Poverty and Economics

The upcoming elections have me thinking about the different approaches to social economics.

Democrats tend to talk a lot about being for the little-guy, the middle-class, the worker, and doing things that will rescue people from poverty. Republicans have the same desire to help the little-guy, the middle-class, and the worker, but they take a different approach. Democrats tend to talk about the people and the goal. Republicans tend to talk about the task and the means. That’s not to say that Democrats don’t talk about the tasks they will undertake to help people or the means of accomplishing those tasks, or that Republicans don’t talk about the people that will be helped by the tasks they hope to accomplish or the goals that will be achieved by the processes they hope to use.

Not only do people at different ends of the political spectrum communicate differently, they have different ideas about how to accomplish their (shared) goals. And this is the difference that really matters. If Democrats and Republicans were going to do the same things, and just talked about them differently, then it wouldn’t really matter what your political views are, we would get the same results in the end. However, since they mostly have different ideas of what it will take to reduce poverty (the shared goal, in this case), it is important to evaluate whose techniques actually work the best.

(Note: I’m using the words “Democrat” and “Republican” in this article, because those are the two major political parties in the US, and they represent ideologies that tend to be distinct and in opposition. There are other words that could convey similar distinctions, like “liberal,” “conservative,” “socialist,” “capitalist,” etc. If you like some of these or other words better, feel free to substitute them in your mind as you read this article.)

The U.S. Census Bureau recently (August 2008) released a report on Income, Poverty and Health Insurance in the US for the year 2007. The report found that the real median household income in 2007 was $50,233. What does this mean? The “Real” refers to income after
adjusting for inflation. This means all income comparisons in the report are based on 2007 dollars (e.g., if you earned $45,000 in 2005, but that has the same purchasing power as $50,000 in 2007, then your 2005 income would be reported as $50,000). “Median” means “halfway” or “in the middle.” This means that 50% of households in the US made $50,233 or less in 2007, and 50% made that much or more.

To understand the difference between “median” and “mean” (or what we commonly refer to as “average”), consider the following five numbers: 2, 2, 3, 4, 20. Let’s say these are salaries of five people. Two people made $2/hr, one made $3/hr, one made $4/hr and one made $20/hr. The “mean” average is (2+2+3+4+20)/5 = 6.2. So if you use the “mean,” you would say that the average wage of these five people is $6.2/hr. However, only one person in this group made that much. The guy that made $20/hr “wrecked” the average. A better way to describe how much people in this group make is to use the “median” or “middle” value, which is 3. There are two people who made less, and two people who made more. If the guy who makes $20/hr gets a raise, the “average” wage goes up, but the “median” wage doesn’t change.

Back to the U.S. Census report, they also found that 12.5% of US households were considered to be in poverty. The challenge then, for both Democrats and Republicans, is to reduce the number of households in poverty.

The Democratic approach (the “means”) is typically to force the transfer of money from the richest people to the poorest people. In the five person example used above, that might mean taking $5/hr away from the guy who makes $20/hr, giving and extra $2/hr to the two people who only make $2/hr and an extra $1/hr to the guy who makes $3/hr. The end result is wages of 4, 4, 4, 4, and 15. Really nice for the guys who were making $2/hr, also nice for the guy who was making $3/hr, no different for the guy who was already making $4/hr, and not necessarily what the guy who was making $20/hr had in mind.

The Republican approach is typically to lower taxes and make it easier to find jobs that pay more. With lower taxes on businesses, companies don’t have to charge as much for their products. With lower taxes on individuals, people have more of their money available to spend. Even if wages don’t go up, purchasing power goes up, and the poverty rate goes down. Furthermore, those with money to spare will look for ways to make even more money. This means expanding their businesses, which means hiring more people. They can also afford to pay better wages, attracting better workers, and therefore achieving better results.

So, which approach actually works better? That’s a really complicated question. Lots of really smart economists disagree about which approach works better. Also, my description is an over-simplified description, which makes it hard to make an unqualified assessment of which of the two approached is “better.”

In general, I believe that too much government involvement on either end of the spectrum will produce less then stellar results. In the example used above for the Democratic approach, the guy making $4/hr loses his motivation to strive for a $4/hr wage, because he sees that the government will make up the difference if he makes less. The guy making $20/hr gets frustrated because he loses part of his gain, and his incentive for out-performing his peers is reduced.

The economy works because people want to work. Economic transactions work when both parties of the transaction receive something of value; the transaction is to the benefit of both parties. Let’s look at an example:

I exchange $1 for a double-cheeseburger, because I’d rather have the burger than keep my dollar. McDonald’s likes getting my dollar, and they like getting me in their store. If the burger was $5, I wouldn’t buy it. If I was only willing to pay $0.25, McDonald’s wouldn’t sell it. If the government takes control of McDonald’s and decides that everyone should get a burger, regardless of what it costs to make a burger, and regardless of what people are willing to pay, then the basic economic structure collapses. The government can require that burgers be sold for $1, but because the government has decided how things are going to be, McDonald’s no longer has the motivation to make sure the transaction is mutually advantageous to both parties. You might find that McDonald’s tries to take advantage of the situation, and make the burgers out of horsemeat to save money. It could also go the other way, with citizens and/or politicians influencing McDonald’s to starting making the burgers out of Kobe beef, regardless of cost. The government then has to keep infusing money into McDonald’s so they can keep selling the burgers for $1.

If we want people to escape poverty, it’s going to take more than giving them a handout or controlling the economy to their benefit. It requires motivating people to do things that are to their benefit, and perhaps removing some of the obstacles that prevent them from accomplishing the tasks they need to accomplish.

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