Barack Obama says to the entrepreneur, You have always depended on the kindness of strangers.
Mitt Romney says in return, I did it myself.
Ann Althouse, floating above it all, says, Nicht wahr?
Who is right? Anyone? Everyone?
The current debate goes to the heart of something called the marginal productivity theory of income distribution, which starts with the unremarkable observation that the maximum amount anyone will pay for a productive service is the increment to value provided by that service. (Or, in cases such as professional sports, the providers of services are paid what they’re expected to add to value.) This really is just simple common sense. But things can get interesting very quickly.
Let’s think about a simple operation like a farm. The basic inputs are land, labor, equipment, fertilizer, water, and sunshine. Adding a little bit more of any of these things will usually result in a bigger harvest.
But think about what happens to the value of a farm worker when he is provided with better equipment to work with–it increases. One worker atop a tractor can plow a lot more land than the same worker behind a horse-drawn plow. So upgrading the equipment on the farm increases the marginal product of a worker–and so increases his value to the farm.
This effect runs in both directions. Adding more workers means that extra farm equipment–and acreage–will add more to output than it would without those extra workers to exploit it. So where does this all lead us? Is there a unique value to each productive resource, or is this a hopeless mess of interdependence?
The question can be answered rigorously through the application of Euler’s theorem on homogeneous functions, but I don’t expect anyone to hang around here for that exposition. But the basic idea is this: As long as the interdependencies among productive resources are such that if you double all your inputs you’ll exactly double your output (which simply means that your production process can always be replicated, either by you or by a competitor), then paying every input its incremental contribution to the value of output will exactly distribute the entire output.
That previous paragraph is both important and–to me, at least–utterly amazing. What is says is: Sure, there are all sorts of interdependencies among the various things that go into the process of bringing goods to market, but we can ignore all that in determining the incremental contribution of each of those productive inputs. And since it’s precisely that incremental contribution of each input that determines its value to its employer, then we can measure the incremental contribution of every productive resource by the price a unit of it commands in a free market.
Now in the case of public infrastructure there’s no buying or selling in a market. The decision to build a highway or a bridge is made collectively, and the project is funded through taxes. But if those collective decisions are made according to standard investment principles, the final result is the same: we will add to the public infrastructure as long as its incremental contribution to the private sector is at least as great as what it costs us to build it. (If, instead, we overinvest in public works in a misguided attempt to “create jobs,” then the public sector will cost us more than its contribution to output. Oops!)
If businesses have acquired productive resources in the marketplace according to these principles, and if the government has done that also, then there is no way to change the allocation of resources that will not reduce the value of total output. Why is that? Because that will necessarily mean moving resources to lower-valued uses than the ones they’re allocated to already. (The highest-valued uses are also the highest-bidding ones.) And that is just another way of saying that the allocation of resources resulting from offering to pay each input the value of its incremental contribution to output maximizes the total value of that output. Which is why free-market economies are high-output (and, therefore, high-income) countries.
You know what’s even more amazing to me than the beauty of the theory of income distribution? The fact that this has been settled doctrine in economics for over 100 years, and yet it’s so completely unknown to the President of the United States and other law professors who talk and write incessantly about it.
I suppose “amazing” isn’t the right word to use here, though. The time is long past when anyone could possibly be amazed to learn of another gap in our president’s knowledge of how things work.
The right word is “appalling.”