Sunday, December 19, 2004

The market for savings

In response to a blog entry by Arnold Kling, Boonton writes:
If you believe the market works & is usually smarter than its participants what makes you think your feelings about optimal savings are more valid than the actual market result?
I don't mean to speak for Arnold, but I want to respond based on my understandingof what Arnold has written in the past on the subject of savings. A market, all by itself, isn't the positive thing. In order for a market to be positive, it has to be a free market. Free markets provide surprising, sometimes counter-intuitive results. But those results are generally positive-sum -- the gains are more than the losses. In contrast, non-free markets produces results which are generally zero-sum (gains = losses) or negative-sum (losses are more than the gains).

I think Arnold's position is that the market for savings isn't free. The government keeps meddling with it through the style of taxation that we have. That style of taxation causes the market to react. What I think Arnold is complaining about is the style of taxation - the cause of the market reaction, not the market reaction.

The government taxes production (income, interest, capital gains) instead of taxing consumption. The market's reaction is to favor consumption over production. The relative comparison of tax between different forms of production (say income vs capital gains) is not nearly as important as the comparison of tax between production and consumption. The end result of this is that the non-free market for savings does not result in the most efficient savings mechanisms. This isn't the market's fault. It's the fault of those who interfere in the market. The fix isn't to complain about the "failure of the market". It's to complain about those who are meddling with the market.

The market reaction to favor consumption over production is bad, because as a society, production benefits everyone, whereas consumption takes away from everyone. That isn't to say that consumption is bad. Consumption is necessary. We need to eat. But consuming is zero-sum. When I eat a bagel, it's good for me, but bad for you because we both can't consume the exact same thing. Your loss = my gain. But production on the other hand makes all of us richer. The person who produces the bagel allows for at least one of us to eat. Over time, someone else figures out how to produce bagels better. Consequently, more people get fed for the same amount of effort. The free market for bagel production is positive-sum for everyone. This can be generalized: the free market for production of anything is positive-sum for everyone. The system of taxation that we have should reflect this. The market for production should be completely free.

The only alternative to taxing production, and still have a funded government, is to tax consumption. But consumption is already zero-sum. So long as the taxation on production
doesn't go overboard, it does not make the consumption market negative-sum.

There are practical, everyday reasons that I wish we had a tax system that stopped penalizing production. The first result is that taxing consumption would encourage savings. Free markets invariably create job churn. For example, in my bagel production example above, the guy who figures out how to make more bagels for less cost results in a job loss for the first bagel producer. If the first bagel producer had sufficient savings, this wouldn't matter to him because he could draw down on that savings while he learned some new way to be productive. This applies generally: If we all had sufficient savings to be able to survive the job churn that markets invariably create, we wouldn't be so concerned about the impact of a bunch of things that are positive-sum yet cause loads of irrational fear, e.g. outsourcing and immigration. I think it would also impact our view of social security, minimum wages and medicare. We'd see them for what they are instead of what they're not.

I'd like for us to be able to see all of the following for what they really are:
  • outsourcing = increased productivity
  • immigration = willing workers interested in starting at the bottom and working their way up
  • minimum wage = job destruction w/out corresponding increased productivity
  • social security = ongoing government debt that must be eventually paid through some form of taxation
  • medicare = wealth redistribution
The key to this, I think, is to modify our taxation system to encourage savings. Then we might be more willing to accept some of these things (outsourcing and immigration) and reject others (social security, medicare and minimum wage) and choose things that will actually provide the benefits those things purport to provide.

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