George Reisman’s Pepperdine Lectures: “Micro” Lecture 13B

From George Reisman’s Program of Self-Education in the Economic Theory and Political Philosophy of Capitalism: the Pepperdine lectures.

Lecture Micro 13B The Productivity Theory of Wages II Supplement 8 [mp3; youtube]

 Transcript

[Via Youtube and Grok]

Self-Correcting Mistakes in Relative Investment

0:00

In certain lines, the effect will be a low rate of profit, and if it’s really a lot of investment losses to the degree that we have inadequate investment in other lines, what’s the effect on the rate of profit there? And it goes up. So the very consequence of making mistakes in the relative over-investment and overproduction in certain industries and relative under-investment and relative underproduction in other industries, the very consequence of such mistakes is low profits or losses in the cases in which there has been the mistake of relative over-investment and overproduction, which obviously puts a stop to the further over-expansion of those industries and will operate to reverse it, and the premium profits in the industries with inadequate investment—well, that creates an incentive and also provides the means for stepped-up investment.

1:00

So it’s in this way that the mistakes made in relative levels of investment in different industries are self-correcting. They produce consequences, the effect of which is to throw things in reverse. And it’s, uh, we’re precisely for this kind of reason that, uh, people often talk about, uh, the automatic mechanism of the market—compare it to an automatic governor on a machine, a thermostat on a boiler. You know, a boiler may heat the temperature in a room too hot; that expands some piece of metal, which then shuts the boiler off. If the temperature cools down too much, the piece of metal contracts, turns the boiler back on. If a machine is going too fast, there can be an automatic governor on it that slows it down. If it’s not fast enough, the same gizmo speeds it up. And the uniformity of profit principle is very analogous to that.

2:00

Yes, Mr. Levy. Is the reason for this because the profits are being distributed against a smaller base? Is the reason that the profits are being distributed against a smaller base of investors? No, I don’t think so. That’s, uh, there’s too little capital relative to the demand, so if we have too little capital, too little supply of the item relative to the demand, that results in a premium price, a premium profit margin, a premium rate of profit. And by the same token, if we have too much investment, too much production, we’ll have a temporarily low price, a lower, negative profit margin, lower, negative rate of profit.

2:47

Could I ask for an account? Okay, the bubble. Uh, we certainly had a relative over-expansion in telecommunications equipment, and, uh, I read that there was some telecommunications equipment, uh, selling for 10 cents on the dollar compared to what had been paid to buy it. Now that is an example of a relative over-investment. That industry went way too far. That would not be among the usual or ordinary mistakes that would be made. The market left on its own would be very unlikely to carry things that far.

3:28

Uh, in the, uh, in the bubble, and in all bubbles, uh, there’s another phenomenon going on that creates the artificial appearance of more capital available to invest than is actually available. Uh, you have the expansion of the money supply, uh, lending it out in the form, introducing it into the economy in the form of new loans to business. So the appearance is created of more capital, uh, being around than is in fact there, and so undertakings have begun for which the actual supply of capital is not sufficient. And that’s where the relative over-investment occurs. And this is greatly exacerbated to the extent that new and additional money is going into the stock market and driving up stock prices. If you think of the extent to which people calculate their wealth on the basis of the value of their stocks—well, a bubble in the stock market creates the delusion of more capital throughout the economy and can result in really gross, disproportionate investment.

Examples from the Dot-Com Bubble

4:37

Example: I remember the bubble, listening to a radio show about the, uh, Procter & Gamble evaluation. However, the hospital that was invested in communities—was that the demand for soap should come on? You’re saying that Procter & Gamble stock decreased in the bubble? Well, uh, I’m not familiar with that. That would be highly unusual. Very few stocks were decreasing in the bubble unless they had some really, uh, special problem. So I don’t know what the story of Procter was. That the capital was, was white from traditional to high tech? Yeah. So I’m trying to associate that. Well, uh, it’s conceivable. I mean, people are thinking high tech is going to be so profitable, and here’s Procter & Gamble in a stodgy old industry, so let’s invest all the more heavily. Well, then that would qualify.

5:38

Yes, Mr. Severn. In the industry, we had many retirees abandoned value-type stocks, and on average, you have these funds that were very consistent over time. They weren’t down a lot, but they were down, you know, one to five percent that year in 1999, when growth stocks had taken off. So there was that little shift, although it was temporal. Okay, because we’re people who are saying, well, I got to get in on the action. Yeah, okay, exactly. So yeah, the band—they abandoned what is treated them well over the years, yeah, went over here and bought lottery tickets. Okay, yeah. All right. Well, to that extent, uh, you’d have not only this relative over-expansion, but, uh, possibly some withdrawal of capital from, uh, some of the industries.

6:32

Okay, so, uh, I want to make you aware of the fact that, uh, mistakes of relative over-investment and overproduction, relative under-investment and underproduction, in a free market are self-correcting. They’re self-correcting. And the same applies, uh, in cases in which an industry is extraordinarily profitable for a time. Well, uh, what’s the effect of its extraordinary profitability on investment in that industry?

7:07

Find me. Okay, there’ll be a stepped-up investment, and that will operate to bring down that high rate of profit. So this is why you can read stories every so often, uh, the profits in this or that industry are absolutely outrageous; the government should come in and do something. Well, if the government does nothing, the market will take care of it because the very height of the extreme profit will provide the incentive and means for stepped-up investment.

7:38

Yes, Mr. Underwood. Does that apply even if the businesses, the, if it, if new technology is continually being brought in? Okay, that’s a very good question: what about continuing new technology? Uh, I’d like to postpone that for a few minutes, uh, because, uh, I intend to deal with that under number three: the need of businessmen to introduce continuous improvements in production. And that, I think, is the best place to address that.

Incentives in Free Markets vs. Socialism

8:13

That’s something. All right, are you asking what is the case with a socialist economy, because I’ve said only a free market? Well, in a free market, uh, you have the incentive of profit to bring about stepped-up investment, and you have the incentive of loss or low profit to withdraw capital. Now, in socialism, does any individual official lose any of his personal wealth? Or even in our economy, insofar as the government is involved in running anything—if a government enterprise takes a loss, imagine the post office takes a loss—does the Postmaster General, or whatever the title of the individual now is, or any member of the congressional committees overseeing the post office, uh, do they lose any of their wealth? So does anyone anywhere have a personal financial incentive to, uh, stem losses of government enterprises? Were to be profitable—is any government official legally allowed personally to profit from it now? So what do you think is the government’s response to any mistakes it might make of insufficiently doing something or excessively doing something? Should we expect there to be any kind of automated or automatic corrective mechanism?

9:41

But I mean, well, they have no incentive to really move, uh, so, uh, you can expect that the same kinds of response will apply. It’s a very, very important matter, uh. This is the whole price system does not really apply to socialism because of the absence of profit and loss motivation, plus no possibility—if you have a whole socialist system—of possibility of competition.

10:18

Okay, so now also you should realize that the bigger the mistakes, the harder they are to make, because if you have a modest mistake, all right, that means a modest reduction or increase in the rate of profit. A bigger mistake means a greater reduction or increase, so you’re leaning against more powerful counteracting forces of correction. So it’s very, very difficult for a mistake of over-investment and overproduction in normal circumstances—unless fanned by credit expansion, this process of creating new money, introducing it in the economy in the form of new loans—unless fanned by that sort of development, the size of mistakes will typically not be very great.

11:12

And the very fact that people want to make profitable investments—and more profitable rather than less profitable—and they want to avoid losses—that leads them to try to avoid, in the very first place, stay out of any kinds of investments in which there’s, there appears to be over-investment and overproduction or that have such a prospect. Rectify anyone else’s mistakes of under-investment and underproduction—jump in to where the returns are expected to be highest. So this operates to, uh, hold down the number of such mistakes because people are exercising forethought of a kind that operates to minimize the mistakes in the first place. And this is reinforced by the fact that at any given time, most of the capital in the economy will be in the possession of people who have avoided the mistake of over-investment and overproduction and have done, uh, reasonably well in rectifying others’ mistakes of under-investment and underproduction.

Consumer Sovereignty and Shifting Production

12:29

All right, let me say a little bit about this second point: the power of the consumers to shift the course of production—consumer sovereignty, point two. Now imagine that we had a uniform rate of profit having been realized, and now some change occurs for whatever reason. The consumers decide they want more of some products, less of other products. An example in recent years: people change their diet patterns. A few years ago, lots of people were switching out of fatty foods—foods they thought had high cholesterol—and so that was red meat and into things like chicken and fish.

13:18

Okay, if we started out with the, uh, cattle industry having a comparable rate of profit to chicken-raising and fish-farming and fishing, uh, what’s the effect of large numbers of consumers deciding they want to change their diet plan on the rates of profit in these industries? Pardon me. Okay, with the rate of profit in beef goes down; the rate of profit in chicken and fish goes up.

13:50

Okay, now what is the further effect in response to these changes in the relative rates of profit? What would be the effect on investment in beef production? We’ll go down. Capital we’ll be withdrawn from beef production. An additional capital will be invested in raising chickens and, uh, and fish. And so what’s going to be the effect on the rates of profit in these industries?

14:22

Okay, cattle will be coming back up; chicken and fish will be going back down. So we’ve had a change in the pattern of demand, which initially operates to reduce the profits where demand has fallen, increase the rate of profit where demand has risen. But then, in response to this change in the pattern of demand, there is a change in the state of capital investment: less capital is invested in the lines where the consumers want less; more capital is invested in the lines where consumers want more. And this would go on until again the rate of profit were equalized.

14:58

Well, what would be different after the rate of profit were equalized again? What would be different compared to the way things were at the very beginning? We started out: beef production was at a certain level; fish and chicken production was at a certain level. And now the demand for the one has fallen; the demand for the other has increased. So what’s going to be different?

15:28

The ratio of investment. Okay, when you say the ratio of investment, do you mean the amount of capital invested? Okay, so what’s going to be the effect on the size of the industries? What’s going to be the effect after the dust has settled and the rates of profit are once again, uh, comparable? Uh, what’s going to be the effect on the size of the beef industry compared to what it was before, and the size of chicken- and fish-raising compared to what they were before? Find me.

16:07

Okay, beef will have shrunk, and fish will have expanded. So the permanent effect of this change in the pattern of consumer demand is a change in the relative size of the industries. Notice: the consumers have it in their power—and regularly exercise that power—to change the relative size of the various industries in the economy simply by changing their pattern of spending. Wherever the consumers want more, the immediate effect will be to make such industries more profitable; where they want less, the immediate effect is to make such industries less profitable. The further effect is a stepped-up investment in the industries where the consumers wanted more; diminished investment in the industries where they wanted less. And the economy is readjusted, re-patterned to fit the change in consumer demand.

17:04

What if the consumers decided they didn’t want to buy anything any longer of a certain industry? I suppose people—I suppose everybody decided to quit smoking. Then what would happen to the tobacco industry? How much capital would remain invested in tobacco and cigarette production?

17:33

Okay, so capital certainly would be shrinking. Now you see, it’s one thing if, let’s say, we started out half the population—half the adult population—smoked, and we had a cigarette industry geared to producing for half the population. And now we—it falls to 40 percent of the adult population smokes. Uh, that would cut the rate of profit; make the tobacco industry smaller than it was. But suppose it continues on down: it’s 30, 20, 10, zero. Then what is left of the tobacco industry? Nothing. It’s gone. So if there’s something that the consumers just don’t want, it cannot remain in existence. Anyone producing it will find he’s producing something that he can’t sell or can’t sell out of profit, so they’ll stop.

18:29

Now, typically, we don’t take an industry all the way to the point of extermination, but that would happen if there just were no customers. If there’s to be any industry of a certain type, uh, it’s necessary that there’d be enough customers to cover the full costs of whatever size of the industry remains, plus provide a competitive rate of profit—as good a rate of profit as can be earned in other lines of investment. And if that’s not the case, the industry heads for extinction.

Application to Illegal Industries and Risk Premiums

19:04

Does it only work in legal industries? You suspect maybe not in illegal industries? How would, uh, it would work in industries that both legal and illegal. Let’s apply it to narcotics. Suppose people decided that narcotics was really self-destructive, and they weren’t going to use them. Talk about, yeah, intervention. I’m just saying it’s—if it became legal with deep narcotics, for example, would that decrease return investment period? Okay, oh, I see what you mean. All right, right now in the narcotics industry, for those who can get away with it, there’s a premium rate of profit. You risk going away to jail for a long period; you also risk being killed by rival dealers. So there are high risks associated with it.

20:00

Now let’s imagine the prevailing rate of profit in the economy is about 10% or whatever. Do you think anyone would say, “Wow, if I can make 11% dealing narcotics, that’s for me”? I don’t think so. So this—where there is, uh, an undue, an unusual degree of risk, uh, social opprobrium, uh, in such a case, there can be a premium rate of profit to compensate for these negative elements. So never even out? In that case, they would tend to be a premium compensating for the extra degree of risk, social opprobrium, any kind of negative.

20:49

Uh, by the same token, there can be instances where the rate of return might be somewhat lower—like if you have an extra-secure type of investment; there the rate of return can be somewhat lower. So this tendency toward equalization of rates of return applies, other things being equal: the degree of risk, social opprobrium, whatever. Yes, Mr. Traxler. Um, mentioned that who were changing sizes.

21:21

Yeah, the only thing that could also happen if there’s under-investment in an industry because against the rate of profit would apply equilibrial and other industries, but you would probably see a shrinkage, and possibly that industry could cause people in the same substitute another product, another in another industry. So that under-investment would cause some shrinkage in itself.

21:58

I think you’re referring to the fact that if there is a relative under-investment, underproduction, the price of the product will be at a premium. And in response to the premium price, there’ll be a reduction in quantity demanded along the given demand curve. I’ll stay along the lines—say [Music] consumers [Music].

22:28

Yeah, now I think that’s the very kind of situation I was naming. Let’s suppose we have some part of the oil production is knocked out by terrorists, so we have a reduced supply of oil. The price of oil will go up. In response to the higher price of oil, what will happen to the quantity demanded? It’ll go down. Okay, now that is not something making the production of oil less profitable. It’s simply an adjustment to the reduced supply and higher price. What would equalize the rate of return would now be: here is oil production which has gotten more profitable. So what incentive should that provide, and what means should it provide? That your bride in incentive and means to step up oil production.

23:19

Now let’s imagine we had a very extreme case. Suppose there was no possibility of increasing the production of something. Such a case was developed a couple hundred years ago by David Ricardo. He cited the case of wines of a special quality grown from grapes produced from grapes that can only be grown on a soil a very limited extent. So suppose there’s a certain flavor of wine; it requires grapes of a kind that have to be grown at a certain elevation with a certain temperature, a certain wind, etc., etc. And there’s only a thousand acres in the world that qualify for this, and we’re producing as much as we possibly can. I know the price of this wine might be very, very high—a couple hundred bucks a bottle, perhaps.

24:15

All right, can anyone figure out how the tendency toward a uniform rate of profit would apply in a case of this kind? Just think: what is it that limits the ability, uh, to produce these, uh, special grapes? But let’s say the demand is inelastic, whatever, and there’s a price that is setting the wine high enough to limit the quantity demanded to the limited supply that can be produced. And so it costs you only so much in wages and materials and equipment to produce the grapes, to make the wine. What is the limiting element in production? What, what element, what part of capacity?

25:02

What the land? It’s the—it’s the land, a very limited extent. All right, what do you think would be the effect on the price of such land if this land can yield a product of exceptionally high value, and it’s the key limiting element, and you have a product that is much more valuable than the ordinary costs of production—the labor costs, the equipment costs, the chemical fertilizers, whatever? Um, imagine that if you just calculated the capital invested in the casks in which you age the wine, the capital that needs to be invested in paying the, the wine growers, the capital that needs to be invested in any kind of processing operation—uh, suppose the rate of return calculated on that part of the capital alone—imagine that we’re 40 or 50 percent. That would be a huge rate of return. And here you are: if you will provide the capital—that amount of capital—and plus you can get hold of the land, you’ll make this, uh, high rate of return. How would this affect—what would be paid for the land?

26:24

The land would go to such a premium; the price of the land would go so high that when you calculate—when you added in its value as part of the capital invested—you’d have the uniform rate of profit again. So even when you can’t expand production at all, the whatever it is that is limiting the output—that will acquire a premium capitalized value such that the extra profit will yield only the going rate of return on this enlarged capital base.

Limiting Factors and Capitalized Value: Taxi Medallions Example

26:54

Uh, you can see an example of the same principle. Is anyone familiar with the New York City taxi cab industry?

27:08

Yes, you need a medallion affixed to the hood of the cab. Now, a new cab—what may cost up to twenty thousand dollars, twenty-five thousand dollars, whatever. You don’t have to be a genius to drive a cab, but in order to drive a cab legally and pick up passengers for hire while cruising the streets, it’s required that you have one of these medallions. And the city council of New York essentially stopped issuing them or froze their number, uh, at about 12,000 back in 1938. It was a little under twelve thousand; a few years ago they added a few hundred, so it’s still limited around twelve thousand. And, uh, the last time I heard, the price of one of these medallions was over two hundred thousand dollars.

27:58

Now, why do you think anyone would pay two hundred thousand dollars for a taxi cab medallion? Well, similar, but the reference by me it represents people. Yes, it’s the capitalized value of a premium future income. And what creates that premium future income? The limitation, the license. So you’re willing to pay a premium. And when you calculate the premium, then the rate of profit in operating a New York City taxi cab is not so high relative to anything else. So where you have a limiting element on the supply side, and the production and supply just can’t be expanded, then a sufficiently high value will end up being attached to that limiting element—so that that high value will bring the rate of return down toward the general level.

29:03

Yeah, yeah, I understand how the principle will work if there was just this land that would be used, that, you know, that the people that want to work in that industry want to purchase this claim. Yeah, but if you own that land, your, your profit’s not limited by, by that part of your capital. I mean, as I said, that fixed assets—that’s never gonna, for a profit standpoint, isn’t going to increase. Correct. Wait.

29:29

Here you are: let’s say you own some land, right? Okay, and maybe this has been in your family for generations, okay? And, uh, you’re, you personally are just incurring, uh, relatively minor costs of production, and you’re selling your product at an enormous price. So if we calculated your capital as only what has been invested in your agricultural equipment, your payroll, etc., then your rate of profit would appear to be stupendously high. Uh, when we say there is this tendency toward a uniform rate of return, we have to allow for the fact—we have to allow for the market value of the land. The market value of such land as the, the ownership of which is the precondition to earning this huge, uh, profit—it would have a very high market value. And the rate of return calculated on that basis is what would be tending toward uniformity.

30:35

Yeah, okay. Now, if you had someone—let’s say there’s some present-day cab driver whose grandfather was a cab driver too, and he got his medallion, or great-grandfather in 1938 for ten dollars or whatever, and it’s been passed down, uh, generation to generation—maybe whose book value of the medallion is ten dollars, and he’s earning the premium income corresponding to 200,000 of additional investment—uh, it might look like, uh, he’s earning a very high rate of profit. But we’d have to bring in the market value of the medallion.

31:11

Okay, well, this point about the power of the consumers to shift the course of production—and it’s a consumer buying patterns that determine the relative size of all the different industries. Why, for example, is the automobile industry, uh, so much larger than the book-publishing industry? Does that have anything to do with the way people are spending their money—of their funds—in buying automobiles than, than books? And that’s what brings about a much heavier capital investment than the auto industry. The kinds of products produced—that reflects consumer demand.

31:57

Why is it that some part of the publishing industry is, uh, bringing, bringing out new editions of old classics like Shakespeare and whoever, and another part is bringing out pornography? What does that have to do with the pattern of consumer demand?

32:23

Accordance with the demand. Now, if there’s something that they publish that the public decides it doesn’t want to buy, and what will happen to the continued publication of such material? It’ll cease because it won’t be profitable. And the same thing applies to breakfast cereals. You know, there, I believe there have been congressional hearings where executives of the breakfast cereal companies are grilled by congressmen: “Why are you producing these cereals with a high sugar content? Don’t you care about the cavities of the children and all?” Well, you get—it’s hard to avoid the impression that business firms get some kind of perverse pleasure out of producing unhealthful products, salacious literature—that they’re getting their kicks from harming the public in one way or another.

33:18

Well, why do you think they produce sweet cereals rather than supposedly nutritious ones that don’t taste particularly good? Understand? Because they want to sell them. If the children sitting in there at the table or whatever—if they were knocking over the bowls of sweet cereal and saying, “This is disgusting junk,” and insisting on porridge or whatever—well, what do you think would be the effect on the kinds of products the breakfast cereal companies produce? And then they produce porridge. They’re driven by demand. It’s not the case that they somehow decide they want to produce some bad set of products, and then they manipulate people into buying them.

33:59

Yeah, now you see, it’s amazing the congressmen can concentrate their ire on the business executives, but the business executives who are really just carrying out the will of the buying public. And these congressmen are in a position really of overriding—implicitly—the will of the consumers. They make it appear that they’re overriding the will of some vicious capitalist pig executives, but what they’re really doing is attempting to overturn the choice of the consumers.

Innovation and Unequal Profits

34:31

Now, uh, let me turn to point three, which will connect. Uh, I think it was, uh, either Mr. Underwood or Mr. Traxler raised the question earlier about, uh, technology. And notice we have, uh, this principle of a tendency toward a uniform rate of profit. We certainly don’t observe a uniform rate of profit at any given time. Rates of profit are very unequal when we look across the entire economy. It’s just a tendency. And one of the things that works to keep the rate of profit non-uniform is innovation. That’s the major factor, I think, that maintains inequalities in the rate of profit: continuing innovation. And I refer here to the need of businessmen to introduce continuous improvements in production and do it ahead of their rivals.

35:31

And let’s just look at this. Confirm introduces some improvement in its product. We can use the automobile industry. There was a time early in the 20th century when automobiles had to be started using a hand crank. I’m sure you’ve all seen movies where someone has to get out in front of the car in the rain, and he’s cranking up the engine. And I, I don’t know when this ended—maybe around World War One, thereabouts.

36:08

I now imagine the position of a company that introduces the self-starter: the—it alone has the self-starter. What’s going to be the effect on its market share, its profit margin, and rate of profit? Okay, it’s going to be very high. This will be an extremely profitable technology, circa 1910. Okay, but now this company is doing very, very well. What is the effect on the sales and profits of the other automobile companies that don’t have this improvement? They’re down. So here we have a significant inequality in profits within the same industry.

36:47

Uh, what do you think would be the response of the other firms in the auto industry? Uh, just as fast as they can to duplicate—as soon as they possibly can. And once they do—once something like the self-starter becomes the general standard of the industry, once everybody’s got a self-starter—can any special profit any longer be made from it? No. Then the rate of profit is brought back down. The low rates of profit of those who hadn’t had the innovation—as soon as they match it, their low rate of profit will be restored to the normal level; the premium profit will be brought down.

37:28

Yeah, now if you see—notice: you have high profits from innovation. There are high profits from innovation if you introduce an improved product. That’s the source of high profits—so long as it’s not the general standard of the industry, so long as you’re alone in doing it, or you don’t have too many, uh, others duplicating it yet. Similarly, if you can produce your product at a lower cost of production and charge the same price as the others—but your costs are lower—you’ll have a premium rate of profit, too. But again, what will the others do as soon as they learn of your premium profit? Uh, what would they be attempting to do? Duplicate your cost-cutting efficiency.

38:12

And once they have, what will you be able to earn a premium profit on the basis of that cost cut over and over again? There was a time in the 19th century when some firms—I guess notably Carnegie Steel, the predecessor of United States Steel—I believe they were the first in the United States to introduce the Bessemer process of steel-making, which represented a major improvement in efficiency, a major reduction in cost. And they profited very, very handsomely. How long has it been since any steel firm has been able to profit because it uses the Bessemer process—if anyone still does, if that hasn’t been entirely superseded by still more efficient methods?

38:58

Okay, so no one can profit from that. No one profits because their automobiles have the self-starter. No one is profiting because their trousers come with zippers. There are all kinds of things that in their day were a source of special profits but have long since ceased to be. The premium profits attached to improvements in products—so long as they’re not yet the general standard—and more efficient methods—so long as they’re not yet the general standard—but once they become the general standard, those premium profits are eliminated. Well, what do you have to do if you want to maintain a premium rate of profit over a long period of time? Well, you can have patent protection, and that will extend your profitability for some time. But if you wanted to have a premium profit after the patent expires, they have to have further innovation.

39:58

You see, any innovation can be profitable for a limited period—even with a patent—but then the special profit, once the technology is known and others are able to duplicate it, the special profit is eliminated. You can go on earning a special profit, but then what’s required is further innovation. And I think perhaps the best example of this—of all right—from our own time is Intel. Uh, 20 years ago, the hottest thing in computing was the 80-286 chip, and Intel was in the forefront of producing that. And then they made very good profits off the 8286. Well, how long would those profits last once others—like AMD, then whoever else was in the industry—once they’re producing the 286 also? Is the 286 any longer especially profitable?

40:56

So what did Intel have to do to maintain its profitability? The 386. And then the same story, and now the latest is the Pentium 4. Now notice, uh, the high profits last only so long as you’re in the forefront or early in the process of innovation. And if you—you stop; if you fail to continue to innovate, your premium profits will be eliminated. And if you stop innovating and others continue, then what happens to you? And if you do not catch up to them fairly fast, where do you end up? You’ll be out of business. You’ll be driven out of business.

41:44

Merely to remain in business at all, how? You have to adopt innovations. It’s just a question of how soon: you may not be the very first, but you’ll have to adopt the innovations of the leaders as soon as you can—so as not to be passed by too great a margin, or you’ll be driven out of business. So a major aspect of business activity is continuous improvement. Yes, Mr. Feldman. Yeah.

42:17

Kodak. Now, Kodak has had to abandon ordinary film developing—unless others are doing it more efficiently. There was a Polaroid—Polaroid was a major innovator after World War II: these self-developing pictures. And now that process has been made obsolete by digital photography, and they didn’t catch up quickly enough—nor Kodak. So no one is safe permanently. Any firm, however big, however wonderful its past accomplishments have been, it can end up going out of business the event does not continue to be a leader in innovation, and others start to get too great an advantage over it. So no, no one’s, uh, status is secure indefinitely.

43:09

Now there’s a question over here. Mr. Okay.

43:16

All right, now that we look at this a little bit further: there’s a premium profit when an innovation comes on, but then the premium profit is eliminated through competition. And to continue a premium profit, you need further innovation. Okay, we’ve established that. What does this imply about who is ending up pocketing—in the long run—who is gaining the benefit of all these innovations? The consumer, the general consuming public. The general consuming public is getting progressively better products at lower and lower prices. The public is ending up with better and better products at lower and lower prices.

How Profits Drive Production Expansion

43:59

Now, um, there are a number of things to say. Uh, I make a point here: how the concern with profits expands production in the economy. Now, insofar as profit is the incentive to introduce new, improved products—if it’s the incentive to replace the wooden plow with the iron plow, the iron plow with the steel plow, the horse-drawn steel plow with a tractor-drawn steel plow, and on and on and on—well, in from such examples, you can see how the profit motive is operating to expand production, improve production. But I want to develop the implications just of the quest to cut costs: how cost-cutting operates to expand production in the economic system as a whole.

44:48

The more we can reduce the cost of producing any particular item, the more—whether we are aware of it or not—the more we’re tending to increase the ability to produce in the economy as a whole. Now, what is one very major—not the only way, but perhaps the most prominent way—of cutting costs?

45:25

The labor-saving improvements. Labor-saving improvements, uh, that was that underlay practically all machinery: produce using less labor. All right, well, what is the connection between producing any given product—any given quantity of a given product—with less labor? How can we connect that to increasing production in the economy as a whole? Is released, and it didn’t die off; it’s there, available to produce. So whatever it had been producing, we now continue to produce that using fewer people, and the people we no longer need—they’re available to produce more of something else, or maybe even more of that same thing, but more of something. So to the extent that we attempt and succeed in producing each given thing with less labor, we’re making the labor available to produce more of other things.

46:32

You’re also elevating, of course, so that sophistication is only the products would—I argue, if I understand the correction correctly, that a side effect of this process of improved products and methods of production is that the labor force becomes more improved, that reaches a higher level.

46:57

I’d say there’s an indirect connection. It’s not because of what’s required in the productive process itself. Uh, you know, sometimes people think that since production methods are getting more sophisticated, you need to have more education to keep up with this. I don’t think that it’s that this progress is raising the level of intellectual demands. Perhaps the opposite. Just think what can be accomplished using computers. Or just think: you go into McDonald’s and you buy something, and you need change. Do you think many of the people giving you change would even know how to calculate the correct change if they didn’t have that simple machine that they plug in—how much you’ve given them, what the cost of the thing was, and it calculates what the change is? So you’re gonna have people giving correct change—I, whom I doubt many of whom would know how to, how to do that, uh, mentally or even with pen and paper.

48:07

Similarly, you have, uh, because of computers, the high school graduates—I understand—using computers are routinely able to solve mathematical problems that not too many years ago required PhDs in mathematics to solve. Think of furniture-making machinery. Furniture-making machinery permitted people to accomplish results comparable to what had previously required skilled cabinet makers. And now you could have just semi-skilled workers using furniture-making machinery accomplishing results that used to require skilled cabinet makers. So I’d say the actual effect of our improvements is typically to lower the human skill level required to accomplish a given set of results—to make it easier for people with any given skill set to accomplish greater results.

48:51

But nevertheless, there is a tie to higher levels of intellectual achievement. And I think the connection there is that to the extent we adopt the improved products and methods of production, uh, what’s the effect on the general standard of living and the time available for leisure?

49:28

Firstly, high standard of living in everybody is, has a level of stress and disease. Okay, we have a very high standard of living; a lot of people are stressed. But in terms of the time available that you don’t need to spend at a paying job, what do you think is the general effect? It’s more free time, isn’t it? Now, what people do with the free time—they do. A byproduct of a higher productivity of labor is that people don’t need as many hours to produce more than they used to have with more hours. Now, between the higher standard of living and greater leisure, I would say that’s the foundation of the population having a higher level of education and being generally more sophisticated.

50:27

If you think about it, thanks to these various improvements, the average worker in any first-world country is able to have a first-class library in his own apartment or home in paperback. You could buy any of the great books of philosophy or science that he has an interest in; them they’re affordable now. You can have a music collection that is very impressive; reprints of works of art. So this is working in the direction of a rise in the intellectual level. And then there are other things which I don’t think are necessary but are present and are working in the opposite direction. And that’s the state of contemporary education. So we—we should be having a society where the general level of knowledge is getting higher and higher, but I don’t think we can observe that. It’s not the fault of the economic system. The economic system is laying the foundation for greater knowledge and education, but the educational system isn’t working right.

51:35

All right, well, now going further with cost cuts: the most prominent method is labor-saving machinery. But also notice: when you can substitute a comparably good but less expensive material, that’s a way of cutting costs. How does that often translate into a saving of labor—unless the release of labor to expand the production of other things?

52:07

Yeah, if you, if you can replace a more expensive material with an equally good, less expensive material, why would that likely be an indirect way of saving labor? So less labor to produce the material. Why is the material less expensive? Well, a likely explanation—or a good part of the explanation—is that the less expensive material requires less labor in its production than does the more expensive material. So to that extent, shifting to equally good but less expensive materials would save labor also.

52:45

Now, ultimately, I think cost savings translate into either labor savings or, uh, making it possible for labor of lesser skill to accomplish what used to require labor of greater skill. And sometimes, uh, making it possible for less-valued materials—that whose value is determined not by the quantity of labor but by their own scarcity—how we can have different materials, uh, the value of which is determined on the basis of the limitation of their supply at any given time, together with the demand. And sometimes we can substitute a less expensive one for a more expensive one, and we’ll see that that’s analogous to substituting less-skilled labor for more-skilled labor.

53:41

Why should we expect that being able to produce something using less-skilled labor instead of more-skilled labor should make a contribution to increasing overall production? Live. Yes, I’m sorry. Let’s go: labor is cheaper, and that’s why we’d want to do it as far as we can. But why should we expect that that would translate into an enhancement in our overall ability to produce in the economic system?

54:12

Yeah, isn’t it equivalent if we can make it possible for people of lower skill to achieve the same sort of results that used to require only people of greater skill? Isn’t that essentially similar to having more skilled people? If we can enable people with IQs of 100 to accomplish what used to require an IQ of 120, isn’t that comparable to having more people with IQs of 120? At least to this extent. Okay, well, what do you think the effect of a more intelligent population on the ability to produce must be? In the nature of the case, who should be able to produce more?

54:57

What we do is, when we substitute less-skilled labor for more-skilled and make it possible for it to produce the same kind of results—because we’re using better machinery or something of that kind—that is equivalent to having a larger supply of skilled labor available. We’ll have more skilled labor available for other things. And even if it were the case that some of the skilled workers who had a given skill—that’s being made obsolete—even if they couldn’t learn another skill, what will be true of their successors?

55:29

Imagine even if it were the case that someone who’s 50 years old and whose skill is made obsolete—even though at one time he had the ability to acquire skills—now he’s lost it through rust, mental rust. But his place is going to be taken by somebody else of comparable ability. And where will that other person go?

55:56

Not the same place. He’ll be available for some a higher-skill job somewhere else. So this—if we think of furniture-making machinery: if we don’t need people—as many people with the level of skill of skilled cabinet makers—to produce furniture, well then other people who would have had that potential—who don’t go along that path—they apply their same basic level of ability to learning some, some other skill set. And we have a larger supply of skills available for somewhere else. Yes, Mr. Feldman.

56:37

I’ll send you a lot of jobs.

57:00

Okay, now you see, it’s true that there are certain jobs that have been done here that will cease being done here and will be done abroad. But isn’t that true with any kind of free trade? Uh, we are producing something domestically, and now instead of producing it domestically, we import it. And so the people producing that thing are no longer within our borders; they’re outside the country. But does this mean that free trade causes unemployment? What happened to the people who used to produce the goods for the domestic market—now no longer produce the goods for the domestic market because we’re importing those goods? Well, they will produce. And I would say—

57:42

A way to analyze the job-export issue, the outsourcing of jobs—I suppose you start with the example: here’s an American programmer who’s getting a hundred thousand a year, and the same level of programming can be done in India for twenty thousand a year. Okay, now why does the American programmer refuse to accept twenty thousand a year and be competitive with the Indian programmer? But is it just that he doesn’t like that level of living, or that there is some much better alternative available to him that he’s almost certain to find within not too long a time? There’s a better alternative. He doesn’t have to go, uh, to 20,000. He may have to take a cut; he won’t be earning a hundred thousand anymore. But he’s almost certainly not going to have to earn as little as his Indian replacement. He might have to earn eighty, sixty thousand or seventy thousand—which is not very nice for someone used to a hundred thousand. But notice the point is that his income will not fall to the same degree as the reduction in cost of doing what he’s doing.

Outsourcing and Cost Reductions

58:54

Suppose we generalize this. Suppose we think of the economy as consisting of a hundred different jobs—some, however many different jobs there are. And suppose we start thinking of outsourcing, uh, everything we can outsource—every type of job—and accomplish it at a fraction of the present cost of cost. But the people who are doing the present jobs will not have to take reductions equivalent to the reductions in cost. I suppose the general case where the American begins with an income level of 100; his foreign competitor has an income level of 20. The American doesn’t have to come down to 20. He comes down to 60.

59:42

All right, what would be the effect on the cost of producing—or all the goods that we previously were buying, and in which Americans are no longer working—to what level of cost will they correspond? Ent. So 20. Well, now if you’re earning 60, but the prices that you have to pay are governed by cost corresponding to 20—how does that affect you?

1:00:09

Well, yeah, because you see, the cost cuts—in the principle of the thing—the cost cuts are greater than the income cuts. And we have to recognize that if you have widespread, general cost cuts, they’re going to show up in comparable price cuts. But in general, does that make it way for the market rate of return? Right. Okay, now let’s imagine that we started out: companies are cutting their costs to a fraction, and somehow this is all going right into profit. Well, then the key question is: what are they doing with the profits?

1:00:56

Now see, a question that we won’t get into in this term—I go into it heavily in macro, if anyone were really interested. I would refer them to chapter 16 in Capitalism. What’s governing the average rate of profit in the economy as a whole in the long run? There has to be—it’s the extent to which the amount of money spent to buy the products in the economy exceeds the amount of money spent to buy the means of producing the products.

1:01:22

So if we had a situation where the total product of the whole economy were sold every year for a thousand units of money—each unit of money representing however many billions of dollars—if the whole sales revenue of the economy could be conceived of as a thousand, but year in and year out, 900 were being spent for the means of production—what do you think this would imply about the total cost deducted from the sales revenue of a thousand? Thank you. Pardon me.

1:02:06

The total amount of costs—if 900 is spent year in and year out to produce the products which are sold for a thousand—what should we expect to be the magnitude of the cost deducted from the thousand? By me, 900—90? So what should be profits? Ten percent. So, uh, this sort of thing: when you have reductions in unit cost—productions in unit cost, uh, will not show up—at least not lastingly—as increases in the rate of profit. They’ll show up as a larger volume of means of production purchased, a larger volume of output produced.

1:02:53

So if you ask: must this flow through to the market when you have cost savings? If the ratio of expenditure for means of production to the sales revenues—if that remains the same—it must flow through to the market. It can’t be retained as higher profits for long. So and this is why, when we do have cost cuts, you can rely on it flowing through to the market. And a way to see this—a related aspect, uh, I suspect I might have given you this example earlier. Uh, imagine, uh, Gillette Razor Company figures out a way to produce their razor blades at a sharply lower cost, and they get a patent on it.

1:03:38

Okay, so here they are, uh, they’re charging—they’ll make my chain charge the same price. They might decide: we’re not going to sell many more razor blades if we cut the price, so we’ll keep the price the same, and we’ll make higher profits, uh, by cutting the costs. Well, the key question is: what are they doing with those profits? To the extent they save and reinvest them and put them into some other line of production, what would be the effect on production and supply somewhere else in the economy? It will increase. And to find buyers, what will have to happen to prices elsewhere in the economy? They have to decrease.

1:04:17

So you might have a situation: there’s a cost cut in one industry; it doesn’t flow through right away because there’s patent protection, or maybe other people just can’t figure out how to do it. But if the profits are saved and reinvested, they’re going to operate to expand production somewhere else and bring down prices somewhere else. And then ultimately, they’ll bring down prices back in this line as soon as the technology becomes known or the patent comes off. And profit.

1:04:36

Well, this is—this goes to something related to the determination of where the rate of profit becomes uniform. See, we’d have the uniformity profit principle in one state of affairs, uh, operating, uh, to equalize the rate of profit at 10 percent. In a different state of affairs, uh, 20%; in another, at five percent. Uh, so what I was talking about in the last few minutes, uh, pertains to what’s governing the level at which the rate tends to equalize. Because each time you say that uniformity—explain it in my mind—I keep silently saying “within a relevant range.” Is that—well, if you wanted to generalize, there’s certain—not every industry.

1:05:28

No, at any given time, there’ll be a huge spread. Yeah, and even on a permanent basis, if there are some things that are especially risky or highly disfavored, that would have a premium profit to compensate for the other negatives. And, uh, you see, in order for a uniform rate of profit to be achieved—plus or minus whatever premiums and discounts—there have to be, you’d have to have the basic data of the system being unchanged. You’d have to stop innovation; people would have to maintain the same set of tastes and preferences—so that everything fundamental could remain the same. Then it would work out toward that.

Falling Prices and Inflation

1:06:14

Okay, now, uh, I want to call your attention to something. Uh, I’ve maintained that, uh, because of the incentives to cutting costs, we should expect prices to fall. But things should be getting not only better as time goes on but cheaper. Now, in a few cases, we can actually observe that—notably computers. And I had a personal confirmation today, in a way: I bought a 250-gigabyte internal hard drive for about two hundred dollars. I think of that: that’s 80 cents a gigabyte. Twenty years ago, I paid twenty-five hundred dollars for 40 megabytes. Okay, now think about a reduction in cost per megabyte. This is—and similarly with the, with RAM and so on. So in computers, you certainly see an incredible reduction in prices per unit of storage, of megahertz or whatever—RAM, random access memory.

1:07:23

But we don’t see that in many other cases. Usually we’re seeing prices rise. Well, is this a contradiction? Is the implication of the uniformity of profit principle that you make high profits by cutting costs; then competitors duplicate your advance; that brings the price of the product down; then you need to cut costs further? Uh, that would imply that prices should be getting cheaper and cheaper pretty much across the board—adjusted uneven rates. But what we see far more often—certainly in the last, for most of the last 100 years—is, uh, prices rising from year to year.

1:08:09

Well, can anyone reconcile the implications of a principle which I’m saying is really a solid and true principle with our observation of prices actually rising for the most part in most years?

1:08:27

Okay, now we have an expansion in demand for everything. And Miss, uh, I’m awfully sorry, I don’t know how to pronounce your name properly. Way we? Okay, thank you. Uh, Miss We refers to inflation. What do you mean by inflation, Miss We?

1:08:59

Okay, if by inflation you mean you’re referring to more money being pumped in—that’s, that’s essentially it. Not every last increase in the quantity of money, but certainly increases at an undue rate. And you could take as a rough guide to the standard below which it’s not undue and above which it is undue—I think you could take the rate of increase in a gold money. There would be some rate of increase, and inflation is the rate of increase in the quantity of money over and above that—perhaps the rate of an increase in the quantity of money greater than, say, two percent a year. And that would be the essence of inflation. And what is the effect of new and additional money on people’s ability to spend? Is it—and so that’s what operates to raise the demand for everything.

1:10:04

It’s not more population. Suppose we didn’t have an increase in the quantity of money, but we had more population. And now that means there’s more people out there seeking jobs. What’s the effect of a larger number of job seekers in the face of the same demand? What would be the effect on wage rates? Wage rates would be going down. But what will allow more people to be employed at the same wage rates—or even higher wage rates—is an increase in the quantity of money and volume of spending.

1:10:37

Well, we actually have two processes going on at the same time. On the one side, profit-seeking businessmen are introducing ever-better products and ever-more-efficient methods of production, which are operating to increase the supply—production and supply—of everything and operating to bring prices down. That’s the effect coming from the side of business. Then we have another process coming from the side of the government, which issues the—which issues the money supply. And they are issuing a larger quantity of money each year at a rate more rapid than the increase in the supply of gold, and at a rate more rapid than businessmen are able to increase the production and supply of ordinary commodities.

1:11:23

Yes, Mrs. Inc. So are you saying that it is necessary to increase the money supply periodically, but that’s got to be within a certain balance? Am I saying that it is necessary to increase the money supply periodically, but it has to be within certain bounds? What I would say is that in a free market, that would almost certainly be some increase in the quantity of money. Uh, I hesitate to say that it’s necessary to have a certain rate of increase. Conceivably—and there are some economists who have argued that—we could have a functioning economy with no increase in the money supply. I don’t think that would come up under a gold standard, but that’s their position. Uh, and if so, prices would fall the more rapidly.

1:12:13

Now what we have is, if you put everything together, and you think of people in your own company—you think of you yourself—how many hours do you spend in connection with your job, and how often are you putting in, uh, hours above 40 hours a week? And what kind of hours are put in by people playing a really key role in your company? I think it’s very, very common that businessmen are staying up late into the night, uh, and they’re engineers and, and scientists and so on, doing as much as they can to improve production and make it more efficient.

1:12:49

And if you put it all together across the whole spectrum of the economy, maybe in a good year—between them all—they could succeed in increasing the overall production and supply of goods three percent, four percent in a year. That would be high. And that’s working as hard as they can, as conscientiously and efficiently as they can. Okay, how difficult is it to increase the quantity of this paper money three or four percent a year—or twice that rate? How difficult is it to expand the supply of this? What does this depend on? Do we need people discovering new processes of, of ink production, new processes of printing paper to what? Do you need to manufacture more of this stuff? We need the presses, the paper. And is there a shortage of any of this? Is there a scarcity of any of this?

1:13:48

Okay, so and also, what is the cost of producing a dollar bill or a hundred-dollar bill?

1:13:55

It’s just innocent; it’s inconsequential—less than a penny a piece, I’m sure. All right, so imagine for a moment that paper money were subject to freedom of competition. And here we are: we start out, the cost of production of a dollar bill or hundred-dollar bill is a penny—let’s assume. But what’s the initial buying power? Well, a dollar or a hundred dollars. What kind of implied rate of profit is that? 100—what kind of profit margin is there if you have something—if you have a product that you can sell as a hundred dollars, and the cost of production as a penny? Isn’t this the most profitable—the highest profit margin—industry in the world? And the rate of return that would be incredibly high.

1:14:50

All right, what would happen if this were open to free competition—so that if you could have a good likeness of Washington and Grant and so forth, and get the right paper and the right ink, you could be in business? What is the uniformity of profit principle imply about the rate of profit to be made in the production of paper money if it were subject to free competition?

1:15:16

General level. This would mean that the cost of producing a dollar bill would approach a dollar bill, but the cost of producing the hundred-dollar bill I would approach a hundred dollars. That’s what would happen under free competition. And what do you think would happen to the value of the money? With such a money—would such a thing even be used as money? Just think: today you go into a supermarket; you have a few bills in your wallet. They come out with a shopping cart full of bills. So you’re happy to do it that way. What if they had to go into the supermarket with a shopping cart full of money and come out with a wallet full of goods? Do you think such a money would remain as money?

1:16:03

To some monies in the course of history—it happened to the German mark in 1923. I think it happened to the Hungarian forint around the same period of time. That happened in the 1790s to the French assignats. That happened in Nationalist China in 1948. So prices in such a money would be in the millions, billions. And if you think about it, uh, if you look at other things of comparable cost—the cost of producing a dollar bill or a hundred-dollar bill is really not significantly different than the cost of producing a paper clip or a rubber band. Suppose you were calculating prices of automobiles in terms of paper clips. And say you can buy a hundred paper clips for a dollar. Well, how many paper clips would it cost you to buy a 25,000 automobile? Well, you could have to multiply 100 times 25,000. That’s two and a half million paper clips is the paper-clip price of a new medium-priced automobile.

1:17:17

Uh, why should we expect the price in dollars to be permanently different if they have a comparable cost of production, and nothing physical limits the production? It shouldn’t be a big shock. Well, what does, uh, limit the production of dollars? Is it’s not open to free competition. It’s a monopoly privilege of the government. And so it’s not increased in quantity overnight to the point of destroying its value. But what does the government do each year?

1:17:52

If anything happens to the quantity of money from one year to the next, it’s increased. Now, the government is not, uh, immune to the kinds of pressures that have an effect on ordinary people. The government knows that it costs it virtually nothing to produce additional money. Does it have any need for additional money?

1:18:17

All right, there are all kinds of people with their hands out to the government, saying, “Give me money, give me money,” cover all sorts of programs. Now, if the government were not to resort to creating money—if they couldn’t create money—where would it have to get the money to satisfy the demands of the people who want something from it?

1:18:40

They’d have to impose additional taxes. Well, uh, that is not—that would not be a popular arrangement. Uh, just think how hard it is. The government can buy votes by giving people money. That’s what it amounts to. Uh, uh, the president introduced this prescription drug benefit. Do you think the votes of elderly citizens played no consideration—played no role?

1:19:13

Program that he’s helping to attract some votes to his party. Now suppose in doing that he said, “Yes, here I’m offering the new prescription drug benefit, and at the same time I’m raising taxes to pay for it.” Well, he might have some votes of some elderly people, but what about the people who’d have to pay the higher taxes? That wouldn’t be very popular. But if the government has the ability to expand its expenditures without raising taxes, and what is it that enables it to do that? Well, it’s got the ability to print money. So the expenditures are not closely tied to taxes.

1:19:55

So the government yields to such pressures. They’re not doing it to such an extent that the value of money is utterly destroyed in a short time, but from year to year, they are increasing the quantity of money at a rate more rapid than the increase in the production and supply of goods. And to the extent that there is this difference, what happens to prices?

1:20:15

So the way to think of how prices are rising while the uniformity profit principle implies they should be falling—well, we are expressing prices in terms of something that is getting cheaper faster than most goods. You see, it is true: the uniformity of profit principle is out there working to make practically all goods cheaper and cheaper and cheaper. But the value of the money is cheapening faster than the value of the goods. Let me give you this illustration of the idea, then we’ll take our break—back around [time not specified].

1:20:49

Back around 1970, pocket calculators first came out, and a new pocket calculator at that time—a pretty primitive thing—was selling for about four hundred dollars. Uh, VCRs were also appearing at a brand the same time, and a new VCR at that time was selling for around twenty-four hundred dollars. I suppose you wanted to express the price of a VCR in terms of pocket calculators: how many 400 pocket calculators would be required to equal one twenty-four-hundred-dollar VCR? Six.

1:21:25

Okay, now what has subsequently happened to the price of both? They’re both certainly dropped, but I don’t think they’ve dropped to quite the same degree. Now, uh, uh, let us assume that the price of a new VCR is today, uh, two hundred dollars—maybe it’s actually cheaper, but make the assumption that it’s two hundred dollars. And the price of a comparable pocket calculator—to one that used to cost 400—is now ten dollars. And now notice: VCRs used to be six pocket calculators, and now how many pocket calculators—at ten dollars per pocket calculator—would be required to buy one VCR at two hundred dollars? Twenty.

1:22:14

Okay, what’s happened to the pocket-calculator price of the VCR? It’s gone from six to twenty. Right. So in terms of pocket calculators, the price of VCRs has risen. But what has happened to the price of both expressed in ordinary money? It’s both—both have sharply dropped. But if we express the price of the one in terms of something whose own price has fallen even more—fallen from 400 to ten dollars—while the other has fallen from 2400 to 200—but we have this inequality in the rate of fall—if we express the price of the one that has fallen less in terms of the one that’s fallen more—what has happened to the price expressed that way?

1:23:00

It’s gone up. It’s gone from six to twenty. Well, that’s the way to understand the rise in prices. It is true that the uniformity of profit principle is out there working—for the reasons I’ve explained—to bring down the price of virtually everything. But we’re expressing prices in terms of a unit—the paper money—that is getting cheaper faster. The paper money is in the position of the pocket calculators; the ordinary goods and services are in the position of the VCRs. So the profit motive is driving down the price of the VCRs, but if we express them in paper money—the value of which has declined even further—prices have risen. And prices would—as I’ve explained—be in the millions and billions if we had free competition in paper money.

1:23:48

So, uh, the fact that we observe prices rising while our principle implies they should be falling—there is no contradiction. They are reconcilable when you realize that what explains is that the value of paper money has declined more than the profit motive has reduced the, uh, the cost and price of ordinary commodities.

1:24:13

Okay, let’s take our break here. And I hope this has sunk in—that you’re following it. If you have any problems with it, please raise questions on it when we return from the break. Okay, okay, all right.

Repealing Farm Subsidies: Application of Uniformity Principle

1:24:34

Any questions from before the break? All right, let me, uh, turn—I’m just going to touch upon, uh, 0.1 under C: the repeal of farm subsidies, rent controls, and price controls on oil and natural gas. Uh, this will be an important application of the uniformity profit principle. I pick farm subsidies as an example of a minimum price control—price that is set artificially high. The government wants the price to be higher; it makes it illegal for people to sell below a certain minimum. Farm subsidies are similar to minimum wage laws in that you’re not legally allowed—in one way or another—to have farm prices below what the government is aiming at. Rent control and price controls on oil and natural gas are examples of price controls of an opposite kind: those are maximum prices—prices above which you’re not legally allowed to sell. And we can use both kinds to illustrate the uniformity of profit principle and the effects of such controls.

1:25:50

Now, the government currently pays to the farmers, I believe, something around 20 billion a year—I may be off somewhat; I saw the figure not too long ago—for the purpose of achieving higher farm prices than would otherwise exist. And the reason for the program: there’s still a number of key states with two senators each in which the farm vote is crucial. And, uh, the paying the farm subsidies is a way—an attempt—to buy a significant part of the farm vote. And the purpose is to enable people to continue as farmers, to remain in business, who otherwise would have been driven out at lower prices—which their costs would be too high to make profitable.

1:26:49

Now let us imagine what would happen if the farm subsidy program were abolished. Here’s the government spending however many billions—assume 20 billion. The farmers would now have 20 billion less revenues. And let us also assume the government would reduce its tax collections by 20 billion—I know that may be an unrealistic hope, but let us assume that. So here we are: the government is spending 20 billion dollars less; the farmers are getting 20 billion dollars less; the taxpayers have 20 billion dollars more.

1:27:21

All right, how would this affect the pattern of demand coming from the taxpayers? Might they be making an increased demand for a wide variety of things? The sales revenues and profit margins of the industries selling to the taxpayers would be increased somewhat. The sales revenues and profits of the farmers would be very badly reduced. It’s possible that all of agriculture for a year or more might be running at a loss. In any case, we have a situation where the rate of profit in a major industry—agriculture—plunges. The rate of profit throughout the rest of the economy is more or less—is modestly increased. It’s modest because it’s a much broader base; the pain is concentrated; the increase is very heavily spread out.

1:28:12

Okay, that’s the immediate effect. What would be the further effect? What would happen to the amount of labor and capital employed in agriculture as the result of very low profits—or indeed heavy losses? It would be decreased. The capital and labor would be withdrawn from agriculture. Uh, would there be alternative opportunities for people to be employed and capital to be invested elsewhere in the economy?

1:28:46

Short time: all those areas where the taxpayers were now spending, uh, the money the government had spent. All right, so the effect is: capital and labor would be withdrawn from agriculture, and more of it would be invested in other parts of the economy. And as capital and labor were withdrawn from agriculture, what would be the effect on production and supply in agriculture—and on the selling prices, profit margins, and rate of profit in agriculture?

1:29:28

Production would decline as capital and labor on withdrawing, and so what would happen to the price? It would start coming back up—initially it would have been sharply reduced. Now, as capital and labor are withdrawn from agriculture, the price starts coming back up. And what would be happening to the profitability of those who remained in agriculture? Okay, that would be coming back up. So starting from an initial plunge, we would have a withdrawal of capital and labor that would restore the rate of profit on the agriculture that remained. And the influx of capital and labor throughout the rest of the economy, uh, what effect would that have on the rate of profit elsewhere?

1:30:22

Pardon me. And the rate of profit would decline. So here we are: we have an event—the abolition of the farm subsidies. The immediate effect is a sharp reduction—perhaps a total wiping out—of profits in agriculture; an increase in profits elsewhere. Then that results in a movement of labor and capital out of agriculture into the rest of the economy. And this goes on until the agriculture that remains is once again profitable, and there’s no longer a premium profit elsewhere in the economy.

1:30:58

All right, what would be the, uh, enduring effect? What would—what would remain after the dust had settled? It’s not going to be the rate of profit is permanently reduced or raised; it tends to return to normal. But what would be different that would be of significance?

1:31:20

Agriculture would have been sharply reduced, and other branches of the economy would have been increased. Now why would that make a difference? What—what is the government doing with the agricultural produce that it buys up to elevate farm prices?

1:31:40

I mean, it doesn’t give you a reason to pull capital out of that. No, it doesn’t give you a reason. But well, what—what is happening to the output that the government buys—or at least did happen for many, many years? It could be stored.

1:32:06

Now, for many years, it was simply stored. They ran out of grain elevator space; they were storing some crops in caves in the holds of mothballed ships. And they were looking for ways to get rid of the surpluses. And then they came up with such things as the food stamp program and Food for Peace. And the one allows the giveaway of food to people within the country, and the other outside the country. Now, from the point of view of the taxpayers, what is the benefit to the taxpayers of the food that either stores and rots or is given away free to other people? That’s not a benefit to them. If instead of having the production of that food—they had that food were ceased to be produced, and instead other things were produced that they would be buying—well, which is a better use of their income?

1:33:00

What’s a better use of your income—the share of your income that you presently pay away in taxes every year, that the government then uses to buy farm products to store or give away—or that same income spent in a way you individually decide and resulting in a larger production of the things that you individually are buying? What represents a more efficient use—from the point of view of the taxpayers—of the labor and capital? The part of the labor and capital that’s presently tied up in producing the part of the agricultural output that the government buys up? Thank you. Better serve producing—does a higher it would be much better producing the goods that the taxpayers want.

1:33:46

Mr. Zinc refers to the principle of marginal utility, which is a good introduction integration which two two discontinue this episode. Well, we’re looking: the short-run effect is profitability is wiped out in agriculture and enhanced elsewhere. Then the longer-run effect is profitability is restored in agriculture and reduced elsewhere. But the enduring effect is there’s less labor and capital employed in agriculture, more elsewhere. And the point Mr. Zinc was referring to is: where would the marginal utility of the output be greater—when it’s in the form of food products that the taxpayers don’t want, or when it’s in the form of additional products that they do want? Obviously: additional products that they do want. So I’m not taking accounts also well by external social implications. What do you mean? And they did put it food for peace, which means they do export a lot to Africa, which helps see it started across the rest of the world. Okay, let’s say word of goods that they do export to other countries; it will import. Okay, okay.

1:34:58

Huge impact on one sector of national security that our country—which is supplying ourselves with food—versus the marginal impact—your words. Okay, increasing—increasing the value of something else, hoping the government will give the 40 billion dollars back. Okay, say that we have some way to support ourselves. Well, all right, so you’re tying into, uh, Mr. Goodrich’s point about securing the food supply. Okay, now people could make that point, but let me point out that the market does an awful lot to secure the food supply. And this is a major function of the commodity futures markets. See, it’s not the case that we simply have a supply and people are thinking just of the immediate moment. We have a large number of professional commodity speculators who are spending their full time following every development that could affect the demand for or supply of agricultural commodities for several years out.

1:36:12

And if anything occurs that can be interpreted as making food scarcer—reducing the supply or increasing the demand—what does that imply about the prospective future price? The prospective future price will be higher. And if the prospective future price is higher, this relates very directly to the—to another topic: the tendency toward a uniformity of prices over time—how the price of a good in the present tends to equal its expected price in the future, or more precise.