04 June, 2015

Economic Law and Catholic Social Doctrine, Part One

Since the beginning of her existence on this earth the Church of Jesus Christ has taught about both faith and morals, that is, about what we are to believe and how we should behave. Under the latter head the Church has taught much about the virtue of justice and has applied that teaching to many specific situations in human affairs. Many of these situations are complex, but that has not prevented the Church from making moral judgments about the rights and the wrongs that are involved. Since the latter half of the nineteenth century the Church has addressed the modern economy of Capitalism, and rendered judgments on many aspects of that economy. The body of these teachings is generally known as Catholic Social Teaching, and it began in an authoritative way with Leo XIII’s 1891 encyclical Rerum Novarum. Since then nearly every pope has added to the corpus of the Church’s social teaching through encyclicals or other documents, as did the Second Vatican Council in its constitution Gaudium et Spes.

Anyone who glances at any of these documents will immediately notice the fact that the various supreme pontiffs make moral judgments about economic relations. Of course one would expect that in documents that deal with right and wrong, justice and injustice.  But when we begin to think about these papal teachings, we encounter sooner or later an objection to them. This is the objection offered by economics, that is by the subject or science which studies our economic behavior and purports to enlighten us about it. For this subject, as it is generally taught and studied throughout the world, at bottom does not think that ethical judgments apply to its subject matter any more than they do to chemistry or physics. Economics asserts that its findings are simply descriptive, or positive as they are called, statements about how the world works. Therefore, it is often said, those who have concerns about economic justice or injustice must respect the conclusions of positive economics in their proposals. Although this might seem like a reasonable enough demand, in fact there would seem to be little if any room for inserting judgments about justice or injustice into the assertions of economics, and thus it does seem difficult to reconcile economics as usually taught with Catholic Social Teaching. The latter seems to many economists simply the well-meaning pleas of clerics ignorant about how the economy works and about the inexorable laws which govern it.

However, those who are concerned with ethical economic behavior need not despair, for it is economics that is lacking, not the Church’s teaching. In order to understand this, let us consider first economics as it is usually understood and then how the Church conceives her social teaching to relate to human acts in the economic realm. Lastly we will see if there is any approach to economics that does not pose a conflict with the Church’s social teaching.

Most economics departments in the world teach mainstream or what is called neoclassical economics. This is a tradition of economic thought descending from Adam Smith, who of course took ideas from earlier thinkers, but was among the first to systematize them. Neoclassical economics is largely deductive in its approach. That is, on the basis of certain limited axioms about human nature, it posits general principles from which it then deduces specific applications to economic behavior. The most fundamental of these principles is the law or principle of supply and demand. This is a simple principle but can be applied to a great variety of situations and with great sophistication. In a nutshell, it means that everyone wants to profit from each economic exchange as best he can. We all want to pay as little as we can for what we buy and in turn to sell our products or services for as much as we can. And of course when we speak of selling a service, we include the personal wage labor of employees.

Although everyone wants to obtain the most he can, since others want to pay out as little as they can, there is normally competition among sellers or buyers or both. If I charge more than others want to pay for my product, no one will buy from me. The fact that people want product “x” but do not want to buy it at my price will tempt others to produce the same or a similar product and offer it at a lower price. But if what I sell is in high demand and there are few sellers, then these sellers will usually be able to command a higher price. Now this rough sketch of how a market works is true up to a point. How it is true and how it is not true we will explore later.

This basic notion of supply and demand is the basis for the ubiquitous demand curve that economists employ with so many variations. Let us consider just one example of how this is applied to concrete situations. In the textbook that is one of the citadels of neoclassical economic theory, Paul Samuelson’s and William Nordhaus’s Microeconomics, (2001 ed.), there is a chapter, “How Markets Determine Incomes.” Incomes are said to be merely,

a special case of the theory of prices. Wages are really only the price of labor; rents are similarly the price for using land.  Moreover, the prices of factors of production are primarily set by the interaction between supply and demand for different factors – just as the prices of goods are largely determined by the supply and demand for goods. (p. 229)

Different salaries or wages of different types of workers can be explained by means of the principles of supply and demand. Since “the supply of surgeons is severely limited [and] [d]emand for surgery is growing rapidly… surgeons earn $270,000 a year on average.” On the other hand, “fast-food…jobs have no skill or educational requirements and are open to virtually everyone. The supply is highly elastic… Wages are close to the minimum wage because of the ease of entry into this market, and the average full-time employee makes $12,000 a year.” (p. 236) In fact, a conclusion frequently drawn from this understanding of wage determination is that each worker is paid as much as he possibly can be, since if an employer offered less than the employee was worth (his marginal product), then other employers would be glad to hire him at a higher wage.

Now is there anything wrong with this explanation of the difference in incomes between surgeons and fast-food workers, and by extension for all income disparities always and everywhere? For if Samuelson is right, then the Church’s call for a living wage for every adult worker encounters a serious obstacle. While Samuelson is correct that if you take for granted our present economic arrangements, supply and demand does pretty much explain the difference between incomes of surgeons and fast-food workers, as a general explanation of income or wage differences it is sadly lacking. It is lacking not so much because what it says is wrong, but because what it says is merely a special case, and a case that is largely arbitrary at that. When considering income determination what Samuelson does not address, and indeed has little or no interest in, is the role of power and of institutions, using this latter term in its broadest sense. I will explain what I mean by that below. But first let us consider the question of power.

An easy way to disprove Samuelson’s assertion, it seems to me, is to set forth the case of the extraordinary rise in CEO income in the late 1990s and since. Now if Samuelson is right, their income should be based on the demand for CEOs who can successfully manage a corporation and make it more profitable. CEOs who fail would, on this account, lose their jobs or at least receive reduced incomes. But as a matter of fact, this is often not what happened. Consider these instances. Although Apple Computer’s “shareholders’ return declined by 34 percent” CEO Steve Jobs received $78 million, and although Lucent’s “shareholder return declined by more than 75 percent” Pat Russo was paid $38 million. Even more telling is the case of Disney’s Michael Eisner. Eisner, “after he failed to clear his bonus hurdle two years running, his board lowered the performance bar, and then…he finally cleared it. An Olympian effort worth $5 million.”[1]

So how can this happen? Why would anyone be rewarded for failure? Why do the owners of the corporations, that is, the stockholders, tolerate this?

So why, you may wonder, aren’t investors up in arms over these jaw-dropping retirement giveaways?  The answer is that hardly anybody knows about them.  The complex details surrounding executive pensions are typically buried deep within a company’s SEC filings, far removed from the salaries, bonuses, and stock options that dominate the headlines.[2]

These CEO incomes are not the result of market forces, the forces of supply and demand. Instead they are the result of the CEOs’ ability, with the help of their cronies, to take advantage of the complex corporate legal structure. In other words, the corporate insiders have power which they exercise to their own advantage and despite the fact that, according to the supposed laws of economics, such executives would no longer have their jobs.[3] Admittedly this example is among the more extreme, but it serves to disprove the comfortable assertion that it is markets that determine incomes always and everywhere. Rather, markets are merely one factor that help to determine incomes, and not always even the most important factor.

Above I said that power and institutions are two elements that Samuelson does not take into consideration in his economic theories. Let us consider them further. In fact they are connected, for those with sufficient power will shape the institutions to favor their interests. Now by institutions I mean not only organizations or agencies of various kinds, but a society’s legal system, including its tax structure, the way that its technology has developed, and even its cultural norms, since these last affect all the other types of institutions. How are power and institutions related? In a normal capitalist enterprise, those with capital hire workers to perform a task and pay those workers an agreed wage. The capitalists of course are responsible for paying all other expenses in addition to the wages. But beyond that they get to keep the profits. And those profits can be considerable, much more considerable, in proportion, than the wages paid to the workers. That is why the rich are most often the capitalists. But suppose that a society, via its government or some intermediate body, offered groups of workers easy access to start-up capital so that they could establish their own firms, and subsequently borrow capital from lenders for their needs? In that case, the workers would be the owners and they would keep the profits after the capitalists had received the agreed upon interest payments. Is there anything in the nature of economics preventing such a scenario? No, but for the most part, workers have not commanded enough power to obtain such an arrangement. It is doubtless true that in many cases they have not been interested in such worker-owned companies, but that also is the result, in part at least, of cultural norms. Regardless of this last point, however, it is a false claim that it is in the nature of economics that profits accrue to the Capitalist owners. Rather profits accrue to whoever is the owner, and this can vary considerably depending on the law.

Another instance of how institutions determine economic outcomes may be found in the case of the corporate CEOs discussed above, whose compensation is determined by their boards of directors. But there are many ways that such compensation could be determined. The whole body of stockholders could vote on it, for example, in which case it is unlikely that those who were presiding over failing corporations would receive such generous benefits. Another example of the key role of institutions consists in the limited liability laws governing corporations, by which their stockholders are protected from civil and even more from criminal judgments. Such limited liability laws could be changed, however, and doubtless, if they were, that would have profound effects on how corporations behaved, for then their stockholders would be liable to prison terms based on corporate misdeeds. Similarly, in the United States, government spending on all levels has created a society dependent on the automobile. That money could as easily have gone into mass transit. But automobile and oil companies, and their many subsidiary and supplier firms have had sufficient power, including power to shape cultural norms via advertising, so that our society was willing to put immense sums into road building and related projects and relatively little into mass transit. Even the mass transit systems, such as streetcars and interurbans, that existed in the past were dismantled, in some cases, such as in Los Angeles, deliberately due to automotive industry power.

These examples will be enough, I hope, to show that the simplistic understanding of the workings of supply and demand is false. Certainly the principle of supply and demand is valid, but it always operates within legal and other institutional norms, and it is subject to being manipulated by those with sufficient power or skill to do so. Market forces are not mechanical or chemical laws. They are human acts, and even though there are certain constant tendencies in human behavior, they are filtered through so many other factors that it is difficult to make statements about the economy that will hold true in every case.

In part two of this article, I will consider Catholic Social Teaching and examine whether there are approaches to economics that seem to harmonize better with the Church’s doctrinal approach.

Originally published by
The Distributist Review on 19 January, 2011

End Notes

[1]. Peter Carlson, “A Few Blips in the Search for Unsung Life Forms”  Washington Post (April 22, 2003) p. C1.

[2]. Janice Revell, “CEO Pensions: The Latest Way to Hide Millions” Fortune (April 28, 2003) p. 68.

[3]. At one point Samuelson does address the question of why “some top executives at poorly performing companies have received salaries and bonuses totaling $50 million or more,” and seems to realize that there might be more to income distribution than the automatic workings of the market.  He explains that “insiders may vote themselves large salaries, expense accounts, bonuses, and generous retirement pensions at the stockholders’ expense” (p. 192).  But Samuelson does not seem to realize that this one counterexample destroys his thesis that it is markets that determine incomes.

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