Do the Rich Help the Poor?

Do the Rich Help the Poor?
by Jacob G. Hornberger, October 2000

PRESIDENT CLINTON justified his veto of Congress’s recent repeal of the estate tax by suggesting that most of the benefits of the repeal would go to the wealthy. “Of the $750 billion the repeal costs [sic], one-half — nearly $400 billion — goes to the top one-tenth of one percent of estates,” said Gene Sperling, the president’s national economic advisor. Democratic presidential candidate Al Gore chimed in with his own endorsement of Clinton’s position when one of his campaign spokesmen, Douglas Hattaway, said, “Most of the benefits under the Republican plan go to the extremely wealthy.”

Do the poor benefit when the wealthy are free to become more wealthy? Absolutely. In fact, the freedom to acquire unlimited amounts of wealth is the greatest thing that could ever happen to those at the bottom of the economic ladder. And this is true not simply because the poor are then able to acquire more easily the capital needed to compete against established businesses. It is also true because capital accumulation is the only way in which real wages — and therefore standards of living — can rise for salaried workers.

What causes the real wages of workers to rise in a society? Most people believe that the only reason that wages rise is that governments enact minimum-wage laws that place a floor below which wages cannot fall and then periodically raise the minimum, thereby ostensibly ensuring a rising wage rate for the worker.

But if it were that easy to raise real wage rates, then every nation on earth would have high standards of living. All that underdeveloped countries would have to do is raise their minimum wage to the equivalent of $5 per hour and then $10 per hour and — voilà! — standards of living would constantly be rising.

The reality is that the legally established minimum wages do nothing to help those at the bottom of the economic ladder and actually cause them harm. For one thing, minimum wages do not cause businesses to pay higher wages. Businesses make wage decisions on one simple determination: Will the employee produce a return that exceeds the amount that the business is paying him? If a business believes that a worker will produce $6 an hour worth of revenue in return for a wage of $5 per hour, it will hire the worker. If the government requires the worker to be paid $10 an hour, that worker — the worker whom the employer values at only $6 per hour — will, quite simply, not be hired.

“But without a legally established minimum wage, wages would continue to drop because employers have no incentive to pay more than what they are required to pay?” Oh? Then why do some businesses pay a wage rate higher than what they are required to pay?

The reason is that they place a higher value on that person’s ability to bring revenue to the firm — a value that competing firms are just as likely to recognize. Thus, it is neither the law nor benevolence that motivates a business to pay a high wage but instead self-interest and greed.

The key to wealth

But why do workers in some countries make less money than workers in other countries? Don’t self- interest and greed characterize businesses all over the world?

The answer lies in savings, capital, and productivity. Societies in which there are massive amounts of productive capital being accumulated in the private sector are societies where wage rates will be increasing for workers. Societies in which there is little capital in existence or coming into existence are societies in which workers will be receiving low wages.

Let’s analyze why. Suppose farm workers are working on farms that use hoes for plowing. Let’s assume that the owner of the farm receives a total sum of $1,000 when he sells his crops. This means that the maximum amount he can pay his workers is $1,000. Realistically, he pays the workers less than $1,000 and uses a portion of the money to pay other expenses. If there is money left over, that is his profit.

Let’s assume that our farmer pays $600 in wages and $200 in other expenses and retains $300 as his profit.

How can workers be sure that he’s paying the highest amount possible to them out of the $1,000 that he has received? Because they check and see what the farmer next door is paying. If he’s paying more, they can ask their boss to match it or they can quit and go work for his competitor.

How can wages rise? Not with a law, because a law cannot increase the amount of money the farmer receives, year after year, for his crop. After all, a law cannot change the quantity of the crop that the farmer and his workers are producing. Remember: the absolute most that the farmer can pay is $1,000. Make him pay more than that and he’ll simply close the business.

“But the government can force him to pay his profits to the workers in the form of higher wages.” Yes, and that was the argument that Karl Marx used — that profits were simply a form of theft by which the employer steals what rightfully belongs to the worker. But let’s keep in mind that a businessman customarily does not organize a business enterprise with benevolence in mind. He himself wishes to improve his economic and financial condition. And he risks the money he invests in an enterprise in the hope of receiving a return on his investment.

The owner’s profit is his compensation for putting the enterprise together and risking his capital, just as the worker is compensated for contributing to the success of the business. Confiscating the businessman’s anticipated return only means that he might very well close down the business, thereby shutting his workers out of jobs, or it might mean that he will never open the business in the first place.

Why do wages rise?

If government cannot make wages rise, then what does make wages rise? I repeat: The only way that real wages can rise in a society is through the accumulation of capital.

For example, let’s assume that our farmer has been saving $200 a year from the $300 annual profit he has been making. At the end of the fifth year, the farmer uses his savings to purchase a tractor. So now his workers, instead of using hoes, are using a tractor to plow and harvest the crops. As a result of using the tractor (capital), the workers become more productive. They now produce $2,000 in total revenues for the farmer rather than the $1,000 they produced with hoes.

The increase in productivity now enables the farmer to pay higher wages. Notice a crucial point: In the absence of the tractor, the maximum that the farmer could have paid his workers was $1,000, which represented his total amount of receipts. There is no way that a law could have effectively forced him to pay more.

It is only through the increase in productivity that the farmer is now able to pay more than $1,000 in wages. That increase in productivity could come about only through the acquisition of capital, not through the coercive power of the state or even through such exhortations as “Work harder!” And the capital — that is, the tractor — could only be purchased with savings.

Thus, the workers on that farm have benefited because the farmer was free to accumulate wealth.

But how do we know that the farmer will increase wages? How do we know that he won’t keep all of the money for himself? Do the workers have to rely on the goodwill and benevolence of the farmer in order to receive higher wages from the increased productivity?

The wage rate that the farmer pays will be based not only on the value that he places on the worker but also on the value that others place on the worker. The workers will again check to see what competing farmers are paying. If they’re paying significantly higher wages, the farmer will have to match those wages or he risks losing the workers to his competitors.

This is why it is in the interests of the workers that all the farmers (and everyone else in society) be free to accumulate wealth. If that money is going into productive capital (tractors), then all the farms in the area become more productive and therefore have more money to offer workers.

And the cycle is an endless one. The more wealth that people are able to accumulate, the more savings there are in a society. The more savings, the more capital (e.g., tractors, baling machines, and trucks). The more capital there is, the more productive workers become. The more productive workers are, the more the owner earns. The more the owner earns, the more there is to pay workers.

Interests are harmonious

Thus, every business enterprise is a cooperative venture between the owner and the worker. It is in the interest of every worker that the business succeed and that it earn the largest profits possible. And it is in the interests of every business to have the best and most productive workers.

And the principle applies not just for workers in their particular company but all across the board for all companies and all lines of work. If companies everywhere become more productive as a result of the capital they are acquiring from savings in society (i.e., through loans), that benefits everyone else in society as well. How? Not only in people’s role as prospective employees in an entirely new (better-paid) line of work but also in their role as consumers. Because the increase in the supply of goods and services that companies are producing means a decrease in the price of those goods and services. And that’s good for consumers.

This helps to explain why people were fleeing Europe and Asia to come to the United States throughout the 19th century. Despite all the propaganda about how horrible the Industrial Revolution was, the average person knew that it was the best thing that ever happened to him. Not only was he free to accumulate wealth by saving a portion of his earnings, he was also receiving the societywide benefits of increasing levels of productivity and gradually decreasing price levels. In other words, for the first time in history, when people were free to accumulate wealth, the standard of living for just about everyone was increasing, sometimes exponentially.

Were there enormous disparities of wealth? Absolutely. But so what? If everyone is better off, why should it matter that some have significantly more than others?

For example, suppose we have a society in which the government is constitutionally prohibited from equalizing disparities in wealth. The top 10 percent earn $1,000,000 per year. The bottom 10 percent earn $10,000 each.

Now, let’s assume that the citizenry decide to change their own system in order to equalize these disparities of wealth. They amend their constitution to enable their government to confiscate the wealth of the rich and give the money to the poor. The government then embarks on a massive tax-and-welfare scheme that distributes $2,000 to every poor person.

The confiscation of capital results in less savings among the rich, which causes productivity to drop, which causes wage rates to drop. Let’s say that the 10 percent at the top are now earning $700,000 a year and that the bottom 10 percent are now earning $7,000 a year (plus the $2,000 in welfare they’re now receiving).

Obviously the poor are not better off simply because the rich are worse off, at least not in the long run.

The short-term illusion, of course, is that the poor feel that they’re better off when the state distributes a part of the loot to them, which is what happened in Cuba and other communist countries.

By confiscating the capital of the rich, the government makes the poor less productive. And since the rich now know that their savings are going to be confiscated in the future, the incentive to save and acquire productive capital diminishes.

Ultimately, if the redistributive policies are continued, the golden goose is killed and everyone, rich and poor alike, ends up living a life of impoverishment. Again, this is what happened in Cuba, East Germany, and other communist countries.

And remember: the state cannot confiscate wealth in order to equalize unless wealth has first been created. And wealth is created in a climate of economic liberty, that is, one in which the state is prohibited from confiscating and redistributing wealth.

Unfortunately, the success generated by economic liberty often triggers the envy and jealousy that motivate people to change their system to one of confiscation and redistribution of wealth. This is what happened to the United States in the 20th century.

What saved the 20th-century American from lower standards of living was the fact that capital continued to accumulate at a rate faster than the rate of confiscation. It is impossible to imagine how much higher the standard of living of the American people would be today, especially for those at the bottom of the economic ladder, had the state not been permitted to confiscate so much income and wealth in the 20th century.

The crucial issue, of course, is the one that Adam Smith raised some 250 years ago. What are the causes of wealth and poverty in a society? Unfortunately, Bill Clinton and Al Gore and people of their ilk remain convinced that the poor are poor because the rich are rich. The truth is that when people such as Clinton and Gore are prohibited from confiscating the wealth of the rich, the biggest beneficiaries are the poor.

Mr. Hornberger is founder and president of The Future of Freedom Foundation.

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