Table of Contents
- Chapter 1: The Lesson
- Chapter 2 – The Broken Window
- Chapter 3 – The Blessings of Destruction
- Chapter 4 – Public Works mean Taxes
- Chapter 5 – Taxes Discourage Production
- Chapter 6 – Credit Diverts Production
- Chapter 7 – The Curse of Machinery
- Chapter 8 – Spread-The-Work Schemes
- Chapter 9 – Disbanding Troops and Bureaucrats
- Chapter 10 – The Fetish of Full Employment
- Chapter 11 – Who’s ‘Protected’ by Tariffs?
- Chapter 12 – The Drive for Exports
- Chapter 13 – ‘Parity’ Prices
- Chapter 14 – Saving the X industry
- Chapter 15 – How the Price System Works
- Chapter 16 – ‘Stabilizing’ Commodities
- Chapter 17 – Government Price-Fixing
- Chapter 18 – What Rent Control Does
- Chapter 19– Minimum Wage Laws
- Chapter 20 – Do Unions Really Raise Wages?
- Chapter 21 – ‘Enough to Buy Back the Product’
- Chapter 22 – The Function of Profits
- Chapter 23 – The Mirage of Inflation
- Chapter 24 – The Assault on Saving
- Chapter 25 – The Lesson Restated
- Chapter 26 – Lesson after thirty years
Henry Hazlitt’s Economics in One Lesson is an eye opener on a number of different issues and questions that form part of our daily life – What is the effect of taxes? Do unions really help workers? Are protective tariffs really helping our economy? What is the effect of Rent control? – and many more.
Economics in One Lesson is that one book that should be taught in schools and I wish I had come across this book earlier in my life. The author starts from a simple and basic premise, his only lesson in the book – The merits or demerits of an economic policy cannot be determined by looking at a small part of the population or for a very small period of time (or as is often the practice – immediately after the policy comes in force).
Written back in 1946, it is almost prophetic in tone when it warns one of the sure ruin that is to follow if basics laws of economics and of common sense are ignored – That what is not created cannot be consumed (or distributed), that economy is not a machine where induvial parts can be tinkered with without affecting the entire system.
Henry Hazlitt even has a section at the end on “Lesson after Thirty Years” where he mourns that none of his lessons were taken heed of and where it has led the American and the world economy. The world economy today is increasingly funded through debt and governments around the world have not heeded to calls for fiscal prudence, instead choosing to widen the fiscal deficits with their acts while talking of reducing it.
But coming back to the Economics in One Lesson, the more general suggestion to policy makers and to public is that there are no economic miracles. Money cannot be created out of thin air and anyone who promises to do so is merely swindling Peter to benefit Paul.
When A raises a demand for subsidies, what he means that someone else should be taxed, often against their will, so that he can have the goods for less that what it’s really worth. When lobbyists lobby for protective tariffs to save the domestic industry, what they essentially mean that the regular consumers should pay more for goods because the industries wouldn’t buckle up and face the competition.
Economics for me is simply a collection of some basic rules – People respond to incentives, Every action has a cost, and every decision has an opportunity cost that represents what we lost when we choose what we choose – and in reading Economics In One Lesson I was reminded of these basic laws and how they cannot be evaded. Someone has to pay the bill and if you feel no one is paying it, you have not really looked around carefully.
As we enter into a new year and a new decade an economic slowdown seems eminent and so is the anxiety around it. While the efforts to tackle it are yet to be seen, it is a good time for us to realize where we’re coming from and how we got here. We need to identify the mistakes that altruistic governments and individuals preach rather than blame economic necessities like “profit” for it. Reading Economics in One Lesson is an essential part of the training for us to demand greater accountability from our governments and to avoid future mishaps.
Chapter 1: The Lesson
- Economic ideas are full of fallacies and these ideas are usually prompted by groups with special interest who would either promote the idea relentlessly or obscure the reality around it so that it cannot be analyzed anymore.
- Men tend to see only the immediate effects of a given policy, or its effects only on a special/specific group and neglect inquiring the long-term effects of that policy on a whole, and not just on a specific group.
- A good economist looks not only at what is immediate but what list at a distance; he enquires not only about a single group but also about effects on all the groups.
- The 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.” #quote
- Classical economists tend to look at long-term consequences ignoring the immediate benefits; or the consequences on entire community and ignoring the effect on the few.
- The ‘new’ economists concentrate on the ‘short-term’ benefits and thus consider themselves revolutionary, as they are not ignoring short-term benefits in favor of long-term effects.
- The ‘new’ economists are more effective in crafting a narrative, since their narrative involves immediate visible effects, the target of their theories are special groups as opposed to economy as a whole.
Chapter 2 – The Broken Window
- People are mesmerized by the benefits of a broken window, and the money spent on repairing it, as the window and the glazier are visible parties in the transaction.
- However, in absence of a broken window, the baker might have instead paid to stitch a new suit and since the suit was not created, the people analyzing this with a short-term lens do not get to look at the suit that was never made or the tailor who was never employed.
Chapter 3 – The Blessings of Destruction
- Need should not be confused with demand.
- People who have their house destroyed in a war, or a baker who has his window broken, need to make the repairs and thus the economic activity that results from their actions is not indicative of growth in demand but a temporary diversion in demand, due to the paramountcy of needs.
- This resultant demand (which actually is just need) will shrink after the needs are met. The funds that go towards fulfilling towards the pressing needs are temporary and come at the expense of other industries whose demand has shrunk because people ‘need’ something else. These do not lead to long-term prosperity.
- Prosperity should not be measures in terms of demand (which has hidden component of need in it) but in terms of purchasing power. Wars reduce the purchasing power and erode wealth.
- Post-war periods experience ‘backed-up demand’ in certain sectors/industries and this can give an illusion of increased demand. However, this backed up demand is accompanied by fall in purchasing power.
- Wars, in short, change the post-war direction of effort and the balance of industries. Industries that grow in post war era will shrink when the needs are met and, in some case, this artificial shrinking and swelling may result in wiping out industries in total.
- Supply and demand are two sides of a coin. A farmer creates wheat to buy automobiles and people creating automobiles demand wheat. This relation is obscured by the presence of money.
- Mere inflation i.e. mere issuance of more money, with the consequence of higher wages and prices may look like creation of more demand but it really is not.
- Similarly, a fall in post-war demand may be concealed by higher money wages that are more than offset by higher prices.
- Post-war demand in most countries, will shrink in absolute amount as compared to pre-war demand because post-war supply will have shrunk.
- If a war destroys all the cities, all the capital goods and consumer goods in a country, it would reduce purchasing power and then the benefits of a war (that come in play in a limited destruction scenario) would not even exist in any sense even though national incomes would have risen.
Chapter 4 – Public Works mean Taxes
- A certain limited amount of public works is necessary and part of the government’s mandate (like maintaining public infrastructure, staffing personnel), but any Public works beyond this should be seen clearly as Taxation.
- When a bridge is constructed to ‘create jobs’, then the question is not if we need a bridge but where we can build a bridge. This leads to a lot of wastage of resources.
- To pay for such unwanted public works, taxes need to be raised and these taxes hurt the private enterprise and this leads to either loss of productivity or the private enterprises can’t grow, leading to lesser private employment, which further increase the need for public works for employment.
- This effect is largely unnoticed by public because we can see a bridge that has been built using a million dollars (even if we did not necessarily need it), but we cannot see the jobs that could have been created by private enterprise using this one million dollars that were taken from them.
- This fallacy of chasing tangible benefits, in lieu of real benefits, leads to greater taxation and consequently inflation, since the money for these projects must be paid eventually, either directly from taxes or from debt, which again would have to be paid using taxes.
Chapter 5 – Taxes Discourage Production
- A tax rate of 25% effectively means that if you earn a dollar, you gain only 75 cents from it, but if you lose a dollar, you still lose full one hundred cents that form it. This effectively disincentivizes risk. Everyone wants to play safe.
- This eventually reduces the efficiency in the economy. People no longer wish to invest in an effort to boost production and hence employ more people. This leads to stagnation in the economy.
- Moreover, taxation is presented as a case where money merely is moved from one part of the economy to the other without any tangible loss to anyone. In reality however, one part of the economy/society gains from the loss of others and this transfer is not voluntary.
- A certain amount of taxes is necessary and does not hurt the private enterprise because these taxes are used for purposes which safeguard the private enterprise (like police, roads etc.).
Chapter 6 – Credit Diverts Production
- Government credit and loans make sense only as long as you look at the recipient of the loans. Loans are essentially debt and to supply people with debt is to put them under servitude.
- Private lenders lend money, but government complains that they don’t give enough credit, or to enough people or at appropriate interest rate. Private lenders do so, primarily, because they are motivated by profit and responsibly for the funds that they give out.
- The government on the other hand can’t operate by same standards. It instead aims to provide credit to those, who the private sector does not deem worthy of. An important point to note is why is private sector reluctant to lend to them – because they are not sure if the loans will be repaid.
- Now if government decides to lend to these people, it’s not just providing credits to those who were deprived of it earlier. Since money can’t be created out of thin air, the funds used and given to these lenders is taken from the ones who would otherwise have received them. These deprived people are actually the ones that have a demonstrated record of production and social standing; hence they are considered favorably for the loans. By funding the less productive at the cost of more productive members of the society, government hurts production. Moreover, when money is lent to buy farm, tractor etc., what is lent is not just money but the commodities. The number of tractors up for sale is limited. If a less productive member is given access to the tractor, then by definition, a more productive member is deprived of it.
This metric does not consider the people who are deprived of credit because of social issues and bias. In such a case, isn’t it the moral imperative of the society and consequently of the government to look after the ones left behind, even if it hurts others in the short run? A counter however can be made as to how will such a scenario be judged and if we sanction hurting members who are considered productive over lesser productive members, where do we draw the line?
- Another important point to note is that Credit is not something that a banker gives to an individual. Credit is the ability to payback a sum borrowed and is earned through frugality and hard work. A man has credit or is considered worthy of credit when he has marketable assets and a reputation. These things can’t be given to a man, he possesses them in his own right.
- Coming back to the point of government funding, it aims to find those whom private entities consider a risk. Therefore, what we’re asking for is that bureaucrats use public funds to find those who private sector would because of the risk. This would either lead to favoritism and inefficiency in the system as less productive members are intentionally being funded. In the flip side that these individuals turn profit, a case can be made that government deserves a slice from their profits since it’s the one funding them. This would eventually lead to socialism and death of capitalism.
- Private lenders lend money that is their own or has been entrusted to them. They are therefore more likely to scrutinize the recipients of loans and make better loans than government which gets its money by taking it from the people. The money that they could have invested productively, but instead have to give and for use by the government. This obviously hurts production in the economy.
This brings us back to the point mentioned earlier, by helping a certain group in the short term, the society as a whole suffers in the long run.
- An important point to note and to remember is that government aid to anyone can be simply states as government taxing the successful ventures and individuals to help the unsuccessful and the inefficient.
Chapter 7 – The Curse of Machinery
- Machines and technological improvements are often times blamed for and seen as a source of unemployment. But various historical cases prove that while machines destroy existing jobs, the improvements due to them cause greater Employment as industries become more efficient, flourish and hire more people.
- During the great depression of 1930s the same folly was repeated by a group that called itself the technocrats. These arguments led to absurd make-believe rules by unions which were preposterous in nature. Such as having a stand-in orchestra in places where only phonograph records were needed.
- Whenever machines replace human labor, they will create more employment for the labor that creates the machines. Secondly, if the machines actually help produce more and causes lesser demand for labor thereby saving labour and the cost associated with it, it’s not the end of the cycle.
- The profits generated from this reduction of labor will be used by the capitalist in either of the three ways: In expansion of his factory, investing in some other industry or boosting his personal consumption. In every case, the money saved leads to new employment and money makes its way back into the economy and the pocket of the workers.
- A secondary effect is that once one player adopts machines, others will too. This will either lead to the expansion of the industry as needs of more consumers can be fulfilled, leading to greater employment or even if the demand does not increase and industry does not expand, there will still be a drop in prices due to the competition and this will lead to savings for the consumers. That money will boost demand somewhere else.
- Machines and technological improvements give rise to new industries that employ more people. They also lead to better products, but the job of machines and technological advancements is not to provide employment but to improve the standard of living. An industrialized nation will have people working less hard, but working better jobs, with more time for leisure. Moreover, without the machines, we would not have been able to sustain the population levels that we have. Machines make this world possible; they open up and support new possibilities that we humans would not have had just on our own.
- The primary function of machines is and always will only be either to raise production (and thereby reduce prices) or to improve productivity of workers (leading to higher wages).
- An important side note here is that while classical economists looked at second order effects and the long-term implications of a policy decision, one should not forget the immediate costs. A worker losing his job, because market no longer values his skill, his investment in himself, is a real tragedy, one that must not be overlooked. Efforts should be made to help him, but the consideration should not make us myopic and we should not focus just on him.
Chapter 8 – Spread-The-Work Schemes
- Spread-the-work schemes imagine that existing work can be spread among more participants so than more people are employed. They do this by making stupid rules through the unions that may force the hand of the industry. This leads to two outcomes and both hurt the workers.
- In the first case, workers will work less hours and the remaining work will have to by picked up by other workers who would otherwise have gone unemployed. But by reducing the work week/hours, the already employed are sacrificing their employment and the potential wages that would have arisen out of it to subsidize the others who did not have a job but now do.
- The other possible option is that even though the workers work less, they get a higher pay to compensate for the loss of working hours and subsequently the income from those hours. In case the industry has the margin to afford so, this step could have been implemented without spreading the work and that could have led to greater incomes. Or if the industry can’t afford to pay the higher margin, they will inevitably have to fire the less efficient workers, the less efficient firms will also get shut down and on a whole, unemployment will increase and not decrease as hoped.
Chapter 9 – Disbanding Troops and Bureaucrats
- Disbanding extra troops after a war or getting rid of extra bureaucrats is sometimes avoided by giving the argument that this will hurt their purchasing power and thus of the nation. While such people, released of their public service would surely face issues in the short run, in the longer run they will eventually by absorbed by the private enterprise.
- Moreover, if the extra troops or extra bureaucrats are retained just for the sake of preserving the purchase parity, one must focus on the source of funds for providing this parity. These funds are taken from the people and keeping them hurts the people. Their purchasing power, simply put, comes at the cost of other people’s purchasing power, provided they are serving no purpose. This is no different from a thief stealing your money to boost his purchasing power, while you lose the money.
Chapter 10 – The Fetish of Full Employment
- Employment is a byproduct in the pursuit of Production and thus the aim should be to maximize the production. Production is the ends while employment is just a means. This fact should always be kept in mind.
- Rather than picking a project that provides full employment with substandard quality of work, the converse should be selected. It is better to have partial employment with undisguised relief, than to provide full employment with various forms of disguised make-work.
- A truly prosperous nation does not have work for all, it has enough production for all. Only when we produce can we distribute, so the focus should be on maximizing production that can be distributed rather than maximizing distribution of what little is produced.
Chapter 11 – Who’s ‘Protected’ by Tariffs?
- Free trade is a no-brainer since the days of Adam Smith. One should produce according to one’s competitive advantage and feel free to buy the rest from others. But tariffs impede this process. This leads to increase in prices to help the incumbent, causing loses to the consumers. Moreover, world as a whole end us with more waste as inefficient firms are kept in business and the more efficient and productive businesses that could have taken their place are not allowed to take birth or grow. Everyone is worse off.
- On a national level, this diversion of money from more efficient firms to less efficient firms mean that overall productivity of the nation drops and as a result the real wages of the nation drop. Another drawback of erecting tariff barriers is that while we spend money on technological innovations to make business smooth, by building freight corridors and other improvements, we then negate the effects of those improvements by inflating the prices of goods that come to us cheaply thanks to these innovations.
- Introducing tariffs also means that the countries that are exporting to you don’t have your currency to buy your goods with, which leads to a drop in your competitive industries that could have exported to you.
- One however should not be an over-enthusiast of free trade. Industries that have enjoyed the benefits of tariffs will surely suffer, maybe permanently, if the tariffs are removed. Also, in some cases, the tariffs are a necessity like in industries related to war and can’t be wished away, but what should be kept in mind is that these tariffs are there to protect special strategic interests. Tariffs can’t help with improving standard of living or wages. The same goes for other kinds of trade barriers such as import quotas, exchange controls etc.
Chapter 12 – The Drive for Exports
- Author makes a case that exports have to equal import if everything is considered and there is no way in which either can exceed the other. I find the argument worth of a bit more scrutiny than what is discussed here, because the main idea that the author tackles is of export subsidies or loans made to foreign nations (in terms of foreign aid etc) so as to boost exports.
- While he’s insistent on his point that exports have to equal imports, I’ll take that on the face value for now to discuss the secondary idea, that of export boosting measures. He points out that when we give away export subsidies in any form, we can’t be better off if the loans are not repaid. While the business that exported the commodity might benefit from the transaction, the nation on a whole loses out because the money comes from taxes which come at the cost of domestic consumption. But this fact is often ignored while watching out for the short run.
- He maintains that in real terms, imports are far more valuable than exports because that lets our consumers have what they normally couldn’t or at lower costs. According to him, the only reason for having exports is to pay for imports.
This chapter is very confusing since it goes against a number of notions, often considered conventional wisdom. Trade surplus (or deficit) is not an accounting oversight but a reality, now as well as historic. This topic needs more examination than what has been offered.
Chapter 13 – ‘Parity’ Prices
- It is argued that farm prices must be increased to be in proportionally in parity with prices from an earlier era because the prices if farm products have not increased in proportion with other parts of the economy and hence the farmers are lagging behind.
- But this is a devious scheme to create a special interest group and benefit it at the cost of others. While it is true that the farm prices may not have risen proportionally, but prices for a number of objects have actually fallen with respect to the past. Does it mean that we should negate the positive effects of technology that have made these products cheaper. Moreover, people advocating such measures don’t take into account the improvements in farming that have led to improved yields of products.
- Another argument made is that by raising the prices for farm products, the farmer will earn more which they’ll use on products of the industry which will benefit as well. But this does not take into account the end consumer, who may not be associated with the industry and hence may only suffer without gain.
- Subsequently the case is made that the duties that industries enjoy against the foreign products hurt the farmer and hence they need to be subsidized for the duty that they pay to help the industrialist. But by the extension of this same argument, every person should be subsidized for the duties that they pay. Now if everyone is subsidized for the duties, no one really earns anything more and the entire calculation is reduced to zero. Then why employ an army of bureaucrats to first administer the application of duties followed by disbursal of benefit from the same.
- Therefore, this is the same problem in a new form. A special interest group is being favored and benefits to it are listed while the costs to others and in the long run are ignored.
Chapter 14 – Saving the X industry
- Whenever any industry is lagging, the special interest groups start lobbying to save it. The help usually takes two forms – Bar fresh entry or Give subsidies. Now the second option is better from the view of public, because in this case at least the public knows what cost it is paying to keep it alive.
- Regarding barring fresh entry, the argument is made that the industry is already very saturated and new entrants won’t help. But if such were the case then the labor and capital would move out on its own, and to more productive and profit-making sectors of the economy. Banning or raising the bar for entry of new entrants is allowing monopoly or cartelization of an industry.
- Moreover, the death of industries is as important as their growth. Infact death of old industries is part of the process. By impeding this process, we are hurting the growth of new and more productive industries. For example, by artificially keeping the horse carriages and drivers in business even after cars are available, would mean impeding the growth of automobile sector and consequently hurting the growth of industries and jobs that arise out of the growth of automobiles.
Chapter 15 – How the Price System Works
- It is erroneously believed that prices represent the cost-of-production, but this can’t be further from the truth. Prices represent the information in an economic system, the information about supply and demand.
- When the demand of a commodity increases, many marginal producers, switch to producing the commodity and the prices fall as supply starts to increase. The opposite happens eventually – as the supply increases, the prices start to fall and soon the marginal producers leave and only the most efficient producers stay.
- Thus, the price of an object may be equal to the marginal cost of production but that is not what it represents. Prices cannot be fixed because they represent the flow of information in a dynamic and complicated system.
- Moreover, prices determine the flow of capital and labor. Since prices carry the information about supply and demand, and producing one commodity comes at the cost of not producing another commodity; prices help determine this diversion.
- By fixing prices to “save” any industry, we are stopping the natural diversion of capital and more importantly labor, away from the inefficient parts of the economy to the more efficient parts. Dying industries need to die so that resources can shift to growing industries.
Chapter 16 – ‘Stabilizing’ Commodities
- “Stabilizing” the prices of a commodity is a dangerous pursuit because it involves disrupting the market forces. Stabilizing measures are undertaken when the prices of a commodity rise and fall sharply over a period of time. For example, when farmers bring their produce to the markets, the prices may fall due to excess supply and the rise at a later point in the year when the supply is scarce.
- The logic is that the produce of the farmers is bought by speculators, who hold it till prices rise and then sell it at a premium, making profit at the xost of farmers and producers. Stabilizing measures thus involving loaning money to farmers so that they can hold their produce from the market. This is imagined will help the farmers to hold the produce when market prices fall and then release the produce eventually.
- But what happens in reality is that these speculators are better suited at holding the produce. They pay to farmers, a sum greater than what they would fetch at the lowest point in the time period and wait till the prices rise. They bear the storage costs and other insurance charges. They also take the risks based on their speculation of the future prices.
- By forcing farmers to bear these risks themselves, they are pushed to ruins while the prices actually rise. This rise is funded by the tax payers. Another effect of the price fluctuation is that only the marginal and the unproductive farmers suffer when the prices fall. The productive farmers will be left when the marginal and inefficient farmers leave the marketplace due to low prices. This may cause unemployment in the short run, but the money that the consumers save as opposed to the consistently high price, is spent towards other industries that employ these unemployed farmers. The economy thus, as a whole move towards a more efficient direction
- Past efforts of price stabilization efforts in the past have mostly failed as it kills the international demand of our products as the produce is held off the market. The solution being touted is an international agreement to fic prices between the global producers and the global consumers, so that a fair price can be set. One more excuse to replace Free Markets by a distorted version involving hordes of bureaucrats!
Chapter 17 – Government Price-Fixing
- Governments sometimes embark on the mission to suppress prices with an aim to fix them. This is usually done at the time of a war and involves the government controlling the costs of certain commodities. But as soon as the prices are fixed for end products, the need arises for controlling the costs of the input materials for the product. This backward producing then moves all the way back till almost all commodities have their prices fixed.
- A second order effect of price fixing is that consumer demand rises sharply. This is followed by efforts at rationing, in the form of coupons. This introduces a double currency system where you need money as well as the coupons to buy a commodity that you want.
- Eventually these give rise to the black markets which after a certain point in time start to mimic the real markets therefore rendering the entire exercise futile.
- Now price controls are not totally avoidable in critical circumstances such as war and even are successful in the short run, but in the long run they do more damage. They hurt the producers at the cost of consumers. In some cases, price controls and rationing may lead to mushrooming of marginal players who get the resources at the expense of more productive producers who are not allowed to get as much resources as they need.
- Price controls also receive a lot of support because each one of us consumes hundreds of products but we produce only one or two. This makes us think that our industry needs help but others don’t and hence price control on others is justified, but not on me.
Chapter 18 – What Rent Control Does
- Rent controls are put in place when it is felt that there is a sudden enormous demand on the properties (due to troops landing in a city, or houses destroyed) and the rent rises dramatically. Rents are frozen and the tenant is said to be rescued.
- But this is a grave injustice to the landlord, who can now not charge the rate he deserves. This often leads to landlord not maintaining the property due to diminished returns leading to dilapidated houses. Moreover, this leads to wastages since the rent is not in proportion to the wants of individuals but fixed. This also leads to further scarcity down the roads. Since existing properties are making little or no profit, the landlord or the developer may not have funds to start new projects and this accentuates the problem. New tenants looking for rental spaces may not get them and there is no incentive for existing tenants to economize. Thus, older tenants, who were lucky to have homes are favored over new tenants and landlords.
- In certain cases, luxury apartments maybe exempt from rent control since rich can afford to pay more. But this leads to more money in the hands of those developers and landlord who operate in this space and as a result luxury housing grows while low- and middle-income houses keep shrinking.
- The case is then made for repealing of rent control, but by then difference has risen to be over even 20 times or more. Rather than rent control, there are ideas about subsidizing the rent or for government to build low income housing. Often these projects, since driven by the compulsion to be affordable, do not recover the cost invested by the government. In both cases, the majority of taxpayers end up subsidizing the rent for a smaller group of tenants.
- Rent controls are just another perverted for of price controls discuss earlier. But one key difference is that homes are durable. A baker forced to make bread at loss may choose not to but a landlord forced to give away his property at loss has no recourse. The often end up abandoning their properties and in the end everyone is worse off.
Chapter 19– Minimum Wage Laws
- Wage, simply put, is the price we pay for labor. Therefore, efforts at boosting wages artificially are going to fail and with the same repercussions as the other efforts to boost prices of commodities artificially.
- It will reduce the demand for labor and less people will be employed than before. It may be thought that Minimum Wage Laws will pass the costs to the consumer, but in real these increased prices may not be possible and this may lead to losses or fall in demand.
- People agree to work on wages that they can get according to their skills, if they’re not getting it means that the demand for their skills is less. Moreover, to mitigate situations where the wages are artificially suppressed, unions can come in handy, without forcing an enterprise out of business.
- Secondly, if relief is paid at $70 a month and minimum wage is set as $108, a job that pays $90 is illegal to offer for the employer.
- Now if the aim is to boost wages, the only way to do that is to improve the productivity of the workers and the economic activity in the economy. Make believe government work doesn’t help because that subsidized unproductive work at the expense of productive work.
- Finally, the argument that Minimum Wage laws have helped raise wages is incorrect. The Minimum Wages were increased in US in proportion to the existing wage rates, so while there is correlation, it definitely does not imply causation.
Chapter 20 – Do Unions Really Raise Wages?
- Unions play a crucial role in the welfare of workers. They help pass the information about wages and insure safe working conditions. But this does not mean unionization can help raise worker wages, because wages depend on the productivity of the workers and the industry in general.
- Unions that are able to get a “above market” wages for their members do so politically and at the cost of others. So, when a certain union is able to command greater wages for its members this raises the prices in general and since this is extra price than what the fruits of their labor deserve, the difference should be borne by others.
- Now in the highly unlikely but probable case the workers force the employers to raise wages, without employing less people and without raising prices (due to government regulation, market compulsions etc.), the workers would have gained in the short run, but in the long run, investors of such a business will not invest more in such a business. The business will not upgrade and in the long run national produce and consequentially national income will fall.
- The job of unions is to ensure the welfare of workers not increase their wages. When unions force the employers to accept undue demands of theirs, they hurt the industries for which their members are part of. This also prevents the expansion of these industries and as a result rather than more people employed in that industry (i.e. future union members) less are employed creating a barrier for new workers.
- The demand for less working ours at the same wage has the same effect. Rather than working on workers leisure time, unions should help workers earn more, have safer conditions and then if they wish to have a more leisurely life, they can choose the same themselves, but forcing leisure on everyone when they could be wanting more pay is coercion in its worse form and for your own members.
Chapter 21 – ‘Enough to Buy Back the Product’
- Arguments are made that labor should be paid enough wages so that they are able to buy the products that they produce, but how is that to be fixed. Should a worker producing cheap shoes only enough to buy cheap shoes while the producer of an expensive shoe should earn enough to buy the super expensive shoe.
- Jokes aside, the essential argument is to increase wages, so as to boost the consumption by workers, especially of the produce of their labor. But then such measures come at the cost of others. The author gives calculations that show that wages make up two-thirds of the cost of products and thus a 30% increase in wages should result in 20% increase in prices.
- Now if the monetary policy allows it, the prices would rise and so would inflation. But if that is not allowed it would lead to loss of production and consequently the loss of employment. The workers may get a larger slice of the pie, but the pie would have shrunk. A more profitable proposition, in terms of absolute gains, is to go for a smaller portion of a larger pie. This also disincentivizes investment and entrepreneurship in favor of employment. More people will want to be workers than investors till a new balance is set.
- Therefore, the best wages are not the highest wages, but those wages that facilitate the highest production. The best profits are not the lowest profits but the ones that lead to the expansion of industry.
Chapter 22 – The Function of Profits
- Profit for long has been viewed with disgust by governments and societies in general. But this misplaced notion overlooks the fact that profit is not an assured privilege of the industry. Infact corporate profits over long periods of time usually hover around 6-7%.
- This is mainly because of the optimism of the investor, who pumps money into an enterprise and often fails. The profit thus is reward for a risk taken that results in higher employment and production in the society.
- Moreover, unless an industry is dominated by a monopoly, firms make a profit when they economize. When they raise the efficiency of production and reduce the cost. It does not come from higher prices.
- When governments proceed to cap profits, without insuring losses, they kill the entrepreneurial spirit of the economy leading to its eventual decay and downfall.
Chapter 23 – The Mirage of Inflation
- It is assumed that inflation will help raise prices and this will help labor and capital owners. The increased room created by inflation can be used to increase wages or to increase margins of the firms. This is thought of as increasing purchasing power and this fallacy arises from the fact that money is confused with wealth.
- Wealth is increased when an individual can afford to consume more than he would earlier. Money obviously is the instrument through which prices are negotiated but it is not indicative of wealth. If the government simply prints more money and hands it over to people, the initial receivers may be able to consume more and in the short run. But subsequently the benefits will be passed to others, but in an attenuated manner. Therefore, society as a whole does not have more wealth in the longer run and the only beneficiaries are those who get access to new easy money earlier. They prosper at the expense of others.
- The value of currency is subject to the value that people ascribe to it and thus if people get more money easily, the subjective valuation in their minds will reduce and this reduces the valuation of the money.
- Next it is argued that inflation can be used to make up for increased wages that the cost of production can’t sustain. But to cheat people in this manner will points to economic and political short sightedness.
- When governments spend what they do not have, these public works can either be financed by public taxation. But since this is unpopular, they resort to borrowings to unmask the value they are destroying by taking away money out of free markets and instruments of productive production. This eventually is repaid in terms of inflation and inflation can be thought of as tax on the poor. Everyone pays the tax of inflation but since it affects everyone equally, poor people pay more in terms of proportion of their wealth. It is a tax that is out of control of any tax authority.
Chapter 24 – The Assault on Saving
- Savings and savers are denigrated as enemies of economy. It is said that people should spend money and those who save it are not contributing to the economy. But those who save money are putting it in banks or investing it somewhere (in hopes of getting a higher return). This is putting money in the economy, and in fact, this is a productive use of money that helps the economy rather than senseless consumption.
- Secondly a distinction is made between savings and investments, but savings and investments are simply the supply and demand of capital. Both have to equalize each other.
- Next savings are blamed for the recession as people are not spending as much as is produced. But this is one more sophism as what is produced (supplied) should be equal to what is consumer (demanded). In the rare case where people don’t consume despite their wants is when people feel the prices will fall and they choose to defer their consumption either in hopes of better prices or to save for a future date when they might not have enough (since prices of all commodities are falling) due to grim economic future. In such a case, while saving does hurt the economy, it aggravates the slowdown rather than create it. The bad news is slowdown, not the natural reaction to it (held back consumption). In any case, once the economic future is more certain, the held back demand will be met anyway.
- Another way of discouraging savings is to keep interest rates low. But interest is simply the price of capital and by suppressing the prices of capital artificially, the results are the same with other commodities. It increases demand and decreases supply. The capital is put to less productive uses by those who can get it and which causes and overall decay in the economy.
- The money rate can be kept artificially low only by continuous new injection of currency or bank credit in place of real savings and this creates an illusion of more capital (just like adding water to milk creates illusion of more milk). But this eventually leads to inflation because lenders realize that the value of money is falling and thus to their interest rate, they add a premium for this which simply put, is inflation. Rather if the interest rates would have been kept at its natural levels, this would have created an incentive to save and hence a supply of real capital.
- Lastly it is argued that some economies have reached economic maturity or that the level of capital absorption has been maximized and now new capital can be utilized. But this fallacy can be exposed simply by considering that the need for capital will exhaust only when we have all that we want (houses, fridges, cars etc.) . Even if all these demands are met in the consumer durables, the capital will be used by industries to lower the cost of production and to improve further, which should trigger its own cycle of savings. This saturation in improvement of production technology is possible when human creativity is dead and no further improvement has been made and all the factories is the world are as productive as each other and as productive it is possible to be.
Chapter 25 – The Lesson Restated
- Economics is simply the study of secondary consequences and general consequences. The economic lesson is as obvious as mathematical equation with a variable. The answer lies in the problem statement itself; one just needs to work out the solution. Similarly, when an economic statement is made, few realise the other side of their argument and fewer evaluate both sides of the situation before making an assertion. More credit simple means more debt, and debt may be necessary in some cases but we can come to conclusion when we have considered both the pros and cons of the argument.
- Author invokes The Forgotten Man of William Graham Sumner who is summoned to help others. But the powers that ask him to help others, never ask him what he wants or needs. He is the forgotten man.
- The central idea thus reiterated is that the effects of an economic policy cannot be measured correctly by focusing only on certain parts of the society or for a short duration. One needs to look around and at everyone to really reach a conclusion.
Chapter 26 – Lesson after thirty years
- The author mourns that none of his lessons were taken heed of in the 30 years succeeding the book and that government intervention in terms of various welfare schemes has grown exponentially and so has the inflation leading to the fall in value of currencies.
- He then explores the example of social security and how letting it loose on people has led to an ultimate loss.
These notes are based on my reading of the book and were originally for meant for my personal use only. As such there may inadvertently contain any biases or errors. I'd be grateful if you point out errors (if any) as well as discuss any point that you may not agree with.
Just to be absolutely sure, please note that I have not proof-read these notes, but simply copied them verbatim from my notes app to cut down the time taken. At the time of writing these notes were purely for personal consumption and/or further enquiry. So if you find any sentence/reference/comment to be offensive, please contact me first before "calling me out". I'll remove it if I agree with you or at the very least will try to make my case