Economics in One Lesson

9/19/2020

Henry Hazlitt’s Economics in One Lesson was published at the heels of WWII shortly after Friedrich Hayek’s The Road to Serfdom and not long before Milton Friedman’s Capitalism and Freedom. In this book, Hazlitt extends the argument for the freeing of markets from government intervention. The promised lesson of the book, inspired by Frédéric Bastiat’s Broken Window parable from 1850, is that all economic debates arise from diverging views on the consequences of economic policies in one or both of two ways. Debates arise either when economic policy is considered only in its effects on a particular group while ignoring all groups actually involved or when its effects are considered only in the short run while ignoring the long run.

Hazlitt applies this lesson throughout the book to address fallacy-ridden topics. Barring a few expository chapters, the core of this work covers four overlapping themes distinct enough to be categorized. The first is taxation, a certain degree of which is needed for proper governance. Make-work policies, subsidies, and price-fixing are the remaining three. They involve more direct government intervention and thus complex side-effects on which this book focuses. Hazlitt closes with a discussion of savings and inflation which adds a layer of complexity to the policies considered.

To intervene in markets (and disappoint Hazlitt), governments must spend money. To spend this money, governments must first raise it. And to raise it, governments must tax the citizenry. For this reason, Hazlitt addresses taxes at the outset where he introduces the mother of all fallacies as the belief that government spending will cure most economic ills and that citizens owe this public spending to themselves. Conceding to a necessary yet limited level of taxation, Hazlitt argues that a high tax disincentivizes laborers from laboring and producers from producing because it forces them to share their wages and profits, respectively. This in turn hinders improvements in production, meaning prices are kept higher and productivity is kept lower than they would have been otherwise. All this then holds down real wages and people’s standard of living.

“Make-work” policies are the first of the three direct government interventions that Hazlitt addresses. Usually at the prodding of labor unions, governments will be inclined to protect workers from the machines that steal their jobs and from perceived limitations in job opportunities. Governments can protect laborers from such fears implicitly by conceding to unions and suppressing the adoption of technology. But they can just as well do so explicitly by enforcing regulations that spread existing work among a larger number of people (think: shorter workweeks) or by maintaining large numbers of government employees regardless of the need for them. While he admits that there are indeed great human losses to be managed when technology makes workers redundant, Hazlitt argues that production and real wages are held down when we hinder the efficient operation of business, that production not employment must be targeted by policy, and that full employment is not a worthy goal for developed nations, but an ailment for developing ones. He dedicates a special chapter to this “fetish” of full employment and thus concludes this section on the fallacies of limited work.

Subsidies in their various forms are the second type of direct government intervention Hazlitt discusses. Just as make-work policies look only at the laborers directly involved and ignore the long-term consequences of inefficiencies in production, Hazlitt argues that subsidies directed at one industry are also shortsighted. They impose immediate harm on other unsubsidized industries, they deprive consumers of their purchasing power, and they tamper with the natural tendencies of production, introducing inefficiencies and in the long run hurting everyone’s standard of living. Subsidies translate to taxes whether they are intended to protect certain industries from failure or to bring non-existent industries to life and whether they take the form of tariffs (restricting imports or foreign competition), a drive for exports, or parity prices (price floors to help an industry). Thus, Hazlitt invokes his original argument against taxes and closes this set of chapters on subsidies with a special chapter on the price system that lays out the market’s natural tendency to arrange itself without the need for central planning.

Policies aimed at fixing prices are the final type of intervention that Hazlitt addresses. Compared to make-work policies that attempt to improve life for laborers, or the subsidies discussed above that make market conditions better for producers, price-fixing (which targeted subsidies may bring about) is more versatile. It can be used to make life easier for laborers, producers, or even consumers. Of course, depending on how it is used, price-fixing helps one group while hurting another and might work in the short run before it becomes a menace in the long run.

Prices of goods or, say, housing rents can be fixed at artificially low levels guaranteeing more affordable goods and houses for consumers. But by forcing low prices, we fail to recognize that demand will surge while a producer's marginal profits fall. This will lead to a supply shortage as some producers are forced out of business.[1] Besides disrupting production and thus employment, a shortage will tempt governments to react with yet more policies: rations (supply cuts) that are useful in wartime, subsidies discussed above, and universal price-fixing where governments get even more involved by controlling supply chains (vertically) or by controlling competition and substitutes (horizontally). The same argument applies to housing rents although the effects there take longer to be noticed. What is unique about housing is that instead of being forced out of business due to low profits, landlords simply cease to improve or maintain rent-controlled properties and so housing quality deteriorates. Governments then get tempted to step in, building or improving low-rent housing, and we thus return to Hazlitt's original argument against taxes.

Prices can also be fixed at artificially high levels guaranteeing higher profits for producers (see parity prices above). However, to repeat, what we ignore here is that consumers' purchasing power falls when prices are set too high and output is restricted. Furthermore, seeing that wages represent the price of one's employment, artificially high (minimum) wages guarantee workers higher incomes. Unions might insist on artificially higher wages or for each laborer to receive a high enough wage "to buy back" what they produce. But supposing unions are successful and their members irreplaceable, the resulting higher cost of production harks back to previous arguments: diminished profits drive out marginal producers, hurting output, employment, and everyone's standard of living.

Having thus established the dangers of tampering with free-market prices, Hazlitt closes with one final general lesson on profits. Free-moving prices and thus profits are the surest way to maximize the production of goods in demand thereby relieving shortages where it makes sense to do so. For enterprise always leaves behind winners as well as losers.

Throwing a veil of illusion over every process Hazlitt outlines is inflation. Because it is commonly achieved through targeted government spending, it might help the targetted group by incentivizing them to set higher prices. But high prices then spread through the economy, raising everyone's cost of living without raising their incomes and therefore leaving them worse off. Again with the central lesson of the book. Perhaps if inflation is short-lived, it will indeed raise prices as well as incomes. But the losses to the downstream groups (typically consumers) during the transitionary period will not be compensated. [Minsky addresses this point, saying let's try it anyway and see what happens.]

Regardless of how it is achieved, inflation is mainly used to raise prices relative to wages and thus spur business profits where idle resources exist. The policy alternative of course is to reduce wages but that is politically impossible. The problem is often maladjustment between wages, costs, and prices that disincentivizes production. The average person--who confuses money with wealth or supposes their purchasing power is deficient--is happy receiving more money. They do not realize, however, that such deficit spending sows the seeds of communism by requiring increased central planning. They do not realize that inflation is tantamount to a nationwide tax. And they do not realize that rising price expectations are an upward spiral that motivates squandering, speculation, and reckless waste.[2]

Using Bastiat's example of the spendthrift Alvin who consumes and the frugal Benjamin who invests, Hazlitt points to the misperceived equivalence between spenders and savers in driving economic activity. There are two major arguments against saving that are based on misperceptions. First, hoarding (refusing to spend) during a downturn is perceived as harmful saving whereas it is an effect not a cause of depression. Second, saving is acknowledged to cause an increase in production, but it is perceived to restrain consumption. This is only partly true, Hazlitt argues, because despite restrained consumption (i.e. despite saving), an increase in production implies an increase also in the absolute amount consumed.

Hazlitt closes the savings discussion with two additional fallacies. First, he says, savings are erroneously distinguished from investment. When savings exceed investment, this false distinction leads policymakers to invent unnecessary projects and provide employment. And when savings fall short of investment, this false distinction leads policymakers to implement "cheap money" policies that create the illusion of available capital. This "tampering with" interest rates to keep them artificially low is done by injecting currency into banks [which today is known as quantitative easing]. Second, he discusses the fallacy of "economic maturity." There is no such maturity, he implores. Capital will always be needed in production so long as the unit cost of production is not zero. And capital will always be needed to improve the quality if not the quantity of things like houses (a consumer's durable good) or machines and factories (capital proper). And then again, on a global scale, only when all countries in the world enjoy the same quality of goods and services will capital seize to be needed.

Hazlitt restates his central lesson highlighting the common sense in Adam Smith's hands-off approach. He reminds readers of William Graham Sumner's "forgotten man," the taxpayer whom the policymaker calls upon to address the problems of society. In the 1978 edition of the book, Hazlitt reflects on the state of the world in the 32 years following his original publication. He criticizes Keynes and Keynsians by name (which he had refrained from doing in the original work) and points out that no one learned the lesson on the benefits of small government. The money supply and hence prices had risen dramatically and large welfare programs were introduced. Taxes had become egregiously high and government intervention had become unsustainable. Before closing the book with a list of books for further reading, Hazlitt suggests that his lesson though not implemented has indeed been recognized. [Some thirty-odd years after it was first published, his lesson was finally applied by Thatcher and Reagan who soon embarked on their programs of deregulation and privatization.]

Extras:

• Drawing heavily on the early work of Adam Smith, Hazlitt places himself among contemporary free-market thinkers such as Friedrich Hayek and Milton Freidman.

• Both Hayek and Hazlitt see wartime as one of the circumstances when gov spending is justified.

• In terms of constraints, all these chapters argue that work is unlimited while capital, land, labor, and time are indeed limited and hence should not be directed except freely. Hence Hazlitt repeats many times that it is no challenge to achieve full employment.

• It is worth mentioning Hazlitt’s strong opinions on bureaucrats. He sees no difference between them and parasites or thieves for their needless draining of taxpayer money. (Response to purchasing power argument).

• Defends speculators as the farmer's best friend and "essential to his best welfare."

• Most of the arguments here assume perfect competition and substitutability. The American economy today looks far from being in perfect competition. Contrast this work with Minsky's.

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[1] But Hazlitt also mentions that more profitable producers operating on wider profit margins will soon sweep in to replace the producers who go out of business due to the price ceiling. I am not so sure Hazlitt's argument holds here.

[2] This is an old book. Current deficit spending under COVID pressures and the debate marked by MMT enthusiasts would probably not have pleased Hazlitt. I also don't see what his policy recommendation is. Is this just a rant? What does one do instead? Set a zero inflation target?