DRI-146 for week of 12-29-13: Catholic Doctrine and Economics: History and Evidence

An Access Advertising EconBrief:

Catholic Doctrine and Economics: History and Evidence

Pope Francis’s recent apostolic exhortation denouncing capitalism earned plaudits from mainstream media and the political Left. Last week’s EconBrief exposed the Pope’s rhetoric as emotive, superficial and devoid of intellectual content. Two questions follow: First, what impelled the Pope to comment at all? Second, what accounts for his assurance that the case for capitalism “has never been confirmed by the facts?”

Catholic Socio-economic Doctrine

Hostility to money, trade and finance by organized religion and the Catholic Church in particular dates back centuries. Religion developed in opposition to political absolutism. Prior to the rise of specialization and markets, economic stasis was the rule. Wealth was attained by military conquest and plunder rather than economic growth or, on a small scale, by banditry rather than business. Thus, wealth itself was suspect, as was its expression via money. Life expectancy was short and investment possibilities were scant, so the need for finance was correspondingly limited. Thus, financiers were viewed askance.

This view found expression within the Catholic Church in the prohibition of usury, defined as loaning money at interest. Since there was no economic theory to speak of, there was no recognition of principles such as time preference. Consequently, when medieval nobles purchased indulgences from the Catholic Church, the Vatican had no compunctions about insisting on paying less than the nominal value of a noble’s right to receive annual rents on his land. That is, the noble might own land on which he contractually received the equivalent of $30 per year in annual rent from the lessee, and the Church would pay less than $30 to gain title to that contractual payment. The Church was charging rent to the noble; i.e., was itself guilty of the usury it forbade its flock to commit.

This historic example tells us several things – that interest is an ineradicable, inevitable category of human action even outside of a monetary context; that the Church was slow to appreciate the economic logic governing human action; and that church doctrine tended to inhibit rather than accommodate change and progress.

By the 19th century, the Industrial Revolution had dramatically widened the scope of human possibility. Productivity was now increasing rapidly. Economic growth was a reality. War was more destructive and less beneficial to the victor. But all this was gained at a price – the time-honored ways of society were changing. Rather than embrace change, the Catholic Church lined up against it. After witnessing a century of political upheaval and the birth of socialism and communism, the Vatican issued its first formal statement on social policy in 1891 – the Rerum Novarum. Fourteen subsequent papal encyclicals followed, refining the doctrine and developing several fundamental principles.

Man is made in the image of God and thus inherits the quality of human dignity. This is expressed in various ways, one of which is through work. The principle of subsidiarity allows individuals to attain self-expression in their work and thus contribute to the communal welfare. While the principle of private property is recognized, however, it is subordinated to enjoyment of “the goods of the whole Creation,” which are “meant for everyone.” The principle of distributism governs the allocation of goods in a fashion consistent with “social justice.”

Which political system – capitalism, socialism or communism – is optimal for achievement of social justice? None of them, according to explicit Catholic doctrine. Communism not only violates private property but also renounces religion – so much for that. “Unfettered capitalism” is not acceptable either – here we can see the roots of Pope Francis’s call for subordination to government authority, which apparently acts as surrogate for the Church in enforcing social justice. As for socialism – well, the longtime affinity between Catholicism and the political Left suggests that this is the de facto preference of a sizable fraction of the flock.

If the above summary seems vague by the standards of political economy, there are good reasons for that. The Vatican had to somehow reconcile the rapidly evolving standards of science and technology and the brute facts of modern economic life with the basic teachings of the Church – without alienating the flock and causing an exodus of believers. Obviously, it took refuge in comforting generalities and uplifting rhetoric at the expense of logic. If there are no hard edges or bright lines drawn, then the faith can dodge its contradictions and practical shortcomings just well enough to survive.

It was this doctrinal tradition of emotive uplift and vague generalization that Pope Francis called upon in his latest apostolic exhortation. For over a century, the Church had relied upon government as its deus ex machina in social policy, and Pope Francis was certainly not about to deviate from that playbook now.

Economic History and the Church

Pope Francis’s quaint ideas about capitalism were not generated spontaneously within his brain. They were the outgrowth of a long history of antipathy expressed toward capitalism and free markets by historians and commentators, some of them affiliated with the Church. This attitude began at the time of the Industrial Revolution. We can simplify it by breaking it down into two key propositions: first, that the industrial factories worsened the lot of the working population and the poor by substituting an inferior lifestyle for a preferable one spent working on farms; and second, that factories were especially harmful to children, who were shamefully exploited and maimed by the factory system.

One of the leading historians of the Industrial Revolution and child labor, Clark Nardinelli, characterized the opponents of industrialization as the “Romantic movement.” During the “golden age” (e.g., prior to the Industrial Revolution), “England was populated with sturdy yeoman farmers who…produced enough for a comfortable subsistence for their families.” And shortfall in material goods was “more than compensated for [by] the serenity and beauty of rural life.” The Industrial Revolution “tore workers away from the land and forced children to enter the labor market” rather than enjoy a joyous, pastoral existence as carefree as it was healthful. Although the best-known Romantics today are writers such as Coleridge and Wordsworth, the Catholic Church provided a great deal of moral support and front-line activism to this movement. It also drew upon the Romantic literature for much of its later doctrinal expression.

The reality of industrial life and child labor, both pre- and post-Revolution, had little to do with Romanticism. It was driven by economics.

Prior to the Industrial Revolution, economies were predominantly agricultural. At the time of the American Revolution, for example, over 90% of U.S. output was produced on farms. Beginning in the mid-1700s, economic productivity began a long upward climb that is still underway today. It started with the birth of factories housing production processes for raw materials and finished goods. This affected agriculture at first by drawing away labor and other resources from farms to cities. Eventually the Revolution spread to agriculture itself; many machines and processes for producing and harvesting farm goods were invented. The increase in agricultural productivity led to huge increases in supply and lowered prices. Since increases in demand were less-than-commensurate with these supply increases, the result was a net exodus of resources away from agriculture and toward industry. This transformation occurred around the world and continues to accentuate the trend toward urbanization today.

British economist N.F.R. Crafts estimated that British per-capita income rose from $333 in 1700 to $399 in 1760 to $427 in 1800 to $498 in 1830 to $804 in 1860 (all figures expressed in 1970 U.S. dollars). As Nardinelli infers, this implies that economic growth occurred very slowly prior to 1760, slowly from 1760 to around 1820 and much faster between 1820 and 1860. According to detractors of free markets (to whom Nardinelli attaches the non-partisan label of Industrial Revolution “pessimists”), workers drawn into the factories were actually made worse off by the transformation.

Nardinelli estimates that the lowest 65% on the British income totem-pole received about 29% of all income in 1760. By 1860, this share had declined – but only to about 25%. (This relatively glacial pace of change is consistent with rates of change in the 20th century, too, despite loud protestations about the rapid pace of inequality.) On average, this would justify only a modest downward adjustment in the per-capita near-doubling of real income in Crafts’ figures, to about a 70% increase.

Within the historical profession, debate over the effects of the Industrial Revolution has raged for well over a century. “Optimists” like T.S. Ashton and R. M. Hartwell assembled data on real wages to overcome the anecdotal impression left by “pessimists” that life was a living hell for factory workers and children. Pessimists were left to argue that countervailing factors like urban crowding, unemployment and pollution overcame the material wealth created by capitalism to make workers worse off after all. But the best that pessimists have been able to manage is a case that the rate of growth was slow prior to 1840 and only began to accelerate thereafter.

Among many factors complicating the evaluation is the fact that the Romantics overlooked all the drawbacks of pre-Industrial life. While the factor system may have worsened air pollution, for example, the relative decline in air quality was not as great as it might seem. The widespread use of horses for transportation, for example, was a substantial source of air pollution. Agriculture caused water pollution and reduction in land quality, both of which were ameliorated by the outflow of resources from agriculture to cities. The fact that life expectancy in Great Britain rose 15% from 1781 to 1851 does not tell in the pessimists’ favor. The strong population growth between 1760 and 1830 is the only thing that kept per-capita growth in real income from being even larger, but this cuts both ways – it holds down per-capita income but suggests that dis-amenities of industrial life were not life-threatening in magnitude.

The Truth About Child Labor

History books throughout the 19th and early 20th centuries were replete with gruesome tales of children mangled and crushed by machinery or driven to early graves by the unhealthy hours and working conditions inside factory walls. Beginning in the 1940s, however, what the late Paul Harvey would have called “the rest of the story” started to emerge. Even before the Industrial Revolution, children normally worked on farms, either from age 12 onwards as outdoor farmhands or as younger hirelings of cottage industries. Outdoor farm labor was hardly less arduous and dangerous than factory labor. And it was certainly less remunerative. Today, child labor survives not in Western factories but rather in the subsistence agricultural economies of Africa and India.

There is no systematic evidence of child abuse and mistreatment of child labor by factor owners – which is what we would expect of factory owners who were dependent on child labor for substantial productivity. That productivity earned substantial wage income – this was what lured the children into work in the first place. Thus, the Industrial Revolution did not result in the exploitation of child labor, regardless of how the term “exploitation” is defined. Factories and other industrial employments were not a magnet for child labor; rather, large-scale child labor was a localized phenomenon confined mostly to portions of Great Britain and the American South where cotton mills were numerous. Children were ideally suited for textile production, which explains their sudden rise to prominence at the strategic moment in the Industrial Revolution. Employment of roughly 122,000 children in the textile mills of Lancashire, Yorkshire and Cheshire constituted the bulk of child labor – about 203,333 – in England and Wales. Since the total population of children was over 2,400,000, child labor accounted for only a little over 8% of the population of children. As the Revolution went on, the need for more technologically sophisticated labor militated against the use of child labor.

Free Markets and the Poor: Evidence from Around the Globe

Not surprisingly, the Pope’s proclamation and its ecstatic reception triggered indignant reaction from knowledgeable sources. One of America’s leading experts on economic policy, John Goodman of the NationalCenter for Policy Analysis, recalled his participation in an economic conference called by Pope John Paul II in 1996. Contrary to longstanding Church policy, then-Pope Karol Wotyla sought counsel from free-market economists before issuing his encyclical Centesimus Annus. This time, Pope Francis pointedly ignored economic logic and principles in adhering to traditional Church doctrine.

In an op-ed entitled “Papal Economics,” Goodman noted that for some 100,000 years, most of mankind subsisted on a real income equivalent to $1 per day, rarely reaching $3 per day. Then, about 200 years ago [actually, closer to 250], capitalism began to blossom throughout the world with the spread of free markets. Today, even the poor in the wealthiest countries are better off by thousands-fold.

Economists Benjamin Powell and Darren Hudson, writing on “Pope Francis’s Erroneous Economic Pontifications” for the Independent Institute, take on the Pope’s assertions directly. After excoriating “trickle-down” economics, the Pope further maintained that “when the glass [of economic growth] is full, nothing ever comes out for the poor.” Citing the specific case of China, the world’s most populous nation and formerly home to its largest quotient of poor residents, the authors remind the Pope that since 1980, 500 million people have been lifted out of poverty under the new, market-friendly economic policies pursued within China. This could hardly have been the work of the Catholic Church, since Christianity was condemned by the Communist regime of Mao Zedong and barely tolerated subsequently.

The Pope’s confident assertion that faith in free markets and economic growth as a tonic for the poor has “never been confirmed by the facts” was next to fall to the authors’ analytical scythe. They calculate that the average annual per-capita income of the poorest 10% of the population in the world’s freest countries exceeds $10,000 annually. In the world’s least-free countries, that same average annual per-capita income is less than $1,000.

But surely the Pope’s headline-grabbing point about capitalist inequality is ironclad? After all, today even defenders of capitalism and free markets fall over themselves apologizing for the widening gap between rich and poor. But Powell and Hudson utilize the most popular tool of left-wing student economists, the quintile tables, in comparing income distribution in most-free and least-free countries. The share of total income going to the poorest 10% of the population in the freest countries in the world is 2.76%. In the least-free countries, that same share of total income is less – 2.57%.

The quintile method (in this case, actually a decile method) is an analytically inferior method of parsing the mysteries of income distribution because it aggregates huge numbers of individuals inside each quintile (or decile) and hides the results of changes felt by them. Only the overall averages are visible. Just as bad is the fact that the individual components of the quintile do not stay the same over time. People are born and die. Even more pertinent to the analysis, their incomes change so much that they leave one quintile and move to another one. Historically, Americans have been quite mobile between quintiles; that is, they are likely to spend time at both the low end and the high end at different points in their lives.

Left-wing students of income distribution tend to act as though the makeup of the quintiles did not change – as if the poor remained in the poorest 20% (or 10%) all their lives. The evidence suggests that some do, but most don’t. This radically changes the implications of inequality between quintiles, since it is completely different to spend your whole life poor than (let’s say) to spend a few years poor, a few years well off, a few years very well off and a few years rich. It is no accident that the Left prefers the quintile method. Socialism began as a movement proposed by French philosopher Saint Simon, who longed to operate an entire national economy as if it were one big factory; in short, to pretend that a nation was a single collective entity.

Messrs. Powell and Hudson graciously agreed to play the comparative income-distribution game in the left-wing ballpark by employing the quintile method, a technique containing inherent bias against free-market outcomes. Yet the free-market side still won, which makes the victory all the more telling.

The immediate reaction to this analysis is to wonder what Pope Francis would respond when confronted with the refutation of his arguments. In fact, he has already responded. He told an interviewer that “I was not speaking from a technical point of view but according to the Church’s social doctrine.”

Exactly. Since 1891, the Catholic Church’s social policy has served the vital function of allowing Popes to speak out of both sides of their mouth on social policy. To the public, they can appear to address real-world problems and public-policy issues directly by using terms and phrases that seem to have real-world referents. To the cognoscenti, though, they can de-fang their comments by translating them into the vague mush of Catholic doctrine, chock-full of good intentions and nobility but unrelated to any logical or practical program. That is the way to understand Pope Francis’s latest apostolic exhortation, as just another in the long line of these duplicitous exercises.

The only exception in this deplorable line of double-talk was provided by John Paul II. John Goodman noted that, in Centesimus Annus, John Paul actually came out and said that capitalism was the most efficient instrument for utilizing resources and effectively responding to needs. It can hardly have been coincidental that John Paul was also the courageous Pope who joined with Ronald Reagan and Margaret Thatcher to topple Communism in the Soviet Union and Eastern Europe. He recognized the role played by capitalism in overcoming Communism and restoring religious freedom to his home country and a substantial chunk of his flock worldwide. He knew that capitalism created prosperity and that material security and leisure time enhance the quality of religious observance.

Summing Up

The Pope’s latest apostolic exhortation earned headlines and fawning press coverage for the Papacy but broke no new ground in theology or public policy. Pope Francis was simply plowing inside the same furrow cultivated by his predecessors for over a century. The Catholic Church’s exhortations can be traced back to the Church doctrine first codified in 1891. With only one exception, this policy has followed a consistently vague and unproductive line since its inception.

The Pope’s confident assertion that free-market economics has no provenance is the outgrowth of over a century’s worth of mistaken history. Accurate revisions in estimates of real wages and a more realistic comparison of life prior to the Industrial Revolution have put the effects on workers and children in proper perspective. Poor workers gained from the Industrial Revolution; children were not exploited but rather benefitted from relatively high wages and favorable working conditions within factories.

The world’s freest countries and economies not only enable their poorest citizens to have much higher real incomes than poor people in the least-free countries, those poorest people also enjoy larger shares of total income than the poorest people in the least-free countries. In short, Pope Francis was wrong about nearly everything he said.

DRI-297 for week of 10-20-13: Bad News on the Journalism Watch

An Access Advertising EconBrief:

Bad News on the Journalism Watch

“Never ascribe to venality that which can be explained by mere stupidity.” Many a pundit and commentator would profit from this bit of folk wisdom. Economists have more occasion to remember it than most – but heeding it sometimes requires more forbearance than any human should have to display.

“Bad News for Social Security Recipients”

A recent AP story appeared on MSN with the video caption reading: “Bad News for Social Security Recipients.” The sub-head broke the bad news: “Social Security Raise to be Among Lowest in Years.” The piece was bylined to one Stephen Ohlemacher.

The body of the story revealed that the facts were as advertised. “For the second straight year, millions of Social Security recipients can expect historically small increases in their benefits come January. Preliminary figures suggest a benefit increase of roughly 1.5%, which would be among the smallest since automatic increases were adopted in 1975, according to an analysis by the Associated Press.” So far, so good – or bad, depending on how you choose to put it. The story says that retirees saw an annual increase in those benefits of comparatively small magnitude. It relies on our casual understanding that most retirees depends on Social Security benefits for the bulk of their annual income.

The punchline – with the emphasis on “punch” – comes with the next line. “Next year’s raise will be small because consumer prices, as measured by the government’s Consumer Price Index, went up only 1.6% this past year.” If you’re an economist, you stare in silent disbelief at this line before the involuntary reaction hits, like the reflex when the doctor strikes your knee with the rubber hammer. You shout in disbelief, or derision, or anger, or merriment. You can’t believe what you just read – that anybody could write this as honest reporting or commentary.

Contrary to the headline, this isn’t bad news for social-security recipients. It is bad news for journalism.

The Return of the Broken-Window Fallacy

The purpose of a Cost of Living Index (COLA) is to compensate those covered by it for price changes. In theory, benefits indexed to consumer prices should rise by an amount just sufficient to enable consumer purchasing power to remain intact after price increases. That is, any combination of consumer goods affordable before the price increases should be affordable after the price increases and COLA adjustment. In practice, no price index works that well because the enormous number of goods and typically vast array of price changes defeat the best efforts of any price index to reflect every nuance and variation.

Nonetheless, it makes absolutely no sense to say that it is “bad news when prices don’t go up [much] because that results in only a small upward COLA adjustment.” That is tantamount to saying that you suffered the bad fortune of a minor auto accident because you could only collect a small collision-insurance reimbursement.

It is best that prices don’t go up at all, just as it is best that you suffer no auto accident whatsoever. It may be the case that, because your personal consumption pattern is so idiosyncratic, the price index that determines your COLA does not adequately compensate you for the actual price increases that your particular consumption goods suffered over the survey period. (Just as it may also be true that your insurance adjustor does not adequately reward you for the actual damages your car suffers in an accident.) If the price index or insurance adjustment fails to adequately protect you, that is “bad news,” but stable prices and safe driving are not bad things just because you cannot collect on the respective forms of insurance that protect you when they break down.

And to say otherwise, as reporter Ohlemacher plainly does, is just crazy.

The 19th-century French economic Frederic Bastiat earned immortality by identifying the fallacy of the broken window. Even as early as 1848, self-appointed economic savants were declaring that destructive events such as vandalism were disguised blessings because their cleanup and reconstruction afforded employment and income to carpenters, glaziers, stonemasons and such. It was Bastiat who pointed out the fallacy in this solemn nonsense. The time and effort spent in reconstruction is lost to new construction, while the end result simply gets us back to square one, prior to the destruction. If the destruction had never happened, those same carpenters, glaziers, stonemasons, et al, could have been building new structures, leaving us better off than before. It is clearly folly to suggest that wealth can be enhanced by destroying wealth, then building it up again.

In the present day, it is just as fallacious to claim that the relative lack of a disaster is a bad thing because it denies us the opportunity to be compensated for the disaster. At least in theory, all that compensation accomplishes is… well, compensation. It just gets us back to even, back to square one. At best. If the compensation is imperfect, it may not even do as well as that. And all forms of inflation indexation are imperfect.

The Nuts and Bolts of Indexation

A great microeconomist once described blackboard analysis in the classroom as “getting down on our hands and knees” to examine a problem closely. The issue of indexation for price changes affects so many people that it merits minute examination. Let’s haul out the nuts and bolts of the problem highlighted by this news story and get down on all fours with them.

Last year, many thousands of prices changed over the course of the calendar year. Enough of them rose to cause the Consumer Price Index – which we can think of as a kind of weighted average of all price changes – to rise by a modest amount just under 2%. This rise in the price index triggered a “cost-of-living-adjustment” (COLA) in the benefits paid out by the Social Security Administration. Hurrah!

But wait – we cheered when Social Security benefits went up, but we forgot to boo the price increases that occurred last year, before the benefit increase took place. After all, the benefit increase is only intended to compensate us for price increases that have already taken place in the past, when our Social Security payments were stuck at their previous lower level. Assuming the CPI perfectly adjusts to account for all the price increases, the price index change and the resulting upward revision in our benefits will exactly compensate us for the price increases. Now our buying power is back to where it was at the start of last year, before the price increases took place. So there is really no great reason to cheer, since the COLA is only getting us back to even, so to speak, in terms of our purchasing power.

Except we’re not even, are we? Or rather, we weren’t even last year, when we had to buy goods and services for the whole year with prices higher but possessing only our lower pre-indexation benefit amount. Alas, our COLA indexation comes in arrears; as long as inflation persists, our real income is like a dog always chasing its tail but never quite able to catch it. Of course, indexation is one heck of a lot better than nothing, but it is not a panacea for the detrimental effect of inflation on fixed incomes.

Think back to the news story. The bad news for Social Security recipients is that the coming year’s benefit adjustments are among the smallest ever. Why? “Next year’s raise will be small because consumer prices…haven’t gone up much in the past year.” Well, if small price increases produce small benefit increases and larger price increases would have produced larger benefit increases, then the author is clearly implying that larger price increases would have brought good news this year instead of bad news. But we just showed that larger price increases last year would have made recipients even worse off last year than they actually were – then this year’s benefit increase would merely have gotten them back to even.

So the author is wrong. No, that doesn’t quite capture it. He is gloriously, symmetrically wrong, in the sense that his flatfooted declaration is the exact opposite of the truth. This is truly industrial-strength stupidity. But that isn’t all.

No price index works perfectly. As soon as the statistician introduces more than one good or service into the index, unavoidable imprecision crops up. When thousands of goods are indexed, this problem mushrooms. That is why the Bureau of Labor Statistics calculates so many different versions and subsets of the various price indices, of which the Consumer Price Index is merely the best known. The statisticians are trying valiantly to tailor these sub-indices to the income and consumption patterns of identifiable groups. This is another way of saying that, in actual practice, indexation using the CPI as its base does not exactly compensate for the previous year’s price changes. Moreover, the degree of variance from the ideal differs from person to person and group to group.

At least in principle, this technical imprecision might work in either direction – either in or against the consumer’s favor. As it happens, though, our news story makes certain claims on that score. “Advocates for seniors say the government’s measure of inflation doesn’t accurately reflect price increases older Americans face because they tend to spend more of their income on health care. Medical costs went up less than in previous years but still outpaced other consumer prices, rising 2.5%. ‘This (COLA) is not enough to keep up with inflation, as it affects seniors,’ said Max Richtman, who heads the National Committee to Preserve Social Security and Medicare. ‘There are some things that became cheaper but they are not the things that seniors buy. Laptop computers have gone down dramatically but how many people at 70 are buying laptop computers?'”

In other words, the author of our news story has introduced evidence that the COLA fails to compensate Social Security recipients for purchasing power lost to inflation. He has introduced no counterbalancing evidence, even though ample evidence to the contrary is available. (Some will be adduced below.) Now how does the author’s central contention – that Social Security recipients face bad news created by the failure of prices to rise more last year – look? According to the logic and evidence the author has written into his own article, the author’s own conclusion looks even stupider than it did when first stated. To recipients’ disadvantage that the COLA adjustment is attained in arrears, the author has now added the further disadvantage that the adjustment allegedly fails to compensate Social Security recipients for the full effects of inflation on their purchasing power. Both of these disadvantages are triggered by price increases; the bigger the price increase, the more wounding the disadvantage.

The author’s industrial-strength stupidity has now ratcheted up to industrial-strength stupidity squared.

Stupidity, Yes – But What Else?

The author of this story displayed stupidity on an epic scale. That much is beyond doubt. Is stupidity alone enough to account for such a breathtaking display? Might there be a concealed agenda at work to motivate such blindness to elementary logic?

Not so long ago, a news story underwent a fairly rigorous editing process prior to publication. It is highly unlikely that any national publication would have allowed anything as ghastly as this to slip past its editors. But today, journalism as it once was no longer exists. Its place has been taken by advocacy thinly veiled as reporting or commentary.

The prevailing bias is leftward in general and pro-Obama-administration in particular. The Obama issue du jour is – or was, when the article appeared – the federal-government shutdown. Sure enough, much of the article’s content is intended to rake up sympathy for Social Security recipients, the largest entitlement group whose check receipts were threatened by the shutdown.

The bad-news recipients are characterized as “millions of Social Security recipients, disabled veterans and retirees.” They are wholly dependent on government for their incomes, which are now – for the second year in a row – “historically small.” And, to top it off, “the exact size of the cost-of-living adjustment, or COLA, won’t be known until the Labor Department releases the inflation report for September. That was supposed to happen Wednesday, but the report was delayed by the government shutdown. [emphasis added]…The Social Security Administration has given no indication that raises would be delayed because of the shutdown, but advocates for seniors said the uncertainty was unwelcome…More than one-fifth of the country is waiting for the news.”

A story can also be slanted by what is left out as well as what is included. While Mr. Ohlemacher’s story plants the impression of seniors as badly used by the CPI, economist Michael Boskin has the opposite impression in his Wall Street Journal op-eds over the years. In 2005, Boskin estimated that CPI indexing overestimated inflation by 80-90 basis points, or nearly one full percentage point. More recently, n the course of listing numerous ways in which the federal government can save money by eliminating waste, fraud and abuse in its budget, Boskin suggests switching Social Security indexation to the chained CPI, which would estimate inflation more conservatively than does the current version. (The chained CPI would adjust the index every month for “upper-level substitution bias” – a recondite way of describing the fact that the index currently captures economic substitution induced by price changes better for close substitute goods than for more distant substitutes.) Formerly, straight-news stories would have cited opposing views like this one, for “balance.” These days, a balanced story is a rarity.

It is tempting to believe that ideological or partisan political bias blinded the author to his egregious mistakes and nourished a single-minded search for stories that conformed to a pre-set template of “helpless victims endangered by short-sighted government shutdown.”

Another ideological agenda on display in the article is that of the victimized group. Here it is seniors. The above-quoted reference to COLA bias against senior consumption patterns is the tipoff. But there is no mention of the fact that economists warned for years that Social Security benefits over-compensated for inflation. Instead, we get bite-sized quotes from victims picked for their emotive power.

“‘It is very important to get the COLA because everything else you have in your life is on an upward swing, and if you’re on a downward swing, that means your quality of life is going down,’ said Gaskins [Alberta Gaskins, of the District of Columbia, who “is concerned about household bills], who retired from the Postal Service in 1989.” Somehow, the juxtaposition of Ohlemacher’s inane analysis of indexation, his dry technical explanations of COLAs and price changes and the “Gaskins Swing Index” lends a surreal aura to this article. It almost seems as though Ohlemacher approached a garden-fresh set of facts on Social Security and set out to knead, pound and stretch them into as much propaganda dough as he could mold. The result doesn’t rise and leaves a mess in the oven for the reader to deal with.

Yesterday’s Hack is Today’s Hero

In the journalistic jungle of yesteryear, writers who sold their soul for a buck were called “hacks.” They were understood to be willing to say anything on behalf of anybody who paid their (not too elevated) price. Today’s front-line reporters have adopted the work habits and standards of yesterday’s hacks. But unlike the hacks, they do not suffer for it by being relegated to the fringes and netherworld of journalism. A search on Mr. Ohlemacher reveals that he writes often for salon.com, MSN and the Associated Press. Copious samples of his work are available online. His do not appear to be the credentials of a hack. But the reasoning displayed in this article is an insult to the discipline of economics. The fact that Ohlemacher’s piece includes some technical details about COLAs and their calculation does not mitigate the gravity of his offense as outlined above.

Still… there is that old adage to contend with. “Never ascribe to venality that which can be explained by mere stupidity.”

DRI-326 for week of 9-1-13: Quantity vs. Quality in Economists

An Access Advertising EconBrief:

Quantity vs. Quality in Economists

Students of economics have long complained that economics texts focus too much on quantity and not enough on quality when evaluating goods. The same issue arises when comparing economists themselves. The career of Nobel Laureate Ronald Coase, who died this week at age 102, is a polar case.

Economists advance by publishing articles in prestigious, peer-reviewed journals. The all-time leader in the number of articles published is the late Harry G. Johnson. Despite dying young at age 53, Johnson compiled the staggering total of 526 published articles during his lifetime.

The use of advanced mathematics and abstract modeling techniques has enabled economists to rack up impressive publications scores by introducing slight mathematical refinements that add little to the substantive meaning or practical value of their achievement. When asked to account for the comparative modesty of a list of publications only one-fourth the size of Johnson’s, Nobel Laureate George Stigler countered, “Yeah, but mine are all different.”

Coase stands at the other extreme. His complete list of articles numbers fewer than twenty, but two of those are among the most-frequently consulted by economists, lawyers and other specialists, not to mention by the general public. He published a long-awaited, widely noticed book in 2012 despite having passed his centenary the year before. His life is an advertisement for the value of quality over quantity in an economist.

Another notable aspect of Coase’s work is its accessibility. In an age when few professional contributions can be read and understood by non-specialists, much less by interested non-economists, Coase’s work is readily comprehensible by the educated layperson. Now is the time to rehearse the insights that made Coase’s name a byword within the economics profession. His death makes this review emotionally as well as intellectually fitting.

Why Do Businesses Exist?

At 26 years of age, Ronald Coase was a left-leaning economics student. He pondered the following contradictory set of facts: On the one hand, socialists ever since Saint-Simon had advocated running a nation’s economy “like one big factory.” On the other hand, orthodox economists declared this to be impossible. Yet some highly successful corporations reached enormous size.

Who was right? It seemed to Coase that the answer depended on the answer to a more fundamental question – why do businesses exist? Be it a one-person shop or a huge multinational corporation, a business arises voluntarily. What conditions give birth to a business?

Coase found the answer in the concept of cost. (In his 1937 article, “The Nature of the Firm,” Coase used the term “marketing costs,” but the economics profession refined the term to “transactions costs”.) A business arises whenever it is less costly for people to organize into a hierarchical, centralized structure to produce and distribute output than it is to produce the same output and exchange it individually. And the business itself performs some activities within the firm while outsourcing others outside the firm. Again, cost determines the locus of these activities; any activity more cheaply bought than performed inside the firm is outsourced, while activities more cheaply done inside the firm are kept internal.

Like most brilliant, revolutionary insights, this seems almost childishly simple when explained clearly. But it was the first lucid justification for the existence of business firms that relied on the same economic logic that business firms themselves (and consumers) used in daily life. Previously, economists had been in the ridiculous position of assuming that businesses used economic logic but arose through some non-economic process such as habit or tradition or government direction.

Today, we have a regulatory process that flies in the face of Coase’s model. It implicitly assumes that markets are incapable of correctly organizing, assigning and performing basic business functions, ranging from safety to hiring to providing employee benefits. To make matters worse, the underlying assumption is that government regulatory behavior is either costless or less costly than the correlative function performed by private markets. As Coase taught us over 75 years ago, this flies in the face of the inherent “nature of the firm.”

The “Coase Theorem”

In mid-career, while working amongst a group of free-market economists at the University of Virginia, Ronald Coase made his most famous discovery. It assured him immortality among economists. Just about the best way to make a name for yourself is to give your name to a theory, the way John Maynard Keynes or Karl Marx did. But in Coase’s case, the famous “Coase Theorem” was actually devised by somebody else, using Coase’s logic – and Coase himself repudiated the use to which his work was put!

To appreciate what Coase did – and didn’t do – we must grasp the prior state of economic theory on the subject of “externalities.” Tort case law contained examples of railroad trains whose operation created fires by throwing off sparks into combustible areas like farm land. The law treated these cases by either penalizing the railroad or ignoring the damage. A famous economist named A. C. Pigou declared this to be an example of an “externality” – a cost created by business production that is not borne by the business itself because the business’s owners and/or managers do not perceive the damage created by the sparks to be an actual cost of production.

Rather than simply penalizing the railroad, Pigou observed, the economically appropriate action is to levy a per-unit tax against the railroad equal to the cost incurred by the victims of the sparks. This would cause the railroad to reduce its output by exactly the same amount as if it had perceived its sparks to be a legitimate cost of production in the first place. In effect, the railroad “pays” the costs of its actions in the form of reduced output (and reduced use of the resources necessary to provide railroad transport services), rather than paying them in the form of a fine. Why is the former outcome better than the latter? Because the purpose is not to hurt the railroad as retaliation for its hurting the farmer, the way one child hurts another in revenge for being hurt. A railroad is a business – in effect, it is a piece of paper expressing certain contractual relationships. It cannot feel hurt the way a human being can, so the fine may make the farmer feel better (if he or she received the fine as proceeds of a tort suit) but does not compensate for the waste of resources caused by having the railroad produce too much output. (“Too much” because resources will have to be devoted to repairing the damage caused by the sparks, and consumers value the resources used to do this more than the farmer values the loss.) In contrast, when the costs are factored into the railroad’s production decision, everybody values the resulting output of railroad services and other things as exactly worth their cost.

Of course, the catch is that somebody has to (1) realize the existence of the externality; and (2) calculate exactly how much tax to levy on the railroad to neutralize (or internalize) the externality; and then (3) do it. In the manner of a philosopher king, Pigou declared that this task should be assigned to a government regulatory bureaucracy. And for the next half-century (Pigou was writing in the early 1900s), mainstream economists salivated at the prospect of regulatory agencies passing rules to internalize all the pesky externalities that liberals and bureaucrats could dream up.

In 1960, Ronald Coase came along and gave the world a completely new slant on this age-old problem. Consider the following type of situation: you are flying from New York to Los Angeles on a low-price airline. You have settled somewhat uncomfortably into your seat, survived the takeoff and are just beginning to contemplate the six-hour flight when the passenger in front of you presses a button at his side and reclines his seatback – thereby preempting what little leg room you previously had. Now what?

This is not actually the example Coase used – it was used by contemporary economist Peter Boettke to illustrate Coase’s ideas – but it is especially good for our purposes. Using the same logic Coase applied to his examples, we reason thusly: It would be completely arbitrary to assign either of us a property right to the space preempted by the seatback. Why? Because the problem is not to stop bad people from doing bad things. Instead, we are faced with a situation in which ordinary people want to do good things that are in some sense contradictory or offsetting in their effects. On the airplane, my wish to stretch out is no more or less morally compelling than his to recline. The problem is that  we can’t do both to the desired extent at the same time without getting in each other’s way; e.g., offsetting each other’s efforts.

Indeed, this is true of most so-called externalities, including the railroad/farmer case. Case law usually treated the railroad as a nefarious miscreant imposing its will on the innocent, helpless farmer. But the railroad’s wish to provide transport services is just as reasonable as the farmer’s to grow and harvest crops. It is not unthinkable to enjoin the railroad against creating sparks – but neither should we overlook the possibility of requiring the farmer to protect against sparks or perhaps even not locate a farm within the threatened area. Indeed, what we really want in all cases is to discover the least-cost solution to the externality. That might involve precautions taken by the railroad, or by the farmer, or emigration by the farmer, or payment by the railroad to the farmer as compensation for the spark damage, or payment by the farmer to the railroad as compensation for spark avoidance.

 

In general, it is crazy to expect an uninvolved third party – particularly a government regulator – to divine the least-cost solution and implement it. The logical people to do that are the involved parties themselves, who know the most about their own costs and preferences and are on the scene. These are also the people who have the incentive to find a mutually beneficial solution to the problem. In our airline example, I might offer the man in front of me a small payment for not reclining. Or he might pay me for the privilege of reclining. But either way, we will bargain our way to a solution that leaves us both better off, if there is one. One of us would object to any proposed solution that did not leave him better off.

Of course, it would be useful for bargaining purposes to have an assignment of property rights; that is, a specification that I have the right to my space or that the man in front of me has the right to recline. That way, the direction of compensatory payments would be clear – money would flow to the right-holder from the right-seeker.

What if bargaining does not produce an efficient outcome, one that both parties can agree on? That means that the right-holder values his right at more than the right-seeker is willing to pay. But in that case, no government tax would produce an efficient outcome either.

On the airline, suppose that I value the leg room preempted by the reclining seat at $10. Suppose, further, that airline policy gives him the right to recline. If I offer him $6 not to recline, he will accept my offer if he values reclining at any amount less than $6 – say, $5. Notice that we are now both better off than under the status quo ante bargain. I get leg room I valued at $10 – or course, I had to pay $6 for it, but that is better than not having it at all, just as having the airline’s cocktail is better than being thirsty even though I had to pay $5 for it. He loses his right to recline, but he gets $6 instead – and reclining was only worth $5 to him. He is better off, just as he would be if he accepted an airline’s offer of $500 to surrender his seat and take a later flight, as sometimes happens.

We cannot even begin to estimate how many times people solve everyday problems like this through individual bargains. The world would be vastly better off if we were trained from birth in the virtues of a voluntary society where bargaining is a way to solve everyday disputes and make everybody better off. That training would stress the virtues of money as the lubricant that facilitates this sort of bargain because it is readily exchangeable for other things and because it is the common denominator of value. Instead, most of us are burdened by an instinctive tribal suspicion that money is evil and bargaining is used only to seek personal advantage at the expense of others. Experienced businesspeople know otherwise, but throughout the world the Zeitgeist is working against Coase’s logic. More and more, government and statutory law are held up as the only fair mechanism for resolving disputes.

University of Chicago economist George Stigler used Coase’s logic to devise the so-called Coase theorem, which says that when the transactions costs of bargaining are zero, the ultimate price and output results will be the same regardless of the initial assignment of property rights. This is true because both parties will have the incentive to bargain their way to an efficient improvement, if one exists. The assignment of property rights will affect the wealth of the bargainers, because it will determine the direction of the money flow, but economists are concerned with welfare (determined by prices and quantities), not wealth. No government regulatory body can improve on the free-market solution.

Coase disagreed with the theorem named after him – not because he disputed its logic, but because he foresaw the results. Economists would use it to look for circumstances when transactions costs were low or non-existent. Instead, Coase wanted to investigate real-world institutions such as government to compare its transactions costs to those of the market. He knew that real-world transactions costs were seldom zero but that government solutions almost never worked out as neatly in practice as they did on the blackboard. In fact, he invented the phrase “blackboard economics” to refer to solutions that could never work in practice, only on a theoretical blackboard, because real-world governments never had either the information or the incentive necessary to apply the solution.

Why China Became Capitalist

Ronald Coase devoted his last years to learning how and why China evolved from the world’s last major Communist dictatorship to the world’s emerging economic superpower. In Why China Became Capitalist, he and his research partner Ning Wang delivered an account that contravened the popular explanation for China’s rise. China’s ruling central-government oligarchy has received credit for the country’s emergence as the growth leader among developing nations. Since the Communist Party retained political control throughout the growth spurt, it must have been responsible for it – so the usual explanation runs. Coase and Wang showed that government’s presence as the agency in charge of political life does not automatically entitle it to credit for economic growth.

The death of Mao Zedong in 1976 rescued China from decades of terror, famine and dictatorship. Mao’s designated successor, Hua Guofeng, was an economist who outlined a program of state-run investment in heavy industry called the “Leap Outward.” This resembled the various Five-Year Plans of Soviet ruler Joseph Stalin in general approach and in overall lack of results. Hua’s successors, Deng Xiaoping and Chen Yun, abandoned the Leap Outward in favor of an emphasis on agriculture and light industry. Although Deng was the political figurehead who garnered the lion’s share of the publicity, Chen was the guiding spirit behind this second centralized plan designed to spur Chinese economic growth. It placed less emphasis on production of capital goods and more on consumer goods. Chen allowed state-controlled agricultural prices to rise in an effort to stimulate production on China’s collective farms, which had failed disastrously under Mao, resulting in approximately 40 million deaths from famine. He also allowed state-run enterprises a measure of autonomy and private profit, heretofore unthinkable under Communism.

Although these central-government measures were the ostensible spur to China’s remarkable growth run, Coase and Wang assign actual responsibility to the resurgence of China’s private economy. Private farms had always existed as part of the nation’s 30,000 villages and towns, much as neighboring Russians continued to nurture their tiny private plots of land alongside the Soviet collective farms. And, just as was the case in Russia, the smaller private farms began to outdo the larger collectives in productivity and output. Mao fanatically insisted on agricultural collectivization, but his death freed private farmers to resume their former lives.  By late 1980, the Beijing government was forced to officially acknowledge the private farms. In 1982, China formally abandoned its costly experiment with collective agriculture and de-collectivized its farms. Official grain prices were allowed to rise and grain imports were permitted.

Agriculture wasn’t the only industry that flourished at the local level. Small businesses in rural China labored under official handicaps; their access to raw materials was not protected and they had no officially sanctioned distribution channels for their output. But they bought inputs on the black market at high prices and groomed their own sales representatives to scour the nation drumming up business for their goods. These local Davids outperformed the state-run Goliaths; they were the real vanguard of Chinese economic growth.

Growth was slower in China’s major cities. Mao had sent some 20 million youths to the countryside to escape unemployment in the cities. After his death, many of these youths returned to the cities – only to find themselves out of work again. They demonstrated and formed opposition political movements, sometimes paralyzing daily life with their protests. This forced Beijing to permit self-employment for the first time – another Communist sacred cow sacrificed to political expediency. This, in turn, created an urban class of Chinese entrepreneurs. This led to yet another government reaction in the form of Special Economic Zones, somewhat reminiscent of the U.S. “enterprise zones” of the 1980s. Economic freedom and lower taxes were allowed to exist in a controlled environment; Chinese officials hoped to encourage controlled doses of capitalist prosperity in order to save socialism.

Gradually, the limited reforms of the Special Economic Zones became more general. Increased freedom of market prices was introduced in 1992, taxes were lowered in 1994 and privatization of failing state-run enterprises began in the mid-1990s. For the first time, China began to replace local and regional markets with a single national market for many goods.

Coase and Wang identify perhaps the most important but least-known capitalist element to arise in China as the improved pursuit of knowledge. They accurately attribute the recognition of knowledge’s role in economics to Nobel Laureate F.A. Hayek and note the increasing popularity of books and articles by Hayek, his mentor Ludwig von Mises and classical forebears such as Adam Smith. The economics profession has pigeonholed the subject of knowledge under the heading of “technical coefficients of production,” but the authors know that this is only the beginning of the knowledge needed to make a free-market economy work. The knowledge of market institutions and the dispersed, specialized “knowledge of particular time and place” that can only be collated and shared by free markets are even more important than technical knowledge about how to produce goods and services.

The upshot of China’s private resurgence has been to make the country a “laboratory for capitalist experimentation,” according to Coase and Wang. That laboratory has brewed a recipe for unparalleled economic growth since the 1990s, leading to China’s admittance into the World Trade Organization in 2001. The final piece of the puzzle, the authors predict, is a true free market for ideas – the one thing that Western economies have that China lacks. When this falls into place, China will become the America of the 21st century.

Thus did Ronald Coase add a landmark study in economic history to his select resume of classic works.

Quality vs. Quantity

Never in the history of economics has one economist achieved so much productivity with so little scholarly output. Ronald Coase economized on the scarce resources of time and human effort (ours) by devoting the longest career of any great economist to specializing in quality, not quantity, of work.

DRI-280 for week of 11-11-12: Restaurant-Dish Takeaway and Comparative Economic Systems


An Access Advertising EconBrief:

 Restaurant-Dish Takeaway and Comparative Economic Systems

You are eating dinner in a casual restaurant with a spouse. No sooner does the last forkful of food ascend toward your mouth than your waiter whisks away the plate. His request for permission – “Done with that?” – is purely a formality since the plate is gone before you can object.

You have observed a tendency in recent years for restaurant servers to remove dishes with increasing alacrity. You remark this to your dinner companion who, unlike you, is a non-economist. Her all-purpose explanation of human behavior is binary: Is the object of study a nice guy or not? Nice guys remove dishes quickly so diners have more elbow room to relax.

You are an economist. You believe people act purposefully to achieve their ends. Moreover, you are thoroughly acquainted with tradeoffs. You have often had waiters take your plate before you were through with it. Some people bristle when they perceive others constantly hovering over them. There are even those – not you, of course, but boors and gluttons – who eat the food of others after finishing their own. One of these types might just react by snatching back his plate and declaring, a la John Paul Jones, “I have not yet begun to eat!”

The “nice-guy” explanation won’t suffice, since the quick-takeaway approach will suit many people well but others poorly. Restaurants that follow a consistent policy of quick takeaway risk offending some customers. Offending customers is not something restaurants do lightly. In order to make this risk worthwhile, there should be some strong motivation in the form of a compensating prospect of gain. What might that be?

One way to define an economist is by saying that they are the kind of people who ask themselves questions like this. And the mark of a good economist is that he can supply not only answers but also further implications and ramifications for social life and government policy.

The Economics of Restaurant Service

Americans have eaten in restaurants ever since America became the United States and before that. While the basic concepts underlying the restaurant sector have remained intact, structural changes have remade the industry in recent decades. The most important contributor has been the institution of franchising.

Fast-service franchising began was begun in the 1920s by A&W root-beer stands and Howard Johnson motel-restaurants. Baskin Robbins, Dairy Queen and Tastee Freeze hopped on the bandwagon in the 1930s and 40s. McDonald’s and Subway became big business in the 1950s. The decade of the 1960s saw restaurant franchises zoom to over 100,000 in number. After overcoming legal challenges posed by antitrust and the economic threat of OPEC in the 70s, franchising became the dominant form of restaurant business organization in the 1980s.

Franchising enlarged markets and made competitive entry easier. By standardizing both product and service, it made restaurant operation easier. It raised the stakes involved in success and failure. All these increased the intensity of competition. In turn, this shone the spotlight on even the minutest aspects of restaurant operation. Franchises and food groups ran schools in which they taught their franchisees and managers the fundamentals of restaurant success. Managers went out on their own to put those principles into practice. The level of professional operation ratcheted upward throughout the industry.

The word “professional” means numerous things, but in context it refers to the rigorous, even relentless application of restaurant practices single-mindedly aimed at achieving profitable operation. This entails developing a repeat-customer base and making the largest profit possible from serving that base.

Whether the quality of all types of restaurant food improved is open to debate, but it cannot be doubted that average quality rose. Today, the “greasy spoons” of yesteryear are nearly as scarce as passenger pigeons.

It was during this period of franchise domination that the practice of quick takeaway gained widespread currency. Maximizing the daily turnover of the given restaurant capacity is a commandment in the operations bible for profit-maximization. Minimizing the time between the departure of one set of guests and the arrival of their successors at each table is one way to maximize turnover. One way to reduce the time taken by clearing tables at meal’s completion is to begin the process before departure rather than waiting until the guests get up to leave; that way, fewer dishes remain to remove upon actual departure.

Fast removal of dishes not only maximizes turnover, it also maximizes the revenue take from each separate turnover. From the restaurant owner’s perspective, maximizing the size of each table’s check is another step toward maximizing total profit. After-dinner items like coffee and dessert are the obvious route to that goal. (Alcoholic drinks are the before-dinner complement of this strategy, which is why attainment of a liquor license is a coveted goal for most restaurants.) Quick takeaway aids this strategy in two ways. First, it speeds the transition from dinner to dessert. Second, it aids the server, who is in no position to handle dish removal when arriving at the table laden with desserts.

“Quick takeaway” has been standard practice throughout most of the industry for quite awhile, though. This doesn’t account for a recent speedup. For that, look deeper into the details of restaurant operation.

Table Size, Takeaway and… Demographic Trends?

Concomitant with the trend toward faster takeaway, the economist has also observed a trend toward smaller tables and booths in casual restaurants. Tables, chairs and booths come in standard sizes (there are five different booth sizes, for example), but the observed trend has been toward more booths designed to accommodate two people. Greater usage has been made of bar areas to provide food service, wherein diners can often obtain quicker service at the cost of table space and chairs limited to two people.

To understand the rationale for this changeover, pretend for a moment that all of the restaurant’s patronage consists of parties of two. Larger tables and booths would waste space and unnecessarily limit revenue per turnover, whereas designing for two would maximize the number of people served (and revenue collected) from an individual full-house turnover.

The link between table size and quick takeaway is obvious. Smaller table and booth sizes leave less room to accommodate elbows, books, newspapers, miscellaneous articles – not to mention additional dishes like dessert. (Technically, a smaller table doesn’t mean less room per person, but the whole idea behind the move to smaller tables is to achieve better utilization of capacity – the result leaves much less unused space available than did the larger tables and booths.) Now servers have even more reason to get those vacated dishes moving back to the kitchen, since there was barely room for them on the table to begin with. This reinforces the preexisting motivation for fast table-clearing and enlists the diners’ sympathy on the side of management, since table-crowding has become all too obvious.

There is still one major link left out of the chain of reasoning. In practice, restaurant parties do not consist entirely of twosomes. Casual restaurants usually include a few larger tables and/or booths, but what is to prevent larger parties from dominating smaller ones in the great scheme of things?

The last four decades have seen an increasing demographic trend toward smaller U.S. household size. In 1970, there an average of 3.1 people comprising the average U.S. household. By 2000, this had fallen to 2.62; by 2007, to 2.6 and by 2010, to 2.59.

Several forces drove this trend. First has been a shrinking birthrate. Here the U.S. is merely following the lead of other Western industrialized nations, which have seen shrinking birthrates throughout the 20th century. In the U.S., the shrinkage has waxed and waned since the 1930s. The 1990s saw a modest resurgence and U.S. births barely struggled above 2.0 per 1,000 early in the millennium. That is the replacement point – the level at which births and deaths counterbalance. As noted by leading demographer Ben Wattenberg and others, the large influx of Hispanic immigrants in recent decades undoubtedly spearheaded this comeback. Hispanics tend to be Catholic, fecund and pro-life. But since 2007, the rate has backslid down to 1.9; even the Hispanics seem to have assimilated the American cultural indifference to reproduction.

Other cultural forces have reinforced demography. Birth control has become omnipresent and routine. Divorce and illegitimacy have lost their stigma, thereby conducing to households containing only one parent. Whereas formerly it was commonplace for two men or two women to room together and share expenses, the legal status granted to homosexual partnerships has now placed a question mark around those arrangements. (This applies particularly to males; apparently the politically correct status conferred upon homosexuals does not much reassure two heterosexual men who contemplate cohabitation.) Indeed, it is today less socially questionable for unmarried male/female couples to live together than for same-sex couples – but this is practical only as a substitute for marriage, so its effect on household size is negligible.

The aggregate effect of this cultural attrition has been nearly as potent at the declining birthrate. In 1970, the fraction of households containing one person living alone was 17%. By 2007, this had risen to 27%.

Given this trend toward declining household size, we would expect to see a corresponding decline in the average size of parties at casual restaurants. After all, households (particularly adults) typically dine together rather than separately. Certainly, large groups do assemble on special occasions and regular get-togethers. But the overall trend should follow this declining pattern.

And there you have it. Smaller average household size produces smaller restaurant table and booth size, which in turn produces quick – or rather, quicker – takeaway of dishes at or before meal completion.

Many people instinctively reject this kind of analysis because they can’t picture most restaurant owner and employees thinking this deeply about such minute details or putting their plans into practice. But the foregoing analysis doesn’t necessarily assume that all restaurant owners and managers are this single-minded and obsessive. In a hotly competitive environment, the restaurants that survive and thrive will be those that do take this attitude. They will attract more business – thus, the odds of encountering smaller tables and quick takeaway will be greater even though those practices may not be uniform across the industry. Indeed, this reasoning supports the very notion of profit maximization itself. This survivorship principle was pioneered by the great economist Armen Alchian.

The Larger Meaning of Little Details

Economics is capable of supplying answers to life’s quaint little questions. (Some people would rearrange the wording of that sentence to “quaint little answers to life’s questions.”) But economics was developed to tackles bigger issues. It turns out that the little questions bear on the big ones.

One of the big questions economists ask about the behavior of business firms is: Is it socially beneficial? Business firms exist because, and to the extent that, they produce goods and services cheaper and better than individual households can. The gauge of success is the welfare of consumers.

Smaller tables and quick takeaway enable restaurants to achieve better capacity utilization. This enables them to cut costs and serve more customers. These are beneficial to consumers. The more intense competition serves to lower prices of restaurant food. This also benefits consumers.

What about the quality of food served? Table size and dish removal do not bear directly on this question, but the industry shift towards corporate control and franchised ownership has sometimes been blamed for a supposed decline in overall food quality. This hypothesis overlooks the analytical nose on its face – the fact that consumers themselves are the only possible judges of quality. Even if we assume that average quality has fallen, we have no basis for second-guessing the willingness of consumers to trade off lower quality for lower price and greater quantity. This is the same sort of tradeoff we make in every other sphere of consumption – housing, clothing, entertainment, medical care, ad infinitum.

The Left wing has recently developed a variation on its theme of corporate malignity in production and distribution of food. Corporations are destroying the health of their customers by purveying food containing too much sugar, salt, fat and taste. Only stringent government regulation of restaurant operations can hope to counteract the otherwise-irresistible lure of corporate advertising and junk food.

This hypothesis is not merely wrongheaded but wrong on the facts. Consumers have every right to trade off lower longevity for heightened enjoyment of life. This is something people often do in non-nutritive contexts such as athletics, extreme leisure pursuits like hang-gliding or public-service activities like missionary work. History indicates that, far from promoting public health, government has aided and abetted the increased incidence of type-II diabetes through wrong-headed dietary insistence on carbohydrate consumption as the foundational building block of nutrition.

Any objective appraisal must recognize that nowhere on earth can consumers find such abundance and diversity of cuisine as in the United States of America. World cuisine is amply represented even in mid-size metropolitan markets like Kansas City, Missouri and Sioux City, Iowa. There is no taste left unfulfilled – even the esoteric insistence on vegetarian meals, organic cultivation and free-range animal raising.

Restaurant Regulation

In order to appreciate the operation of a free market for restaurant meals, we need to dial down our level of abstraction and conduct a comparative-systems comparison. Heretofore we have conducted an imaginative exercise: we have explained a piece of restaurant operations under free-market competition. Now we need to envision how that piece would work under an alternative system like socialism.

In a socialist system, public ownership of the means of production dictates thoroughgoing, top-down regulation of business practice. For example, a regulator will pose the questions: How many booths and tables should the restaurant have? How big should they be? How far apart should they be spaced? How many people should we allow the restaurant to serve and how many should be allowed to sit at each table and booth?

In a socialist system, a regulator or group of them will ask this question in a centralized fashion. That is, he will ask it for a large grouping of restaurants – perhaps all restaurants, perhaps all fast-service restaurants, all bar-restaurants, all casual sit-down restaurants and all fine-dining restaurants. Or perhaps regulators will choose to group the restaurant industry differently. But group it they will and regulate each group on a one-size-rule-fits-all basis.

How will the regulator decide what regulations to impose? He will have government statistics at his disposal, such as the information cited above on average household size. It will be up to him to decide which information is relevant and how to apply the aggregate or collective information that governments collect to each individual restaurant being regulated. Even in the wildly unlikely instance that a regulator could actually visit each regulated restaurant, that could hardly happen more than once per year.

As we have just seen, free markets don’t work that way. One of the most misleading of popular perceptions is that free markets are “unregulated.” In reality, they are subject to the most stringent regulation of all – that of competition. But because the regulation part of competition works invisibly, people seem to miss its importance completely.

Instead of waiting for a central authority to certify its product as tasty and wholesome, markets supply their own verdict. Consumers try it for themselves. They ask their friends or take note when opinions are volunteered. They seek out reviews in newspapers, online and on television. When the verdict is unfavorable, bad news travels fast. This applies even more strongly to the aspect of health, by the way. Nothing empties a restaurant quicker than food-borne illness or even the rumor of it – as entrepreneurs know only too well.

In contrast, government health regulation doesn’t move nearly this fast. The cumbersome process of visits by the health inspector, trial-by-checklist followed by re-inspection – a pattern broken only rarely by a shutdown – is a classic example of bureaucracy at work. Political favoritism can affect the choice of inspections and the result. The de facto health inspector is the free market, not the government employee who holds that title.

Competitive regulation is decentralized. In our restaurant example, decisions about table size and restaurant takeaway are not made by a far-off government authority and applied uniformly. They are made on the spot, at each restaurant on a day-by-day basis. Restaurant owners and managers may possibly have the same government-collected information available to regulators, although it seems likely that they will be too busy to spend much time evaluating it. More to the point, though, they will have what the late Nobel laureate F. A. Hayek called “the information of particular time and place.” That is the time- and place-specific information about each particular restaurant that only its owner and managers can mobilize.

Merely because average household size has fallen over the U.S. does not mean that households in each and every individual neighborhood are smaller. It may be the case, for example, that in Hispanic neighborhoods – not gripped by declining birthrates or an epidemic of divorce – average household size has not fallen as it mostly has elsewhere. Those restaurants would not feel the urge to decrease table size and speed up dish collections in line with most restaurants. And well they shouldn’t, since they would serve their particular customers better by not blindly playing follow-the-leader with national trends.

Would centralized regulators pick up on this distinction? No, they would have to be clairvoyant in order to sort out the kind of exceptions that markets automatically catch.

After all, their aggregate statistics simply do not sift the data finely enough to make individual distinctions and differences visible.

But decentralized markets make those individual differences keenly felt by the people most affected. For restaurants, variations in consumer preference are felt by the very people who serve the consumer groups. Changes in demographic trends are witnessed by those whose very livelihoods are at stake. Competitive regulation works because it is on the spot, informed by the exact information needed and directed by the very people – on both sides of the market – with the motivation and expertise needed to make it effective.

Free markets allow participants to collect, disperse and heed information from any source but do not force people to respond to it. They do, however, provide incentives to respond proportionately to the magnitude of the information provided. A huge disruption of the supply of something will produce a big increase in price, suggesting to people that they reduce their consumption of this good a lot. A small decrease in a good’s price will offer a gentle inducement to increase consumption of something but not to go hog wild over it.

Again and again, we find ourselves saying that free markets nudge people in the right direction, towards doing the thing that we would want done if we could somehow magically observe all economic activity and direct by waving a magic wand. Economists laconically define this quality as being “efficient.”

Restaurant Economics and Rational Behavior

This object lesson in restaurant economics reminds us of a perceptive argument for free markets put forward by Hayek. He was responding to longtime arguments put forth by critics on the Left. The same arguments have recently reechoed following the housing bubble, financial crisis and ensuing Great Recession. Free markets may be logical, the critics concede, but only if people are rational. Since people behave irrationally, free markets must fail in practice, however well grounded their principles might be.

Hayek observed that the critics had it backwards. Markets do not require rational behavior by participants in order to function. Instead, markets encourage rational behavior by rewarding those who act rationally and penalizing those who do not. The history of mankind reveals a gradual movement towards more rational behavior; the widely noted reduction in the incidence of warfare is one noteworthy example of this.

The Audience Responds With a Burst of Applause

Can you imagine a nobler progression from the trivially mundane to the globally significant? That is what economists do.

And, by way of gratitude for this insight, your dinner companion rewards you by inquiring: “OK, now explain why restaurants are so stingy with the butter these days.”