A society structured as the above has two great benefits. First, incentives are aligned to produce more output. A person can only acquire wealth by producing wealth. Thus the production of wealth is encouraged, as man’s natural greed is channeled towards productive ends. Second, humans are innately goal seeking creatures. It makes us fundamentally happy to strive towards a goal – whether that goal be winning a football game, learning a new song on the piano, leveling up in Warcraft, or producing a product that people want.

In a dysfunctional society, people acquire wealth via corruption, rent-seeking, and theft. Perhaps they steal it at the point of a sword. Perhaps they acquire wealth through outright corruption. Perhaps they acquire wealth through holding a position in a completely dysfunctional management structure that requires internal politicking and Kabuki make work rather than actual performance.

As Adam Smith wrote, “there is a great deal of ruin in a nation” Corruption has always existed in America. But in the past decades it seems as if the dominant paradigm has shifted, so now more and more income comes via dysfunctional rent-seeking rather the net creation of new wealth. ¹

A most severe case of a rent-seeking economy was described by the historian Rostovtvzeff, who wrote of the late Roman empire:

The reforms of Diocletian and Constantine, by implementing a policy of systematic spoliation to the profit of the State, made all productive activity impossible. The reason is, not that there were no more large fortunes: on the contrary, their build-up was made easier. But the foundation of their build-up was now no longer creative energy, or the discovery and bring into use the new sources of wealth, or the improvement and development of husbandry, industry and commerce. It was, on the contrary, the cunning exploitation of a privileged position in the State, used to despoil people and State alike. The officials, great and small, got rich by way of fraud and corruption.

The problem in America is not quite this bad – yet. But it is bad, and getting worse.

The “rent-seeking” economy has several variations:

Rent-Seeking Variation #1: Groups and individuals exploit a dysfunctional political system to get insanely rich.

Exhibit A is Wall St’s strategy of developing “financial innovations” that produce immense profits in the short term by creating systematic risk in the longer term. When the long term arrives and the systemic threat blows up, the government bails out the banks and the firms survive to play again in the next cycle.

Wall St. abounds with other examples. If the political-economic structure was rebuilt according to Finbarrian guidelines, I suspect that the financial sector would be under 5% of GDP, rather than approaching 20% of GDP.

Wall Street hedge funds rarely make their fortunes by placing sound long term bets about the proper allocation of resources. In reality, they make money by skimming off the top as trillions of dollars slosh around due to the endemic instability in the financial system (instability that would be fixed with sensible reform). In a well ordered financial system, the stock market would be flat and predictable ². Interest rates would never change, housing, equities and bonds would trade at unchanging ratios based on long term cash flow predictions. The only way to make money would be to actually predict the performance of particular companies. There would be no IPO “bounce”, no stock bubbles, no real estate bubbles. 401Ks would be invested in low expense ratio, future cash-flow weighted index funds, not in market cap weighted funds. The era of being forced to invest in a Fidelity plan with a 1% expense ratio that churns 150% of its stocks each year would be over.

High Frequency Traders make money not by adding liquidity or playing market maker (in fact they remove liquidity), but by gaming design flaws in the SEC regulated stock market (essentially they get to peek into the order book and front run the market, a sensible black box auction system would remove this source of gamesmanship). ³

Beyond Wall St. there are thousands of more run-of-the-mill cases of corruption. Washington D.C. is one of the wealthiest metropolitan areas in the country due to number the government contractors, lobbyists, and consultants finding ways to get a piece of the government pie.

A more petty example of corrupt riches is the wealth of professionals who are protected from competition by licensing laws. I am not opposed to some sort of occupational licensing. But standards should be set to reflect actual job requirements, not to create artificial barriers to entry. Professions such as podiatrists or orthodontists have hard caps on how many people can enter their profession each year. Only 280 orthodontists may graduate a year. The supply limitation allows them to earn 50% more than dentists ($350k for a 35 hour work week). The number of medical school seats in the U.S. remained flat from 1980 to 2006, despite a 37% increase in the population. The artificial supply constraints allow doctors to extort high wages from middle class Americans.

Variation #2: Bureaucracies and pseudo-bureaucracies (grant funded NGO’s, subsidized university system) that thrive not in proportion to meeting their stated goals of working for the public benefit, but due to politicking, unionized voting blocks, or – in the worst cases – actually creating problems and thus needing more funding in order to fix the crisis.

Typical government workers do not earn exorbitant wages, so it may seem unseemly to target them for criticism. But the income they do earn is rarely linked to producing stuff people want. For example, teachers do not earn money based on how well they inspire and educate children. Their aggregate salaries are determined based on the political clout of the unions, and individual salaries are based purely on seniority.

A professor at an architecture school or law school does not earn a six figure salary due to providing such superior mentoring and teaching. They earn their money because they are the legal gate keepers to entering licensed occupations.

Police officers who earn time and a half overtime for drinking coffee at construction sites, do not earn six figures salaries for providing such valuable traffic management skills. They earn their salaries because the police unions lobbied for laws mandating their employment.

Variation #3: Corporations with dysfunctional management structures that maintain their position only through economic rents, monopoly, or cozy relations with government, and thus have no discipline in working to create products that people want, but rather direct all effort towards internal politicking.

The rise of the mega-federal-state resulted in a dramatic increase in the size of corporations. It is always easier for a huge top down government in Washington D.C. to interact with and regulate a few corporations rather than hundreds of corporations. Economies of scale are generally greatly overrated, but one area where economies of scales really exist is in government lobbying – bigger corporations can afford lobbyists to write the laws that serve their interests.

If you look at the origin of most mega-corporations, you will see a link with government. IBM hit it big when it won the original contract for providing the counting machines that processed FDR’s new Social Security program. General Motors, Boeing, Honeywell, and Anheuser-Busch all leapt past competitors thanks to World War II contracts. Chase and Bank of America have grown massive due to too-big-to-fail policies. Citigroup has been bailed out multiple times over its 175 year history, and grows bigger each time. Fidelity and State St. grow huge managing government pensions and from exploiting 401k regulations. TV broadcast companies and telecoms gained a market oligopoly due to the methods of auctioning off spectrum rights.

The U.S. government appointed several ‘Nationally Recognized Credit Rating Organizations’. These three main agencies for many years dictated top-down control on the price of capital for American businesses. Naturally, big corporations are highly favored. If you are Starbucks, you get extremely cheap credit. Note also that thanks to government control of the interest rate, the interest rate has generally been lower than the rate of monetary inflation. Thus these favored, highly rated corporations essentially get free money. Starbucks uses that cheap credit to buy up the choice real estate. It’s coffee sucks, but that doesn’t matter, few local operators can out bid subsidized Starbucks for a hot corner location.

Not every inefficient-mega-corporation owes its dominance solely to federal assistance. There is such a thing as natural monopoly – cable TV is an example. Barriers to entry are so high that in most cities little market competition exists. I live in the Comcast Imperium. The prices keep rising, the customer service is notoriously awful, and broadband speeds remain behind other developed countries.

Credit cards are another natural oligopoly due to network effects – you need to use the credit card that stores accept, stores need to use the credit card that everyone has. As a result, Visa and Mastercard get to exact a 1-2% tax on transactions across the country.

Ever wonder why glasses at Lenscrafter costs $300? Luxotica owns every single major brand – and has purchased many of the chain lens stores. This gives it enormous power to set prices. If a local store sells discount frames, Luxotica will threaten to pull all of its products from the store, ruining the shop.

My region has among the highest medical costs in the world. One reason is because the major hospitals banded together for the purposes of price collusion. When insurers refused to give into the hospitals demands for increased reimbursements, the hospitals dropped the insurer. Enrollees rebelled, the bargaining power of the combined hospital network was too great, and the insurers had to give in.

These oligopolistic mega-corporations present an enormous problem. They make money not primarily from producing awesome products, but rather by manipulating regulatory procedures, long standing relationships, and rent-seeking. As a result, there is a lack of internal pressure focusing the organization on producing great products. Instead the main activity of people in the organization is towards personal enrichment and empire building. Furthermore, these organizations are fundamentally too large for effective management. The end game is a nation of Dilberts.

Variation #4: Productive enterprises are blocked and stymied by misguided regulation.

For centuries the price of energy dropped. Inventors developed ways to replace wood with coal, whale oil with crude oil. But since 1970 this progression has stopped. The natural successor energy source – nuclear – has been halted. Nuclear power has dangers, but the fear of these problems was so great that development in solving safety problems was basically halted ⁴.

Much debate has spewed forth about the fact that rises in the costs of living have nearly outstripped the rise in median income. One reason for this great stagnation, is that cheap products have been outlawed forcing people to buy expensive products. The Chevrolet Spark costs around $7,000 U.S. dollars new in Chile, but it’s not street legal at that price and specifications in the U.S.

Want to open a cheap walk in health clinic? You can’t fight city hall. Want to open up a doctor owned specialty clinics where you can perform cheaper surgery in a safe environment? The big hospitals will gang up to shut you down. Want to start a doctor run health network? The insurance companies will lobby to ban you. Want to start an insurance company that offers lower premiums because it takes advantage of scientific evidence to only cover treatments that look promising? Tough cookies – regulations explicitly state what you have to cover.

Want to start an architectural grad school that costs $5k a year instead of $40k? You’ll never get accredited. Look at the accreditation standards, notice how many of the standards are subjective matters of having enough resources and qualified faculty (aka Ph-D’s). Then notice that the people doing the accreditation are backed by the power of the existing architectural schools. A true low cost competitor has zero chance of gaining accreditation.

The growing problem of trivial patents and patent trolls further stymies productive enterprises. Innumerable Patents are granted for trivial technology, thus resulting in any other firm discovering the same technique having to either stop its innovations or lawyer up.

Variation #5: Seville Disease has wiped out the manufacturing base

The American manufacturing base was once the envy of the world. Cities from San Jose to Detroit, from St. Louis to New Haven, hummed with the work of clock makers, furniture crafters, car makers, and chip fabricators. Now hundreds of thousands of factories have folded. The blight first hit makers of toys and trinkets. But now production of high tech goods such as circuit boards, memory chips, and LCD displays have packed up and gone over seas. My dad worked at Bell Labs for three decades designing telecommunications equipment. As he winded down his last few years, he trained a Chinese team to take his place, rather than training Americans.

A recent Forbes article states:

The U.S. has lost or is on the verge of losing its ability to develop and manufacture a slew of high-tech products. Amazon’s Kindle 2 couldn’t be made in the U.S., even if Amazon wanted to:

* The flex circuit connectors are made in China because the US supplier base migrated to Asia.
* The electrophoretic display is made in Taiwan because the expertise developed from producting flat-panel LCDs migrated to Asia with semiconductor manufacturing.
* The highly polished injection-molded case is made in China because the U.S. supplier base eroded as the manufacture of toys, consumer electronics and computers migrated to China.
* The wireless card is made in South Korea because that country became a center for making mobile phone components and handsets.
* The controller board is made in China because U.S. companies long ago transferred manufacture of printed circuit boards to Asia.
* The Lithium polymer battery is made in China because battery development and manufacturing migrated to China along with the development and manufacture of consumer electronics and notebook computers.

America’s problem is the same problem that afflicted the 16th century Spain. When America established its hegemony and set up the world currency system, her leaders installed the U.S. dollar as the reserve currency for the world. America took advantage of this position to export dollars and import goods, rather than to manufacture goods herself. With demand for the dollar as reserve currency pushing up the price of the dollar, local manufacturers lost their ability to compete. Furthermore, China in the past decades has enacted an overt policy of keeping its currency undervalued to encourage exports. This is a violation of trade agreements and should enable the U.S. to take counter measures. But the political leadership has been asleep at the wheel.

Thus instead of Americans earning money via creating manufactured goods that people want, the American government prints money, gives the money to politically favored corporations, bureaucrats, and workers, who then export the dollars in return for cheap HDTV’s. ⁵

Variation #6: The Internet Monopoly Gold Rush

Every day, tens of millions of people log into Facebook and derive pleasure from stalking crushes, commenting on photos, organizing events, and posting funny status messages. The enablement of this pleasure requires the work of hundreds of thousands of people. There are the engineers that designed the chips in the home computer, the technicians maintaining network switches that route the internet, the open source hackers that wrote the operating system that Facebook runs on, the assemblers in China who put together the server boxes and laptops needed to run Facebook, the laborers who laid the fiber wire for the internet backbone.

The labor of all of these was required to make the pleasure of Facebook happen. The vast majority of the people involved make a normal, decent working wage. Some – particularly the factory assemblers – make a less than decent wage. One person – Mark Zuckerberg – has made a sum equivalent to the yearly wages of 400,000 Americans.

Why did Mark Zuckerberg make so much compared to everyone else? He does not personally write the code of 400,000 others, or personally design operating systems and build servers. If he retired tomorrow, Facebook would still function normally. He he never existed, some other social network would surely reign supreme instead.

Mark Zuckerberg is rich because he was able to capture ownership a natural monopoly opportunity.

Linus and the other contributors to Linux created an enormous amount of utility by creating Linux. But they did not capture this value because they open sourced it – all the value ended up as consumer surplus.

My dad was an ordinary electrical engineer at Bell Labs who helped design the routers and multiplexers which made the early internet possible. He never got rich because a) he had little bargaining power so he only got an employees salary and not a share of profits b) by the time he did get stock options there was fierce competition in the space and profits went to zero.

The assemblers in China makes so little because they must compete with hundreds of millions of other potential workers who can easily replace them. They have no monopoly, no bargaining power.

In the early 2000′s, the advancement of technology and the internet created an opportunity for a large scale, online, social network. This opportunity was a natural monopoly due to both the network effects involved and due to the natural returns to scale of software ⁶. The market opportunity existed outside the brain of any one person. The opportunity existed like the precence of a river and the invention of turbines creates a market opportunity for an electic dam, or the existence of a mountain and the invention of TNT creates an opportunity for a railway tunnel. Even more fortuitously for Zuckerberg, this market opportunity could be captured with very little up front capital outlay. All it took was to be among the fastest and the best. Thus Zuckerberg wrote the first version himself, and was able to capture a critical mass of users without giving up significant ownership.

When Zuckerberg captured the social network, he became the toll taker over a large swath of the internet. Many things are required to get the pleasure of sharing photos with friends, but Zuckerberg owns the one point which is a natural monopoly, and thus can earn enormous rents.

Now credit must be given where credit is due – Zuckerberg captured this natural monopoly because he outplayed the other competitors. While MySpace and Friendster crashed under load, Facebook scaled remarkably well. The product was solid with good enough design and well managed.

So what is the problem?

Problem number one is that thanks to mechanization, the bargaining power of ordinary labor has fallen. More and more income is being captured by those who hold rent-seeking positions – such as possessing a scarce skill, joining a guild, or capturing a natural monopoly. From a utilitarian standpoint this is undesirable as the median person faces more financial stress and a stagnant income. (See also my essay on economic classes )

Problem number two is that the economic system does not create incentives to produce the products or technology that generate the most utility. The economic system produces the incentive to create products where the entrepreneur can capture as much of the consumer surplus/utility created as possible. Even better is if the entrepreneur can create a monopoly platform where the entrepreneur can take a toll on the value created by others (see for example Google and Facebook). The best and brightest are pulled into creating social networks, games, and socially enabled fantasy football. Much less incentive exists to develop risky, ground breaking technologies, because in those situations there is a low probability that the initial ground breakers will capture the value of any ultimate success.

As a startup entrepreneur I include myself in this category, I create software sold to marketing folk, if my software did not exist, little meaningful utility to the world would be lost. Yet I make three or four times as much money as my roommates who work in research labs trying to cure breast cancer and stop aging. ⁷

Variation #7: The Marketing and Sales Treadmill

In the modern world, natural resources are the limiting factor of production. It takes only a tiny percentage of the population to farm the arable land, mine iron ore, cut down and process the timber, and extract the oil. A somewhat larger percent converts those resources into the necessities of life – bread, vehicles, homes, roads, bridges, clothing, furniture, stocked grocery aisles, appliances, etc. The worker entering the economy has a problem. They must find a source of income so they can access resources and manufactured goods. But there are no unexploited resources and no surplus jobs to be had processing those resources. They need a job, but their labor is surplus and unnecessary.

What is this worker to do? One possibility is that he starts creating luxuries. He might design iphones, code for Facebook, open a yuppie coffeeshop, start a hand carved furniture business, or brew craft beer.

A second possibility is that he manages to finagle his way into one of the rent-seeking cartels or guilds, as mentioned above.

But perhaps the most common path is that our prospective worker enters the sales and marketing business. It is quite astounding the portion of the economy dedicated to sales and marketing. Even engineering focused companies like Facebook have more sales people than engineers. The basic problem is that there is a surplus of basic goods in the world, but each person still needs some money to get access to those goods. So everyone’s energy is focused on imagining some gimmick – a six bladed razor, a beer can that turns blue when its cold, a funny talking gecko – that gives someone a reason to give you money when there is no real differentiation based on product value.

The sales and marketing economy is zero sum. Each business must work harder and harder at new tag lines, gizmos, tricks, and jingles. And when sales guys at the other company work harder, you must work harder too.

Past writers who imagined the future thought that as machines saved our time, we would have more time for leisure. That has not happened. Instead, since no one is self-sufficient, we must work in sales and marketing to convince someone with money to trade cash for our trinket, so that we can have purchasing power to access the natural bounty of the land. Average work hours declined for a century – and then started curving back upwards as the everyone switched the zero sum battle of sales and marketing. The future is here, and it is the sales desk at Dunder Mifflin.

To understand American economic conditions, it is helpful to generalize Americans into four economic classes:

• The Underclass Those scraping by at the fringes of economy, often subsisting on crime or welfare.
• The Plebs The interchangeable parts in the machinery of the economy. Because plebs are so easy to replace, they earn low wages and have little job security.
• The Rat-racers Those who have found a career track that offers leverage and rewards inside knowledge. The inside knowledge makes it harder to replace the rat-racer, thus earning them higher salaries. But they must grind out long work hours to maintain their competitive edge.
• The Rentiers Those who have achieved complete economic security. They no longer need to work to live, instead they work for personal fulfillment.

Please note that the above classes are economic classes, not social classes. A hipster coffee shop barista and a high school dropout janitor both belong in the same pleb economic class, but they are in very different social classes.

Let’s examine each class in detail.

The Underclass

Underclass members live outside the formal economy. Some may loiter at the corner stoops selling drugs. Some may lack homes, eat from soup kitchens, and sleep in store doorways. Some roam the neighborhood as bandits. Some live off food stamps and welfare. Some go on disability and live off government checks.

The underclass are ensnared in a multi-layered trap that keeps them from rising up into the pleb class.

Underclassers did not grow up in homes where parents instilled middle class culture and values. They may have never learned to dress for a job interview, to show up at work on time day after day, and to follow the rules set by the boss. Decades of hood life have bred in vulgar language and a contempt for authority. The underclass street culture has an honor culture. A man must show strength and retaliate for slights or else he becomes an easy target and attracts more abuse. In any confrontation, you have to stand your ground and not show weakness. This attitude does not work well with managers.

As the economy shifts to a service economy, worker traits such as appearance and attitude matter more than physical skill. Underlcass workers with their attitude problems provide negative value to employers, and thus may not be employable at any wage.

The street life generally pays less than minimum wage and is more dangerous than coal mining, but there is a certain status to running with your bros. It is cooler to tell a girl you are in a gang than to tell her you flip burgers at Mickey D’s. Thus many young men would often rather stick to the street life than to go clean.

Many underclass have criminal records, and more employers now blanket exclude convicted criminals. One drug possession conviction can earn a man a lifetime of exclusion from employment.

Many underclass live off of government welfare rather than crime. Underclass single mothers often live off a combination of welfare (TANF), food stamps and Medicare. Older men often live off of disability. These folk often face a financial trap. Government benefits cut out very sharply with income, and often all the benefits cut out at nearly the same income levels. As a result, a welfare recipient will often net less total income and benefits as their wage rises. A person who receives disability insurance also gets Medicaid. If they leave disability to take a full time job at McDonald’s, they will lose their health care. As a result, they are better off staying on disability. They remain idle and their job skills atrophy.

The poverty trap can be eliminated in two in ways. Benefits can be reduced for the poorest, or the benefits can be phased out much more slowly, thus raising total welfare spending overall. Progressives oppose the former, conservatives oppose the latter. Thus nothing is done to fix the problem.

Fixing the plight of the underclass requires both carrots and sticks.

On the stick side, underclass neighborhoods need fair, consistent policing. Crime control deserves its own essay and so I won’t discuss it further here. People should not be allowed to subsist forever on food stamps, unemployment or sham disability claims. All recipients of government checks should be required to take a “job of last resort.”

On the carrot side, entrance to the pleb class must be made more accessible and more attractive. Plebs face low wages and job insecurity themselves. If the underclass try and move up, they will be at the very bottom rung of the pleb class. By increasing the rewards of working, and increasing the supply of jobs, moving into the pleb class will be a more attractive and achievable option. We’ll discuss how this can be done in the pleb section of this essay.

But simply creating the opportunity for gainful employment will not be enough. Progressive social workers have tried all sorts of programs to get underclass members into the normal work force, few have worked. Attitude problems still prevent many underclassers from getting jobs.

What’s actually needed is to subject the unemployable to a regime of paternalistic authority to remold their values and attitudes. Basically, you need to give them the middle class parenting that they never had. Society used to have institutions that did this – the church, justices of the peace, orphanages, work houses, etc.. Most middle white class white people owe their values to the paternalistic authority of the church and nobles, which was applied centuries ago, and then passed on from parent to child.

The problem is that this plan is acceptable to neither progressives nor conservatives. “Paternalism” and “authority” are dirty words to progressives. The institutions needed would have to be government institutions, and the idea that government is the solution is anathema to conservatives¹. Thus both sides oppose such institutions and nothing is done.

Other people’s writings about the underclass

The underclass are the subject of the TV show The Wire. I recommend reading the non-fiction book that inspired the TV show: The Corner – A Year in the Life of an Inner City Neighborhood. Also check out Wilson’s The Truly Disadvantaged, Banfield’s The Unheavenly City, David Kennedy’s Don’t Shoot. The underclass have also been called the lumpen-proletariat by Marx.

The Plebs

Pleb occupations exhibit two defining traits:

1) With a bit of training, anyone can do a pleb job. Any American of normal intelligence could learn the job via self-study and on the job training in under a year.

2) The job has little leverage. At a leveraged job, a workers performance can cause dramatic swings in the firms profits. A world class brand manager, executive, or programmer can create millions or tens of millions of dollars in additional profits compared to their average peer. But a world class assembly line worker or nursing home orderly creates little more profit for their firm than an average worker.

Example pleb jobs include: assembly line worker, garbage man, truck driver, landscaper, construction worker, house painter, pool cleaner, line cook, barista, store clerk, customer support representative, quality assurance technician, nursing home orderly, kindergarten teacher, parole officer, police officer, child care worker, hair dresser. ²

Plebs have been repeatedly kicked in the teeth over the past 40 years.

First, globalization has added billions of unskilled laborers to the worker pool. The car assembler in Michigan now competes against millions of auto workers across Asia. If globalization also had created equal competition for rat-race jobs, and also had increased the worldwide output of natural resources, then the net economic impact on plebs would wash out. But this has not happened. The rise of China has added hundreds of millions of worker to the worldwide economy, but little more oil or arable land to the economy. Thus the peasants in China who forty years ago who consumed no oil or lumber, now compete against American plebs to acquire purchasing power for oil, food, and other goods.

Second, mechanization and automation have eliminated many pleb jobs. For example, the rise in use of shipping containers and computer aided loading tools reduced the employment of dock workers by over 80%. Some neoliberals believe that productivity improvements always help the worker in the long run, after the economy has a chance to reallocate the displaced to new jobs. This can happen, but there is no guarantee the worker will come out ahead in the end. Labor saving innovations will not increase the overall output of many essential goods, because the production of many goods is bounded by available natural resources, not labor. If the invention does not increase the total production of resources, and the owner of capital uses his savings from the new labor-saving technology to purchase more resource intensive goods (more meat in the diet, jet fuel intensive vacations, etc.) the price of resources is bid up while the bargaining power and wages of labor declines. Machines can make the laborer worse off.

Third, the mass immigration of pleb-class workers from Mexico and other countries has driven down the wages of plebs. This is supply and demand 101 – when poor workers willing to work for low wages move into town and look for jobs as clerks, cooks, landscapers, etc, the increased supply of labor will push down the wages of the class of workers competing with them for jobs.

Fourth, women entering the work force has the same impact as mechanization and immigration. Women entering the work force has not increased the supply of houses, wheat, oil, or electricity. The output of economics goods such as food and oil is not bound by the quantity of pleb labor. Adding more pleb labor adds little more to output, it only introduces more competition for jobs and drives down the average wage.

The income statistics show the decline: CPI adjusted median income for white, 24-35 year old white males has declined by 21% over the last 40 years. Median income for white males of all ages has been flat.

The CPI has many problems. I myself am a hater. Some claim that the CPI understates economic growth because it does accurately take into account the benefit of innovations like the internet and free google books for everyone.

The reality is that pleb purchasing power of information, communication, and entertainment has greatly increased. One hour of labor earns far more in terms of TV, games, movies, books, phone calls, news, etc. than the same hour earned in 1971.

But worker purchasing power of the basic necessities of life has declined sharply. A basket of goods can be created using the base necessities of life: the cheapest car on the market that will get you to work, a plot of land to buy a house on, lumber to build the home, a one night stay in the hospital, bread, beef, broccoli, gasoline to power your car, etc.. When you build a price index from these goods, worker purchasing power has in fact declined. In some cases, such as health care, both quality and price has increased dramatically. But there is no available option to purchase a discount version and trade some quality for a lower price.

Sixty years ago a pleb might live in a tight-knit, urban, ethnic community. The neighborhood would have very low crime, safe schools, and strong churches. Censorship laws promoted family values in movies and on TV. The upper class would live blocks away from the lower class. In ensuing decades, a combination of demographic changes, “urban renewal” projects, and legal changes rocked this world. The great migration brought into the city a poor, uneducated African-American population from the south. This migrant population had a much higher rate of criminal behavior. Housing projects and forced integration mixed this population into the ethnic white enclaves. Legal changes made policing much less effective. Crime in these neighborhoods rose dramatically. Court rulings and policy changes stripped public school teachers of tools to discipline unruly children.

After these changes, the only way a person could avoid a high-crime neighborhood was to move to a neighborhood where the underclass cannot afford to live. If a parent wants to send their kid to a school where class is not continually interrupted by underclass children, they must send their kid to a school with no underclass children. That means they must buy a home in a school district where the underclass are priced out. Parents use the coded, politically correct language of “finding a neighborhood with good schools.” But in reality, school spending, pedagogy, and teacher qualification do not differ much between the underclass inner city and suburban neighborhoods. What parents are really doing is “finding a neighborhood with good students”.

Schools no longer view instilling traditional morality and character as part of their mission. The Hays code that guided movie censorship is long gone. As a result, parents must take on the full burden of controlling their children’s media intake. Parents must live in neighborhoods where the other parents uphold the same values, otherwise their children will pick up the wrong values from their friends.

Some plebs manage to work extra hard, stress finances to the max, and buy their way into a classier neighborhood. But they will live on the edge – a layoff or furlough could bankrupt them. Their landlord will boot them right back into the underclass neighborhood.

Many plebs cannot afford to exit the underclass neighborhood. They live in neighborhoods with high crime, drug dealers on the street, and wild schools. They might get mugged on the street. Their children may end up falling into drugs or a gang. Their daughter might follow her friends and get knocked up at 17. The pleb who remains in the underclass neighborhood lives in constant danger of falling into the underclass.

Charles Murray wrote a recent book Coming Apart that documents how plebs decline into the underclass. Commenter Graham Seiter follows up with his personal observation:

In 1960 Fishtown was a very Catholic neighborhood in which the men worked, the women stayed home, and the kids went to Catholic school. My ex-wife was one of them. What they considered to be social problems were excess drinking, quite a bit of it, fist fights and a bit of philandering. Young people, however, knew what was expected of them. They got married, before or after becoming pregnant, and provided families for kids. It was a moral expectation that was generally observed. People had responsibilities and took them seriously. They did not accept welfare, they answered the call when they were drafted, and they participated in church and civic organizations.

Fishtown in 2010 is a very different place. People simply don’t feel an obligation to either work or get married. There are many never married people, and many out of wedlock children. A lot of the guys are just bums – don’t work, don’t want to work, don’t want to get married, and waste their time watching television. An inordinately large number have figured how to game the system by qualifying for Social Security disability. Their attitude is that work is for chumps. Quite a few of them have drinking and drug problems, but Murray does not consider these disabilities to be nearly as important as the lack of any of the four foundations in their lives. No more religion, no social connections with the community, either no marriage or an unsatisfactory marriage, and no vocation.

Current attempts to Help Plebs

The Republican plan for the plebs is to cut taxes – especially taxes on the rich. Cutting taxes on the plebs by a few percentage points will make the plebs better off by a couple hundred dollars. But that hardly compensates for the decline in wages and job security.⁴ Cutting taxes on the rich does nothing for plebs. If the government spends one less dollar on hiring bridge builders, and that dollar goes to a rich person who spends that dollar on a gardener, then the pleb is in the same position as before. If lack of venture capital investment or lack of bank lending was a blocking factor for the formation of new companies, then cutting taxes could help form more companies. But there is a surplus of venture capital and surplus of money willing to be loaned. The limiting factor for business creation is the base rate of technological progress and the availability of profitable business opportunities.

Progressives advocate for laws making it easier to form unions. These laws would help immovable workers at highly profitable companies, such as the janitors at Google. But unions do not help the clerks at Sears (which has no profits) or the assembly line workers at some company where management is debating whether to move off shore.

Progressives blame current unemployment on austerity and lack of fiscal stimulus. I partially agree with this view, but the broader structural problems still exist and were present before the downturn in 2008.

Progressives and neo-liberals advocate spending more money on education and sending everyone to college. The idea is that graduating college is positively correlated with obtaining a higher income, rat-racer job. Therefore sending everyone to college will result in everyone earning a higher income. This logic is completely specious and has proven to be disastrously wrong.

The number of available high-paying, rat-racer jobs is limited by the structure of the economy. You cannot simply have everyone move from store clerk to store manager, from product assembler to product manager, from customer service to corporate counsel. These ratios are fixed based on the nature of the technology of production. ³

If more plebs go to law school, it’s not going to magically create more jobs for high paid attorneys. The wages and working conditions of lawyers will be pushed down. The graduates at the less prestigious law schools will be unable to find work entirely. As more people have gone to the law school in the past decades, most graduates find themselves either out of work or at low paying jobs struggling to pay off loans.

If more people attend college, they will not all magically become Bain consultants and brand managers. The application process for the high paying career tracks will simply become more competitive. Hiring managers will require more prestigious degrees, exclusive internships, and higher GPA’s. Those not making the cut will end up unemployed living at home, or forced to find a job stocking super market shelves.

A century ago, top firms would hire workers for prestigious white collar jobs straight out of high school. Once the masses started attending high school, the firms changed their recruiting practices to hire out of college instead. Now that the masses have started going to college, hiring practices are changing once again to require prestigious colleges and grad programs. More schooling helps on an individual basis but is a treadmill for society as a whole.

Schooling improves wages, but the aspect of school that improve wages require very little money. A prestigious college is valuable because it links you to a social network of high earners and provides a stamp of approval that gets your resume noticed in the pile. Most actual education is done via self-study, self-practice, and on the job training. Spending some money for teaching/mentorship can definitely aid in the self-study, but the effect quickly maxes out.

Further reading about plebs

David Shipler’s The Working Poor describes the life of the bottom part of the pleb class. Barbara Ehrenreich’s Nickeled and Dimed describes her attempt to live the life of a pleb.

The Rat-Race Class

Rat-racer occupations have two defining traits:

1) While the basics of the job can be taught, the capability to perform the job at a high level cannot be taught. Elite performance requires some rare combination of on the job experience, natural talent, a creative knack, and social connections.

2) The job has leverage. A world class rat-racer can create orders of magnitude more profits for the company than their average peer. A subpar rat-racer can do enormous damage. Thus a company is willing to pay top dollar for proven talent.

Example rat-race occupations: brand manager, McDonald’s franchise owner, lawyer, doctor, accountant, product manager, executive assistant, consultant, any middle management or executive position, engineer, product manager, graphic designer, professional athlete, star actor, etc.

The supply of rat race jobs is highly inelastic. The quantity of available jobs is fixed based on the nature of the productive structure. You only need X number of executives for every Y truck drivers. General motors only needs X number of brand managers for every Y number of automotive assembly line workers. You only need Z number of in house corporate counsel per head the company employs.

The only rat-race job category that is slightly elastic is that of engineering, as engineers can create new categories of employment and change the structure of production altogether. However, even the elasticity of engineering jobs is commonly overstated – graduating 10X more software engineers will not create 10X as much software engineering employment, and will not increase the rate of innovation by 10X. The economy cannot support 10 Googles or 10 Facebooks. And the pace of underlying technological innovation that allows new products to be created is limited by mythical man month considerations (adding more engineers to a project does not necessarily make it go faster) ⁵

Rat-racers earn much higher incomes than plebs because their talents are both scarce and valuable. A company cannot just pick any old bloke off the street and replace a rat-racer. This scarcity gives the rat-race real bargaining power.

Lazy reporters will describe rat-racer occupations as “jobs that require education”. That is actually the inversion of the truth. College is required for these jobs, but not education. You can learn to be a machinist in a classroom, but you cannot learn how to be a middle manager in school. For the vast majority of rat-race jobs, the actual skills are learned on the job. Little taught in undergraduate is really needed or applicable. The rat-race job recruiters use the college diploma as a filter for intelligence, ability to jump through hoops, and polish. Those who skip college, or those who cheap out and go to East Iowa State College, will never make it through the recruiters filters. Nor will they have the social connections to bypass recruiters and get the attention of a hiring manager. Thus attending college is practically mandatory in order to obtain a high-paying, rat-racer career. Obtaining a top rat-race career – such as a consultancy at McKinsey – requires attending a prestigious school.

Rat-racer career tracks have a competitive, winner-loser dynamic. If a marketer at Nike works long hours to develop a brilliant marketing campaign, the marketers at Reebok must respond in kind or lose market share. If a sales rep at Oracle works extra hours to gain a sale, so must the sales rep at SAP. If a staff attorney at a top law firm slacks off, there are hundreds of new graduates and attorneys at lesser firms waiting to jump in rank.

Even engineers who create new new wealth for society still face a competitive, winner-loser dynamic in their particular endeavor. Market opportunities exist outside the control of any one engineer. The opportunity to create an online social network existed based on the ubiquity of computers and broadband internet. But the nature of social networks dictates that it will be a winner take all market ( you want to be on the social network your friends are on). Any company attacking that market needed to work harder and smarter than all the other competitors. Most technology products have a a winner take-all dynamic, because engineering costs are one time and up front, but the product can be sold thousands of millions of times.

Rat racers earn nice incomes, but they cannot trade their income for leisure. Two rat-racers working 20 hours a week cannot do the work of one rat-racer working 40 hours a week. Rat-racer jobs require accumulated inside knowledge, connections, and communication. It is much more efficient to concentrate that knowledge in one person. Furthermore, leveraged jobs require 100% effort. If a product manager works fewer hours than competitors, the product will suffer versus competitors and the company might lose millions or tens of millions in market share. Nor is it easy for the product manager to work three years and then take two years off. The product manager will lose touch with industry developments and his social network will go stale.

I once thought French employment laws were overly restrictive. I thought workers should have the freedom to choose their own balance between income and vacation. But mandatory vacation laws solve a collective action problem. I cannot take a vacation unless my competitor takes a vacation. If we both take vacations, we both win. The French work fewer hours, yet almost match the U.S. in per capita output. The extra hours worked by Americans are a result of the competitive thrashing of the rat-race, and produce no greater good for society.

Every rat-racer fears dropping out of the race. If a rat-racer fails to put in enough effort, he will fall into the pleb class. I have seen it happen to friends. Maybe they take it easy at work and get laid off. Maybe they do not build the needed career connections. They might have had slightly lower SAT scores, and gone to a less prestigious school, and then failed to get the high powered finance job. They take a crappier job and end up laid off during a downturn in business. Desperate for a job they end up bartending or painting houses.

The first few years as a rat-racer are precarious. The worker has not built up unique skills and connections, and is therefore replaceable. Because a rat-race career takes time to establish, rat-racers do not feel comfortable starting families until they near thirty. At that point, their career still requires long hours to maintain, so balancing work and children can be stressful. Thus rat-racers rarely have more than two children.

Rat-racers do not want themselves or their children to fall down into the pleb class. So rat-racers must buy expensive homes so that the plebs and the underclass are priced out of the town and its schools. By sending their kids to school and college with other rat-racers, parents can prevent their kids from making friends with underclassers, and ensure their kids pick up the proper polish. However, since rat-racers are bidding against other rat-racers for slots in these towns and schools, the price of the rat-race life keeps going up. Entering the rat-race life used to only require attending college. Now it can require paying for grad school, plus supporting the child through unpaid internships. Having more than two children is quite out of the question – children are too expensive and take up too much time. Given that many rat racers never feel the urge to have children at all, the total fertility for rat racers is well below replacement.

Rat-racers are good, smart, hard-working folk.⁶ That their work ethic is driving them to extinction is tragic and long term catastrophic. The plight of the rat-racer is one of the great problems of our age.

The Rentier Class

Rentiers have locked in complete economic security and no longer need to do unpleasant work in order to survive. Examples of rentiers include: Cashed out entrepreneurs, wall street types who banked their salary and now no longer need to work, small business owners who have grown a profitable business that now runs itself, super star athletes who invested their earnings well, etc.

The rentier class is not limited solely to those who have amassed independent wealth. I count as rentiers tenured professors who love their jobs and who can pick their own research topics. A staff engineer at Google who can pick and choose projects might also count as a rentier.

The Rentier Class has no plight. They are the winners. As the structure of the economy has shifted to more of a winner-takes-all dynamic, the rentiers have benefited greatly.

Within the Rentier Class there are gradations of rich:

Lower Gentry do not have to work for a living. But their yearly dividend provides little more income than the typical rat-racer salary. Thus their spending habits are upper-middle class/rat-racer. They do not behave like the rich in the movies. Their acquaintances would not think them of being “rich”. Lower gentry requires $2-$8 million in net worth.

Middle Rich can afford multiple homes and fancy cars. They can also afford not only to support themselves, but to also employ other people. The more crass will employ servants. The ambitious will fund companies or foundations. Middle rich have $8-$100 million in net worth.

Upper Rich can own yachts and mansions and fly around in private jets. Those who wish to fund projects can fund truly ambitious companies. Upper rich is what you think of rich when you view life styles of the rich and famous. Upper rich have $100+ million in net worth.

Davos Rich are the highest class. Not not only are they super-rich, but they have parlayed their wealth into real political and cultural influence.

“Keeping up with the Jones” never ends, so within each group above there are gradations based on the size of your yacht, size of your private jet, etc.

Note that many of the middle-rich have a choice: They can continue to work long strenuous hours as rat-racers in order to live a lifestyle that is one notch higher. Or they can cut back on work and settle into a more genteel life, but at the cost of cutting back on the more extravagant expenses such as mansions and ski homes. Many choose the rat-race as they are addicted to the lifestyle and their career.⁷

Social Classes

The above classes are all economic classes. Economic classes are defined by the nature of the person’s occupation.

The country can also be divided into social classes. Social classes are defined by networks of friendship and dating. The status of social classes is defined by who admires/envies/copies whom.

SWPL class

This is the class described by the Stuff White People Like Blog.
SWPL’s are educated, urban, Bohemian, progressives. The social network centers around the upper tier universities and the “blue”/progressive urban centers.

Common activities of this class include: listening to NPR, drinking locally roasted coffee, attending an upper tier college, voting for Obama, shopping at Whole Foods, drinking a micro brew, or engaging in some activity to raise awareness.

The class is mostly white, but there is a substantial minority of Asian members, and a smaller minority of black and Hispanic members. Blogger Mencius Moldbug describes it (paraphrasing since I cannot find his original quote): “Christian Lander has one joke. He describes a class that does not like to described, and he uses the last label they would ever use… They [SWPL's] are ‘white’ in the sense of what a black person says when he accuses his friend of ‘acting white’”

Rat-racer SWPL’s can be called Yuppie’s, but not all Yuppies are SWPL’s. Pleb SWPL’s are known as hipsters. Hipsters have opted out of the rat race and would rather have a lower earning and casual life working at coffee shops and bike repair shops. Mencius Moldbug has used the monikers “Brahmin” and “Eloi” for SWPL. David Brooks also wrote about older rat-racer SWPL’s, calling them “bourgeois Bohemians” (Bobo’s).

Amerikaner (A.K.A. Red State Whites, Tea Partiers)

Amerikaners reside in the South, Midwest, and the outer suburbs of blue state urban centers.

Common Amerikaner activities include: drinking Budweiser instead of craft beer, watching NASCAR, listening to Rush Limbaugh or Fox News, hunting, playing hockey, owning a gun, attending a high school football game, owning a gas guzzling car, driving that car everywhere instead of walking or biking, tinkering on cars, attending a traditionalist Christian church, eating at chain family restaurants like Applebee’s, sending off family members to the military, etc.

Charles Murray’s recent book “Coming Apart” includes a quiz titled, “How thick is your bubble?” The quiz is slightly misnamed. It actually tests, “How much contact with Amerikaner culture do you have?”

Politically, Amerikaners refer to the government as “them”. An Amerikaner will say: I don’t like it when the government raises taxes. While a SWPL views the government as “us” and says: We need
to raise taxes to that everyone pays a fair share. As a result, Amerikaners respond better to small government political government rhetoric (since the government is an “other”, why would you want to pay any more money to it any more than you want to pay a higher cable bill to Comcast?).

High earning, Amerikaner, rat-racers could be called country clubbers. Mencius Moldbug called them optimates, a name I like. Young urban optimates share the “yuppie” moniker with young urban SWPL’s. Lower earning pleb Amerikaner can be called be proles.

Optimates often follow the trends set by SWPL’s. SWPL’s enjoy hanging out at a independent coffee shop drinking expensive, high quality, fresh roasted coffee. Starbucks picked up on the trend, turned it into a cookie cutter experience, and marketed it to Amerikaners across the country. Optimates or their children who attend SWPL universities or move to SWPL cities gradually succumb to social pressure and start voting for Obama or driving a Prius instead of a BMW (Occasionally the shift goes the other way – a SWPL tires of the social activism of his college days, finds a hierarchical capitalist job, and enjoys spending his salary on fancy goods).

Ethnic Social Groups

Every ethnic group in the United States – Mexican, Chinese, black, south Asian, etc, has its own social group distinct from Amerikaners and SWPL’s. These groups usually live in their own ethnic communities and have their own culture. Economically, these social groups are usually either pleb or underclass.

When ethnic group members rise up to rat-race jobs they almost always assimilate into the SWPL class. Or rather, I should say that in order to get a rat race job an ethnic minority must first assimilate into the SWPL class. Progressives who denounce the existence of “structural racism” are not entirely wrong. Rat-race employers desire employees who demonstrate polish and cultural fit. If you interview for a Gen-Y, SWPL, rat-race job, and judiciously break out the LOLCat speak, people will laugh and mentally award points. If you come in speaking ghetto ebonics, you will accrue negative points.

The Laffer Curve is everywhere misundestood (even I think by Art Laffer himself). The point of tax policy is not to maximize revenue. Modern governments can print their own currency. If a government wanted to maximize revenue, it could simply print money. The point of a tax policy is to maximize the government’s long term purchasing power. And theoretically, In a democracy, the goal is to maximize the life time purchasing power of the median voter.

Thus the real Laffer Curve effect to watch for is not the change in revenue, but the change in productive output.

For example, raising the income tax rate from 30% to 60% might in some cases increase short term revenues in dollar terms. It might even raise long term revenues in dollar terms. But if the tax increase suppresses investment, production, and innovation, the tax hike might lower growth over the next decades, and thus the tax hike ends up lowering the total long term purchasing power of the government. The government has more money in ten years, but can buy less with that money.

However, it is also possible that raising the top tax rates might decrease revenues but actually grow purchasing power. Imagine the government raises the top rate on normal income to 95%. Lawyers only work three months of the year. Financiers retire early. Athletes take less money to be with their hometown team. Government revenue falls. Despite all this, it is possible that the purchasing power of the median voter rises. If athlete salaries fall, there will not be fewer athletic games. Team spirit will not fade. If lawyers booked fewer hours, we would probably all be better off – lawyers mostly create litigation that other lawyers have to deal with. If financiers are mostly getting wealthy by bilking the public, then having them go into early retirement would be a boon.

Let’s say that the net impact on output is zero – some productive people retire but also anti-productive people retire. So the remaining impact is that the rich have less money to spend. The nominal dollars that would have gone to the lawyers, instead gets paid out as corporate profits/dividends, or goes to bid up salaries, or just gets stashed away. If paid out in dividends or salaries the average person benefits. If it is stashed away, that means fewer dollars chase the same number of goods, which means that the purchasing power of the average person rises. So either way, despite the fact that the tax did not increase government revenue, the tax still had its intended impact – the tax increases the purchasing power of the voter.

Both the left and right commit the money illusion fallacy with regards to the Laffer Curve. When a tax rate raises revenue, the left says, “ah ha, the tax hike worked!” When a tax hike causes revenue to fall, the right claims the hike failed. But both claims are irrelevant. The impact on short term nominal revenues does not matter one whit. What matters is the long term impact on purchasing power. And that can only be estimated by looking at the micro level and seeing how the work habits of productive and parasitic workers change.

From a deductive, micro perspective, I suspect that high capital gains taxes have a negative impact on long term output. (full disclosure – I work for a tech startup and stand to benefit personally from low capital gains taxes). If capital gains were taxed at something like 80% for all income over $1,000,000, then there would be virtually no point in ever becoming an entrepreneur. If the business fails you make nothing. If you are the one in ten that succeeds you barely end up better off than if you had worked for wages. Thus I’d expect high capital gains taxes to inhibit productivity and innovation.

However, I think an ordinary income tax of 80%-90% of income over $1 million may have very little negative impact on output. If you earn a great sum via capital gains, it is because you created some productive improvement that exists outside of your own person- you created some lasting technology, machinery, building, etc. But if you earn money via ordinary income, the productivity is entirely within yourself. You have created no value that exists outside of your own output, there is no permanent lasting technology that you gave to society. Furthermore, observationally, the people earning those incomes tend to be victors of contrived winner take all tournaments (athletes, movie stars). Or they are excellent at gaming bureaucratic systems (lawyers, lobbyists). Or they great at salesmanship. Or they are executives that have played the bureaucratic game well but who have not increased the value of their company. If these people all have their income capped, and thus end up working less, is the median person really worse off?

Empirically, the 1950′s to 1970′s were a period of lowish taxes on capital gains, very high taxes on income, and very high growth (source).

Of course, having an enormous disparity between the income tax rate and the capital gains tax rate invites all sorts of gamesmanship which might be impossible to deal with efficiently.

Also of note, in the case of Britain (which is Jim’s original example), the bankers who are retiring may be both parasitic and beneficial to England. That is, since Britain is a world financial hub, the financiers may be skimming primarily from the funds of other countries, and thus Britain benefits from having them work as hard as possible and in order to bring purchasing power to the island.

Underestimated, in my opinion, is a peculiar historical accident. Imagine a thought experiment: What if North America was only 100 miles wide?

The European monarchs won a number of battles against the democratic radicals of the 1600-1800′s. The kings were not savage tyrants of the sort that afflicted the 20th century. So rather than slaughtering dissidents wholesale, the monarchs usually expelled the radicals to the Americas. Thus the Puritans departed for America in the 1630′s as Charles I cracked down on dissenters. Numerous German revolutionaries departed after the failed 1848 revolution.

Unfortunately for the kings, they had just granted their enemies three million square miles of fertile, resource rich land. The dissidents conquered the continent, plowed the plains, drilled her oil, and multiplied like rabbits. The fertility rates in Puritan New England were close to 10.0, the highest in recorded history. Out of 20,000 Puritan settlers 16 million are now descendents.

The radical American settlers used their power first to break free of the English monarchy. Then they exported their ideas around the world, to France and South America. They intervened in World War I to crush the counter-revolutionary regimes once and for all and wiped out monarchy across Europe.

A lesson for future kings: do not export your dissidents to the most fruitful land on Earth. Try Siberia next time.

If North America was a mere 100 miles wide, chances are that Britain wins the revolutionary war. The radicals in France would never had an example to follow. Louis the XVIII would have saved a lot of money. The royal loyalists in Britain would have gained great prestige.

If North America was a 100 miles wide, it would not have had the resources and man power to project power into Europe during World War I. Germany would have won the war. After the war, Germany would have aided the White army in Russia. The houses of Hohenzollern, Romanov, and Habsburg may have stood until this day.

Some of these cities, such as Rio, Lagos, or Johannesburg, suffer incredible levels of violence. Police rarely dare to enter the Rio favellas. In South Africa, a survey revealed that one in four men admitted to committing rape. In Monrovia locals have forgotten the basic rule of life, “don’t shit where you eat”.

The Indian slums do not have a violence problem, but they continue to be more and more of a dung hole (here and here). The combination of bad sanitation and overpopulation is so bad that it’s breeding outbreaks of drug resistant super bacteria.

Guatemala is riveted with gang warfare and now has a higher violent death rate than when it was in civil war. Drug cartel battles in Mexico spill over into United States. Arizona citizens have been kidnapped and brought back into Mexico for ransom. Drive-by shootings by El Salvadoran gangs lead the news reports in San Francisco.

The Congo remains hell. South Africa is turning into what the Congo was 20 years ago. Brazil is turning into what South Africa was twenty years ago. Southern California is turning into what Brazil was. And the rest of the U.S. is following California.

The reader of this blog is most likely an upper middle class resident of a developed country. To you it may appear that the Malthusian age is over, that technology has brought us a new age of plenty for all. You may read with hope the latest Thomas Friedman bloviation about Prius driving Chinese or iPhone addicted Nigerians. But in fact we may simply be repeating the cycles of the past. New technology allows for great output, and temporary riches, but as the generations pass, the poor breed and fill the slums, while the rich live in childless plenty. As the s-curve of technological growth flattens, the average person is just as poor as ever. In fact, they may be even worse off. As Jared Diamond points out the transition from hunter-gatherer to agriculture left the next generations poorer and less nourished than their ancestors. In China, the great technological works to irrigate the land led to a rise in output in rice. The narrow gain in rice output led to a massive population that lacked the protein intake and balanced nutrition to live a healthy, energetic life. Similarly the denizens of the third world slums might have cell phones, mopeds, penicillin, and a higher GDP on paper, but the quality of life in the noisy, smoggy, sewage filled city may be worse than the life of their ancestors.

While life is good for us first worlders, our life style is dying out. In Brazil, the fertility rate of the poorest fifth is 4.8, while the richest fifth average a mere .7. A middle class American woman averages 1.7 children, while the average woman in Ethiopia produces 5.9 kids (source and source).

Despite my reactionary leanings, my approach to political thought is somewhat Rawlsian. Imagine we were summoned behind the veil of ignorance, and randomly re-born into the current world. While it might seem like the world has become richer, due to the birth differential between the rich and poor of the planet, you have a much better chance of being born into a third world slum than into a middle class developed world household. The combined decadence of the first world rich and the irresponsibility of the third world poor is leading to a great squandering of the technological surplus of the modern age.

From 1950 to 1990 the great American cities fell into ruins. Rioters smashed windows and torched houses. Thugs roamed the streets assaulting and robbing decent folk. Homicide rates rose 1,000%. Grandiose “urban renewal” projects razed entire neighborhoods to make way for highways, housing projects, and political trophy towers. The middle class fled the dangerous streets and violent schools. Tight-knit ethnic neighborhoods evaporated. Zoning laws, urban planning fads, and home loan regulations conspired to replace lively, mixed use urban streets with repetitive, isolated boxed housing in suburban neighborhoods.

“Ruin porn” showcasing the devastated cities can be found on the web, see Detroit, Philadelphia, or Baltimore. Watch the Corner or Law & Disorder for a documentary version. The most informative book I have read on the subject is Devil’s Night. I also recommend the The Unheavenly City, Canarsie, The Slaughter of the Cities, City, and the book version of the Corner (a non-fiction account of Baltimore by the creator the Wire).

In the past few years a few city neighborhoods have recovered. Craft beer bars and coffee micro-roasters pop up in Northern Liberties in Philadelphia. Downtown Boston feels safe at virtually any hour.

But the danger and devastation mostly remain. Just in the the past few months in Philadelphia, my girlfriend’s sister was robbed at gunpoint outside her apartment, a young professional was mugged, shot and paralyzed a few blocks away, a flash mob assaulted and beat up a couple walking on her street, and a shooting occurred outside a nightclub we pass on our walk home. In Boston, I was recently walking through Dorchester and police rolled up alongside me and told me that I was in the murder capital of Boston. They told me to get on a bus because the neighborhood was too dangerous for someone who looked like me to walk through. Detroit remains in ruins. Don’t be deceived by the slick Chrysler commercials and ‘Detroit renaissance talk’.

The fastest growing areas have been strip mall suburbs such as the Phoenix and Houston metropolitan areas. A combination of lack of planning and anti-planning (zoning laws forcing a separation office space and residential) have ensnared Americans in long commutes, expensive gasoline addictions, and bland, homogeneous developments.

American urban planning failed to adapt to the invention of the internal combustion engine. Americans have been in a slow motion arms race where we all have to discard bicycles and drive tank-like cars for safety. When my neighbor buys a bigger car, I must buy a bigger car for safety, and it escalates until we all drive giant SUV’s. Now that our cars take up so much space, we must build wide roads and giant parking lots, which then force us to drive everywhere. Now that we drive everywhere we must work harder and longer to pay for mutant cars and imported oil. When we work more, we buy even more oil for the commute, driving up oil prices, forcing us to work even more. The entire car culture ends in epic fail.

Thus as Americans we end up with three bad choices a) affordable urban living where you have to watch your back at night and pray your kids don’t end up in a knife fight at school b) long commutes isolated suburban areas or c) expensive, fashionable urban neighborhoods that poor violent people cannot afford to live in.

Stay tuned for future installments, in which I will cover the other six great problems of our time.

As with all religions, the practice of the institutions can diverge sharply from the official ideology. The luxury of the 14th century Catholic Church was a long way from the ascetic poverty found in the Gospels. Similiarly, the elitism of Harvard is somewhat incongruous with the egalitarian and democratic ideology promoted by the leftist professors.

The central ideology of leftism centers around equality, personal freedom, egalitarianism, and anti-hierarchy. You’ll find this ideology described in the writings of Rousseau to the wrtings of Chomsky.
The institutions and social networks of the left evolved out of the reformation and Calvinist protestanism (which preached bottom up control of congregrations rather that opposed the top down hierarchy of both the Catholic and Anglican churches). You can trace this development from Locke and Rouseaou, Roundheads, and the Puritan dissenters, through their offshoot in the New World, the revolutionaries in Boston, the unitarians and utopians of the New World, through to the campus leftwing movements incubated in the unitarian universities. In short – the left is the institutional social network centered out of Harvard University.

The right-wing, in practice, consists of the assortment of people and institutions that opposed the current left. Since the left is anti-hierarchy, the right wing institutions tend to be hierarchical – such as the Catholic Church, military, and corporations.

“Right-liberatarians” oppose subordination, but only when the control and subordination is at the hands of the state. “Left-libartarians” oppose control by both the state and private actors. It follows that in order to prevent private domination the poor need money – if you have no money you have to submit to wage contract and to being bossed by an overseer. If a left-libertarian believes in using force or the state to redstribute wealth from the rich to the poor with the goal of eliminating private domination, then left-libertarianism becomes straight up leftism.

My own brand of “right-wing” is that I believe in “order”. I am not opposed to egalitarianism or personal freedom, but I belive that liberty follows from order. What does “order” mean? The shortest definition is that “promises are kept.” If I have property rights to my home or factory or store, those rights are clear and will not be arbitrariliy taken away. I can walk down the street without threat of violence. If I get a marriage contract that is a promise for permanent union, culture and institutions ensure there is a high probability that the union will in fact be permanent. Disputes have clear institutions for resolving them. There is government in place to lay down ordinances where people may infringe on each other – such as forcing noisy bars to close at a certain time, or preventing someone from opening a garbage dump next to my house, and even enforces rules against public vulgarity.

The second part of my right-wing beliefs is that I believe that hierarchy is a necessary evil. Modern civilization requires large organizations. Organizing a army that defeat invading barbarians and protect the property of civilized people requires organization and hierarchy. Operating an automobile factory, an offshore oil platform, a chip fabrication plant or gas power plant requires coordination of dozens or hundreds of people. Based on the physics of the machinery, there is a minimal size of a plant. Now maybe someday we can all have home based replicators.

Please note that being “pro-hierarchy” does not mean that I am pro-top-down-micromanagement. Most arguments against hierarchy are really arguments against micromanagement. In the ideal hierarchy, lower level managers and employees have very broad ownership and control of their area of discretion, and their superior mainly provides overall accountability, not day-to-day orders.

Many mainstream progressive will have no problems with the above statements. What then makes me righ wing? While modern mainstream progressive ideology allows for some amount of order and hierarchy, on certain issues, if you advocate the “more order” and less egalitarianism position, you are branded a heretic, ejected from the left-wing movement, and considered a right wing person that must be defeated.

My three most pro-order right wing beliefs are:

a) in crime ridden major cities such as Philadelphia, the police new more power to constantly patrol neighborhoods and to stop people and find guns.

b) In return for recieving government benefits, single mothers should be required to live with their children in convent-like institutions under the watchful eye of a master and matron, with curfews and strick behavior rules.

c) School teachers need more powers to discpline students, including corporal punishment.

And my most anti-egalitarian beliefs are:

d) We invest too much money in education, if a student is innately smart they will learn a subject effectively from dirt cheap books, if the student is innately dull, no amount of one-on-one teacher time will allow them to master the subject at a competitive level. ( I do think that duller students could be raised to at least adequate level on many subjects if cheap, but high quality teaching methods were more common, such as computer programs that would produce drills with difficulty levels adjusted by past results)

e) Universal suffrage electionocracy is a lousy government, and would best be replaced with a form of government that was more aristocratic and more hierarchical.

th ]is the way that we often percieve the things the way is the future

The “right” should aspire to be the faction of ordered liberty.

True reactionaries will protest that order and liberty are really synonyms, and that I’m being needlessly wordy. They are correct. I use both words to make the phrase more appealing to the non-initiated.

Left is the faction of anarcho-tyranny

The basic problem is that Europe cloned a banking system that was designed for nation-states ( such as the U.S., Japan, or pre-Euro Germany) without understanding how it applied to a federation of independent states.

There is not enough money in the world to pay back America’s national debt. Total United States currency (paper and electronic entries in reserve accounts) sums to about $2 trillion. The national debt sums to over $14 trillion. If people ever really suspected that the U.S. monetary printing press was broken, there would be the mother of all bank runs. Bond holders would redeem their U.S. debt instead of rolling it over. Savers would hold tightly to any real currency. The entire banking system would collapse. But such a crisis has no chance of happening because the Federal Reserve promises to buy up government debt with cash as demand for currency rises. American government debt is thus risk less. Since it is both risk less and it pays interest, nobody actually redeems their treasury bills for real currency, and the ratio of $14 in ‘debt’ to $2 trillion in currency can be maintained forever.

The reality of American treasury “debt” is that it is not really debt. Treasury bills should be considered part of the money supply – TBills are simply dollars with not valid dates. T-Bills are equivalent to restricted shares in a company.

The European financial system operates in the same manner. The monetary base – actual currency and reserves – is about $1.3 trillion. The total amount of government debt runs in the tens of trillions.

Thus the key thing to understand about Europe is that no country in Europe is solvent. No country can pay back its debts without the central bank printing money. The only reason Greece ran into trouble first is due to the perception of insolvency. Since Germany is perceived as responsible, people still buy Germans bond. The entire Euro-Zone is having a Wile E. Coyote moment. The Greece bondholders looked down first and are falling. But if Euro bond holders refuse to buy bonds, and wish to redeem their holdings, no government in Europe could stay solvent. How is it possible for Germany to pay back $4 trillion in debt when only $1.3 trillion real Euros exist?

But Europe has a problem, because if the European Central Bank acts like the American federal reserve, and buys up government debt as needed, it is essentially transferring money to that government. All the countries in the Euro-zone would race to issue more debt and have the central bank give that country cash.

So how to fix Europe?

The best solution has two parts a) all sovereign Euro debt is assumed by the European Central bank. The bank prints money to retire the debt as it matures. b) Each country is given a one time grant of Euros equal to 150% GDP. (or perhaps base the grant on population or a combination of GDP and population – this boils down to a political question of who gets what). The grant amount is reduced by the amount of debt assumed by the central bank. So Greece nets a grant of 10% of GDP while Germany nets a grant of 70% of GDP. (1)

This solution makes the entire Euro-zone solvent. The debt crisis disappears. But the solution does not punish responsible countries. Everyone receives the same grant, those with less debt now have cash in the bank they can spend. Germany can use its trillions to issue a general dividend to all citizens, send a man to the moon, or do whatever else it fancies.

After the above solution, going forward there is only one golden rule of the Euro-zone – sovereign countries cannot issue debt denominated in Euros (2). If Greece wants run deficits in the future, it must borrow in dollars, gold, yuan, bitcoin or its own scrip. But it cannot run deficits in Euros (3). If there is a recession, any counter-cyclical/stimulus spending should be handled by the central bank. The central bank should print money and grant wads of cash to each country on a per capita or per GDP basis.

(1) Some might view this policy as a wee bit inflationary. But the actual amount of inflation will not be that great. Price inflation requires people to have more purchasing power to bid up goods. After this plan, Greece will not have much money in the bank to spend, it will simply be free from having to undergo massive austerity. Thus the plan will be anti-deflationary, not inflationary. Germany will have a huge chunk of cash to spend. But I’m guessing the responsible countries will only spend this cash gradually, if at all, and thus the inflationary impact will be limited. Also some inflation is appropriate to get the economy back on track. And inflationary is only really bad when it transfers money from the savers to the profligate. But this inflation will be the result of giving savers the same purchasing power that the profligate already abused.

(2) An a possible alternative solution is that the European government allows issuing of Euro denominated debt, but swears to the ghost of Ludwig von Mises that it will never bail out a member state. If the market believes this promise, the valuation of government debt will drop continuously as a government issues new debt, rather than all at once during a crisis. Thus there will be no big crisis moment that causes contagion. But I do not think the Euro central bank could make a promise strong enough for the markets to believe, so I think you end up back in the same situation in a few years.

(3) Frankly, there is almost never a need for a country to go into debt. Debt is useful for entities that have a life cycle. People go into debt when young to buy a home, and then pay it back as they age. Companies go into debt to buy capital, and then pay it back as they mature. But a country (should) never die. There is no reason to pay for tomorrow what can be paid for today. The only reason ever to go into debt is if you have a tremendous, one time expense, that is large in relation to current income. Buying a home or a factory qualifies. But countries almost never have single one time expenses that are large in proportion to GDP. Thus they should never go into debt. Even a highway should be an operating expense for a country. The only time a country should go into debt is during war. But that’s hardly an issue for Europe right now. Better that the financial system be structured to make it more difficult to wage war.

Freedom from Violence and War

The last few decades have been among the most non-violent in human history. The rise of state power over the last eight centuries ended the clan based and vengenece based murders endemic to more primitive societies. Policing techiniques made committing crime more difficult.
The rise of America as world hegemon has created two decades of general world peace. No general wars and mass mobilization towards general slaughter have marred our generation.

A robust legal infrastructure that allows an amazing degree of business integration

I punch in 16 digits at a computer terminal and click submit. Instantly money leaves my bank account and flies over fiber wires to the account company thousands of miles away. A few days later I will recieve the book or DVD that I ordered. I do not fear the shipment being stolen by band of pirates or brigands. I do not fear Amazon stealing my cash and giving me nothing. The seller of the trinket does not fear getting stiffed by my bank.

From my computer I can buy shares of companies, take out loans, buy long term certificate of deposits. All of these transactions I do without fear of fraud.

The creation of this network of contracts and institutions is a marvel of the modern age.

Rule of law in most areas

Most Americans live secure from the potential for arbitrary arrest. Police do not shake down people for cash. Recourse to a trial by jury remains (albeit somewhat eroded by the plea bargain system). No secret police will arrest you in the middle of the night for undisclosed crimes and execute you after a secret trial.

Strong property rights

I can buy a home and feel secure that a band of thieves will not hold me up and force me to hand over the deed. I do not fear invading tribes or barbarian raiders. There is a very feint risk of emminent domain, and some risk that zoning laws might change so much to make my property unsellable. But in general I can buy property and feel very secure in its ownership.

Freedom of Conscience

Americans can generally say what they want. You can write a newspaper article or a blog post condemning God, America, Obama, motherhood, or apple pie, and you will not be fined or arrested. That said, while speech is more free than in most time periods, it is not as free as Americans believe. “Political correctness” is the modern version of heresy. Its definition has been expanded to be broad enough that accurately diagnosing many of the great problems I listed above require making ‘politically incorrect’ statements. And making politically incorrect comments in front of a co-worker will legally obligate your employer to either re-educate you or terminate your employment.

While Americans have religious freedom, the atheistic ideological institutions that preach the religion of the progressive state have extensive tax advantages, subsidies, and government privileges that other religions have trouble competing with.

Fake Problems of Our Age

While the problems of our age are great, much political discourse fills with issues that really do not matter.

Corporate Power

The Occupy Wall St. movement is very concerned about excessive corporate power.

I too despise the policies that resulted in the looting of America by Wall St. I agree that corporate influence peddling is a major problem and it needs to be ended. But I think focusing too much on corporate power misses the root issues. Most suggested solutions would not significantly fix the problems of the value transference economy.

The financial crisis is a result of imcompetence as much as it is a result of corruption. And the corruption problem is not isolated to corporations – corruption is built in to the structure of the political system.

The core problem was not corporate money influencing politics. Obama raised tens of millions of dollars from ordinary voters. He had every mandate in the world to enact something like the Finbarr financial reform plan. He could have enacted the plan by giving a thumping speech and issuing executive orders. But Obama did not do this. He failed to do this because he knows nothing about banking or economics. So he had to rely on bankers and advisors in bed with the bankers to craft an economic policy.

Bureaucrats face the same pressure. Read Foseti’s excellent post on regulatory capture. Bureaucrats rule in favor of industry, not because the bureaucrats are corrupt, but because they simply have neither the training nor ability to make independent judgement. So they have to rely on the judgement on the only people who know how it works – the banking industry representatives.

Other forms of corruption happen for reasons that go beyond campaign contribution. Congressmen give subsidies to local businesses because those business provide jobs and the workers at that company vote.

The problem of value transference goes well beyond corporations.

Much has been written about the prison-industrial complex. But the biggest proponent of “three strikes laws” and prison building has been the California prison worker unions. Police unions use their bargaining power to earn six figure salaries watching construction sites. Teacher unions use their power to lobby for rubber rooms instead of firings.

The general problems is that the basic electoral and Congressional system exacerbrates the Mancur Olson collective action problem – our system allows the concentrated interest to enrich itself at the expense of the general interest.

White on black racism

White racism has not disappeared and it never will. And frankly nor should it – some recognotition of the strengths and weaknesses of various ethnic groups is not entirely unhealthy.

But from my observation point, overt white on black racism is no longer a defining problem in the life of black people. Companies face the fear of lawsuits if they employ racists. The public spaces, from atheltic fields to buses to sidewalks to television shows, have been cleared of racial epiphets. With the implementation of affirmative action, on net, black people of a given level of qualification recieve positive discrimination in most circumstances. Even far right Republicans bend over backwards to prove they are not racist.

That does not mean life is hunky dory for all black people. Black Americans have been hit the hardest from the decline of the inner city cores, the rise of the value transference economy, and the shattering of the culture templates. The rise of the guild/cartel/service economy has hurt many black Americans, because success is more linked to social networks and having cultural compatibility with the rich segments of the population. But I do not observe that the these problems are related to racism.

Wealth Inequality

From a long term historical persepective, the amount of inequality in modern America is not worrisome. From an ideological perspective, I do not think inequality in itself is a problem. Some degree of inequality is an inevitable result of the existence of risk. If an entrepreneur such as Jeff Bezos or Steve Wozniak quits his job and forgoes hundreds of thousands of dollars in salary, he needs the prospect of large returns to make the risk worth it. Without allowing for some inequality, entreneurship could not exist.

Nor do I think inequality in and of itself is a problem. I am not any more unhappy because people richer than me exist. Perhaps some people are bothered by Bill Gate’s fortune, but those people need to mature and quit measuring themselves against other people.

I have also researched the arguments linking inequality to crime or the business cycle or the problem dejure of the day, and I’ve found the arguments bogus.

I do care if rich people earn great fortunes by theft or corruption. And much of the inequality in the past forty years does stem from corruption. But here the root problem is theft/value transference, not inequality. I wrote about this problem already, above.

Women’s Rights

The revolution is over and the feminists won. Where I live (in a very, very blue city) even suggesting that raising a family is more important for woman than a career is a taboo. While in absolute terms a pay gap remains, after controlling for work hours and career choices the gap disappears. Women now initiate most divorces, win the children post-divorce, and extract child support from husbands banned from living with their kids.

Extremist feminists and the Democratic Pary want even further efforts – they feel that pay should be equalized across professions. But men deliberately seek out productive, competitive, high paying careers because money is a key asset that they bring to the dating market. Women can afford to take low paying jobs because fertility is their main asset. Women fill the ranks of art history grad school while men disproportionately go for engineering jobs. For women, the ability to earn less by choosing a more nurturing career is a luxury. Preventing men from reaping the rewards of productive careers like construction and engineering would wreck both the economy and what remains of the social fabric.

I do not deny that there is some cultural messaging that creates disadvantages for women in earning income. The studies showing that managers of both sexes react more negatively to women speaking out in the work force or negotiating for pay. But, fundamentally I do not think that completely homogenizing the two sexes should be a societal goal. There are innate differences between the sexes, and I do not have a problem if a cultural develops around the differences, and proviides some amount of soft gender roles, as long as those roles can provide meaningful happy lives for people of both sex.

Global warming

Academics face the intense pressure of publish or perish. Academic fashion holds that only excessively mathematical papers are truly “rigorous” and publishable. It is an open secret that professors routinely play with the data and adjust dozens of variables until they get a result that is both plausible and statistically significant at the 5% level. The open scandal is that these papers are all junk – if you have dozens of degrees of freedom you need a much higher bar than 5% to be certain.

Climate science faces this problem in spades. The climatologists (wisely) shy from predictions. To the extent they do, the predictions do not come true. Thus we are left with statistics. And from the looks at it, the statistical practices are a notch more dishonest than the already scandalous academic norm.

The famous ‘hockey stick’ graph from Al Gore’s documentary was a sham. In the climategate emails we have examples of top scientists writing bald face lies to a NY Times science reporter. Another climatologist writes, “”. The “consensus” means little since grant-based science follows a somewhat hierarchical structure. Climate skeptics have zero chance of making it through grad school and getting grants.

From the basic science behind the greenhouse effect, temperature increases logarithmicly with the increase in CO2. Double CO2, temperature increases by 1 degree. Double CO2 again, temperature increases by another degree. Triggering a catostrophic level of global warming via first level effects requires far more carbon production than even the most pessimistic climatologists predicts.

The evidence for catostrophic global warming comes down to the existence of positive feedback loops. No one knows if these feedback loops exist or not. Positive feedback loops are exceedingly rare in nature. From the historical record, we have been in a cyclical high point in temperature for the past ten thousand years and the major danger is a return to ice age levels of temperature.

The case for addressing global warming comes down to the precautionary principle. I think we should take steps to address global warming that make sense anyway. Any promising avenue towards alternative engery merits support. Reducing gasoline usage of cars makes sense on pure economics and quality of life, in addition to the precautionary principle. But I do not believe that the threat of catostrophic climate change is significant enough to warrant the insane 80 by 50 plan. The precautionary principle does not justify stopping the growth of China in its tracks and turning back the clock on the industrial revolution.

Civil Libterties

Debate over civil liberties fills the news – Guatanomo Bay, the Patriot Act, torturing prisoners, executing a possibly innocent person, police pepper spraying protestors, etc. The discussions always bore me. The seven issues I listed are life changing to tens of millions of people. Every day they affect myself and people I care about. Issues such as the Patriot Act or Guatnamo Bay have never affected anyone I know.

Police brutality and police overreach happens. But the vast majority of people who do not deliberately antagonize the police will never have any issues. If you get pulled over, turn on your car lights and keep your hands visible. If you are forming a human chaing blocking a walkway, and the police tell you to move along, move along.

The net total impact to America of the above civil liberty violations is trivial. In terms of long term trends and historical precedence, the current American government is among the most conscience towards civil liberties of any government in the history of the world. Some vigiliance is good in order to keep it that way. But it does not come close to ranking among the great problems of our age.

Composition Problems

The BEA calculates GDP by totaling the dollar expenditures of every person and organization in the United States (this is called “Nominal GDP”), and then multiplying that total by the change in a price index. This results in a number the bureau refers to as “Real GDP”.

The “Nominal Gross Domestic Product” metric is grossly misnamed. The units of the number are dollars, thus it is a measure of money, not “product”. If the government printed $100 trillion dollars, national income would skyrocket, but that does not mean any more goods would be produced, it would just mean that prices would rise. The number is a measure of the supply and velocity of money, it has zero to do with the production of goods. The name should be “Gross Expenditures” or “Gross Money Flow”.

To calculate actual economic growth, the government takes the growth in expenditures and subtracts the growth in prices. The difference is the actual growth in production of goods. At least that is the theory.

The first problem is the composition of the price index. This is such a big problem that by itself it invalidates use of GDP as a metric. The price index is calculated by calculating the prices of a basket of goods.

The trouble is that the basket excludes a) all goods that are produced but not measured/traded and b) goods that the economy can no longer produce at all, for whatever reason.

The famous example from Paul Samuelson is that if a man married his maid, then, all else being equal, GDP would fall. Or if a nanny has a child and quits her nanny job to take care of that child, GDP falls, despite the total amount of child care being produced remaining the exact same.

The most glaring absence from the “goods basket” is leisure time. And in fact any non-economic good is excluded: working on the house, taking care of children, doing private research, writing a book to distribute for free over the Internet, etc.

Futurists in the 1800′s used to imagine that as society grew richer, people would work very short weeks and dedicate most of their time to leisure, learning and the arts. In such a scenario, GDP would actually be stagnant or declining, as GDP stats would not pick up the increased production of leisure, learning, or arts. In policy circles, officials think that greater GDP is always good. But we have no idea if that’s actually the case – we might be better off under scenarios where GDP is falling.

The astute reader may complain, “But GDP is not trying to be a measure of well being, it is supposed to be a measure of output, to be weighed in policy decisions against other factors.” But this is incorrect. GDP does try to measure of “well being” because there is entire system of “hedonics” built into the price index. These hedonic measure try to measure how much the good has improved well being.

Nor does GDP measure output; it just measures changes in a price index. If the entire industrial base atrophies, manufacturing disappears, and a country survives off of exporting its currency like 16th Century Spain or modern Iceland, numbers such as the GDP will not pick this up until it is far, far too late.

Finally, policy makers with an economics background do overly focus on GDP. Just pick up a random economics paper or read a Fed report to Congress. These documents mostly discuss what factors or policies will raise GDP. They never discuss the scenarios in which raising GDP is actually desirable. The policy papers rarely concern the trade-offs with other factors such as leisure time, commute time, community, environment, etc.

Exports amd Imports

The price index used by GDP excludes all imported goods. This has some logic to it. GDP is supposed to measure output of the U.S. If the U.S. imports all its wool, and the price of wool rises due to a sheep epidemic in Australia, that is not representative of a fall in output in the U.S.

But this logic collapses upon further inspection. Let’s say there is a thriving export industry making airplanes. U.S. manufacturers and export the planes to Saudi Arabia, Saudi Arabia ships back oil. Now let’s say that due to bad management the quality of the planes declines. Saudi Arabia buys European made Airbus planes instead, and the American companies go out of business. What will happen? National Income in dollars of the U.S. will be the same (remember National Income is simply a measure of the supply of dollars and people’s desire for cash balances, it has nothing to do with goods produced). The price of oil will rise significantly. The U.S. has less goods to exchange for oil and thus the dollar must weaken against Saudi’s currency. The price of other goods will rise a bit due to increased oil costs, but not as much. Thus if you exclude oil from the price index, you would miss this huge drop in production. And in fact, this has happened over the last decade as GDP continues to climb despite the disappearance of the U.S. manufacturing base.

So we have good reasons for excluding imports from the price index, and good reasons for including imports. Which is correct? The economist at the Bureau of Economic Analysis tries to patch it up the best they can, and kludge a number together.

The reasonable person must admit: “We do not know”. You fundamentally cannot reduce all of a nations output to a signal number. Any attempt to do so will simply combine dozens of different assumptions that will react or cancel each other out in weird ways, giving you a resulting number that is completely useless.

And we are still not done yet.

Substitutions

If the price of steak rises, consumers will shift their consumption to another good, perhaps ground beef. This will in turn change the weightings used by the CPI and GDP, so that the more expensive good, now being consumed less, will get weighted less. The CPI allows limited substitution, while the GDP is a full substitution index. These different assumptions can have dramatic differences in the resulting numbers. John Williams writes:

Nonetheless, if steak prices were to rise, strapped consumers indeed likely would shift to cheaper meats, and such would be reflected in the broader weighting categories. The problem from the BLS standpoint, though, was that those weightings traditionally were recast only every ten years. So, the broad-category reweighting process was accelerated, with a reweighting in 1998, and, thereafter, reweightings were structured formally for every two years starting in 2002. This process moved the CPI closer to a fully substitution-based index.

These approaches, in conjunction with other methodological changes ranging from increased use of discount-store surveying to shifting quality and hedonic adjustments, resulted in meaningful downside adjustments to reported annual CPI inflation of roughly 300 basis points (3%), of which 28 basis points currently is estimated by the BLS as the effect of geometric weighting. The period involved here, from the early-1990s to date, was dominated by efforts to address the Greenspan/Boskin contention that the CPI “overstated” inflation.

Nonetheless, the resulting, current CPI was and still is not a fully-substitution-based inflation index. An experimental substitution-based index, the Chain Weighted CPI-U (C-CPI-U), is published monthly by the BLS along with the CPI-U and CPI-W. At present, the C-CPI-U is showing the annual inflation rate running about 80 basis points (0.8%) below the official CPI-U. It is plotted as one of the three CPI measures in the inflation graph on the http://www.shadowstats.com home page.

Infrastructure

GDP numbers measure the dollar value spent on infrastructure, but they do not measure the amount actually produced. If the government pours money down the drain in wasteful and corrupt corruption projects, this will show up in the figures as net production.

GDP numbers do not show depreciation. So if existing infrastructure is crumbling faster than it gets replaced, GDP might show up as actually growing while in reality things are falling apart.

If the entire city of Detroit gets destroyed in riots, fires, crime waves, and ethnic cleansing, and is left in ruins, this will not show up in GDP numbers. In fact, GDP might actually increase since the destruction would spur the creation of new housing (which does show up in the numbers) and the average home price might actually fall (reducing the GDP delfator) due to homes becoming unlivable due to violence.

Hedonic Hell

Both the Consumer Price Index and GDP deflator rely on “hedonic adjustments”. They adjust the numbers based on improvements in quality. On the surface, there is some plausibility to these adjustments. Cars have risen in price since 1970, but they have also improved greatly in quality. We now have air bags, crunch zones, better mileage, greater durability, etc. If you just look at price, you may think that the quality of life has dropped when in fact it has risen.

But the trouble is that none of these improvements are numerically quantifiable. Try answering for yourself. How much better is a 2010 computer than a 2002 computer? 2.3 times better? 1.7 times better? 20% worse? If you cannot answer this number numerically, for yourself, how can anyone answer it, especially for the entire country?

The 2010 computer has three times the processing power, so is it three times better? But most people will never use this processing power, so for them the quality is the same. Those who hate windows Vista might argue that the quality has actually declined. The answer is entirely subjective, and defies a numerical categorization.

The BEA uses several methods for adjusting based on hedonics. All of these methods have a surface plausibility, but upon a deeper look are completely invalid.

Method one is overlap pricing. For a brief period of the year, an applicance company might sell both the 2009 microwave model and the 2010 model at the same time. The price difference between the models can be used as the hedonic adjustment. This method is complete absurd. New products often sell for more even if they are not really any better. New game consoles sell for huge premiums upon release, but quickly fall in price. It costs $12 to watch GI Joe II in the theater the week it comes out, at the same time it costs $3 to watch The Avengers in a second run theater. Does this mean that GI Joe is four times better than the Avengers? Overlap pricing strategies actually measure the amount of price discrimination a company is using to gain extra money from people who want to show status by having the very latest gadget. There is no predictable relationship to overall increase in quality.

Method two is the **explicit quality adjustment method** in which the government tracks the amount spent on improvements. For instance, if a car company spent $100 per model adding a new support beam for safety, that would be counted as $100 worth of quality improvements. Again, this is invalid. Just because a company spent $x dollars on improvement does not mean it actually increased in quality that much. This number has the potential to exclude various items the car company might subtract from the car. The new oven might have a slick digital interface, but perhaps some of the internal parts have been replaced by plastic. Nor it is easy to distinguish improvements that are marketing gimmicks from actual long term quality improvements. The CPI excludes money spent on cosmetic changes like new paint colors and reshaped bumpers. But take the example of the Lexus that can parrallel park itself. Is that a valuable long term quality improvement, or really just a style change that allows its rich owner to show off?

Method three is to measure some component of the product – such as processing speed or gas milage – and detect how much it improves. Again, this is almost always invalid because it is impossible to relate something like processing speed to an overall quality value for the product. Doubling the processing speed of the computer has no hedonic impact on my mother’s ability to send email to her friends.

These problems are not merely academic, hedonic adjustments have a dramatic impact on the numbers.

From 1996 to 2010, the average sale price of an American car rose from $16,901 to $23,182 (37%). The Ford Taurus rose in price from $18,545 in 1996 to 25,018 in 2010. The cheapest Ford rose in price from $11,430 (the escort) to $13320 (the Fiesta). The cheapest Honda rose in price from $9,980 (the Civic) to $14,900 (the Fit).

Depending on the measure we use then, the prices of cars rose by 22% to 49%.

Yet from the CPI index for automobiles from January 1996 to April 2010 actually fell by 1.5%. In other words, the bureau of statistics has decided that the 2011 cars are ~35% better in quality than the 1996 cars.

Compare the 1996 Ford Escort specs to the 2011 Ford Fiesta Specs. The new model has no more gas mileage, no greater trunk space, no more seats. The new model does have more horsepower, but that’s not going to get you to your destination any faster.

I do not know know exactly how the BLS determined that the price of cars did not actually rise from 1996 to 2010. The general outlines of their methodology is generally available but not the details.

What’s amazing though, is that if you use the straight price numbers, and use gas milage, car space, and speed to calculate hedonic changes, then that means there has been essentially no economic growth in the automobile sectors. Growth is wiped out. The assumptions used by the BLS thus create the econonmic growth. Change the assumptions and you get very different growth numbers.

Of course, in other respects, common statistics may be dramatically underpricing growth. Thanks to Rhapsody + Netflix + Google Books + the Kindle I have instant access to a virtually unlimited number of books, movies, and music for a total monthly price of $25. My Google Books collection alone would have cost thousands of dollars to build a few years ago. But I downloaded it all for free.

ShadowStats does their own calculation of CPI numbers. By using pre-Boskin commission methodology, the ShadowStats estimate of CPI is nearly double the official number.

The point is not that GDP numbers are overstating growth or understating growth. The point is that GDP numbers have absolutely no meaning whatsoever. The numbers are very sensitive to the assumptions you make, and a wide range of plausible assumptions can be used, each producing a very different GDP number. The GDP flunks a sensitivity analysis and is therefore useless. If the number seems close to your intuitive sense of how fast the economy has grown, it is because the calculations were retroactively fitted to match your intuitive sense.

Adjusting the data

Every year. the BEA makes adjustments and revisions to previous years GDP data. For instance, the growth numbers for Q3 2002 were revised downward in three successive revisions. The end result was changing the growth rate from 3.3% to 2.2%. In the 2009 comprehensive revision, the growth rate for 2008 was changed from 1.1% to .4%.

Economist Jeremy Nalewaik has pointed out that GDP tends to be adjusted in the direction of the GDI estimates (GDP and GDI should be indentical, GDP is calculated by adding up expenditures while GDI is calculated by adding up incomes).

Again, the point is not that these adjustments are right or wrong. The point is that the results are extremely sensitive to the assumptions and adjustments made. The end result is that GDP numbers will simply replicate what the people doing the adjustments think it should look like.

Composition problems with the CPI

The CPI excludes the price of housing. Instead they use owner-equivalent rent. The claim is that since money paid for a home is actually income for another person, it is not necessary to include the home price in the index. But this claim applies to the price of every good. Money you pay for oil goes to the shareholders of the oil company. Money you pay for services is someone elses income. The net result of excluding housing was creating a much lower inflation estimate for the past decade.

We all know that from 2006 to 2010 the housing market crashed. Across the nation housing prices dropped dramatically. The Case-Shiller index reported that home prices fell by 31.5%. Yet the CPI index for housing costs (based on equivalent rent) actually rose by 7.7%. Again, by using a different methodology, the CPI produces a wildly different number.

The issue becomes even more complicated when you include foreign investment. Imagine China is implementing a mercantilist policy. China bids up the price of a current home and buys it from the owner (via the channel of mortgage backed securities). The owner then uses the money to buy products from China. China then sells the home to a new buyer at a higher price, who takes out a mortgage. The net result is that America is a net seller of home equity and in return has gotten goods. The price of a home will be pushed up. In the GDP statistics this will actually show up as economic growth (since the cheap Chinese goods will push down the GDP deflator). But in reality, there has been no growth.

“Give me four parameters, and I can fit an elephant. Give me five, and I can wiggle its trunk”

The most seductive call of the GDP is that the resulting number seems somewhat plausible. But that’s part of the problem.

I don’t know exactly what goes on in the heads of the gnomes at the BEA. But I assume it’s no different than what goes on with a college senior trying to write a thesis, or a marketing department trying to figure out ROI numbers for their product.

As we noted, there are huge range of “adjustments” that go into making the GDP. Everything from excluding oil imports, to including paid child care but not household child care, to the various hedonic adjustments are dubious adjuments and fudge factors. The art is that you take these assumptions, and you keep tweaking them until you get something that “feels right”. While this sounds nefarious, the economist might not think so. For he assumes that it is possible to boil down the economic output to a number. He also assumes that the plausible adjustments are the best possible. Therefore, any tweak to those adjustments to make it “feel right” is a tweak towards greater accuracy, it’s fine tuning.

One analyst at a government agency in Canada writes:

Much of our time is spent “forecasting,” which basically means making a common-sense appraisal of what some indicator or variable will do in the coming years, and creating a statistical model that confirms it. The second step adds nothing of value to the prediction – the math is just there for show, a means of impressing the innumerate by camouflaging shot-in-the-dark guesses in rigorous clothing.

Forecasting is different field than compiling GDP statistics, but this quote shows the general mindset that exists.

The problem is that you cannot boil the economy down to single number. The result of this entire process is pure numerology. You are data mining a pre-determined conclusion. Numerology is when people calculate numbers from the bible to get results. Since the Bible is so big, you can get pretty much any number you want. Similiar with GDP. The space in which you can make adjustments and tweak varaibles is so great, you can get any result you want. So the fact that the numbers say GDP grows 2% a year is not the result of “science”, but of psuedo-science. It’s a deeply complicated model that simply spits back the assumptions of the model’s creator.

The result that the designers of the CPI wanted was a reduction in social security payments. Congress felt that social security payments were too high, and they wanted to balance the budget, so they assigned the Boskin commission to redesign the formula. Now there is some validity to this. IMO, seniors were getting too much. But it’s not because the CPI was “overstating” inflation. It was because a) the components of inflation that were rising the fastest affected seniors the least. Healthcare costs were rising, but seniors get covered by Medicare. Housing costs were shooting up, but far more seniors are sellers than buyers. But in changing the CPI numbers to stop overpaying seniors the designers ruined the number as an overall measure of well being.

GDP and dveloping countries

All the problems of GDP apply 100X when we’re talking about developing countries. Yale economist Chris Blattman writes:

Doesn’t it strike you as odd that the World Development Indicators have annual infant mortality data for most countries in Africa for most years? It should. Most of that data is interpolated, and the rest is (as often as not) close to made up. It’s not just the human development indicators. You wouldn’t want to be inside the sausage factory that is the GDP calculation in Chad.

A commenter on his blog, Mona follows up: “As someone who, another lifetime ago, worked on the World Development Indicators, I can corroborate the claims in that last paragraph!”

Often GDP numbers for developing countries look plausible. But that could just because the number was fitted to be plausible. If the GDP number counters your intution, you certainly cannot treat the GDP number as authoritive. Thus there is no reason to use the GDP number at all.

What is the overall bias in the RGDP number?

The Real GDP number is NGDP adjusted by a price index. NGDP is a measure of monetary inflation, in other words it is a measure of the supply and velocity of money. Thanks to excluding certain classes of goods such as imports and real estate, and including hedonics, the price index is less sensitive to growth in the money supply than is NGDP. So in any period of monetary inflation the economy will appear to be growing, while in periods of monetary stability the economy will appear to be shrinking. What this means is that the Real GDP number has a built in bias that makes policy makers confuse inflation with growth. Policy makers might think the economy is growing, as in 2006, but in reality the purchasing power of the average worker is eroding as the inflation is going to the well connected while the price of oil and food rises.

And of course, due to the mechanisms of the modern business cycle, inflation will be associated with high utilization of economic resources (labor and factories) while deflation will be associated with recessions. Another bad problem is that there is two types of growth that get badly mixed up. There is the “growth” that occurs when exiting a downturn – this is a growth in utilization as idle resources go back to work. This kind of growth can be stimulated by inflation. Then there is the growth due to the creation of new technologies and products. This growth has very little to do with inflation. Unfortunately all these mixed definitions leads to smart people writing hopelessly confused essays where they try to apply policies to stimulate technological growth towards stimulating utilization growth, or they use charts of RGDP (ie monetary inflation) to examine the problems of technological growth (which has nothing to do with RGDP).

Is the GDP good for anything?

“GDP” refers to either nominal GDP or Real GDP. Nominal GDP is a misnomer. It’s a measure of the flow of dollars, not of production. However, comparing the nominal GDP of Country A in 2010 to the nominal GDP of country B in the same year can be useful. Because there is an exchange rate between the two countries, comparing any cross section of income (nominal GDP, median income, wage of the average McDonald’s worker, total taxable income, etc, etc) will give a reasonable comparison of quality of life. Of course, there is still much room for fudge (Purchasing power parity, potential double counting in the GDP calculations, etc).

It is so called real GDP that is completely useless. Real GDP attempts to put a dollar price on the change of output overtime. But since there is no exchange of goods between 2010 and 1970, this can only be calculated via the tortuous statistics that I discussed above. These statistics simply replicate what the economists want to find, they do not add any information, and only open opportunities for being misled.

How to replace GDP and CPI

The last argument of the GDP/CPI fans is that, “GDP/CPI may be imperfect, but it’s the best number we got for (insert use case here).”

We will demolish this one last argument. In some cases we must accept that the attempt to use any number is fundamentally flawed. But in many cases there is actually a replacement number that is far more accurate and sensible for the given purpose. Let’s go through each use case one by one.

Measuring changes in well being: the Basic Living Index

Is there any way we can measure well-being numerically?

Creating some sort of “national happiness number” is an impossible task. It will contain all the problems of measuring GDP and then some. It will bury the underlying data and create endless arguments that it’s not taking into acount x, y, or z.

The best way to measure changes in well being over time is to do the following:

Create an index where you have precisely defined set of goods in the basket that maintain their definition over the time period that you are measuring. For instance, the basket might include:

• 100 dozen eggs
• 200 pounds of ground beef
• 300 pounds of flour
• one day at the hospital, one prescription drug, 2 hours with a doctor
• 350 gallons of gasoline
• enough heating gas for a year
• the cheapest car that can legally drive on the highway, cost amortized over its lifetime
• the median home amortized

The goods should be weighted by the actual, typical consumption over the course of the year. Then the total cost of buying one year’s worth of the good should be divided by the median wage of a 30 year old male worker. The basic living index now has a precisely defined definition that is true across the entire time period: “The number of hours you must work to meet your basic needs of food, shelter, clothing, heat, and healthcare.”

Then leave everything else to subjective discussions and interpretations. Do not try to turn subjective things into a number, leave them for the reader to decide. Each person for themselves can debate subjective claims such as: The median home in 1970 was smaller, but had a shorter commute. We have more access to music now, but the live music sucks.

Monetary Control

The primary number the government should use for monetary control is total personal income. Total income is simply a measure of the supply and demand for money. If the supply of money increases national income will rise as a person will have more money to spend. If demand money for falls, by definition the price at which a person is willing to exchange money for goods will rise, and thus national income will rise.

By preventing national income from falling, the government can prevent or stop recessions, which are caused by falling aggregate demand. And by controlling the rise of national income, the government can prevent destabilizing bubbles from developing ( I’ll explain this point in a future essay).

The second number the government should use is an index of the prices of alternative stores of value. Money is fundamentally a store of value. If the price of other stores of values are rising with respect to dollars, that is a good sign that the currency is frying. An index of alternative stores of value would include: central city real estate, farmland, stocks, oil, and gold.

Illustration

Sometimes you wish to adjust prices for the purpose of illustration. You may be reading a book that cites the price of a movie ticket in 1910. What does that price mean to someone today? The best way to adjust the price is by using a measure of wage. Median wage is good if the number is availble. Otherwise use the wage of a typical farm hand or carpenter. A wage number is less suspectible to fudge factors (although still not perfect), and is more directly aligned with what you actually want to know. If you are adjusting a price for illustration prices, you are trying to figure out what the price means to you. The best way to illustrate the price is by telling you how many hours it would take to earn that movie theater ticket.

Indexing Social Security

Social Security should be indexed to national income. In fact, the way to solve the entire social security crisis is to simply state that 12.6% of national income will go to social security, and whatever that income buys, it buys. If the economy produces fewer goods because seniors retire, there is no inflation adjustment possible that can give those seniors the promised income. If the cost of living increases because the economy is shrinking, everyone must bear the pain. Conversely, if the economy grows really fast there is no reason to exclude seniors from this windfall by reducing their income.

Comparing cross country wealth

Let’s say we want to compare the wealth of two countries. The best number to use is some sort of income measure adjusted for exchange rate. The best way is to find the types of jobs the median worker is employed in at that country – carpenter, taxi driver, factory worker, secretary or whatever – use that to find an average nominal median wage, and then multply by the population. If the country has accurate measurements of total income, then that could be used. But for third world nations where no good national income numbers exist, the median wage method will give more meaningful numbers.

Measuring the start and end of a recession

Use the unemployment rate. This will eliminate the absurdity of people saying the recession is over when the unemployment rate is still at 10% and rising. Any measure of utilization is also useful, such as automobiles manufactured as a percentage of peak output.

Measuring national output

For some purposes – such as military planning, studying the history of economic development in a country, or gauging the depth of a depression – it is useful to have actual measure of output. In this case the various industrial outputs should be measured directly. Compile a list of statistics for all industries – miles of railway, tons of steel, units of automobiles, cargo containers shipped, KWH produced, airplane flights made, the total horsepower of all machinery, bushels of wheat, phones per capita, etc. The units on these figures are the unit that you are measuring. There is no way to convert the units to dollars and compare the results across time period. Instead just compare the output directly.