author: henry hazlitt
lesson 1
- main error economists and politicians make is to concentrate on the short-run effects of policies on special groups and ignore or belittle the long-run effects on the community as a whole
- bad economists present their "errors" to the public better than the good economists present their truth
- reason is that bad economists are presending half truths. they speak only of a proposed policy or its effect upon a single group...they can say this quickly and simply..and the public can understand it easily as their is always a very clear logic to it...
- good economists have to describe a lengthy chain of events to get across their point...and speaking usually of invisible results that are harder to comprehend
lesson 2: the broken window
- a criminal breaking a window seems to cause a circle of money traveling throughout the system as the store owner has to pay a window guy to fix the window which brings upon demand to the economy...
- but in fact, that money that was wasted on fixing a window could have went into buying something else the store owner wanted which causes also a circle of demand in the economy
- the truth is that the broken window only causes inefficiencies with the use of money as instead of adding a new item to the economy (the thing store owner would buy with the window fixing money), the economy has only just went back to the way it was with an unbroken window...no added value to the economy
lesson 3: blessings of destruction
- war destruction is the same as the broken window
- seems to improve and boost production in the destroyed countries but all they doing is fixing what didn't have to be fixed
- without the war, these countries would have eventually improved their technology anyway as the old machines become obsolete...
- all war does is waste money...money that could have been spend elsewhere which adds new value to the countries
lesson 4: public works means taxes
- government projects are paid for by taxes which is just money out of the public's pockets
- so if the project is not cost effective or unnecessary, it is just a waste of money...
- politicians say that it increases jobs but it takes away cash from the public that could have went into demand for products which would increase jobs as well...
- but instead of having necessary products bought, the gov't many times wastes money on useless projects especially bridges
lesson 5: taxes discourage production
- no incentive to work harder or more efficient if taxes increase with more wages
- capital gains are taxed which means u only keep a portion of your hard earned money, but when u lose money u have to take on the full burden...this does not encourage investment
- for businesses, they can offset their gains with last year's losses...but only up to the losses...therefore businesses have an incentive not to make much more than the losses as they will be liable for more taxes
lesson 6: credit diverts production
- gov't gives loans to people who don't quality for private company loans
- which means that the loan default rate will be high
- gov't is taking on more risk than a normal company would...and this risk is taken on the taxpayer's dollars
- credit is given to busineses that would otherwise fail...in this sense, it does not allow the strong companies to shine and take over the industry...instead it makes for more inefficiencies as the bad companies are left to stay around causing less efficient production for that industry
- in a better world, the gov't would not give credit to these companies and instead let the bad companies fail so that the industry can improve its production on the backs of the strongest companies that can get private loans
Lesson 7: curse of machinery
- techniology take away jobs...they replace people with modern machines...this decreases employment...but thats only a half truth
- truth is that technology increases production and lowers cost...which lowers cost for the products which increases demand....in turn, that will allow for more employment by the companies to make up for the increases demand...so, overall many of the jobs will be reclaimed
- better yet though, this new machine or technology causes emplyment in a industry...people to make these machines, to fix these machines, etc...as with computers, it increased employment, not decreased...what it does mainly is divert the jobs, end obsolete jobs and create a new industry that will add new jobs to the economy
Lesson 8: spread the work schemes
- primary practice of unions is to keep jobs by requiring certain professionals for certain jobs...this way, just to fix a toilet, u need several people who are specialties in their field to oversee the project...that way, no jobs get cut...but as we noted before, this is wasteful and adds nothing but decreases production
- gov't wanted no overtime for people as to make it 40hrs a week so that companies have incentive to hire more workers and not just give some workers more hours...even if they more productive, they can't as their pay will increase
- dropping the workweek to 30 hr weeks with the same pay raises production costs and will not help employment in the overall economy
- dropping work week to 30hr weeks with no increase of pay just spreads out money from the productive, experienced workers to the new trainees which should also decrease production
Chapter 9: Disbanding troops and bureaucrats
- when government officials or soldiers do not perform services for the community reasonably equivalent to the remuneration they receive, they should be cut
- cutting their jobs seems bad as more unemployment...but it also leaves better production and money left over for the payers of their salaries (taxpayers) to spend their money in other ways in the market, which of course will make back up for the loss of money these employees would have spent with their salaries.
Chapter 10: the fetish of full employment
- full employment is easy...done by every communist country and socialist country...can give everyone job no problem..but that doesn't mean it solves problems or boosts productivity
- full employment is not needed for full production...full production almost always means no full employment
- idleness and unemployment is a biproduct of efficient production...less people need to be employed to do the same task...then these people can go out and do things that benefit the country in other ways....it adds to the production, not lessens it
- the progress of civilization lessened the need for jobs, not raised it...and that is not a bad thing...its the reason why we don't need child labor and why moms can stay at home with their kids and why the elderly don't have to work forever
Chapter 11: who's protected by tariffs?
- tariffs only protect the industries in which they protect...it decreases productivity and makes it more expensive for people to buy the same goods
- as a result of a raise in the price of products, there is less money to be spent in other industries which hurts other industries...
- also hurts the trading ties with other countries.
- if another country can produce something cheaper, allow us to buy from them and have our country exit these industries and into others that we are more efficient at producing...its a way to concentrate resources into our strengths and rids us of weaknesses
- trade is always good as imports are directly related to imports...foreign companies that gain from us buying their products will in turn use that money to buy some of our products...smooth trade allows for more money to exchange hands which is better for all parties
- tariffs can even hurt the protected companies as they themselves are consumers as well and not just producers...they will be hit with higher prices as the result to some other tariffs.
chapter 12: the drive for exports
- goal is to actually have exports and imports be equal, not more exports vs imports as its a circle...
- people need to sell in order to buy...countries who sell are going to buy...countries buying our products will then need to sell in order to buy more products...then we buy from another country, they will us that money to buy products from other countries, including us...
- if countries only sell to us and don't buy from us, its not a need for protectionist or trade barriers...its the need for better companies who produce better products at more competitive prices...its failure of our companies, not of the regulations...its sure supply and demand..make good things and when other countries make money from selling to us, they will reciprocate that by using that same money to buy from our companies...all as long as we make products they want to buy.
Ch 13: Parity Prices
- problem: The argument for "parity" prices ran roughly like this.
Agriculture is the most basic and important of all industries.
It must be preserved at all costs. Moreover, the
prosperity of everybody else depends upon the prosperity
of the farmer. If he does not have the purchasing power
to buy the products of industry, industry languishes. This
was the cause of the 1929 collapse, or at least of our failure
to recover from it. For the prices of farm products dropped
violently, while the prices of industrial products dropped
rery little. The result was that the farmer could not buy
industrial products; the city workers were laid off and
could not buy farm products, and the depression spread in
ever-widening vicious circles. There was only one cure,
and it was simple. Bring back the prices of the farmer's
products to a "parity" with the prices of the things the
farmer buys. This parity existed in the period from 1909 to
1914, when farmers were prosperous. That price relationship
must be restored and preserved perpetually. - The higher price can be forced by mere
edict, which is the least workable method. It can be brought
about by the government's standing ready to buy all the
farm products offered to it at the "parity" price. It can
be brought about by the government's lending to farmers
enough money on their crops to enable them to hold the
crops off the market until "parity" or a higher price is
realized. It can be brought about by the government's enforcing
restrictions in the size of crops. It can be brought
about, as it often is in practice, by a combination of these
methods. - If the farmer then has 50cents more purchasing power to buy industrial products,
the city worker has precisely that much less purchasing
power to buy industrial products. On net balance industry
in general has gained nothing. It loses in city sales precisely
as much as it gains in rural sales. - It also means a forced cut in the production
of farm commodities to bring up the price. This
means a destruction of wealth. It means that there is less
food to be consumed. How this destruction of wealth is
brought about will depend upon the particular method
pursued to bring prices up. It may mean the actual physical
destruction of what has already been produced, as in the
burning of coffee in Brazil. It may mean a forced restriction
of acreage, as in the American AAA plan. - To help the farmers, in other
words, it merely reduces the purchasing power of city
workers and other groups still more.
Chapter 14: Saving the X Industry
- problem: The X industry is sick. The
X industry is dying. It must be saved. It can be saved only
by a tariff, by higher prices, or by a subsidy. If it is allowed
to die, workers will be thrown on the streets. Their landlords,
grocers, butchers, clothing stores and local motion
picture theaters will lose business, and depression will
spread in ever-widening circles. But if the X industry, by
prompt action of Congress, is saved—ah then! it will buy
equipment from other industries; more men will be employed;
they will give more business to the butchers, bakers
and neon-light makers, and then it is prosperity that will
spread in ever-widening circles. - We are concerned only with a single argument for saving the X
industry—that if it is allowed to shrink in size or perish
through the forces of free competition (always, by spokesmen
for the industry, designated in such cases as'a laissezfaire,
anarchic, cutthroat, dog-eat-dog, law-of-the-jungle
competition) it will pull down the general economy with
it, and that if it is artificially kept alive it will help everybody
else. - Now if the X industry is really overcrowded as compared with other industries it will not need any coercive
legislation to keep out new capital or new workers. New
capital does not rush into industries that are obviously
dying. Investors do not eagerly seek the industries that
present the highest risks of loss combined with the lowest
returns. Nor do workers, when they have any better alternative,
go into industries where the wages are lowest and
the prospects for steady employment least promising. - But the result of this subsidy is not merely that there
has been a transfer of wealth or income, or that other industries
have shrunk in the aggregate as much as the X
industry has expanded. The result is also (and this is
where the net loss comes in to the nation considered as a
unit) that capital and labor are driven out of industries in
which they are more efficiently employed to be diverted to
an industry in which they are less efficiently employed.
Less wealth is created. The average standard of living is
lowered compared with what it would have been. - The idea that an expanding economy
implies that all industries must be simultaneously expanding
is a profound error. In order that new industries may
grow fast enough it is necessary that some old industries
should be allowed to shrink or die. They must do this in
order to release the necessary capital and labor for the new
industries. If we had tried to keep the horse-and-buggy
trade artificially alive we should have slowed down the
growth of the automobile industry and all the trades dependent on it. - it is just as necessary to
the health of a dynamic economy that dying industries be
allowed to die as that growing industries be allowed to
grow. The first process is essential to the second. - 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.
Ch 15: How the price system works
- THE whole argument of this book may be summed up
in the statement that in studying the effects of any
given economic proposal we must trace not merely the immediate
results but the results in the long run, not merely
the primary consequences but the secondary consequences,
and not merely the effects on some special group but the
effects on everyone. - let us consider the problem
that confronts a Robinson Crusoe on his desert island.He needs everything: drinking water, food, a roof over his
head, protection from animals, a fire, a soft place to lie
down. It is impossible for him to satisfy all these needs at
once; he has not the time, energy or resources. He must
attend immediately to the most pressing need. He suffers
most, say, from thirst. When he has provided for only a small water supply, however,
he must turn to finding food before he tries to improve
this. He can try to fish; but to do this he needs either a
hook and line, or a net, and he must set to work on these.
But everything he does delays or prevents him from doing
something else only a little less urgent. He is faced constantly
by the problem of alternative applications of his
time and labor. - Prices are determined by supply and
demand, and demand is determined by how intensely
people want a commodity and what they have to offer in
exchange for it. It is true that supply is in part determined
by costs of production. What a commodity has cost to produce
in the past cannot determine its value. That will
depend on the present relationship of supply and demand.
But the expectations of business men concerning what a
commodity will cost to produce in the future, and what its
future price will be, will determine how much of it will be
made. This will affect future supply. - When people want
more of a commodity, their competitive bidding raises its
price. This increases the profits of the producers who make
that product. This stimulates them to increase their production.
It leads others to stop making some of the products
they previously made, and turn to making the product that
offers them the better return. But this increases the supply
of that commodity at the same time that it reduces the supply
of some other commodities. The price of that product
therefore falls in relation to the price of other products, and
the stimulus to the relative increase in its production disappears.
In the same way, if the demand falls off for some product,
its price and the profit in making it go lower, and its
production declines. - 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. - It follows that it is just as essential for the health of a
dynamic economy that dying industries should be allowed
to die as that growing industries should be allowed to grow.
For the dying industries absorb labor and capital that should
be released for the growing industries. It is only the much
vilified price system that 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. These otherwise bewildering
equations are solved quasi-automatically by the system
of prices, profits and costs. They are solved by this system
incomparably better than any group of bureaucrats could
solve them. For they are solved by a system under which
each consumer makes his own demand and casts a fresh
vote, or a dozen fresh votes, every day; whereas bureaucrats
would try to solve it by having made for the consumers, not
what the consumers themselves wanted, but what the
bureaucrats decided was good for them.
ch 16: "stabilizing" commodities
- But it is now
obviously selling far below its natural level. The producers
cannot make a living. Unless we act promptly, they will
be thrown out of business. Then there will be a real
scarcity, and consumers will have to pay exorbitant prices
for the commodity. The apparent bargains that the consumers
are now getting will cost them dear in the end. For
the present "temporary" low price cannot last. But we
cannot afford to wait for so-called natural market forces,
or for the "blind" law of supply and demand, to correct
the situation. For by that time the producers will be ruined
and a great scarcity will be upon us. The government must
act. All that we really want to do is to correct these violent,
senseless fluctuations in price. We are not trying to boost
the price; we are only trying to stabilize it. - There are several methods by which it is commonly
proposed to do this. One of the most frequent is government
loans to farmers to enable them to hold their crops
off the market
Such loans are urged in Congress for reasons that seem
very plausible to most listeners. They are told that the
farmers' crops are all dumped on the market at once, at
harvest time; that this is precisely the time when prices
are lowest, and that speculators take advantage of this to
buy the crops themselves and hold them for higher prices
when food gets scarcer again. Thus it is urged that the
farmers suffer, and that they, rather than the speculators,
should get the advantage of the higher average price. - For the loan policy is usually accompanied by, or inevitably
leads to, a policy of restricting production—i. e., a
policy of scarcity. In nearly every effort to "stabilize" the
price of a commodity, the interests of the producers have
been put first. The real object is an immediate boost of
prices. To make this possible, a proportional restriction of
output is usually placed on each producer subject to the
control. This has several immediately bad effects. Assuming
that the control can be imposed on an international
scale, it means that total world production is cut. The
world's consumers are able to enjoy less of that product
than they would have enjoyed without restriction. The
world is just that much poorer. 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
driven out by a fall in price. In the case of an agricultural
commodity it is the least competent farmers, or those with
the poorest equipment, or those working the poorest land,
that are driven out. The most capable farmers on the best
land do not have to restrict their production. On the contrary,
if the fall in price has been symptomatic of a lower
average cost of production, reflected through an increased
supply, then the driving out of the marginal farmers on
the marginal land enables the good farmers on the good
land to expand their production. So there may be, in the
long run, no reduction whatever in the output of that commodity.
And the product is then produced and sold at a
permanently lower price. - If that is the outcome, then the consumers of that commodity
will be as well supplied with it as they were before.
But, as a result of the lower price, they will have money left
over, which they did not have before, to spend on other
things. The consumers, therefore, will obviously be better
off. But their increased spending in other directions will
give increased employment in other lines, which will then
absorb the former marginal farmers in occupations in which
their efforts will be more lucrative and more efficient.
ch 17: Government Price- Fixing
- The argument for holding down the price of these goods
will run something like this. If we leave beef (let us say)
to the mercies of the free market, the price will be pushed
up by competitive bidding so that only the rich will get it.
People will get beef not in proportion to their need, but
only in proportion to their purchasing power. If we keep
the price down, everyone will get his fair share. - But schemes for maximum price-fixing usually begin as
efforts to "keep the cost of living from rising." And so their
sponsors unconsciously assume that there is something
peculiarly "normal" or sacrosanct about the market price
at the moment from which their control starts. That starting
price is regarded as "reasonable," and any price above
that as "unreasonable," regardless of changes in the conditions
of production or demand since that starting price
was first established. - Now we cannot hold the price of any commodity below
its market level without in time bringing about two consequences.
The first is to increase the demand for that commodity.
Because the commodity is cheaper, people are both
tempted to buy, and can afford to buy, more of it. The
second consequence is to reduce the supply of that commodity.
Because people buy more, the accumulated supply
is more quickly taken from the shelves of merchants. But
in addition to this, production of that commodity is discouraged.
Profit margins are reduced or wiped out. The
marginal producers are driven out of business. - the consequence of fixing a maximum price for a particular commodity would
be to bring about a shortage of that commodity. But this
is precisely the opposite of what the government regulators
originally wanted to do. For it is the very commodities
selected for maximum price-fixing that the regulators most
want to keep in abundant supply. But when they limit the
wages and the profits of those who make these commodities,
without also limiting the wages and profits of those who
make luxuries or semi-luxuries, they discourage the production
of the price-controlled necessities while they relatively
stimulate the production of less essential goods - At first it is contended that
wages and living costs are not connected; that wages can
easily be lifted without lifting prices. When it becomes
obvious that wages can be raised only at the expense of
profits, the bureaucrats begin to argue that profits were
already too high anyway, and that lifting wages and holding
prices will still permit "a fair profit." As there is no such
thing as a uniform rate of profit, as profits differ with each
concern, the result of this policy is to drive the least
profitable concerns out of business altogether, and to discourage
or stop the production of certain items. This means
unemployment, a shrinkage in production and a decline in
living standards. - What lies at the base of the whole effort to fix maximum
prices? There is first of all a misunderstanding of what it is
that has been causing prices to rise. The real cause is either
a scarcity of goods or a surplus of money.
- Just as the endless plans for raising prices of favored commodities are the
result of thinking of the interests only of the producers
immediately concerned, and forgetting the interests of
consumers, so the plans for holding down prices by legal
edict are the result of thinking of the interests of people
only as consumers and forgetting their interests as producers. - Each one of us is producer, taxpayer, consumer. As a producer
he wants inflation (thinking chiefly of his own services
or product); as a consumer he wants price ceilings
(thinking chiefly of what he has to pay for the products
of others). As a consumer he may advocate or acquiesce
in subsidies; as a taxpayer he will resent paying them. Each
person is likely to think that he can so manage the political
forces that he can benefit from the subsidy more than he
loses from the tax, or benefit from a rise for his own product
(while his raw material costs are legally held down) and
at the same time benefit as a consumer from price control.
Ch 18 - What Rent Control Does
- Rent control is initially imposed on the argument that the supply of housing is not “elastic”—i.e., that a housing shortage cannot be immediately made up, no matter how high rents are allowed to rise. Therefore, it is contended, the government, by forbidding increases in rents, protects tenants from extortion and exploitation without doing any real harm to landlords and without discouraging new construction.
- If landlords are allowed to raise rents to reflect a monetary inflation and the true conditions of supply and demand, individual tenants will economize by taking less space. This will allow others to share the accommodations that are in short supply. The same amount of housing will shelter more people, until the shortage is relieved.
- Rent control, however, encourages wasteful use of space. It discriminates in favor of those who already occupy houses or apartments in a particular city or region at the expense of those who find themselves on the outside. Permitting rents to rise to the free market level allows all tenants or would-be tenants equal opportunity to bid for space.
- The effects of rent control become worse the longer the rent control continues. New housing is not built because there is no incentive to build it. With the increase in building costs (commonly as a result of inflation), the old level of rents will not yield a profit. If, as often happens, the government finally recognizes this and exempts new housing from rent control, there is still not an incentive to as much new building as if older buildings were also free of rent control. 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.) Under such conditions existing tenants in old buildings are indisposed to move, no matter how much their families grow or their existing accommodations deteriorate.
- Because of low fixed rents in old buildings, the tenants already in them, and legally protected against rent increases, are encouraged to use space wastefully, whether or not their families have grown smaller. This concentrates the immediate pressure of new demand on the relatively few new buildings. It tends to force rents in them, at the beginning, to a higher level than they would have reached in a wholly free market.
- Nevertheless, this will not correspondingly encourage the construction of new housing. Builders or owners of preexisting apartment houses, finding themselves with restricted profits or perhaps even losses on their old apartments, will have little or no capital to put into new construction. In addition, they, or those with capital from other sources, may fear that the government may at any time find an excuse for imposing rent controls even on the new buildings. And it often does.
- The housing situation will deteriorate in other ways. Most important, unless the appropriate rent increases are allowed, landlords will not trouble to remodel apartments or make other improvements in them. In fact, where rent control is particularly unrealistic or oppressive, landlords will not even keep rented houses or apartments in tolerable repair. Not only will they have no economic incentive to do so; they may not even have the funds. The 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.
- A common next step of legislatures, acting under merely political pressures or confused economic ideas, is to take rent controls off “luxury” apartments while keeping them on low or middle-grade apartments. The builders and owners of luxury apartments are encouraged and rewarded; the builders and owners of the more needed low-rent housing are discouraged and penalized. The former are free to make as big a profit as the conditions of supply and demand warrant; the latter are left with no incentive (or even capital) to build more low-rent housing.
- The result is a comparative encouragement to the repair and remodeling of luxury apartments, and a tendency for what new private building there is to be diverted to luxury apartments. But there is no incentive to build new low-income housing, or even to keep existing low-income housing in good repair. The accommodations for the low-income groups, therefore, will deteriorate in quality, and there will be no increase in quantity. Where the population is increasing, the deterioration and shortage in low-income housing will grow worse and worse. It may reach a point where many landlords not only cease to make any profit but are faced with mounting and compulsory losses. They may find that they cannot even give their property away. They may actually abandon their property and disappear, so they cannot be held liable for taxes. When owners cease supplying heat and other basic services, the tenants are compelled to abandon their apartments. Wider and wider neighborhoods are reduced to slums.
- A further effect is the erosion of city revenues, as the property-value base for such taxes continues to shrink. Cities go bankrupt, or cannot continue to supply basic services
- The very fact that the legal rents are held so far below market rents artificially increases the demand for rental space at the same time as it discourages any increase in supply. So the more unreasonably low the rent ceilings are held, the more certain it is that the ‘‘scarcity” of rental houses or apartments will continue.
- When unreasonable price controls are placed on articles of immediate consumption, like bread, for example, the bakers can simply refuse to continue to bake and sell it. A shortage becomes immediately obvious, and the politicians are compelled to raise the ceilings or repeal them. But housing is very durable. It may take several years before tenants begin to feel the results of the discouragement to new building, and to ordinary maintenance and repair. It may take even longer before they realize that the scarcity and deterioration of housing is directly traceable to rent control.
Ch 19 - minimum wage laws
- The first thing that happens, for example, 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. You cannot make a man worth a given amount by making it illegal for anyone to offer him anything less. You merely deprive him of the right to earn the amount that his abilities and situation would permit him to earn, while you deprive the community even of the moderate services that he is capable of rendering.
- The only exception to this occurs when a group of workers is receiving a wage actually below its market worth. This is likely to happen only in rare and special circumstances or localities where competitive forces do not operate freely or adequately; but nearly all these special cases could be remedied just as effectively, more flexibly and with far less potential harm, by unionization.
- It may be thought that if the law forces the payment of a higher wage in a given industry, that industry can then charge higher prices for its product, so that the burden of paying the higher wage is merely shifted to consumers. Such shifts, however, are not easily made, nor are the consequences of artificial wage-raising so easily escaped. A higher price for the product may not be possible: it may merely drive consumers to the equivalent imported products or to some substitute. Or, if consumers continue to buy the product of the industry in which wages have been raised, the higher price will cause them to buy less of it. While some workers in the industry may be benefited from the higher wage, therefore, others will be thrown out of employment altogether. On the other hand, if the price of the product is not raised, marginal producers in the industry will be driven out of business; so that reduced production and consequent unemployment will merely be brought about in another way.
- And it ignores, finally, that bad as were the wages paid in the X industry, they were the best among all the alternatives that seemed open to the workers in that industry; otherwise the workers would have gone into another. 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. Their competition for jobs will drive down the pay offered even in these alternative occupations.
- By a minimum wage of, say, $2.65 an hour, we have forbidden anyone to work forty hours in a week for less than $106.[5] Suppose, now, we offer only $70 a week on relief. This means that we have forbidden a man to be usefully employed at, say, $90 a week, in order that we may support him at $70 a week in idleness. We have deprived society of the value of his services. We have deprived the man of the independence and self-respect that come from self-support, even at a low level, and from performing wanted work, at the same time as we have lowered what the man could have received by his own efforts.
- These consequences follow as long as the weekly relief payment is a penny less than $106. Yet the higher we make the relief payment, the worse we make the situation in other respects. If we offer $106 for relief, then we offer many men just as much for not working as for working. Moreover, whatever the sum we offer for relief, we create a situation in which everyone is working only for the difference between his wages and the amount of the relief. If the relief is $106 a week, for example, workers offered a wage of $2.75 an hour, or $110 a week, are in fact, as they see it, being asked to work for only $4 a week—for they can get the rest without doing anything.
- I should perhaps mention another argument sometimes put forward for fixing a minimum wage rate by statute. This is that in an industry in which one big company enjoys a monopoly, it need not fear competition and can offer below-market wages. This is a highly improbable situation. Such a “monopoly” company must offer high wages when it is formed, in order to attract labor from other industries. Thereafter it could theoretically fail to increase wage rates as much as other industries, and so pay “substandard” wages for that particular specialized skill. But this would be likely to happen only if that industry (or company) was sick or shrinking; if it were prosperous or expanding, it would have to continue to offer high wages to increase its labor force.
- We know as a matter of experience that it is the big companies —those most often accused of being monopolies—that pay the highest wages and offer the most attractive working conditions. It is commonly the small marginal firms, perhaps suffering from excessive competition, that offer the lowest wages. But all employers must pay enough to hold workers or to attract them from each other.
- The question is not whether we wish to see everybody as well off as possible.The real question concerns the proper means of achieving it.
- We cannot distribute more wealth than is created. We cannot in the long run pay labor as a whole more than it produces.
- The best way to raise wages, therefore, is to raise marginal labor productivity. This can be done by many methods: by an increase in capital accumulation — i.e., by an increase in the machines with which the workers are aided; by new inventions and improvements; by more efficient management on the part of employers; by more industriousness and efficiency on the part of workers; by better education and training. 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.
- So government policy should be directed, not to imposing more burdensome requirements on employers, but to following policies that encourage profits, that encourage employers to expand, to invest in newer and better machines to increase the productivity of workers — in brief, to encourage capital accumulation, instead of discouraging it—and to increase both employment and wage rates.
ch 20 - do unions really raise wages?
- The belief that labor unions can substantially raise real wages over the long run and for the whole working population is one of the great delusions of the present age. This delusion is mainly the result of failure to recognize that wages are basically determined by labor productivity.
All this does not mean that unions can serve no useful or legitimate function. The central function they can serve is to improve local working conditions and to assure that all of their members get the true market value of their services.
For the competition of workers for jobs, and of employers for workers, does not work perfectly. Neither individual workers nor individual employers are likely to be fully informed concerning the conditions of the labor market. An individual worker may not know the true market value of his services to an employer. And he may be in a weak bargaining position.
- And in their early history they did much to protect the health of their members. Where labor was plentiful, individual employers often stood to make short-run gains by speeding up workers and working them long hours in spite of ultimate ill effects upon their health, because they could easily be replaced with others. And sometimes ignorant or shortsighted employers might even reduce their own profits by overworking their employees. In all these cases the unions, by demanding decent standards, often increased the health and broader welfare of their members at the same time as they increased their real wages.
- But in recent years, as their power has grown, and as much misdirected public sympathy has led to a tolerance or endorsement of antisocial practices, unions have gone beyond their legitimate goals.
ch 21 - enough to buy back the product
- The real question, they insist, is whether or not they will work. And the only wages that will work, they tell us, the only wages that will prevent an imminent economic crash, are wages that will enable labor “to buy back the product it creates.”
- This brings us to the general meaning and effect of economic equilibrium. Equilibrium wages and prices are the wages and prices that equalize supply and demand. If, either through government or private coercion, an attempt is made to lift prices above their equilibrium level, demand is reduced and therefore production is reduced. If an attempt is made to push prices below their equilibrium level, the consequent reduction or wiping out of profits will mean a falling off of supply or less production. Therefore any attempt to force prices either above or below their equilibrium levels (which are the levels toward which a free market constantly tends to bring them) will act to reduce the volume of employment and production below what it would otherwise have been.
- the best prices are not the highest prices, but the prices that encourage the largest volume of production and the largest volume of sales. The best wage rates for labor are not the highest wage rates, but the wage rates that permit full production, full employment and the largest sustained payrolls. The best profits, from the standpoint not only of industry but of labor, are not the lowest profits, but the profits that encourage most people to become employers or to provide more employment than before.
ch 22 - the function of profits
- One function of profits, in brief, is to guide and channel the factors of production so as to apportion the relative output of thousands of different commodities in accordance with demand. No bureaucrat, no matter how brilliant, can solve this problem arbitrarily. Free prices and free profits will maximize production and relieve shortages quicker than any other system. Arbitrarily fixed prices and arbitrarily limited profits can only prolong shortages and reduce production and employment.
- The function of profits, finally, is to put constant and unremitting pressure on the head of every competitive business to introduce further economies and efficiencies, no matter to what stage these may already have been brought. In good times he does this to increase his profits further, in normal times he does it to keep ahead of his competitors, in bad times he may have to do it to survive at all.
- Contrary to a popular impression, profits are achieved not by raising prices, but by introducing economies and efficiencies that cut costs of production. It seldom happens (and unless there is a monopoly it never happens over a long period) that every firm in an industry makes a profit. The price charged by all firms for the same commodity or service must be the same; those who try to charge a higher price do not find buyers. Therefore the largest profits go to the firms that have achieved the lowest costs of production. These expand at the expense of the inefficient firms with higher costs. It is thus that the consumer and the public are served.
- Profits, in short, resulting from the relationships of costs to prices, not only tell us which goods it is most economical to make, but which are the most economical ways to make them.
ch 22 - the mirage of inflation
- The more knowing inflationists recognize that any substantial increase in the quantity of money will reduce the purchasing power of each individual monetary unit—in other words, that it will lead to an increase in commodity prices. But this does not disturb them. On the contrary, it is precisely why they want the inflation. Some of them argue that this result will improve the position of poor debtors as compared with rich creditors. Others think it will stimulate exports and discourage imports. Still others think it is an essential measure to cure a depression, to “start industry going again, and to achieve "full employment"
- In other words, the gains of the first groups of producers to benefit by higher prices or wages from the inflation are necessarily at the expense of the losses suffered (as consumers) by the last groups of producers that are able to raise their prices or wages.
- In our own day the most persistent argument put forward for inflation is that it will “get the wheels of industry turning,” that it will save us from the irretrievable losses of stagnation and idleness and bring “full employment.” It assumes that new “purchasing power” is being brought into existence, and that the effects of this new purchasing power multiply themselves in ever-widening circles, like the ripples caused by a stone thrown into a pond. The real purchasing power for goods, however, as we have seen, consists of other goods. It cannot be wondrously increased merely by printing more pieces of paper called dollars.
- In brief, they divert both the public attention and their own from the real causes of any existing depression. For the real causes, most of the time, are maladjustments within the wage-cost-price structure: maladjustments between wages and prices, between prices of raw materials and prices of finished goods, or between one price and another or one wage and another. At some point these maladjustments have removed the incentive to produce, or have made it actually impossible for production to continue; and through the organic interdependence of our exchange economy, depression spreads. Not until these maladjustments are corrected can full production and employment be resumed.
- Inflation, indeed, throws a veil of illusion over every economic process. It confuses and deceives almost everyone, including even those who suffer by it. We are all accustomed to measuring our income and wealth in terms of money. The mental habit is so strong that even professional economists and statisticians cannot consistently break it. It is not easy to see relationships always in terms of real goods and real welfare. Who among us does not feel richer and prouder when he is told that our national income has doubled (in terms of dollars, of course) compared with some preinflationary period?
- Yet when the government comes to repay the debt it has accumulated for public works, it must necessarily tax more heavily than it spends. In this later period, therefore, it must necessarily destroy more jobs than it creates. The extra-heavy taxation then required does not merely take away purchasing power; it also lowers or destroys incentives to production, and so reduces the total wealth and income of the country.
- Inflation itself is a form of taxation. It is perhaps the worst possible form, which usually bears hardest on those least able to pay. On the assumption that inflation affected everyone and everything evenly (which, we have seen, is never true), it would be tantamount to a flat sales tax of the same percentage on all commodities, with the rate as high on bread and milk as on diamonds and furs. Or it might be thought of as equivalent to a flat tax of the same percentage, without exemptions, on everyone’s income. It is a tax not only on every individual’s expenditures, but on his savings account and life insurance. It is, in fact, a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man.
- The poor are usually more heavily taxed by inflation, in percentage terms, than the rich, for they do not have the same means of protecting themselves by speculative purchases of real equities. Inflation is a kind of tax that is out of control of the tax authorities. It strikes wantonly in all directions. The rate of tax imposed by inflation is not a fixed one: it cannot be determined in advance. We know what it is today; we do not know what it will be tomorrow; and tomorrow we shall not know what it will be on the day after.
- Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce.
ch 26 - the assault on savings
- If he puts it either into a commercial or a savings bank, the bank either lends it to going businesses on short term for working capital, or uses it to buy securities. In other words, Benjamin invests his money either directly or indirectly. But when money is invested it is used to buy or build capital goods—houses or office buildings or factories or ships or trucks or machines. Any one of these projects puts as much money into circulation and gives as much employment as the same amount of money spent directly on consumption.
- “Saving,” in short, in the modem world, is only another form of spending. The usual difference is that the money is turned over to someone else to spend on means to increase production. So far as giving employment is concerned, Benjamin’s “saving” and spending combined give as much as Alvin’s spending alone, and put as much money in circulation. The chief difference is that the employment provided by Alvin’s spending can be seen by anyone with one eye; but it is necessary to look a little more carefully, and to think a moment, to recognize that every dollar of Benjamin’s saving gives as much employment as every dollar that Alvin throws around.
- Mere hoarding of hand-to-hand money, if it takes place irrationally, causelessly, and on a large scale, is in most economic situations harmful. But this sort of hoarding is extremely rare.
But consumers reduce their buying for another reason. Prices of goods have probably fallen, and they fear a further fall. If they defer spending, they believe they will get more for their money. They do not wish to have their resources in goods that are falling in value, but in money which they expect (relatively) to rise in value.
The same expectation prevents them from investing. They have lost their confidence in the profitability of business; or at least they believe that if they wait a few months they can buy stocks or bonds cheaper. We may think of them either as refusing to hold goods that may fall in value on their hands, or as holding money itself for a rise.
And it is a still more serious error to say that this sort of “saving” is the cause of depressions. It is, on the contrary, the consequence of depressions.
- It is true that this refusal to buy may intensify and prolong a depression. At times when there is capricious government intervention in business, and when business does not know what the government is going to do next, uncertainty is created. Profits are not reinvested. Firms and individuals allow cash balances to accumulate in their banks. They keep larger reserves against contingencies. This hoarding of cash may seem like a cause of a subsequent slowdown in business activity. The real cause, however, is the uncertainty brought about by the government policies. The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty.
- It is said that the various consumers goods industries are built on the expectation of a certain demand, and that if people take to saving they will disappoint this expectation and start a depression. This assertion rests primarily on the error we have already examined—that of forgetting that what is saved on consumers’ goods is spent on capital goods, and that “saving” does not necessarily mean even a dollar’s contraction in total spending. The only element of truth in the contention is that any change that is sudden may be unsettling.
- The fact that 20 percent of the national income goes each year for saving does not upset the consumers’ goods industries in the least. If they sold only the 80 units they produced in the first year (and there were no rise in prices caused by unsatisfied demand) they would certainly not be foolish enough to build their production plans on the assumption that they were going to sell 100 units in the second year. The consumers’ goods industries, in other words, are already geared to the assumption that the past situation in regard to the rate of savings will continue. Only an unexpected sudden and substantial increase in savings would unsettle them and leave them with unsold goods.
- 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. Its first effect on net balance would be to force shifts in employment and temporarily to decrease employment by its effect on the capital goods industries. And its long-run effect would be to reduce production below the level that would otherwise have been achieved.
- If money is kept either in savings banks or commercial banks, as we have already seen, the banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to try to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is, as we have seen, either fear that prices of goods are going to fall or the fear of banks that they will be taking too great a risk with their principal. But this means that signs of a depression have already appeared, and have caused the hoarding, rather than that the hoarding has started the depression.
- It is argued that if interest rates are too high it will not be profitable for industry to borrow and invest in new plants and machines. This argument has been so effective that governments everywhere in recent decades have pursued artificial “cheap-money” policies.
- If interest rates are artificially kept too low in relation to risks, there will be a reduction in both saving and lending. The cheap-money proponents believe that saving goes on automatically, regardless of the interest rate, because the sated rich have nothing else that they can do with their money.
- 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. It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing. It tends, in fact, to encourage highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift, saving, and investment. It reduces the accumulation of capital. It slows down that increase in productivity, that “economic growth,” that “progressives” profess to be so eager to promote.
- It remains to be pointed out that while new injections of currency or bank credit can at first, and temporarily, bring about lower interest rates, persistence in this device must eventually raise interest rates. It does so because new injections of money tend to lower the purchasing power of money. Lenders then come to realize that the money they lend today will buy less a year from now, say, when they get it back. Therefore to the normal interest rate they add a premium to compensate them for this expected loss in their money s purchasing power.
- If no effort is made to tamper with money rates through inflationary governmental policies, increased savings create their own demand by lowering interest rates in a natural manner. The greater supply of savings seeking investment forces savers to accept lower rates. But lower rates also mean that more enterprises can afford to borrow because their prospective profit on the new machines or plants they buy with the proceeds seems likely to exceed what they have to pay for the borrowed funds.
- But how can the additional capital be “absorbed”? How can it be “paid for”? If it is set aside and saved, it will absorb itself and pay for itself. For producers invest in new capital goods—that is, they buy new and better and more ingenious tools — because these tools reduce costs of production. They either bring into existence goods that completely unaided hand labor could not bring into existence at all (and this now includes most of the goods around us—books, typewriters, automobiles, locomotives, suspension bridges); or they increase enormously the quantities in which these can be produced; or (and this is merely saying these things in a different way) they reduce unit costs of production. And as there is no assignable limit to the extent to which unit costs of production can be reduced—until everything can be produced at no cost at all—there is no assignable limit to the amount of new capital that can be absorbed.
- The steady reduction of unit costs of production by the addition of new capital does either one of two things, or both. It reduces the costs of goods to consumers, and it increases the wages of the labor that uses the new equipment because it increases the productive power of that labor. Thus a new machine benefits both the people who work on it directly and the great body of consumers. In the case of consumers we may say either that it supplies them with more and better goods for the same money, or, what is the same thing, that it increases their real incomes. In the case of the workers who use the new machines it increases their real wages in a double way by increasing their money wages as well.
- A typical illustration is the automobile business. The American automobile industry pays the highest wages in the world, and among the very highest even in America. Yet (until about 1960) American motorcar makers could undersell the rest of the world, because their unit cost was lower. And the secret was that the capital used in making American automobiles was greater per worker and per car than anywhere else in the world.
ch 25 - the lesson restated
Economics,, as we have now seen again and again, is a science of recognizing secondary consequences. It is also a science of seeing general consequences. It is the science of tracing the effects of some proposed or existing policy not only on some special interest in the short run, but on the general interest in the long run.
Now few people recognize the necessary implications of the economic statements they are constantly making. When they say that the way to economic salvation is to increase credit, it is just as if they said that the way to economic salvation is to increase debt: these are different names for the same thing seen from opposite sides. When they say that the way to prosperity is to increase farm prices, it is like saying that the way to prosperity is to make food dearer for the city worker. When they say that the way to national wealth is to pay out governmental subsidies, they are in effect saying that the way to national wealth is to increase taxes. When they make it a main objective to increase exports, most of them do not realize that they necessarily make it a main objective ultimately to increase imports. When they say, under nearly all conditions, that the way to recovery is to increase wage rates, they have found only another way of saying that the way to recovery is to increase costs of production.
Ordinarily these selfish feelings would have no effect on the total production of wheat. Wherever competition exists, in fact, each producer is compelled to put forth his utmost efforts to raise the highest possible crop on his own land. In this way the forces of self-interest (which, for good or evil, are more persistently powerful than those of altruism) are harnessed to maximum output.
But if it is possible for wheat growers or any other group of producers to combine to eliminate competition, and if the government permits or encourages such a course, the situation changes.- But the solution is never to reduce supplies arbitrarily, to prevent further inventions or discoveries, or to support people for continuing to perform a service that has lost its value. Yet this is what the world has repeatedly sought to do by protective tariffs, by the destruction of machinery, by the burning of coffee, by a thousand restriction schemes. This is the insane doctrine of wealth through scarcity.
- For 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.
ch 26 - the lesson after thirty years
- One of the worst results of the retention of the Keynesian myths is that it not only promotes greater and greater inflation, but that it systematically diverts attention from the real causes of our unemployment, such as excessive union wage-rates, minimum wage laws, excessive and prolonged unemployment insurance, and overgenerous relief payments.
- The anticapitalistic mentality seems more deeply embedded than ever. Whenever there is any slowdown in business, the politicians now see the main cause as “insufficient consumer spending.” At the same time that they encourage more consumer spending they pile up further disincentives and penalties in the way of saving and investment. Their chief method of doing this today, as we have already seen, is to embark on or accelerate inflation. The result is that today, for the first time in history, no nation is on a metallic standard, and practically every nation is swindling its own people by printing a chronically depreciating paper currency.
The original federal Social Security Act was passed in 1935. The theory behind it was that the greater part of the relief problem was that people did not save in their working years, and so, when they were too old to work, they found themselves without resources. This problem could be solved, it was thought, if they were compelled to insure themselves, with employers also compelled to contribute half the necessary premiums, so that they would have a pension sufficient to retire on at age sixty-five or over. Social Security was to be entirely a self-financed insurance plan based on strict actuarial principles. A reserve fund was to be set up sufficient to meet future claims and payments as they fell due.
It never worked out that way. The reserve fund existed mainly on paper. The government spent the Social Security tax receipts, as they came in, either to meet its ordinary expenses or to pay out benefits. Since 1975, current benefit payments have exceeded the system’s tax receipts.
As inflation developed and progressed, Social Security benefits were increased not only in proportion, but much more. The typical political ploy was to load up benefits in the present and push costs into the future. Yet that future always arrived; and each few years later Congress would again have to increase payroll taxes levied on both workers and employers.
- Not only were the tax rates continuously increased, but there was a constant rise in the amount of salary taxed. In the original 1935 bill the salary taxed was only the first $3,000. The early tax rates were very low. But between 1965 and 1977, for example, the Social Security tax shot up from 4.4 percent on the first $6,600 of earned income (levied on employer and employee alike) to a combined 11.7 percent on the first $16,500 (Between 1960 and 1977, the total annual tax increased by 572 percent, or about 12 percent a year compounded.
- In brief, the main problem we face today is not economic, but political. Practically all government attempts to redistribute wealth and income tend to smother productive incentives and lead toward general impoverishment. It is the proper sphere of government to create and enforce a framework of law that prohibits force and fraud. But it must refrain from specific economic interventions. Government’s main economic function is to encourage and preserve a free market.
