Pope Francis on Economics

by Fred E. Foldvary

Any statements which deplore “trickle down” economics reveal that the author has not quite yet grasped the heart of economics.

On November 26, 2013, The Vatican press published the apostolic exhortation, “The Joy of the Gospel.” The text was written in Spanish, and its full title in the English translation (converted here from upper case to initial capitals) is “Evangelii Gaudium of the Holy Father Francis to the Bishops, Clergy, Consecrated Persons and the Lay Faithful on the Proclamation of the Gospel in Today’s World.” Besides its religious calls, Pope Francis makes statements about today’s economic problems, and calls for greater economic justice.

One of the aims of this proclamation is to point out “new paths for the Church’s journey in years to come.” One of the questions the Pope seeks to discuss is “the inclusion of the poor in society.” Chapter Two is entitled, “Amid the Crisis of Communal Commitment.” In paragraph 52, Francis writes that “today we also have to say ‘thou shalt not’ to an economy of exclusion and inequality. Such an economy kills… Today everything comes under the laws of competition and the survival of the fittest, where the powerful feed upon the powerless.”

The Pope is wise and correct in seeing the harm done by inequality, but I urge him to see past the appearances to study the underlying reality. What provides the powerful with their might? The state has the ultimate power of force, and by its power to tax, to restrict, to mandate, and to subsidize, the state endows the powerful with the means to feed on the powerless. Market competition as such cannot impose force, and it does not create poverty. In a free society, each person has the power to be employed and pursue happiness. In a truly free market, all are fit to survive, because workers have access to natural opportunities. It is government intervention that stops this access.

Paragraph 54 is the key, widely cited, economic passage. We need to be sure that the English version is true to the original Spanish. In Spanish, Francis wrote, “algunos todavía defienden las teorías del « derrame », que suponen que todo crecimiento económico, favorecido por la libertad de mercado, logra provocar por sí mismo mayor equidad e inclusión social en el mundo.”

The Vatican’s English translation says, “some people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world.”

The English-edition term “trickle-down theories” is translated from the Spanish, “teoria del derrame.” “Derrame” means a slow leak, hence a trickle, and so the English translation is accurate. The translated term “free market” is more literally “the liberty of the market” in the original Spanish, but the meaning is the same.

As noted by Harvard professor Greg Mankiw in his blog, critics of markets often use the term “trickle down” as a pejorative for the effects of a market economy. There is indeed a trickle down effect, for example, when a tourist resort is built in a location with many poor people, where a few get hired to work to clean rooms and wash dishes. A bit of the wealth of the resort trickles to the local population. But this situation does not confront the issue of why the poverty exists in the first place.

The theory of the free market is not one of “trickle down.” A truly free market is a fountain that gushes up wealth for all. Moreover, economic growth in market economies has indeed raised millions of persons up from poverty. However, the theory of market-driven growth does not claim that growth brings justice. The causation is the opposite: economic justice promotes growth. Moreover, justice and liberty are two faces of the same coin, so if a market has liberty, it must also provide justice.

The Pope continues: “This opinion, which has never been confirmed by the facts, expresses a crude and naïve trust in the goodness of those wielding economic power and in the sacralized workings of the prevailing economic system.”

But the proposition that free markets provide growth that benefits all is not a mere opinion. The proposition is a theory of growth that was first analyzed by the French economists of the 1700s, who concluded that the unhampered market, with free trade, would provide the greatest prosperity for all.

The prescription of the French economists was to abolish taxes on labor and trade, and instead use the surplus of the economy, which is land rent, for public revenue. Adam Smith in his Wealth of Nations brought this theory into classical economics. The American economist Henry George a century later explained in detail how land rent captures the gains from economic progress, and how growth generates inequality and poverty if that rent is not equally shared.

Markets have had various degrees of freedom, but there is no truly free market in the world today. Those who advocate a pure free market do not defend the “prevailing economic system,” but rather, they seek to stop the state’s subsidy of economic powers. The greatest subsidy and economic power is the land rent generated by the public goods provided by government.

The Pope is correct in decrying “the denial of the primacy of the human person” (paragraph 55) and that “Behind this attitude lurks a rejection of ethics” (57). Ethics and the primacy of the human person requires the equal right of each person to pursue happiness without harming others and to keep the earnings of his labor, as recognized by the commandment, “Thou shalt not steal.” Ethics must also respect the equal sharing of the benefits of nature and community, as stated in Ecclesiastes 5:9, “the profit of the earth is for all.”

The heart of economics is the understanding of the root cause of poverty: the forced redistribution of wealth from the working poor to the landed rich. This is caused not by markets but from state policy. It is good that Pope Francis seeks to remedy poverty. His “new path” should be to go more deeply into the economics and politics of maldistribution.

Look Who’s Practicing Trickle-Down Economics

Thomas Sowell is one of the clearest contemporary thinkers on economic and political issues, both as a theoretician and a commentator on current events. His recent piece on “Tax Cuts for the Rich and Trickle-Down Theory” is an excellent example. In it, he shows how tax rate cuts for the highest earners can actually increase the tax revenue collected from that group. He also recalls challenging his readers to name a single economist who advocated a “trickle-down” theory of economics. No one did so.

Trickle-down is the idea that when the highest income-earners keep more of their income, some of their spending will eventually reach lower-income workers. Their purchases of luxury items will bolster employment in the production of those items. Leftists are fond of setting up this theory and then attacking it on the grounds that the benefits to the wealthiest overshadow the benefits that trickle down to those at the bottom. Government spending cuts hurt low-income people the most. Therefore, they say, tax cuts for the highest earners are a disguised scheme to siphon yet more wealth from the bottom to the top.

The “trickle down” phrase has been around at least since the 1930’s and was restated recently by the current White House occupant when he attacked what he called “The economic philosophy which says we should give more to those with the most and hope that prosperity trickles down to everyone else.”

Does the theory make sense? First off, it ignores the morality of the situation. As T. J. Rodgers, CEO of Cypress Semiconductor, puts it, “I’m proud of my wealth. I earned it.” He explains how increased income taxes will not reduce his personal consumption but will instead reduce his investments in Silicon Valley startups and his charitable activities. Just what is the benefit, he asks, in taking money away from these uses and giving it instead to programs like Cash for Clunkers or Solyndra?

Secondly, trickle-down theory ignores the fact that high-income people like T. J. tend to invest a greater portion of their marginal income. Capital accumulation is the key to higher worker productivity and thus higher wages and higher standards of living.

There is actually one institution that does practice trickle-down economics. That would be the Federal Reserve System. The Fed recently announced its QE3 program under which it will purchase $40 billion of mortgage-backed securities each month for an indefinite period of time. One aim of this program is to push down long-term interest rates and thereby encourage businesses to borrow. But those rates are already historically low. Can we really expect further cuts to have any significant stimulative effect given the current high level of regime uncertainty?

The other purpose mentioned by Chairman Bernanke is to keep the stock and bond markets propped up. The idea is to pump up the “wealth effect.” This is the idea that when people who see increases in the market value of their holdings of investment or real estate, they will be more inclined to spend, even with unchanged income. Their spending will then trickle down into the economy. As an investor I ought to say thanks but as a citizen I would say to the leftists, look to the Fed to find a real example of exploitative trickle-down economics.