Animal Power, Waterwheel, Ship Transport, Steam Engine, Railroad, Steel Industry, Robotics, Rust Belt and Minimills

Posted by PITHOCRATES - November 14th, 2012

Technology 101

Rent-Seeking Captains of Industry and Commerce give Capitalism a Bad Name

Once upon a time you lived, worked and died all within a short walk from each other.  In feudalism people owned land and lived well.  The landed aristocracy.  And other people (the peasants) worked the land.  But did not live as well as those who owned it.  For it was back-breaking work for long hours with no respite except in death.  For those who worked the land belonged to the land.  Just as the trees and fields and rivers did.  Peasants belonged to the land and the land belonged to the landowner.  The peasants couldn’t leave.  And they couldn’t work hard to provide a better life for their children.  For they were bond to the land as their patents were.  With no choice but to work the land like their parents did.

This was how life was before we started to use power to make our work easier.  We had long been using animal power to do things we didn’t have the strength or the endurance to do.  Such as pulling a plow.  Or a wagon full of goods.  Or to travel great distances more quickly than we could by walking.  Harnessing the power of moving water changed all of that.  For a river moves constantly.  And when you place a waterwheel in moving water you can convert the linear motion of the water into rotational motion.  This rotational motion could turn a main shaft running though a factory.  Belts and pulleys could transfer this power to workstations throughout the factory floor.  And these powered workstations could do far more work than a person could.  Lumberjacks could transport logs down a river to a lumber mill.  Where a waterwheel could spin a saw that made lumber out of those logs at such a rate that great cities could arise around these mills.  Cities with other factories powered by waterwheels.  And homes.

So it’s no surprise that our early cities grew up on rivers.  Both for water power.  And the ability to use them to ship bulk goods.  Ship transport.  Something even animals weren’t good at.  It is in these cities that wealth and political power grew.  Centers of industry and commerce.  Creating great wealth for those who controlled the resources that made all of that possible.  So another aristocracy grew.  Rent-seeking captains of industry and commerce.  Who give capitalism a bad name.  Who use their political power to maximize their profits.  And buy favors from those in power to protect their particular interests.  Such as using the power of government to create monopolies for themselves.  But advancing technology made that harder to do.  Especially the steam engine.  And the railroad.

The Steel and Heavy Manufacturing Industries required a Massive Infrastructure and Regionally Located Raw Materials

Control of rivers, ports and harbors provided a great opportunity to amass wealth at other people’s expense.  For when economic activity centered on water it made land around that water very valuable.  Which concentrated wealth and power on the rivers.  Until the steam engine replaced the waterwheel.  And the railroad provided a way to transport people and goods inland.  So not only did cities grow up along the waterways they grew up along the rail lines.  Those controlling these resources still had great wealth and power.  But they also offered competition.  And more economic liberty.  For while there can only be one Tennessee River flowing through Chattanooga, Tennessee, there can be more than one railroad running through Chattanooga.  Which made Chattanooga an important city to hold during the American Civil War.  For there was a great rail junction in that city.  Giving anyone who controlled the city access to any part of the Confederacy.

While the steam engine and railroad allowed industries to grow anywhere in the country some industries still clustered in regional areas.  Such as the steel industry.  It required three ingredients to make steel.  Iron ore, coke (coal cooked into hard charcoal briquettes) and limestone.  To make steel you use 6 parts iron ore, 2 parts coke and 1 part limestone.  Iron ore was plentiful around Lake Superior.  Because it takes a lot of iron ore and a lot of iron ore is located around Lake Superior the steel makers built their mills long the Great Lakes.  In Milwaukee.  Chicago.  Gary.  Detroit.  Toledo.  Cleveland.  Or in places like Pittsburgh where coal and iron ore deposits surround the city.  These cities made up the Manufacturing Belt.  Places with access to bulk ore shipping (on Great Lakes freighter or river barge).  And where the steel mills arose so did heavy industry that built things from that steel.  From structural steel.  To automobiles.

For a while these new industries dominated the economic landscape.  Big, heavy industries that couldn’t move.  Concentrating money and political power.  Giving rise to organized labor.  Who took advantage of the fact that these heavy industries could not move.  Negotiating lucrative union contracts.  With generous pay and benefits.  Raising the price of steel and the things we made from steel.  Like automobiles.  Making the rank and file like rent-seekers of old.  Looking to personally benefit from their near-monopoly conditions.  Like those early captains of industry and commerce.  Life was good for awhile for the rank and file.  Who lived very well.  And better than most American workers.  Thanks to those monopoly-like conditions in these steel and heavy manufacturing industries.  Allowing them to charge high prices for their goods to pay for those generous pay and benefits.  As there was no competition.  For the steel and heavy manufacturing industries required a massive infrastructure and an abundant supply of regionally located raw materials, making it very difficult for a new competitor to open for business.  At least, in the United States.

High Costs and Low Efficiencies have shuttered most of America’s Steel Making Past

Foreign competition changed all that.  And large ocean-going ships.  So new industries in other countries with lower labor costs could manufacture these goods and ship them to the United States.  And did.  Challenging the monopoly-like conditions of the rent-seeking steel and heavy manufacturing industries.  So the rent-seekers turned to government for protection.  And got it.  Import tariffs.  Which raised the price of those imported goods to the higher price level of the domestic goods.  Which did two things.  Insulated the domestic manufacturers from market pressures allowing them to continue with the status quo.  And forced the foreign manufacturers to find less costly and more efficient ways to make their goods to counter those import tariffs.

So what happened?  Technology advanced in these industries overseas while they stagnated in the US.  The US didn’t invest in new technologies like they did in the previous century to find better ways to do things.  Because they didn’t have to.  While the foreign competitors worked harder to find better ways to do things.  Because they had to.  As they weren’t insulated from market forces.  The Japanese invested in robotics.  Transforming their auto industry.  Improving quality and lowering costs.  Making their cars as good if not better than the Americans did.  And selling them at a competitive price even with those import protections.  So what did these US actions to protect the domestic manufacturers do?  Changed the Manufacturing Belt to the Rust Belt.

The big steel cities in America are no more.  High costs and low efficiencies have shuttered most of America’s steel making past.  Gone is the era of the sprawling steel mill.  Today it’s the minimill and continuous casting.  Small and efficient steel mills with small labor forces that can make small batches.  Thanks to their electric arc furnaces that are easy to turn on and off.  Unlike the big blast furnaces that took a while to reach operating temperatures and when they did they didn’t shut them down for years.  Making it difficult to adjust to falling demand.  Like the minimills could.  Which helped save the steel industry by finally adopted technology that allowed it to sell at market prices.  Making it harder for the rent-seekers these days.  But better for consumers.  Because of this relentless march of technology.  That allows us to continuously find better ways to do things.

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Clinton Tax Rates, Japan’s Lost Decade, Irrational Exuberance, Dot-Com Bubble, EBT and Job-Creating Capital

Posted by PITHOCRATES - November 14th, 2012

History 101

The Economy of the Nineties boomed because of Japan’s Lost Decade and Irrational Exuberance

President Obama wants to raise taxes on the wealthy.  He wants to go back to the Clinton tax rates.  The economy was booming during the Clinton Nineties.  Better than it is now.  Tax rates were higher in the Nineties than they are now.  While the deficit is greater now than it was in the Nineties.  And the debt is greater than it was in the Nineties.  The conclusion?  Higher tax rates improve economic activity.  Produce smaller deficits.  And grow the debt at a slower rate.  At least, that’s what those who want to raise tax rates say.  The only problem with this is that there are reasons why the economy was booming in the Nineties.  And it didn’t have to do with tax rates.  But, instead, the Japanese.  And irrational exuberance.

The Japanese government partnered with business in the Eighties.  Corporations worked closely together for the good of the export economy.  And the national economy.  This was Japan Inc.  And the economy surged.  Fueled by low interest rates.  People in America worried about the Japanese buying American landmark assets with their fat profits.  An American magazine joked that America would become a wholly owned subsidiary of a Japanese corporation.  A Democrat presidential candidate said America was a fool for not doing what the Japanese were doing.  But the good times didn’t last.  That inflationary monetary policy caused a massive asset bubble.  And when it burst the Japanese suffered a deflationary spiral that last a decade or more.  Their Lost Decade.  This great contraction weakened America’s greatest economic competitor.  Greatly helping the US economy.

Also during the Nineties the Internet was coming of age.  In the Eighties there was the personal computer.  Silicon Valley.  And Microsoft.  A lot of investors were looking for the Microsoft of the Nineties.  No one knew who that was going to be.  But one thing everyone knew was that it was going to be a dot-com.  Investors poured money into dot-coms that didn’t have anything to sell.  Hence the irrational exuberance.  Dot-coms built great office buildings and technology corridors in cities.  New ‘Silicon Valleys’ were appearing across the country.  Kids went to college to learn how to make websites and set up ecommerce.  All these young kids filled these new dot-com buildings.  But when the investment money ran out these companies went bankrupt.  As they had no revenue.  Or anything to sell.  The dot-com bubble burst after Clinton’s Nineties.  Giving George W. Bush a bad recession at the beginning of his first term.  Also, President Clinton pressured lenders to qualify the unqualified for mortgages they couldn’t afford.  Starting a great real estate bubble.  That burst after Clinton’s Nineties.  Causing the subprime mortgage crisis about a decade later.

The Government taxes Small Business Owners as Rich People even though they’re not really Rich People

So there is more to the Nineties than those Clinton tax rates.  The Japanese gave them an able assist.  Then a lot of bad investing creating a lot of artificial economic activity that created a bubble.  That crashed into a recession.  Thanks to a lot of governmental interference in the private sector economy.  They kept interest rates artificially low.  And offered a lot of incentives to get those dot-coms to build in their cities.  Leaving cities with a lot of empty buildings, budget deficits, bloated public sector payrolls and no increase in tax revenue to pay for the additional infrastructure and services.  This is what the Clinton policies gave us.  Not sustained economic activity.  Or a budget surplus.  So going back to the Clinton tax rates is not likely to produce sustained economic activity.  Or a budget surplus.  Especially when President Obama has outspent Clinton over a trillion dollars a year.

So returning to the Clinton tax rates won’t help to reduce the deficit unless they return to the Clinton spending as well.  And that’s not likely to happen.  So what will the increase in tax rates do?  Well, we can get an idea by comparing the Clinton tax rates (1999) to the last tax rates we used (2011).  As they apply to a small business.  The following is an income statement for what could be a typical small business with about $1.8 million in annual sales revenue.

This is a very summarized income statement using some typical percentages for cost of sales and overhead.  This also assumes about $350,000 of debt on the company books.  Giving an interest expense of about $28 grand.  When you subtract all of these expenses from revenue you arrive at an earnings before taxes (EBT) of $358,016.73.  For many small business owners this EBT flows to their personal income tax return as personal income.  Which sounds like a lot.  But business owners will leave most of this money in their businesses.  So while the government taxes them as rich people they’re not really rich people.  For what the government doesn’t tax away will become retained earnings.  And reinvested back into their businesses.

Higher Taxes and Higher Regulatory Costs hurt Job Growth by taking away Job-Creating Capital from Businesses

All right, so let’s look at what the government would tax away.  Based on the 1999 tax rates.  And the 2011 tax rates.  Using the tax rates for married filing jointly we get the following income tax for each set of tax rates.

The 1999 tax brackets give an effective tax rate of 31.4%.  In 2011 that fell 4.7 points to 26.7%.  Which increased net profit from 13.7% in 1999 to 14.6%.  An increase of 0.93 points.  Not as big a change as in the income tax rate.  But it’s an additional $16,730.50 the small business would have to reinvest into the business.  Which could pay for a lot (even help pay their interest expense).  Especially over time.  In two years that’s about $33,461.  In five years that’s about $83,650.  In ten years that’s about $167,300.  That’s a lot of ‘free’ money the business could use to grow their business that they didn’t have to pay back.  But if we returned to the Clinton tax rates that’s money these businesses would no longer have to invest into their business.  Forcing them to pay to borrow money.  Adding additional interest expense.  And burdening the business with greater debt.  Which would be a disincentive to add additional costs.  Like creating new jobs and hiring people.

A lot of small business owners don’t pay themselves.  That is, they don’t get a paycheck like everyone else in their business.  Instead they distribute earnings from the business.  People think all business owners are rich.  But here’s something they don’t understand.  Even though they pay income taxes on their total business earnings they may only take a small percentage of their earnings out of the business.  In this example the married couple draws $75,000 a year to live on.  Even though they paid income taxes on $358,016.73.  Netting only $75,000 on these earnings would be like having 79.1% of your earnings withheld in taxes from your paycheck.  While these numbers vary among business owners this generally holds true.  They pay taxes on amounts far greater than what they take out of their business to live on.

If we go back to the Clinton tax rates it will reduce the amount of investment capital owners have to grow their business.  Which new regulations have already reduced by increasing costs.  With the unknowns of Obamacare basically freezing all new hiring.  As small business owners don’t know if the government will leave them enough money to grow their businesses.  Or even enough to maintain their current business operations.  Which is how higher taxes and higher regulatory costs hurt job growth.  By taking away job-creating capital from businesses.

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