Economics in One Lesson by Henry Hazlitt (1978 revised edition) is a short introduction to basic economics for the layperson. The book was originally published in 1946, but the economic lessons presented remain vital to the present day. Hazlitt articulates the core idea of the book in chapter one: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” The remainder of the book explores this idea through a range of economic fallacies, public misconceptions, and failed government policies.
Rent control is one policy is viewed through the lens of the “one lesson.” Rent control is attractive to politicians and renters when legislation is initially implemented. But these short-run benefits bring a broad range of long-run problems: inefficient allocation of housing, reduced housing supply, and higher aggregate prices to name a few. For those of us living in housing markets with strong rent control laws—like the San Francisco Bay Area where I reside—the litany of bad economic consequences cited by Hazlitt makes him appear like a modern Nostradamus.
Despite the fact that this book was published right after World War II, I found myself discomforted by how little we have learned from the mistakes of the past. On one hand, it is a source of comfort to know that human folly is unique to our era. On the other, it’s disappointing to realize that many of the failed policies and ideas of the past continue to reappear and reassert themselves in the present (sometimes under new guises but still clinging to the same economic fallacies). One can only hope that future generations of policy-makers and citizens are willing to improve their understanding of basic economics and the long-term consequences of our collective choices.
Pros: Solid primer on basic economic ideas. Content and examples are remarkably evergreen and relevant.
Cons: Hazlitt has a strong libertarian and conservative bent that might put off some readers (doesn’t bother me, but it’s worth noting for others).
Notes & Highlights
1: The Lesson
Economic fallacies are spawned by two factors:
- Policies that benefit individual groups at the expense of other groups.
- The human shortcoming of only considering short-run, immediate effects of a given policy (and ignoring long-run or secondary consequences).
Good economists vs. bad economists:
- Bad economists: Only sees the direct consequences of a proposal. Considers the impact of a policy on one particular group (narrow consideration).
- Good economists: Considers the long-run and indirect consequences. Considers the impact of policy on ALL groups (broad or holistic consideration).
The whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
2: The Broken Window
- Story used to demonstrate a common fallacy.
Scenario: Young hoodlum throws a brick and breaks the window of a baker’s shop.
Observers consider the silver linings:
- Incident will create work for a glazier (new glass).
- Glazier will now have more money to spend.
- Smashed window will provide income and employment in widening circles.
The invisible consequences:
- The money the baker would have spent on other purchases must now be directed to repairing the window.
- Example: The baker wanted to purchase a new suit. Now a tailor will lose out on this income.
One person’s gain (the glazier) is another person’s loss (the tailor). No net new employment has been created.
- Lesson: Visible consequences results in consideration of only two visible parties in the transaction: the baker and the glazier. In reality there is a third (forgotten) party: the tailor.
- People often consider only what is visible to the eye.
3: The Blessings of Destruction
- Consider the broken-window fallacy whenever a public leader exalts the prosperity that results from natural disasters, wars or other calamities.
- Need is confused with demand: “The more war destroys, the more it impoverishes, the greater is the postwar need. Indubitably. But need is not demand. Effective economic demand requires not merely need but corresponding purchasing power.”
- Purchasing power cannot be considered merely in terms of money. Value of the money is a critical consideration as well (e.g. inflation).
- Diversion of demand takes place when purchasing decisions are moved from one product to another.
- Where business is increased in one direction, it is correspondingly reduced in another.
- “Many of the most frequent fallacies in economic reasoning come from the propensity, especially marked today, to think in terms of an abstraction—the collectivity, the “nation”—and to forget or ignore the individuals who make it up and give it meaning.”
Demand and supply are two sides of the same coin: “they are the same thing looked at from different directions.”
- The supply of a thing one makes is what one has to offer in exchange for the things they want.
- Example: A farmer’s supply of wheat constitutes demand for automobiles and other goods.
- “This is inherent in the modern division of labor and in an exchange economy.”
- “Mere inflation—that is, the mere issuance of more money, with the consequence of higher wages and prices—may look like the creation of more demand. But in terms of the actual production and exchange of real things it is not.”
- “It is never an advantage to have one’s plants [factories] destroyed by shells or bombs unless those plants have already become valueless or acquired a negative value by depreciation and obsolescence.”
- There are legitimate productivity enhancing developments like technological advances that do lead to greater output (some of which are the result of wars and other calamities).
4: Public Works Means Taxes
- Fallacy: “Government spending is presented as a panacea for all our economic ills.”
- “Everything we get, outside of the free gifts of nature, must in some way be paid for. The world is full of so-called economists who in turn are full of schemes for getting something for nothing.”
- Ultimately, every dollar of government spending must be paid through a dollar of taxation (even when payment is deferred).
- The crux of the problem is determining the appropriate amount of public spending. The author agrees that basic infrastructure, military spending, government administrative costs and emergency services (police, fire, etc.) are essential.
Public works as acts of job creation follow the broken window fallacy.
- The provision of employment should not be the primary objective for public works projects.
- Costs must be considered. In particular, the invisible costs of lost alternatives (opportunity costs) and consumption that was otherwise diverted through taxes and spending.
- If a bridge costs $10 million, the tax payers lose $10 million that could be spent on other projects or needs.
- Job creation results in job destruction in other parts of the economy.
- A virtuous cycle: “The more wasteful the work, the more costly in manpower, the better it becomes for the purpose of providing more employment.”
5: Taxes Discourage Production
- “Taxes inevitably affect the actions and incentives of those from whom they are taken.”
- When employers lack incentive to upgrade machinery and invest in technology, the rate of progress slows and consumers ultimately pay the price of not enjoying better products and cheaper prices. Real wages and employment are also impacted.
- Government taxation and spending exacerbates the problem of unemployment that it purports to solve.
6: Credit Diverts Production
- “Government encouragement to business is sometimes as much to be feared as government hostility. This supposed encouragement often takes the form of a direct grant of government credit or a guarantee of private loans.”
- Public appetite for government incentives and credits is insatiable.
- Debt is the flip-side of credit: “Proposals for an increased volume of credit, therefore, are merely another name for proposals for an increased burden of debt.”
Public vs. private lending:
- Private lenders risk their own capital. The result is that they take greater care in screening, structuring risk, securing collateral, etc.
- Public lending operates on different set of standards. Government extends credits to individuals and entities that would otherwise not be eligible for private loans at lower rates.
- “The proposal is frequently made that the government ought to assume the risks that are “too great for private industry.” This means that bureaucrats should be permitted to take risks with the taxpayers’ money that no one is willing to take with his own.”
- Government credit carries a risk of corruption, favoritism, cronyism, bribery and scandal.
- Government credit results in credit being extended to the wrong entities and activities.
Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to “buy” houses that they cannot really afford. They tend eventually to bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion.
- “When the government makes loans or subsidies to business, what it does is to tax successful private business in order to support unsuccessful private business.”
7: The Curse of Machinery
- “Among the most viable of all economic delusions is the belief that machines on net balance create unemployment.”
- “The belief that machines cause unemployment, when held with any logical consistency, leads to preposterous conclusions. Not only must we be causing unemployment with every technological improvement we make today, but primitive man must have started causing it with the first efforts he made to save himself from needless toil and sweat.”
- Efficiency is not too be feared: “Every day each of us in his own activity is engaged in trying to reduce the effort it requires to accomplish a given result. Each of us is trying to save his own labor, to economize the means required to achieve his ends.”
The effects of labor saving innovation:
Jobs associated with the construction, operation and maintenance of the new machinery.
Efficiency and productivity gains allow the business owner to deploy profits in multiple ways:
- Expanded operations by purchasing more machinery and raw material.
- Investments in other businesses.
- Increased personal consumption.
The spent profits, in turn, generate additional demand and employment.
“The real result of the machine is to increase production, to raise the standard of living, to increase economic welfare.”
- They make goods cheaper for consumers.
- They increase wages through higher worker productivity.
- “Machines, inventions and discoveries increase real wages.”
8: Spread-the-Work Schemes
- Union make-work and featherbed practices: Policies that create dubious or unnecessary work for the sake of providing jobs or enhancing job security.
- Fallacy: “The belief that a more efficient way of doing a thing destroys jobs, and its necessary corollary that a less efficient way of doing it creates them.”
- Related fallacy believes there is a fixed amount of work to be done.
- Arbitrary subdivisions of labor occur when trade unions try to carve out jurisdictional areas of labor monopoly (e.g. bricklayers not allowed to work on stone chimneys which are the domain of the stonemasons).
- Gatekeeping of this sort raises production costs and results in a net balance of less work done and fewer goods produced.
- Shorter work weeks are another form of “spread-the-work” strategy:
“Though more workers will be employed, each will be working fewer hours, and there will, therefore, be no net increase in man-hours. It is unlikely that there will be any significant increase in production. Total payrolls and “purchasing power” will be no larger. All that will have happened, even under the most favorable assumptions (which would seldom be realized) is that the workers previously employed will subsidize, in effect, the workers previously unemployed.”
9: Disbanding Troops and Bureaucrats
What happens when a large number of soldiers return to civilian life?
- Labor market needs time to reabsorb a large influx of new workers.
- Government no longer financially supports the soldiers.
- Taxpayers retain funds that previously supported the soldiers.
- Taxpayers have greater discretion over spending and consumption and pump these funds back into the economy (spurring job growth).
- “If we assume that the men who would otherwise have been retained in the armed forces are no longer needed for defense, then their retention would have been sheer waste. They would have been unproductive.”
- “The same reasoning applies to civilian government officials whenever they are retained in excessive numbers and do not perform services for the community reasonably equivalent to the remuneration they receive. Yet whenever any effort is made to cut down the number of unnecessary officeholders the cry is certain to be raised that this action is ‘deflationary.’”
- “The country is not merely as well off without the superfluous officeholders as it would have been had it retained them. It is much better off.”
10: The Fetish of Full Employment
“The economic goal of any nation, as of any individual, is to get the greatest results with the least effort.”
- Production is the end.
- Employment is the means.
- “We cannot continuously have the fullest production without full employment. But we can very easily have full employment without full production.”
- Public policy, however, tends to favor “full employment” bills over “full production” bills.
- “Wages and employment are discussed as if they had no relation to productivity and output.”
- Focus on policies that maximize production.
11: Who’s Protected by Tariffs?
- Adam Smith: ““In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest, it seems ridiculous to take any pains to prove it; nor could it ever have been called in question, had not the interested sophistry of merchants and manufacturers confounded the common-sense of mankind.”
- Free trade is an important facet of the economic concept of specialization of labor.
- Tariffs usually only consider the domestic manufacturer or supplier of a good and its employees.
- Tariffs often fail to consider or discuss the associated consumer cost (domestic and foreign consumers are impacted).
- The tariff does not raise domestic wages. There is no increase in wages in general as a result of the tax as there are no net increases in jobs provided, demand for goods nor labor productivity.
The real effect of a tariff: “It is not merely that all its visible gains are offset by less obvious but no less real losses. It results, in fact, in a net loss to the country. For contrary to centuries of interested propaganda and disinterested confusion, the tariff reduces the American level of wages.”
- Consumers pay more for tariff-protected goods.
- This reduces consumer spending in other goods.
- Purchasing power is reduced which means real wages are effectively reduced.
- Tariffs help special interests: “the protected producers at the expense of all other American producers, and particularly of those who have a comparatively large potential export market.”
The effect of a tariff, therefore, is to change the structure of American production. It changes the number of occupations, the kind of occupations, and the relative size of one industry as compared with another. It makes the industries in which we are comparatively inefficient larger, and the industries in which we are comparatively efficient smaller. Its net effect, therefore, is to reduce American efficiency, as well as to reduce efficiency in the countries with which we would otherwise have traded more largely.
12: The Drive for Exports
- “In the long run imports and exports must equal each other…it is exports that pay for imports, and vice versa.”
- “When we decide to increase our exports, we are in effect deciding also to increase our imports.”
- “Each of us must sell something, even if for most of us it is our own services rather than goods, in order to get the purchasing power to buy.”
- “When a gold standard exists the demand for gold is almost indefinitely expansible (partly because it is thought of and accepted as a residual international ‘money’ rather than as just another commodity)…”
- Government aid, unpaid loan and export subsidies s as a means of propping up exports are flawed (it is a form of giving things away). Note that author is not addressing the charitable angle of aid (which is legitimate).
- “In the long run business and employment in America would be hurt, not helped, by foreign loans that were not repaid. For every extra dollar that foreign buyers had with which to buy American goods, domestic buyers would ultimately have one dollar less.”
- Foreign trade is essential because critical imports that are NOT produced domestically can be accessed at better prices. For example: coffee and tea are not produced in the USA.
13: Parity Prices
- Special interests will seek special government policies/treatment.
- Because special interests stand to gain so much [concentrated benefit] they can spend time, money and energy on achieving the desired outcome.
Example of agricultural policies:
- Special interests argue that agriculture is the most basic and essential of all industries.
- “It must be preserved at all costs.”
- Farmers must have some level of purchasing power lest the industry languish.
- The notion of “parity” is arbitrary. In the book example the period of 1909-1914 was considered the pricing benchmark to be preserved perpetually.
- “There is no sound reason for taking the particular price relationship that prevailed in a particular year or period and regarding them as sacrosanct, or even as necessarily more ‘normal’ than those of any other period.”
- The determined parity prices will always be decided because they are advantageous to the special interest.
- Price fixing results in market inefficiencies (that will be explored in later chapters).
14: Saving the X Industry
Two flawed schemes for saving a domestic industry:
- Protecting “overcrowded” industries by preventing new entrants.
- Supporting an industry via direct government financial intervention (e.g. subsidies, special tax breaks, etc.).
- “The idea that an expanding economy implies that all industries must be simultaneously expanding is a profound d error.”
- “In order that new industries may grow fast enough it is usually necessary that some old industries should be allowed to shrink or die…to release the necessary capital and labor for the new industries.”
- For example: When the automobile industry was growing, we did not attempt to simultaneously prop up and increase the output of the horse-and-buggy trade.
- Protection of incumbent industries and their labor pools is akin to fighting progress and change. It hinders the growth of new industries.
- “Improved methods of production must constantly supplant obsolete methods, if both old needs and new wants are to be filled by better commodities and better means.”
15: How the Price System Works
The Robinson Crusoe example (aka “Crusoe economics”):
- A way to consider the basic problem that businesses must solve.
- Shipwrecked Crusoe has an endless set of initial needs: shelter, hunger, thirst, security, etc.
- Crusoe must attend to the most pressing need. He lacks time, energy and resources to address all needs simultaneously.
- “Everything he does delays or prevents him from doing something else…he is faced constantly by the problem of alternative applications of his time and labor.”
Swiss Family Robinson example:
- More diverse labor pool to work with despite more mouths to feed.
- Can practice division and specialization of labor: father hunts, mother prepares food, children collect firewood.
- Family cannot afford for individuals to constantly do the same thing. Children, once sufficient wood is gathered, are better utilized gathering water (rather than adding to the wood stores).
- “One occupation can expand only at the expense of all other occupations.”
A system of competitive private enterprise regulates the supply of thousands of commodities:
- When people want more of a commodity, competitive bidding raises the commodity price.
- Higher prices stimulate production of said good and attracts new suppliers.
- Increased supply results in cheaper prices (and may result increased prices in other commodities that have seen labor and capital contraction due to the booming commodity).
- Cycle continues as individual goods reach equilibrium.
Now in an economy in equilibrium, a given industry can expand only at the expense of other industries. For at any moment the factors of production are limited. One industry can be expanded only by diverting to it labor, land and capital that would otherwise be employed in other industries. And when a given industry shrinks, or stops expanding its output, it does not necessarily mean that there has been any net decline in aggregate production. The shrinkage at that point may have merely released labor and capital to permit the expansion of other industries. It is erroneous to conclude, therefore, that a shrinkage of production in one line necessarily means a shrinkage in total production.
- “The much vilified price system solves the enormously complicated problem of deciding precisely how much of tens of thousands of different commodities and services should be produced in relation to each other.”
- The alternative to a free market system is bureaucratic oversight or government intervention which generally is slower, less efficient and more prone to bias and error in obtaining efficient pricing and resource allocation.
- A free market system is “democratic” in that each consumer effectively “votes” with their wallet on the state of supply and demand.
16: Stabilizing Commodities
Common arguments in favor of price stabilization measures:
- Desire to raise the price of a commodity permanently above its natural level as it is selling far below its natural level.
- Producers cannot make a living and will go out of business.
- If they go out of business there will be scarcity for that good or service (and consumers will need to pay high prices).
- The public cannot wait for market forces to correct the situation.
- Not trying to boost the price, but to stabilize it.
- The real effect of price stabilization is a reduction of output and production. This is because supply must be constrained in the long-run to stabilize prices.
- “Consumers are able to enjoy less of that product than they would have enjoyed without restriction…because consumers are forced to pay higher prices than otherwise for that product, they have just that much less to spend on other products.”
- “In a competitive market economy it is the high-cost producers, the inefficient producers, that are drive out by a fall in price…”
17: Government Price-Fixing
Government price fixing comes in two flavors:
- Fixing the prices of commodities above market levels (farm subsidies).
- Fixing the prices of commodities below market levels (rent control, anti-gouging laws).
Below market pricing is frequently advocated in times of rapid inflation.
“By implication they put the blame for higher prices on the greed and rapacity of businessmen, instead of on the inflationary monetary policies of [the government].”
Consequences of below-market pricing:
- Demand for the commodity increases because the commodity is cheaper.
- Supply for the commodity is reduced (partly because of demand) and partly because the incentives to suppliers have been diminished (lower profits).
- Marginal producers are driven out of business and even highly efficient producers might exit the market.
“If we did nothing else, therefore, the consequence of fixing a maximum price for a particular commodity would be to bring about a shortage of that commodity.”
- This is the opposite effect of what most government regulations want (they typically want abundant supply).
- Government price fixing is fixated (erroneously) on a single factor in the supply-demand equation. Hence the predictable consequences.
Regulators typically attempt to “double down” on interventions by employing more contrived price controls to further mitigate the initial price control effects. This typically exacerbates the problem:
- Rationing: Optimizes for equal access over efficiency. Government adopts rules concerning which special interest groups will have priority for a given commodity. Rationing is inherently inefficient and does nothing to address the supply problem.
- Cost-controls: Government attempts to extend price controls deeper into the supply chain by managing underlying costs that comprise the production of a good (labor, raw materials, etc.). This further restricts supplies and harms supply-side incentives.
- Subsidies: Government tries to make up any shortfall between fixed price and market prices. Subsidies are paid via taxes which means that the end-consumer is ultimately paying for systemic inefficiency.
“Price-fixing may often appear for a short period to be successful. It can seem to work well for a while, particularly in wartime, when it is supported by patriotism and a sense of crisis. But the longer it is in effect the more its difficulties increase.”
Over time, it may become necessary to extend price controls “horizontally” into adjacent and/or unrationed commodities.
Price controls are a result of a misunderstanding of what causes prices to rise:
- The real cause is a scarcity of goods or surplus of money.
- Price ceilings fail to address either cause.
Each person has multiple economic personalities (that are contradictory or in conflict with each other):
- Producers want inflation and regulatory protections.
- Consumers want good prices, variety and ample supply.
- Taxpayers want to pay low taxes but reap government benefits.
18: What Rent Control Does
Rent control is a special form of governmental price-fixing.
Rent control advocates often view housing supply as inelastic.
- Price controls protect tenants from extortionate pricing (false).
- Price controls don’t impact new construction (false).
Rent control creates a number of market distortions:
- Inefficient allocation of space: protected tenants consume more housing than they would under market rates.
- Long-run: new housing is not built because market incentives are low (compared to the free market).
- Long-run: capital investments in existing housing slows as there is little incentive to renovate or upgrade rent controlled stock.
- “Depending on the extent of money depreciation since old rents were legally frozen, rents for new housing might be ten or twenty times as high as rent in equivalent space in the old. (This actually happened in France after World War II, for example.)” [me: It’s happening today in San Francisco, 2020]
“Rent-control laws, among their other effects, create ill feeling between landlords who are forced to take minimum returns or even losses, and tenants who resent the landlord’s failure to make adequate repairs.”
Some governments remove rent controls from “luxury” housing while keeping price controls on low or middle class housing.
- This approach is flawed.
- Builders of luxury housing now have a strong incentive and supply luxury housing.
- Lower rate housing is further discouraged and penalized which further exacerbates supply.
When these consequences are so clear that they become glaring, there is of course no acknowledgment on the part of the imposers of rent control that they have blundered. Instead, they denounce the capitalist system. They contend that private enterprise has “failed” again; that “private enterprise cannot do the job.” Therefore, they argue, the State must step in and itself build low-rent housing.
- “A final irony of rent control is that the more unrealistic, Draconian, and unjust it is, the more fervid the political arguments for its continuance…the argument is made that it would be unspeakably cruel and unreasonable to ask the tenants to pay so sudden and huge an increase.”
- Housing shortages take years (sometimes decades) to manifest after rent control is implemented.
- “The politicians—remembering that tenants have more votes than landlords—cynically continue their rent control long after they have been forced to give up general price controls.”
- “The pressure for rent control comes from those who consider only its imagined short-run benefits to one group in the population. But when we consider its long-run effects on everybody, including the tenants themselves, we recognize that rent control is not only increasingly futile, but increasingly destructive the more severe it is, and the longer it remains in effect.”
19: Minimum Wage Laws
Minimum wage laws are another form of governmental price-fixing.
Wages are prices despite the difference in terminology (which prevents some from recognizing that the same price principles apply to wages).
Minimum wages increase unemployment:
- “When a law is passed that no one shall be paid less than $106 for a forty-hour week is that no one who is not worth $106 a week to an employer will be employed at all.”
- “If, therefore, the X industry is driven out of existence by a minimum wage law, then the workers previously employed in that industry will be forced to turn to alternative courses that seemed less attractive to them in the first place.”
Market wages ensure that employers must pay enough to attract and retain workers from alternative companies and industries.
“The best way to raise wages, therefore, is to raise marginal labor productivity.”
Increase marginal productivity can be accomplished in many ways:
- Increase in capital investments: e.g. more machinery that boosts worker productivity.
- Innovation and improvement: e.g. process efficiency.
- Better management to organize and allocate resources more effectively.
- Better trained and educated workers.
- One cannot avoid this basic truth:
The more the individual worker produces, the more he increases the wealth of the whole community. The more he produces, the more his services are worth to consumers, and hence to employers. And the more he is worth to employers, the more he will be paid. Real wages come out of production, not out of government decrees.
20: Do Unions Really Raise Wages?
- “Labor productivity is the fundamental determinant of wages.”
- Employers are primarily driven by profit maximization.
- Unions are useful when they focus on the improvement of local working conditions and ensuring that union members obtain market value wages.
- Unions as a mechanism for price fixing are flawed. Price fixing wages results in higher unemployment and reduced labor supply.
Violent strikes (withholding of labor) impact two groups:
- As an act against the employer.
- As for form of intimidation and means of dissuading competitive workers.
Labor movement holds that labor is generally underpaid and that free market prices are chronically low.
Labor movement holds that labor interests are identical across a broad spectrum of industries and geographies (“an increase in wages for one union in some obscure way helps all other workers”).
Do increases in wages come at the expense of employer profits?
- Short-run this may be true.
- Company may be able to increase prices and have the consumers bear the increased costs of production.
- Alternatively, hiring and employee spending may be reduced in favor of capital investments (machinery/technology to boost worker output) or investments in other industries with lower labor costs.
- Increased production costs can also result in industry contraction or consumers moving to alternative substitute goods (that are cheaper).
- “Unions, though they may for a time be able to secure an increase in money wages for their members, partly at the expense of employers and more at the expense of non unionized workers, cannot, in the long-run and for the whole body of workers, increase real wages at all.”
21: Enough to Buy Back the Product
- Fallacious view on “just wages” advocates that “The only wages that will work…are wages that will enable labor ‘to buy back the product it creates.’”
- “In an exchange economy everybody’s money income is somebody else’s cost. Every increase in hourly wages, unless or until compensated by an equal increase in hourly productivity, is an increase in costs of production.”
- The chief effect of forcing up wage rates is higher unemployment.
- Economists Paul H. Douglas and A.C. Pigou independently determined that the elasticity of labor demand is between 3 and 4: “A 1% reduction in the real rate of wage is likely to expand the aggregate demand for labor by not less than 3%. Or…if wages are pushed up above the point of marginal productivity, the decrease in employment would normally be from 3-4 times as great as the increase in hourly rates so that the total incomes of the workers would be reduced correspondingly.”
- Cost hikes due to wage hikes are poorly estimated because many studies only look at direct wage inputs. However labor costs affect all aspects of the production chain (e.g. for automobiles it is not only the factory workers but also raw materials, purchase parts, transportation charges, etc.).
“Equilibrium wages and prices are the wages and prices that equalize supply and demand.”
- Lifting prices above equilibrium results in reduced demand and production.
- Pushing prices below equilibrium results in reduced profits and reduced supply.
- Cost considerations cannot only look at manufacturing labor alone; it must consider the entirety of the system.
- “The best prices are not the highest prices, but the prices that encourage the largest volume of production and the largest volume of sales.”
- “If we try to run the economy for the benefit of a single group or class, we shall injure or destroy all groups, including the members of the very class for whose benefit we have been trying to run it. We must run the economy for everybody.”
22: The Function of Profits
- “Profits are the form of income toward which there is most hostility.”
- The lure of high profits in certain industries is essential to attract risk-takers.
- Government policies assume that production will occur automatically regardless of regulatory discouragement.
Critics and government decry “excessive,” “unreasonable,” and even “obscene” profits but fail to note that:
- Profitability results in an expansion of production and supply.
- Profitability results in reinvestments of capital and labor.
- Profits help allocate capital and labor across a range of goods and services.
- Profits induce companies to become more efficient and continuously improve.
- “Contrary to a popular impression, profits are achieved not by raising prices, but by introducing economies and efficiencies that cut costs of production.”
- Profits are signals that point to the most economical goods as well as the most economical methods of producing them.
23: The Mirage of Inflation
- “The oldest and most stubborn error on which the appeal of inflation rests is that of confusing “money” with wealth.”
- The simple view is that more money means more goods and services can be purchased. But this narrow view of the situation neglects to understand the gross effects of inflation: higher prices for goods and services, higher wages and costs, reduced real purchasing power, etc.
- Timing and sequencing of inflation allows certain groups to benefit differently from other groups. E.g. a group that first benefits from more money can benefit the most while pricing in other segments adjust.
- “Inflation turns out to be merely one more example of our central lesson. It may indeed bring benefits for a short time to favored groups, but only at the expense of others. And in the long run it brings ruinous consequences to the whole community.”
- “What inflation really does is to change the relationships of prices and costs. The most important change it is designed to bring about is to raise commodity prices in relation to wage rates, and so to restore business profits, and encourage a resumption of output at the points where idle resources exist, by restoring a workable relationship between prices and costs of production.”
- The political function of inflation is that it creates a false sense of progress or economic prosperity (e.g. “National income has doubled” despite any changes in real purchasing power).
- Inflation does not affect everyone equally: “The poor are usually more heavily taxed by inflation than the rich, for they do not have the same means of protecting themselves by speculative purchases of real equities.”
24: The Assault on Saving
- “Saving in short, in the modern world, is only another form of spending.” (e.g. via investments in which money is turned over to others who can use it to increase production).
- Normal purchase of goods and services is “visible consumption” but saving and investing is “invisible.”
- “If money that would previously have been used for savings were thrown into the purchase of consumers’ goods, it would not increase employment but merely lead to an increase in the price of consumption goods and to a decrease in the price of capital goods.”
- “We may define savings and investment as constituting respectively the supply of and demand for new capital. And just as the supply of and demand for any other commodity are equalized by price, so the supply of and demand for capital are equalized by interest rates.”
- “The interest rate is merely the special name for the price of loaned capital. It is a price like any other.”
- Learn to view the setting of interest rates as a form of price fixing.
- “The effect of keeping interest rates artificially low, in fact, is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It creates economic distortions.”
- Be wary of proponents who argue that there are fixed limits of demand: “quantitatively and especially qualitatively, there is no limit to the expansion that is possible and desirable.”
25: The Lesson Restated
- Economics is the the study of secondary consequences as well as general consequences.
- Economics considers the impact of policies on general and special interest groups in both the short run and long run.
- “Depth in economics consists in looking for all the consequences of a policy instead of merely resting one’s gaze on those immediately visible.”
- “Many things that seem to be true when we concentrate on a single economic group are seen to be illusions when the interests of everyone, as consumer no less than as producer, are considered. To see the problem as a whole, and not in fragments: that is the goal of economic science.”
26: The Lesson After Thirty Years
If we go through the chapters of this book seriatim, we find practically no form of government intervention deprecated in the first edition that is not still being pursued, usually with increased obstinacy. Governments everywhere are still trying to cure by public works the unemployment brought about by their own policies.
Author views the main problem as a political not economic one:
- Government’s main function should be to encourage and preserve a free market.
- Government should “create and enforce a framework of law that prohibits force and fraud.”
- Government should refrain from specific economic interventions.