Opinion and Economic Analysis

HICKS: Imperfect markets influence economic growth

February 18, 2012

Markets have no role in determining happiness, love or whether our lives have meaning. They do, however, determine wages and income, and the price of goods. Like it or not, that is fact—and warrants a lesson on how it works.

Businesses combine people, machinery, raw materials and management expertise to produce goods or services. Economists call these inputs to production. The demand for each input—and its share of income—is dependent upon how much value it brings to the product.

Most businesses don’t have much choice in the price of their goods. Only if they enjoy some monopoly power—for example, the Big Three automakers circa 1960—can they realize above-market prices. That is good for workers, management and capital owners, of course, but bad for consumers (that is another story).

Supply also matters. The supply for machinery is global; the rest is more local. If there are few workers of a particular type, for example, they will obtain wages up to the full value they bring to the production process. If they are available in abundance, workers will get less.

Markets rule supreme, but they also work imperfectly and will do so as long as humans themselves remain imperfect.

Workers obtain the wrong skills (38 percent of last year’s graduates with a doctorate in history are unemployed). Businesses make products few consumers want (see Volt, Chevrolet) and governments try to manipulate products and pricing (see again Volt, Chevrolet). Firms mistake the value of a CEO, star player or shift operator.

The rich imperfection of markets does not mean that one can wish them away any more than a paratrooper can wish away gravity. Further, these types of market failures tend to self-correct in time.

Despite the rhetoric of the day, the wage share of income in the United States has remained at about three quarters of total commerce for several decades. Profits have dropped as a share of production for 40 years, while payments to owners of machinery and land have risen, as has the government’s share.

The ineluctable truth is that the only ways to alter the outcome of this equation are for individual inputs to become more productive or to have government redistribute income. Redistributing income is something every society does, and today, roughly one in four households are recipients of this redistribution.

Redistributing income changes the share everyone gets, but does not make the economy larger. Alternatively, boosting the productivity of land, machinery and workers will increase their incomes, even if the share does not change. This process is called simply economic growth.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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