Wednesday, June 05, 2013

Myths of Capitalism (or, Wages III)

I am not trying to pick on capitalism. I really am not. I'm not a fan of capitalism to be sure, but I am not trying to pick on it. Instead, what I am trying to do is point out some of the myths that surround it. The idea here is that by pointing out the myths people will not make assumptions about capitalism that they should not make, assumptions that are inconsistent with it. Perhaps if we know more about capitalism, we can have a more reasoned discussion of it. The first myth I discussed related to complaints I hear about "lazy" workers. I tried to explain that, for a real capitalism, laziness is not the issue; the issue is labour supply and it has a market-based solution: pay more. The second blog I wrote on this subject looked at the "coldness" (for lack of a better term) of capitalism. A market economy is not a moral economy. Adam Smith, btw, was clear on this point. He noted that capitalism was built on "private vices." I've actually been more generous than Smith. I'm not saying capitalism is immoral. I'm saying it is a-moral. Market based transactions are determined on their utility to individuals; not on their moral worth. Periodically, you do hear capitalists explain this to workers they are about to lay off but the logic applies to all of capitalism. For instance, our small business owner complaining that he cannot get workers to work for such and such a rate and if he can't his business will go bankrupt. Not my concern: it is the logic of the market and what is actually supposed to happen. You and I might think it a drag that someone, say, loses their retirement fund to a bad investment -- say the small business of a relative who begs them to invest so he or she can make a go of it -- but that is actually the way capitalism is supposed to work. Businesses are businesses: the market does not differentiate between one whose capital comes from a retirement fund and one whose capital comes from a venture capitalist. It just determines the viability of the business.

I should also say that when I say "myth" in this context I am not talking about what some Marxists called "false consciousness." (No one does anymore and frankly, I don't actually ever recall hearing a Marxist actually use the term but some capitalists I know claim that Marxists believe in false consciousness so I'll make use of the term here). I am not talking about a conscious effort to manipulate popular views. Instead, what I am talking about just general views: perspectives that people hold for whatever reason (it could be conscious manipulation, but it is more likely just "common sense"). These are things that people happen to believe and which affect their behaviour (for instance, my friend who believes that the problem with the Maritimes is lazy workers). But, they could, and likely do, come from a broad range of sources.

The myth to which I would like to point to day is the idea that what is good for a company is good for consumers. It might be. But, if you ask an economist, they will tell you that you cannot and should not make assumptions in advance. Instead, you should study an issue making as few assumptions as possible.  Thus assuming that what is good for business is good for people is actually an assumption that  runs deeply against the grain of economics. But, even worse, is it s a problematic assumption because it can be demonstrated to be not true.

Generally, the myth works like this: a company wants to increase its profits. To do so, it will lower prices and be nice to consumers in order to attract more consumers. Thus, the interests of the company (profits) and those of consumers (better produce, good customer service) are in sync with each other. This might happen. It really might, but there are other situations where it will not happen, where it is not in a business' interest to increase the number of consumers it has. That sounds really counter-intuitive, doesn't it? The myth of good for business = good for consumer is so deeply embedded that we have a hard time thinking that there is no necessary connection between the two sides of this equation.

The problem with this assumption is that it actually belies a lack of knowledge of economics, in particular of something call marginalism. Marginalism is about what you can charge any one person for product. You might have noticed that some people are willing to pay more for a particular product than other people are willing to pay. My daughter, for instance, is willing to pay more to have an iPhone than I am (andoird user). I might buy an iPhone sometime in the future but the price would need to come down. Not so for my daughter. Now, there is nothing wrong with this, according to capitalism. It is, yet again, the operation of the market. If you run a business, what you are trying to do, in the first instance, is to find that market segment that is willing to pay a lot for your product and sell it to them.

If you are a baseball fan, you could call this the "Prince Fielder Effect." Prince Fielder gets paid,  oh, a bazillion dollars to play first base for the Detroit Tigers. Why? It is not because everyone thinks Prince Fielder is worth a bazillion dollars. In fact, just about everyone did not. But, Prince Fielder's agent was pretty swift. He recognized the did not need to find a bunch of buyers for his product (Prince Fielder). All he needed to do was find one buyer who was willing to pay a lot, and this is precisely what he did. The Toronto Blue Jays would not have paid as much as the Tigers, but so what …? As long as you have one person who is willing to pay a lot … you can sell your product for that amount.  The real term for this is "segmented market."

It is also the same logic behind buy one get one for half price sales. I might be willing to pay, $50.00 for pair of pants, but I won't pay $100.00 for two pairs ($50.00 x 2). So, what the clothing store does is sell offer me a cut rate on the second set of paints. They lower the price of the second pair -- segmenting the market -- to a point where I would consider buying them. In effect, they create two markets for pants: one for those who are buying their first pair and one for those buying their second pair.

Now, let's apply this discussion (which is, btw, basic Econ 101, nothing fancy, basic rules of the game) to an example.We assume the goal of the company is to make a profit. That assumption, in a capitalist economy is pretty fair. If you run a company and don't make a profit, you won't run that company very long. If you own a business that does not make a profit … that business won't be around very long. So, a company wants to make a profit. And, you want to make as much profit as you can, being capitalists. Imagine the product you sell is … let's pick my gig: post-secondary education. If you ran post-secondary education onf a for profit basis … how can you maximize your profit? Well, I'd suggest that what you need to do is pay attention to the "Prince Fielder Effect". What you need to do is find a small number of dumb but very rich kids who are willing to pay a premium for their education. For instance, imagine you normally charge $100.00 for tuition and the costs of running your university is $1000.00.  You need 10 students, in this example, to break even and 11 to start turning a profit. But, imagine that you could find one student -- a real dummy who can't get into any other university -- who is rich and so willing to pay $1000.00 just so they can get a degree.

This is how a segmented market works. To the business looking to make a profit. that one dumb rich studnet has an equal value to the ten regular students you otherwise would have admitted. Moreover, since you have lowered the student body your costs go down. You can lay off faculty, not buy as many books, heck, you don't even need as much toilet paper. Because having only one students lowers the costs of production, you can actually start turning a profit with this one student, whereas before, you needed 11 to turn a profit.

You see what I am saying: consumers are clearly disadvantaged by this. 10 kids who would have gone to university do not go and one who should not go to university does. The society is impoverished because the level of training has, overall, gone down and people have been laid off. But, you get my point. What I am trying to do is demonstrate that because of segmented markets based on marginalism … what I called the Prince Fielder Effect -- the assumption that good for business = good for consumers is just not right.
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