Tuesday, December 29, 2015

Freedom Guarantees Inequality

Let’s start in grade school, the first time in life there is some correlation between performance and reward. Take any two random children. One of them will be smarter. One of them will work harder. The results of their efforts, in simplistic terms, are some combination of their native ability combined with the level of effort they apply to the task at hand. If one child produces measurable results that meet the criteria for a superior rating and the other child efforts are rated a failure, should both children receive a letter grade of C? Should all children receive a trophy even if they lose the little league game? Even children know what that trophy is worth?

Equal isn’t fair.

Let’s move on into adult life. Most people, by definition, are just average. Like most humans in matters of employment, I was not a risk taker. I didn’t want to start my own company. I didn’t want to work as a commission sales person. I don’t have a single salesman’s bone in my body. I wanted someone to give me a job. This is the approach that will be used by almost everyone in the world.

There are two inherent problems found in “working for the man.” First, you will need to cover your expenses plus contribute a reasonable profit to the enterprise or you will very quickly join the ranks of the unemployed.

Companies do not pay employees’ salaries. Customers pay employees’ salaries.

The second problem is time. It doesn’t matter if you are a world famous heart surgeon working for a great research hospital or a barista at Starbucks boiling coffee water and handing out a few pennies in change from a ten dollar bill to your customers. Your salary, whether minimum wage or something in the top 1% is limited by the number of hours you can work. In order to earn money, your presence at the job site is a necessary condition of your employment.

Assuming a free economy in which individuals are protected from immoral coercion by rule of law and property rights, your hourly pay is a direct measure of the value of your contribution to the welfare of your neighbor. If you want more money, find a way to become a greater blessing. There is a reason a man with a BS/RN earns more money than someone who pushes a lawnmower for a lawn service. I discovered that for some strange reason, the economy valued my degree in Mechanical Engineering at a higher level than my degree in English Literature and U.S. History.

Go figure.

I can’t see why any rational person wouldn’t expect to pay a heart surgeon more than someone who can spin a weed whacker. However, that is not where the one finds the greatest income inequalities in our economy. The really big numbers are generated when an individual finds a way to produce revenue without requiring their physical presence or by generating economies of scale.

In the 19th century the earnings of performing artists and athletes was limited by the size of the theaters and arenas of the day. An actor’s physical presence was required to give a performance. This limited his salary. With the introduction of new technologies such as radio, movies, and the Victrola wind up phonograph the salaries of performing artists and athletes began to rise to unheard of levels. Babe Ruth was asked why he deserved a higher salary than the President of the United States, his famous reply, “I had a better year.” while certainly true didn’t explain the fundamental change that had occurred in the economy of professional baseball. Now the amount of income the Babe could generate for the owner of the New York Yankees was no longer limited by the number of tickets he could sell to a game. The description of Babe Ruth’s exploits now could be broadcast on radio stations all over the country. Advertisers would pay top dollar to promote their products on this new medium. Today a major box office draw can earn $20 million or more working three months, the length of time required to film a movie. The producers consider it a bargain because that actor can appear simultaneously on thousands screens in movie theaters all over the world. Then the movie can appear on television, sold on DVDs, and downloaded from the Internet, generating more income for the owners of the film and for the actors even after their death.

Economies of scale can generate geometric increases in profits with mere arithmetic increases in efforts. Consider: One of my former neighbors started flipping houses on the side. He would buy a run down house from owners who need to make a quick sale for a bargain basement price. He would then spend six months or so rehabilitating the property for a quick sale at a reasonable profit. This worked quite well until 2006 when the bubble popped. He was funding this operation with borrowed money. When he could no longer make the payments, he lost everything including his own personal residence. The math worked something like this. He would buy a property for $150K, put about $85K of improvements into the house, and then sell it for $400K. Really, this is pretty much the same thing that made Donald Trump a billionaire. The Donald would buy a run down building in New York City for $100 million, spend two years rehabbing the place, and selling the finished product as a condominium development for $300 million. It maybe takes four times as long to generate 1,000 times the profit. The relationship between time spent and profitability is nonlinear. An interesting side note, early in his career Donald Trump came close to personal bankruptcy, as always debt was the culprit. However, there is an old saying, “If you owe the bank $1,000 and you can’t pay; you have a problem. If (as in the case of The Donald) you owe the bank $800 million; the bank has a problem.” Reasonable men allowed Trump the opportunity to work his way back to profitability thereby saving themselves from losses that would have cost their institutions hundreds of millions in an avoidable beat down.

This becomes even more dramatic in the stock market. It takes no more research or time to buy 400 shares of stock than it takes to buy 400,000 shares in the same company.

The same principal is at work in the development of passive income from sales of a digital product on a website. Once an independent musical artist has made a recording that can be sold from her website, it will generate income for as long as people want to hear her music. Her presence is not required once the product is in the can. I will be interested to see how this phenomenon might affect teachers’ salaries as Web based education begins to take hold. Today a teacher’s salary is limited by her presence in the classroom. Will superstar teachers command much higher salaries to develop and record course material in some brave new world of $2,000 college degrees?

So far so good; income inequality is not only fair, but it is a signal to those who have the ears to hear. Temporary shortages create opportunities for those who have the necessary skills and courage to make a quick profit. The demand for qualified experts in various computer languages and programming protocols come and go like changes in women’s fashions. Every few years we read stories about high school dropouts who are earning six figure incomes writing code for the latest and greatest operating system. Then articles are published lamenting that the market is now over saturated with unemployed programmers writing in the same language that is now considered obsolete.

The problems arise when the economy becomes distorted by direct Government coercion through punitive taxation, Government malinvestment, corruption, a politically well connected union such as the American Medical Association, or the power of a predatory monopoly such as Microsoft during the 1990s. In the past eight years we have witnessed one of the greatest transfers of wealth in history. The Federal Reserve Bank along with the Department of Treasury have mortgaged the future of our nation to benefit the major money center banks and similar “too big to fail” financial institutions. By allowing these corporations the opportunity to borrow nearly limitless amounts of money at close to zero percent interest, not only are the middle class investors and savers punished to benefit the well connected and powerful, but distortions in regulations and the tax code encourage these institutions to engage in financial engineering rather than investing in creating factories that would provide the economy with new jobs. This money, created at taxpayer expense, is also in use enslaving the naive (think student loans) or the impoverished (think payday loans). Government malinvestment seems to be the rule, rather than the exception. From bridges to nowhere to wars for no reason, hardly a day goes by without a report of Government waste, fraud, or abuse.

If there is any tectonic shift in the strata underlying the American republic that concerns me it would be the marriage between big Government and big business. We have had the military industrial complex since World War II. Today the profitability of the financial sector of our economy, automobile manufacturing, and a good portion of the health care industry is guaranteed by the American taxpayer. There is movement towards a national police force equipped with military style weapons. If this comes to pass we will have created the American equivalent of the First Triumvirate. I can assure you that Caesar’s children will not share the same opportunities given our children. Freedom guarantees inequality, but then so does tyranny.


  1. I googled the term, "bridge to nowhere," and found only one bridge that seems never to have gone anywhere. It is in Germany. More typically, they are bridges that used to go somewhere, would have gone somewhere had construction not been halted, or do go somewhere, but not anywhere that matters to their critics. I feel better for having cleared that up.

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