I’ve been rereading F.A. Hayek’s The Road to Serfdom lately. I count Hayek as one of the most brilliant economists of the last century. If you haven’t read the book, I highly recommend it. If you have, considering reading it again. Hayek was a great writer, and some of the quotations from the book just can’t get any better. Here is a real gem:

“[Competition is] superior not only because it is in most circumstances the most efficient method known but even more because it is the only method by which our activities can be adjusted to each other without coercive or arbitrary intervention of authority.”

Adam Smith’s seminal work, The Wealth of Nations, argued for capitalism primarily on practical grounds; capitalism is the best system because it delivers the most benefit to the most people. Many collectivists have challenged Smith’s practical defense over the years, but today most acknowledge the simple reality that capitalism works. Given the demise of the USSR, China’s economic changes, and present conditions in Cuba and North Korea, the economic vitality of collectivism can hardly be defended. Most socialists now call for a “middle ground” between capitalism and socialism. Some call it “managed capitalism” or “planned competition.” Both are oxymorons.

Hayek concurred with Smith, but argued against a middle ground on the grounds of morality and liberty. Collectivism always leads to coercion or arbitrary government intervention. You can’t have political freedom without economic freedom, and the middle ground ultimately deprives you of both. It can’t be implemented without a government official telling you what kind of car you can drive, where you can and cannot work, how much you can make, how much you must pay your employees, and how much you must pay for their healthcare.

Capitalism values individual liberty. Socialism sacrifices liberty for the collective. You can’t have both.

Henry Hazlitt’s Economics in One Lesson is one of the best primers in the discipline. The test of any work in economics is the test of time, and Hazlitt passes with flying colors. The latest example is Washington’s’ “reigning in” of the credit card companies.

Congress passed and Obama signed the so-called Credit Card Accountability Responsibility and Disclosure Act of 2009. Among other things, this piece of legislation limits many of the penalties credit card companies can charge their customers. These rules went into effect on Sunday. Today—with interest rates at an all-time low—the average credit card interest rate is 14.7%, 1.6% HIGHER than it was a year ago. We were told that consumers would SAVE money as a result of this legislation, but the reality is that many Americans with credit card balances will pay more in interest to compensate.

This should come as no surprise, and was really an easy prediction. Hazlitt warned policy-makers of the UNINTENDED CONSEQUENCES of their economic manipulations over 60 years ago. Yet, Obama and Congress apparently didn’t understand this when the bill was passed, and many in the mainstream media don’t even get it now. The credit card business is not that complicated. Individuals who carry large balances and/or don’t make their monthly payments represent a higher risk of default, so they have to pay more or companies won’t issue them a card. If companies can’t levy hefty penalties, they’ll have to charge higher interest rates.

I heard an unrelated AP report the other day that illustrates the same intellectual folly: “It’s going to cost more for travelers to fly American Airlines.” AA, like other airlines, is starting to charge a little more for its most desirable coach seats. We were told that this raises the cost of flying, which is clearly not true for two reasons. First, it only raises costs for passengers who want the purchase those desirable seats. Second, it will LOWER the cost for everyone else in the long run because AA is able to charge more to those passengers. Airlines have to cover their costs from somewhere. The more OTHER PEOPLE pay for their seats, the more likely you are to get a better deal on yours.

As a university professor, I hear a lot about the need to teach critical thinking skills to my students. It never ceases to amaze me how much critical thinking appears to be in short supply among our politicians and throughout the mainstream media. Perhaps they really understand and are just banking on the fact that we can be easily fooled.

By the way, the solution to the credit card problem is simple: Pay your bills on time and you won’t have to worry about penalties or high interest rates. If you’re in the hole now, cut back on your lifestyle and pay your way out of it. We can’t expect Washington to live within its means if we can’t live within ours.

Ed Whitacre surprised the business world on Thursday when he announced that he would step down as GM’s CEO on September 1 and as Chairman of the Board at the end of the year. Whitacre became Chairman when GM emerged from bankruptcy protection in July 2009 and was officially named as its CEO in January 2010. GM has reported profits for each of the first two quarters of 2010. “It was my public duty to help return this company to greatness,” he remarked, “and I didn’t want to stay a day beyond that, really.”

Something isn’t right here. First, the notion that Whitacre took on the challenge as a public duty strikes me as disingenuous. Including stock options, Whitacre will earn about $9 million for 8 months service as CEO. If this was merely a public duty, then why is he accepting the stock option piece of his package totaling $7.3 million? Maybe he’ll refuse it as part of his “public duty.” Don’t hold your breath.

Second, the idea that Whitacre has “returned GM to greatness” is a massive overstatement as well, and it takes a lot of chutzpah to make such a claim in the first place. Even if these profits are the basis for optimism (and I’m not convinced), two quarters in the black just doesn’t constitute greatness.

The more I think about his decision and departing statement the more bizarre it sounds. It’s as if Whitacre’s team cut a 30-point half-time lead to 25 by the end of the third quarter, at which time he claimed victory and left the arena.

My guess is that Whitacre sees long term problems with GM, decided to appoint himself as company savior and bail out with a cool $9 million before things turn sour. GM’s fundamental problems haven’t been resolved and the company’s international operations aren’t doing well. Perhaps we’ll find out why he really stepped down in the coming months.

Lee Iacocca’s stint at Chrysler from 1979 to 1992 is one of the best known corporate turnarounds in American history. Iacocca secured a $1.2 billion government loan guarantee, a mere drop in the bucket when compared to the US government’s 61% ownership stake in GM. Iacocca wasn’t perfect, but when all is said and done, I doubt historians will mention these two names in the same sentence.

The Democrat Congress approved another bailout, this time $26 billion for states. Supposedly, the bill won’t increase the deficit and will help states keep from laying off teachers and first responders. There is so much wrong with this bill, but I’ll be as succinct as possible.

First, this bill—like the others—WILL increase the deficit. We are told it will be paid for by closing a business tax loophole and cutting food stamp payments in 2014. “Closing the loophole” is a tax increase that will have negative unintended consequences, and if you really believe food stamp payments in 2014 will change as a result of this bill, then you are naïve as Obama must think you are.

Second, education and local police and fire protection are the Constitutional responsibility of states and local municipalities. The federal government should play no role in hiring teachers and policemen. States are free to raise their own taxes if they wish, and the fact that they have chosen not to means they are either facing budget realities on their own or they are cajoling Washington for more money they don’t have to raise on their own.

I don’t expect many states to refuse the money. Even if they strongly disagree with the approach, governors and state legislators know that their citizens will ultimately pay for it one way or another, so why not get their share of the pork? But herein lies the problem. States cannot print money and are not able to incur debt to the extent that the federal government can. Washington is simply doing the dirty work for the states, who are able to avoid tough budget choices without raising taxes. We are supposed to see the Obama administration as the compassionate caretaker willing to step in and help when states are in trouble. We’re supposed to feel warm and fuzzy. We aren’t supposed to ask the obvious questions:

Who is really going to pay for this? You will—sooner or later—if you earn enough to pay taxes.

Why can’t the states raise their own taxes? They can, but they chose not to.

What’s going to happen if and when state budgets run short next year? They’ll expect another bailout.

Why is any of this Washington’s business? It’s not.

If it makes sense to reduce food stamp payments by $12 billion in 2014 or to close a business tax loophole, then why tie these reductions to more spending? The Democrats are not interested in cutting either spending or the deficit.

Why are we constantly told that more spending is needed to save teachers, police officers, and firefighters, while less popular programs are not on the cutting block? This is a con game. The public simply would not stand for $26 billion more to fund the burgeoning welfare state.

If this $26 billion bailout is sorely needed, why not simply redirect unspent funds from the previous bailout? This bill is really about expanding government and buying votes.

Why is Obama telling us that it’s time for the federal government to make hard budget choices when he’s unwilling to let states make their own? He’s simply not serious about fiscal responsibility.

We will be told that those who oppose incurring $26 billion in additional national debt so that states won’t have to balance their own budgets just hate kids, oppose education, or don’t want to fight crime. Don’t let them frame the argument around emotion. This is a golden opportunity for Republicans who are serious about limited government to take a stand. Let’s hope they do.

There may be no such thing as a free lunch, but it is often available at a reduced price, especially for governments willing to privatize services.

A number of examples of local government waste have been reported lately. In a less publicized case, a July 19 Wall Street Journal story opened with the following: “Faced with a $118 million budget deficit, the city of San Jose, California recently decided it could no longer afford its own janitors. So the city’s budget staff called for dropping its custodial staff and hiring outside contractors to clean its city hall and airport, saving about $4 million.” If an outside contractor could provide the city with the same services as municipal employees, then why was this job done internally in the first place? Why did it take a $118 million deficit before the city took steps to save $4 million without sacrificing the services provided for the public?

The main problem is that government lacks a profit incentive. In the private sector, organizations must get a job done at the lowest cost. This is not true in government, where politicians introduce competing objectives that can raise costs and create inefficiencies. While often demonizing private enterprise for making tough choices in the interest of the bottom line, governments need not be concerned with profits in the first place. Depending on the entity—federal, state, or local—governments can look to tax increases, deficit spending (i.e., future tax increases), or even printing money as possible solutions.

The Los Angeles boycott of Arizona illustrates this point even when government services are obtained from outside firms. Presumably, LA has done business with Arizona companies because they delivered goods and services the city needs at a higher quality and/or a lower cost. “Replacement companies” in other states will be less efficient, raising costs for the city’s taxpayers. In the end, LA will pay more for the same services from companies located in other states, all in the name of political correctness.

I wonder how much more could be saved if non-essential government services were eliminated and the essentials were performed by independent firms. Studies conducted by the Cato Institute and others—not to mention examples like San Jose—suggest that such a figure could be staggering. Organizations that outsource are not required to invest heavily in technology that might not be as efficient in the future. They also retain the flexibility to expand or contract programs more easily as needed.

Why don’t we see more outsourcing of government services? A major reason is union influence. Outsourcing translates into more activity at the small business level where unions wield much less power.

Now more than ever, governments are struggling with financial reality. The current level of spending is far from sustainable, and more taxes and deficits will stifle the economy and pass the problem down to future generations. The battle to eliminate non-essential government spending is important. Equally critical, however, if the need to get the most bang for the buck when governments spend for essentials. Less is usually more when it comes to government.

General Motors announced on Thursday (July 22) that it would acquire AmeriCredit for $3.5 billion (details at http://online.wsj.com/article/SB10001424052748703467304575382810481110230.html).

GM hasn’t had its own lending arm since 2006 when it sold GMAC. Recall that GMAC pushed 72-month car loans to nonprime buyers and questionable mortgages before it got a $17 billion government bailout in 2008. It’s easier to sell cars when you can finance buyers whose credit makes it difficult to buy elsewhere, and GM knows this. But what happens when these buyers are underwater (the car is worth less than the balance of the loan) and can no longer make their payments?

I thought GM was going to reinvent itself by building better cars, not by trying to increase sales to people who can’t afford the payments. I thought the banks and credit card companies were evil by engaging in “predatory” practices that encouraged customers to incur high-interest debt they didn’t need. And I thought GM was going to use taxpayer money to stabilize the firm, not buy other companies. It’s worth noting that the U.S. Treasury owns 61% of GM but denies any involvement in the decision to acquire Americredit.

The bottom line is that GM is using taxpayer money to buy the country’s largest provider of car loans to consumers with bad credit. The big issue here is RISK EXPOSURE. GM sees an opportunity for financial gain, but will not shoulder all of the additional risk associated with the deal. We all know who will end up paying (again) if AmeriCredit experiences the same fate as GMAC. President Obama told us the other day that the era of bailouts is over. Somehow I’m just not convinced.

I’ve quit counting the complaints I heard from the left about “unfettered capitalism” in the past couple of weeks. In an interview with Republican Whip Eric Cantor, a talking head inferred that “unfettered capitalism” underpins our current economic woes and the government should do something about it. To my dismay, Rep. Cantor did not challenge the premise, but seemed to suggest that Obama’s approach to reigning in capitalism was “massive” while the Republicans prefer a more “incremental” (his choice of words) approach. I just didn’t hear the clear, passionate defense of liberty and free markets I was hoping for.

References to “unfettered” or “unbridled” capitalism suggest that free markets are OK, but only to a point. Because reasonable people are supposed to reject anything in the extreme, using the term shifts the debate from whether or not government intervention is justified to how much is appropriate.  It’s like the proverbial question, “When did you stop beating your wife?” If you try to answer the question without challenging the premise, you’ve already lost the argument.

When I am confronted with the term, I demand an immediate definition. If there is a hesitation, I point out that “unfettered” literally means “unchained.” If capitalism is the foundation for economic development, then why would you want to chain it? The response I get inevitably includes a justification of limits on liberty and arguments for wealth redistribution, with most or all of the sacrifices borne by someone else, namely the evil capitalist. Government is presumed to be the fair and just arbiter, ensuring that unskilled workers “forced” to work for low wages end up getting what is rightfully theirs through manipulation of the tax code or other leftist schemes. In other words, my opponent finds himself defending the merits of socialism. I not only win the argument with relative ease, but I also have an opportunity to help by opponent see the folly of his worldview.

Moreover, capitalism in the U.S. is already heavily shackled, with severe restrictions on production, pricing, employment, minimum wages, unions and the like. Arguably the most regulated industry in the country is financial services. If one is looking for a quick culprit in the mortgage crisis, it seems logical to look at the government first, not the banks. Those on the left fail to see this.

As we get closer to election time, my concern is that Republican candidates—the ostensible defenders of liberty and freedom—are either unable or unwilling to defend liberty, free markets, and the Constitution. Libertarians have always claimed that the main difference between the two major parties is one of degree. They charge that Republicans may be less socialistic than the Democrats, but they still suffer from the same mindset.

I’ve part Libertarian and I think this argument is valid in many instance. I’m also seeing a similar defenseless pattern on other issues as well. For example, the use of the term “undocumented worker” suggests that an illegal immigrant is merely lacking the appropriate paperwork; if so, a “pathway to citizenship” only seems reasonable. Amnesty for illegals is simply wrong, and candidates who seek some sort or middle ground and refuse to acknowledge this either lack courage or conviction. I’m not sure which is worse.

The reality is there’s little room for negotiation with collectivists like the likes of Obama and Pelosi on most issues. I am hopeful that the Republicans will do well in November and that they will engage Obama in the kind of tooth-and-nail battles that are sorely needed. I still fear the prospects of mass compromise (i.e., semi-socialism) should Republicans regain the House. I hope I’m just paranoid.

The mainstream media has been proclaiming the beginnings of an Obama economic recovery for some time, but it just hasn’t materialized yet. There is an occasional hopeful sign, but the short term still looks mediocre at best, while the crisis in Europe has temporarily boosted the dollar. Some economists are warning that deflation might be around the corner. What would this mean for the economy and what happened to the long term fear of inflation?

In a classic sense, INFLATION occurs when the money supply expands and DEFLATION occurs when it contracts. More money in circulation means that each dollar is worth less, so inflation typically translates into higher prices, sooner or later. Today, the word INFLATION usually refers more specifically to PRICE INFLATION, but there is always a lag between expansion of the money supply and price increases. The money supply has expanded recently, which means that prices down the road will be higher than they otherwise would have been. This is a fact, although we don’t know when prices will rise and by how much. There are too many other variables at work.

Just as inflation today commonly refers to a general increase in prices, deflation refers to a general decline. Prices are a function of supply and demand, so a drop in consumption results in a drop in prices as suppliers compete more aggressively for fewer buyers. This is happening in some sectors today, causing many economists to warn that the general price level—the average price for a mix of goods and services—is beginning to decline, which means deflation.

Keynesian economists urge governments to manipulate the economy so that inflation occurs but remains low, perhaps around 3%. But their greatest fear is deflation. When prices are falling, they argue that consumers are more likely to hold on to their money in hopes of cheaper and better prices in the future. This would reduce demand even further and lead to greater unemployment, more deflation, and a downward spiral.

There is a kernel of truth to the argument, but is fails to consider adjustment mechanisms already built into the market. Knowing that milk might cost a little less next year won’t keep you from buying a gallon today. The cost of an exterminator’s visit might decline in the future, but you will probably call today if you have a serious bug problem. And computers have been getting both better and cheaper for decades. We expect that $1000 will buy a better system next year than it does today, but knowledge of this fact doesn’t cause us to defer our purchases indefinitely. Computers provide value, so waiting to purchase one can cost us as well.

Keynesians also fail to recognize that deferring consumption means more savings. This increases one’s future quality of life as well as the pool of capital available for expanding businesses to borrow. Besides, deflation increases the value of your savings by expanding the purchasing power of each dollar you have, so it’s good for savers. There is no reason to fear deflation.

What about inflation? The money supply has already expanded considerably, so prices must rise at some point—exactly when is anybody’s guess. I expect low growth for a while, with some price deflation (depending on how you measure it) possible in the short term. I still expect price inflation in the long term, especially when the economy begins to show real signs of recovery. Unfortunately, we’ve been set up for a bout with stagflation that will be difficult to avoid even if we have leadership in the 2010 and 2012 elections.

Labor unrest is becoming more widespread in China. Earlier this year, 10 workers at Hon Hai Precision Industry Company in Shenzen jumped to their deaths, a tragedy allegedly linked to poor working conditions in the factory. Hon Hai is the world’s largest contract electronics manufacturer and is a supplier to companies like Apple and HP.

Historically, labor unions have been largely controlled by firms in China, but some are beginning to demand substantial wage increases. For example, Honda  encountered a strike earlier this month at an auto parts factory in southeastern China. Workers sought a doubling of wages at the plant, but most accepted the company’s increases of 11 percent in pay and 33 percent in the food and housing allowance, a total package of about $211 monthly per worker. Honda was able to end the strike in a matter of days.

According to a New York Times account of Honda’s effort to end the strike (www.nytimes.com/2010/06/14/business/global/14strike.html), “A factory manager with the voice of an auctioneer counted off the minutes until the morning shift started and exhorted the strikers to return to work, using lines like, ‘We won’t give your job to the new workers if you come in now’…In the last five minutes before the gates closed, all but half a dozen strikers went back into the factory, stricken looks on their faces. Some strikers had stayed home from the rally, and may have lost their jobs.”

Events such as these give rise to many on the left (and a few on the right) who decry cheap labor in China. They claim that Chinese workers undercut American labor and have contributed to the current unemployment problem in the US. Two inconvenient truths are overlooked with this emotional response.

First, low wages were prevalent in China long before unemployment in the US rose to the current level. Our economic downturn was initiated by the government-induced mortgage crisis and has been exacerbated by the massive spend-and-tax policies aof the Obama administration. Blaming the Chinese (or anyone else) for the problem is scapegoating.

Second, all companies in the US should be free to do as Honda did in China. Workers should be free to organize as they wish and strike if they believe their wages are too low. Faced with a strike, a company should be free to negotiate with the union OR hire permanent replacements and dismiss striking workers. If suitable replacement workers are available at the existing wage level, then the union demand is—by definition—too high. Many on the left argue that allowing companies to hire replacement workers invalidates the union’s right to strike. In reality, having the ability to fire striking workers is a company’s check and balance on the union’s right to strike in the first place. Strikes can be devastating to a firm, and capitulating to union demands every few years can have a crippling cumulative effect. Just ask GM.

I am not suggesting that tough negotiations with the Chinese are not in order. The Chinese are not free traders, and their manipulation of the yuan-dollar exchange rate has contributed to high trade and budget deficits in the US. Some see the Chinese government’s recent announcement of a shift toward more flexibility in its currency peg as a positive sign. However, the yuan will probably appreciate in the 3-5% next year under the revised approach, far less than would occur if the currency were allowed to trade freely.

Low wages and labor disputes are a part of the market. Companies and workers can sort out these issues on their own with limited government involvement. We shouldn’t focus our attention on low wage rates in China. Remember, cheap labor translates into lower prices, so Americans benefit from low cost production in other countries. Our key concern with China should be with the country’s managed trade approach, and we should insist on a rapid shift to an open exchange rate so that our economy can operate more efficiently. Unfortunately, criticizing China for its heavy economic intervention is difficult to do with a straight face when own current leadership is doing much of the same.

Democrats in South Carolina recently chose Alvin Greene to take on Jim DeMint this November for a US Senate seat. Greene, who is unemployed and currently faces felony obscenity charges, never seriously campaigned for the office. The legitimacy of his win has been challenged by notable Democrats from SC Congressman Jim Clyburn to Obama advisor David Axelrod. State Representative Todd Rutherford even questioned his intellectual fitness for the post. Others have played the “hanging chad” card, suggesting that the vote was somehow manipulated and otherwise did not reflect the real intentions of the voters.

Much has been said of this debacle, but few seem to be asking what I believe is the most important question: What does Greene’s victory say about the intellectual fitness of South Carolina Democrats?

I’ve heard some interesting theories. Some have suggested that voters might have selected Greene because his name was the first on the ballot. Others have argued that Greene—an African-American—might have enjoyed support from a large African-American voter base in a primary where many voters did not know much about Greene or his opponent, Vic Rawl. Someone even noted that the name “Alvin Greene” contains an unusually high proportion of vowels, although I haven’t figured out how this could have influenced the results.

Regardless of the explanation you find most appealing, we must come to terms with one key fact: The majority of Democrats in South Carolina were perfectly willing to select a candidate on the basis of one or more factors other than his fitness for the position. If a case could be made for mass voter ignorance, this is it.

I hope Greene stays in the race. As Al Gore once reminded us, every vote must be counted and respected. South Carolina Democrats have made their choice. May the best man win in November.