in debt servicing from real interest rate growth outpacing real income growth (Mason and Jayadev, 2012). The severe devaluation in housing prices after the burst of the housing bubble resulted in households no longer able to borrow against their homes, and instead had to start repaying their mortgage debt (if possible). Although borrowing turned negative, there was little reduction in debt ratios for households as real income growth stagnated relative real interest rate growth (Mason and Jayadev, 2012). Between 2006 and 2008, household wealth plummeted by 25 percent ($17.6 trillion decrease), which according to research by Maki and Columbo (2001), assuming a modest wealth of effect of 3 percent, would reduce household spending by approximately $525 billion (Pollin, 2012). Such a massive reduction in spending due to a loss of wealth combined with a debt constrained household sector depressed consumer demand, and prolonged both the recession and the recovery after (Mason and Jayadev, 2012; Pollin, 2012; Eggertson and Krugman, 2012).
There is also some empirical evidence suggesting the rise of income inequality since the 1970s are directly related to rising household debt. For example, Van Treeck and Sturn (2012) reference Pollin (1988) and Christen and Morgan (2005) empirical studies which identify a negative correlation between declining real median incomes and household debt and a positive correlation between increasing income inequality and household debt, respectively. The conclusion of these economists and others, essentially, is that consumers have used credit to compensate for their lack of income growth since the 1970s (see Rajan, 2010; Pollin 1988, 1990; Van Treeck and Sturn, 2012). While the trend in income inequality has persisted since the 1970s, the Great Recession has exacerbated the problem with the 1 percent receiving 93 percent of total income growth in 2010 according Saez (2012) (Pollin, 2012). And rising income inequality has only continued to get worse since then. Piketty, Saez, and Zucman (2016) report that “Income has boomed at the top: in 1980, top 1% adults earned on average 27 times more than bottom 50% adults, while they earn 81 times more today. The upsurge of top incomes was first a labor income phenomenon but has mostly been a capital income phenomenon since 2000. The government has offset only a small fraction of the increase in inequality.” While the financial sector and upper strata of income earners have recovered, the rest of the country is still struggling with anemic growth and continued stagnation in wage growth; ironically, as we debate more tax cuts for the rich.
Crotty, J. (2008). Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’. University of Massachusetts - Amherst, Economics Department Working Paper Series No. 2008-14.
Eggertson, G. B. and Krugman, P. (2012). Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach. The Quarterly Journal of Economics. 1469–1513. doi:10.1093/qje/qjs023
Mason J. W. and Jayadev, A. (2012). Fisher Dynamics in Household Debt: The Case of the United States, 1929-2011.
Piketty,T., Saez, E. and Zucman, G. (2016). Distributional National Accounts: Methods and Estimates for the United States. The National Bureau of Economic Research. NBER Working Paper No. 22945.
Pollin, R. (2012). The Great U.S. Liquidity Trap of 2009-11: Are We Stuck Pushing on Strings? Political Economy Research Institute. Working Paper Series No. 284.
Van Treeck, T. and Sturn, S. (2012). Income inequality as a cause of the Great Recession? A survey of current debates. International Labour Office - Geneva: ILO, 2012. Conditions of Work and employment Series No. 39, ISSN 2226-8944 ; 2226-8952.
While the overall trend in gun related violence has declined in the U.S. since the 1990s, it is not hyperbole to say gun violence is still a major public health epidemic. On average, 93 Americans are killed each day, 12,000 per year, and two more are injured for every one killed. While other countries have been able to muster the political will to enact major gun control legislation in the wake of a mass shooting, such as Australia in 1996 after the Port Arthur Massacre, the U.S. has been in a state of political paralysis. Not even incidents such as the Sandy Hook Massacre where 20 school children and 6 adults were gunned down have had any impact at the national level. Until the current political climate changes, significant gun control legislation is unlikely to pass anytime soon. This doesn’t mean we should give up, but rather be more creative.
Despite what your position may be on issue of abortion, you have to admit the cleverness of the Pro-life (anti-abortion) movement. While many gun rights advocates would have you believe an individual’s right to bear arms has always been enshrined in the constitution by the 2nd Amendment, the U.S. Supreme Court has only recently affirmed this right in 2008 in the case of District of Columbia v. Heller; which has made gun control legislation all the more difficult to pass locally and nationally. Anti-abortion activists have had to deal with a similar constitutional barrier since 1973, Roe v. Wade. Unable to restrict abortions directly, they develop legislation to institute waiting periods and counseling. In certain, notably Republican, states, counseling must be provided in-person, and require doctors to provide medically inaccurate information. They also go after abortion providers with unnecessary, restrictive regulations aimed at closing down clinics. While I disagree with their goal, I can’t help but admire their creativity. And I believe a similar strategy is applicable to help reduce gun circulation and violence.
Unfortunately, there is no single policy, short of abolition, that would significantly curb gun violence. The best we can hope for is marginal reduction given the right policies. The problem requires a multi-prong strategy which addresses the following: (1) Research funding. (2) Reduction in gun demand. (3) Instituting required training, waiting periods and universal background checks. Universal background checks have been attempted at the federal level, but have proven difficult to pass in this legislature despite Sandy Hook and a bi-partisan bill. The fact is any legislative attempt at the federal level is likely to fail, but more and more states are reforming gun laws on their own. While direct restrictions can be struck down by courts, states' rights to tax cannot.
The first and most important step we can take is funding research. To properly diagnose the epidemic of gun violence and evaluate appropriate policy measures, more extensive research is needed. The Center for Disease Control has not engaged in research funding on firearms and public health since 1996 when congress threatened to strip funding from the agency after it was accused of promoting gun control. This has produced a chilling effect through the social research community more broadly. While this is beginning to change as advocacy groups are pulling together resources to fund research, funding is still a major barrier to fully documenting the effects of gun violence in our society. Research grants to universities and institutions studying gun violence is the most important part of any legislative strategy. Without it, we’re unlikely to break through the circular arguments of gun rights activists. However, a clever policy may be able to fund research and reduce consumer demand for guns at the same time.
Purchasing a firearm is just like any other economic activity subject to the laws of demand and supply. There is little research on the elasticity of demand in the market for firearms, but one study by Bice and Hemley (2002) found that the demand for handguns is elastic, meaning it is sensitive to price changes. They report a 1 percent increase in the price of handguns decreases the quantity demanded by 2 to 3 percent. Furthermore, they find the supply of firearms is also elastic to price changes of production inputs. They estimate a 1 percent increase in unit costs reduces supply by 2 percent. The implication is that by increasing the price of firearms, either directly through a tax and or by increasing the cost of manufacturing will reduce the number of new firearms entering circulation.
Increasing costs on the supply side is an obstacle given that gun manufacturers are relocating to conservative states friendly to the industry. However, 15 states and the District of Columbia have adopted dealer license requirements in addition to the license requirement by the Department of Alcohol, Tabacco, and Firearms (ATF). States can increase the cost of these licenses to increase the market entry cost to gun dealers. Furthermore, past polls of Americans indicate majority support for regulations on dealers to complete inventory inspections, locking up guns to prevent theft, and camera surveillance. More granular regulation can be applied to make these precautions more expensive and cumbersome just as such regulation has been applied arbitrarily to abortion providers in conservative states.
On the demand side, there is currently an experiment underway in Seattle, Washington which introduced a sales tax on firearms and ammunition. The City Council intends to use the revenue to fund research on gun violence. Some news reports have focused on the shortfall in projected revenue (here, here, and here), but gun control advocates should focus on the fall in gun sales reported by retailers and the decrease in federal firearms retail licenses(from 40 to 35 since implementation); including the closure of the only two dedicated gun stores in the city. While these reports have suggested the policy is a failure because gun violence appears to be ticking up since the tax went into effect, such causal inferences are specious without empirical evidence. Others note Seattleans are choosing to purchase guns outside the city, but the result still demonstrates a decrease in sales for the jurisdiction the law was intended. If applied more broadly, a similar shift in demand should occur. guns purchased outside the state, assuming a registration system is in place, the retail location should be recorded on the registration as well as a interstate sale tax levied just as most states do for out of state vehicle purchases.
An additional effect of price changes is the substitution effect. When prices of goods increase, consumers look to cheaper substitutes. A 2017 survey by the Pew Research Center found most American gun owners, 67 percent, cited protection as the primary reason to own a gun. Handguns make up the majority of these purchases. While owning a handgun provides the illusion of security, research informs us otherwise. According to Kellerman et al.(1998), handguns are more likely to be involved in an unintentional shooting, criminal assault or suicide attempt than to be used to injure or kill in self-defense. Eliminating the need to own a handgun is important to reducing gun injuries and violence in households. Therefore, a cheaper substitute is needed which can provide an equal or greater sense of protection. Home security systems are designed to do just that: protect your home and its inhabitants. There are a wide range of security systems and services available to deter intruders whether you are home or not, which a gun cannot do. Furthermore, a city-wide spatial analysis of Newark, New Jersey by Lee (2008) has shown that dense concentrations of households with alarms systems is associated with reduced incidents of burglaries relative to lesser dense areas. Therefore, it is in the interest of public welfare to find ways to reduce the price for such systems providing a plausible substitute for guns for low income households.
In conclusion, any legislative efforts to curb gun violence should include higher licensing costs for gun dealers and a tax on the sale of guns. Higher costs to gun dealers will make it harder to enter the market, and more regulation will further reduce margins and cost of operations of existing dealers. Increasing sales taxes on gun purchases will inflate the price and reduce overall demand. The revenue generated should fund research and tax credits on home security systems for lower income households as much as possible. Revenue from said tax will not be enough, but it will help. Although such efforts will not be enough due in part to a pervasive gun culture in America, even the smallest marginal reduction in gun violence will save lives.
Bice, Douglas and Hemley, David (2002), The Market for New Handguns: An Empirical Investigation, The Journal of Law & Economics, Vol. 45, No. 1 (April), pp. 251–265.
Hepburn, Lisa and Hemenway, David (2004), Firearm availability and homicide: A review of the literature. Aggression and Violent Behavior: A Review Journal. 2004; 9:417–40.
Kellerman, Arthur et al. (1998), Injuries and Deaths Due to Firearms in the Home, 45 J. Trauma 263, 263, 266.
Lee, Seungmug (2008), The Impact of Home Burglar Alarm Systems on Residential Burglaries, Rutgers University.
Aaron Medlin is a PhD student at the University of Massachusetts Amherst studying macroeconomics of private debt, monetary economics, international finance, and comparative economic systems.