Issue 11.3: Free Markets Are Efficient, but Heartless
I have said in Facebook several times, 'Free Markets are efficient, but they are heartless'. Socialists object, suggesting that Socialism is more efficient. It is not. Free Enterprise advocates argue that it isn't heartless. Of course, it is. Both objections are not just wrong, they are silly.
The heartless portion is easy enough to demonstrate. Unfettered by moderating influences, competition will lead to wealth and income distributing according to Pareto (80-20 rule). Therefore, .8^3:.2^3 means that 0.8% of the population will get 51.2% of wealth and income. Consequently, even in a very wealthy Free Enterprise system, there will be a whole lot of economic losers. Fortunately, a portion of the economic system allocates income based upon a minimum wage rather than by market mechanisms. In some jurisdictions, this is established in law, in other by custom and as a natural consequence of welfare systems not by a programmatic minimum wage. So, in the U.S.that means that $7.25 per hour will be a floor income for employed people, however. However, the rest of the economy will still follow Pareto.
$7.25 per hour is equivalent to a $1,257 per month pre-tax income and no more than $1,163 per month after-taxes. This compares to Numbeo's basic Cost of Living rate in a low cost city, such as Birmingham, Alabama, of $2,488 per month. The U.S. poverty line for a single person is $1,073 which implies that a person earning minimum wage is not living in poverty. However, I would defy anyone to find a place in the U.S. where it is possible to live on $1,073 per month. Amazingly, in 2020, despite the low hurdle, 11.2% of the U.S. population lived below the poverty line.
In the U.K. poverty is defined as less than 40% of median income after housing costs. While this results in a poverty rate similar to the U.S., it is a substantially higher standard of living and, in reality, the percent of U.K. citizens living below the U.S. poverty line is much less. On the basis of nominal currency conversion, the U.K. minimum wage is equivalent to $11.40 per hour. However, based on purchasing power, it is 12.67 Int’l$. Minimum wage rates at this level will substantially lower the income inequality caused by Pareto.
The argument that Free Enterprise is more efficient is somewhat more complex. Art Laffer has made the simplest argument. He points out that when you take money from the high producers and give it to the low producers, which can be done either by high a tax rate or by a high minimum wage, it disincentivizes both. Many people don't understand the high income side because they have never been a high producer. These people typically work very long hours and often incur non-trivial financial risks. If the government takes half their income, they will be less inclined to work that hard or take those risks. The payoff is less. For the low producers, if they are simply given money, either in the form of means tested transfer payments or through indirect government support, they will see less advantage to working harder. The statistics are difficult to find, but they do exist. Median income is less in countries with very high taxes. People pressure their governments for shorter work weeks and more days of vacation.
Also, the GDP per capita in the EU is 48,435 Int'l$ and in the U.S. 63,543 Int'l$. Government expenditures in the U.S. (prior to the stimulus packages) was 35.7% and in the EU it stands at 47%. So, the theory that government trades economic efficiency for a more robust social safety net, in addition to being theoretically supported, is consistent with the empirical evidence.
It is not my intention to denigrate Free Markets nor is it meant to support substantial tax funded social safety nets. Rather, I advocate that it be a matter of social contract and, reasonably, it should vary between jurisdictions. Essentially, by default, this is the current state of affairs. Hungary has an individual tax rate of 15% while France has a top income tax rate of 48%. The U.S. has a top tax rate of 37.0% at the Federal level and an additional income tax in the states of 0% to a top rate in California of 13.3%.
This militates against large, homogeneous jurisdictions with the same tax rates and the same social safety net programs. They blunt the dynamics of social contract negotiations. There is little or no incentive to change either tax or programs when there are no reasonable alternatives. No matter what political theoreticians might say, the most effective force for change is the ability to ‘vote with our feet’.
Of course, it is natural that the 'winners' will be antagonistic toward high cost, tax supported social spending programs and 'losers' will generally be supportive of them. This is one of several arguments against large jurisdictions with homogeneous tax laws.They blunt the dynamics of social contract negotiations. Less motivated low income workers will be inclined to move to high support jurisdictions. Higher motivated low income workers will be inclined to move to low support, but higher minimum wage jurisdictions.
On the other side, in some jurisdictions, the high income citizens may put low cost above high quality. Other jurisdictions will prefer to compete for the best low income workers and, thus, they will offer higher wages but lower social safety net benefits.
There is likely an equilibrium point where the distribution of tax rates, minimum wage and social safety net benefits will create little net migration between jurisdictions. The greater the distribution of these criteria, the less validity there is to arguments of social injustice as evidenced by income and wealth inequality.