[Music] this is the memo by Howard marks shall we repeal the laws of [Music] Economics for months I've been saving up clippings for a memo on the above topic but favorite subjects such as risk debt and uncertainty repeatedly jumped the queue delaying my intended memo until the US election season got into full swing making it compelling like me you've undoubtedly noticed that politicians ranging from former president Trump and vice president Harris to down ballot candidates are back to making promises that ignore economic reality Trump's call for tariffs and Harris's attack on grocery profiteering are merely two examples of proposals that would impose costs the candidate ignores in Trump's case or that fail to reflect a meaningful understanding of the problem in Harris's case my purpose of course is not to promote or dismiss either candidate but rather to illustrate that there is no free lunch in economics despite candidates assertions to the contrary the background in 2016 with an unusually clamorous presidential election in full swing I published two memos that strayed from investing into the World At Large called economic reality and political reality the first explain that economics is largely the study of how we make choices how people allocate finite resources among the available options the second stated that in politics and especially in the land of campaign promises there's no such thing as finiteness as I wrote in political reality I've always gotten a kick out of oxymorons phrases that are internally contradictory such as jumbo shrimp and Common Sense I'll add political reality to the list the world of politics has its own altered reality in which economic reality often seems not to impinge no choices need be made candidates can promise it all and there are no consequences if something might have negative consequences in the real world politicians seem to feel free to ignore them I followed those two memos with one in 2019 entitled political reality meets economic reality its main thrust was that politicians can promise whatever they want regarding the economy but they won't be able to deliver if their promises fly in the face of economic reality because ultimately the laws of Economics are incontrovertible free economies are driven by self-interested decisions made by millions of producers and consumers employers and employ employees and Savers and investors governments can pass laws designed to encourage or even compel Behavior but in general they can't mandate economic outcomes there are so many moving pieces and secondorder consequences that governments generally can't engineer both prosperity and the specific economic outcomes that policy makers May seek history is littered with command economies that didn't succeed there's proof for this that includes the control group required by the scientific method 80 years ago Korea was a single country then following World War II it was split in two obviously with similar people geography and resources South Korea under US influence and North Korea under Soviet influence since then South Korea has operated as a capitalist democracy and North Korea as a Communist dictatorship there's little Rel iable economic data regarding North Korea but according to the cia's world book its GDP and purchasing power terms is estimated at $2,000 per person versus $50,000 in South Korea North Korea's citizens are described as impoverished but at least it doesn't have a border problem since nobody's trying to sneak in there are political differences democracy versus dictatorship in addition to the economic ones but I think it's fair to say capitalism has won in discussions of economic systems I usually ask people what they think has been responsible for the economic preeminence the US has enjoyed since the end of World War I and thus for its citizens higher average standard of living are Americans smarter harder working more deserving none of the above I'm confident it's because of our historical Embrace of the free market system and capitalism the incentives provided by free markets efficiently direct capital and other resources where they'll be most productive they prompt producers to make the goods people want most and workers to take the jobs where they'll be most productive in terms of the value of their output and they encourage hard work and risk-taking the result is a higher standard of living for society in general but certainly not everyone benefits to the same degree thanks to the way incentives interact with people's different abilities some people do considerably better than others some also Prosper thanks to Good Luck Andor inherited Advantage rather than innate ability the free market system doesn't necessarily produce Fair outcomes in all circumstances but economic systems designed to do so generally don't provide the incentives needed to encourage economic productivity for the collective good that's what accounts for their record of failure on August 15th the media reported that the next day vice president Harris would announce her economic policies the bulk of the attention went to her promise to ban price gouging in the grocery industry grocery prices have jumped 26% since 2019 according to Elizabeth pancotti director of special initiatives at the Roosevelt Institute a left leaning tank The Washington Post August 15th and many voters say inflation is their greatest concern for this combination of reasons Harris's targeting of grocery prices is entirely predictable ironically August 15th was also the day US inflation was reported to have fallen below 3% for the first time since March 2021 I'm certain however that this falls under the heading of simplistic economic Solutions better designed to appeal to voters but are un soundly based and likely to fail what is price gouging price gouging is generally defined as sellers taking advantage of Market power or temporary Supply demand imbalances to raise prices to levels that otherwise wouldn't Prevail and food prices did rise significantly in 2021 and 2022 leading to suspicion of food retailers but might there be reasons for the price increases other than a malevolent decision to gouge on the part of sellers here are a few possibilities when the pandemic began in March 2020 most people stayed home and cooked their own meals significantly increasing the demand for groceries and depleting inventories the production system was disrupted with inputs in short supply or in the wrong places relative to the needs this led to the much discussed supply chain problems too few goods when coupled with too much money chasing them constitute the classic reason for inflation the federal government sent taxpayers massive amounts of covid-19 relief many more people received benefits than had been hurt financially by the Pandemic those people came out ahead capturing trillions of dollars for future spending when the Delta variant of covid popped up in mid 2021 people again stayed home and shrunk from contact with others spending more on goods and less on Services than they otherwise might have demand for goods was strong as a result outstripping The Limited supplies and causing prices to rise profit margins in the supermarket industry are low about 1 to 2% of sales and that changed only a little in 2021 to 22 so was there gouging and if gou ing is the explanation for the price increases why did it occur in those years rather than sooner again might today's high prices be explained by something other than gouging the New York Times rarely a defender of capitalism wrote The Following on August 15th researchers from the Federal Reserve Bank of Kansas City reported last year that rapid job growth in the US economy and the wage increases that came with it were major contributors to Rising groceries prices a number of factors contributed to the increase in food prices many of them linked to the macroeconomy but the bottom line is that conditions allowed food sellers to raise prices and they did so is Raising prices wrong that is the key question definitions of price gouging invariably include words like unfair excessive and exorbitant these are sub objective terms that are open to judgment and debate the propriety of behavior with regard to these words is usually in the eye of the beholder the seller's highly reasonable price increase is the customer's gouging the difficulty of defining gouging reminds me of those who say we're not out to soak the rich we just want to make them pay their fair share in taxes I'm far from saying the rich shouldn't pay their fair share but what's what's the standard for a fair share and who gets to set it in the same way who determines whether prices are fair and how when a supermarket raises the price of a necessity like bread is that gouging the answer is that it's complicated and that's what makes it hard to regulate prices fairly if the farmer pays more for fertilizer and labor and then charges the baker more for wheat can the baker fairly pass that on to the supermarket in the form of a higher price for bread if the baker raises the price he charges the supermarket for bread is it wrong for the supermarket to pass on the increase to the consumer if the supermarket's employees demand higher pay can it offset the increase by raising the prices of the things it sells if demand increases because a hit TV show popularizes sandwiches is it wrong for people in the supply chain to take advantage and charge more for bread in a free market prices are determined by supply and demand is it wrong per se for providers of goods and services to raise prices in response to reduced Supply or increased demand a few examples should make clear the complex nature of this question Uber applies surge pricing during rush hour when more people want rides is that an unfair practice if the government says Uber mustn't do so that will make rides available at prices below what some people would pay and deprive drivers of the full Fair they could otherwise collect and the rate the drivers would then receive might not be high enough to justify the time they'd spend stuck in traffic meaning fewer drivers would be available to handle the peak demand and people needing rides would remain unserved is that preferable if 1,000 tickets for a Taylor Swift concert are put on sale at $100 and 3,000 people line up to buy them what's the message simple they're too cheap would it be unfair for the concert promoter to raise the price until there are just 1,000 people in line few people would say so but if instead the price remains at $100 and the first 1,000 people buy them all that leaves unmet demand in which case those who bought the tickets would be able to resell the them for more than $100 the profit would go to the resellers who got their tickets at a price that was too low is that fair wouldn't it be fairer if the ticket prices were raised and the increment went to Tay Tay reflecting the full value her fans put on her labor in 2021 when people wanted to leave their City apartments and homes and building materials were in short supply home prices shot upward if you owned a home worth 400 ,000 in 2019 and asked $500,000 for it in the post-pandemic environment was your behavior immoral should the government prosecute people who asked more for their homes lastly when the economy sprung back to life in 2021 and there were multiple job openings per unemployed worker making higher salaries attainable workers were able to tell the boss I can get a higher salary down the road if you don't give me a raise I'm leaving should the government limit wage increases at a time when employees have an edge in negotiations in the fall of 2023 the United Auto Workers Union took advantage of the bargaining power caused by the tight labor conditions to extract from Ford an 11% wage increase in the first year and total 25% increase in wages over the 4.5-year contract a $5,000 ification bonus and a cost of living adjustment Wikipedia this was a huge package did it represent couching each of these examples shows one party taking advantage of Supply demand conditions to charge more for the thing they have to offer but certainly their actions aren't illegitimate they're simply examples of how markets work the alternative would be to have the government decide who should Prevail in each case should it be the Uber driver or the passenger the concert goer or the performer the home owner or the home buyer the worker or the employer many have a knee-jerk tendency to sympathize with the passenger concert goer home buyer and worker as it's easy to care less about the person who's profiting the driver pop star homeowner and employer but if the government puts its thumb on the scale in favor of one party or the other it distorts the workings of the free market and keeps it from functioning efficiently on behalf of society overall more on this later there are forms of seller behavior that are clearly wrong these include collusion price fixing and predatory pricing designed to drive competitors out of the market but laws prohibiting these behaviors are already on the books additional laws designed to prohibit and punish price increases that someone views as unfair excessive or exorbitant as opposed to being the result of improper conduct are sure to prove difficult to enforce and counterproductive would a law against price gouging work just as history is full of failed command economies it also shows the ineffectiveness of attempts to regulate prices in 197 4 when the OPEC oil embargo set off inflation that made life difficult for Millions the US government countered by Distributing win buttons standing for whip inflation now I still have mine but neither it nor the voluntary consumer actions that were supposed to follow were enough to keep inflation from reaching 13.5% in 1980 the buttons were derided with some Skeptics wearing them upside down according to wikip media warn that way Nim stood for no immediate Miracles nonstop inflation merry go around or need immediate money there's more recent experience with price controls in Venezuela here's what I said about it in economic reality a case in point is the price controls which have expanded to apply to more and more Goods food and vital medicines yes but also car batteries Essential Medical Services deodorant diapers and of course toilet paper the ostensible goal was to check inflation and keep Goods affordable for the poor but anyone with a basic grasp of Economics could have foreseen the consequences when prices are set below production costs sellers can't afford to keep the shelves stocked official prices are low but it's a mirage the products have disappeared Atlantic Monthly May 12th 2016 here's a shocker you can set prices for goods but you can't make people produce them that sounds a lot like economic reality this is an example of the fact that officials May believe they can control economic developments with a stroke of the pen but they'll be thwarted by second order consequences that complicate the effort there's nothing wrong with trying to bring down the cost of Necessities however the best way to do this is to encourage additions to supply another way is to not overstimulate Demand by injecting excessive liquidity into the economy mandating lower prices is generally the least effective way to get them this is a good time for me to site the economists adage that the best solution for high prices is high prices this isn't a joke far from it in general High prices mean demand is strong relative to supply eventually those high prices will encourage producers to produce more and consumers to consume less and the depressant impact on prices from both directions is obvious we see this all the time in the oil market for just one example a government bureaucracy set up to regulate the price of food is very unlikely to succeed and almost certainly would have adverse effects so are there no benefits we can count on from Price controls I can think of one thousands of new albe it unproductive jobs in that new bureaucracy as Jason Ferman a relatively liberal Economist said of Harris's anti- gouging efforts this is not sensible policy and I think the biggest hope is that it ends up being a lot of rhetoric and no reality another case in point rent control the issue that first suggested this memo several months ago was rent control something I've had personal experience with having lived in an apartment that rented for $92 a month in 1956 when I was 10 the federal government implemented rent control during World War II so that with few new apartment buildings being built and Breadwinners away fighting the war rather than earning their normal wages families wouldn't be priced out of their apartment rents on New York City Apartments were frozen at 1943 levels this was probably a good idea under the unusual circumstances of wartime but the program wasn't dismantled afterwards and it still governs some apartments that were built more than 80 years ago and rent regulation still plays havoc with the supply and demand for New York City apartments in general New York City rent control limits rent increases on apartments so so long as they're occupied by people who were tenants in 1971 or relatives who lived with them the law was enacted to protect the occupants at the time but Apartments have been passed down at controlled rents to people who didn't necessarily live in them in 1971 fewer and fewer people are still around to satisfy the above Criterion so this form of rent regulation is winding down newer regulations continue enforce under the rubric of rent stabilization one example is mandatory inclusionary housing which has been explained to me as follows if you want to build an apartment building and need some zoning relief and virtually all projects do you must agree as follows a percentage of the apartments will be affordable tenants for affordable apartments must earn incomes well below the average in the area the maximum allowable rent will be set based on a percentage of tenants income rent increases upon lease renewal will be regulated usually at a few per per year most would agree that it's laudable to encourage the creation of new affordable apartments but this particular method of doing so has the related effect of increasing the cost of apartment construction probably everyone would be better off if there were simply more new Apartments built every year the bottom line is that rents for the majority of New York City Apartments remain subject to one form of control or another and are unlikely to ever become fully deregulated as a result the incentives to build new apartments are limited and between 2002 and 2017 for example the growth in the number of rental apartments in New York City was only 0.3% per year improvements in regulated apartment ments are also regulated expenditures on improvements are limited to a very small amount in any 15-year period and the investment can be recouped only through an increase in the monthly rent equal to a tiny percentage of the cost of the improvements thus making improvements is generally uneconomic many landlords do not fill their vacant rent stabilized units as the operational and renovation costs May exceed exed the legal maximum rent as of 2022 there are roughly 20,000 vacant rent stabilized departments in New York City Wikipedia might there be something wrong with a system where a there's strong demand for apartments but B it's more profitable to keep Apartments vacant than rent them out apartments aren't much different from bread or toilet paper officials can limit the price people have to pay Which is popular with consumers but other than in the most dictatorial jurisdictions they can't force suppliers to produce goods for sale at the regulated prices as I've tried this year to keep up with articles about New York's apartment situation I've noticed that the following factors are usually listed as discouraging apartment creation a a lack of tax incentives and subsidies B resistance to construction of affordable apartment building in the suburbs and see high interest rates albeit the last one can't be used to explain the low level of apartment Construction in the 2010s what struck me most was the absence of any mention of the impact of rent regulations a February 9th article in the New York Times particularly piqued my interest the article reported that the percentage of New York City rental apartments that were vacant and available had fallen to 1.4% the lowest since 1968 it went on to say housing experts consider a healthy vacancy rate to be somewhere around 5 to 8% so why are so few apartments vacant it comes down to supply and demand a as in the example of Taylor Swift tickets they're simply too cheap that means demand is strong and apartments don't sit vacant B also because rents are kept too low would be Builders can't achieve attractive returns meaning there are few additions to supply I also imagine that if apartment Builders could earn an acceptable return on investment they'd have to worry about new regulations expropriating it as mentioned earlier with regard to prices in general if demand for apartments is strong and Supply is restricted the result should be rents that rise encouraging landord s to add to supply but Market forces aren't allowed to freely function in New York City the laws of Economics have been blunted by regulation the February 9th article included the following statements and this is from The New York Times again usually not the capitalist friend the answer is that developers generally can't make returns for building apartments that are competitive with the Returns on other forms of Investment Housing experts estimate that the number of homes the city needs to build is in the hundreds of thousands so far however the city and state have not made moves that could accelerate enough Housing Development to solve the crisis Governor Kathy hokel said in a statement that the survey was the latest reminder that we can only build our way out of this crisis but it's interesting to note that the moves that are described as having the potential to lead to building our way out of this crisis always emphasize government provided subsidies and incentives never allowing the free market to set rents a person in favor of this Arrangement would argue that it maintains affordability and diversity what it means in purely economic terms is that some people who couldn't afford to live in New York City if rents were set by free market forces are able to live there if they're lucky enough to secure an apartment with regulated rent but other people who would like to live in New York City and can afford higher rents can't do so because there are no apartments for them and lastly landlords that have apartments that are somehow unregulated can command higher rents than would be the case if additions to the supply of Apartments weren't being discouraged it's a matter of personal philosophy whether this is good or bad but clearly the laws of economics and the actions of free markets aren't at work in New York City someone in government is making the decisions I'll end this discussion with a comment Jason Ferman made about grocery prices Mr Ferman said if prices do not rise in response to strong demand new companies may not have as much inclination to jump into the market to ramp up Supply the New York Times August 15th by the way as part of her August 16th economic package Harris said she would prohibit landlords who own more than 50 apartments from Raising rents by more than 5% for two years that may or may not be a good idea but it's certainly not going to encourage increased investment in apartments regulatory miscellane there are so many examples of governmental attempts to ignore or override the laws of Economics that it's daunting to think of cataloging them but I must discuss a few here and there are shortcomings another component of Harris's economic program is a plan to give firsttime home buyers $225,000 to help with down payments certainly it's hard these days for young people to come up with the cash needed to become homeowners the problem here is that giving a million wouldbe buyers $25,000 each or $25 billion in all would almost certainly result in an immediate increase in home prices eliminating much of the hoped for benefit from the program easy that can be prevented by passing a law that prohibits current Sellers from Raising home prices in response to enactment of the program but what about homes that will come on to the market in the future simple enact another law that says you can't ask more for your home then you would have asked if the program didn't exist try enforcing that one when he was president Donald Trump enacted tariffs on goods from China to counter Trade Practices he considered unfair now he promises a 10% across theboard tariff on Imports those tariffs might discourage Imports stimulate domestic production and reduce the US's chronic trade deficit but they'd likely be paid by consumers of imported goods as manufacturers and exporters are unlikely to absorb a tariff if they can pass it on for many years lowcost Imports have held down inflation in the US and enabled Americans to enjoy an attractive standard of living Broad New tariffs are likely to be the equivalent of price increases for American consumers and the tariffs and those imposed by other nations in retaliation would hamper globalization which benefits the global economy by letting people in each Nation do for the world what they're best at Trump's policy proposals also include the extension of his expiring 2017 tax cuts and a panoply of new ones there's something for everyone tax cuts for corporations and individuals including ending the taxation of tips Social Security benefits and overtime pay the pen Wharton budget model estimates that in 2026 the plan would reduce taxes by $320 for the average person in the bottom income quintile and by $ 47,2 120 for those in the top percentile even without factoring in the latest proposals like exempting overtime pay these actions are projected to increase the national deficit by $5.8 trillion over the next decade or $4.1 trillion after incorporating their potential stimulative impact on the overall economy so-called trickle down effects other than that possibility there's no suggestion that the cuts would be paid for California is a petri dish for so-called Progressive economic ideas in 2022 the state legislature passed a bill creating a council comprised of Industry representatives and restaurant workers to set wages in the fast food industry faced with a threatened industry financed referendum to repeal the law legislators modified to mandate a minimum hourly wage of $20 for fast food chains of more than 60 restaurants the new law only took effect in April so it's too early to assess its impact press accounts however are replete with accounts of restaurants closing employees being laid off or having their hours reduced employers investing in labor saving Technologies and substantial price increases for the consumer although mom and pop restaurants are are not required to pay the new minimum wage predictably many have been forced to match the mandated rate to retain their employees meaning the protection legislators intended for small restaurants may be illusory that's how the laws of Economics work similarly California passed a law mandating a $25 an hour minimum wage for workers in the healthc care industry but more recently according to the Wall Street Journal of May 27th officials realized that it would cost the state $4 billion more a year owing to higher Medicaid costs and compensation for workers at state-owned facilities and so they delayed the benefit of the law with respect to those workers shocking here is the idea that you can't give money to someone without getting it from someone else California taxpayers might not enjoy the state directing more of it to healthcare workers especially given the current budget deficit if there's one thing both parties agree on it's hands off Social Security retirees present and future want their monthly payments and they want the rules left as they are the leaders of both parties have agreed to this it's just that it can't work Social Security is a contributory program analogous to insurance and it works through a trust fund workers pay in via taxes and retirees get checks but the number of retirees drawing benefits has been growing relative to the number of active workers paying in and if nothing is changed the fund is sure to become insolvent through an inexurable mathematical process there are many levers that could be pulled to restore Social Security to health but nobody wants to pull them since doing so would displease someone that is displease some voters the options include a raising the Social Security tax rate B raising the ceiling on the earnings on which tax is paid C reducing benefits D limiting cost of living adjustments e raising the retirement age F limiting the number of years for which retirees can collect and g means testing would be recipients none of these is considered acceptable everyone just their checks as promised it doesn't take a degree in economics to know what happens when people spend more than they bring in only in political reality might someone expect a different outcome however we don't hear a word from politicians or elected officials about making the changes that are necessary to keep the Social Security trust fund from insolvency the government can switch Social Security from a self-funded program to a government funded Bank benefit of course and at first glance the change appears to be mainly semantic but depleting the trust fund and paying benefits from the treasury would add further to the already Troublesome deficit the national debt and the annual Debt Service which would feed back to further increase the deficit and debt that leads me to a topic I'm asked about all around the world the US government's deficit and debt I answer that they're an embarrassment oak tree is privileged to manage money for several countries that have Sovereign wealth funds not national debt some countries put windfalls into a lockbox like Norway's oil revenues or the proceeds from the privatization of Australia's telephone company and many other countries live within their means simply because they have to they don't have the luxury of printing unlimited amounts of money without precipitating a devaluation the US habitually funds deficits spending more than it takes in our last Surplus came in 2000 at the end of the Clinton Administration today for the first time simply the annual interest on our national debt exceeds the defense department budget yet neither party is willing to address the deficit or stand for balanced budgets our Congress rarely submits a budget at all no less a balanced one this is irresponsible Behavior we wouldn't tolerate in our own organizations the US acts as if it has a credit card with no limit on the balance and no requirement to pay it down it does so because it's been able to get away with it thus far and our governing officials lack the will to spend less than they can we don't hear much these days about modern monetary Theory The View popularized in 2020 that for countries in control of their currencies deficits and debts don't matter nevertheless our government still acts as if this theory is valid in the 1930s John mayard KES posited that when an economy is growing too slowly to produce the needed jobs the government should increase spending to stimulate demand even if that means running a deficit and covering it by borrowing and then when Prosperity resumes and the jobs are there it should spend less than it takes in a surplus and using it to repay the debt all good except for that last bit the part about surpluses and debt repayment has been forgotten the truth is deficits encourage the economic growth that most people enjoy and spending more than the government takes in permits officials to give away free stuff thereby gaining votes but doing this perpetually requires ignoring the laws of Economics running up debts in the apparent belief that they'll never have to be paid can It Go On Without End we'll see but I would think not what are the common threads the actions and proposed actions described earlier in this memo all have certain elements in common the goals usually seem commendable on the surface cheaper goods and services and more equal outcomes but given the way things work in economics they use usually have second order consequences that are uncontrollable and unhelpful at their core they're all questions of who gets what there's no possibility of money appearing from out of The Ether there are just choices regarding who pays in and who gets something out it's a zero sum game the goals are often populist with legislators and Regulators picking winners and losers they usually fashion their actions as protecting the downtrodden little guy from the rapacious big guy most anti-free Market regulations incorporate size criteria meaning they only apply to supermarkets not Corner Grocery Stores landlords with a lot of Apartments medical facilities of a certain size and restaurant chains not Independence in this context we should note what President Biden said at the Democratic National Convention in August I'm proud to have been the first first president to walk a picket line and be labeled the most pro- union president in history are employees per se more deserving of protection than employers without employers where would people get jobs regardless they do serve as convenient targets for politicians the rhetoric surrounding these matters is often alarmingly classist and divisive here's part of a typical note I received from a candidate last month even with inflation lowering food prices still seem Skyhigh it's another sign of corporate greed hurting consumers CEOs shouldn't be lining their pockets with record profits while families struggle to put food on the table or pay for medications in this kind of environment profit is a dirty word and greedy corporations are right for suspicion and regulation finally elected officials have a habit of exempting themselves from Impact thus it's interesting to observe that California's minimum fast food wage doesn't apply to restaurants and government facilities What official wants to suffer the wrath of an employee forced to pay more for lunch one of the most important characteristics of the laws of Economics is that they apply to everyone on the other hand attempts to negate those laws are usually designed to affect some parties differently from others whenever this is the case case those in charge are picking would be winners and losers not a great idea in a free Society fundamentally government subsidies and economic regulations amount to encouraging actions that people wouldn't take on their own in other words these actions wouldn't happen in a free market mandates like these should be examined critically some may stem from officials solomonic decisions and desire for a fair Society others are probably the result of a philosophic bias in favor of redistribution as still others are just a matter of currying favor with voters for many career politicians the first order of business is getting elected and reelected elected officials tinkering with the economy is often designed to appeal to voters then there's the added benefit of getting officials off the hook since they can redirect blame for politically undesirable developments to Bad actors such as powerful corporations and greedy landlords finally economic regulations can provide temporary paliative outcomes with the negative side effects coming only in later years when the officials who enacted them have left the political stage free markets or controlled markets that is the question governments don't make a product create value over and above the cost of the inputs they employ or other than through their spending contribute to GDP they collect or print money with one hand and distribute money and services with the other they collect taxes from taxpayers and incur debts in the name of future taxpayers then they pay out money for benefit programs salaries Capital expenditures and subsidies policymaking is about who will pay in and who will receive the benefits governments don't strive for profits meaning the people who run governments get a free pass on efficiency corporate management teams that fail to produce a product worth more than the inputs AKA make a profit won't last long but governments aren't expected to do so and as a result there's no easy yard stick for quantifying a government's Effectiveness like profits do for a business governments do play essential roles that may have nothing to do with profits or value added they provide things people can't provide for themselves such as defense Health Care police and fire Services education infrastructure and response to emergencies both physical floods tornadoes and pandemics an economic recessions and hyperinflation they also provide safety nets for those who would otherwise suffer there are extensive differences of opinion over how much of this governments should do as and those differences underly one of the biggest disagreements between the US political parties Beyond Necessities how far should a government go to even out its citizens incomes and quality of life doing so is one of the reasons why governments take from some to give to others as just described but it must be acknowledged that each step in this direction as opposed to requiring people to fend for themselves is a step in conf prevention of free market forces with consequences Darwin described the way species are strengthened through what is known as survival of the fittest it works and species evolve upward but this is by definition a coldblooded process through which the strong Thrive and the weak perish good for the whole of the species but not for every member likewise the collective economic welfare of a society is maximized by the operation of the free market in the process some people do better than others preferably but certainly not always the most talented hardest working and most deserving only in the most rose-colored and ill-fated systems is it not accepted that some people will do better than others but the differential has expanded a great deal of late and there is a growing debate as to how much better is fair and acceptable the choice is clear based on the evidence provided by history a efficient free market economies with their incentives and uneven outcomes or B command economies with their uniform outcomes and subpar performance earlier in this memo I said the following the incentives provided by free markets direct capital and other resources where they'll be most productive they prompt producers to make the good people want most and workers to take jobs where they'll be most productive in terms of the value of their output and they encourage hard work and risk-taking in contrast if markets are made less free that is if they're forced to follow government edicts rather than the laws of Economics capital and raw materials will be directed to places other than where they'll be most productive producers will fail to make the things people want most and in said will make things the government thinks people should have workers will be assigned to work where they'll produce less than they otherwise might and hard work and risk-taking won't take place as much since the rewards for doing those things will be capped and in some cases redirected to people who didn't do the work or take the risk but whom those in control deem deserving incentives and free markets are essential for a high functioning economy but their existence assures that some members of the economy will do better than others you can't have one without the other China at this point you might ask but what about China the Chinese economy isn't free to operate pursuant to the laws of Economics but it's doing well we think of China as a communist country replete with state-owned Enterprises industrial policy and 5-year plans and yet China's GDP has grown at nearly % perom for the last 45 years and in 2010 it became the world's second largest economy how could that be as it turns out much of China's economic success is attributable to its vibrant private sector I've been visiting China for nearly 20 years and especially during my early visits I struggled to comprehend the logic that permits the coexistence of the collective ideology with private Enterprise certainly those are strange bedfellows a visit to Shaman China earlier this month for the China international fair for investment and trade reminded me of this conundrum regardless of the explanation the fact is that China's economy relies heavily on the dynamic private sector in the summer of 2022 Edward Cunningham of the Harvard Kennedy School used a popular formulation to describe it China's private sector is often summed up with a combination of four numbers 60 70 80 90 private firms contribute 60% of China's GDP 70% of its innovative capacity 80% of its urban employment and 90% of new jobs and the government recognizes this on March 13th 2023 CNN reported on a statement from Chinese Premier Lee Chong for a period of time last year there were some incorrect discussions and comments in the society which made some private entrepreneurs feel worried Lee said Monday from a new starting point we will create a market oriented legalized and internationalized business environment treat Enterprises of all types of ownership equally protect the property rights of Enterprises and the rights and interests of entrepreneurs certainly this represents a Triumph of pragmatism over ideological Purity it's a clear example of accommodating to economic reality rather than trying to override it my first step toward understanding the workings of the various economic systems came in junior high school in the late 1950s when I read George Orwell's Animal Farm Orwell wrote it in 1945 as a thinly veiled critique of Russia and communism SLS socialism that book taught me most of what I needed to know about free markets versus Command economies if you haven't read it or if you read it so long ago that you can't remember what it says I suggest you pick it up in the allegory of Animal Farm the animals took over the running of the farm for me the key lesson emanates from The Motto they painted on the barn wall borrowed from KL Marx from each according to his ability to each according to his needs what an idealistic statement it would be great if everyone produced all they could with the more able members of society producing more and it would be great if everyone got what they need with needier individuals getting more but as the animals on the farm soon learned if workers only get to keep what they need there's no incentive for the more able among them to put in the additional effort required to produce a surplus from which to fill the needs of the less able the great challenge of course is to strike the proper balance to take enough from the successful in the form of taxes to fun Services government programs and wealth transfers without eroding their incentive to work or encouraging them to seek out low tax jurisdictions what I just discussed are the economic Facts of Life and some of their ramifications may be less than ideal but idealists wishes don't govern economies these realities do foremost among them are the power of incentives and the influence of supply and demand the rules must be respected they can't be ignored wished away or overridden without consequences anyone who thinks it's better to live in a centrally planned economy that prefers evenly distributed benefits over free markets hasn't studied history or red Animal Farm it may sound good in theory but it has never worked the laws of Economics will always win out eventually Nations can respect them and reap the associated benefits or they can try to contravene them and pay the price in terms of underperformance in the world of politics there can be Limitless benefits and something for everyone but in economics there are only [Music] tradeoffs September 19th 2024 thank you for listening to the memo by Howard Marx to hear more episodes be sure to subscribe wherever you listen to [Music] podcasts this podcast expresses the views of the author as of the date indicated and such views are subject to change without notice oak tree has no Duty or obligation to update the information contained herein further oak tree makes no representation and it should not be assumed that past investment performance is an 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