Month: May 2021

A Worker’s Costs

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May 30, 2021

by Steve Stofka

As an employee, a worker moves between the “work box” and “life box” each working day. The business builds the work box and defines the boundaries for the worker. A worker who is a business and thinks like a business must build a box that incorporates work and life, with a moveable wall between the two. That worker must be more conscious of total production costs or they go out of business.

Almost half of this country’s output is produced by micro and small businesses owned by a few people who take an active part in the business and have their personal fortunes are at stake. Integrating and balancing work and personal life is especially difficult and economic models don’t incorporate the distinct dynamics of these companies. Politicians on both sides of the aisle pay lip service to small business but the substantive beneficiaries of most policies are medium and large businesses who spend heavily to influence lawmakers. Forced to work from home, workers in large companies experienced the production process much like the owners of small businesses. The world’s attention was drawn to a worker’s total costs of production. Will lawmakers and economists finally incorporate the interests and concerns of workers and small businesses?

In economic models there are two inputs to production, capital and labor. In the short-run, capital costs such as plants and equipment are fixed and labor costs are variable. What are the worker’s capital costs of producing that labor? An investment in a home or apartment, in transportation, and in human capital – education, training and past experience. In mainstream economic models, an investment in a home is recognized as an investment, but not as an input to the production of labor. The compensation for the human capital that a worker invests in production is supposedly included in the wage the worker receives. Tax law disregards the costs of housing unless they are traveling expenses away from the primary place of business. How the worker replenishes their physical and emotional needs when they are not at work is not a concern for economics, the Congress or the IRS.

What are a worker’s costs to produce their labor? In the  short-run, six months or less, a worker has supplier costs that are either fixed or “sticky,” variable obligations that are difficult to shed. They have leases and financial obligations for living and transportation, for childcare, for education and other commitments to family. For small business owners and many workers during the pandemic, space in the house must be set aside for work activities. In tax law and economic models, those fixed and variable costs are largely disregarded.

Subchapter S corporations are small businesses usually owned by a few shareholders who take an active part in the business. According to the IRS, there are five million S corps. In 2017, they filed 4.7 million returns accounting for $8.1 trillion in  business receipts. In that same year, more traditional C corporations filed only 1.6 million returns, but accounted for $21.2 trillion in business receipts (IRS, 2021). Even though larger corporations were only a third of small businesses, they produced almost three times the receipts.  

Larger companies leverage that volume to win favors in Congress and state capitols around the country, and those benefits come at the expense of smaller businesses. In political science and economics, it is known as “concentrated benefits, diffuse costs,” a groundbreaking insight of Mancur Olson in 1965 (2014). The few who receive the bulk of the benefits lobby hard to protect them. The many who pay the price are hurt but not crippled by the costs and do not fight as hard for change. Olson challenged the popular notion that the majority always oppresses the minority in a democracy, showing how a minority often controls many agendas. The pandemic has highlighted the plight of the majority of workers in large and small businesses.

In 2017, C Corps deducted 98% of their total business receipts (Table 2.3). S Corps deducted 94% of receipts, but there are also costs of production that a small business owner absorbs because the deduction is either disallowed or requires too much effort to substantiate for the cost of the deduction. For employees, the rules are stacked against them. A worker making $60K per year gets a standard deduction of $12,400, or 20% of their total receipts. If an employee were able to deduct their total costs of production, that standard deduction might be more than $50,000. Employees would pay far less income tax and this would put political pressure on large businesses to pay more taxes. How do a minority of large businesses control the fate of an overwhelming majority?

In Marx’s analysis, the rules of property were a remnant of feudalism, where a small minority of aristocracy controlled the land, had a large influence in policy making, and most workers were agricultural peasants with little education. He thought capitalism was the most formidable force of production that mankind had invented but its rules of who got what were founded on the rules under feudalism – a few got most of the gains.

John Stuart Mill, a contemporary of Marx, agreed that property rights had their foundation in “conquest and violence.” Although a staunch defender of property rights, he acknowledged that the distribution of property was arbitrary and not equitable (Heilbroner, 1997, p. 135). He predicted a gradual transition to socialism where society would distribute the benefits from production more evenly to both the capital and labor responsible for that production.

Those who favor capitalism think that the owners of capital should keep all the profits from production. Those who favor socialism think that the inputs to production should determine the outputs, the profits, from that production. Many advocates on each side are convinced that they are “right.” Believers in capitalism may, like John Locke did in the 17th century, found their “right” on the Bible. Long before game theory was formally developed, both Marx and Mill understood that property distribution was decided by arbitrary rules, not some inherent right. Even Marx disagreed with his own followers in that regard, declaring that he was not a Marxist (Heilbroner, 1999, p. 151). Europeans transplanted their sense of property rights to America, where the acquisition of property was now founded on the three-legged stool of hard work, conquest and violence.  

Economic models and tax law were crafted in the environment of 19th and early 20th century industrial production. Capitalists needed workers as disposable cogs in the factory machine and there weren’t enough of them. Policymakers sold a dream to poor but hopeful people in far off countries but awarded all the profits to the capitalists. A lot of workers died in the fight for an eight-hour workday and prohibitions against child labor.

Programs like Universal Basic Income and other variants hope to alter the distribution of profits. Those who gain from the current arrangements naturally resist any change. Laws and attitudes are “sticky” and slow to adapt. The changes in work production during the pandemic may bring new awareness to the totality of the worker’s cost of production, but will that effect policy changes? Let’s hope so.

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Photo by Martin Sanchez on Unsplash

Heilbroner, R. L. (1997). Teachings from the worldly philosophy. New York, NY: Norton & Company. (p. 137).

Heilbroner, R. L. (1999). The Worldly Philosophers the Lives, Times, and Ideas of the Great Economic Thinkers (7th ed.). New York: Simon and Schuster.

IRS. (2021). SOI Tax Stats – Corporation Complete Report, Table 2.3. Retrieved May 28, 2021, from https://www.irs.gov/statistics/soi-tax-stats-corporation-complete-report. Table 2.4 contains the data on Subchapter S corporations.

Olson, M. (2012). The logic of collective action public goods and the theory of groups. Cambridge, MA: Harvard University Press.

Which Side

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May 23, 2021

by Steve Stofka

A simple economic model of production attributes equal shares to capital and labor. Why then do those who contribute the capital get to keep all the profits? In our political system, Republicans publicly advocate for the owners of capital. The political posture of the Democratic Party falls on the side of workers, but both parties often favor the owners of capital. Most of the 27 Republican led states are ending the Federal program of enhanced unemployment benefits, believing that a weaker bargaining position for workers will help business owners (National Law Review, 2021).

The combined batting average in the Major League Baseball this year is .235, near an all-time low. The ball is too dead, complain the action-oriented fans who think that the batters are the important producers of good baseball. They want more hits. Nonsense, say the fans who like a good defensive game. The pitching is better. Pitchers are the key producers. Nah, pitchers’ battles are too boring, say action-oriented fans. You want a lot of running around, taunt the defensive-oriented fans, go watch basketball. If we can argue this point about a sport, is it any wonder that we split into two political camps, those favoring capital and those favoring labor?

150 years ago, the economist Karl Marx asked why do the contributors of capital get to keep all the profits? Capitalists had more political power, an evolution of the system of property rights under feudalism. Under those arrangements, the workers were bound to the land and the landowners had all the power. Marx predicted that industrialization would continue to concentrate workers in urban areas, a radical prediction at a time when the economy was almost entirely agricultural. Through greater association, Marx thought that workers would command more political power and overthrow the system of property rights that gave capital most of the power (Marx, 1994, p. 169). Why hasn’t that occurred?

In our country, the owners of capital have prevailed, both politically and economically. Policies that favor workers are branded as communist or socialist, and in the minds of many Americans, the two are synonyms. Until a hundred years ago when Progressives enacted child labor laws, American industry, particularly cloth mills, depended on child labor. Before American independence, the colonies encouraged British courts to send them children to work in the linen mills (Abbott, 1908, pp. 18-21). The justification for laws and property arrangements that forced children to work was the Puritan belief that idleness is evil and subverts character and spiritual growth (Abbot, 1908, p. 15). Conservative values are the political form of Puritan religious beliefs.

It is no surprise that Puritan Republicans would favor laws that reduce the bargaining power of workers. They believe that it is better that a worker be employed at any wage than be idle. They can’t force workers to work – that would be slavery – so they construct a system of laws and property arrangements that “induce” workers to “voluntarily” enter employment. As a governing strategy, Republicans believe in less freedom for workers and more freedom for capital. Republicans have picked the side of capital.

Using the impetus of the social uprisings of the early 20th century, Progressives in the Republican Party helped enact greater rights for workers. In a “whose side are you on” split in the party, the Progressives broke away from the Republicans and joined forces with the Democrats in the 1910s. Republicans became the party that favored the owners of land and capital and that was the end of their ideological growth. They became a reactionary party, a party of “No,” acting with one mission – to curb the growth of Progressive policy proposals that changed the power dynamic. Republicans would be the Party of the Haves.

In The Discourses written 500 years ago Niccolò Machiavelli wrote that in any society there are two factions, the “haves” and the “have-nots.” In a discussion of which group is more likely to cause social disturbances, he reasoned that it was the haves because they “can bring about changes with greater effect and greater speed” (1983, p. 118). Republicans disagree. In their analysis, it is the have-nots, the working class, that threaten social stability. When Mitch McConnell, the minority leader in the Senate, voices dismay at the ordinary folk at BLM protests, he expresses the view of the aristocratic haves who are suspicious of any expression that threatens the power balance.  To the haves the existing power balance is social stability.

Republican states are dominated by the interests of extractive industries, the companies that mine, drill and dig to get resources from the land. These industries are a critical component of our economy but they have an extractive mindset, regarding politicians as clay to be molded to their interests and people as replaceable resources to be mined for profit. Because many of these states have low population densities, profits have a greater vote than people. To retain their own  power, Republican governors and legislators lighten the pockets of workers to pad the pockets of big industry owners.

Whether it is sports, religion or politics, each side constructs justifications as castle walls to defend their position. Each side lobs fireballs of criticism into the strongholds of those on the opposite side, and each side is ready to extinguish any criticism before it does damage. For thousands of years, we have migrated across the globe because we could not negotiate with our families or others who held power. America is the land of people who ran away from wherever they were to get away from “those people.” We’re run out of room so now we run into, not away, from each other. Will we learn to negotiate with “those people” or will we destroy each other?

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Photo by Bill Stephan on Unsplash

Abbott, E. (1908). A study of the early history of child labor in America. American Journal of Sociology, 14(1), 15-37. doi:10.1086/211641

Machiavelli Niccolò̀. (1983). The Discourses. (B. Richardson & L. J. Walker, Trans., B. Crick, Ed.). Penguin Books.

Marx, K. (1994). Selected writings. (L. H. Simon, Ed.). Hackett. National Law Review. (2021, May 22). Unemployment insurance system update, Part III: Additional states opting out of federal unemployment benefits. Retrieved May 22, 2021, from https://www.natlawreview.com/article/unemployment-insurance-system-update-part-iii-additional-states-opting-out-federal

A Hook or a Bend

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May 16, 2021

by Steve Stofka

Eight-year-old Gwen shot out the back door, soccer ball in hand. “Dad!” she yelled. He released the safety handle on the mower as she ran across the yard to him. “Mom said she’ll take me to the game but you need to help me warm up.” When her dad bounced the ball to her, Gwen made a series of estimates of the ball’s trajectory, then corrected her estimates with the actual path of the ball as it bounced along the ground to her. As the ball neared her, she made a final OLS estimate of the ball’s destination, planted her feet and swung one foot at the ball. The side of her toe grazed the surface as it skittered past her and rolled toward the backyard fence. “Darn!” she said.

The Federal Reserve has had a lot of experience at estimating the trajectory of inflation. Just as everyone gets better with practice, so has the Fed. Gwen’s use of statistical methods is instinctive and unconscious; the Fed’s approach is quite deliberate and focused on the medium term. Unlike the Fed, the stock market acts with a short-term focus. Trading algorithms trained to react in milliseconds to key words in a data release make buy and sell orders. Human traders follow their lead, not wanting to be caught out in the open. If a trader makes a wrong turn but is among a crowd of traders that have made the same turn, they are less likely to come under scrutiny. While the market jogs along the beach, the Fed cruises offshore, watching for larger trends.

Because of the shutdown last April, economists estimated a strong uptick in prices as many states and localities began lifting sanctions and people spend money. Survey estimates of April’s inflation was high, about 3.6%, but the actual report showed an increase of 4.15%. By comparing the index this year to the index in April 2019, the rise over the two years was 4.3%, an average of 2.1% per year, exactly the average inflation since the year 2000. The rise was entirely due to “base effects,” a comparison of a data point with a previous data point that was abnormally low. On a vacation trip we slow down from 60 MPH to 30 MPH as we go through a town. When we speed up again on the other side of town, we have doubled our recent speed, but have returned to our average speed.

Our inflation expectations have stabilized over the past twenty years because we have been going the same 2.1% speed averaged over each quarter. For twenty years beginning in 1980, inflation began to decline .1% per quarter. It was like riding a bike on an almost level street with a barely noticeable decline. The pedaling lessens just a bit. Since 2000, the average quarterly change in inflation is a big fat zero. Any change becomes alarming.

Inflation has increased 3% over the past three months. A similar uptick occurred in the 4th quarter of 2009 as the economy emerged from a deep recession. The Fed computes a probability of inflation being greater than 2.5% and it rose to 60% this month, an increase from 20% last month (Series STLPPM). A similar jump occurred in April 2000 and April 2005.

A mainstream economic model depends on the assumption that workers estimate price changes and respond to their estimates with higher wage demands. Karl Marx, the 19th century economist, regarded this assumption as a fanciful notion. We pay attention to prices just as Gwen pays attention to the soccer ball, but the precision of our estimates degrade over longer periods of time. Every spring we remark on the increase in gas prices. Gas prices go up in the spring every year when refineries switch over to summer gas, which is more expensive to make. Really, we ask? Funny, I don’t remember that. Next year we will forget again. We lead busy lives and don’t have the mental storage to keep track of seasonal changes. It’s why we need multiple reminders about the tax filing deadline every year.

The Fed has a lot of data and a long memory. The Fed has adopted a wait and see approach to assess whether upward price pressures are due to base effects, supply bottlenecks and price surges typical in the initial recovery. Is this a jig and a jag of the coastline or a true bend in the land? Alan Greenspan, the second longest serving Fed chairman, reacted quickly – too quickly and too strongly – to inflationary pressures in 2004-2005 after the long slump of 2001-2003. He did not want to relive the slow recovery of a decade earlier after the 1990 recession. Those policy choices helped create the financial environment that led to the financial crisis. The Fed has more effective tools and data than it did then. Experience is a good teacher.

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Photo by Jeremy Bishop on Unsplash. Coastline of O’ahu, U.S.

When Data Disappoints

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May 9, 2021

by Steve Stofka

The April labor report released this week was far below expectations. Economists expected an addition of one million jobs; the reported job increase was 266,000. Some analysts and politicians attributed the lower-than-expected job gains to generous unemployment benefits that dissuade job applicants from seeking employment. For centuries, the upper class have believed that the working class is inherently lazy, that people only work out of necessity. It is an implicit assumption of mainstream economics which is founded on the disutility of labor.

When asked to comment on the influence of “plussed up” unemployment benefits at a press conference on Friday, Treasury Secretary Janet Yellen raised a data point that contradicted that concern. States with the most generous unemployment benefits have the highest job-finding rates (White House, 2021). We would expect the opposite.

Ms. Yellen cited other factors with far greater importance. Topmost was the lack of childcare. 4.2 million women dropped out of the workforce in April 2020. Two million still have not returned. The two childcare facilities near my home in Denver are still closed.

A second factor was a mismatch of skills. Many entertainment venues are still closed. These typically employ younger workers under 25 with a modest skill set. They man ticket booths and concession stands at movie theaters. They take orders at restaurants cook food and bus tables. They stock and sort food items on our grocery shelves. Many have childcare needs, which are not being met. For these younger workers and their families, a modest wage that barely covers childcare expenses is not an attractive option.

The crunch in the construction industry has been an ongoing development for more than a decade. I spoke to a dental assistant this week, a man in his 20s. During the financial crisis, many parents with blue collar skills lost their jobs. Parents with some college education or a degree didn’t. Many kids compared their circumstances with others at school and were attracted to white collar jobs as being more permanent, even if they didn’t pay as much. This younger generation, dubbed Gen Z, experienced the disruptions to their homelife brought on by the financial crisis. Now they are experiencing another severe crisis as adults. Will they spend most of their lives seeking stability?

Economists and policymakers argue: are employers not offering a high enough wage? Are the unemployed unwilling to lower their wage expectations? The economic euphemism is “sticky prices” – that prices are slow to change to evolving circumstances. A more accurate term would be sticky contracts. Both employers and job applicants have existing arrangements – leases, childcare needs, school district preferences, mortgages, rents – at prices that are resistant to change.

The heartening aspect of this debate is that we are discussing these issues. The prior administration would call a disappointing labor report “fake news.” They would have cast doubt on the intentions of government officials who compiled the data as a conspiracy against the former President. A smart 8-year-old could tell a more convincing lie. After four years, it’s refreshing to have an adult public conversation.

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Photo by Christina @ wocintechchat.com on Unsplash

White House. (2021, May 08). Press briefing by press SECRETARY Jen Psaki and Secretary of the Treasury Janet Yellen, May 7, 2021. Retrieved May 09, 2021, from https://www.whitehouse.gov/briefing-room/press-briefings/2021/05/07/press-briefing-by-press-secretary-jen-psaki-and-secretary-of-the-treasury-janet-yellen-may-7-2021/

Different Rules

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May 2, 2021

by Steve Stofka

This past week President Biden presented some details of the American Family Plan to Congress (WH, 2021). The goal of the proposals is to restore some equity in our economic and political system. Some ask whether the estimated cost of $1.8 trillion is too much. The Federal debt just crossed above the 100% line of debt to GDP. Will the debt cause global investors to demand higher interest for loaning the U.S. money? Will the higher government spending lead to higher inflation? Could a U.S. default on debt payments and interest provoke a global financial crisis even worse than the one in 2008?

How worried are investment managers around the world who hold and manage trillions of US debt? When debt holders are worried about default, they want a higher risk premium, a higher return or interest rate on the debt they hold. When foreign investors are worried that the dollar will significantly depreciate in the next four to five years, a medium term, they want higher interest to compensate for the depreciation of the dollar. When we compare international interest rates in the medium term, we don’t see worry reflected in higher interest rates. We see that the rest of the world is treating U.S. debt as though it were cash.

A mix of interest rates for U.S. debt is 1.61% (UST, 2021). Around the world, Germany’s debt is considered a benchmark of safety because the country has a strong credit rating and is a prudent manager of their finances and economy. Germany’s interest rate mix is a negative .36% (FRED, 2021. Details on the data series are in the footnotes at the end of this blog). The difference between those two rates indicates how much foreign holders expect the U.S. currency to depreciate over several years – about ½% per year. Unlike Germany, the U.S. has total control of monetary policy so that is worth at least ½% annually in risk premium. The real interest rate on the U.S. debt is about 0%, the same rate as cash. How much U.S. debt does the rest of the world hold?

The Congressional Budget Office estimated that the rest of the world owned 40% of all U.S. publicly held debt at the end of 2019 (CBO, 2020). That percentage has probably changed since the pandemic, but I’ll use that as a proxy for the percent of the currently held public debt of $21.6T. Given that percentage estimate, money managers around the world own $8.6 trillion of US debt at an effective average real interest rate of 0%. Why would they do that? A large part of U.S. debt is being used as an effective currency.

The percent of circulating currency in the U.S. to GDP is almost 10%. Remember that currency is a liability of the government that issues the currency. If US Debt held by the rest of the world is $8.6T, then it is about 12.7% of an estimated $68T in rest-of-the-world GDP. The Fed is often accused of “printing money.” We could replace $8.6 trillion of all foreign held debt with cash and the liability would shift from the U.S. Treasury’s balance sheet to the Federal Reserve’s balance sheet. Since the Federal Reserve is also an agency of the U.S. government, it is like moving an I.O.U. from the left pocket to the right pocket. Why are the rules different for the U.S.?

It is the leading economic power and, since WW2, the global financial leader. As the leader, the U.S. is responsible for a global medium of exchange. When Britain was the world’s financial leader the pound and British debt was used as cash around the world. Isn’t gold or silver supposed to be that global currency?

The world has never formally adopted a gold standard. After the war of 1870, European nations agreed to a gold standard in the hopes that this dependent interconnection would prevent another world war. It didn’t. Countries cheat when they want to go to war. Despite the gold standard, Britain’s pound and her debt was the dominant currency around the world. Consols, a perpetual bond that never came due, were first issued by Britain in the 18th century. They were finally retired a few years ago. Anything that will reliably hold an agreed upon value will do as a currency, including debt.

What would happen if the U.S. defaulted on its debt tomorrow? History provides a guide. After WW2, Britain’s debt held by foreigners was about 1/3 of its GDP. It’s economy crippled by the war, that debt was forgiven. The world kept on turning and the U.S., its primary debtor, became the dominant economic power and financial leader. The U.S. debt held by foreigners is currently 39% of GDP, a bit more than Britain’s was after WW2. Should the U.S. default or be unable to pay its interest, China, the largest U.S. creditor, would probably become the financial leader.

The debt of the U.S. has not been paid off since 1835. On the books are remnants of debts from past wars, international and domestic. They include Civil War debts, expenses from WW1 and WW2. Once the U.S. became the financial leader, it was expected to foot the bill for global stability just as Britain had done for 150 years. The U.S. debt includes the war debts of Britain, France and Germany, and partial forgiveness of bond debt from the 1980s crisis in Latin America. It includes war expenses for the Vietnam War and other wars meant to bring global stability. The financial leader of the world carries some of the world’s debt on its books. If China were to take the leadership position, it would assume some of that past debt and become the bearer of those global responsibilities.

Despite its vibrant people, culture and economy, China has an autocratic system of governance. As President Biden noted in his speech this week, Chinese leaders believe that democracy is an outmoded political system. Would I feel comfortable with China as the financial leader? No. I’m an American who has known only the U.S. dollar as the dominant world currency. I have lived in British countries where the people were not comfortable with U.S. leadership. Americans are used to U.S. dominance. Others see only the privileges of being the financial leader and regard the American attitude as arrogance. With that privilege comes extraordinary responsibility and expense. The rules are different.

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Photo by Sharon McCutcheon on Unsplash

CBO. (2020, March). Federal debt: A primer. Retrieved May 01, 2021, from https://www.cbo.gov/publication/56309

U.S. Treasury (UST). (2021, March). Interest rates and prices. Retrieved May 01, 2021, from https://www.treasurydirect.gov/govt/rates/avg/2021/2021_03.htm

White House (WH). (2021, April 28). Fact sheet: The American Families Plan. Retrieved May 02, 2021, from https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/28/fact-sheet-the-american-families-plan/

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These data series can be view at the Federal Reserve web site, https://fred.stlouisfed.org/

Trade-weighted exchange rate is 112.44 (DTWEXBGS). Germany’s interest rate mix is -.36 (FRED IRLTCT01DEM156N). The percent of circulating currency to U.S. GDP is 9.5% (CURRCIR / GDP *100). Publicly held Federal debt is $21.6 trillion (FYGFDPUN).