Monthly Archives: October 2013
The Foundation for Economic Education is out with a new short video. It’s simple and easy to understand and I recommend watching it if you’ve ever wondered why business cycles occur.
This is one of the major reasons I started this blog 2 years ago: to explain business cycle theory.
I’ve made a few attempts at making this as simple as possible:
If you want a slightly more elaborated version of the video, feel free to check out Business Cycles for Dummies. The other two links don’t give as full an explanation of it, but they will help see how the process occurs more clearly. If you have any questions, feel free to ask them as well, I’d be glad to help in any way if I can.
Check out this post if you are unfamiliar with tax shifting. It will help in understanding the following.
Rothbard states “Shifting occurs if the immediate taxpayer is able to raise his selling price to cover the tax, thus “shifting” the tax to the buyer, or if he is able to lower the buying price of something he buys, thus “shifting” the tax to some other seller.” (p. 1156)
As he goes on to point out in the case of the general sales tax, however, both a producer’s selling prices go up and buying prices go down. So I thought these clearly could not be the key criteria.
He states “It is true that a tax can be shifted forward, in a sense, if the tax causes the supply of the good to decrease, and therefore the price to rise on the market. This can hardly be called shifting per se, however, for shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be “shifted,” it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation.” (p. 1156-1157)
My issue with Rothbard was, however, that I felt this argument could be flipped on him; Rothbard believed that a sales tax could be shifted backward.
I could say “It is true that a tax can be shifted backward, in a sense, if the tax causes the demand for the factors of the production of the good to decrease, and therefore the price of the factors to fall on the market. Production in this way is hampered, causing supply to decrease and marginal firms to go out of business. This can hardly be called shifting per se, however, for shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be “shifted,” it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation.”
This is because, even in Rothbard’s proposed correct version of events where a tax is shifted backward, supply decreases, meaning marginal firms go out of business.
If the above seems a little confusing to you, try this one instead:
In Murphy’s Study Guide to Man, Economy, and State with Power and Market, he states:
“Tax incidence refers to the actual long-run burden of taxation, which may differ from the immediate target. No tax can be shifted forward. (If retailers had this power, why wait for the tax?)”
That’s basically what I was trying to do, although my response to Rothbard’s is more detailed.
After discussing this with Dr. Herbener, he pointed out that the two cases are not symmetric in the relevant sense. What matters is not whether firms eventually go out of business, but whether firms immediately go out of business as a result of shifting the tax. It’s true that firms eventually go out of business in both scenarios, but in the forward shifting scenario, firms go out of business immediately (as supply decreases – this is the proposed mechanism for tax shifting for this scenario, firms immediately go out of business) while in the backward shifting scenario, firms go out of business eventually (the tax shift occurs earlier, the proposed mechanism being firms paying lower incomes to their facts, which they do not directly go out of business from, but eventually go out of business from because of the “other effects”).
Why is this important? Because the immediate effect is what matters for whether we call it tax shifting or not. If firms go out of business as an immediate effect of shifting the tax, this cannot be properly seen as shifting a tax. However, in every scenario where taxes are added to a free market, there will be “other effects”, or as I have been saying, eventual effects, where people are harmed, including firms. So firms being eventually hurt does not invalidate backward shifting as an example of tax shifting.
In conclusion, yes: a tax can be shifted backward and this is perfectly consistent with Rothbard’s argument against forward shifting.
The larger the incentive to surpass the network?
If there is a strong presence of a network effect in an industry along with economies of scale, this industry will tend to only have one or a few providers of a service. If neoclassical monopoly/oligopoly theory is correct, then this company or these companies will earn higher profits than normal. What is not discussed, however, is that these higher profits will serve as an extra incentive for competitors to improve on the existing system and achieve those abnormally high profits themselves. (Note: I think this is a large “if”; there are certainly problems with neoclassical monopoly/oligopoly theory but I am not prepared to defend or attack it on its position that there tend to be higher than normal returns in industries with only a few competitors)
In other words, network externalities (and likely all types of externalities) are self-regulated by the market. If such externalities lead to higher profits, they also lead to a higher incentive for a competitor to attempt to improve beyond the incumbent and make those profits himself.
Any argument advocating government intervention to “fix” the inefficiency that is present with abnormally high profits must acknowledge this market self-regulation and take it into account.
This element of self-regulation might be so great as to reduce the monopoly profits down to normal profits or reduce it by some extent.
Finally: another way of stating the conclusion of this post is that potential competition (that is, competition that is not physically competing, but a force which still exerts some pressure) is stronger in those very sectors where it is often ignored by government apologists.
Often, after someone hears of anarchocapitalism, all sorts of objections on practical grounds are raised. How would the roads be built? How would private defense function? Wouldn’t warlords just take over?
The ironic feature of all these questions is that they are purely speculative. Meanwhile, more fundamental knowledge is on the side of the anarchist libertarian, who points out, e.g. in response to the second question, that not only is there nothing logically incoherent about private defense (you could just defend yourself or hire others, after all), but practically speaking, we have reason to expect private defense to be much more efficient.
Ex ante, two individuals that engage in a voluntary transaction both gain from the trade. Otherwise, they would not have engaged in the trade. So we know that private defense would satisfy the desires of consumers far more effectively than government, an institution completely separated from the satisfaction of preferences.
I find this analogous to the knowing vs. thinking (or believing) distinction. The more fundamental knowledge i.e. knowing, is what we can deduce from human action about voluntary transactions, e.g. that a private defense agency must satisfy the preferences of consumers or it would go out of business, and a more efficient competitor would take its place. The less fundamental knowledge, thinking, is the speculative objection, e.g. that an incentive exists known as the “free rider” incentive and such an incentive could possibly lead to worse defense service production on a free market (for a quick rebuttal, note that the free rider incentive is one of many competing incentives involved in human action. Another, for example, is the desire for social acceptance, and those who paid for a private defense agency could socially reject free riders). Of course, this distinction can be applied to a number of examples.
This is why so many libertarians who read Mises and Rothbard (especially the latter) on economics have no problem imagining a stateless society. If the state can’t manufacture and sell shoes as well as the market, why should we expect it to do better anywhere else? Praxeology, after all, makes no distinction between the content of means or ends, but only discusses the fact that man does have means and ends (and so a consistent application of the praxeological analysis to economics should lead one to taking the libertarian position on every issue when it comes to economic efficiency).
In fact, as I heard Tom Woods say recently, to him it’s so clear a stateless society could work (he did not say this last phrase, but I believe it was a hidden part of his argument; if he ever sees this and doesn’t think this is accurate, then I would take his word over mine), we should accept that as our initial premise and fully accept the non-aggression principle, and those in favor of a State must make their case why a stateless society cannot work. In other words, it should not be up to the libertarian to prove a stateless society could work.
A response to ABCT from the typical person is a “well duh, of course if banks create money out of thin air, creating more claims on their supplies then they actually have, people will realize their insolvency and there’ll eventually be a bank run.”
Or “of course interest rates are a price just like any other price and coordinate market activity, and if you essentially place a price control on interest rates there’ll be unintended consequences.”
ABCT is common sense applied to economics. The reason that business cycles occur is not that complicated.