by William L. Anderson via Mises Wire
One of the first lessons I give my economics students in the principles courses I teach or in my MBA classes is the famous Diamond-Water Paradox, or what economists historically have called the Paradox of Value. Why are diamonds more expensive than water? Why are professional athletes paid better than teachers or soldiers?
When I present these paradoxes in the form of test or homework questions, my students often miss them, not understanding the difference between measuring at the margin and total measurement of something. For example, I sometimes present a quote which I saw posted in a teachers’ lounge at a middle school almost 40 years ago in which the writer in a National Education Association newsletter claimed that Americans “don’t value education,” the “proof” being that professional athletes are paid more than teachers despite the difference in their apparent “usefulness” to society.
Every once in a while, a student will reply correctly that this is an example of the Diamond-Water Paradox in which the pay differentials are the result of there being only a small number of people who qualify as professional athletes versus the much larger number of teachers. Dealing with this subject nearly 20 years ago, I wrote :
People who can qualify to be teachers are relatively more abundant than athletes who can withstand the rigors of professional sports. Furthermore, the professional athlete operates in an arena in which he (or she, as women’s professional sports are increasing) can entertain large numbers of people at one time. For example, it is estimated that more than a billion people worldwide see the Super Bowl. The best lecturers may speak before a few hundred listeners, and most teachers teach 25 students or so at a time.
Each year more than 40,000 people receive Ph.Ds. in the United States, while perhaps 40 rookies may make it into the NBA. For the few who do make it into the pros, their expected tenure is short, maybe a few years on average. A teacher, on the other hand, may be able to practice his profession for up to 40 years. Nor do most professional athletes strike it rich. The vast majority work in the obscurity of minor league sports or other relatively low-paid positions, such as a golf professional at a country club. In other words, the multimillionaire athlete is the great exception, not the rule.
I can understand why teachers and politicians misunderstand the Paradox of Value. The former, for the most part, never have been presented with such lessons, especially since the concept is a bit technical, while the latter (politicians) do not like anything to be in the way of their demagoguery, especially when they are putting something over on the public. (As for socialists like Bernie Sanders or Alexandra Occasio-Cortez, I doubt seriously that they even are intellectually and morally capable of learning about such paradoxes, especially since such knowledge undercuts their own political narratives.)
It is quite another thing when economists and especially Nobel-winning economists such as Paul Krugman fail to understand economic fundaments, and especially the D-W Paradox. Marginal utility is at the very heart of economic analysis and one cannot understand economic concepts of value without knowing that marginal utility means.
In a recent column and blog post , Krugman lamented the fact that income for transfer truck drivers has fallen in the past 40 years, and he used that as “proof” that overall payment for labor services is lower than it was in the 1970s. He claims that the decline of organized labor in the USA is the main reason for this “injustice,” in which (according to Krugman) almost all of the productivity gains in the economy have accrued to a tiny number of people, thus, appealing to the urban legend, “The rich get richer, and the poor get poorer.) He writes:
The decline of unions , which covered a quarter of private-sector workers in 1973 but only 6 percent now, may not be as obviously political. But other countries haven’t seen the same kind of decline. Canada is as unionized now as the U.S. was in 1973; in the Nordic nations unions cover two-thirds of the work force. What made America exceptional was a political environment deeply hostile to labor organizing and friendly toward union-busting employers.
And the decline of unions has made a huge difference. Consider the case of trucking, which used to be a good job but now pays a third less than it did in the 1970s, with terrible working conditions. What made the difference? De-unionization was a big part of the story.
There is much here not to agree with the various laws of economics, but this analysis will be limited to Krugman’s last paragraph about truck driving, as his statement about compensation for truck drivers demonstrates a stunning lack of understanding of what economists call marginal utility and the discounted marginal revenue product, or DMRP. (Murray Rothbard refers to it as discounted marginal value product, or DMVP.) As I will point out, Krugman’s errors are not trivial; they are fundamental to the understanding of economic theory itself.
In explaining the concept of DMVP, Rothbard writes: “…the marginal value product of a factor service unit is equal to its marginal physical product times the price of that product.” Rothbard further points out that as the number of available factors increases, its DMVP, naturally, will fall, owing to the Law of Diminishing Returns to factors of production and the decline in marginal revenue as supply of the final good increases.
What does this have to do with Krugman’s assessment of the decline in pay of American truck drivers? First, we have to remember that Krugman is engaging in an “apples and oranges” comparing of trucking 40 years ago and trucking today. The trucking industry is 1979 was much smaller than it is today due to the fact that the Interstate Commerce Commission tightly controlled the industry by severely limiting routes trucks could use and suppressing competition between trucking firms.
Business Insider notes that before the early 1980s, the trucking industry was much smaller than it is now, as the government restricted industry growth:
In 1935, the Interstate Commerce Commission (ICC) became the oversight board for the trucking industry. A law also passed that limited the number of new entrants to the trucking industry.
Trucking companies that were already in existence could continue operation, but new carriers “found it extremely difficult to get certificates,” wrote Thomas Gale Moore, then a senior fellow at Stanford University’s conservative public policy think tank Hoover Institution.
The legislation set forth other limitations, according to Moore. Companies had to file their rates with the ICC thirty days before they came into effect. Other companies or individual carriers were allowed to see those rates, and would often protest the rates if they found them low enough that they would undercut their own business. The ICC could then suspend those rates as it inspected them.
Truckers also had to buy routes, usually from firms that already had the authority to operate on those routes, and it often led to inefficiencies. Even if a trucker had the authority to transport, say, produce from Sacramento to Seattle, he or she might lack the authority to carry anything on the return trip.
To put it another way, the ICC regulated trucking in the same way it did passenger airlines and railroads and, not surprisingly, many of the gains fell to the industry’s unionized workforce. Writes Business Insider:
These route regulations were jacking up the price of goods. Certain goods exempt from regulation moved at rates 20% to 40% below similar products that were regulated. Moore noted that rates for “cooked poultry” were 50% higher than rates for “fresh dressed poultry.”
However, the average truck driver during this era was well-paid. It was the sort of high-quality, blue-collar job that many lament doesn’t exist today. In 1977, the mean earnings of a unionized truck driver stood at $96,552 in 2018 dollars. At least 80% of drivers were unionized at this time.
That arrangement ended in 1980 with the passage of the Motor Carrier Act, which ended ICC oversight, allowed much more competition in the industry, along with ending the ICC’s near-prohibition on new industry entrants. Not surprisingly, the unions and the trucking firms themselves opposed the law. (When running for president in 1980, Ronald Reagan gained the endorsement of the Teamsters Union by promising to delay carrying out deregulation for two years.)
As Business Insider demonstrates, the lifting of restrictions led to a doubling of trucking firms within a decade and hauling prices dropped dramatically, leading to lower consumer prices and much more availability of consumer goods. None of this is surprising. Business Insider estimates that overall trucking costs have fallen (in real terms) more than 40 percent since 1980:
Truckload shipment rates fell by about 25%, adjusted for inflation, from 1977 to 1982. Logistics (half of which are trucking costs) used to account for 16% of our country’s annual expenditure. Even though we’re shipping more goods than ever, it’s now down to less than 8%.
Of course, the explosion of new trucking firms meant new demand for drivers, but with deregulation also came a lessening of the restrictions on people becoming drivers. When the industry was under tight government control, it operated as a legal cartel supervised by regulators “captured” by industry executives and organized labor. Owners and employees received monopoly rents that simply would not have existed in a competitive industry.
The addition of new factors of production into trucking also has had the effect of lowering the DMVP of drivers, which means truck-driving pay is less in real terms than it was when the number of drivers was artificially limited by self-serving regulation. To put it another way, while marginal compensation to drivers is less than pay in the past, total compensation to factors is greater. This is simple economics at work.
Although Krugman does not bring the DMVP, he clearly confuses total compensation with marginal compensation and is extrapolating the decline in truck driving pay to the entire workforce. Thus, he presents a picture in which real American wages have fallen in the last four decades, which implies that American workers have a lower standard of living than they did in the 1970s. There can be no other meaning to Krugman’s claims.
Mark J. Perry of the American Enterprise Institute, however, notes that contrary to what Krugman is saying,living standards for American workers are much higher than they were in the “golden days” of regulated government cartels. This should surprise no one, as when government regulations artificially restricting productivity are lifted, the economy becomes more productive, which means that consumers are the main beneficiaries. It would seem, then, that Krugman is arguing for a return to the era when entire industries were regulated cartels or, like AT&T before its breakup and telecommunications deregulation, had government-protected monopolies.
Krugman is partially correct on one point, and that is regarding the decline of labor unions in the United States. I say partially correct because the Teamsters Union was a powerful force in keeping the trucking industry much smaller and less productive than it is now, with union members capturing much of the monopoly rents created by the regulatory arrangements. However, if Krugman is claiming that the Teamsters could somehow have managed to keep the same pay levels for truck drivers and the industry also become more productive and cost-efficient, he is not telling the truth.
The employment numbers in trucking tell the story that refutes Krugman’s claim that the fall in real wages for truck drivers is due solely to the decline of union membership. According to the Bureau of Labor Statistics , there were about 1.3 million truck drivers employed in the trucking industry. By 2018, however, the American Trucking Association reported that the number of truck drivers had grown to 3.5 million.
Business firms in competitive markets look to provide better products and services while cutting costs. Trucking deregulation enabled exactly those things to happen in transportation, something that Krugman apparently does not understand. Instead, he presents the false picture in which prosperity comes only when the government forces up business costs and creates monopoly rents that are politically distributed. It is one thing for a politician to paint such a picture; it is quite another when a Nobel laureate does it.