Murphy Battles Anti-Market Economics and Ethics

By David Gordon

[The Politically Incorrect Guide to Capitalism. By Robert P. Murphy. Regnery, 2007. Xii + 206 pages.]

Robert Murphy's admirable book is much more than a conventional defense of capitalism. Murphy includes standard material, e.g., why price controls, minimum wage legislation, and rent control do not work. Though it was once controversial to point to the inadequacies of these measures, now even mainstream textbooks hasten to condemn them. Murphy goes far beyond this. He takes on the most difficult and controversial challenges to the free market, and offers convincing responses to them.

Few matters excite critics of the market to rage as the high salaries of corporate CEOs; Paul Krugman, e.g., in his Conscience of a Liberal, makes little effort to conceal his envy at those who dare to earn more than he does.[1] The response by defenders of the market is obvious: if the market pays the CEOs high salaries, this indicates that those who pay the salaries expect the executives to generate sufficient profits to justify their high compensation. Critics are often invited to found their own corporations.

But is not this defense of the high salaries open to objection? The claim is that financial success justifies the high salaries: how, then, can one justify enormous severance packages to CEOs who fail? Surely one cannot here appeal to market efficiency. Murphy accepts the challenge:

Unlike routine managerial work, the task of a CEO often involves bold innovation. If the steps necessary to turn a particular company around and earn millions were "obvious," the company wouldn't be in trouble in the first place. When a new CEO comes in with ambitious plans, he knows that failure is entirely possible. If the shareholders said, "We'll pay you $20 million if you succeed, but nothing if you fail," it wouldn't be a very attractive offer at all. This is because the type of person who gets picked to head a major corporation could easily make hundreds of thousands, if not millions, for certain by consulting or offering other services less glamorous than being CEOs. (p. 21)

Murphy continues the same pattern with another issue. The free market cannot be blamed, an often-repeated argument tells us, for racial discrimination. Quite the contrary, those who discriminate pay a penalty. If an employer refuses to hire people of a certain race or religion, he will pay a penalty.

If an employer has an opening that pays $50,000 in salary, and the Christian applicant will bring in $51,000 in extra revenue while the Muslim will bring in $55,000, then to discriminate against the creed of the latter will cost the employer $4000 in potential profits. (p. 31)

This point, though expressed characteristically well by Murphy, is well known; but it must withstand an objection.

The argument relies on the fact that businessmen aim at maximizing profits; but to do so, must they not endeavor to satisfy consumers? Here precisely the problem arises. What if the consumers themselves hold discriminatory views? Will it not be to the interest of businessmen to satisfy them? Suppose, e.g., that customers in a restaurant would prefer not to be served by blacks. Why would a restaurant owner interested in profit risk the loss of his business by hiring black waitresses?

Murphy again responds in convincing fashion to this difficult problem.

But in cases like this the free market … still punishes discrimination — only this time the customer pays the "racist fee": the customer pays extra (in the form of inferior service) to be served by a white waitress who is worse at her job than a better-qualified black candidate. (p. 32)

It does not follow from this that people will be unwilling to pay the price: but the fact that the market imposes a cost tends to deter discrimination by consumers. (One might object that this does not cover the case of a black waitress who is an equally good server as her white competitor; in this situation, will not consumers be able to satisfy their prejudiced tastes without penalty? But here the owner has an incentive to hire the black waitress by offering her a lower salary. So long as his loss of business is outweighed by his lower costs, he will do so.)

Another objection to the free market has enticed even some economists of libertarian views, though not of the strict observance, Tyler Cowen not least among them. How could the market on its own have gotten us to the moon? What private corporation could have supported the Apollo Mission, or the rest of the space program? If one counters that a consortium of corporations could eventually have financed a space program, would not the inevitable difficulties of coordination mean that our progress into space would have been much slower?

Murphy responds by challenging the argument at its suppressed premise. Why should we think that the space program should have proceeded faster than consumers on an unhampered market were willing to support? Following Bastiat, he notes:

To understand if a program is sensible, we must compare the benefits with the costs. By using up scarce resources in the space program (or building a sports stadium), the government delivers tangible benefits, but also destroys unseen possibilities of the alternative products and services that those resources could have created. Critics of capitalism think (wrongly) that the profit and loss test is arbitrary and crude. On the contrary, it provides an indispensible barometer of the consumers' preferences over how resources are deployed. (p. 119)

Murphy is at his best in his magnificent defense of free trade against a variety of specious objections. Many who should know better complain that free trade takes away the jobs of American workers. Are not supporters of the free market willing to sacrifice the interests of Americans to their single-minded pursuit of profit? The view here sketched is a common fallacy, many times refuted; but Murphy, displaying a remarkable ability for apt illustration, responds exceptionally well. Tariffs, he notes, may help particular groups of workers, but they hurt the whole population:

To see this, suppose the government fined Americans $10 every time they ate dinner at home. Such a measure would certainly boost sales and wages in the restaurant industry. Yet does anyone think it would be a good idea for America as a whole? Would such a tax on home cooking make us all richer? (p. 148)

This is all very well, modern day Hamiltonians may respond, but the argument can be carried too far. What if free trade depletes our entire manufacturing sector? Consumers may be better off, but our greatness as a nation depends on large-scale manufacturing. Even if free trade is generally a good idea, it must be practiced with restraint. Murphy will have none of this:

Even if the claims about the alleged crisis in manufacturing were true, the ultimate response is a big "So what?" There is nothing sacrosanct about manufacturing jobs. Surely we wouldn't expect hundreds of thousands of Americans to be involved in the assembly of automobiles in, say, the year 2050 … Yet suppose we accept for argument's sake that a country ought to have a strong manufacturing sector. Even so, the real issue wouldn't be industrial employment but rather manufacturing output … So when people point to the drop in manufacturing employment since, say, the 1950s, don't for one second believe that our economy is producing less stuff than it did fifty years ago.[2]

But what about the trade deficit? Can America continue indefinitely to increase its deficit, already at an unprecedented height? A standard response, which Murphy makes, is to point out that a trade deficit is nothing to be feared: "If foreigners really are stupid enough to send us goodies year after year without buying as many US goods in exchange, why does this constitute a problem for Americans?" (p. 156).

But Murphy also has another answer.

What the mercantilists overlook is that the trade balance must always balance. This is not an economic theory but an accounting truism. If Americans buy $1 trillion of merchandise from Japan while Japanese consumers purchase only $850 billion in merchandise from the U.S., what happens to the missing $150 billion? … Except for foreigners who literally stockpile hoards of U.S. dollar bills, the money flowing out of the country (because of trade deficits) must somehow find its way back in. (p. 157)

One way this can happen is for the foreigners to invest in America. Ironically, often the same people who complain about the deficit also complain about foreign investment: apparently it is bad both when money leaves America and when it comes back.

Murphy conforms to his usual pattern. He refutes not only the standard antimarket fallacies, but new and difficult arguments as well. Paul Craig Roberts, for one, has claimed that the standard economic argument for free trade is outmoded. Free trade, David Ricardo long ago showed, will be beneficial even if one country is superior in all lines of production to its trading partner. The more productive nation should specialize in what it does best: the less able nation has a "comparative advantage" in the area where it is closest to the superior nation in productivity. Roberts objects that Ricardo's law of comparative cost holds true only if capital is fixed. If capital can freely migrate from country to country, as it now can, the general case for free trade is undermined.

To this Murphy has an insightful reply:

What the view of Roberts and others overlooks is that capital mobility enhances the productivity of the capital. By passing laws that prevent drill presses from being shipped to Bangladesh, yes, the U.S. government can (at least temporarily) prop up the wages of American workers who use these drill presses. But at the very same time, the artificial constraints reduce the earnings of the American owners of the drill presses, and moreover their losses outweigh the (temporary) benefits to the workers. On net, the government restriction makes America poorer … government restrictions on capital export destroy wealth by preventing the most efficient organization of global production. (pp. 168–69)

But even if this is right, does not the increased mobility of capital render the situation of many workers untenable? It is all well and good to say, in the usual fashion, that workers displaced by imports can find jobs elsewhere; but does not outsourcing change matters entirely? If a corporation ships its entire factory abroad, in order to staff it with low-paid foreign workers, does this not mean that these foreigners have in effect joined the American labor pool? How can our American level of wages be maintained at all close to its present level in these circumstances?

Murphy replies in a similar way as he does to the case of capital export.

[T]he laid off U.S. workers are obviously hurt, at least in the short run. They will have to take jobs that pay less (or at least are inferior in some other respect) to their old jobs … However their loss is more than counterbalanced by the gain of the shareholders of the corporation [of the factory shipped abroad], who are American … if the displaced workers lost more in wages by switching to a different job than the corporation saved in production costs … then the corporation wouldn't have outsourced the jobs in the first place. It would have been more profitable to simply cut the wages of the U.S. workers while keeping the operation in America. (p. 163)

$20

One might object to Murphy's argument in this way. He has shown that capital export is, in economists' trade jargon, Kaldor-Hicks efficient: winners from exports could compensate losers. But why should this sort of efficiency be the test of policy? To this Murphy could answer that those who demand restrictions on capital exports often claim that the measures they favor will promote efficiency. Precisely the reverse is the case. If it is then said that the welfare of the displaced workers trumps economic efficiency, then suitable taxes on the corporation and subsidies to the workers can rectify matters. Murphy of course does not favor such efforts to "correct" the market. I bring up the case just in order to show that the objection leaves Murphy's argument intact, even if one accepts the false assumption, i.e., that the state should promote the welfare of one social group at the expense of others, on which the objection rests.

This would not be The Mises Review if I failed to find fault with the book, but Murphy has made my task difficult. In a quiz that begins the book, he asks, "If you are a car producer, how many deaths should your product cause per year?" The provocative answer he favors is "Whatever number of deaths makes your firm the most money" (p. xi). He has in mind an entirely valid point: safety precautions impose costs, and these must be balanced against other considerations. Car buyers in a free market may choose to purchase less expensive cars that are inferior to other cars in their standard of safety. But I think it a misuse of language to say that in this situation, car producers "cause" a certain number of deaths. To cause a death connotes an action aiming at that outcome: Murphy wrongly conflates cause and foreseen consequence. In one place, his language wrongly suggests that Ricardo, and possibly Bastiat as well, defended free trade in the 18th as well as the 19th century (p. 147). Otherwise, I have no complaints. Murphy has written an outstanding contribution to economics.