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Income without Work   1 comment

We like to think that universal basic income is a new idea that has never been considered before, but that would be untrue. Henry Hazlitt (Economics in One Lesson) dealt with the concept in 1966 and his arguments against it are still valid 50 years later. I’ve provided some notes and organization to his arguments. You can read the original at this location. https://fee.org/articles/income-without-work/  Lela

Income without Work

Henry Hazlett

 

A group of social reformers, im­patient with the present “rag bag” of measures to combat poverty, propose to wipe it out in a sin­gle swoop. The government would simply guarantee to everybody, re­gardless of whether or not he worked, could work, or was will­ing to work, a minimum income. This guaranteed income would be sufficient for his needs, “enough to enable him to live with dig­nity.”

Image result for image income redistribution from workers to nonworkers by coercionThe reformers estimate that the guaranteed income ought to range somewhere between $3,000 ($22,776.60 today) and $6,000 ($45,553.21 today) a year for a family of four.

This is not merely the proposal of a few starry-eyed private in­dividuals. The National Commission on Technology, Automation, and Economic Progress, estab­lished by Congress in 1964, brought in a 115-page report to the President (Johnson) on February 4 of this year recommending guaran­teed incomes for all. And in Janu­ary the President’s Council of Economic Advisers indicated ap­proval of “uniformly determined payments to families based only on the amount by which their in­comes fall short of minimum sub­sistence levels.” This plan, they declared, “could be administered on a universal basis for all the poor and would be the most direct approach to reducing poverty.”

The plan is spelled out and ar­gued in detail in a book called The Guaranteed Income, a sym­posium of articles by ten contrib­utors, edited by Robert Theobald, who calls himself a “socio-econo­mist.” Mr. Theobald has contribu­ted three of the articles, including his preface.

Of the following three para­graphs, Mr. Theobald prints the first two entirely in italics:

“This book proposes the estab­lishment of new principles spe­cifically designed to break the link between jobs and income. Imple­mentation of these principles must necessarily be carried out by the government….

“We will need to adopt the con­cept of an absolute constitutional right to an income. This would guarantee to every citizen of the United States, and to every per­son who has resided within the United States for a period of five consecutive years, the right to an income from the federal govern­ment to enable him to live with dignity. No government agency, judicial body, or other organiza­tion whatsoever should have the power to suspend or limit any pay­ments assured by these guaran­tees….

“If the right to these incomes should be withdrawn under any circumstances, government would have the power to deprive the in­dividual not only of the pursuit of happiness, but also of liberty and even, in effect, of life itself. This absolute right to a due-in­come would be essentially a new principle of jurisprudence.” (emphasis Lela)

The contributors to this volume have arrived at these extraordin­ary conclusions not only because they share a number of strange ideas of jurisprudence, of “rights,” of government, and of the true meaning of liberty and tyranny, but because they share a number of major economic mis­conceptions.

Strange ideas about:

  • jurisprudence
  • “rights”
  • government
  • true meaning of liberty and tyranny
  • economic misconceptions

Nearly all of them seem to share the belief, for example, that the growth of automation and “cyber­nation” is eliminating jobs so fast (or soon will be) that there soon just won’t be jobs for even the most industrious. “The continu­ing impact of technical change will make it impossible to provide jobs for all who seek them.” The goal of “jobs for all” is “no longer valid.” And so on.

Ancient Fears of Automation

The fears of permanent unem­ployment as a result of technolog­ical progress are as old as the In­dustrial Revolution in the late eighteenth and early nineteenth century. They have been constant­ly reiterated in the last thirty-five years and as often completely refuted. (more than 80 years now). It is sufficient to point out here that not only has the average unemployment of slightly less than 5 per cent in the last twenty years not been growing, and that two-thirds of the jobless have usually remained so for periods of not more than ten weeks, but that the total volume of em­ployment in the United States has reached a new high record in near­ly every one of these years.

Even if it were true, as the authors of the guaranteed income proposal contend, that the Ameri­can free enterprise system will soon become so productive that more than anybody really wants can be produced in half the time as now, why would that mean the disappearance of jobs? And how could that justify half the popu­lation’s, say, being forced to work forty hours a week to support the other half in complete idleness? Why couldn’t everybody work only in the mornings? Or half in the mornings and the other half in the afternoons at the same ma­chines? Or why could not some people come in on Mondays, others on Tuesdays, and so on? It is dif­ficult to understand the logic or the sense of fairness of those who contend that as soon as there is less to be done some people must be supported in idleness by all the rest.

No historical evidence that increased productive eliminates jobs, but even if it did, people could work parttime. “It is difficult to understand the logic or … fairness of those who contend that … some people must be supported in idleness by all the rest.

“An Absolute Right”

But that is precisely the conten­tion of the advocates of the guar­anteed annual income. These hand­out incomes are to be given as “an absolute constitutional right,” and not to be withheld “under any circumstances.” (Theobald’s ital­ics.) This means that the recipi­ents are to continue to get this in­come not only if they absolutely re­fuse to seek or take a job, but if they throw the handout money away at the races, or spend it on prostitutes, on whiskey, cigarettes, marijuana, heroin, or what not. They are to be given “sufficient to live in dignity,” and it is appar­ently to be no business of the tax­payers if a recipient chooses none the less to live without dignity, and to devote his guaranteed leisure to gambling, dissipation, drunken­ness, debauchery, dope addiction, or a life of crime. “No government agency, judicial body, or other organization whatsoever should have the power to suspend or limit any payments assured by these guarantees.” This is surely a “new principle of jurisprudence.”

Unrealistic Cost Estimates

How much income do the guar­anteed-income advocates propose to guarantee? They differ regard­ing this, but practically all of them think the government should guarantee at least what they and government officials call the “min­imum maintenance level” or the “poverty-income line.” The Social Security Administration calculat­ed that the 1964 poverty-income line for nonfarm individuals was $1,540 a year. A nonfarm family of four was defined as poor if its money income was below $3,130. The Council of Economic Advisers has calculated that by this stand­ard 34 million out of our 190 mil­lion 1964 population, or 18 per cent, were living in poverty. This is in spite of the $40 billion total spent in welfare payments, of which it estimated that $20 billion (in the fiscal year 1965) went to persons who were, or would other­wise have been, below the poverty-income line.

How much would a guaranteed-income program cost the taxpay­ers? This would depend, of course, on how big an income was being guaranteed. Many of the income-guarantee advocates think that a guarantee merely of the poverty-line income would be totally in­adequate. They appeal to other “minimum” budgets put together by the Social Security Administra­tion or the Bureau of Labor Sta­tistics, some of which run up to nearly $6,000 ($45,553) for a family of four.

One of the contributors to the Theobald symposium makes the following estimates of the cost to the taxpayers of different guar­antees:

  • For a “minimum maintenance” level of $3,000 a year: total cost, $11 billion a year. ($835 Billion a year today)
  • For an “economy” level of $4,000: $23 billion a year. ($1.7 trillion annually)
  • For a “modest-but-adequate” level of $5,000: $38 billion a year. (almost $2.9 trillion annually)

These figures are huge, yet they are clearly an underestimate. For the calculations take it for granted that those who could get govern­ment checks of $3,000 to $5,000 a year, as an absolute guarantee, without conditions, would con­tinue to go on earning just as much as before. But as even one of the contributors to the Theo-bald symposium, William Vogt, re­marks: “Those who believe that men will want to work whether they have to or not seem to have lived sheltered lives.”

Who Would Do the Work?

He goes on to point out, with refreshing realism, how hard it is even today, before any guaran­teed income, to get people to shine shoes, wash cars, cut brush, mow lawns, act as porters at railroad or bus stations, or do any number of other necessary jobs. “Millions of service jobs are unfilled in the United States, and it is obvious that men and women will often prefer to exist on small welfare payments rather than take the jobs…. If this situation exists before the guaranteed income is made available, who is going to take care of services when every­one can live without working—as a right?”

Who is, in fact, going to take the smelly jobs, or any low-paid job, once the guaranteed income program is in effect? Suppose, as a married man with two children, your present income from some nasty and irregular work is $2,500 a year. Comes the income guaran­tee, and you get a check in the mail from the government for $630. This is accompanied by a letter telling you that you are en­titled as a matter of uncondition­al right to the poverty-line income of $3,130, and this $630 is for the difference between that and your earned income of $2,500. You are happy — for just a day. Then it occurs to you that you are a fool to go on working at your nasty job or series of odd jobs for $2,­500 when you can stop work en­tirely and get the full $3,130 from the government.

So the government would, in fact, have to pay out a tremendous sum. In addition, it would create idleness on a huge scale. To pre­dict this result is not to take a cynical view, but merely to rec­ognize realities. The beneficiaries of the guaranteed income would merely be acting sensibly from their own point of view. But the result would be that the fifth of the population now judged to be below the poverty line would stop producing even most of the neces­sary goods and services it is pro­ducing now. The unpleasant jobs would not get done. There would be less total production, or total real income, to be shared by every­body.

The Shifting “Poverty Line”

But so far we have been talking only about the effect of the guar­anteed income on the recipients whose previous incomes have been below the poverty line. What about the other four-fifths of the population, whose incomes have previously been above it? What would be the effect on their incen­tives and actions?

Suppose a married man with two children found at the end of a year that he had earned $3,500? And suppose he found that his neighbor, with the same-sized fam­ily, had simply watched television, hung around a bar, or gone fishing during the year and had got a guaranteed income from the gov­ernment of $3,130? Wouldn’t the worker begin to think that he had been something of a sap to work so hard for a mere $370 net, and that it would be much better to lead a pleasantly idle life for just that much less? And wouldn’t the same thing occur to all others whose earned incomes were only slightly above the guarantee?

It is not easy to say how far above the guarantee any man’s in­come would have to be for this consideration not to occur to him. But we would do well to remember the following figures: The median or “middle” income for all families in 1964 was $6,569. The median income for “unrelated” in­dividuals was $1,983. People with these incomes or less — i.e., half the population—would be near enough to the guarantee to won­der why they weren’t getting any of it.

Someone Must Pay

If “everybody should receive a guaranteed income as a matter of right” (and the italics are Mr. Theobald’s), who is to pay him that income? On this point the advocates of the guaranteed in­come are either beautifully vague or completely silent. The money, they tell us, will be paid by the “government” or by the “State.” “The State would acknowledge the duty to maintain the individual.”

[T]he gov­ernment has nothing to give to anybody that it doesn’t first take from someone else.

The state is a shadowy entity that apparently gets its money out of some fourth dimension. The truth is, of course, that the gov­ernment has nothing to give to anybody that it doesn’t first take from someone else. The whole guaranteed-income proposal is a perfect modern example of the shrewd observation of the French economist, Bastiat, more than a century ago: “The State is the great fiction by which everybody tries to live at the expense of everybody else.”

“The State is the great fiction by which everybody tries to live at the expense of everybody else.” Bastiat

Rights vs. Obligations

None of the guaranteed-income advocates explicitly recognizes that real “income” is not paper money that can be printed at will but goods and services, and that some­body has to produce these goods and services by hard work. The proposition of the guaranteed-in­come advocates, in plain words, is that the people who work must be taxed to support not only the peo­ple who can’t work but the people who won’t work. The workers are to be forced to give up part of the goods and services they have cre­ated and turn them over to the people who haven’t created them or flatly refuse to create them.

{T}he people who work must be taxed to support not only the peo­ple who can’t work but the people who won’t work.

Once this proposition is stated bluntly, the spuriousness in all the rhetoric about “the absolute con­stitutional ‘right’ to an income” becomes clear. A true legal or moral right of one man always im­plies an obligation on the part of others to do something or refrain from doing something to ensure that right. If a creditor has a right to a sum of money owed to him on a certain day, the debtor has an obligation to pay it. If I have a right to freedom of speech, to privacy, or to the ownership of a house, everyone else has an obligation to respect it. But when I claim a “right” to “an in­come sufficient to live in dignity,” whether I am willing to work for it or not, what I am really claim­ing is a right to part of somebody else’s earned income. What I am asserting is that he has a duty to earn more than he needs or wants to live on so that the surplus may be seized from him and turned over to me to live on.

[If] I claim a “right” to “an in­come sufficient to live in dignity,” … what I am really claim­ing is a right to part of somebody else’s earned income.

What the guaranteed-income advocates are really saying, be­hind all their high-sounding phrases and humanitarian rhet­oric, is something like this: “Look, we find ourselves with this wonder­ful apparatus of coercion, the gov­ernment and its police forces. Why not use it to force the workers to pay part of their earnings over to the nonworkers?”

Lack of Understanding

We can still believe in the sin­cerity and good intentions of these people, but only by assuming an appalling lack of understanding on their part of the most elementary economic principles. “This book,” writes Robert Theobald, “proposes the establishment of new princi­ples specifically designed to break the link between jobs and income.” But we cannot break the link be­tween jobs and income. True in­come is not money, but the goods and services that a money will buy. These goods and services have to be produced. They can only be produced by work, by jobs. We may, of course, break the link be­tween the job and the income of a particular person, say Paul, by giving him an income whether he consents to take a job or not. But we can do this only by seizing part of the income of some other per­son, say Peter, from his job. To believe we can break the link between jobs and income is to be­lieve we can break the link be­tween production and consump­tion. Goods have to be produced by somebody before they can be con­sumed by anybody.

Claimants to Be Trusted, Taxpayers to Be Examined

One reason for the agitation for an unconditionally guaranteed income is the dislike of some so­cial reformers for the “means test.” The means test is disliked on two grounds — that it is “humil­iating” or “degrading,” and that it is administratively troublesome — “a comprehensive examination of means and resources, applicant by applicant.” The guaranteed-income advocates think they can do away with all this by using the “simple” mechanism of having everybody fill out an income tax blank, whereupon the government would send a check to everybody for the amount that his income, so reported, fell below the govern­ment’s set “poverty-line” mini­mum.

The belief that this income-tax mechanism would be administra­tively simple is a delusion. Before the introduction of the withhold­ing mechanism, before the report­ing requirements for payments made to individuals in excess of $600 in any year, and the still more recent requirements for the reporting of even the smallest in­terest and dividend payments, the income tax was in large part a self-imposed tax. The government de­pended heavily on the taxpayer’s conscientiousness and honesty. To a substantial extent it still does.

The government can check the honesty of individual returns only by a random or arbitrary sam­pling process. It is altogether prob­able that more evasion and cheat­ing go on in the low income-tax returns than in the high ones—not because the big-income earn­ers are more honest, but simply because their chances of being ex­amined and caught are higher. The amount of concealment and falsification that would be prac­ticed by persons trying to get as high a guaranteed income as pos­sible would probably be enormous. To minimize the swindling, the government would have to resort to the same case-by-case and ap­plicant-by-applicant process as it does to administer current relief, unemployment insurance, and so­cial security programs.

Is a means test for relief necessarily any more humiliating than the ordeal that the taxpayer must go through when his income tax is being examined, and when every question he is asked and record he is required to provide implies that he is a potential crook? If the reply is that this inquisition is necessary to protect the govern­ment from fraud, then the same reply is valid as applied to appli­cants for relief or a guaranteed income. It would be a strange double standard to insist that those who were being forced to pay the guaranteed income to others should be subject to an in­vestigation from which those who applied for the guaranteed income would be exempt.

Is a means test for relief necessarily any more humiliating than the ordeal that the taxpayer must go through when his income tax is being examined, and when every question he is asked and record he is required to provide implies that he is a potential crook?

Finally, the income-tax mechan­ism would be irrelevant to the real problem with which the guaran­teed-income advocates profess to be concerned. For the applicants would presumably be reporting last year’s income, which would have no necessary relation to their present need. An applicant’s in­come in the previous year or other previous period might be either much higher or much lower than it is today. The process would not meet present emergencies, such as illness or temporary loss of em­ployment. The guaranteed-income payment might either come too late or prove unneeded or exces­sive.

Old Subsidies Never Die

One of the main selling argu­ments of the guaranteed-income advocates is that its net cost to the taxpayers would not be as great as might appear at first sight because it would be a substi­tute for the present “mosaic” or “rag bag” of measures designed to meet the same goal — social secur­ity, unemployment compensation, medicare, direct relief, free school lunches, stamp plans, farm subsi­dies, housing subsidies, rent sub­sidies, and all the rest.

Neither the record of the past nor a knowledge of political reali­ties supports such an expectation. One of the main selling arguments in the middle 1930′s, first for un­employment insurance and later for social security, was that these programs would take the place and eliminate the need for the various relief programs and pay­ments then in existence. But in the last thirty years these pro­grams have continued to grow year by year with only minor in­terruptions. The result is that public assistance payments (in­cluding old age assistance, aid to dependent children, general assist­ance, etc.) have risen from a total of $657 million in 1936 to $4,736 million in 1963, an increase of 620 per cent. And this cost is in addi­tion to the present $30 billion or more that the Federal government now spends annually on social security and other welfare pro­grams.

So not only may we expect that the guaranteed-income would be thrown on top of all existing wel­fare payments (we can expect a tremendous outcry against dis­continuing any of them), but that demands would arise for constant enlargement of the guaranteed amount. If the average payment were merely the difference be­tween an assumed “poverty-line” income of, say, $3,000 and what the family had earned itself, all heads of families earning less than $3,000 would either quit work or threaten to do so unless they were given the full $3,000, and so allowed to “keep” whatever they earned themselves. And once this demand was granted (in an effort to avoid the wholesale idle­ness and pauperization that would otherwise occur), the people whose earnings were just above the gov­ernment minimum, or less than twice as much, would point out how unjustly they were being treated. And the only “logical” and “fair” stopping place, it would be argued, would be to give every­body the full minimum of $3,000 no matter how much he was earn­ing or getting from other sources.

Anyone who thinks such a pre­diction farfetched need merely re­call how we got into the present system of paying everybody over 72 social security benefits regard­less of his current earnings from other sources, and paying benefits to every retired person over 65 re­gardless of the size of his un­earned income from other sources. By the same logic, the British government pays comprehensive unemployment, sickness, matern­ity, widowhood, funeral and other benefits, and retirement pensions, regardless of need or the size of the recipient’s income.

Incentives Undermined

We have seen how the guaran­teed-income plan, if adopted in the form that its advocates propose, would lead to wholesale idleness and pauperization among nearly all those earning less than the minimum guarantee, and among many earning just a little more. But it would also undermine the incentives of those much further up in the income scale. For they would not only be deprived of the benefits that they saw millions of others getting. It is they who would be expected to pay these benefits, through the imposition upon them of far more burden­some income taxes than they were already paying. If these taxes were steeply progressive in pro­portion to income, as is probable, they would discourage long hours and unusual effort.

It is difficult to make any pre­cise estimate of the effect of a given income-tax rate in discour­aging or reducing work and pro­duction. Different individuals will, of course, be differently affected. The activities of a man whose whole income comes in the form of a single salary from a single job will be differently affected than those of a surgeon, a doctor, a writer, an actor, an architect, or anyone whose income varies with the number of assignments he is willing to undertake or clients he is willing to serve.

What we do know is that the higher income-tax rates, contrary to popular belief, just don’t raise revenue. In the current 1966 fiscal year, individual income taxes are estimated to be raising $51.4 bil­lion (out of total revenues of $128 billion). Yet the tax rates in ex­cess of 50 per cent have been bringing in only about $250 mil­lion a year — less than 1 per cent of total income tax revenues and not enough to run even the present government for a full day. (In other words, if all the personal income-tax rates above 50 per cent were reduced to that level, the loss in revenue would be only about $250 million.) If these rates above 50 per cent were raised fur­ther, it is more probable that they would raise less revenue than more. Therefore, it is the income‑tax rates on the lower and middle incomes that would have to be raised most, for the simple reason that 75 per cent of the personal income of the country is earned by people with less than $15,000 gross incomes.

Poverty for All

It is certain that high income tax rates discourage and reduce the earning of income, and there­fore the total production of wealth, to some extent. Suppose, for illustration, we begin with the extreme proposal that we equalize everybody’s income by taxing away all income in excess of the average in order to pay it over to those with incomes below the average. (The guaranteed income proposal isn’t too far away from that!)

Let us say that the present per capita average yearly income is about $2,800. Then everybody who was getting less than that (and would get just that whether he worked or not) would, of course, as with the guaranteed-income proposal, not need to work produc­tively at all. And no one who was earning more than $2,800 would find it worth while to continue to earn the excess, because it would be seized from him in any case. More, it would soon occur to him that it wasn’t worth while earning even the $2,800, for it would be given to him in any case; and his income would be that whether he worked or not. So if everybody acted under an income equalization program merely in the way that seemed most rational in his own isolated interest, none of us would work and all of us would starve. We might each get $2,800 cash (if someone could be found to con­tinue to run the printing machines just for the fun of it), but there would be nothing to buy with it.

A less extreme equalization pro­gram would, of course, have less extreme results. If only 90 per cent of all incomes over $2,800 were seized and people could keep 10 cents of every “excess” dollar they earned, there would of course still be a little incentive to earn a little more. And if everyone could keep 25 cents out of every dollar he earned above the $2,800, the in­centive would be slightly higher.

But every tax or expropriation must reduce incentives to a cer­tain extent. The effect of the guar­anteed-income proposal would be practically to wipe out incentives for those earning (or even want­ing) no more than the guarantee, and greatly to reduce incentives for all those earning or capable of earning more than the guaran­tee. Therefore the guaranteed-income would reduce effort and earning and production. It would violently reduce the national income (measured in real terms). And it would reduce the standard of living for four-fifths of the population. The government might be able to pay out the specified amount of guaranteed dollar “in­come,” but the purchasing power of the dollars would appallingly shrink.

The Negative Income Tax

Recognizing the calamitous ero­sion of incentives that would be brought about by a straight guar­anteed income plan, other reform­ers have advocated what they call a “negative income tax.” This pro­posal was put forward by the prominent economist, Professor Milton Friedman of the Univer­sity of Chicago, in his book Capi­talism and Freedom, which ap­peared in 1962. The system he pro­posed would be administered along with the current income tax system.

Suppose that the poverty-line income were set at $3,000 per “consumer unit” (families or in­dividuals), and suppose that the negative income tax (which is really a subsidy), were a flat rate of 50 per cent. Then every “con­sumer unit” (this is the statisti­cians’ technical term) whose in­come fell below $3,000 would be paid a subsidy of, say, 50 per cent of the difference. If its earned in­come were $2,000, for example, it would receive $500; if its earned income were $1,000 it would re­ceive $1,000; if its earned income were zero it would receive $1,500.

Professor Friedman freely con­cedes that his proposal, “like any other measure to relieve poverty… reduces the incentives of those helped to help themselves.” But he argues that “it does not eliminate that incentive entirely, as a sys­tem of supplementing incomes up to some fixed minimum would. An extra dollar earned always means more money available for expend­iture.”

It is true that the “negative in­come tax” would not have quite the destructive effect on incentives that the guaranteed income would. Nevertheless, once the principle of the negative income tax were accepted, the demand would im­mediately arise that the minimum subsidy to be paid should be at least “adequate” to provide a min­imum income to support a family “in decency and dignity.” So we would be back to the minimum guaranteed income, plus supple­mental subsidies for those who al­ready had some earned or private income of their own. If this mini­mum were set at $3,130 for a married man with two children (to return to the Social Security Administration’s “poverty-line” figure), this subsidy would be re­duced, say, by 50 cents for every dollar earned, and therefore would not stop entirely until the family’s own earned income had reached $6,240.

Not Enough Rich to Soak

How many billions of dollars in subsidies this would involve, and what rate of income tax would be required on all families with in­comes above $6,240 to raise the revenue necessary to pay these subsidies, if any rate could, I leave to the professional statisti­cians to calculate.

But it is obvious that this pro­gram could not be paid for by “the rich.” If we were to subsi­dize all family incomes below $6,240 it would be hardly consis­tent to tax them. Yet net incomes below $6,000 (after exemptions and deductions) are now taxed at rates up to 22 per cent, beginning with 14 per cent even on the first $500 of net income. In fact, all personal net income of $6,000 or less is now the source of nearly 80 per cent of all personal income tax revenue. Yet, as I have al­ready pointed out, the Census Bureau calculates that the median income for all families in 1964 was only $6,569; and taxpayers with adjusted gross incomes of $15,000 or less receive three-quarters of the total personal income there is to be taxed.

Neither a “negative income tax” nor a guaranteed income plan of the dimensions being suggested could possibly be put into effect with dollars of present purchas­ing power.

It may be added that the nega­tive income tax would have all the administrative problems that would afflict the guaranteed in­come proposal — fraud, corruption, necessary applicant-by-applicant investigation, and irrelevance of payment to present need.

And once the main principle of either proposal were accepted, the minimum subsidy or guarantee de­manded would be bound constant­ly to increase. Anyone who doubts this need merely consult the his­tory of unemployment insurance and social security benefits since the plans were initiated in the 1930′s. It is significant that sev­eral of the advocates of the guar­anteed income acknowledge that their idea originated with the more modest negative income tax proposal of Milton Friedman. They just expanded it.

So knowing what we do of polit­ical pressures, and of the past history of relief, “social insur­ance,” and other “antipoverty” measures, we are forced to con­clude that once the principle of either the negative income tax or the guaranteed income were ac­cepted, it would be made an addi­tion to and not a substitute for the present conglomeration of re­lief and “antipoverty” programs. And even alone it would drastical­ly reduce the productive incentives of those earning less than the guaranteed amount and seriously reduce the incentives of those earning more, because of the op­pressive taxation it would neces­sarily involve. Its over-all effect would be to level real incomes down, not up.

Even at present our large and overlapping assortment of relief and antipoverty measures is seri­ously reducing incentives to the production that would otherwise be possible. Our social reformers have been everywhere overlooking the two-sided nature of the prob­lem of reducing poverty. The ob­stinate two-sided problem we face is this: How can we mitigate the penalties of misfortune and fail­ure without undermining the in­centives to effort and success?

The Poor Laws of England

Our social reformers — who sometimes talk as if no govern­ment ever did anything to relieve the plight of the jobless and the poor until the New Deal came along in 1933 — are constantly de­ploring the alleged indifference, callousness, or niggardliness of our forefathers in dealing with the poor. But wholly apart from pri­vate charity, previous generations in their governmental capacity were sharply aware of the prob­lem of poverty and made some effort to alleviate it almost as far back as the records go. There were “poor laws” in England even before the days of Queen Eliza­beth. A statute of 1536 provided for the collection of voluntary funds for the relief of those un­able to work. Eleven years later the City of London decided that these voluntary collections were insufficient, and imposed a com­pulsory tax to support the poor. In 1572 a compulsory tax for this purpose was imposed on a national scale.

But the problem soon proved a very serious one for the people of that age. The upper class was very small numerically and pro­portionately. The middle class it­self was always very close to what we would today call the poverty line. The workhouse and other conditions imposed on those on relief seem very cruel to us to­day. But our ancestors were in constant fear that if they in­creased relief or relaxed the stern conditions for it they would pau­perize increasing numbers of the population and create an insoluble problem.

At the beginning of the nine­teenth century, indeed, the cost of poor relief began to get out of hand. The total cost of the poor law administration increased four­fold in the thirty-two years be­tween 1785 and 1817, and reached a sixth of the total public expen­diture. One Buckinghamshire vil­lage reported in 1832 that its ex­penditure on poor relief was eight times what it had been in 1795, and more than the rental of the whole parish had been in that year.

In face of statistics of this kind, England’s Whig government decided to intervene. It appointed a royal commission, and in 1834 a new and more severe poor law was passed in accordance with the commission’s recommenda­tions.

The guiding principle of the new law was that poor relief should be granted to able-bodied poor and their dependents only in well-regulated workhouses under conditions inferior to those of the humblest laborers outside. This seemed harsh, but the com­missioners had argued that “every penny bestowed that tends to rend­er the condition of the pauper more eligible than that of the in­dependent laborer is a bounty on indolence and vice.”

If the pendulum swung too far in the direction of severity and niggardliness in the middle nine­teenth century, it may be swing­ing too far in the direction of lax­ity and prodigality today. As weeping subsidization of idleness, such as is proposed by the guar­anteed income, would only weaken or destroy all incentive to effort, not only on the part of those who were subsidized and supported, but on the part of those who would be forced to support them out of their own earnings. There could be no faster way to impoverish the nation.

The Cure Is Production

One of the worst features of all the plans for sharing the wealth and equalizing or guaran­teeing incomes is that they lose sight of the conditions and insti­tutions that are necessary to cre­ate wealth and income in the first place. They take for granted the existing size of the economic pie; and in their impatient effort to see that it is sliced more equally they overlook the forces that have not only created the pie in the first place but have been baking a larger one year by year. Eco­nomic progress and justice do not consist in beautifully equalized destitution, but in the constant creation of more and more goods and services, of more and more wealth and income to be shared.

The only real cure for poverty is production.

The way to maximize production is to maximize the incentives to production. And the way to do that, as the modern world has dis­covered, is through the system known as capitalism — the system of private property, free markets, and free enterprise. This system maximizes production because it allows a man freedom in the choice of his occupation, freedom in his choice of those for whom he works or who work for him, freedom in the choice of those with whom he associates and cooperates, and, above all, freedom to earn and to keep the fruits of his labor. In the capitalist system each of us, with whatever exceptions, tends in the long run to get what he creates or helps to create. When each of us recognizes that his reward de­pends on his own efforts and out­put, and tends to be proportionate to his output, then each has the maximum incentive to maximize his effort and output.

No Effective Poverty Programs for Underdeveloped Countries

Capitalism brought the Indus­trial Revolution, and the enormous increase in productivity which this has made possible. Capitalism has enormously raised the economic level of the masses. It has wiped out whole areas of poverty, and continues to wipe out more. The so-called “pockets of poverty” con­stantly get smaller and fewer.

The condition of poverty, more­over, is relative rather than ab­solute. What we call poverty in the United States would be re­garded as affluence in most parts of Africa, Asia, or Latin Amer­ica. If an income sufficient to en­able a man “to live with dignity” ought to be “guaranteed” as a matter of “absolute right,” why don’t the advocates of a guaran­teed income insist that this right be enforced first of all in the poor countries, such as India and China, where the need is most widespread and glaring? The rea­son is simply that even the better-off groups in these nations have not produced enough wealth and income to be expropriated and distributed to others.

What we call poverty in the United States would be re­garded as affluence in most parts of Africa, Asia, or Latin Amer­ica.

One of the guaranteed-income advocates, in a footnote, admits naively: “We must also recognize that we still have no strategy for the elimination of poverty in the underdeveloped countries.” Of course they haven’t. The “strat­egy” would be the introduction of free enterprise, and of incentives to work, to save, to accumulate capital, better tools, and equip­ment, and to produce.

But would-be income guarantors ignore or despise the capitalistic system that makes their dreams dreamable and gives their redis­tribute-the-income proposals what­ever plausibility they have. The capitalist system has made this country the most productive and richest in the world. It has con­tinued to achieve its miracles even in the last generation, and to increase them year by year. It has raised the average weekly factory wage from less than $17 in 1933 to $110 today. Even after the rise in prices is allowed for, it has more than doubled our real per capita disposable income — from $893 in 1933 to $2,200 in 1965.

Allowed to continue to operate with even the relative freedom that it has enjoyed in recent years, the capitalist system will continue to produce these miracles. It will continue to make progress against poverty by a general increase in income and wealth. But short­sighted and impatient efforts to wipe out poverty by severing the connection between effort and re­ward can only lead to the growth of a totalitarian state, and destroy the economic progress that this country has so dearly bought.

Posted October 27, 2017 by aurorawatcherak in economics

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Economics in One Lesson Review   Leave a comment

Henry HazlittEconomics in One Lesson was recommended reading in my Econ 101 class in college and because it was short, I actually did skim it. I’m not sure how much I learned from that cursory glance with 20-year-old eyes, but when I reread it a few years ago, I kept feeling as though the book could have been written yesterday. You could insert today’s headlines into Hazlitt’s pages. I think everyone should read it. Fortunately, thanks to the Foundation of Economic Education, you don’t even need to spend money to read it.

I’ve given you a sampling of what Hazlitt wrote, but you can read the entire book in an afternoon or a couple of nights. It’s only 200 pages. The clear writing provides simple examples that refute many of the myths perpetrated by politicians and self-interest groups. Hazlitt’s clear insights are relentlessly applied until he erodes the myths promoted by pundits, politicians and economists alike.

One chapter is devoted to public works. Keep in mind that the following was written more than 60 years ago:

There is no more persistent and influential faith in the world today than the faith in government spending. Everywhere government spending is presented as a panacea for all our economic ills. Is private industry partially stagnant? We can fix it all by government spending. Is there unemployment? That is obviously due to ‘insufficient private purchase power.’ The remedy is obvious. All that is necessary is for the government to spend enough to make up the ‘deficiency.’

Vast amounts of economic literature is based on this fallacy. As so often happens with doctrines of this sort, it has become part of an intricate network of fallacies that mutually support each other.

Hazlitt goes on to clearly show the fallacies underpinning the thinking. We tend to look at things in isolation instead of as a whole, and, as Hazlitt concludes his book, seeing them in the whole is the goal of economic science.

I can’t recommend this book highly enough. No one who reads it will ever think about economic policy analysis in the same way again.

The Lesson Restated   1 comment

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.

Image result for image of interest ratesThis is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

We’re coming to the end of Hazlitt’s book and I hope we’ve learned something. Although I shouldn’t be surprised, I was very surprised by Hazlitt’s spot-on analysis of our 2017 economy. It’s been 50 years since he wrote his book and it appears we have learned nothing in the intervening years. Lela

 

Economics … 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.

Economics is the science of tracing inevitable implications. The answer already lies in the statement of the problem. We may think we’re learning something new when we arrive at the result, but in reality, the inevitable result of a failed policy was just not recognized when it was proposed.

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,” they fail to see that credit is debt, so they’re advocating for increased debt.
  • increase farm prices, they fail to see that city workers will now be poorer.
  • pay out government subsidies, they fail to see that means increased taxes on everyone eventually.
  • increase exports, they fail to see that will eventually increase imports.
  • increase wages, they fail to see that will increase to costs of production.

We must pay closer attention to the two-sided nature of these proposals. We also must stop looking at the effect of economic policies only on specific groups for the short run.

It would not occur to anyone unacquainted with the prevailing economic half literacy that it is good to have windows broken and cities destroyed; that it is anything but waste of men return to work; that machines which increase the production of wealth and economize human effort are to be dreaded; that obstructions to free production and free consumption increase wealth; that a nation grows richer by forcing other nations to take its goods for less than they cost to produce; that saving is stupid or wicked and that dissipation brings prosperity.

“What is prudence in the conduct of every private family,” said Adam Smith’s strong common sense in reply to the sophists of his time, “can scarce be folly in that of a great kingdom.”

But lesser men get lost in complications. They do not re-examine their reasoning even
when they emerge with conclusions that are palpably absurd.

The reader, depending upon his own beliefs, may or may not accept the aphorism of Bacon that “A little philosophy inclineth man’s mind to atheism, but depth in philosophy bringeth men’s minds about to religion.” 

A little economics can easily lead to the paradoxical and preposterous conclusions we have just rehearsed, but that depth in economics brings men back to common sense. For depth in economics consists in looking for all the consequences of a policy instead of merely resting one’s gaze on those immediately visible.

Hazlitt hoped we have rediscovered the “forgotten man” (from William Graham Sumner’s 1883 essay):

As soon as A observes something which seems to him to be wrong, from which X is suffering, A talks it over with B, and A and B then propose to get a law passed to remedy the evil and help X. Their law always proposes to determine what C shall do for X or, in the better case, what A, B and C shall do for X. . . . What I want to do is to look up C. . . . I call him the Forgotten Man. . . . He is the man who never is thought of. He is the victim of the reformer, social speculator, and philanthropist, and I hope to show you before I get through that he deserves your notice both for his character and for the many burdens
which are laid upon him.

Ironically, that phrase was revived in the 1930s, but it wasn’t applied to C, but to X. C was expected to support still more Xs and became more completely forgotten than ever.

It is C, the Forgotten Man, who is always called upon to stanch the politician’s bleeding heart by paying for his vicarious generosity.

The middle-class is C. You and I, dear readers, are C.

The fundamental fallacy that Hazlitt had examined in detail was, he felt, an almost. inevitable result of the division of labor.

In a primitive community, or among pioneers, before the division of labor has arisen, a man works solely for himself or his immediate family. What he consumes is identical with what he produces. There is always a direct and immediate connection between his output and his satisfactions. But when an elaborate and minute division of labor has set in, this direct and immediate connection ceases to exist. I do not make all the things I consume but, perhaps, only one of them. With the income I derive from making this one commodity, or rendering this one service, I buy all the rest. I wish the price of everything I buy to be low, but it is in my interest for the price of the commodity or services that I have to sell to be high. Therefore, though I wish to see abundance in everything else, it is in my interest for scarcity to exist in the very thing that it is my business to supply. The greater the scarcity, compared to everything else, in this one thing that I supply, the higher will be the reward that I can get for my efforts.

We each look to our own interests, but we don’t often realize the consequences of our actions. We rarely restrict our own efforts or output in order to create a scarcity in whatever it is we produce. It might make sense to do this if our aim is the drive up the price, but if there are others in our field, that doesn’t work, so we are concerned only with out own material welfare. We have no humanitarian scruples.

I want the output of all other wheat growers to be as low as possible; for I want scarcity in wheat (and in any foodstuff that can be substituted for it) so that my particular crop may command the highest possible price.

These selfish feelings wouldn’t affect only one else in ordinary circumstances, because wherever competition exists, 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 are harnessed to maximum output. But if it is possible for wheat growers, for example, to cooperate to eliminate competition, and if the government permits or encourages this monopolization, the situation changes. The wheat growers may be able to persuade the national government or even the UN to force all of them to reduce the acreage planted to wheat, thus creating a shortage and raising the price per bushel of wheat. This might make the wheat growers better off. Everyone else is worse off because they must produce more to get less of what the wheat grower produces.

So the nation as a whole will be just that much poorer. It will be poorer by the amount of wheat that has not been grown, but it will be poorer also in everything else.

{W]hat applies to changes in supply applies to changes in demand, whether brought about by new inventions and discoveries or by changes in taste. A new cotton-picking machine, though it may reduce the cost of cotton underwear and shirts to everyone, and increase the general wealth, will throw thousands of cotton pickers out of work. A new textile machine, weaving a better cloth at a faster rate, will make thousands of old machines obsolete, and wipe out part of the capital value invested in them, so making poorer the owners of
those machines. The development of atomic power, though it could confer unimaginable blessings on mankind, is something that is dreaded by the owners of coal mines and oil wells.

There is no technical improvement that would not hurt someone, but there’s also no change in public taste or morals, that would not hurt someone. An increase in sobriety would put thousands of bartenders out of business. A decline in gambling would force croupiers and racing touts to seek more productive occupations. A growth of male chastity would ruin the oldest profession in the world.
But it is not merely those who deliberately pander to men’s vices who would be hurt by a sudden improvement in public morals. Among those who would be hurt most are precisely those whose business it is to improve those morals. Preachers would have less to complain about; reformers would lose their causes; the demand for their services and contributions for their support would decline. If there were no criminals we should need fewer lawyers, judges, and firemen, and no jailers, no locksmiths, and (except for such services as untangling traffic snarls) even no policemen.
Under a system of division of labor, in short, it is difficult to think of a greater fulfillment of any human need which would not, at least temporarily, hurt some of the people who have made investments or painfully acquired skill to meet that precise need.

This highlights the folly of the planend economy. It is impossible to create completely even economic progress. But the acolytes of economic planning repeatedly turn to protective tariffs, the destruction of machinery, the burning of crops … to a thousand restrictive schemes..

This is the insane doctrine of wealth through scarcity. It is a doctrine that may always be privately true, unfortunately, for any particular group of producers considered in isolation—if they can make scarce the one thing they have to sell while keeping abundant all the things they have to buy. But it is a doctrine that is always publicly false. It can never be applied all around the circle. For its application would mean economic suicide.

This was Hazlitt’s lesson in generalized form. Many of the things we think are true when we concentrate on a single economic group are really illusions when we apply them to everyone.

To see the problem as a whole, and not in fragments: that is the goal of economic science.

I got my copy of Hazlitt’s Economics In One Lesson from the Foundation for Economic Education. It was free. If you want to read the whole book, go find it.

Posted February 11, 2017 by aurorawatcherak in economics, Uncategorized

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The Assault on Savings   1 comment

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

From time immemorial proverbial wisdom has taught the virtues of saving, and warned against the consequences of prodigality and waste. This proverbial wisdom has reflected the common ethical as well as the merely prudential judgments of mankind. But there have always been squanderers, and there have apparently always been theorists
to rationalize their squandering.

The classical economists, refuting the fallacies of their own day, showed that the saving policy that was in the best interests of the individual was also in the best interests of the nation. They understood that economics does not change from micro to macro scale. They offered evidence that the rational saver, in making provision for his own future, was not hurting, but helping, the whole community.

Image result for image of savingsIn 1946 and in 2017, you won’t find a lot of “mainstream” economists who embrace the ancient virtue of thrift. The Keyesenians claim they have new reasons for opposing savings and encouraging government spending, but Hazlitt recognized that there was nothing particularly new in their foolishness.

He asked his readers to return to the classical example offered by Bastiat nearly 100 years before. Imagine two brothers – one a spendthrift and
the other a prudent man. Both inherit an income of $50,000 a year. Disregard the income tax and don’t ask if either brother works for a living because such questions are irrelevant in this thought experiment.

Alvin is a lavish spender. He spends not only by temperament, but on principle. He is a disciple of Rodbertus, who declared in the middle of the 19th century that capitalists “must expend their income to the last penny in comforts and luxuries,” for if they “determine to save . . . goods accumulate, and part of the workmen will have no work.”

Alvin lives the high life and doesn’t stint himself on luxuries or staff to take care of those baubles and his wife and friends glitter with his presents. This means his savings account is dwindling, but savings is a sin, so not saving must be a virtue. Plus, he’s balancing out the economic harm being done by his miserly brother, Ben. It’s obvious to anyone with eyes that Alvin is stimulating employment wherever he spreads his money.

Ben is much less popular with tradesmen, restaurants and nightclub owners because he lives much more modestly and spends only about $25,000 of his annual income. For those people who only see the obvious, he is providing less than half as much employment as Alvin, and the other $25,000 is as useless as if it did not exist.

But with Bastiat as with Hazlitt, there was the unseen effect as well to be considered. What does Ben do with the other $25,000? He gives about $5,000 a year to charitable causes and to friends in need. These families then spend these funds on groceries, clothing or rent. So Ben’s funds create as much employment as if Ben had spent them directly on himself, but he has actually made more people happy as consumers, and that production is going more into essential goods and less into luxuries and superfluities.

So, what happens to the $20,000 Ben neither spends nor gives away? He doesn’t hide it under a matteress. He deposits it in a bank or he invests it. If deposited in a bank, the bank either lends it to businesses on short term for working capital, or uses it to buy securities. Ben is, therefore, investing his money either directly or indirectly and that money is invested to buy capital goods—houses, office buildings, factories, ships, 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 modern 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, Ben’s “saving” and spending combined give as much as Alvin’s spending alone, and put as much money in circulation.

Image result for image of interest ratesThe 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, to recognize that every dollar of Ben’s saving gives as much employment as every dollar that Alvin throws around.

So time flies and a decade later, Alvin is broke and is no longer spending lavishly. He’s begging Ben for money. Ben continues with about the same ratio of spending to saving, provides more jobs than ever, because his income, through investment, has grown. His
capital wealth is greater. Moreover, because of his investments, the national wealth and income are greater; there are more factories and more production.

Of course, by 1946 and certainly in 2017, there are far more fallacies in play than in Bastiat’s time. Some stem from logical leaps that make no sense, especially coming from men who claim to be educated.

The word “saving” … is used sometimes to mean mere hoarding of money, and
sometimes to mean investment, with no clear distinction, consistently maintained, between the two uses.

Hoarding without purpose, especially on a large scale, would probably harm the economy, but the money-in-the-strongbox-in-the-basement sort of hoarding is extremely rare. There is a distinct form of this that occurs after a recession has commenced. We saw this (and are still seeing it) in 2009. Consumptive spending and investment contract as consumers reduce their buying, partly because they fear job loss, so they want to conserve their resources. They are planning for the future — spending less on luxuries now so they can continue to consume necessities if they lose their jobs.

Consumers also sometimes hedge their bets, assuming prices will fall and continue falling, so they hold money for a later time when they expect their money to have more value. This pattern does not spring from the same motives as normal saving, but it is still ridiculous to say that this sort of “saving” is the cause of depressions. It’s actually a CONSEQUENCE of depressions.

Hazlitt noted that sometimes “capricious government intervention in business” creates uncertainty, so profits are not reinvested and firms and individuals allow cash balances to accumulate in their banks. They keep larger reserves against contingencies. This cash hoarding may appear at casual glance to the cause of a subsequent slowdown in business activity, but the real cause is uncertainty created by government policies.

The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame “excessive saving” for the business decline would be like blaming a fall in the price of apples not on a bumper crop but on the people who refuse to pay more for apples.

When people embrace a fallacy, sometimes they refuse to listen to any good argument against it. They will argue that 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 neglects the reality 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. Yes, sudden changes can upset the economy, but the same unsettling without occur if consumers suddenly switched their demand from one consumers’ good to another.

Another objection against savings is to deride the 19th century with its supposed doctrine that mankind can grow a larger economy through saving and thrift. Hazlitt felt it necessary to address this objection with a more realistic picture of what actually happened.

There is a difference between savings and investment, but the enemies of savings tries to make these two independent variables. They create a picture where you have savers automatically, pointlessly, stupidly continuing to save while on the other hand, there are limited “investment opportunities” that cannot absorb this saving. The result, they claim, is stagnation. The only solution, they declare, is for the government to expropriate these stupid and harmful savings and to invent its own projects to use up the money and provide employment.

There is so much that is false in this picture and “solution” that we can here point only to some of the main fallacies. “Savings” can exceed “investment” only by the amounts that are actually hoarded in cash. Few people nowadays, in a modern industrial community like the United States, hoard coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even cumulative: dishoarding, as eccentric recluses die and their hoards are discovered and dissipated, probably offsets new
hoarding. In fact, the whole amount involved is probably insignificant in its effect on business activity.

Most of us keep our money, if we have any savings, in the bank, and banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is 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. That only happens AFTER signs of a depression, when it is prudent to hold some cash reserves.

“Savings” and “investment” are brought into equilibrium in the same way that the supply of and demand for any commodity are brought into equilibrium. In fact, they are analogolous. 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.

Hazlitt might have been writing to people in 2017 instead of 1946 as he laughed into explaining interest rates.

This whole subject has been so appallingly confused in recent years by complicated sophistries and disastrous governmental policies based upon them that one almost despairs of getting back to common sense and sanity about it.

There’s an almost pathological fear of “excessive” interest rates. The argument goes 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 caused governments everywhere to pursue artificial “cheap money” policies that overlook the effect of these policies on the supply of capital.

Yes, once again, government is looking at the effects of a policy only one one group and forgetting to look at the rest of the economy. If interest rates are artificially kept too low in relation to risks, funds will neither be saved nor lent. The cheap-money proponents
believe that saving goes on automatically regardless of interest rate. Rich people can only spend so much money, right? But what about the middle class? Savings has been virtually useless for 30 years and the savings rate in the United States is abysmal. Most of us live paycheck to paycheck and think Dave Ramsey is crazy. The argument overlooks the marginal saver, who is representative of the great majority of savers.

The effect of keeping interest rates artificially low … 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 brings
about a scarcity. It creates economic distortions.

The artificial reduction in the interest rate encourages increased borrowing, which encourages 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 and saving, brings about a comparative shortage of real capital.

Constant new injections of currency or bank credit is necessary to take the place of real savings.

This can create the illusion of more capital just as the addition of water can create the illusion of more milk.

This creates continuous inflation, leading to cumulative danger. The money rate will rise and a crisis will develop if the inflation. Cheap money policies eventually lead to more violent oscillations in business than those they are designed to remedy. If government doesn’t tamper with money rates through inflationary 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. Equilibrium is achieved without government intervention.

Hazlitt also dealt with the fallacy that there is a limited amount of new capital that can be absorbed. He seems to shake his head sadly in his writing because this was believed not just by the uneducated, but by those claiming to be trained economists.

Almost the whole wealth of the modern world, nearly everything that distinguishes it from the pre-industrial world of the 17th century, consists of its accumulated
capital.

This capital consists of “durable goods” like automobiles, refrigerators, furniture,
schools, colleges, churches, libraries, hospitals, and private homes.

Never in the history of the world has there been enough of these. There is still, with the postponed building and outright destruction of World War II, a desperate shortage of them. But even if there were enough homes from a purely numerical point of view,
qualitative improvements are possible and desirable without definite limit in all but the very best houses.

The second part of capital consists of the tools of production, from crudest axe to amazing electronics. Similarly, there is no limit to the expansion that is possible and desirable in this area.

There will not be a “surplus” of capital until the most backward country is as well-equipped technologically as the most advanced, until the most inefficient factory in America is brought abreast of the factory with the latest and most elaborate equipment, and until the most modern tools of production have reached a point where human ingenuity is at a dead end, and can improve them no further. As long as any of these conditions remain unfulfilled, there will be indefinite room for more capital.

But how can the additional capital be “absorbed”? If it is set aside and saved, it will absorb itself and pay for itself. Producers invest in new capital goods by buying new and more ingenious tools because these tools reduce cost of production, by creating goods completely unaided by hand labor or they increase the quantities in which these can be produced or by reducing unit costs of production.

It should not be difficult to decide, after our analysis, with whom the real folly lies.

Posted February 10, 2017 by aurorawatcherak in economics, Uncategorized

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The Mirage of Inflation   3 comments

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.
The most obvious and yet the oldest and most stubborn error on which the appeal of inflation rests is that of confusing “money” with wealth.

That wealth consists in money, or in gold and silver,” wrote Adam Smith more than two centuries ago, is a popular notion which naturally arises from the double function of money, as the instrument of commerce, and as the measure of value. . . .

To grow rich is to get money; and wealth and money are considered synonymous. Real wealth consists in what is produced and consumed: the food we eat, the clothes we wear, the houses we live in. It is railways, roads, and cars; ships, planes, factories; schools, churches and theaters; pianos, paintings, and books.

Yet so powerful is the verbal ambiguity that confuses money with wealth, that even those who at times recognize the confusion will slide back into it in the course of their reasoning. Each man sees that if he personally had more money he could buy more
things from others. If he had twice as much money he could buy twice as many things; if he had three times as much money he would be “worth” three times as much. And to many the conclusion seems obvious that if the government merely issued more money and distributed it to everybody, we should all be that much richer.

Image result for image of inflationThese are the most naive inflationists, but there is a second group that is less naive, that senses there is a catch somewhere. They would limit in some way the amount of additional money they would have the government issue. They would have it print just enough to make up some alleged “deficiency” or “gap.” We call that “quantative easing” in the 21st century.

This second group reasons that purchasing power is chronically deficient because industry somehow does not distribute enough money to producers to enable them to buy back, as consumers, the product that is made. There mysterious leakage somewhere. There’s evena  group of economists who “prove” this by equations. On one side of their equations they count an item only once; on the other side they unknowingly count the same item several
times over. This produces an alarming gap between what they call “A payments” and what they call “A+B payments.”

So they found a movement, put on green uniforms, and insist that the government
issue money or “credits” to make good the missing B payments. The cruder apostles of “social credit” may seem ridiculous; but there are an indefinite number of schools of only slightly more sophisticated inflationists who have “scientific” plans to issue just enough additional money or credit to fill some alleged chronic or periodic “deficiency” or “gap” which they calculate in some other way.

There’s a third group — more knowing inflationists — who recognize that any substantial
increase in the quantity of money will reduce the purchasing power of each individual monetary unit, causing an increase in commodity prices. They aren’t disturbed by this. They actually want this sort of inflation because they believe it improves the position of debtors compared to reditors. Others believe 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.”

Image result for image of inflationThere are innumerable theories concerning the way in which increased quantities of money (including bank credit) affect prices. Some imagine that the quantity of money could be increased by almost any amount without affecting prices. They merely see this increased money as a means of increasing everyone’s “purchasing power,” in the sense of
enabling everybody to buy more goods than before. Maybe they never paused to consider that people cannot buy twice as much goods as before unless twice as much goods are produced. Maybe they fail to recognize the shortages of manpower, working hours, productive capacity or raw materials as a limitation on production and believe that is merely a shortage of monetary demand that prevents people from purchasing goods that don’t exist yet.

There are some eminent economists who hold a rigid mechanical theory of the effect of the supply of money on commodity prices. They believe the value of the total quantity of money multiplied by its “velocity of circulation” must always be equal to the value of the total quantity of goods bought. Multiply the quantity of money n times, in short, and you must multiply the prices of goods n times.

There is not space here to explain all the fallacies in this plausible picture. Instead we shall try to see just why and how an increase in the quantity of money raises prices.

 

Let’s say the government makes larger expenditures than it can or wishes to meet out of the proceeds of taxes or the sale of bonds paid for by the people out of actual savings. For example, the government prints money to pay war contractors.

Image result for image of inflationThe first effect of these expenditures is to raise the prices of supplies used in war and to put additional money into the hands of war contractors and their employees. The war contractors and their employees now have higher money incomes, which they can spend for goods and services they want. The sellers of these goods and services will be able
to raise their prices because of this increased demand. Those who have the increased money income will be willing to pay these higher prices rather than do without the goods; for they will have more money, and a dollar will have a smaller subjective value in the eyes of each of them.

So Group A (the war contractors and their employees) buys goods and services from Group B (those who produce those goods and services). Group B, as a result of higher sales and prices, will now buy more goods and services from Group C. Group C in turn will be able to raise its prices and will have more income to spend on group D. Okay, point taken. Circle of life. When the process has been completed, nearly everybody will have a higher income measured in terms of money. But (assuming that production of goods and services has not increased) prices of goods and services will have increased correspondingly; and the nation will be no richer than before.
This does not mean that everyone’s relative or absolute wealth and income will remain the same as before. The process of inflation will affect different groups to a greater or lesser extent. The first groups to receive the additional money will benefit most. The money incomes of Group A will have increased before prices have increased, so that they
will be able to buy almost a proportionate increase in goods. The money incomes of Group B will advance later, when prices have already increased somewhat; but Group B will also be better off in terms of goods. In the meantime, the groups that have still had no advance in their money incomes will find themselves forced to pay higher prices for the things they buy.

Let’s say we divide the community arbitrarily into four main groups of producers, A, B, C, and D, who get the money-income benefit of the inflation in that order. When the money incomes of Group A have already increased 30 percent, the prices of the things they [urchase have not yet increased at all. By the time money incomes of Group B have increased 20 percent, prices have still increased an average of only 10 percent. When money incomes of Group C have increased only 10 percent, however, prices have already gone up 15 percent. It gets worse. Although they money incomes of Group D have not yet increased, the average prices they have to pay for the things they buy have gone
up 20 percent.

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.

It may be that, if the inflation is brought to a halt after a few years, the final result will be an average increase of 25 percent in money incomes, and an average increase in prices of an equal amount, both of which are fairly distributed among all groups. This does not cancel out the gains and losses of the transition period. Group D even though its own incomes and prices have at last advanced 25 percent, will be able to buy only as much goods and services as before the inflation started. It will never compensate for its losses during the period when its income and prices were lagging.
Inflation turns out to be merely one more example of our central lesson. “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.”

It may indeed bring benefits for a short time to favored groups, but only at the expense of others. In the long run it brings disastrous consequences to the whole community. Even a relatively mild inflation distorts the structure of production, leading to the over-expansion of some industries at the expense of others in a misapplication and waste of capital. When the inflation collapses, or is brought to a halt, the misdirected capital investment—whether in the form of machines, factories, or office buildings—cannot
yield an adequate return and loses the greater part of its value.

Nor is it possible to bring inflation to a smooth and gentle stop in order to avert a subsequent depression. It is not even possible to halt an inflation, once embarked upon, at some preconceived point, or when prices have achieved a previously-agreed-upon level; for both political and economic forces will have got out of hand.

You cannot make an argument for a 25 percent advance in prices by inflation without
someone’s contending that the argument is twice as good for an advance of 50 percent, and someone else’s adding that it is four times as good for an advance of 100 percent. The political pressure groups that have benefited from the inflation will insist upon its continuance.

It is also impossible to control the value of money under inflation because the causation if not a merely mechanical one. You cannot say in advance that a 100 percent increase in the quantity of money will mean a 50 percent fall in the value of the monetary unit. The value of money depends on the subjective valuations of the people who hold it.

All this explains why, when super-inflation has once set in, the value of the monetary unit drops at a far faster rate than the quantity of money either is or can be increased. When this stage is reached, the disaster is nearly complete; and the scheme is bankrupt. Yet the ardor for inflation never dies. It would almost seem as if no country is capable of profiting from the experience of another and no generation of learning from the sufferings of its forbears. Each generation and country follows the same mirage. Each grasps for the same Dead Sea fruit that turns to dust and ashes in its mouth. For it is the nature of inflation to give birth to a thousand illusions.

In Hazlitt’s day as in our own, the most persistent argument put forward for inflation (uh, quantative easing) is that it will “get the wheels of industry turning” and save us from the irretrievable losses of stagnation and idleness, bringing “full employment.”

This argument in its cruder form rests on the immemorial confusion between money and real wealth.

It assumes new “purchasing power” is being created, and that the
effects of this new purchasing power multiply themselves in ever-widening
circles. Just look at the ripples!

The real purchasing power for goods consists of other goods. It cannot be wondrously increased merely by printing more pieces of paper called dollars. Fundamentally what happens in an exchange economy is that the things that A produces are exchanged for the things that B produces.

What inflation really does is to change the relationships of prices and costs. It is designed to raise the price of commodities in relation to wage rates and so restore business profits, by encouraging a resumption of output where idle resources exist, by restoring a workable relationship between prices and costs of production.

Historically this was done by a reduction in wage rates, but proponents of inflation believe that this is now politically impossible. Some go so far as to say reductions in wages are “anti-labor” or against the poor. Yet what they propose deceives labor by reducing real wage rates through an increase in prices. They disingenuously talk about paper money is if it were a form of wealth that can be created by will at the printing press.  They even solemnly discuss a “multiplier,” by which every dollar printed and spent by the
government becomes magically the equivalent of several dollars added to the wealth of the country. Like magicians, they divert attention from the real causes of any existing depression.

The real causes, Hazlitt said, are usually mal-adjustments 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 mal-adjustments are corrected can full production and
employment be resumed.

True, inflation may sometimes correct them; but it is a heady and dangerous method. It makes its corrections not openly and honestly, but by the use of illusion.

Hazlitt actually touched on the daylight savings time manipulation.

For inflation 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.

Economic reality is sometimes hard to understand. Who among us does not feel richer and prouder when we hear that our national income has doubled compared with some pre-inflationary period?

Inflation is the autosuggestion, the hypnotism, the anesthetic, that has dulled the pain of the operation for him. Inflation is the opium of the people.

Because inflation confuses everything is the reason “planned economy” governments resort to it. We saw in chapter 14, to take but one example, that the belief that public works necessarily create new jobs is false. If the money was raised by taxation, we saw, then for every dollar that the government spent on public works one less dollar
was spent by the taxpayers to meet their own wants, and for every public job created one private job was destroyed.
Suppose the public works were not paid for from the proceeds of  taxation? Suppose they are paid for by deficit financing—that is, from the proceeds of government borrowing or from resorting to the printing press? Then the result just described does not seem to take place. The public works seem to be created out of “new” purchasing power. You cannot say that the purchasing power has been taken away from the taxpayers. In the short-term, the nation seems to have got something for nothing.
Then we look at the long-term reality. The borrowing must someday be repaid. The government cannot keep piling up debt indefinitely. That leads to bankruptcy. As Adam Smith observed in 1776:

When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.

Of course, for government to repay the debt it has accumulated for public works or war or whatever, it must necessarily tax more heavily than it spends. When it is time to pay the piper, 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 incentives to production, and so reduces the total wealth and income of the country.
The only escape from this conclusion is to assume in true Keysenian form, that the politicians in power will spend money only in what would otherwise have been depressed or “deflationary” periods, and will promptly pay the debt off in what
would otherwise have been boom or “inflationary” periods.

This is a beguiling fiction, but unfortunately the politicians in power have never acted that way. Economic forecasting, moreover, is so precarious, and the political pressures at work are of such a nature, that governments are unlikely ever to act that way. Deficit spending, once embarked upon, creates powerful vested interests which demand its continuance under all conditions.

The country as a whole cannot get anything without paying for it. If no honest attempt is made to pay off the accumulated debt, and outright inflation is resorted to instead, then inflation becomes a form of taxation, which bears hardest on those least able to pay. Inflation is 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.
It can also 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, life insurance and retirement.

It is a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man.

Of course, that is assuming inflation affects everyone equally, which it rarely does. Some suffer more than others. The poor may be more heavily taxed by inflation, in percentage
terms, than the rich.

For 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.

Of course, like every other tax, inflation determines the individual and business policies we are all forced to follow. It discourages all prudence and thrift, encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce.

It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.

Posted February 9, 2017 by aurorawatcherak in economics, Uncategorized

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The Function of Profits   1 comment

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

Profit is the difference between the cost of production (including materials, wages, distribution and overhead) and the price at which the product can be sold at.

Profit is a dirty word according to many people today. This is because they don’t understand it. When Barack Obama said “I think there’s a point when you’ve made enough profit”, he showed his lack of understanding of the vital function profits play in our economy. Hazlitt invited his readers to review Chapter 14 on the price system, but to know he would be looking at it from a different angle.

Profits actually do not bulk large in our total economy. The net income of incorporated business in the fifteen years from 1929 to 1943, to take an illustrative figure, averaged less than 5 percent of the total national income. Yet “profits” are the form of income toward
which there is most hostility.

Image result for image of profitsThe average business in America makes about a 6% profit margin in 2016. Consider that we have the word “profiteer” to stigmatize those who make allegedly excessive profits, but there is no such word as “wageer”—or “losseer.” The profits of the owner of a barber shop may average much less than the salary of a movie star or the head of a Wall Street bank, but often they make less even than the average wage for skilled labor.

Hazlitt used a lot of examples from his own era that mean nothing to us today, but he pointed out that most entrepreneurs do not succeed in becoming rich, mainly because they tend to be too optimistic about their ability to succeed in business.

It is clear … that any individual placing venture capital runs a risk not only of earning no return but of losing his whole principal.

Governmental policy almost everywhere today tends to assume that production will go on automatically, regardless of what is done to discourage it. In Hazlitt’s day government price-fixing policies were a real concern.

Not only do these policies put one item after another out of production by leaving no incentive to make it, but their long-run effect is to prevent a balance of production
in accordance with the actual demands of consumers.

If the economy were free, demand would caused some branches of production to make what government officials would regard as “excessive” or “unreasonable” profits. That would prompt every in that industry to expand its production to the utmost and reinvest its profits in more machinery and more employment. It would also attract new investors and producers from everywhere, until production in that line was great enough to meet
demand, and the profits in it again fell to the general average level.

Image result for image of profitsIn a free economy, in which wages, costs, and prices are left to be set by the interaction of the competitive market, the prospect of profits decides what articles will be made, and in what quantities—and what articles will not be made at all. If there is no profit in making an article, it is a sign that the labor and capital devoted to its production are misdirected.

Profits function to channel the factors of production so as to apportion the 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.

Profits also function to put constant pressure on the head of every competitive business to introduce further economies and efficiencies. In good times he does this to increase his
profits further. In ordinary times he does it to keep ahead of his competitors. In bad times, he does it to maximize his chance of survival.

For profits may not only go to zero; they may quickly turn into losses; and a man will put forth greater efforts to save himself from ruin than he will merely to improve his position.

Profits, which result from the relationships of costs to prices, tell us which goods it is most economical to make, but also which are the most economical ways to make them.

A socialist system must answer these questions too. Every economic system must. The capitalist system has proven incomparably superior than others at obtaining this information.

Posted February 7, 2017 by aurorawatcherak in economics, Uncategorized

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Enough to Buy Back the Product   1 comment

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

Again, this is an extremely timely chapter written 50 years ago.

 

Amateur writers on economics are always asking for “just” prices and “just” wages. These nebulous conceptions of economic justice come down to us from medieval times. The classical economists worked out, instead, a different concept—the concept of functional prices and functional wages. Functional prices are those that encourage the largest volume of production and the largest volume of sales.

Functional wages are those that tend to bring about the highest volume
of employment and the largest payrolls. Oddly, the Marxists took over the concept of functational wages, which has then been promoted by their unconscious disciples, creating the “purchasing power” myth.

Image result for image of factory workerMarxist (socialists/central planners) insist that the only wages that will work to prevent an imminent economic crash are wages that enable labor to buy back the product it creates. They attribute every economic depression and recession to a preceding failure to pay wages that allowed this. And no matter the era they live in, they will insist that wages are still not high enough to buy back the product.

Unions use this argument all the time and quite effectively. They can’t persuade “wicked” employers to be “fair” and sometimes even the public doesn’t like their antics, but they know they can appeal to the public’s selfish motives and frighten it into forcing employers to grant their demands.

How are we to know, however, precisely when labor does have “enough to buy back the product”? Or when it has more than enough? How are we to determine just what the right sum is? As the champions of the doctrine do not seem to have made any clear effort
to answer such questions, we are obliged to try to find the answers for ourselves.

In theory the buy-back-the-product myth implies that workers in a given industry should receive enough income to buy back the particular product they make. So fast-fashion garment workers should be able to buy back the cheap clothes they make?

Image result for image of porscheIn Hazlitt’s time, the automobile industry’s union workers were already in the top third of the country’s wage earners. Their weekly wage, according to government figures, was 20 percent higher than the average wage paid in factories and nearly twice as great as the average paid in retail trade. Yet when Hazlitt wrote this book, they were demanding a 30 percent increase so that they might, according to one of their spokesmen, “bolster our fast-shrinking ability to absorb the goods which we have the capacity to produce.”

Dad would have said “bully for the car union workers”, but Mom would have pointed out that the average factory and retail worker couldn’t afford to buy the cars the auto union workers produced. Hazlitt estimated workers in those industries would require wage increases of 55 to 160 percent to give them as much per capita purchasing power as the automobile workers?

The argument that labor should receive enough to buy back the product is merely a special form of the general “purchasing power” argument. The workers’ wages, it is correctly enough contended, are the workers’ purchasing power. This neglects the fact that the grocer, landlord and even the employer must also have purchasing power to buy what others sell.

And one of the most important things for which others have to find purchasers is their labor services.

In an exchange economy everybody’s income is somebody else’s cost. An increase in wages must be compensated by an increase in productivity, otherwise, it becomes an increase in the cost of production, which increases prices. If government controls prices and forbids any price increase, then increases in the cost of production forces marginal producers out of the market, causing a shrinkage in production and a growth in unemployment.

Even where a price increase is possible, the higher price discourages buyers, shrinks the market, and also leads to unemployment. If a 30 percent increase in hourly wages all around the circle forces a 30 percent increase in prices, labor can buy no more of the product than it could at the beginning; and the merry-go-round must start all over again.

The problem is that we don’t think long-term. A 30 percent increase in wages can force a 30 percentage or greater increase in prices only over the long run. .If money and credit are so inelastic that they do not increase when wages are forced up, then the chief effect of forcing up wage rates will be to force unemployment. Total payrolls, both in dollar
amount and in real purchasing power, will be lower than before. For a drop in employment necessarily means that fewer goods are being produced for everyone.

And it is unlikely that labor will compensate for the absolute drop in production by getting a larger relative share of the production that is left.

The belief that the price increase would be substantially less than the increase in wages rests on two main fallacies.

The first looks only at the direct labor costs of a particular firm or industry and assumes these to represent all the labor costs involved. But this is the elementary error of mistaking a part for the whole. Each “industry” represents not only just one section of the productive process considered “horizontally,” but just one section of that process considered “vertically.” Thus the direct labor cost of making automobiles in the automobile factories themselves may be less than a third, say, of the total costs; and this may lead the incautious to conclude that a 30 percent increase in wages would lead to only a 10 percent increase, or less, in automobile prices.

This overlooks the indirect wage costs in the raw materials and purchased parts, in transportation charges, in new factories or new machine tools, or in the dealers’ markup.

Government estimates show that in the fifteen-year period from 1929 to 1943, inclusive, wages and salaries in the United States averaged 69 percent of the national income. These wages and salaries had to be paid out of the national product. While there would have to
be both deductions from this figure and additions to it to provide a fair estimate of “labor’s” income, we can assume on this basis that labor costs cannot be less than about two-thirds of total production costs and may run above three-quarters. If we take the lower of these two estimates, and assume also that dollar profit margins would be unchanged, it is clear that an increase of 30 percent in wage costs all around the circle would mean an increase of nearly 20 percent in prices.

But such a change would mean that the dollar profit margin, representing the income of investors, managers, and the self-employed, would then have, say, only 84 percent as much purchasing power as it had before. The long-run effect of this would be to cause a diminution of investment and new enterprise compared with what it would otherwise have been, and consequent transfers of men from the lower ranks of the self-employed to the higher ranks of wage earners, until the previous relationships had been approximately restored.

[T]his is only another way of saying that a 30 percent increase in wages under the conditions assumed would eventually mean also a 30 percent increase in prices.

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, followed by a reduction of production. If an
attempt is made to push prices below their equilibrium level, the consequent reduction of profits will mean a falling off of supply or new production. Therefore an 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 national product is not created or bought by manufacturing labor alone. It is bought by
everyone—by white collar workers, professional men, farmers, employers, big and little, by investors, grocers, butchers, owners of small drug stores, and gasoline stations—by everybody, in short, who contributes toward making the product.

As to the prices, wages, and profits that should determine the distribution of that product, 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.

By trying to run the economy for the benefit of restricted groups or classes, the central planners injure all groups, including the members of the very class for whose benefit they are trying to run it.

We must run the economy for everybody and that’s a highly complex calculation that has proven impossible time after time.

Posted February 6, 2017 by aurorawatcherak in Uncategorized

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Do Unions Really Raise Wages   1 comment

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.

Image result for image of union picket lineThis is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

This chapter is especially interesting to me because my father was a union organizer. I grew up serving coffee in the union meetings, listening to the other side of this argument. I have matured in my own understanding of unions over time. Lela

 

“The power of labor unions to raise wages over the long run and for the whole working population has been enormously exaggerated. This exaggeration is mainly the result of failure to recognize that wages are basically determined by labor productivity. It is for this reason, for example, that wages in the United States were incomparably higher than wages in England and Germany all during the decades when the “labor movement” in the latter two countries was far more advanced.”

Labor union leaders don’t agree with this, of course, and economic writers love to parrot them, as if they are experts. Hazlitt didn’t just rest his argument on assumptions. He provided reasoned analysis.

Image result for image of detroit shuttered factoriesNo, employers are not uniformly kind and generous folks eager to do what is right. They are, in fact, eager to increase their own profit to the maximum. “If people are willing to work for less that they are really worth to him, why should he not take the fullest advantage of this?” It makes sense for an employer to get $10 an hour’s worth of work out of a workman than to see a rival get $20 an hour’s worth of work out of him. “Thus, there is a tendency for employers to bid workers up to their full economic worth.”

In other words, the employer who really wants to succeed will pay his workers slightly more than the competition does because he knows he’ll get more value out of them.

This doesn’t mean that unions serve no useful of legitimate function. They assure their members get the true market value of their services. Hazlitt recognized the market 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, without the help of a union or a knowledge of “union rates,” may not know the true market value of his services to an employer.

Workers are in a much weaker bargaining position than an employer because mistakes of judgment are far more costly to him than to an employer. An employer merely loses the net profit he might have made from employing that one man out of a hundred or a thousand. A worker’s entire livelihood is involved. He can’t afford to be without work, so may take a job for less that what he knows is his “real worth” rather than face unemployment.

When an employer’s workers deal with him as a body, however, and set a known “standard wage” for a given class of work, they may help to equalize bargaining power and the risks involved in mistakes.

Government-mandated organizing unions that put compulsions solely on employers, such as seeking to fix wages above their real market work may create unemployment. We certainly saw this after Hazlitt’s time when Detroit began shedding auto manufacturing jobs.

Image result for image of real wagesUnions use many methods for making this possible. One of the most common is restricting membership of the union on some other basis than proven skill. This is done in a variety of ways. Nowadays the most common are arbitrary membership qualifications. In Hazlitt’s day these restrictions were based on religion, race or sex, but today’s Alaska IBEW has what the guys refer to as “the secret handshake”. If the BA doesn’t want you to work, you’ll be turned around by every company they dispatch you to. The employer doesn’t have to say why they rejected you. You weren’t a good fit. And, yes, the employers and the IBEW work together for this purpose because many of the employers were union hands, indoctrinated into the system and then given permission to become signatories to the union.

Unions also tend to resort to intimidation and force. The most obvious example of this is a strike.

A peaceful strike is possible. To the extent that it remains peaceful, it is a legitimate labor
weapon, even though it is one that should be used rarely and as a last resort. If his workers as a body withhold their labor, they may bring a stubborn employer, who has been underpaying them, to his senses. He may find that he is unable to replace these workers by workers equally good who are willing to accept the wage that the former have now
rejected.

Hazlitt considered pickets to be a form of union violence and intimidation. They are meant to prevent old workers from continuing at their jobs, or to prevent the
employer from hiring new permanent workers to take their places.

Their case becomes questionable. For the pickets are really being used, not primarily against the employer, but against other workers. These other workers are willing to take the jobs that the old employees have vacated, and at the wages that the old employees now reject. The fact proves that the other alternatives open to the new workers are not as
good as those that the old employees have refused. If, therefore, the old employees succeed by force in preventing new workers from taking their place, they prevent these new workers from choosing the best alternative open to them, and force them to take something worse. The strikers are therefore insisting on a position of privilege, and are using force to maintain this privileged position against other workers.

Hazlitt distinguished between the “strikebreaker” who is a professional thug or someone hired for a temporarily higher wage to keep a factory going until the striking workers can be frightened back to work at the old rates and the men and women who are looking for permanent jobs and are willing to accept them at the old rate.

[T]hey are workers who would be shoved into worse jobs than these in order to enable the striking workers to enjoy better ones. And this superior position for the old employees could continue to be maintained, in fact, only by the ever-present threat of force.

The use of emotional economics has created theories that reason could not justify. One of these is that labor is “underpaid” generally. That’s like saying grocery prices are chronically too low.

Another weird theory that makes no rational sense is that the interests of the nation’s workers are all identical and that an increase in the wages for one union somehow helps all other workers.

[T]he truth is that, if a particular union by coercion is able to enforce for its own members a wage substantially above the real market worth of their services, it will hurt all other workers as it hurts other members of the community.

Imagine a community with overly simplified numbers. There’s a half dozen groups of workers who are all paid equally and their product all as the same market value.

Let’s say these groups are:

  1. farm hands
  2. retail store workers
  3. workers in the clothing trades
  4. coal miners
  5. building workers, and
  6. railway employees.

Their wage rates, determined without any element of coercion, are not necessarily equal; but whatever they are, let us assign to each of them an original index number of 100 as a base. Now let us suppose that each group forms a national union and is able to enforce its demands in proportion not merely to its economic productivity but to its political power and strategic position. Suppose the result is that the farm hands are unable to raise their wages at all, that the retail store workers are able to get an increase of 10 percent, the clothing workers of 20 percent, the coal miners of 30 percent, the building trades of 40 percent, and the railroad employees of 50 percent.

Using these assumption, we can say the overall wages increased by 25 percent. For the sake of arithmetical simplicity, let’s say the price of the product that each group of workers makes rises by the same percentage as the increase in that group’s wages.

The cost of living has risen by an average of 25 percent. Yay!

Unless you’re a farm hand. The farm hands received no change in their monetary wages, so they are considerably worse off in regards to purchasing power.

The retail store workers got an increase in their monetary wages of 10 percent, but they are still worse off than before the race began. So are the garment workers who received a 20 percent increase in wages, which doesn’t match the 25% increase in prices.

The coal miners, with a money-wage increase of 30 percent, will have made a slight gain in purchasing power.

The building and railroad workers will of course have made a gain, but one much smaller in actuality than in appearance.

Of course, these calculations rest on the assumption that the forced increase in wages didn’t cause any unemployment.

This is likely to be true only if the increase in wages has been accompanied by an equivalent increase in money and bank credit; and even then it is improbable that such distortions in wage rates can be brought about without creating pockets of unemployment, particularly in the trades in which wages have advanced the most. If this corresponding monetary inflation does not occur, the forced wage advances will bring about widespread unemployment.

The situation cannot be rectified by providing unemployment relief, which is paid for out of the wages of those who work, thus reducing actual wages. As Hazlitt has previously demonstrated, adequate relief payments create unemployment through various means. When strong labor unions in the past made it their function to provide for their own unemployed members, they thought twice before demanding a wage that would cause
heavy unemployment. Now that the relief system is supported by taxes, the restraint on excessive union demands is no longer in force.

Moreover … “adequate” relief will cause some men not to seek work at all, and will cause others to consider that they are in effect being asked to work not for the wage offered, but
only for the difference between that wage and the relief payment.

High unemployment means fewer goods are produced, which makes the nation poorer overall. There is less for everybody.

Union leaders will sometimes attempt to answer this problem with a bit of magical thinking. It may be true, they will admit, that the members of strong unions today exploit, among non-unionized workers, but the remedy is to unionize everybody.

Problem solved. Let’s head home!

Of course, even in Hazlitt’s day when union membership was at its fullest, only about one-quarter of gainfully employed workers were unionized. That number is down to single digits now, though higher in the government sectors.

The conditions propitious to unionization are much more special than generally recognized. But even if universal unionization could be achieved, the unions could not possibly be equally powerful, any more than they are today. Some groups of workers are in a far better strategic position than others, either because of greater numbers, of the more essential nature of the product they make, of the greater dependence on their industry of other industries, or of their greater ability to use coercive methods.

But set that aside for a moment and just assume that “all workers by coercive methods could raise their wages by an equal percentage. How would anyone be better off in the long run, since the increase in wages would cause a concurrent increase in the cost of living?

An increase in wages is gained at the expense of the profits of employers. That’s the general assumption anyway, and may be the case for short periods or under special circumstances.

If wages are forced up in a particular firm, in such competition with others that it cannot raise its prices, the increase will come out of its profits. This is much less likely to happen, however, if the wage increase takes place throughout a whole industry. The industry will in most cases increase its prices and pass the wage increase along to consumers. As these are likely to consist for the most part of workers, they will simply have their real wages reduced by having to pay more for a particular product.

Hazlitt proposed that it is possible to imagine a case in which the profits in a whole industry are reduced without any corresponding reduction in employment, that somehow an increase in wage rates means a corresponding increase in payrolls, with the whole cost coming from the industry’s profits without throwing any firm out of business. Such a result is not likely, but Hazlitt found it remotely conceivable.

He used the railroads as an example. They cannot always pass increased wages along to the public in the form of higher rates, because government regulation will not permit
it, although Hazlitt noted that the railroads had laid off a lot of workers since they were unionized. He suggested we overlook actualities for the moment and talk as if we were discussing a hypothetical case.

It is possible for unions to make their gains in the short run at the expense of employers and investors. The investors put their liquid funds into the fixed assets of rails and freight cars. That investment is now trapped, so to speak, in one particular form. The railway unions may force them to accept smaller returns on this invested capital. It will pay the investors to continue running the railroad if they can earn anything at all above operating expenses, even if it is only one-tenth of 1 percent on their investment.

But there is an inevitable corollary of this. If the money that they have invested in railroads now yields less than money they can invest in other lines, the investors will not put a cent more into railroads. They may replace a few of the things that wear out first, to protect the small yield on their remaining capital; but in the long run they will not
even bother to replace items that fall into obsolescence or decay. If capital invested at home pays them less than that invested abroad, they will invest abroad. If they cannot find sufficient return anywhere to compensate them for their risk, they will cease to invest at all.

The exploitation of capital by labor can at best be merely temporary. It will come to an end by forcing marginal firms out of business entirely, increasing unemployment, and the forced readjustment of wages and profits to the point where the prospect of normal profits leads to a resumption of employment and production.

[A]s a result of the exploitation, unemployment and reduced production will have made everybody poorer. Even though labor for a time will have a greater relative share of the national income, the national income will fall absolutely; so that labor’s relative gains in these short periods may mean a Pyrrhic victory.

Unions may, for a time, be able to secure an increase in monetary wages for their members, partly at the expense of employers and non-unionized workers, but in the long run, the whole body of workers do not see an increase real wages at all.

Whoa, where is that topic being discussed today?

Remember, Hazlitt was talking about fallacies — economic delusions. One such fallacy is post hoc ergo propter hoc. The 20th century saw an enormous rise in wages in the last half century, primarily due to the growth of capital investment and scientific and technological advances. Those who don’t recognize the fallacy, ascribed this phenomenon to the unions because the unions were also growing during this period.

By considering only the short term benefit to a limited group of people (union workers), the advocates for this fallacy failed to trace the effects of this advance on employment,
production and the living costs of all workers, including those who forced the increase.

One may go further … and raise the question whether unions have not, in the long run and for the whole body of workers, actually prevented real wages from rising to the extent to
which they otherwise might have risen. They have certainly been a force working to hold down or to reduce wages if their effect, on net balance, has been to reduce labor productivity; and we may ask whether it has not been so.

Hazlitt praised the trade unions that had insisted upon standards to increase the level of skill and competence. My dad would have pointed to all the unions had done to protect the health of their members. Where labor was plentiful, individual employers often stood to gain 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. At times ignorant or shortsighted employers would 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.

As their power grew and the public became more tolerant of union violence, unions had begun to work against their own members. Hazlitt used the example of the shorter work week that started out as a health benefit that actually increased productivity, but that had become more of a gain for leisure that had affected both productivity and worker income.

But it is not only in reducing scheduled working hours that union policy has worked against productivity. That … is one of the least harmful ways in which it has done so; for the compensating gain, at least, has been clear. But many unions have insisted on rigid subdivisions of labor which have raised production costs and led to expensive
and ridiculous “jurisdictional” disputes. For example:

  • They have opposed payment on the basis of output or efficiency, and insisted on the same hourly rates for all their members regardless of differences in productivity.
  • They have insisted on promotion for seniority rather than for merit.
  • They have initiated deliberate slowdowns under the pretense of fighting “speedups.”
  • They have denounced, insisted upon the dismissal of, and sometimes cruelly beaten, men who turned out more work than their fellows.
  • They have opposed the introduction or improvement of machinery.
  • They have insisted on make-work rules to require more people or more time to perform a given task.
  • They have even insisted, with the threat of ruining employers, on the hiring of people who are not needed at all.

Most of these policies have been followed under the assumption that there is just a fixed amount of work to be done, a definite “job fund” which has to be spread over as many people and hours as possible so as not to use it up too soon. This assumption is utterly false.

There is no limit to the amount of work to be done because work creates work. What A produces constitutes the demand for what B produces. This false assumption and the union policies based on it have resulted in reduced productivity below what it would otherwise have been. Real wages have been reduced in the long run and for all workers. By real wages we mean what can be bought with what is earned. And we see the consequences of that in 2017

The real cause for the tremendous increase in real wages in the last half century (especially in America) has been, to repeat, the accumulation of capital and the enormous technological advance made possible by it. Reduction of the rate of increase in real wages is not, of course, a consequence inherent in the nature of unions. It has been the result of shortsighted policies. There is still time to change them.

Minimum Wage Laws   1 comment

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

Image result for image of minimum wage

Yes, Hazlitt foresaw the fight for $15. Arbitrary government attempts to raise wages through minimum wages has the same basic effects as price fixing for favored commodities. Most people don’t recognize that the same principles govern both. It’s a very emotional and political issue.

People who would be the first to deny that prosperity could be brought about by artificially boosting prices often advocate for minimum wage laws and to denounce opponents without misgivings.

The more ambitious such a law is, the larger the number of workers it attempts to cover, and the more it attempts to raise their wages, the more likely are its harmful effects to
exceed its good effects.

First consequences of a law that says no one may be paid less than $15 an hour is that no one who is worth less than $15 an hour will be employed. 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 of the moderate services that he is capable of rendering. By doing away with low wages, you increase unemployment. You do harm all around, with no comparable compensation.

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 as consumers may simply shift to a 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 will be benefited from the higher wage, others will be thrown out of employment altogether. 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.

Image result for image of minimum wage

Some people may argue that if X industry cannot exist without paying starvation wages, then it’s good that the minimum wage will drive it out of existence altogether. Let’s use the example of fast food. Workers will be replaced by robots. Consumers will suffer a loss of quality and the people who were working in the fast food field will now be unemployed with little prospect of finding another job. How do we know that? If they’d had alternative employment available that paid better than fast food, they would have already migrated into those industries. There is no escape from the conclusion that the minimum wage will increase unemployment.

So then they sit around on their butts at home, collecting government benefits, deprived of the independence and self-respect that comes from self-support. Some might suggest we can escape the consequences by offering “work relief ” instead of “home relief;” but we merely change the nature of the consequences. “Work relief ” means that we are paying the beneficiaries more than the open market would pay them for their efforts. Only part of their relief wage is for their efforts, while the rest is a disguised dole.

All this is not to argue that there is no way of raising wages … the apparently easy method of raising them by government fiat is the wrong way and the worst way. … What distinguishes the reformers from those who cannot accept their proposals is not their great philanthropy, but their greater impatience.

There are some facts to be considered.

  • We cannot distribute more wealth than is created.
  • We cannot pay labor as a whole more than it produces.

 

The remedy for low wages is to raise labor productivity so that the market can afford to pay higher wages.

 

How do you do that?

  • Increase capital accumulation by increasing the machines that help workers be more productive.
  • Introduce new inventions and improvements
  • Introduce more efficient management on the part of employers.
  • Give workers better education and training, so as to improve their efficiency.

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.

By the way, there is now evidence showing the results of Seattle’s minimum wage increase to $15 an hour and it’s not good news for low-skilled workers.

Posted February 3, 2017 by aurorawatcherak in economics

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Government Price-Fixing   1 comment

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.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

Hazlitt had touched briefly on the effects of government efforts to fix commodities prices above free-market levels. Now he turned his attention to some of the results to hold commodities levels below their natural market levels.

Hazlitt admitted that this had been common during the War and asked his readers to just set the wartime economy aside and consider the wisdom of continuing this practice long after the war is over.

Consider, he asked, when the government tries to keep the price of a single commodity, or small group of commodities, below the price set by a free competitive market.

When the government tries to fix maximum prices for only a few items, it usually chooses certain basic necessities, on the ground that it is most essential that the poor be able to obtain these at a “reasonable” cost.

He chose bread, milk, and meat as examples, but we could just as easily use New York City apartment rentals.

Image result for image of government price fixing

The argument goes something like this — if we leave beef (milk, bread) 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.

Hazlitt noted how inconsistent this argument was because it relied on need rather than purchasing power. Why charge for beef (milk, bread) at all? Why not just give it away?

Schemes for maximum price-fixing usually begin as efforts to “keep the cost of living from rising.” 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.

Image result for image of government price fixingWe must assume that the purchasing power in the hands of the public is greater than the supply of goods available, and that prices are being held down by the government below the levels to which a free market would put them. Now we cannot hold the price of any commodity below its market level without in time encountering two consequences. When something is cheaper, people are both tempted to buy, and can afford to buy, more
of it. The second consequence is reduction in the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. Additionally, production of that commodity is discouraged. Profit margins are
reduced or wiped out. The marginal producers are driven out of business. Even the most efficient producers may be called upon to turn out their product at a loss, which happened during the War when slaughterhouses were required by the Office of Price Administration to slaughter and process meat for less than the cost of cattle on the hoof and the labor of slaughter and processing.

The consequence of fixing a maximum price for a particular commodity would be to bring about a shortage of that commodity, but this is the opposite of what the government regulators originally wanted to do. They wanted to keep those commodities in abundant supply, but when their policy limits the wages and profits of those who make these commodities, without also limiting the wages and profits of those who make other items, they discourage the production of the price-controlled necessities while they relatively stimulate the production of less essential goods. Some of these consequences in time become apparent to the regulators, who then adopt various other devices and controls in an attempt to avert the consequences of their price controls. Among these devices are rationing, cost-control, subsidies, and universal price-fixing.

Image result for image of government price fixingWhen it becomes obvious that a shortage of some commodity is developing as a result of a price fixed below the market, rich consumers are accused of taking “more than their fair share;” or, if it is a raw material that enters into manufacture, individual firms are accused of “hoarding” it. The government then adopts a set of rules concerning who shall have priority in buying that commodity, or to whom and in what quantities it shall be allocated, or how it shall be rationed. If a rationing system is adopted, it means that each consumer
can have only a certain maximum supply, no matter how much he is willing to pay for more.

If a rationing system is adopted, it means that the government adopts a double price system, or a dual currency system, in which each consumer must have a certain number of coupons or “points” in addition to a given amount of ordinary money. In other words, the government tries to do through rationing part of the job that a free market would have done through prices. The effect is only partial because rationing merely limits the demand without also stimulating the supply, as a higher price would have done.
The government might try to assure supply through extending its control over the costs of production of a commodity. To hold down the retail price of beef, for example, it may fix the wholesale price of beef, the slaughterhouse price of beef, the price of live cattle, the
price of feed, and the wages of farmhands. To hold down the delivered price of milk, it may try to fix the wages of milk-wagon drivers, the price of containers, the farm price of milk, the price of feedstuffs. To fix the price of bread, it may fix the wages in bakeries, the price of flour, the profits of millers, the price of wheat, and so on.

As the government extends this price-fixing backwards, the consequences that originall drove them to this course also extend backward. Assuming that it has the courage to fix these costs, and is able to enforce its decisions, then it creates shortages of the various factors—labor, feed stuffs, wheat, or whatever—that enter into the production of the final commodities. The government is driven to controls in ever-widening circles, and the final consequence will be the same as that of universal price-fixing.

Recognizing that the attempt to keep the price of milk or butter below the level of the market might cause a shortage because of lower wages or reduced profit margins on the production of milk, the government may attempt to compensate for this by paying a subsidy to the milk and butter producers. Of course, this really subsidizes the consumers. The producers are not getting more for their milk and butter than if they had been allowed to charge the free market price in the first place, but consumers are getting their milk and butter at below the free market price. Those with the most purchasing power will buy the most of it, so they are being subsidized more than those with less purchasing power. Tax collectors will, in effect, but subsidizing themselves in their role of consumers.

There is no such thing as a free lunch, so while price-fixing may often appear for a short period to be successful, it eventually leads to demand chronically in excess of supply. If we ration one commodity, and the public cannot get enough of it, though it still has excess purchasing power, it will turn to some substitute. The rationing of each commodity as it grows scarce, in other words, must put more and more pressure on the unrationed commodities that remain.

The natural consequence of a thoroughgoing overall price control which seeks to perpetuate a given historic price level, in brief, must ultimately be a completely regimented economy. Wages would have to be held down as rigidly as prices. Labor would have to be rationed as ruthlessly as raw materials. The end result would be that the government would not only tell each consumer precisely how much of each commodity he could have; it would tell each manufacturer precisely what quantity of each raw material he could have and what quantity of labor.

Of course, this leads to a black market that will meet the needs of the public by end-running the errors of the bureaucrats. This was common in Europe during and after World War 2. In some countries the black market kept growing at the expense of the
legally recognized fixed-price market until the former became, in effect, the market.

By nominally keeping the price ceilings, … the politicians in power tried to show that their hearts, if not their enforcement squads, were in the right place.

There were consequences to this as well. During the transition period, the large, long-established firms, with a heavy capital investment and a great dependence upon the retention of public goodwill, are forced to restrict or discontinue production. Their place is taken by fly-bynight concerns with little capital and little accumulated experience in
production. These new firms are inefficient compared with those they displace; they turn out inferior and dishonest goods at much higher production costs than the older concerns would have required for continuing to turn out their former goods. A premium is put on dishonesty. The new firms owe their very existence or growth to the fact that they are willing to violate the law; their customers conspire with them; and as a natural consequence demoralization spreads into all business practices.

What lies at the base of the whole effort to fix maximum prices?

There is a misunderstanding of what causes prices to rise. The real cause is either a scarcity of goods or a surplus of money. Legal price ceilings cannot cure either — they merely intensify the shortage of goods. Price-fixing, like all the other government controls Hazlitt looked at, are the result of thinking only of the interests of the consumers immediately concerned and forgetting the interests of the producers. It is the same problem as existed with tariffs and subsidies, just in reverse.

The political support for such policies springs from a similar confusion in the public mind. People do not want to pay more for milk, butter, shoes, furniture, rent, theater tickets, or diamonds. Whenever any of these items rises above its previous level the consumer
becomes indignant, and feels that he is being rooked. The only exception is the item he makes himself: here he understands and appreciates the reason for the rise. But he is always likely to regard his own business as in some way an exception. He can see the inequity in holding down the price of what he produces, but not of what he consumes. Just as every manufacturer wants a higher price for his particular product, so each worker wants a higher wage. Each can see as producer that price control is restricting production in his line, but they don’t see it applying to other products.

Each one of us …has a multiple economic personality. Each one of us is producer, taxpayer, consumer. The policies he advocates depend upon the particular aspect under which he thinks of himself at the moment. For he is sometimes Dr. Jekyll and sometimes Mr. Hyde. 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. But the overwhelming majority will be deceiving themselves. For not only must there be at least as much loss as gain from this political manipulation of prices; there must be a great deal more loss than gain, because price-fixing discourages and disrupts employment and production.

Posted February 2, 2017 by aurorawatcherak in economics

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