by Henry Hazlitt (1946)
This book is an analysis of economic fallacies that are at last so prevalent that they have almost become a new orthodoxy. The one thing that has prevented this has been their own self-contradictions, which have scattered those who accept the same premises into a hundred different "schools", for the simple reason that it is impossible in matters touch in practical life to be consistently wrong. But the difference between one new school and another is merely that one group wakes up earlier than another to the absurdities to which its false premises are driving it, and becomes at that moment inconsistent by either unwittingly abandoning its false premises or accepting conclusions from them less disturbing or fantastic than those that logic would demand.
There is not a major government in the world at this moment, however, whose economic policies are not influenced, if they are not almost wholly determined, by acceptance of some of these fallacies. Perhaps the shortest and surest way to an understanding of economics is through a dissection of such errors, and particularly of the central error from which they stem. That is the assumption of this volume and of its somewhat ambitious and belligerent title.
The volume is therefore primarily one of exposition. It makes no claim to originality with regard to any of the chief ideas that it expounds. Rather its effort is to show that many of the ideas which now pass for brilliant innovations and advances are in fact mere revivals of ancient errors, and a further proof of the dictum that those who are ignorant of the past are condemned to repeat it.
The present essay itself is, I suppose, unblushingly "classical", "traditional", and "orthodox": at least these are the epithets with which those whose sophisms are here subjected to analysis will no doubt attempt to dismiss it. But the student whose aim is to attain as much truth as possible will not be frightened by such adjectives. He will not be forever seeking a revolution, a "fresh start", in economic thought. His mind will, of course, be as receptive to new ideas as to old ones; but he will be content to put aside merely restless or exhibitionistic straining for novelty and originality. As Morris R. Cohen has remarked: "The notion that we can dismiss the views of all previous thinkers surely leaves no basis for the hope that our own work will prove of any value to others."
Because this is a work of exposition I have availed myself freely and without detailed acknowledgment (except for rare footnotes and quotations) of the ideas of others. This is inevitable when one writes in a field in which many of the world's finest minds have labored. But my indebtedness to at least three writers is of so specific a nature that I cannot allow it to pass unmentioned. My greatest debt, with respect to the kind of expository framework on which the present argument is hung, is to Frederic Bastiat's essay Ce qu'on voit et ce qu'on ne voit fas, now nearly a century old. The present work may, in fact, be regarded as a modernization, extension, and generalization of the approach found in Bastiat's pamphlet. My second debt is to Philip Wicksteed: in particular the chapters on wages and the final summary chapter owe much to his Commonsense of Political Economy. My third debt is to Ludwig von Mises. Passing over everything that this elementary treatise may owe to his writings in general, my most specific debt is to his exposition of the manner in which the process of monetary inflation is spread.
When analyzing fallacies, I have thought it still less advisable to mention particular names than in giving credit. To do so would have required special justice to each writer criticized, with exact quotations, account taken of the particular emphasis he places on this point or that, the qualifications he makes, his personal ambiguities, inconsistencies, and so on. I hope, therefore, that no one will be too disappointed at the absence of such names as Karl Marx, Thorstein Veblen, Major Douglas, Lord Keynes, Professor Alvin Hansen and others in these pages. The object of this book is not to expose the special errors of particular writers, but economic errors in their most frequent, widespread, or influential form. Fallacies, when they have reached the popular stage, become anonymous anyway. The subtleties or obscurities to be found in the authors most responsible for propagating them are washed off. A doctrine becomes simplified; the sophism that may have been buried in a network of qualifications, ambiguities, or mathematical equations stands clear. I hope I shall not be accused of injustice on the ground, therefore, that a fashionable doctrine in the form in which I have presented it is not precisely the doctrine as it has been formulated by Lord Keynes or some other special author. It is the beliefs which politically influential groups hold and which governments act upon that we are interested in here, not the historical origins of those beliefs.
I hope, finally, that I shall be forgiven for making such rare reference to statistics in the following pages. To have tried to present statistical confirmation, in referring to the effects of tariffs, price-fixing, inflation, and the controls over such commodities as coal, rubber, and cotton, would have swollen this book much beyond the dimensions contemplated. As a working newspaper man, moreover, I am acutely aware of how quickly statistics become out-of-date and are superseded by later figures. Those who are interested in specific economic problems are advised to read current "realistic" discussions of them, with statistical documentation: they will not find it difficult to interpret the statistics correctly in the light of the basic principles they have learned.
I have tried to write this book as simply and with as much freedom from technicalities as is consistent with reasonable accuracy, so that it can be fully understood by a reader with no previous acquaintance with economics.
While this book was composed as a unit, three chapters have already appeared as separate articles, and I wish to thank The New York Times, The American Scholar, and The New Leader for permission to reprint material originally published in their pages. I am grateful to Professor von Mises for reading the manuscript and for helpful suggestions. Responsibility for the opinions expressed is, of course, entirely my own.
Henry Hazlitt
New York
March 25, 1946
1
Economics is haunted by more fallacies than any other study known to man. This is no accident. The inherent difficulties of the subject would be great enough in any case, but they are multiplied a thousandfold by a factor that is insignificant in, say, physics, mathematics, or medicine -- the special pleading of selfish interests. While every group has certain economic interests identical with those of all groups, every group has also, as we shall see, interests antagonistic to those of all other groups. While certain public policies would in the long run benefit everybody, other policies would benefit one group only at the expense of all other groups. The group that would benefit by such policies, having such a direct interest in them, will argue for them plausibly and persistently. It will hire the best buyable minds to devote their whole time to presenting its case. And it will finally either convince the general public that its case is sound, or so befuddle it that clear thinking on the subject becomes next to impossible.
In addition to these endless pleadings of self-interest, there is a second main factor that spawns new economic fallacies every day. This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences.
In this lies almost the whole difference between good economics and bad. The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.
The distinction may seem obvious. The precaution of looking for all the consequences of a given policy to everyone may seem elementary. Doesn't everybody know, in his personal life, that there are all sorts of indulgences delightful at the moment but disastrous in the end? Doesn't every little boy know that if he eats enough candy he will get sick? Doesn't the fellow who gets drunk know that he will wake up next morning with a ghastly stomach and a horrible head? Doesn't the dipsomaniac know that he is ruining his liver and shortening his life? Doesn't the Don Juan know that he is letting himself in for every sort of risk, from blackmail to disease? Finally, to bring it to the economic though still personal realm, do not the idler and the spendthrift know, even in the midst of their glorious fling, that they are heading for a future of debt and poverty?
Yet when we enter the field of public economics, these elementary truths are ignored. There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: "In the long run we are all dead." And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.
But the tragedy is that, on the contrary, we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore. The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg, the flower in the seed.
From this aspect, therefore, the whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate hut at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
2
Nine-tenths of the economic fallacies that are working such dreadful harm in the world today are the result of ignoring this lesson. Those fallacies all stem from one of two central fallacies, or both: that of looking only at the immediate consequences of an act or proposal, and that of looking at the consequences only for a particular group to the neglect of other groups.
It is true, of course, that the opposite error is possible. In considering a policy we ought not to concentrate only on its long-run results to the community as a whole. This is the error often made by the classical economists. It resulted in a certain callousness toward the fate of groups that were immediately hurt by policies or developments which proved to be beneficial on net balance and in the long run.
But comparatively few people today make this error; and those few consist mainly of professional economists. The most frequent fallacy by far today, the fallacy that emerges again and again in nearly every conversation that touches on economic affairs, the error of a thousand political speeches, the central sophism of the "new" economics, is to concentrate on the short-run effects of policies on special groups and to ignore or belittle the long-run effects on the community as a whole. The "new" economists flatter themselves that this is a great, almost a revolutionary advance over the methods of the "classical" or "orthodox" economists, because the former take into consideration short-run effects which the latter often ignored. But in themselves ignoring or slighting the long-run effects, they are making the far more serious error. They overlook the woods in their precise and minute examination of particular trees. Their methods and conclusions are often profoundly reactionary. They are sometimes surprised to find themselves in accord with seventeenth-century mercantilism. They fall, in fact, into all the ancient errors (or would, if they were not so inconsistent) that the classical economists, we had hoped, had once for all got rid of.
3
It is often sadly remarked that the bad economists present their errors to the public better than the good economists present their truths. It is often complained that demagogues can be more plausible in putting forward economic nonsense from the platform than the honest men who try to show what is wrong with it. But the basic reason for this ought not to be mysterious. The reason is that the demagogues and bad economists are presenting half-truths. They are speaking only of the immediate effect of a proposed policy or its effect upon a single group. As far as they go they may often be right. In these cases the answer consists in showing that the proposed policy would also have longer and less desirable effects, or that it could benefit one group only at the expense of all other groups. The answer consists in supplementing and correcting the half-truth with the other half. But to consider all the chief effects of a proposed course on everybody often requires a long, complicated, and dull chain of reasoning. Most of the audience finds this chain of reasoning difficult to follow and soon becomes bored and inattentive. The bad economists rationalize this intellectual debility and laziness by assuring the audience that it need not even attempt to follow the reasoning or judge it on its merits because it is only "classicism" or "laissez-faire", or "capitalist apologetics" or whatever other term of abuse may happen to strike them as effective.
We have stated the nature of the lesson, and of the fallacies that stand in its way, in abstract terms. But the lesson will not be driven home, and the fallacies will continue to go unrecognized, unless both are illustrated by examples. Through these examples we can move from the most elementary problems in economics to the most complex and difficult. Through them we can learn to detect and avoid first the crudest and most palpable fallacies and finally some of the most sophisticated and elusive. To that task we shall now proceed.
Let us begin with the simplest illustration possible: let us, emulating Bastiat, choose a broken pane of glass.
A young hoodlum, say, heaves a brick through the window of a baker's shop. The shopkeeper runs out furious, but the boy is gone. A crowd gathers, and begins to stare with quiet satisfaction at the gaping hole in the window and the shattered glass over the bread and pies. After a while the crowd feels the need for philosophic reflection. And several of its members are almost certain to remind each other or the baker that, after all, the misfortune has its bright side. It will make business for some glazier. As they begin to think of this they elaborate upon it. How much does a new plate glass window cost? Fifty dollars? That will be quite a sum. After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $50 more to spend with other merchants, and these in turn will have $50 more to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be, if the crowd drew it, that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor.
Now let us take another look. The crowd is at least right in its first conclusion. This little act of vandalism will in the first instance mean more business for some glazier. The glazier will be no more unhappy to learn of the incident than an undertaker to learn of a death. But the shopkeeper will be out $50 that he was planning to spend for a new suit. Because he has had to replace a window, he will have to go without the suit (or some equivalent need or luxury). Instead of having a window and $50 he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window and no suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer.
The glazier's gain of business, in short, is merely the tailor's loss of business. No new "employment" has been added. The people in the crowd were thinking only of two parties to the transaction, the baker and the glazier. They had forgotten the potential third party involved, the tailor. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye.
So we have finished with the broken window. An elementary fallacy. Anybody, one would think, would be able to avoid it after a few moments' thought. Yet the broken-window fallacy, under a hundred disguises, is the most persistent in the history of economics. It is more rampant now than at any time in the past. It is solemnly reaffirmed every day by great captains of industry, by chambers of commerce, by labor union leaders, by editorial writers and newspaper columnists and radio commentators, by learned statisticians using the most refined techniques, by professors of economics in our best universities. In their various ways they all dilate upon the advantages of destruction.
Though some of them would disdain to say that there are net benefits in small acts of destruction, they see almost endless benefits in enormous acts of destruction. They tell us how much better off economically we all are in war than in peace. They see "miracles of production" which it requires a war to achieve. And they see a postwar world made certainly prosperous by an enormous "accumulated" or "backed-up" demand. In Europe they joyously count the houses, the whole cities that have been leveled to the ground and that "will have to be replaced". In America they count the houses that could not be built during the war, the nylon stockings that could not be supplied, the worn-out automobiles and tires, the obsolescent radios and refrigerators. They bring together formidable totals.
It is merely our old friend, the broken-window fallacy, in new clothing, and grown fat beyond recognition. This time it is supported by a whole bundle of related fallacies. It confuses need with demand. The more war destroys, the more it impoverishes, the greater is the postwar need. Indubitably. But need is not demand. Effective economic demand requires not merely need but corresponding purchasing power. The needs of China today are incomparably greater than the needs of America. But its purchasing power, and therefore the "new business" that it can stimulate, are incomparably smaller.
But if we get past this point, there is a chance for another fallacy, and the broken-windowites usually grab it. They think of "purchasing power" merely in terms of money. Now money can be run off by the printing press. As this is being written, in fact, printing money is the world's biggest industry -- if the product is measured in monetary terms. But the more money is turned out in this way, the more the value of any given unit of money falls. This falling value can be measured in rising prices of commodities. But as most people are so firmly in the habit of thinking of their wealth and income in terms of money, they consider themselves better off as these monetary totals rise, in spite of the fact that in terms of things they may have less and buy less. Most of the "good" economic results which people attribute to war are really owing to wartime inflation. They could be produced just as well by an equivalent peacetime inflation. We shall come back to this money illusion later.
Now there is a half-truth in the "backed-up" demand fallacy, just as there was in the broken-window fallacy. The broken window did make more business for the glazier. The destruction of war will make more business for the producers of certain things. The destruction of houses and cities will make more business for the building and construction industries. The inability to produce automobiles, radios, and refrigerators during the war will bring about a cumulative postwar demand for those particular products.
To most people this will seem like an increase in total demand, as it may well be in terms of dollars of lower purchasing power. But what really takes place is a diversion of demand to these particular products from others. The people of Europe will build more new houses than otherwise because they must. But when they build more houses they will have just that much less manpower and productive capacity left over for everything else. When they buy houses they will have just that much less purchasing power for everything else. Wherever business is increased in one direction, it must (except insofar as productive energies may be generally stimulated by a sense of want and urgency) be correspondingly reduced in another.
The war, in short, will change the postwar direction of effort; it will change the balance of industries; it will change the structure of industry. And this in time will also have its consequences. There will be another distribution of demand when accumulated needs for houses and other durable goods have been made up. Then these temporarily favored industries will, relatively, have to shrink again, to allow other industries filling other needs to grow.
It is important to keep in mind, finally, that there will not merely be a difference in the pattern of postwar as compared with pre-war demand. Demand will not merely be diverted from one commodity to another. In most countries it will shrink in total amount.
This is inevitable when we consider that demand and supply are merely two sides of the same coin. They are the same thing looked at from different directions. Supply creates demand because at bottom it is demand. The supply of the thing they make is all that people have, in fact, to offer in exchange for the things they want. In this sense the farmers' supply of wheat constitutes their demand for automobiles and other goods. The supply of motor cars constitutes the demand of the people in the automobile industry for wheat and other goods. All this is inherent in the modern division of labor and in an exchange economy.
This fundamental fact, it is true, is obscured for most people (including some reputedly brilliant economists) through such complications as wage payments and the indirect form in which virtually all modern exchanges are made through the medium of money. John Stuart Mill and other classical writers, though they sometimes failed to take sufficient account of the complex consequences resulting from the use of money, at least saw through the monetary veil to the underlying realities. To that extent they were in advance of many of their present-day critics, who are befuddled by money rather than instructed by it. Mere inflation -- that is, the mere issuance of more money, with the consequence of higher wages and prices -- may look like the creation of more demand. But in terms of the actual production and exchange of real things it is not. Yet a fall in postwar demand may be concealed from many people by the illusions caused by higher money wages that are more than offset by higher prices.
Postwar demand in most countries, to repeat, will shrink in absolute amount as compared with pre-war demand because postwar supply will have shrunk. This should be obvious enough in Germany and Japan, where scores of great cities were leveled to the ground. The point, in short, is plain enough when we make the case extreme enough. If England, instead of being hurt only to the extent she was by her participation in the war, had had all her great cities destroyed, all her factories destroyed and almost all her accumulated capital and consumer goods destroyed, so that her people had been reduced to the economic level of the Chinese, few people would be talking about the great accumulated and backed-up demand caused by the war. It would be obvious that buying power had been wiped out to the same extent that productive power had been wiped out. A runaway monetary inflation, lifting prices a thousandfold, might nonetheless make the "national income" figures in monetary terms higher than before the war. But those who would be deceived by that into imagining themselves richer than before the war would be beyond the reach of rational argument. Yet the same principles apply to a small war destruction as to an overwhelming one.
There may be, it is true, offsetting factors. Technological discoveries and advances during the war, for example, may increase individual or national productivity at this point or that. The destruction of war will, it is true, divert postwar demand from some channels into others. And a certain number of people may continue to be deceived indefinitely regarding their real economic welfare by rising wages and prices caused by an excess of printed money. But the belief that a genuine prosperity can be brought about by a "replacement demand" for things destroyed or not made during the war is nonetheless a palpable fallacy.
1
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 purchasing
power". The remedy is just as obvious. All that is necessary is for the
government to spend enough to make up the "deficiency."
Having put aside for later consideration the network of fallacies which rest
on chronic government borrowing and inflation, we shall take it for granted
throughout the present chapter that either immediately or ultimately every
dollar of government spending must be raised through a dollar of taxation.
Once we look at the matter in this way, the supposed miracles of government
spending will appear in another light.
A certain amount of public spending is necessary to perform essential
government functions. A certain amount of public works -- of streets and
roads and bridges and tunnels, of armories and navy yards, of buildings to
house legislatures, police, and fire departments -- is necessary to supply
essential public services. With such public works, necessary for their own
sake, and defended on that ground alone, I am not here concerned. I am here
concerned with public works considered as a means of "providing employment"
or of adding wealth to the community that it would not otherwise have had.
A bridge is built. If it is built to meet an insistent public demand, if it
solves a traffic problem or a transportation problem otherwise insoluble, if,
in short, it is even more necessary than the things for which the taxpayers
would have spent their money if it had not been taxed away from them, there
can be no objection. But a bridge built primarily "to provide employment"
is a different kind of bridge. When providing employment becomes the end,
need becomes a subordinate consideration. "Projects" have to be
invented. Instead of thinking only where bridges must
be built, the government spenders begin to ask themselves where bridges
can be built. Can they think of plausible reasons why an
additional bridge should connect Easton and Weston? It soon becomes
absolutely essential. Those who doubt the necessity are dismissed
as obstructionists and reactionaries.
Two arguments are put forward for the bridge, one of which is mainly
heard before it is built, the other of which is mainly heard after it has
been completed. The first argument is that it will provide employment.
It will provide, say, 500 jobs for a year. The implication is that
these are jobs that would not otherwise have come into existence.
This is what is immediately seen. But if we have trained ourselves to
look beyond immediate to secondary consequences, and beyond those who are
directly benefited by a government project to others who are indirectly
affected, a different picture presents itself. It is true that a particular
group of bridgeworkers may receive more employment than otherwise. But the
bridge has to be paid for out of taxes. For every dollar that is spent on
the bridge a dollar will be taken away from taxpayers. If the bridge costs
$1,000,000 the taxpayers will lose $1,000,000. They will have that much
taken away from them which they would otherwise have spent on the things
they needed most.
Therefore for every public job created by the bridge project a private
job has been destroyed somewhere else. We can see the men employed on
the bridge. We can watch them at work. The employment argument of the
government spenders becomes vivid, and probably for most people convincing.
But there are other things that we do not see, because, alas, they have
never been permitted to come into existence. They are the jobs destroyed
by the $1,000,000 taken from the taxpayers. All that has happened, at best,
is that there has been a diversion of jobs because of the project.
More bridge builders; fewer automobile workers, radio technicians, clothing
workers, farmers.
But then we come to the second argument. The bridge exists. It is, let
us suppose, a beautiful and not an ugly bridge. It has come into being
through the magic of government spending. Where would it have been if the
obstructionists and the reactionaries had had their way? There would have
been no bridge. The country would have been just that much poorer.
Here again the government spenders have the better of the argument with all
those who cannot see beyond the immediate range of their physical eyes.
They can see the bridge. But if they have taught themselves to look for
indirect as well as direct consequences they can once more see in the eye
of imagination the possibilities that have never been allowed to come into
existence. They can see the unbuilt homes, the unmade cars and radios,
the unmade dresses and coats, perhaps the unsold and ungrown foodstuffs.
To see these uncreated things requires a kind of imagination that not many
people have. We can think of these nonexistent objects once, perhaps,
but we cannot keep them before our minds as we can the bridge that we
pass every working day. What has happened is merely that one thing
has been created instead of others.
2
The same reasoning applies, of course, to every other form of public work.
It applies just as well, for example, to the erection with public funds of
housing for people of low incomes. All that happens is that money is taken
away through taxes from families of higher income (and perhaps a little
from families of even lower income) to force them to subsidize these
selected families with low incomes and enable them to live in better
housing for the same rent or for lower rent than previously.
I do not intend to enter here into all the pros and cons of public housing.
I am concerned only to point out the error in two of the arguments most
frequently put forward in favor of public housing. One is the argument
that it "creates employment;" the other that it creates wealth which would
not otherwise have been produced. Both of these arguments are false,
because they overlook what is lost through taxation. Taxation for public
housing destroys as many jobs in other lines as it creates in housing.
It also results in unbuilt private homes, in unmade washing machines and
refrigerators, and in lack of innumerable other commodities and services.
And none of this is answered by the sort of reply which points out,
for example, that public housing does not have to be financed by a lump sum
capital appropriation, but merely by annual rent subsidies. This simply
means that the cost is spread over many years instead of being concentrated
in one. It also means that what is taken from the taxpayers is spread over
many years instead of being concentrated into one. Such technicalities are
irrelevant to the main point.
The great psychological advantage of the public housing advocates is that men
are seen at work on the houses when they are going up, and the houses are
seen when they are finished. People live in them, and proudly show their
friends through the rooms. The jobs destroyed by the taxes for the housing
are not seen, nor are the goods and services that were never made. It takes
a concentrated effort of thought, and a new effort each time the houses
and the happy people in them are seen, to think of the wealth that was not
created instead. Is it surprising that the champions of public housing
should dismiss this, if it is brought to their attention, as a world of
imagination, as the objections of pure theory, while they point to the public
housing that exists? As a character in Bernard Shaw's Saint Joan
replies when told of the theory of Pythagoras that the earth is round and
revolves around the sun: "What an utter fool! Couldn't he use his eyes?"
We must apply the same reasoning, once more, to great projects like the
Tennessee Valley Authority. Here, because of sheer size, the danger of
optical illusion is greater than ever. Here is a mighty dam, a stupendous
arc of steel and concrete, "greater than anything that private capital could
have built," the fetish of photographers, the heaven of socialists, the
most often used symbol of the miracles of public construction, ownership,
and operation. Here are mighty generators and power houses. Here is a
whole region lifted to a higher economic level, attracting factories and
industries that could not otherwise have existed. And it is all presented,
in the panegyrics of its partisans, as a net economic gain without offsets.
We need not go here into the merits of the TVA or public projects like it.
But this time we need a special effort of the imagination, which few people
seem able to make, to look at the debit side of the ledger. If taxes are
taken from people and corporations, and spent in one particular section of
the country, why should it cause surprise, why should it be regarded as a
miracle, if that section becomes comparatively richer? Other sections of
the country, we should remember, are then comparatively poorer. The thing
so great that "private capital could not have built it" has in fact been
built by private capital -- the capital that was expropriated in taxes
(or, if the money was borrowed, that eventually must be expropriated in
taxes). Again we must make an effort of the imagination to see the private
power plants, the private homes, the typewriters and radios that were never
allowed to come into existence because of the money that was taken from
people all over the country to build the photogenic Norris Dam.
3
I have deliberately chosen the most favorable examples of public spending
schemes -- that is, those that are most frequently and fervently urged by
the government spenders and most highly regarded by the public. I have not
spoken of the hundreds of boondoggling projects that are invariably embarked
upon the moment the main object is to "give jobs" and "to put people to
work". For then the usefulness of the project itself, as we have seen,
inevitably becomes a subordinate consideration. Moreover, the more wasteful
the work, the more costly in manpower, the better it becomes for the purpose
of providing more employment. Under such circumstances it is highly
improbable that the projects thought up by the bureaucrats will provide the
same net addition to wealth and welfare, per dollar expended, as would have
been provided by the taxpayers themselves, if they had been individually
permitted to buy or have made what they themselves wanted, instead of
being forced to surrender part of their earnings to the state.
There is a still further factor which makes it improbable that the
wealth created by government spending will fully compensate for the wealth
destroyed by the taxes imposed to pay for that spending. It is not a simple
question, as so often supposed, of taking something out of the nation's
right-hand pocket to put into its left-hand pocket. The government spenders
tell us, for example, that if the national income is $200,000,000,000
(they are always generous in fixing this figure) then government taxes
of $50,000,000,000 a year would mean that only 25 percent of the national
income was being transferred from private purposes to public purposes.
This is to talk as if the country were the same sort of unit of pooled
resources as a huge corporation, and as if all that were involved were a
mere bookkeeping transaction. The government spenders forget that they are
taking the money from A in order to pay it to B. Or rather, they know this
very well; but while they dilate upon all the benefits of the process to B,
and all the wonderful things he will have which he would not have had if
the money had not been transferred to him, they forget the effects of the
transaction on A. B is seen; A is forgotten.
In our modern world there is never the same percentage of income tax
levied on everybody. The great burden of income taxes is imposed on
a minor percentage of the nation's income; and these income taxes have
to be supplemented by taxes of other kinds. These taxes inevitably
affect the actions and incentives of those from whom they are taken.
When a corporation loses 100 cents of every dollar it loses, and is
permitted to keep only 60 cents of every dollar it gains, and when it cannot
offset its years of losses against its years of gains, or cannot do so
adequately, its policies are affected. It does not expand its operations,
or it expands only those attended with a minimum of risk. People who
recognize this situation are deterred from starting new enterprises. Thus
old employers do not give more employment, or not as much more as they might
have; and others decide not to become employers at all. Improved machinery
and better-equipped factories come into existence much more slowly than they
otherwise would. The result in the long run is that consumers are prevented
from getting better and cheaper products, and that real wages are held down.
There is a similar effect when personal incomes are taxed 50, 60, 75, and
90 percent. People begin to ask themselves why they should work six, eight,
or ten months of the entire year for the government, and only six, four, or
two months for themselves and their families. If they lose the whole dollar
when they lose, but can keep only a dime of it when they win, they decide
that it is foolish to take risks with their capital. In addition, the
capital available for risk taking itself shrinks enormously. It is being
taxed away before it can be accumulated. In brief, capital to provide new
private jobs is first prevented from coming into existence, and the part
that does come into existence is then discouraged from starting new
enterprises. The government spenders create the very problem of
unemployment that they profess to solve.
A certain amount of taxes is of course indispensable to carry on essential
government functions. Reasonable taxes for this purpose need not hurt
production much. The kind of government services then supplied in return,
which among other things safeguard production itself, more than compensate
for this. But the larger the percentage of the national income taken by
taxes the greater the deterrent to private production and employment. When
the total tax burden grows beyond a bearable size, the problem of devising
taxes that will not discourage and disrupt production becomes insoluble.
1
Government "encouragement" to business is sometimes as much to be feared
as government hostility. This supposed encouragement often takes the form
of a direct grant of government credit or a guarantee of private loans.
The question of government credit can often be complicated, because it
involves the possibility of inflation. We shall defer analysis of the
effects of inflation of various kinds until a later chapter. Here, for the
sake of simplicity, we shall assume that the credit we are discussing is
non-inflationary. Inflation, as we shall later see, while it complicates
the analysis, does not at bottom change the consequences of the policies
discussed.
The most frequent proposal of this sort in Congress is for more credit to
farmers. In the eyes of most Congressmen the farmers simply cannot get
enough credit. The credit supplied by private mortgage companies, insurance
companies or country banks is never "adequate". Congress is always finding
new gaps that are not filled by the existing lending institutions, no matter
how many of these it has itself already brought into existence. The farmers
may have enough long-term credit or enough short-term credit, but, it turns
out, they have not enough "intermediate" credit; or the interest rate is too
high; or the complaint is that private loans are made only to rich and
well-established farmers. So new lending institutions and new types
of farm loans are piled on top of each other by the legislature.
The faith in all these policies, it will be found, springs from two acts of
shortsightedness. One is to look at the matter only from the standpoint of
the farmers that borrow. The other is to think only of the first half of
the transaction.
Now all loans, in the eyes of honest borrowers, must eventually be repaid.
All credit is debt. Proposals for an increased volume of credit, therefore,
are merely another name for proposals for an increased burden of debt.
They would seem considerably less inviting if they were habitually
referred to by the second name instead of by the first.
We need not discuss here the normal loans that are made to farmers through
private sources. They consist of mortgages; of installment credits for the
purchase of automobiles, refrigerators, radios, tractors, and other farm
machinery, and of bank loans made to carry the farmer along until he is able
to harvest and market his crop and get paid for it. Here we need concern
ourselves only with loans to farmers either made directly by some government
bureau or guaranteed by it.
These loans are of two main types. One is a loan to enable the farmer to
hold his crop off the market. This is an especially harmful type; but it
will be more convenient to consider it later when we come to the question
of government commodity controls. The other is a loan to provide capital
-- often to set the farmer up in business by enabling him to buy the farm
itself, or a mule or tractor, or all three.
At first glance the case for this type of loan may seem a strong one. Here
is a poor family, it will be said, with no means of livelihood. It is cruel
and wasteful to put them on relief. Buy a farm for them; set them up in
business; make productive and self-respecting citizens of them; let them add
to the total national product and pay the loan off out of what they produce.
Or here is a farmer struggling along with primitive methods of production
because he has not the capital to buy himself a tractor. Lend him the money
for one; let him increase his productivity; he can repay the loan out of the
proceeds of his increased crops. In that way you not only enrich him and
put him on his feet; you enrich the whole community by that much added
output. And the loan, concludes the argument, costs the government and
the taxpayers less than nothing, because it is "self-liquidating".
Now as a matter of fact this is what happens every day under the institution
of private credit. If a man wishes to buy a farm, and has, let us say, only
half or a third as much money as the farm costs, a neighbor or a savings
bank will lend him the rest in the form of a mortgage on the farm. If he
wishes to buy a tractor, the tractor company itself, or a finance company,
will allow him to buy it for one-third of the purchase price with the rest
to be paid off in installments out of earnings that the tractor itself will
help to provide.
But there is a decisive difference between the loans supplied by private
lenders and the loans supplied by a government agency. Each private lender
risks his own funds. (A banker, it is true, risks the funds of others that
have been entrusted to him; but if money is lost he must either make good
out of his own funds or be forced out of business.) When people risk their
own funds they are usually careful in their investigations to determine the
adequacy of the assets pledged and the business acumen and honesty of the
borrower.
If the government operated by the same strict standards, there would be
no good argument for its entering the field at all. Why do precisely what
private agencies already do? But the government almost invariably operates
by different standards. The whole argument for its entering the lending
business, in fact, is that it will make loans to people who could not get
them from private lenders. This is only another way of saying that the
government lenders will take risks with other people's money (the taxpayers')
that private lenders will not take with their own money. Sometimes, in fact,
apologists will freely acknowledge that the percentage of losses will be
higher on these government loans than on private loans. But they contend
that this will be more than offset by the added production brought into
existence by the borrowers who pay back, and even by most of the borrowers
who do not pay back.
This argument will seem plausible only as long as we concentrate our
attention on the particular borrowers whom the government supplies with
funds, and overlook the people whom its plan deprives of funds. For what
is really being lent is not money, which is merely the medium of exchange,
but capital. (I have already put the reader on notice that we shall
postpone to a later point the complications introduced by an inflationary
expansion of credit.) What is really being lent, say, is the farm or the
tractor itself. Now the number of farms in existence is limited, and so
is the production of tractors (assuming, especially, that an economic
surplus of tractors is not produced simply at the expense of other things).
The farm or tractor that is lent to A cannot be lent to B. The real
question is, therefore, whether A or B shall get the farm.
This brings us to the respective merits of A and B, and what each
contributes, or is capable of contributing, to production. A, let us say,
is the man who would get the farm if the government did not intervene.
The local banker or his neighbors know him and know his record. They want
to find employment for their funds. They know that he is a good farmer and
an honest man who keeps his word. They consider him a good risk. He has
already, perhaps, through industry, frugality and foresight, accumulated
enough cash to pay one-fourth of the price of the farm. They lend him
the other three-fourths; and he gets the farm.
There is a strange idea abroad, held by all monetary cranks, that credit is
something a banker gives to a man. Credit, on the contrary, is something
a man already has. He has it, perhaps, because he already has marketable
assets of a greater cash value than the loan for which he is asking. Or he
has it because his character and past record have earned it. He brings it
into the bank with him. That is why the banker makes him the loan. The
banker is not giving something for nothing. He feels assured of repayment.
He is merely exchanging a more liquid form of asset or credit for a less
liquid form. Sometimes he makes a mistake, and then it is not only the
banker who suffers, but the whole community; for values which were supposed
to be produced by the lender are not produced and resources are wasted.
Now it is to A, let us say, who has credit, that the banker would make his
loan. But the government goes into the lending business in a charitable
frame of mind because, as we saw, it is worried about B. B cannot get a
mortgage or other loans from private lenders because he does not have credit
with them. He has no savings; he has no impressive record as a good farmer;
he is perhaps at the moment on relief. Why not, say the advocates of
government credit, make him a useful and productive member of society by
lending him enough for a farm and a mule or tractor and setting him up in
business?
Perhaps in an individual case it may work out all right. But it is obvious
that in general the people selected by these government standards will be
poorer risks than the people selected by private standards. More money will
be lost by loans to them. There will be a much higher percentage of failures
among them. They will be less efficient. More resources will be wasted by
them. Yet the recipients of government credit will get their farms and
tractors at the expense of what otherwise would have been the recipients
of private credit. Because B has a farm, A will be deprived of a farm.
A may be squeezed out either because interest rates have gone up as a
result of the government operations, or because farm prices have been forced
up as a result of them, or because there is no other farm to be had in his
neighborhood. In any case the net result of government credit has not been
to increase the amount of wealth produced by the community but to reduce it,
because the available real capital (consisting of actual farms, tractors,
etc.) has been placed in the hands of the less efficient borrowers rather
than in the hands of the more efficient and trustworthy.
2
The case becomes even clearer if we turn from farming to other forms of
business. The proposal is frequently made that the government ought to
assume the risks that are "too great for private industry". This means
that bureaucrats should be permitted to take risks with the taxpayers'
money that no one is willing to take with his own.
Such a policy would lead to evils of many different kinds. It would lead
to favoritism: to the making of loans to friends, or in return for bribes.
It would inevitably lead to scandals. It would lead to recriminations
whenever the taxpayers' money was thrown away on enterprises that failed.
It would increase the demand for socialism: for, it would properly be asked,
if the government is going to bear the risks, why should it not also get
the profits? What justification could there possibly be, in fact, for
asking the taxpayers to take the risks while permitting private capitalists
to keep the profits? (This is precisely, however, as we shall later see,
what we already do in the case of "nonrecourse" government loans to farmers.)
But we shall pass over all these evils for the moment, and concentrate on
just one consequence of loans of this type. This is that they will waste
capital and reduce production. They will throw the available capital into
bad or at best dubious projects. They will throw it into the hands of
persons who are less competent or less trustworthy than those who would
otherwise have got it. For the amount of real capital at any moment
(as distinguished from monetary tokens run off on a printing press) is
limited. What is put into the hands of B cannot be put into the hands of A.
People want to invest their own capital. But they are cautious. They want
to get it back. Most lenders, therefore, investigate any proposal carefully
before they risk their own money in it. They weigh the prospect of profits
against the chances of loss. They may sometimes make mistakes. But for
several reasons they are likely to make fewer mistakes than government
lenders. In the first place, the money is either their own or has been
voluntarily entrusted to them. In the case of government lending the money
is that of other people, and it has been taken from them, regardless of their
personal wish, in taxes. The private money will be invested only where
repayment with interest or profit is definitely expected. This is a sign
that the persons to whom the money has been lent will be expected to produce
things for the market that people actually want. The government money,
on the other hand, is likely to be lent for some vague general purpose
like "creating employment"; and the more inefficient the work -- that is,
the greater the volume of employment it requires in relation to the value
of product -- the more highly thought of the investment is likely to be.
The private lenders, moreover, are selected by a cruel market test.
If they make bad mistakes they lose their money and have no more money
to lend. It is only if they have been successful in the past that they
have more money to lend in the future. Thus private lenders (except
the relatively small proportion that have got their funds through
inheritance) are rigidly selected by a process of survival of the fittest.
The government lenders, on the other hand, are either those who have passed
civil service examinations, and know how to answer hypothetical questions
hypothetically, or they are those who can give the most plausible reasons
for making loans and the most plausible explanations of why it wasn't their
fault that the loans failed. But the net result remains: private loans will
utilize existing resources and capital far better than government loans.
Government loans will waste far more capital and resources than private
loans. Government loans, in short, as compared with private loans,
will reduce production, not increase it.
The proposal for government loans to private individuals or projects,
in brief, sees B and forgets A. It sees the people in whose hands the
capital is put; it forgets those who would otherwise have had it. It sees
the project to which capital is granted; it forgets the projects from which
capital is thereby withheld. It sees the immediate benefit to one group;
it overlooks the losses to other groups, and the net loss to the community
as a whole.
It is one more illustration of the fallacy of seeing only a special interest
in the short run and forgetting the general interest in the long run.
3
We remarked at the beginning of this chapter that government "aid"
to business is sometimes as much to be feared as government hostility.
This applies as much to government subsidies as to government loans.
The government never lends or gives anything to business that it does not
take away from business. One often hears New Dealers and other statists
boast about the way government "baled business out" with the Reconstruction
Finance Corporation, the Home Owners Loan Corporation, and other government
agencies in 1932 and later. But the government can give no financial
help to business that it does not first or finally take from business.
The government's funds all come from taxes. Even the much vaunted
"government credit" rests on the assumption that its loans will ultimately
be repaid out of the proceeds of taxes. When the government makes loans
or subsidies to business, what it does is to tax successful private business
in order to support unsuccessful private business. Under certain emergency
circumstances there may be a plausible argument for this, the merits
of which we need not examine here. But in the long run it does not sound
like a paying proposition from the standpoint of the country as a whole.
And experience has shown that it isn't.
1
Among the most viable of all economic delusions is the belief that machines
on net balance create unemployment. Destroyed a thousand times, it has
risen a thousand times out of its own ashes as hardy and vigorous as ever.
Whenever there is long-continued mass unemployment, machines get the blame
anew. This fallacy is still the basis of many labor union practices.
The public tolerates these practices because it either believes at bottom
that the unions are right, or is too confused to see just why they are wrong.
The belief that machines cause unemployment, when held with any logical
consistency, leads to preposterous conclusions. Not only must we be
causing unemployment with every technological improvement we make today,
but primitive man must have started causing it with the first efforts
he made to save himself from needless toil and sweat.
To go no further back, let us turn to Adam Smith's The Wealth of
Nations, published in 1776. The first chapter of this remarkable book
is called "Of the Division of Labor", and on the second page of this first
chapter the author tells us that a workman unacquainted with the use of
machinery employed in pin making "could scarce make one pin a day, and
certainly could not make twenty," but that with the use of this machinery
he can make 4,800 pins a day. So already, alas, in Adam Smith's time,
machinery had thrown from 240 to 4,800 pin makers out of work for every one
it kept. In the pin-making industry there was already, if machines merely
throw men out of jobs, 99.98 percent unemployment. Could things be blacker?
Things could be blacker, for the Industrial Revolution was just in its
infancy. Let us look at some of the incidents and aspects of that
revolution. Let us see, for example, what happened in the stocking
industry. New stocking frames as they were introduced were destroyed
by the handicraft workmen (over 1,000 in a single riot), houses were
burned, the inventors were threatened and obliged to fly for their lives,
and order was not finally restored until the military had been called
out and the leading rioters had been either transported or hanged.
Now it is important to bear in mind that insofar as the rioters were
thinking of their own immediate or even longer futures their opposition
to the machine was rational. For William Felkin, in his History of the
Machine-Wrought Hosiery Manufactures (1867), tells us that the larger
part of the 50,000 English stocking knitters and their families did not
fully emerge from the hunger and misery entailed by the introduction of the
machine for the next forty years. But in so far as the rioters believed,
as most of them undoubtedly did, that the machine was permanently displacing
men, they were mistaken, for before the end of the nineteenth century the
stocking industry was employing at least 100 men for every man it employed
at the beginning of the century.
Arkwright invented his cotton-spinning machinery in 1760. At that time
it was estimated that there were in England 5,200 spinners using spinning
wheels, and 2,700 weavers -- in all, 7,900 persons engaged in the production
of cotton textiles. The introduction of Arkwright's invention was opposed
on the ground that it threatened the livelihood of the workers, and the
opposition had to be put down by force. Yet in 1787 -- twenty-seven years
after the invention appeared -- a parliamentary inquiry showed that the
number of persons actually engaged in the spinning and weaving of cotton
had risen from 7,900 to 320,000, an increase of 4,400 percent.
If the reader will consult such a book as Recent Economic Changes, by
David A. Wells, published in 1889, he will find passages that, except for
the dates and absolute amounts involved, might have been written by our
technophobes (if I may coin a needed word) of today. Let me quote a few:
During the ten years from 1870 to 1880, inclusive, the British mercantile
marine increased its movement, in the matter of foreign entries and
clearances alone, to the extent of 22,000,000 tons ... yet the number
of men who were employed in effecting this great movement had decreased
in 1880, as compared with 1870, to the extent of about three thousand
(2,990 exactly). What did it? The introduction of steam-hoisting
machines and grain elevators upon the wharves and docks,
the employment of steam power, etc. ...
In 1873 Bessemer steel in England, where its price had not been enhanced
by protective duties, commanded $80 per ton; in 1886 it was profitably
manufactured and sold in the same country for less than $20 per ton.
Within the same time the annual production capacity of a Bessemer
converter has been increased fourfold, with no increase but rather
a diminution of the involved labor. ...
The power capacity already being exerted by the steam engines of the
world in existence and working in the year 1887 has been estimated by
the Bureau of Statistics at Berlin as equivalent to that of 200,000,000
horses, representing approximately 1,000,000,000 men; or at least three
times the working population of the earth.
One would think that this last figure would have caused Mr. Wells to pause,
and wonder why there was any employment left in the world of 1889 at all;
but he merely concluded, with restrained pessimism, that "under such
circumstances industrial overproduction ... may become chronic."
In the depression of 1932, the game of blaming unemployment on the machines
started all over again. Within a few months the doctrines of a group calling
themselves the Technocrats had spread through the country like a forest fire.
I shall not weary the reader with a recital of the fantastic figures put
forward by this group or with corrections to show what the real facts were.
It is enough to say that the Technocrats returned to the error in all its
native purity that machines permanently displace men -- except that, in
their ignorance, they presented this error as a new and revolutionary
discovery of their own. It was simply one more illustration of Santayana's
aphorism that those who cannot remember the past are condemned to repeat it.
The Technocrats were finally laughed out of existence; but their doctrine,
which preceded them, lingers on. It is reflected in hundreds of make-work
rules and feather-bed practices by labor unions; and these rules and
practices are tolerated and even approved because of the confusion
on this point in the public mind.
Testifying on behalf of the United States Department of Justice before
the Temporary National Economic Committee (better known as the TNEC) in
March, 1941, Corwin Edwards cited innumerable examples of such practices.
The electrical union in New York City was charged with refusal to install
electrical equipment made outside of New York State unless the equipment
was disassembled and reassembled at the job site. In Houston, Texas,
master plumbers and the plumbing union agreed that piping prefabricated for
installation would be installed by the union only if the thread were cut
off one end of the pipe and new thread were cut at the job site. Various
locals of the painters' union imposed restrictions on the use of spray guns,
restrictions in many cases designed merely to make work by requiring the
slower process of applying paint with a brush. A local of the teamsters'
union required that every truck entering the New York metropolitan area
have a local driver in addition to the driver already employed. In various
cities the electrical union required that if any temporary light or power
was to be used on a construction job there must be a full-time maintenance
electrician, who should not be permitted to do any electrical construction
work. This rule, according to Mr. Edwards, "often involves the hiring of
a man who spends his day reading or playing solitaire and does nothing
except throw a switch at the beginning and end of the day."
One could go on to cite such make-work practices in many other fields.
In the railroad industry, the unions insist that firemen be employed on
types of locomotives that do not need them. In the theaters unions insist
on the use of scene shifters even in plays in which no scenery is used.
The musicians' union requires so-called "stand-in" musicians or even whole
orchestras to be employed in many cases where only phonograph records are
needed.
2
One might pile up mountains of figures to show how wrong were
the technophobes of the past. But it would do no good unless we understood
clearly why they were wrong. For statistics and history are useless
in economics unless accompanied by a basic deductive understanding of
the facts -- which means in this case an understanding of why the past
consequences of the introduction of machinery and other labor-saving
devices had to occur. Otherwise the technophobes will assert
(as they do in fact assert when you point out to them that the prophecies
of their predecessors turned out to be absurd): "That may have been all
very well in the past; but today conditions are fundamentally different;
and now we simply cannot afford to develop any more labor-saving machinery."
Mrs. Eleanor Roosevelt, indeed, in a syndicated newspaper column of
September 19, 1945, wrote: "We have reached a point today where labor-saving
devices are good only when they do not throw the worker out of his job."
If it were indeed true that the introduction of labor-saving machinery
is a cause of constantly mounting unemployment and misery, the logical
conclusions to be drawn would be revolutionary, not only in the technical
field but for our whole concept of civilization. Not only should we have
to regard all further technical progress as a calamity; we should have to
regard all past technical progress with equal horror. Every day each of us
in his own capacity is engaged in trying to reduce the effort it requires
to accomplish a given result. Each of us is trying to save his own labor,
to economize the means required to achieve his ends. Every employer, small
as well as large, seeks constantly to gain his results more economically
and efficiently -- that is, by saving labor. Every intelligent workman
tries to cut down the effort necessary to accomplish his assigned job.
The most ambitious of us try tirelessly to increase the results we can
achieve in a given number of hours. The technophobes, if they were logical
and consistent, would have to dismiss all this progress and ingenuity as
not only useless but vicious. Why should freight be carried from New York
to Chicago by railroads when we could employ enormously more men,
for example, to carry it all on their backs?
Theories as false as this are never held with logical consistency, but they
do great harm because they are held at all. Let us, therefore, try to see
exactly what happens when technical improvements and labor-saving machinery
are introduced. The details will vary in each instance, depending upon
the particular conditions that prevail in a given industry or period.
But we shall assume an example that involves the main possibilities.
Suppose a clothing manufacturer learns of a machine that will make men's
and women's overcoats for half as much labor as previously. He installs
the machines and drops half his labor force.
This looks at first glance like a clear loss of employment. But the machine
itself required labor to make it; so here, as one offset, are jobs that
would not otherwise have existed. The manufacturer, however, would have
adopted the machine only if it had either made better suits for half as much
labor, or had made the same kind of suits at a smaller cost. If we assume
the latter, we cannot assume that the amount of labor to make the machines
was as great in terms of payrolls as the amount of labor that the clothing
manufacturer hopes to save in the long run by adopting the machine;
otherwise there would have been no economy, and he would not have adopted it.
So there is still a net loss of employment to be accounted for. But we
should at least keep in mind the real possibility that even the first
effect of the introduction of labor-saving machinery may be to increase
employment on net balance; because it is usually only in the long run
that the clothing manufacturer expects to save money by adopting the
machine: it may take several years for the machine to "pay for itself."
After the machine has produced economies sufficient to offset its cost,
the clothing manufacturer has more profits than before. (We shall assume
that he merely sells his coats for the same price as his competitors, and
makes no effort to undersell them.) At this point, it may seem, labor has
suffered a net loss of employment, while it is only the manufacturer, the
capitalist, who has gained. But it is precisely out of these extra profits
that the subsequent social gains must come. The manufacturer must use these
extra profits in at least one of three ways, and possibly he will use part
of them in all three: (1) he will use the extra profits to expand his
operations by buying more machines to make more coats; or (2) he will invest
the extra profits in some other industry; or (3) he will spend the extra
profits on increasing his own consumption. Whichever of these three courses
he takes, he will increase employment.
In other words, the manufacturer, as a result of his economies, has profits
that he did not have before. Every dollar of the amount he has saved in
direct wages to former coat makers, he now has to pay out in indirect wages
to the makers of the new machine, or to the workers in another capital
industry, or to the makers of a new house or motor car for himself, or
of jewelry and furs for his wife. In any case (unless he is a pointless
hoarder) he gives indirectly as many jobs as he ceased to give directly.
But the matter does not and cannot rest at this stage. If this enterprising
manufacturer effects great economies as compared with his competitors, either
he will begin to expand his operations at their expense, or they will start
buying the machines too. Again more work will be given to the makers of the
machines. But competition and production will then also begin to force down
the price of overcoats. There will no longer be as great profits for those
who adopt the new machines. The rate of profit of the manufacturers using
the new machine will begin to drop, while the manufacturers who have still
not adopted the machine may now make no profit at all. The savings, in
other words, will begin to be passed along to the buyers of overcoats
-- to the consumers.
But as overcoats are now cheaper, more people will buy them. This means
that, though it takes fewer people to make the same number of overcoats
as before, more overcoats are now being made than before. If the demand
for overcoats is what economists call "elastic" -- that is, if a fall in
the price of overcoats causes a larger total amount of money to be spent
on overcoats than previously -- then more people may be employed even in
making overcoats than before the new labor-saving machine was introduced.
We have already seen how this actually happened historically with stockings
and other textiles.
But the new employment does not depend on the elasticity of demand for the
particular product involved. Suppose that, though the price of overcoats
was almost cut in half -- from a former price, say, of $50 to a new price
of $30 -- not a single additional coat was sold. The result would be that
while consumers were as well provided with new overcoats as before, each
buyer would now have $20 left over that he would not have had left over
before. He will therefore spend this $20 for something else, and so
provide increased employment in other lines.
In brief, on net balance, machines, technological improvements, economies
and efficiency do not throw men out of work.
3
Not all inventions and discoveries, of course, are "labor-saving" machines.
Some of them, like precision instruments, like nylon, lucite, plywood, and
plastics of all kinds, simply improve the quality of products. Others, like
the telephone or the airplane, perform operations that direct human labor
could not perform at all. Still others bring into existence objects and
services, such as X-rays, radios, and synthetic rubber, that would otherwise
not even exist. But in the foregoing illustration we have taken precisely
the kind of machine that has been the special object of modern technophobia.
It is possible, of course, to push too far the argument that machines do not
on net balance throw men out of work. It is sometimes argued, for example,
that machines create more jobs than would otherwise have existed. Under
certain conditions this may be true. They can certainly create enormously
more jobs in particular trades. The eighteenth-century figures for
the textile industries are a case in point. Their modern counterparts are
certainly no less striking. In 1910, 140,000 persons were employed in the
United States in the newly created automobile industry. In 1920, as the
product was improved and its cost reduced, the industry employed 250,000.
In 1930, as this product improvement and cost reduction continued,
employment in the industry was 380,000. In 1940 it had risen to 450,000.
By 1940, 35,000 people were employed in making electric refrigerators,
and 60,000 were in the radio industry. So it has been in one newly created
trade after another, as the invention was improved and the cost reduced.
There is also an absolute sense in which machines may be said to have
enormously increased the number of jobs. The population of the world today
is three times as great as in the middle of the eighteenth century, before
the Industrial Revolution had got well under way. Machines may be said to
have given birth to this increased population; for without the machines,
the world would not have been able to support it. Two out of every three
of us, therefore, may be said to owe not only our jobs but our very lives
to machines.
Yet it is a misconception to think of the function or result of machines
as primarily one of creating jobs. The real result of the machine is
to increase production, to raise the standard of living, to increase
economic welfare. It is no trick to employ everybody, even (or especially)
in the most primitive economy. Full employment -- very full employment;
long, weary, back-breaking employment -- is characteristic of precisely the
nations that are most retarded industrially. Where full employment already
exists, new machines, inventions, and discoveries cannot -- until there has
been time for an increase in population -- bring more employment. They are
likely to bring more unemployment (but this time I am speaking of
voluntary and not involuntary unemployment) because people can now
afford to work fewer hours, while children and the overaged no longer need
to work.
What machines do, to repeat, is to bring an increase in production and an
increase in the standard of living. They may do this in either of two ways.
They do it by making goods cheaper for consumers (as in our illustration of
the overcoats), or they do it by increasing wages because they increase the
productivity of the workers. In other words, they either increase money
wages or, by reducing prices, they increase the goods and services that the
same money wages will buy. Sometimes they do both. What actually happens
will depend in large part upon the monetary policy pursued in a country.
But in any case, machines, inventions, and discoveries increase real
wages.
4
A warning is necessary before we leave this subject. It was precisely
the great merit of the classical economists that they looked for secondary
consequences, that they were concerned with the effects of a given economic
policy or development in the long run and on the whole community. But it
was also their defect that, in taking the long view and the broad view,
they sometimes neglected to take also the short view and the narrow view.
They were too often inclined to minimize or to forget altogether the
immediate effects of developments on special groups. We have seen,
for example, that the English stocking knitters suffered real tragedies
as a result of the introduction of the new stocking frames, one of the
earliest inventions of the Industrial Revolution.
But such facts and their modern counterparts have led some writers to the
opposite extreme of looking only at the immediate effects on certain
groups. Joe Smith is thrown out of a job by the introduction of some new
machine. "Keep your eye on Joe Smith," these writers insist. "Never lose
track of Joe Smith." But what they then proceed to do is to keep their
eyes only on Joe Smith, and to forget Tom Jones, who has just got
a new job in making the new machine, and Ted Brown, who has just got a job
operating one, and Daisy Miller, who can now buy a coat for half what it
used to cost her. And because they think only of Joe Smith, they end by
advocating reactionary and nonsensical policies.
Yes, we should keep at least one eye on Joe Smith. He has been thrown out
of a job by the new machine. Perhaps he can soon get another job, even a
better one. But perhaps, also, he has devoted many years of his life to
acquiring and improving a special skill for which the market no longer has
any use. He has lost this investment in himself, in his old skill, just as
his former employer, perhaps, has lost his investment in old machines
or processes suddenly rendered obsolete. He was a skilled workman, and paid
as a skilled workman. Now he has become overnight an unskilled workman
again, and can hope, for the present, only for the wages of an unskilled
workman, because the one skill he had is no longer needed. We cannot and
must not forget Joe Smith. His is one of the personal tragedies that, as
we shall see, are incident to nearly all industrial and economic progress.
To ask precisely what course we should follow with Joe Smith -- whether
we should let him make his own adjustment, give him separation pay or
unemployment compensation, put him on relief, or train him at government
expense for a new job -- would carry us beyond the point that we are here
trying to illustrate. The central lesson is that we should try to see
all the main consequences of any economic policy or development
-- the immediate effects on special groups, and the long-run effects
on all groups.
If we have devoted considerable space to this issue, it is because
our conclusions regarding the effects of new machinery, inventions
and discoveries on employment, production and welfare are crucial.
If we are wrong about these, there are few things in economics
about which we are likely to be right.
Ihave referred to various union make-work and featherbed practices.
These practices, and the public toleration of them, spring from the
same fundamental fallacy as the fear of machines. This is the belief
that a more efficient way of doing a thing destroys jobs, and its
necessary corollary that a less efficient way of doing it creates them.
Allied to this fallacy is the belief that there is just a fixed amount of
work to be done in the world, and that, if we cannot add to this work by
thinking up more cumbersome ways of doing it, at least we can think of
devices for spreading it around among as large a number of people as
possible.
This error lies behind the minute subdivision of labor upon which unions
insist. In the building trades in large cities the subdivision is notorious.
Bricklayers are not allowed to use stones for a chimney: that is the special
work of stonemasons. An electrician cannot rip out a board to fix a
connection and put it back again: that is the special job, no matter
how simple it may be, of the carpenters. A plumber will not remove or
put back a tile incident to fixing a leak in the shower: that is the
job of a tilesetter.
Furious "jurisdictional" strikes are fought among unions for the exclusive
right to do certain types of borderline jobs. In a statement recently
prepared by the American railroads for the Attorney General's Committee
on Administrative Procedure, the railroads gave innumerable examples
in which the National Railroad Adjustment Board had decided that
each separate operation on the railroad, no matter how minute, such as
talking over a telephone or spiking or unspiking a switch, is so far an
exclusive property of a particular class of employee that if an employee
of another class, in the course of his regular duties, performs such
operations he must not only be paid an extra day's wages for doing so,
but at the same time the furloughed or unemployed members of the class
held to be entitled to perform the operation must be paid a day's wages
for not having been called upon to perform it.
It is true that a few persons can profit at the expense of the rest of us
from this minute arbitrary subdivision of labor -- provided it happens in
their case alone. But those who support it as a general practice fail to
see that it always raises production costs; that it results on net balance
in less work done and in fewer goods produced. The householder who is
forced to employ two men to do the work of one has, it is true, given
employment to one extra man. But he has just that much less money left
over to spend on something that would employ somebody else. Because his
bathroom leak has been repaired at double what it should have cost, he
decides not to buy the new sweater he wanted. "Labor" is no better off,
because a day's employment of an unneeded tilesetter has meant a day's
employment of a sweater knitter or machine handler. The householder,
however, is worse off. Instead of having a repaired shower and a sweater,
he has the shower and no sweater. And if we count the sweater as part of the
national wealth, the country is short one sweater. This symbolizes the net
result of the effort to make extra work by arbitrary subdivision of labor.
But there are other schemes for "spreading the work" often put forward by
union spokesmen and legislators. The most frequent of these is the proposal
to shorten the working week, usually by law. The belief that it would
"spread the work" and "give more jobs" was one of the main reasons behind
the inclusion of the penalty-overtime provision in the existing Federal
Wage-Hour Law. The previous legislation in the States, forbidding the
employment of women or minors for more, say, than forty-eight hours a week,
was based on the conviction that longer hours were injurious to health and
morale. Some of it was based on the belief that longer hours were harmful
to efficiency. But the provision in the Federal law, that an employer must
pay a worker a 50 percent premium above his regular hourly rate of wages for
all hours worked in any week above forty, was not based primarily on the
belief that forty-five hours a week, say, was injurious either to health or
efficiency. It was inserted partly in the hope of boosting the worker's
weekly income, and partly in the hope that, by discouraging the employer from
taking on anyone regularly for more than forty hours a week, it would force
him to employ additional workers instead. At the time of writing this, there
are many schemes for "averting unemployment" by enacting a thirty-hour week.
What is the actual effect of such plans, whether enforced by individual
unions or by legislation? It will clarify the problem if we consider two
cases. The first is a reduction in the standard working week from forty
hours to thirty without any change in the hourly rate of pay. The second
is a reduction in the working week from forty hours to thirty, but with a
sufficient increase in hourly wage rates to maintain the same weekly pay
for the individual workers already employed.
Let us take the first case. We assume that the working week is cut from
forty hours to thirty, with no change in hourly pay. If there is substantial
unemployment when this plan is put into effect, the plan will no doubt
provide additional jobs. We cannot assume that it will provide sufficient
additional jobs, however, to maintain the same payrolls and the same number
of man-hours as before, unless we make the unlikely assumptions that in each
industry there has been exactly the same percentage of unemployment and that
the new men and women employed are no less efficient at their special tasks
on the average than those who had already been employed. But suppose we
do make these assumptions. Suppose we do assume that the right number of
additional workers of each skill is available, and that the new workers do
not raise production costs. What will be the result of reducing the working
week from forty hours to thirty (without any increase in hourly pay)?
Though more workers will be employed, each will be working fewer hours,
and there will, therefore, be no net increase in man-hours. It is unlikely
that there will be any significant increase in production. Total payrolls
and "purchasing power" will be no larger. All that will have happened, even
under the most favorable assumptions (which would seldom be realized) is
that the workers previously employed will subsidize, in effect, the workers
previously unemployed. For in order that the new workers will individually
receive three-fourths as many dollars a week as the old workers used to
receive, the old workers will themselves now individually receive only
three-fourths as many dollars a week as previously. It is true that the
old workers will now work fewer hours; but this purchase of more leisure
at a high price is presumably not a decision they have made for its own
sake: it is a sacrifice made to provide others with jobs.
The labor union leaders who demand shorter weeks to "spread the work"
usually recognize this, and therefore they put the proposal forward in
a form in which everyone is supposed to eat his cake and have it too.
Reduce the working week from forty hours to thirty, they tell us, to provide
more jobs; but compensate for the shorter week by increasing the hourly
rate of pay by 33 1/3 percent. The workers employed, say, were previously
getting an average of $40 a week for forty hours work; in order that they
may still get $40 for only thirty hours work, the hourly rate of pay must
be advanced to an average of $1.33 1/3.
What would be the consequences of such a plan? The first and most obvious
consequence would be to raise costs of production. If we assume that the
workers, when previously employed for forty hours, were getting less than
the level of production costs, prices, and profits made possible, then they
could have got the hourly increase without reducing the length of
the working week. They could, in other words, have worked the same number
of hours and got their total weekly incomes increased by one-third,
instead of merely getting, as they are under the new thirty-hour week,
the same weekly income as before. But if, under the forty-hour week, the
workers were already getting as high a wage as the level of production
costs and prices made possible (and the very unemployment they are trying
to cure may be a sign that they were already getting even more than this),
then the increase in production costs as a result of the 33 1/3 percent
increase in hourly wage rates will be much greater than the existing state
of prices, production, and costs can stand.
The result of the higher wage rate, therefore, will be a much greater
unemployment than before. The least efficient firms will be thrown out
of business, and the least efficient workers will be thrown out of jobs.
Production will be reduced all around the circle. Higher production costs
and scarcer supplies will tend to raise prices, so that workers can buy less
with the same dollar wages; on the other hand, the increased unemployment
will shrink demand and hence tend to lower prices. What ultimately happens
to the prices of goods will depend upon what monetary policies are then
followed. But if a policy of monetary inflation is pursued, to enable
prices to rise so that the increased hourly wages can be paid, this will
merely be a disguised way of reducing real wage rates, so that these
will return, in terms of the amount of goods they can purchase, to the
same real rate as before. The result would then be the same as if the
working week had been reduced without an increase in hourly wage rates.
And the results of that have already been discussed.
The spread-the-work schemes, in brief, rest on the same sort of illusion
that we have been considering. The people who support such schemes think
only of the employment they would provide for particular persons or groups;
they do not stop to consider what their whole effect would be on everybody.
The spread-the-work schemes rest also, as we began by pointing out, on the
false assumption that there is just a fixed amount of work to be done.
There could be no greater fallacy. There is no limit to the amount of work
to be done as long as any human need or wish that work could fill remains
unsatisfied. In a modern exchange economy, the most work will be done
when prices, costs, and wages are in the best relations to each other.
What these relations are we shall later consider.
1
When, after every great war, it is proposed to demobilize the armed forces,
there is always a great fear that there will not be enough jobs for these
forces and that in consequence they will be unemployed. It is true that,
when millions of men are suddenly released, it may require time for private
industry to reabsorb them -- though what has been chiefly remarkable in the
past has been the speed, rather than the slowness, with which this was
accomplished. The fears of unemployment arise because people look at
only one side of the process.
They see soldiers being turned loose on the labor market. Where is the
"purchasing power" going to come from to employ them? If we assume that
the public budget is being balanced, the answer is simple. The government
will cease to support the soldiers. But the taxpayers will be allowed to
retain the funds that were previously taken from them in order to support
the soldiers. And the taxpayers will then have additional funds to buy
additional goods. Civilian demand, in other words, will be increased, and
will give employment to the added labor force represented by the soldiers.
If the soldiers have been supported by an unbalanced budget -- that is,
by government borrowing and other forms of deficit financing -- the case is
somewhat different. But that raises a different question: we shall consider
the effects of deficit financing in a later chapter. It is enough to
recognize that deficit financing is irrelevant to the point that has just
been made; for if we assume that there is any advantage in a budget deficit,
then precisely the same budget deficit could be maintained as before by
simply reducing taxes by the amount previously spent in supporting the
wartime army.
But the demobilization will not leave us economically just where we were
before it started. The soldiers previously supported by civilians will not
become merely civilians supported by other civilians. They will become
self-supporting civilians. If we assume that the men who would otherwise
have been retained in the armed forces are no longer needed for defense,
then their retention would have been sheer waste. They would have been
unproductive. The taxpayers, in return for supporting them, would have
got nothing. But now the taxpayers turn over this part of their funds
to them as fellow civilians in return for equivalent goods or services.
Total national production, the wealth of everybody, is higher.
2
The same reasoning applies to civilian government officials whenever
they are retained in excessive numbers and do not perform services for
the community reasonably equivalent to the remuneration they receive.
Yet whenever any effort is made to cut down the number of unnecessary
officeholders the cry is certain to be raised that this action is
"deflationary". Would you remove the "purchasing power" from these
officials? Would you injure the landlords and tradesmen who depend
on that purchasing power? You are simply cutting down "the national
income" and helping to bring about or intensify a depression.
Once again the fallacy comes from looking at the effects of this action only
on the dismissed officeholders themselves and on the particular tradesmen
who depend upon them. Once again it is forgotten that, if these bureaucrats
are not retained in office, the taxpayers will be permitted to keep the
money that was formerly taken from them for the support of the bureaucrats.
Once again it is forgotten that the taxpayers' income and purchasing power
go up by at least as much as the income and purchasing power of the former
officeholders go down. If the particular shopkeepers who formerly got the
business of these bureaucrats lose trade, other shopkeepers elsewhere gain
at least as much. Washington is less prosperous, and can, perhaps, support
fewer stores; but other towns can support more.
Once again, however, the matter does not end there. The country is not
merely as well off without the superfluous officeholders as it would have
been had it retained them. It is much better off. For the officeholders
must now seek private jobs or set up private businesses. And the added
purchasing power of the taxpayers, as we noted in the case of the soldiers,
will encourage this. But the officeholders can take private jobs only by
supplying equivalent services to those who provide the jobs -- or, rather,
to the customers of the employers who provide the jobs. Instead of being
parasites, they become productive men and women.
I must insist again that in all this I am not talking of public officeholders
whose services are really needed. Necessary policemen, firemen, street
cleaners, health officers, judges, legislators, and executives perform
productive services as important as those of anyone in private industry.
They make it possible for private industry to function in an atmosphere of
law, order, freedom, and peace. But their justification consists in the
utility of their services. It does not consist in the "purchasing power"
they possess by virtue of being on the public payroll.
This "purchasing power" argument is, when one considers it seriously,
fantastic. It could just as well apply to a racketeer or a thief who robs
you. After he takes your money he has more purchasing power. He supports
with it bars, restaurants, nightclubs, tailors, perhaps automobile workers.
But for every job his spending provides, your own spending must provide one
less, because you have that much less to spend. Just so the taxpayers
provide one less job for every job supplied by the spending of officeholders.
When your money is taken by a thief, you get nothing in return. When your
money is taken through taxes to support needless bureaucrats, precisely the
same situation exists. We are lucky, indeed, if the needless bureaucrats
are mere easygoing loafers. They are more likely today to be energetic
reformers busily discouraging and disrupting production.
When we can find no better argument for the retention of any group of
officeholders than that of retaining their purchasing power, it is a sign
that the time has come to get rid of them.
The economic goal of any nation, as of any individual, is to get the
greatest results with the least effort. The whole economic progress
of mankind has consisted in getting more production with the same labor.
It is for this reason that men began putting burdens on the backs of mules
instead of on their own; that they went on to invent the wheel and the
wagon, the railroad and the motor truck. It is for this reason that
men used their ingenuity to develop 100,000 labor-saving inventions.
All this is so elementary that one would blush to state it if it were not
being constantly forgotten by those who coin and circulate the new slogans.
Translated into national terms, this first principle means that our real
objective is to maximize production. In doing this, full employment
-- that is, the absence of involuntary idleness -- becomes a necessary
by-product. But production is the end, employment merely the means.
We cannot continuously have the fullest production without full employment.
But we can very easily have full employment without full production.
Primitive tribes are naked, and wretchedly fed and housed, but they do
not suffer from unemployment. China and India are incomparably poorer
than ourselves, but the main trouble from which they suffer is primitive
production methods (which are both a cause and a consequence of a shortage
of capital) and not unemployment. Nothing is easier to achieve than full
employment, once it is divorced from the goal of full production and taken
as an end in itself. Hitler provided full employment with a huge armament
program. The war provided full employment for every nation involved.
The slave labor in Germany had full employment. Prisons and chain gangs
have full employment. Coercion can always provide full employment.
Yet our legislators do not present Full Production bills in Congress
but Full Employment bills. Even committees of businessmen recommend
"a President's Commission on Full Employment", not on Full Production,
or even on Full Employment and Full Production. Everywhere the
means is erected into the end, and the end itself is forgotten.
Wages and employment are discussed as if they had no relation to productivity
and output. On the assumption that there is only a fixed amount of work to
be done, the conclusion is drawn that a thirty-hour week will provide more
jobs and will therefore be preferable to a forty-hour week. A hundred
make-work practices of labor unions are confusedly tolerated. When a
Petrillo threatens to put a radio station out of business unless it employs
twice as many musicians as it needs, he is supported by part of the public
because he is after all merely trying to create jobs. When we had our WPA,
it was considered a mark of genius for the administrators to think of
projects that employed the largest number of men in relation to the value
of the work performed -- in other words, in which labor was least efficient.
It would be far better, if that were the choice -- which it isn't -- to
have maximum production with part of the population supported in idleness
by undisguised relief than to provide "full employment" by so many forms
of disguised make-work that production is disorganized. The progress
of civilization has meant the reduction of employment, not its increase.
It is because we have become increasingly wealthy as a nation that we have
been able to virtually eliminate child labor, to remove the necessity of
work for many of the aged and to make it unnecessary for millions of women
to take jobs. A much smaller proportion of the American population needs
to work than that, say, of China or of Russia. The real question is not
whether there will be 50,000,000 or 60,000,000 jobs in America in 1950, but
how much shall we produce, and what, in consequence, will be our standard
of living? The problem of distribution, on which all the stress is being
put today, is after all more easily solved the more there is to distribute.
We can clarify our thinking if we put our chief emphasis where it belongs
-- on policies that will maximize production.
1
A mere recital of the economic policies of governments all over the world
is calculated to cause any serious student of economics to throw up his
hands in despair. What possible point can there be, he is likely to ask,
in discussing refinements and advances in economic theory, when popular
thought and the actual policies of governments, certainly in everything
connected with international relations, have not yet caught up with Adam
Smith? For present-day tariff and trade policies are not only as bad as
those in the seventeenth and eighteenth centuries, but incomparably worse.
The real reasons for those tariffs and other trade barriers are the same,
and the pretended reasons are also the same.
In the century and three-quarters since The Wealth of Nations
appeared, the case for free trade has been stated thousands of times,
but perhaps never with more direct simplicity and force than it was
stated in that volume. In general Smith rested his case on one fundamental
proposition: "In every country it always is and must be the interest of
the great body of the people to buy whatever they want of those who sell
it cheapest." "The proposition is so very manifest," Smith continued,
"that it seems ridiculous to take any pains to prove it; nor could it
ever have been called in question, had not the interested sophistry
of merchants and manufacturers confounded the commonsense of mankind."
From another point of view, free trade was considered as one aspect
of the specialization of labor:
It is the maxim of every prudent master of a family, never to attempt to
make at home what it will cost him more to make than to buy. The tailor
does not attempt to make his own shoes, but buys them of the shoemaker.
The shoemaker does not attempt to make his own clothes, but employs
a tailor. The farmer attempts to make neither the one nor the other,
but employs those different artificers. All of them find it for their
interest to employ their whole industry in a way in which they have
some advantage over their neighbors, and to purchase with a part of
its produce, or what is the same thing, with the price of a part of it,
whatever else they have occasion for. What is prudence in the conduct
of every private family can scarce be folly in that of a great kingdom.
But whatever led people to suppose that what was prudence in the conduct
of every private family could be folly in that of a great kingdom?
It was a whole network of fallacies, out of which mankind has still been
unable to cut its way. And the chief of them was the central fallacy with
which this book is concerned. It was that of considering merely the
immediate effects of a tariff on special groups, and neglecting to
consider its long-run effects on the whole community.
2
An American manufacturer of woolen sweaters goes to Congress or to the
State Department and tells the committee or officials concerned that it
would be a national disaster for them to remove or reduce the tariff on
British sweaters. He now sells his sweaters for $15 each, but English
manufacturers could sell here sweaters of the same quality for $10. A duty
of $5, therefore, is needed to keep him in business. He is not thinking of
himself, of course, but of the thousand men and women he employs, and of the
people to whom their spending in turn gives employment. Throw them out of
work, and you create unemployment and a fall in purchasing power, which
would spread in ever-widening circles. And if he can prove that he really
would be forced out of business if the tariff were removed or reduced,
his argument against that action is regarded by Congress as conclusive.
But the fallacy comes from looking merely at this manufacturer and his
employees, or merely at the American sweater industry. It comes from
noticing only the results that are immediately seen, and neglecting the
results that are not seen because they are prevented from coming into
existence.
The lobbyists for tariff protection are continually putting forward
arguments that are not factually correct. But let us assume that the
facts in this case are precisely as the sweater manufacturer has stated
them. Let us assume that a tariff of $5 a sweater is necessary for him to
stay in business and provide employment at sweater making for his workers.
We have deliberately chosen the most unfavorable example of any for the
removal of a tariff. We have not taken an argument for the imposition of a
new tariff in order to bring a new industry into existence, but an argument
for the retention of a tariff that has already brought an industry into
existence, and cannot be repealed without hurting somebody.
The tariff is repealed; the manufacturer goes out of business; a thousand
workers are laid off; the particular tradesmen whom they patronized are
hurt. This is the immediate result that is seen. But there are also
results which, while much more difficult to trace, are no less immediate
and no less real. For now sweaters that formerly cost $15 apiece can be
bought for $10. Consumers can now buy the same quality of sweater for
less money, or a much better one for the same money. If they buy the same
quality of sweater, they not only get the sweater, but they have $5 left
over, which they would not have had under the previous conditions, to buy
something else. With the $10 that they pay for the imported sweater they
help employment -- as the American manufacturer no doubt predicted --
in the sweater industry in England. With the $5 left over they help
employment in any number of other industries in the United States.
But the results do not end there. By buying English sweaters they
furnish the English with dollars to buy American goods here. This, in fact
(if I may here disregard such complications as multilateral exchange, loans,
credits, gold movements, etc. which do not alter the end result) is the only
way in which the British can eventually make use of these dollars. Because
we have permitted the British to sell more to us, they are now able to buy
more from us. They are, in fact, eventually forced to buy more from
us if their dollar balances are not to remain perpetually unused. So, as a
result of letting in more British goods, we must export more American goods.
And though fewer people are now employed in the American sweater industry,
more people are employed -- and much more efficiently employed -- in, say,
the American automobile or washing-machine business. American employment
on net balance has not gone down, but American and British production on
net balance has gone up. Labor in each country is more fully employed in
doing just those things that it does best, instead of being forced to do
things that it does inefficiently or badly. Consumers in both countries
are better off. They are able to buy what they want where they can get
it cheapest. American consumers are better provided with sweaters, and
British consumers are better provided with motor cars and washing machines.
3
Now let us look at the matter the other way round, and see the effect of
imposing a tariff in the first place. Suppose that there had been no tariff
on foreign knit goods, that Americans were accustomed to buying foreign
sweaters without duty, and that the argument were then put forward that we
could bring a sweater industry into existence by imposing a duty of
$5 on sweaters.
There would be nothing logically wrong with this argument so far as it went.
The cost of British sweaters to the American consumer might thereby be forced
so high that American manufacturers would find it profitable to enter the
sweater business. But American consumers would be forced to subsidize this
industry. On every American sweater they bought they would be forced in
effect to pay a tax of $5 which would be collected from them in a higher
price by the new sweater industry.
Americans would be employed in a sweater industry who had not previously
been employed in a sweater industry. That much is true. But there would
be no net addition to the country's industry or the country's employment.
Because the American consumer had to pay $5 more for the same quality of
sweater he would have just that much less left over to buy anything else.
He would have to reduce his expenditures by $5 somewhere else. In order
that one industry might grow or come into existence, a hundred other
industries would have to shrink. In order that 20,000 persons might be
employed in a sweater industry, 20,000 fewer persons would be employed
elsewhere.
But the new industry would be visible. The number of its employees,
the capital invested in it, the market value of its product in terms of
dollars, could be easily counted. The neighbors could see the sweater
workers going to and from the factory every day. The results would be
palpable and direct. But the shrinkage of a hundred other industries, the
loss of 20,000 other jobs somewhere else, would not be so easily noticed.
It would be impossible for even the cleverest statistician to know precisely
what the incidence of the loss of other jobs had been -- precisely how many
men and women had been laid off from each particular industry, precisely
how much business each particular industry had lost -- because consumers
had to pay more for their sweaters. For a loss spread among all the other
productive activities of the country would be comparatively minute for each.
It would be impossible for anyone to know precisely how each consumer
would have spent his extra $5 if he had been allowed to retain it.
The overwhelming majority of the people, therefore, would probably suffer
from the optical illusion that the new industry had cost us nothing.
4
It is important to notice that the new tariff on sweaters would not raise
American wages. To be sure, it would enable Americans to work in the
sweater industry at approximately the average level of American wages
(for workers of their skill), instead of having to compete in that industry
at the British level of wages. But there would be no increase of American
wages in general as a result of the duty; for, as we have seen, there
would be no net increase in the number of jobs provided, no net increase
in the demand for goods, and no increase in labor productivity. Labor
productivity would, in fact, be reduced as a result of the tariff.
And this brings us to the real effect of a tariff wall. It is not merely
that all its visible gains are offset by less obvious but no less real
losses. It results, in fact, in a net loss to the country. For contrary
to centuries of interested propaganda and disinterested confusion,
the tariff reduces the American level of wages.
Let us observe more clearly how it does this. We have seen that the added
amount which consumers pay for a tariff-protected article leaves them just
that much less with which to buy all other articles. There is here no net
gain to industry as a whole. But as a result of the artificial barrier
erected against foreign goods, American labor, capital and land are
deflected from what they can do more efficiently to what they do less
efficiently. Therefore, as a result of the tariff wall, the average
productivity of American labor and capital is reduced.
If we look at it now from the consumer's point of view, we find that he can
buy less with his money. Because he has to pay more for sweaters and other
protected goods, he can buy less of everything else. The general purchasing
power of his income has therefore been reduced. Whether the net effect of
the tariff is to lower money wages or to raise money prices will depend upon
the monetary policies that are followed. But what is clear is that the
tariff -- though it may increase wages above what they would have been in
the protected industries -- must on net balance, when all
occupations are considered, reduce real wages.
Only minds corrupted by generations of misleading propaganda can regard this
conclusion as paradoxical. What other result could we expect from a policy
of deliberately using our resources of capital and manpower in less efficient
ways than we know how to use them? What other result could we expect from
deliberately erecting artificial obstacles to trade and transportation?
For the erection of tariff walls has the same effect as the erection of
real walls. It is significant that the protectionists habitually use the
language of warfare. They talk of "repelling an invasion" of foreign
products. And the means they suggest in the fiscal field are like those
of the battlefield. The tariff barriers that are put up to repel this
invasion are like the tank traps, trenches, and barbed-wire entanglements
created to repel or slow down attempted invasion by a foreign army.
And just as the foreign army is compelled to employ more expensive means
to surmount those obstacles -- bigger tanks, mine detectors, engineer
corps to cut wires, ford streams, and build bridges -- so more expensive
and efficient transportation means must be developed to surmount tariff
obstacles. On the one hand, we try to reduce the cost of transportation
between England and America, or Canada and the United States, by developing
faster and more efficient ships, better roads and bridges, better locomotives
and motor trucks. On the other hand, we offset this investment in efficient
transportation by a tariff that makes it commercially even more difficult
to transport goods than it was before. We make it $1 cheaper to ship the
sweaters, and then increase the tariff by $2 to prevent the sweaters from
being shipped. By reducing the freight that can be profitably carried,
we reduce the value of the investment in transport efficiency.
5
The tariff has been described as a means of benefiting the producer at the
expense of the consumer. In a sense this is correct. Those who favor it
think only of the interests of the producers immediately benefited by the
particular duties involved. They forget the interests of the consumers who
are immediately injured by being forced to pay these duties. But it is
wrong to think of the tariff issue as if it represented a conflict between
the interests of producers as a unit against those of consumers as a unit.
It is true that the tariff hurts all consumers as such. It is not true
that it benefits all producers as such. On the contrary, as we have just
seen, it helps the protected producers at the expense of all other American
producers, and particularly of those who have a comparatively large
potential export market.
We can perhaps make this last point clearer by an exaggerated example.
Suppose we make our tariff wall so high that it becomes absolutely
prohibitive, and no imports come in from the outside world at all.
Suppose, as a result of this, that the price of sweaters in America goes
up only $5. Then American consumers, because they have to pay $5 more for
a sweater, will spend on the average five cents less in each of a hundred
other American industries. (The figures are chosen merely to illustrate
a principle: there will, of course, be no such symmetrical distribution
of the loss; moreover, the sweater industry itself will doubtless be
hurt because of protection of still other industries.
But these complications may be put aside for the moment.)
Now because foreign industries will find their market in America
totally cut off, they will get no dollar exchange, and therefore
they will be unable to buy any American goods at all. As a result
of this, American industries will suffer in direct proportion to the
percentage of their sales previously made abroad. Those that will be
most injured, in the first instance, will be such industries as raw
cotton producers, copper producers, makers of sewing machines,
agricultural machinery, typewriters and so on.
A higher tariff wall, which, however, is not prohibitive, will produce
the same kind of results as this, but merely to a smaller degree.
The effect of a tariff, therefore, is to change the structure of
American production. It changes the number of occupations, the kind of
occupations, and the relative size of one industry as compared with another.
It makes the industries in which we are comparatively inefficient larger,
and the industries in which we are comparatively efficient smaller.
Its net effect, therefore, is to reduce American efficiency, as well
as to reduce efficiency in the countries with which we would otherwise
have traded more largely.
In the long run, notwithstanding the mountains of argument pro and con,
a tariff is irrelevant to the question of employment. (True, sudden
changes in the tariff, either upward or downward, can create
temporary unemployment, as they force corresponding changes in the structure
of production. Such sudden changes can even cause a depression.) But a
tariff is not irrelevant to the question of wages. In the long run it always
reduces real wages, because it reduces efficiency, production and wealth.
Thus all the chief tariff fallacies stem from the central fallacy with which
this book is concerned. They are the result of looking only at the immediate
effects of a single tariff rate on one group of producers, and forgetting the
long-run effects both on consumers as a whole and on all other producers.
(I hear some reader asking: "Why not solve this by giving tariff protection
to all producers?" But the fallacy here is that this cannot help
producers uniformly, and cannot help at all domestic producers who already
"outsell" foreign producers: these efficient producers must necessarily
suffer from the diversion of purchasing power brought about by the tariff.)
6
On the subject of the tariff we must keep in mind one final precaution.
It is the same precaution that we found necessary in examining the effects
of machinery. It is useless to deny that a tariff does benefit -- or at
least can benefit -- special interests. True, it benefits them
at the expense of everyone else. But it does benefit them. If one
industry alone could get protection, while its owners and workers enjoyed
the benefits of free trade in everything else they bought, that industry
would benefit, even on net balance. As an attempt is made to extend
the tariff blessings, however, even people in the protected industries,
both as producers and consumers, begin to suffer from other people's
protection, and may finally be worse off even on net balance than
if neither they nor anybody else had protection.
But we should not deny, as enthusiastic free traders have so often done,
the possibility of these tariff benefits to special groups. We should not
pretend, for example, that a reduction of the tariff would help everybody
and hurt nobody. It is true that its reduction would help the country on
net balance. But somebody would be hurt. Groups previously enjoying
high protection would be hurt. That in fact is one reason why it is not
good to bring such protected interests into existence in the first place.
But clarity and candor of thinking compel us to see and acknowledge that
some industries are right when they say that a removal of the tariff on
their product would throw them out of business and throw their workers
(at least temporarily) out of jobs. And if their workers have developed
specialized skills, they may even suffer permanently, or until they have
at long last learnt equal skills. In tracing the effects of tariffs, as in
tracing the effects of machinery, we should endeavor to see all the
chief effects, in both the short run and the long run, on all groups.
As a postscript to this chapter I should add that its argument is not
directed against all tariffs, including duties collected mainly for
revenue, or to keep alive industries needed for war; nor is it directed
against all arguments for tariffs. It is merely directed against the
fallacy that a tariff on net balance "provides employment", "raises wages",
or "protects the American standard of living". It does none of these
things; and so far as wages and the standard of living are concerned,
it does the precise opposite. But an examination of duties imposed
for other purposes would carry us beyond our present subject.
Nor need we here examine the effect of import quotas, exchange controls,
bilateralism, and other devices in reducing, diverting or preventing
international trade. Such devices have, in general, the same effects as
high or prohibitive tariffs, and often worse effects. They present more
complicated issues, but their net results can be traced through the same
kind of reasoning that we have just applied to tariff barriers.
Exceeded only by the pathological dread of imports that affects all nations
is a pathological yearning for exports. Logically, it is true, nothing
could be more inconsistent. In the long run imports and exports must
equal each other (considering both in the broadest sense, which includes
such "invisible" items as tourist expenditures and ocean freight charges).
It is exports that pay for imports, and vice versa. The greater exports
we have, the greater imports we must have, if we ever expect to get paid.
The smaller imports we have, the smaller exports we can have. Without
imports we can have no exports, for foreigners will have no funds with
which to buy our goods. When we decide to cut down our imports, we are in
effect deciding also to cut down our exports. When we decide to increase
our exports, we are in effect deciding also to increase our imports.
The reason for this is elementary. An American exporter sells his goods
to a British importer and is paid in British pounds sterling. But he
cannot use British pounds to pay the wages of his workers, to buy his
wife's clothes, or to buy theater tickets. For all these purposes he
needs American dollars. Therefore his British pounds are of no use to
him unless he either uses them himself to buy British goods or sells
them to some American importer who wishes to use them to buy British goods.
Whichever he does, the transaction cannot be completed until the American
exports have been paid for by an equal amount of imports.
The same situation would exist if the transaction had been conducted in
terms of American dollars instead of British pounds. The British importer
could not pay the American exporter in dollars unless some previous British
exporter had built up a credit in dollars here as a result of some previous
sale to us. Foreign exchange, in short, is a clearing transaction in which,
in America, the dollar debts of foreigners are cancelled against their
dollar credits. In England, the pound sterling debts of foreigners
are cancelled against their sterling credits.
There is no reason to go into the technical details of all this, which can
be found in any good textbook on foreign exchange. But it should be pointed
out that there is nothing inherently mysterious about it (in spite of the
mystery in which it is so often wrapped), and that it does not differ
essentially from what happens in domestic trade. Each of us must also
sell something, even if for most of us it is our own services rather than
goods, in order to get the purchasing power to buy. Domestic trade is
also conducted in the main by crossing off checks and other claims
against each other through clearing houses.
It is true that under an international gold standard discrepancies in
balances of imports and exports are sometimes settled by shipments of gold.
But they could just as well be settled by shipments of cotton, steel, whisky,
perfume, or any other commodity. The chief difference is that the demand
for gold is almost indefinitely expansible (partly because it is thought of
and accepted as a residual international "money" rather than as just another
commodity), and that nations do not put artificial obstacles in the way of
receiving gold as they do in the way of receiving almost everything else.
(On the other hand, of late years they have taken to putting more obstacles
in the way of exporting gold than in the way of exporting anything
else: but that is another story.)
Now the same people who can be clearheaded and sensible when the subject
is one of domestic trade can be incredibly emotional and muddleheaded when
it becomes one of foreign trade. In the latter field they can seriously
advocate or acquiesce in principles which they would think it insane to apply
in domestic business. A typical example is the belief that the government
should make huge loans to foreign countries for the sake of increasing our
exports, regardless of whether or not these loans are likely to be repaid.
American citizens, of course, should be allowed to lend their own funds
abroad at their own risk. The government should put no arbitrary barriers
in the way of private lending to countries with which we are at peace.
We should give generously, for humane reasons alone, to peoples who are
in great distress or in danger of starving. But we ought always to know
clearly what we are doing. It is not wise to bestow charity on foreign
peoples under the impression that one is making a hardheaded business
transaction purely for one's own selfish purposes. That could only lead
to misunderstandings and bad relations later.
Yet among the arguments put forward in favor of huge foreign lending one
fallacy is always sure to occupy a prominent place. It runs like this.
Even if half (or all) the loans we make to foreign countries turn sour and
are not repaid, this nation will still be better off for having made them,
because they will give an enormous impetus to our exports.
It should be immediately obvious that if the loans we make to foreign
countries to enable them to buy our goods are not repaid, then we are
giving the goods away. A nation cannot grow rich by giving goods away.
It can only make itself poorer.
No one doubts this proposition when it is applied privately. If an
automobile company lends a man $1,000 to buy a car priced at that amount,
and the loan is not repaid, the automobile company is not better off because
it has "sold" the car. It has simply lost the amount that it cost to make
the car. If the car cost $900 to make, and only half the loan is repaid,
then the company has lost $900 minus $500, or a net amount of $400.
It has not made up in trade what it lost in bad loans.
If this proposition is so simple when applied to a private company,
why do apparently intelligent people get confused about it when applied
to a nation? The reason is that the transaction must then be traced
mentally through a few more stages. One group may indeed make gains
-- while the rest of us take the losses.
It is true, for example, that persons engaged exclusively or chiefly in
export business might gain on net balance as a result of bad loans made
abroad. The national loss on the transaction would be certain, but it might
be distributed in ways difficult to follow. The private lenders would take
their losses directly. The losses from government lending would ultimately
be paid out of increased taxes imposed on everybody. But there would also
be many indirect losses brought about by the effect on the economy of these
direct losses.
In the long run business and employment in America would be hurt, not helped,
by foreign loans that were not repaid. For every extra dollar that foreign
buyers had with which to buy American goods, domestic buyers would ultimately
have one dollar less. Businesses that depend on domestic trade would
therefore be hurt in the long run as much as export businesses would be
helped. Even many concerns that did an export business would be hurt on net
balance. American automobile companies, for example, sold about 10 percent
of their output in the foreign market before the war. It would not profit
them to double their sales abroad as a result of bad foreign loans if they
thereby lost, say, 20 percent of their American sales as the result of added
taxes taken from American buyers to make up for the unpaid foreign loans.
None of this means, I repeat, that it is unwise to make foreign loans,
but simply that we cannot get rich by making bad ones.
For the same reasons that it is stupid to give a false stimulation to export
trade by making bad loans or outright gifts to foreign countries, it is
stupid to give a false stimulation to export trade through export subsidies.
Rather than repeat most of the previous argument, I leave it to the reader
to trace the effects of export subsidies as I have traced the effects of bad
loans. An export subsidy is a clear case of giving the foreigner something
for nothing, by selling him goods for less than it costs us to make them.
It is another case of trying to get rich by giving things away.
Bad loans and export subsidies are additional examples of the error
of looking only at the immediate effect of a policy on special groups,
and of not having the patience or intelligence to trace the long-run
effects of the policy on everyone.
1
Special interests, as the history of tariffs reminds us, can think of the
most ingenious reasons why they should be the objects of special solicitude.
Their spokesmen present a plan in their favor; and it seems at first so
absurd that disinterested writers do not trouble to expose it. But the
special interests keep on insisting on the scheme. Its enactment would
make so much difference to their own immediate welfare that they can
afford to hire trained economists and "public relations experts" to
propagate it in their behalf. The public hears the argument so often
repeated, and accompanied by such a wealth of imposing statistics,
charts, curves, and pie-slices, that it is soon taken in. When at last
disinterested writers recognize that the danger of the scheme's enactment
is real, they are usually too late. They cannot in a few weeks acquaint
themselves with the subject as thoroughly as the hired brains who have
been devoting their full time to it for years; they are accused of being
uninformed, and they have the air of men who presume to dispute axioms.
This general history will do as a history of the idea of "parity" prices for
agricultural products. I forget the first day when it made its appearance
in a legislative bill; but with the advent of the New Deal in 1933 it had
become a definitely established principle, enacted into law; and as year
succeeded year, and its absurd corollaries made themselves manifest,
they were enacted too.
The argument for "parity" prices ran roughly like this. Agriculture is
the most basic and important of all industries. It must be preserved at
all costs. Moreover, the prosperity of everybody else depends upon the
prosperity of the farmer. If he does not have the purchasing power to buy
the products of industry, industry languishes. This was the cause of the
1929 collapse, or at least of our failure to recover from it. For the
prices of farm products dropped violently, while the prices of industrial
products dropped very little. The result was that the farmer could not buy
industrial products; the city workers were laid off and could not buy farm
products, and the depression spread in ever-widening vicious circles.
There was only one cure, and it was simple. Bring back the prices of the
farmer's products to a "parity" with the prices of the things the farmer
buys. This parity existed in the period from 1909 to 1914, when farmers
were prosperous. That price relationship must be restored and preserved
perpetually.
It would take too long, and carry us too far from our main point, to examine
every absurdity concealed in this plausible statement. There is no sound
reason for taking the particular price relationships that prevailed in
a particular year or period and regarding them as sacrosanct, or even as
necessarily more "normal" than those of any other period. Even if they
were "normal" at the time, what reason is there to suppose that these
same relationships should be preserved a generation later in spite of
the enormous changes in the conditions of production and demand that have
taken place in the meantime? The period of 1909 to 1914, as the basis of
"parity", was not selected at random. In terms of relative prices it was
one of the most favorable periods to agriculture in our entire history.
If there had been any sincerity or logic in the idea, it would have been
universally extended. If the price relationships between agricultural
and industrial products that prevailed from August, 1909 to July, 1914
ought to be preserved perpetually, why not preserve perpetually the price
relationship of every commodity at that time to every other? A Chevrolet
six-cylinder touring car cost $2,150 in 1912; an incomparably improved
six-cylinder Chevrolet sedan cost $907 in 1942: adjusted for "parity" on
the same basis as farm products, however, it would have cost $3,270 in 1942.
A pound of aluminum from 1909 to 1913 inclusive averaged 22 1/2 cents;
its price early in 1946 was 14 cents; but at "parity" it would then
have cost, instead, 41 cents.
I hear immediate cries that such comparisons are absurd, because everybody
knows not only that the present-day automobile is incomparably superior in
every way to the car of 1912, but that it costs only a fraction as much to
produce, and that the same is true also of aluminum. Exactly. But why
doesn't somebody say something about the amazing increase in productivity
per acre in agriculture? In the five-year period 1939 to 1943 an average
of 260 pounds of cotton was raised per acre in the United States as
compared with an average of 188 pounds in the five-year period 1909 to 1913.
Costs of production have been substantially lowered for farm products by
better applications of chemical fertilizer, improved strains of seed, and
increasing mechanization -- by the gasoline tractor, the corn husker, the
cotton picker. "On some large farms which have been completely mechanized
and are operated along mass production lines, it requires only one-third
to one-fifth the amount of labor to produce the same yields as it did a few
years back." Yet all this is ignored by the apostles of "parity" prices.
The refusal to universalize the principle is not the only evidence that it
is not a public-spirited economic plan but merely a device for subsidizing
a special interest. Another evidence is that when agricultural prices go
above "parity", or are forced there by government policies, there
is no demand on the part of the farm bloc in Congress that such prices be
brought down to "parity", or that the subsidy be to that extent
repaid. It is a rule that works only one way.
2
Dismissing all these considerations, let us return to the central fallacy
that specially concerns us here. This is the argument that if the farmer
gets higher prices for his products he can buy more goods from industry and
so make industry prosperous and bring full employment. It does not matter
to this argument, of course, whether or not the farmer gets specifically
so-called "parity" prices.
Everything, however, depends on how these higher prices are brought about.
If they are the result of a general revival, if they follow from increased
prosperity of business, increased industrial production and increased
purchasing power of city workers (not brought about by inflation), then they
can indeed mean increased prosperity and production not only for the farmers,
but for everyone. But what we are discussing is a rise in farm prices
brought about by government intervention. This can be done in several ways.
The higher price can be forced by mere edict, which is the least workable
method. It can be brought about by the government's standing ready to buy
all the farm products offered to it at the "parity" price. It can be brought
about by the government's lending to farmers enough money on their crops
to enable them to hold the crops off the market until "parity" or a higher
price is realized. It can be brought about by the government's enforcing
restrictions in the size of crops. It can be brought about, as it often
is in practice, by a combination of these methods. For the moment we shall
simply assume that, by whatever method, it is in any case brought about.
What is the result? The farmers get higher prices for their crops.
Their "purchasing power" is thereby increased. They are for the time being
more prosperous themselves, and they buy more of the products of industry.
All this is what is seen by those who look merely at the immediate
consequences of policies to the groups directly involved.
But there is another consequence, no less inevitable. Suppose the wheat
which would otherwise sell at $1 a bushel is pushed up by this policy to
$1.50. The farmer gets 50 cents a bushel more for wheat. But the city
worker, by precisely the same change, pays 50 cents a bushel more
for wheat in an increased price of bread. The same thing is true of any
other farm product. If the farmer then has 50 cents more purchasing power
to buy industrial products, the city worker has precisely that much less
purchasing power to buy industrial products. On net balance industry in
general has gained nothing. It loses in city sales precisely as much as
it gains in rural sales.
There is of course a change in the incidence of these sales. No doubt the
agricultural-implement makers and the mail-order houses do a better business.
But the city department stores do a smaller business.
The matter, however, does not end here. The policy results not merely in
no net gain, but in a net loss. For it does not mean merely a transfer of
purchasing power to the farmer from city consumers, or from the general
taxpayer, or from both. It also means a forced cut in the production of
farm commodities to bring up the price. This means a destruction of wealth.
It means that there is less food to be consumed. How this destruction of
wealth is brought about will depend upon the particular method pursued to
bring prices up. It may mean the actual physical destruction of what has
already been produced, as in the burning of coffee in Brazil. It may mean
a forced restriction of acreage, as in the American AAA plan. We shall
examine the effect of some of these methods when we come to the broader
discussion of government commodity controls.
But here it may be pointed out that when the farmer reduces the production
of wheat to get "parity", he may indeed get a higher price for each bushel,
but he produces and sells fewer bushels. The result is that his income
does not go up in proportion to his prices. Even some of the advocates of
"parity prices" recognize this, and use it as an argument to go on to insist
upon "parity income" for farmers. But this can only be achieved by
a subsidy at the direct expense of taxpayers. To help the farmers, in other
words, it merely reduces the purchasing power of city workers and other
groups still more.
3
There is one argument for "parity" prices that should be dealt with before
we leave the subject. It is put forward by some of the more sophisticated
defenders. "Yes," they will freely admit, "the economic arguments for
parity prices are unsound. Such prices are a special privilege. They are
an imposition on the consumer. But isn't the tariff an imposition on the
farmer? Doesn't he have to pay higher prices on industrial products because
of it? It would do no good to place a compensating tariff on farm products,
because America is a net exporter of farm products. Now the parity-price
system is the farmer's equivalent of the tariff. It is the only fair way
to even things up."
The farmers who asked for "parity" prices did have a legitimate complaint.
The protective tariff injured them more than they knew. By reducing
industrial imports it also reduced American farm exports, because it
prevented foreign nations from getting the dollar exchange needed for
taking our agricultural products. And it provoked retaliatory tariffs in
other countries. Nonetheless, the argument we have just quoted will not
stand examination. It is wrong even in its implied statement of the facts.
There is no general tariff on all "industrial" products or on all
non-farm products. There are scores of domestic industries or of exporting
industries that have no tariff protection. If the city worker has to pay
a higher price for woolen blankets or overcoats because of a tariff,
is he "compensated" by having to pay a higher price also for cotton
clothing and for foodstuffs? Or is he merely being robbed twice?
Let us even it all out, say some, by giving equal "protection" to everybody.
But that is insoluble and impossible. Even if we assume that the problem
could be solved technically -- a tariff for A, an industrialist subject to
foreign competition; a subsidy for B, an industrialist who exports his
product -- it would be impossible to protect or to subsidize everybody
"fairly" or equally. We should have to give everyone the same percentage
(or would it be the same dollar amount?) of tariff protection or subsidy,
and we could never be sure when we were duplicating payments to some groups
or leaving gaps with others.
But suppose we could solve this fantastic problem? What would be the point?
Who gains when everyone equally subsidizes everyone else? What is the
profit when everyone loses in added taxes precisely what he gains by his
subsidy or his protection? We should merely have added an army of needless
bureaucrats to carry out the program, with all of them lost to production.
We could solve the matter simply, on the other hand, by ending both the
parity-price system and the protective-tariff system. Meanwhile they do
not, in combination, even out anything. The joint system means merely that
Farmer A and Industrialist B both profit at the expense of Forgotten Man C.
So the alleged benefits of still another scheme evaporate as soon as we
trace not only its immediate effects on a special group but its long-run
effects on everyone.
1
The lobbies of Congress are crowded with representatives of the X industry.
The X industry is sick. The X industry is dying. It must be saved.
It can be saved only by a tariff, by higher prices, or by a subsidy. If it
is allowed to die, workers will be thrown on the streets. Their landlords,
grocers, butchers, clothing stores, and local motion picture theaters will
lose business, and depression will spread in ever-widening circles. But if
the X industry, by prompt action of Congress, is saved -- ah then!
it will buy equipment from other industries; more men will be employed;
they will give more business to the butchers, bakers, and neon-light makers,
and then it is prosperity that will spread in ever-widening circles.
It is obvious that this is merely a generalized form of the case we have
just been considering. There the X industry was agriculture. But there
are an endless number of X industries. Two of the most notable examples
in recent years have been the coal and silver industries. To "save silver"
Congress did immense harm. One of the arguments for the rescue plan was
that it would help "the East". One of its actual results was to cause
deflation in China, which had been on a silver basis, and to force China
off that basis. The United States Treasury was compelled to acquire, at
ridiculous prices far above the market level, hoards of unnecessary silver,
and to store it in vaults. The essential political aims of the "silver
Senators" could have been as well achieved, at a fraction of the harm and
cost, by the payment of a frank subsidy to the mine owners or to their
workers; but Congress and the country would never have approved a naked
steal of this sort unaccompanied by the ideological flimflam regarding
"silver's essential role in the national currency."
To save the coal industry Congress passed the Guffey Act, under which the
owners of coal mines were not only permitted, but compelled, to conspire
together not to sell below certain minimum prices fixed by the government.
Though Congress had started out to fix "the" price of coal, the government
soon found itself (because of different sizes, thousands of mines, and
shipments to thousands of different destinations by rail, truck, ship and
barge) fixing 350,000 separate prices for coal! One effect of this attempt
to keep coal prices above the competitive market level was to accelerate
the tendency toward the substitution by consumers of other sources of
power or heat -- such as oil, natural gas, and hydroelectric energy.
2
But our aim here is not to trace all the results that followed historically
from efforts to save particular industries, but to trace a few of the chief
results that must necessarily follow from efforts to save an industry.
It may be argued that a given industry must be created or preserved for
military reasons. It may be argued that a given industry is being ruined by
taxes or wage rates disproportionate to those of other industries; or that,
if a public utility, it is being forced to operate at rates or charges to
the public that do not permit an adequate profit margin. Such arguments may
or may not be justified in a particular case. We are not concerned with
them here. We are concerned only with a single argument for saving the X
industry -- that if it is allowed to shrink in size or perish through the
forces of free competition (always, by spokesmen for the industry, designated
in such cases as a laissez-faire, anarchic, cutthroat, dog-eat-dog,
law-of-the-jungle competition) it will pull down the general economy with
it, and that if it is artificially kept alive it will help everybody else.
What we are talking about here is nothing else but a generalized case of
the argument put forward for "parity" prices for farm products or for
tariff protection for any number of X industries. The argument against
artificially higher prices applies, of course, not only to farm products
but to any other product, just as the reasons we have found for opposing
tariff protection for one industry apply to any other.
But there are always any number of schemes for saving X industries.
There are two main types of such proposals in addition to those we have
already considered, and we shall take a brief glance at them. One is to
contend that the X industry is already "overcrowded", and to try to prevent
other firms or workers from getting into it. The other is to argue that the
X industry needs to be supported by a direct subsidy from the government.
Now if the X industry is really overcrowded as compared with other industries
it will not need any coercive legislation to keep out new capital or new
workers. New capital does not rush into industries that are obviously dying.
Investors do not eagerly seek the industries that present the highest risks
of loss combined with the lowest returns. Nor do workers, when they have
any better alternative, go into industries where the wages are lowest
and the prospects for steady employment least promising.
If new capital and new labor are forcibly kept out of the X industry,
however, either by monopolies, cartels, union policy or legislation, it
deprives this capital and labor of liberty of choice. It forces investors
to place their money where the returns seem less promising to them than in
the X industry. It forces workers into industries with even lower wages
and prospects than they could find in the allegedly sick X industry.
It means, in short, that both capital and labor are less efficiently
employed than they would be if they were permitted to make their own
free choices. It means, therefore, a lowering of production which
must reflect itself in a lower average living standard.
That lower living standard will be brought about either by lower average
money wages than would otherwise prevail or by higher average living costs,
or by a combination of both. (The exact result would depend upon the
accompanying monetary policy.) By these restrictive policies wages and
capital returns might indeed be kept higher than otherwise within the
X industry itself; but wages and capital returns in other industries
would be forced down lower than otherwise. The X industry would
benefit only at the expense of the A, B, and C industries.
3
Similar results would follow any attempt to save the X industry by a direct
subsidy out of the public till. This would be nothing more than a transfer
of wealth or income to the X industry. The taxpayers would lose precisely
as much as the people in the X industry gained. The great advantage of a
subsidy, indeed, from the standpoint of the public, is that it makes this
fact so clear. There is far less opportunity for the intellectual
obfuscation that accompanies arguments for tariffs, minimum-price
fixing, or monopolistic exclusion.
It is obvious in the case of a subsidy that the taxpayers must lose
precisely as much as the X industry gains. It should be equally clear
that, as a consequence, other industries must lose what the X industry
gains. They must pay part of the taxes that are used to support the
X industry. And consumers, because they are taxed to support the
X industry, will have that much less income left with which to buy other
things. The result must be that other industries on the average must be
smaller than otherwise in order that the X industry may be larger.
But the result of this subsidy is not merely that there has been a transfer
of wealth or income, or that other industries have shrunk in the aggregate
as much as the X industry has expanded. The result is also (and this is
where the net loss comes in to the nation considered as a unit) that capital
and labor are driven out of industries in which they are more efficiently
employed to be diverted to an industry in which they are less efficiently
employed. Less wealth is created. The average standard of living is
lowered compared with what it would have been.
4
These results are virtually inherent, in fact, in the very arguments put
forward to subsidize the X industry. The X industry is shrinking or dying
by the contention of its friends. Why, it may be asked, should it be kept
alive by artificial respiration? The idea that an expanding economy implies
that all industries must be simultaneously expanding is a profound
error. In order that new industries may grow fast enough it is necessary
that some old industries should be allowed to shrink or die. They must
do this in order to release the necessary capital and labor for the new
industries. If we had tried to keep the horse-and-buggy trade artificially
alive we should have slowed down the growth of the automobile industry and
all the trades dependent on it. We should have lowered the production of
wealth and retarded economic and scientific progress.
We do the same thing, however, when we try to prevent any industry from
dying in order to protect the labor already trained or the capital already
invested in it. Paradoxical as it may seem to some, it is just as necessary
to the health of a dynamic economy that dying industries be allowed to
die as that growing industries be allowed to grow. The first process is
essential to the second. It is as foolish to try to preserve obsolescent
industries as to try to preserve obsolescent methods of production: this
is often, in fact, merely two ways of describing the same thing. Improved
methods of production must constantly supplant obsolete methods, if both old
needs and new wants are to be filled by better commodities and better means.
1
The whole argument of this book may be summed up in the statement that
in studying the effects of any given economic proposal we must trace not
merely the immediate results but the results in the long run, not merely
the primary consequences but the secondary consequences, and not merely the
effects on some special group but the effects on everyone. It follows that
it is foolish and misleading to concentrate our attention merely on some
special point -- to examine, for example, merely what happens in one industry
without considering what happens in all. But it is precisely from the
persistent and lazy habit of thinking only of some particular industry or
process in isolation that the major fallacies of economics stem. These
fallacies pervade not merely the arguments of the hired spokesmen of special
interests, but the arguments even of some economists who pass as profound.
It is on the fallacy of isolation, at bottom, that the
"production-for-use-and-not-for-profit" school is based, with its attack on
the allegedly vicious "price system". The problem of production, say the
adherents of this school, is solved. (This resounding error, as we shall
see, is also the starting point of most currency cranks and share-the-wealth
charlatans.) The problem of production is solved. The scientists, the
efficiency experts, the engineers, the technicians, have solved it.
They could turn out almost anything you cared to mention in huge and
practically unlimited amounts. But, alas, the world is not ruled by the
engineers, thinking only of production, but by the businessmen, thinking
only of profit. The businessmen give their orders to the engineers,
instead of vice versa. These businessmen will turn out any object as long
as there is a profit in doing so, but the moment there is no longer a profit
in making that article, the wicked businessmen will stop making it, though
many people's wants are unsatisfied, and the world is crying for more goods.
There are so many fallacies in this view that they cannot all be
disentangled at once. But the central error, as we have hinted, comes
from looking at only one industry, or even at several industries in turn,
as if each of them existed in isolation. Each of them in fact exists in
relation to all the others, and every important decision made in it is
affected by and affects the decisions made in all the others.
We can understand this better if we understand the basic problem that
business collectively has to solve. To simplify this as much as possible,
let us consider the problem that confronts a Robinson Crusoe on his desert
island. His wants at first seem endless. He is soaked with rain; he
shivers from cold; he suffers from hunger and thirst. He needs everything:
drinking water, food, a roof over his head, protection from animals, a fire,
a soft place to lie down. It is impossible for him to satisfy all these
needs at once; he has not the time, energy, or resources. He must attend
immediately to the most pressing need. He suffers most, say, from thirst.
He hollows out a place in the sand to collect rain water, or builds some
crude receptacle. When he has provided for only a small water supply,
however, he must turn to finding food before he tries to improve this.
He can try to fish; but to do this he needs either a hook and line, or
a net, and he must set to work on these. But everything he does delays
or prevents him from doing something else only a little less urgent.
He is faced constantly by the problem of alternative applications
of his time and labor.
A Swiss Family Robinson, perhaps, finds this problem a little easier to
solve. It has more mouths to feed, but it also has more hands to work for
them. It can practice division and specialization of labor. The father
hunts; the mother prepares the food; the children collect firewood.
But even the family cannot afford to have one member of it doing endlessly
the same thing, regardless of the relative urgency of the common need he
supplies and the urgency of other needs still unfilled. When the children
have gathered a certain pile of firewood, they cannot be used simply to
increase the pile. It is soon time for one of them to be sent, say, for
more water. The family too has the constant problem of choosing among
alternative applications of labor, and, if it is lucky enough to have
acquired guns, fishing tackle, a boat, axes, saws, and so on, of choosing
among alternative applications of labor and capital. It would be considered
unspeakably silly for the wood-gathering member of the family to complain
that they could gather more firewood if his brother helped him all day,
instead of getting the fish that were needed for the family dinner. It is
recognized clearly in the case of an isolated individual or family that one
occupation can expand only at the expense of all other occupations.
Elementary illustrations like this are sometimes ridiculed as "Crusoe
economics". Unfortunately, they are ridiculed most by those who most need
them, who fail to understand the particular principle illustrated even in
this simple form, or who lose track of that principle completely when they
come to examine the bewildering complications of a great modern economic
society.
2
Let us now turn to such a society. How is the problem of alternative
applications of labor and capital, to meet thousands of different needs
and wants of different urgencies, solved in such a society? It is solved
precisely through the price system. It is solved through the constantly
changing interrelationships of costs of production, prices, and profits.
Prices are fixed through the relationship of supply and demand, and in turn
affect supply and demand. When people want more of an article, they offer
more for it. The price goes up. This increases the profits of those who
make the article. Because it is now more profitable to make that article
than others, the people already in the business expand their production of
it, and more people are attracted to the business. This increased supply
then reduces the price and reduces the profit margin, until the profit
margin on that article once more falls to the general level of profits
(relative risks considered) in other industries. Or the demand for that
article may fall; or the supply of it may be increased to such a point that
its price drops to a level where there is less profit in making it than in
making other articles; or perhaps there is an actual loss in making it.
In this case the "marginal" producers, that is, the producers who are least
efficient, or whose costs of production are highest, will be driven out of
business altogether. The product will now be made only by the more efficient
producers who operate on lower costs. The supply of that commodity will
also drop, or will at least cease to expand. This process is the origin of
the belief that prices are determined by costs of production. The doctrine,
stated in this form, is not true. Prices are determined by supply and
demand, and demand is determined by how intensely people want a commodity
and what they have to offer in exchange for it. It is true that supply is
in part determined by costs of production. What a commodity has cost
to produce in the past cannot determine its value. That will depend on the
present relationship of supply and demand. But the expectations of
businessmen concerning what a commodity will cost to produce in the
future, and what its future price will be, will determine how much of it
will be made. This will affect future supply. There is therefore a
constant tendency for the price of a commodity and its marginal cost
of production to equal each other, but not because that
marginal cost of production directly determines the price.
The private enterprise system, then, might be compared to thousands of
machines, each regulated by its own quasi-automatic governor, yet with these
machines and their governors all interconnected and influencing each other,
so that they act in effect like one great machine. Most of us must have
noticed the automatic "governor" on a steam engine. It usually consists
of two balls or weights which work by centrifugal force. As the speed of
the engine increases, these balls fly away from the rod to which they are
attached and so automatically narrow or close off a throttle valve which
regulates the intake of steam and thus slows down the engine. If the engine
goes too slowly, on the other hand, the balls drop, widen the throttle valve,
and increase the engine's speed. Thus every departure from the desired
speed itself sets in motion the forces that tend to correct that departure.
It is precisely in this way that the relative supply of thousands of
different commodities is regulated under the system of competitive private
enterprise. When people want more of a commodity, their competitive bidding
raises its price. This increases the profits of the producers who make that
product. This stimulates them to increase their production. It leads others
to stop making some of the products they previously made, and turn to making
the product that offers them the better return. But this increases the
supply of that commodity at the same time that it reduces the supply of
some other commodities. The price of that product therefore falls in
relation to the price of other products, and the stimulus to the
relative increase in its production disappears.
In the same way, if the demand falls off for some product, its price
and the profit in making it go lower, and its production declines.
It is this last development that scandalizes those who do not understand
the "price system" they denounce. They accuse it of creating scarcity.
Why, they ask indignantly, should manufacturers cut off the production
of shoes at the point where it becomes unprofitable to produce any more?
Why should they be guided merely by their own profits? Why should they be
guided by the market? Why do they not produce shoes to the "full capacity
of modern technical processes"? The price system and private enterprise,
conclude the "production-for-use" philosophers, are merely a form of
"scarcity economics".
These questions and conclusions stem from the fallacy of looking at one
industry in isolation, of looking at the tree and ignoring the forest.
Up to a certain point it is necessary to produce shoes. But it is also
necessary to produce coats, shirts, trousers, homes, plows, shovels,
factories, bridges, milk, and bread. It would be idiotic to go on
piling up mountains of surplus shoes, simply because we could do it,
while hundreds of more urgent needs went unfilled.
Now in an economy in equilibrium, a given industry can expand only
at the expense of other industries. For at any moment the factors
of production are limited. One industry can be expanded only by
diverting to it labor, land, and capital that would otherwise
be employed in other industries. And when a given industry shrinks,
or stops expanding its output, it does not necessarily mean that there
has been any net decline in aggregate production. The shrinkage
at that point may have merely released labor and capital to
permit the expansion of other industries. It is erroneous
to conclude, therefore, that a shrinkage of production in one line
necessarily means a shrinkage in total production.
Everything, in short, is produced at the expense of forgoing something else.
Costs of production themselves, in fact, might be defined as the things that
are given up (the leisure and pleasures, the raw materials with alternative
potential uses) in order to create the thing that is made.
It follows that it is just as essential for the health of a dynamic economy
that dying industries should be allowed to die as that growing industries
should be allowed to grow. For the dying industries absorb labor and
capital that should be released for the growing industries. It is only the
much vilified price system that solves the enormously complicated problem of
deciding precisely how much of tens of thousands of different commodities
and services should be produced in relation to each other. These otherwise
bewildering equations are solved quasi-automatically by the system of prices,
profits, and costs. They are solved by this system incomparably better than
any group of bureaucrats could solve them. For they are solved by a system
under which each consumer makes his own demand and casts a fresh vote, or a
dozen fresh votes, every day; whereas bureaucrats would try to solve it by
having made for the consumers, not what the consumers themselves wanted,
but what the bureaucrats decided was good for them.
Yet though the bureaucrats do not understand the quasi-automatic system of
the market, they are always disturbed by it. They are always trying to
improve it or correct it, usually in the interests of some wailing pressure
group. What some of the results of their intervention is, we shall examine
in succeeding chapters.
1
Attempts to lift the prices of particular commodities permanently above
their natural market levels have failed so often, so disastrously, and so
notoriously that sophisticated pressure groups, and the bureaucrats upon
whom they apply the pressure, seldom openly avow that aim. Their stated
aims, particularly when they are first proposing that the government
intervene, are usually more modest, and more plausible.
They have no wish, they declare, to raise the price of commodity X
permanently above its natural level. That, they concede, would be unfair
to consumers. But it is now obviously selling far below its natural
level. The producers cannot make a living. Unless we act promptly, they
will be thrown out of business. Then there will be a real scarcity, and
consumers will have to pay exorbitant prices for the commodity. The apparent
bargains that the consumers are now getting will cost them dear in the end.
For the present "temporary" low price cannot last. But we cannot afford to
wait for so-called natural market forces, or for the "blind" law of supply
and demand, to correct the situation. For by that time the producers will
be ruined and a great scarcity will be upon us. The government must act.
All that we really want to do is to correct these violent, senseless
fluctuations in price. We are not trying to boost
the price; we are only trying to stabilize it.
There are several methods by which it is commonly proposed to do this.
One of the most frequent is government loans to farmers to enable them
to hold their crops off the market.
Such loans are urged in Congress for reasons that seem very plausible to
most listeners. They are told that the farmers' crops are all dumped on
the market at once, at harvest time; that this is precisely the time when
prices are lowest, and that speculators take advantage of this to buy the
crops themselves and hold them for higher prices when food gets scarcer
again. Thus it is urged that the farmers suffer, and that they, rather
than the speculators, should get the advantage of the higher average price.
This argument is not supported by either theory or experience.
The much-reviled speculators are not the enemy of the farmer; they are
essential to his best welfare. The risks of fluctuating farm prices must be
borne by somebody; they have in fact been borne in modern times chiefly by
the professional speculators. In general, the more competently the latter
act in their own interest as speculators, the more they help the farmer.
For speculators serve their own interest precisely in proportion to their
ability to foresee future prices. But the more accurately they foresee
future prices the less violent or extreme are the fluctuations in prices.
Even if farmers had to dump their whole crop of wheat on the market in
a single month of the year, therefore, the price in that month would not
necessarily be below the price at any other month (apart from an allowance
for the costs of storage). For speculators, in the hope of making a profit,
would do most of their buying at that time. They would keep on buying until
the price rose to a point where they saw no further opportunity of future
profit. They would sell whenever they thought there was a prospect of
future loss. The result would be to stabilize the price of farm
commodities the year round.
It is precisely because a professional class of speculators exists
to take these risks that farmers and millers do not need to take them.
The latter can protect themselves through the markets. Under normal
conditions, therefore, when speculators are doing their job well, the
profits of farmers and millers will depend chiefly on their skill and
industry in farming or milling, and not on market fluctuations.
Actual experience shows that on the average the price of wheat and other
nonperishable crops remains the same all year round except for an allowance
for storage and insurance charges. In fact, some careful investigations
have shown that the average monthly rise after harvest time has not been
quite sufficient to pay such storage charges, so that the speculators have
actually subsidized the farmers. This, of course, was not their intention:
it has simply been the result of a persistent tendency to overoptimism on
the part of speculators. (This tendency seems to affect entrepreneurs in
most competitive pursuits: as a class they are constantly, contrary to
intention, subsidizing consumers. This is particularly true wherever the
prospects of big speculative gains exist. Just as the subscribers to a
lottery, considered as a unit, lose money because each is unjustifiably
hopeful of drawing one of the few spectacular prizes, so it has been
calculated that the total labor and capital dumped into prospecting for
gold or oil has exceeded the total value of the gold or oil extracted.)
2
The case is different, however, when the State steps in and either buys
the farmers' crops itself or lends them the money to hold the crops off
the market. This is sometimes done in the name of maintaining what is
plausibly called an "ever-normal granary". But the history of prices and
annual carryovers of crops shows that this function, as we have seen, is
already being well performed by the privately organized free markets.
When the government steps in, the "ever-normal granary" becomes in fact
an ever-political granary. The farmer is encouraged, with the taxpayers'
money, to withhold his crops excessively. Because they wish to make sure
of retaining the farmer's vote, the politicians who initiate the policy,
or the bureaucrats who carry it out, always place the so-called "fair"
price for the farmer's product above the price that supply and demand
conditions at the time justify. This leads to a falling off in buyers.
The "ever-normal granary" therefore tends to become an ever-abnormal
granary. Excessive stocks are held off the market. The effect of this is
to secure a higher price temporarily than would otherwise exist, but to do
so only by bringing about later on a much lower price than would otherwise
have existed. For the artificial shortage built up this year by withholding
part of a crop from the market means an artificial surplus the next year.
It would carry us too far afield to describe in detail what actually happened
when this program was applied, for example, to American cotton. We piled up
an entire year's crop in storage. We destroyed the foreign market for our
cotton. We stimulated enormously the growth of cotton in other countries.
Though these results had been predicted by opponents of the restriction and
loan policy, when they actually happened the bureaucrats responsible for
the result merely replied that they would have happened anyway.
For the loan policy is usually accompanied by, or inevitably leads to, a
policy of restricting production -- i.e., a policy of scarcity. In nearly
every effort to "stabilize" the price of a commodity, the interests of the
producers have been put first. The real object is an immediate boost of
prices. To make this possible, a proportional restriction of output is
usually placed on each producer subject to the control. This has several
immediately bad effects. Assuming that the control can be imposed on
an international scale, it means that total world production is cut.
The world's consumers are able to enjoy less of that product than
they would have enjoyed without restriction. The world is just that much
poorer. Because consumers are forced to pay higher prices than otherwise
for that product, they have just that much less to spend on other products.
3
The restrictionists usually reply that this drop in output is what happens
anyway under a market economy. But there is a fundamental difference, as we
have seen in the preceding chapter. In a competitive market economy, it is
the high-cost producers, the inefficient producers, that are driven
out by a fall in price. In the case of an agricultural commodity it is
the least competent farmers, or those with the poorest equipment, or those
working the poorest land, that are driven out. The most capable farmers on
the best land do not have to restrict their production. On the contrary,
if the fall in price has been symptomatic of a lower average cost of
production, reflected through an increased supply, then the driving out
of the marginal farmers on the marginal land enables the good farmers on
the good land to expand their production. So there may be, in the
long run, no reduction whatever in the output of that commodity. And the
product is then produced and sold at a permanently lower price.
If that is the outcome, then the consumers of that commodity will be as well
supplied with it as they were before. But, as a result of the lower price,
they will have money left over, which they did not have before, to spend on
other things. The consumers, therefore, will obviously be better off. But
their increased spending in other directions will give increased employment
in other lines, which will then absorb the former marginal farmers in
occupations in which their efforts will be more lucrative and more efficient.
A uniform proportional restriction (to return to our government intervention
scheme) means, on the one hand, that the efficient low-cost producers are
not permitted to turn out all the output they can at a low price. It means,
on the other hand, that the inefficient high-cost producers are artificially
kept in business. This increases the average cost of producing the product.
It is being produced less efficiently than otherwise. The inefficient
marginal producer thus artificially kept in that line of production
continues to tie up land, labor, and capital that could much more
profitably and efficiently be devoted to other uses.
There is no point in arguing that as a result of the restriction scheme at
least the price of farm products has been raised and "the farmers have more
purchasing power". They have got it only by taking just that much purchasing
power away from the city buyer. (We have been over all this ground before
in our analysis of "parity" prices.) To give farmers money for restricting
production, or to give them the same amount of money for an artificially
restricted production, is no different from forcing consumers or taxpayers
to pay people for doing nothing at all. In each case the beneficiaries of
such policies get "purchasing power". But in each case someone else loses
an exactly equivalent amount. The net loss to the community is the loss of
production, because people are supported for not producing. Because there
is less for everybody, because there is less to go around, real wages and
real incomes must decline either through a fall in their monetary amount
or through higher living costs.
But if an attempt is made to keep up the price of an agricultural commodity
and no artificial restriction of output is imposed, unsold surpluses of the
overpriced commodity continue to pile up until the market for that product
finally collapses to a far greater extent than if the control program had
never been put into effect. Or producers outside the restriction program,
stimulated by the artificial rise in price, expand their own production
enormously. This is what happened to the British rubber restriction and
the American cotton restriction programs. In either case the collapse of
prices finally goes to catastrophic lengths that would never have been
reached without the restriction scheme. The plan that started out so
bravely to "stabilize" prices and conditions brings incomparably greater
instability than the free forces of the market could possibly have brought.
Of course the international commodity controls that are being proposed
now, we are told, are going to avoid all these errors. This time
prices are going to be fixed that are "fair" not only for producers but for
consumers. Producing and consuming nations are going to agree on just what
these fair prices are, because no one will be unreasonable. Fixed prices
will necessarily involve "just" allotments and allocations for production
and consumption as among nations, but only cynics will anticipate any
unseemly international disputes regarding these. Finally, by the greatest
miracle of all, this postwar world of superinternational controls and
coercions is also going to be a world of "free" international trade!
Just what the government planners mean by free trade in this connection
I am not sure, but we can be sure of some of the things they do not mean.
They do not mean the freedom of ordinary people to buy and sell, lend and
borrow, at whatever prices or rates they like and wherever they find it most
profitable to do so. They do not mean the freedom of the plain citizen to
raise as much of a given crop as he wishes, to come and go at will, to
settle where he pleases, to take his capital and other belongings with him.
They mean, I suspect, the freedom of bureaucrats to settle these matters for
him. And they tell him that if he docilely obeys the bureaucrats he will be
rewarded by a rise in his living standards. But if the planners succeed in
tying up the idea of international cooperation with the idea of increased
State domination and control over economic life, the international controls
of the future seem only too likely to follow the pattern of the past, in
which case the plain man's living standards will decline with his liberties.
1
We have seen what some of the effects are of governmental efforts to fix
the prices of commodities above the levels to which free markets
would otherwise have carried them. Let us now look at some of the results
of government attempts to hold the prices of commodities below their
natural market levels.
The latter attempt is made in our day by nearly all governments in wartime.
We shall not examine here the wisdom of wartime price-fixing. The whole
economy, in total war, is necessarily dominated by the State, and the
complications that would have to be considered would carry us too far
beyond the main question with which this book is concerned. But wartime
price-fixing, wise or not, is in almost all countries continued for at
least long periods after the war is over, when the original excuse for
starting it has disappeared.
Let us first see what happens when the government tries to keep the price
of a single commodity, or a small group of commodities, below the price
that would be set in 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.
Let us say that the items chosen for this purpose are bread, milk, and meat.
The argument for holding down the price of these goods will run something
like this. If we leave beef (let us say) to the mercies of the free market,
the price will be pushed up by competitive bidding so that only the rich
will get it. People will get beef not in proportion to their need, but
only in proportion to their purchasing power. If we keep the price down,
everyone will get his fair share.
The first thing to be noticed about this argument is that if it is valid
the policy adopted is inconsistent and timorous. For if purchasing power
rather than need determines the distribution of beef at a market price of
65 cents a pound, it would also determine it, though perhaps to a slightly
smaller degree, at, say, a legal "ceiling" price of 50 cents a pound.
The purchasing-power-rather-than-need argument, in fact, holds as long as
we charge anything for beef whatever. It would cease to apply only if beef
were given away.
But schemes for maximum price-fixing usually begin as efforts to "keep the
cost of living from rising". And so their sponsors unconsciously assume
that there is something peculiarly "normal" or sacrosanct about the market
price at the moment from which their control starts. That starting price
is regarded as "reasonable", and any price above that as "unreasonable",
regardless of changes in the conditions of production or demand since
that starting price was first established.
2
In discussing this subject, there is no point in assuming a price control
that would fix prices exactly where a free market would place them in any
case. That would be the same as having no price control at all. We 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 bringing about two consequences. The first is to increase
the demand for that commodity. Because the commodity is cheaper, people
are both tempted to buy, and can afford to buy, more of it. The second
consequence is to reduce the supply of that commodity. Because people
buy more, the accumulated supply is more quickly taken from the shelves
of merchants. But in addition to this, production of that commodity is
discouraged. Profit margins are reduced or wiped out. The marginal
producers are driven out of business. Even the most efficient producers
may be called upon to turn out their product at a loss. This happened
in the war when slaughterhouses were required by the Office of Price
Administration to slaughter and process meat for less than the cost to
them of cattle on the hoof and the labor of slaughter and processing.
If we did nothing else, therefore, the consequence of fixing a maximum
price for a particular commodity would be to bring about a shortage of
that commodity. But this is precisely the opposite of what the government
regulators originally wanted to do. For it is the very commodities
selected for maximum price-fixing that the regulators most want to keep
in abundant supply. But when they limit the wages and the profits of those
who make these commodities, without also limiting the wages and profits of
those who make luxuries or semi-luxuries, they discourage the production
of the price-controlled necessities while they relatively stimulate the
production of less essential goods.
Some of these consequences in time become apparent to the regulators, who
then adopt various other devices and controls in an attempt to avert them.
Among these devices are rationing, cost-control, subsidies, and universal
price-fixing. Let us look at each of these in turn.
When 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, in brief, 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. I say only part of the job, because rationing merely limits the
demand without also stimulating the supply, as a higher price would have
done.
The government may 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,
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.
But as the government extends this price-fixing backwards, it extends at
the same time the consequences that originally drove it to this course.
Assuming that it has the courage to fix these costs, and is able to
enforce its decisions, then it merely, in turn, creates shortages of
the various factors -- labor, feedstuffs, wheat, or whatever -- that
enter into the production of the final commodities. Thus the government
is driven to controls in ever-widening circles, and the final consequence
will be the same as that of universal price-fixing.
The government may try to meet this difficulty through subsidies.
It recognizes, for example, that when it keeps the price of milk or butter
below the level of the market, or below the relative level at which it fixes
other prices, a shortage may result because of lower wages or profit margins
for the production of milk or butter as compared with other commodities.
Therefore the government attempts to compensate for this by paying a
subsidy to the milk and butter producers. Passing over the administrative
difficulties involved in this, and assuming that the subsidy is just enough
to assure the desired relative production of milk and butter, it is clear
that, though the subsidy is paid to producers, those who are really being
subsidized are the consumers. For the producers are on net balance getting
no more for their milk and butter than if they had been allowed to charge
the free market price in the first place; but the consumers are getting
their milk and butter at a great deal below the free market price.
They are being subsidized to the extent of the difference -- that is,
by the amount of subsidy paid ostensibly to the producers.
Now unless the subsidized commodity is also rationed, it is those with the
most purchasing power that can buy most of it. This means that they are
being subsidized more than those with less purchasing power. Who subsidizes
the consumers will depend upon the incidence of taxation. But men in their
role of taxpayers will be subsidizing themselves in their role of consumers.
It becomes a little difficult to trace in this maze precisely who is
subsidizing whom. What is forgotten is that subsidies are paid for by
someone, and that no method has been discovered by which the community
gets something for nothing.
3
Price-fixing may often appear for a short period to be successful. It can
seem to work well for a while, particularly in wartime, when it is supported
by patriotism and a sense of crisis. But the longer it is in effect the
more its difficulties increase. When prices are arbitrarily held down by
government compulsion, demand is chronically in excess of supply.
We have seen that if the government attempts to prevent a shortage of a
commodity by reducing also the prices of the labor, raw materials and other
factors that go into its cost of production, it creates a shortage of these
in turn. But not only will the government, if it pursues this course,
find it necessary to extend price control more and more downwards, or
"vertically"; it will find it no less necessary to extend price control
"horizontally". 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. If we assume that the government is successful in its efforts
to prevent black markets (or at least prevents them from developing on a
sufficient scale to nullify its legal prices), continued price control must
drive it to the rationing of more and more commodities. This rationing
cannot stop with consumers. In war it did not stop with consumers.
It was applied first of all, in fact, in the allocation of raw materials
to producers.
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. Competitive bidding for workers could
no more be tolerated than competitive bidding for materials. The result
would be a petrified totalitarian economy, with every business firm and
every worker at the mercy of the government, and with a final abandonment
of all the traditional liberties we have known. For as Alexander Hamilton
pointed out in the Federalist Papers a century and a half ago,
"A power over a man's subsistence amounts to a power over his will."
4
These are the consequences of what might be described as "perfect",
long-continued, and "non-political" price control. As was so amply
demonstrated in one country after another, particularly in Europe
during and after World War II, some of the more fantastic errors of the
bureaucrats were mitigated by the black market. It was a common story from
many European countries that people were able to get enough to stay alive
only by patronizing the black market. 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, however, the politicians in power tried to show that
their hearts, if not their enforcement squads, were in the right place.
Because the black market, however, finally supplanted the legal
price-ceiling market, it must not be supposed that no harm was done.
The harm was both economic and moral. 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-by-night 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.
It is seldom, moreover, that any honest effort is made by the price-fixing
authorities merely to preserve the level of prices existing when their
efforts began. They declare that their intention is to "hold the line".
Soon, however, under the guise of "correcting inequities" or "social
injustices", they begin a discriminatory price-fixing which gives most
to those groups that are politically powerful and least to other groups.
As political power today is most commonly measured by votes, the groups
that the authorities most often attempt to favor are workers and farmers.
At first it is contended that wages and living costs are not connected; that
wages can easily be lifted without lifting prices. When it becomes obvious
that wages can be raised only at the expense of profits, the bureaucrats
begin to argue that profits were already too high anyway, and that lifting
wages and holding prices will still permit "a fair profit". As there is no
such thing as a uniform rate of profit, as profits differ with each
concern, the result of this policy is to drive the least profitable concerns
out of business altogether, and to discourage or stop the production of
certain items. This means unemployment, a shrinkage in production and
a decline in living standards.
5
What lies at the base of the whole effort to fix maximum prices? There is
first of all a misunderstanding of what it is that has been causing prices
to rise. The real cause is either a scarcity of goods or a surplus of money.
Legal price ceilings cannot cure either. In fact, as we have just seen,
they merely intensify the shortage of goods. What to do about the surplus
of money will be discussed in a later chapter. But one of the errors that
lies behind the drive for price-fixing is the chief subject of this book.
Just as the endless plans for raising prices of favored commodities are
the result of thinking of the interests only of the producers immediately
concerned, and forgetting the interests of consumers, so the plans for
holding down prices by legal edict are the result of thinking of the
interests of people only as consumers and forgetting their interests
as producers. And 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. "Now my own business," he will
say, "is peculiar, and the public does not understand it. Labor costs have
gone up; raw material prices have gone up; this or that raw material is no
longer being imported, and must be made at a higher cost at home. Moreover,
the demand for the product has increased, and the business should be allowed
to charge the prices necessary to encourage its expansion to supply this
demand." And so on. Everyone as consumer buys a hundred different products;
as producer he makes, usually, only one. He can see the inequity in holding
down the price of that. And just as each manufacturer wants a higher
price for his particular product, so each worker wants a higher wage or
salary. Each can see as producer that price control is restricting
production in his line. But nearly everyone refuses to generalize this
observation, for it means that he will have to pay more for the products
of others.
Each one of us, in brief, 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.
1
We have already seen some of the harmful results of arbitrary governmental
efforts to raise the price of favored commodities. The same sort of harmful
results follow efforts to raise wages through minimum wage laws. This ought
not to be surprising; for a wage is, in fact, a price. It is unfortunate
for clarity of economic thinking that the price of labor's services should
have received an entirely different name from other prices. This has
prevented most people from recognizing that the same principles govern both.
Thinking has become so emotional and so politically biased on the subject of
wages that in most discussions of them the plainest principles are ignored.
People who would be among the first to deny that prosperity could be brought
about by artificially boosting prices, people who would be among the first
to point out that minimum price laws might be most harmful to the very
industries they were designed to help, will nevertheless advocate
minimum wage laws, and denounce opponents of them, without misgivings.
Yet it ought to be clear that a minimum wage law is, at best, a limited
weapon for combating the evil of low wages, and that the possible good to
be achieved by such a law can exceed the possible harm only in proportion as
its aims are modest. 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.
The first thing that happens, for example, when a law is passed that no one
shall be paid less than $30 for a forty-hour week is that no one who is not
worth $30 a week to an employer will be employed at all. You cannot make
a man worth a given amount by making it illegal for anyone to offer him
anything less. You merely deprive him of the right to earn the amount that
his abilities and situation would permit him to earn, while you deprive the
community even of the moderate services that he is capable of rendering.
In brief, for a low wage you substitute unemployment. You do harm all
around, with no comparable compensation.
The only exception to this occurs when a group of workers is receiving
a wage actually below its market worth. This is likely to happen only in
special circumstances or localities where competitive forces do not operate
freely or adequately; but nearly all these special cases could be remedied
just as effectively, more flexibly, and with far less potential harm, by
unionization.
It may be thought that if the law forces the payment of a higher wage in a
given industry, that industry can then charge higher prices for its product,
so that the burden of paying the higher wage is merely shifted to consumers.
Such shifts, however, are not easily made, nor are the consequences of
artificial wage raising so easily escaped. A higher price for the product
may not be possible: it may merely drive consumers to some substitute.
Or, if consumers continue to buy the product of the industry in which
wages have been raised, the higher price will cause them to buy less of it.
While some workers in the industry will be benefited from the higher wage,
therefore, others will be thrown out of employment altogether. On the
other hand, if the price of the product is not raised, marginal producers
in the industry will be driven out of business; so that reduced production
and consequent unemployment will merely be brought about in another way.
When such consequences are pointed out, there is a group of people who
reply: "Very well; if it is true that the X industry cannot exist except
by paying starvation wages, then it will be just as well if the minimum
wage puts it out of existence altogether." But this brave pronouncement
overlooks the realities. It overlooks, first of all, that consumers will
suffer the loss of that product. It forgets, in the second place, that it
is merely condemning the people who worked in that industry to unemployment.
And it ignores, finally, that bad as were the wages paid in the X industry,
they were the best among all the alternatives that seemed open to the
workers in that industry; otherwise the workers would have gone into
another. If, therefore, the X industry is driven out of existence by a
minimum wage law, then the workers previously employed in that industry
will be forced to turn to alternative courses that seemed less attractive
to them in the first place. Their competition for jobs will drive down
the pay offered even in these alternative occupations. There is no escape
from the conclusion that the minimum wage will increase unemployment.
2
A nice problem, moreover, will be raised by the relief program designed to
take care of the unemployment caused by the minimum wage law. By a minimum
wage of, say, 75 cents an hour, we have forbidden anyone to work forty hours
in a week for less than $30. Suppose, now, we offer only $18 a week on
relief. This means that we have forbidden a man to be usefully employed at,
say $25 a week, in order that we may support him at $18 a week in idleness.
We have deprived society of the value of his services. We have deprived the
man of the independence and self-respect that come from self-support, even
at a low level, and from performing wanted work, at the same time as we
have lowered what the man could have received by his own efforts.
These consequences follow as long as the relief payment is a penny less
than $30. Yet the higher we make the relief payment, the worse we make the
situation in other respects. If we offer $30 for relief, then we offer many
men just as much for not working as for working. Moreover, whatever the sum
we offer for relief, we create a situation in which everyone is working only
for the difference between his wages and the amount of the relief.
If the relief is $30 a week, for example, workers offered a wage of $1 an
hour, or $40 a week, are in fact, as they see it, being asked to work for
only $10 a week -- for they can get the rest without doing anything.
It may be thought that we can escape these 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, therefore (in work often of doubtful
utility), while the rest is a disguised dole.
It would probably have been better all around if the government in the
first place had frankly subsidized their wages on the private work they
were already doing. We need not pursue this point further, as it would
carry us into problems not immediately relevant. But the difficulties
and consequences of relief must be kept in mind when we consider the
adoption of minimum wage laws or an increase in minimums already fixed.
3
All this is not to argue that there is no way of raising wages.
It is merely to point out that the apparently easy method of raising
them by government fiat is the wrong way and the worst way.
This is perhaps as good a place as any to point out that what distinguishes
many reformers from those who cannot accept their proposals is not their
greater philanthropy, but their greater impatience. The question is not
whether we wish to see everybody as well off as possible. Among men of
goodwill such an aim can be taken for granted. The real question concerns
the proper means of achieving it. And in trying to answer this we must
never lose sight of a few elementary truisms. We cannot distribute more
wealth than is created. We cannot in the long run pay labor as a whole
more than it produces.
The best way to raise wages, therefore, is to raise labor productivity.
This can be done by many methods: by an increase in capital accumulation
-- i.e., by an increase in the machines with which the workers are aided;
by new inventions and improvements; by more efficient management on the part
of employers; by more industriousness and efficiency on the part of workers;
by better education and training. The more the individual worker produces,
the more he increases the wealth of the whole community. The more he
produces, the more his services are worth to consumers, and hence to
employers. And the more he is worth to employers, the more he will be
paid. Real wages come out of production, not out of government decrees.
1
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.
In spite of the overwhelming evidence that labor productivity is the
fundamental determinant of wages, the conclusion is usually forgotten or
derided by labor union leaders and by that large group of economic writers
who seek a reputation as "liberals" by parroting them. But this conclusion
does not rest on the assumption, as they suppose, that employers are
uniformly kind and generous men eager to do what is right. It rests on the
very different assumption that the individual employer is eager to increase
his own profits to the maximum. If people are willing to work for less than
they are really worth to him, why should he not take the fullest advantage
of this? Why should he not prefer, for example, to make $1 a week out of
a workman rather than see some other employer make $2 a week out of him?
And as long as this situation exists, there will be a tendency for
employers to bid workers up to their full economic worth.
All this does not mean that unions can serve no useful or legitimate
function. The central function they can serve is to assure that all
of their members get the true market value of their services.
For the competition of workers for jobs, and of employers for workers, does
not work perfectly. Neither individual workers nor individual employers are
likely to be fully informed concerning the conditions of the labor market.
An individual worker, 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.
And he is, individually, in a much weaker bargaining position. Mistakes
of judgment are far more costly to him than to an employer. If an employer
mistakenly refuses to hire a man from whose services he might have profited,
he merely loses the net profit he might have made from employing that one
man; and he may employ a hundred or a thousand men. But if a worker
mistakenly refuses a job in the belief that he can easily get another
that will pay him more, the error may cost him dearly. His whole means of
livelihood is involved. Not only may he fail promptly to find another job
offering more; he may fail for a time to find another job offering remotely
as much. And time may be the essence of his problem, because he and his
family must eat. So he may be tempted to take a wage that he knows to be
below his "real worth" rather than face these risks. 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.
But it is easy, as experience has proved, for unions, particularly with
the help of one-sided labor legislation which puts compulsions solely on
employers, to go beyond their legitimate functions, to act irresponsibly,
and to embrace shortsighted and antisocial policies. They do this, for
example, whenever they seek to fix the wages of their members above their
real market worth. Such an attempt always brings about unemployment.
The arrangement can be made to stick, in fact, only by some form of
intimidation or coercion.
One device consists in restricting the membership of the union on some other
basis than that of proved competence or skill. This restriction may take
many forms: it may consist in charging new workers excessive initiation
fees; in arbitrary membership qualifications; in discrimination, open or
concealed, on grounds of religion, race, or sex; in some absolute limitation
on the number of members; or in exclusion, by force if necessary, not only
of the products of nonunion labor, but of the products even of affiliated
unions in other States or cities.
The most obvious case in which intimidation and force are used to put or
keep the wages of a particular union above the real market worth of its
members' services is that of 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. But the
moment workers have to use intimidation or violence to enforce their
demands -- the moment they use pickets to prevent any of the 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.
If the foregoing analysis is correct, the indiscriminate hatred of the
"strikebreaker" is not justified. If the strikebreakers consist merely of
professional thugs who themselves threaten violence, or who cannot in fact
do the work, or if they are being paid a temporarily higher rate solely for
the purpose of making a pretense of carrying on until the old workers are
frightened back to work at the old rates, the hatred may be warranted.
But if they are in fact merely men and women who are looking for permanent
jobs and willing to accept them at the old rate, then they 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.
2
Emotional economics has given birth to theories that calm examination
cannot justify. One of these is the idea that labor is being "underpaid"
generally. This would be analogous to the notion that in a free
market prices in general are chronically too low. Another curious but
persistent notion is that the interests of a nation's workers are identical
with each other, and that an increase in wages for one union in some obscure
way helps all other workers. Not only is there no truth in this idea; the
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.
In order to see more clearly how this occurs, let us imagine a community
in which the facts are enormously simplified arithmetically. Suppose the
community consisted of just half a dozen groups of workers, and that these
groups were originally equal to each other in their total wages and the
market value of their product.
Let us say that these six groups of workers consist of (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.
On the assumptions we have made, this will mean that there has been an
average increase in wages of 25 percent. Now suppose, again for
the sake of arithmetical simplicity, that the price of the product that
each group of workers makes rises by the same percentage as the increase
in that group's wages. (For several reasons, including the fact that
labor costs do not represent all costs, the price will not quite do
that -- certainly not in any short period. But the figures will
none the less serve to illustrate the basic principle involved.)
We shall then have a situation in which the cost of living has risen by an
average of 25 percent. The farm hands, though they have had no reduction
in their money wages, will be considerably worse off in terms of what they
can buy. The retail store workers, even though they have got an increase
in money wages of 10 percent, will be worse off than before the race began.
Even the workers in the clothing trades, with a money-wage increase of
20 percent, will be at a disadvantage compared with their previous position.
The coal miners, with a money-wage increase of 30 percent, will have made in
purchasing power only a slight gain. The building and railroad workers will
of course have made a gain, but one much smaller in actuality than in
appearance.
But even such calculations rest on the assumption that the forced increase
in wages has brought about no 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 unemployment need not necessarily be greatest, in percentage terms,
among the unions whose wages have been advanced the most; for unemployment
will be shifted and distributed in relation to the relative elasticity of
the demand for different kinds of labor and in relation to the "joint"
nature of the demand for many kinds of labor. Yet when all these allowances
have been made, even the groups whose wages have been advanced the most will
probably be found, when their unemployed are averaged with their employed
members, to be worse off than before. And in terms of welfare,
of course, the loss suffered will be much greater than the loss in
merely arithmetical terms, because the psychological losses of those
who are unemployed will greatly outweigh the psychological gains of
those with a slightly higher income in terms of purchasing power.
Nor can the situation be rectified by providing unemployment relief.
Such relief, in the first place, is paid for in large part, directly or
indirectly, out of the wages of those who work. It therefore reduces these
wages. "Adequate" relief payments, moreover, as we have already seen,
create unemployment. They do so in several ways. 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. But where there is a relief system under which the general
taxpayer is forced to provide for the unemployment caused by excessive wage
rates, this restraint on excessive union demands is removed. Moreover,
as we have already noted, "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. And heavy unemployment means that
fewer goods are produced, that the nation is poorer, and that there is less
for everybody.
The apostles of salvation by unionism sometimes attempt another answer to
the problem I have just presented. It may be true, they will admit, that
the members of strong unions today exploit, among others, the non-unionized
workers; but the remedy is simple: unionize everybody. The remedy, however,
is not quite that simple. In the first place, in spite of the enormous,
political encouragements (one might in some cases say compulsions) to
unionization under the Wagner Act and other laws, it is not an accident
that only about a fourth of this nation's gainfully employed workers are
unionized. 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 suppose this were not so? Suppose, in spite of the
self-contradictoriness of the assumption, that all workers by coercive
methods could raise their wages by an equal percentage? Nobody would be
any better off, in the long run, than if wages had not been raised at all.
3
This leads us to the heart of the question. It is usually assumed that
an increase in wages is gained at the expense of the profits of employers.
This may of course happen for short periods or in 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. It is true that as a result of the increased prices,
sales of that industry's products may fall off, so that volume of profits
in the industry will be reduced; but employment and total payrolls in the
industry are likely to be reduced by a corresponding amount.
It is possible, no doubt, to conceive of a case in which the profits in a
whole industry are reduced without any corresponding reduction in employment
-- a case, in other words, in which an increase in wage rates means a
corresponding increase in payrolls, and in which the whole cost comes
out of the industry's profits without throwing any firm out of business.
Such a result is not likely, but it is conceivable.
Suppose we take an industry like that of the railroads, for example, which
cannot always pass increased wages along to the public in the form of higher
rates, because government regulation will not permit it. (Actually the
great rise of railway wage rates has been accompanied by the most drastic
consequences to railway employment. The number of workers on the Class I
American railroads reached its peak in 1920 at 1,685,000, with their average
wages at 66 cents an hour; it had fallen to 959,000 in 1931, with their
average wages at 67 cents an hour; and it had fallen further to 699,000
in 1938 with average wages at 74 cents an hour. But we can for the sake
of argument overlook actualities for the moment and talk as if we were
discussing a hypothetical case.)
It is at least possible for unions to make their gains in the short run at
the expense of employers and investors. The investors once had liquid funds.
But they have put them, say, into the railroad business. They have turned
them into rails and roadbeds, freight cars, and locomotives. Once their
capital might have been turned into any of a thousand forms, but today it
is trapped, so to speak, in one particular form. The railway unions
may force them to accept smaller returns on this capital already invested.
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.
Thus the exploitation of capital by labor can at best be merely temporary.
It will quickly come to an end. It will come to an end, actually, not
so much in the way indicated in our hypothetical illustration, as by
the forcing of marginal firms out of business entirely, the growth of
unemployment, and the forced readjustment of wages and profits to the point
where the prospect of normal (or abnormal) profits leads to a resumption
of employment and production. But in the meanwhile, as 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:
they may mean that labor, too, is getting a lower total amount in terms
of real purchasing power.
Thus we are driven to the conclusion that unions, though they may for a time
be able to secure an increase in money wages for their members, partly at
the expense of employers and more at the expense of nonunionized workers,
do not, in the long run and for the whole body of workers, increase
real wages at all.
4
The belief that they do so rests on a series of delusions. One of these is
the fallacy of post hoc ergo propter hoc, which sees the enormous
rise in wages in the last half century, due principally to the growth of
capital investment and to scientific and technological advance, and ascribes
it to the unions because the unions were also growing during this period.
But the error most responsible for the delusion is that of considering
merely what a rise of wages brought about by union demands means in the
short run for the particular workers who retain their jobs, while failing
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 than this conclusion, 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.
With regard to productivity there is something to be said for union
policies, it is true, on the credit side. In some trades they have insisted
on standards to increase the level of skill and competence. And in their
early history they did much 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. And
sometimes 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.
But in recent years, as their power has grown, and as much misdirected
public sympathy has led to a tolerance or endorsement of anti-social
practices, unions have gone beyond their legitimate goals. It was a gain,
not only to health and welfare, but even in the long run to production,
to reduce a seventy-hour week to a sixty-hour week. It was a gain to health
and leisure to reduce a sixty-hour week to a forty-eight-hour week. It was
a gain to leisure, but not necessarily to production and income, to reduce
a forty-eight-hour week to a forty-four-hour week. The value to health
and leisure of reducing the working week to forty hours is much less,
the reduction in output and income more clear. But the unions now talk,
and often enforce, thirty-five- and thirty-hour weeks, and deny that these
can or should reduce output or income.
But it is not only in reducing scheduled working hours that union policy
has worked against productivity. That, in fact, 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. 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 actually no limit
to the amount of work to be done. Work creates work. What A produces
constitutes the demand for what B produces.
But because this false assumption exists, and because the policies of unions
are based on it, their net effect has been to reduce productivity below what
it would otherwise have been. Their net effect, therefore, in the long run
and for all groups of workers, has been to reduce real wages -- that
is, wages in terms of the goods they will buy -- below the level to which
they would otherwise have risen. 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.
1
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.
The concept of functional wages has been taken over, in a perverted form,
by the Marxists and their unconscious disciples, the purchasing-power school.
Both of these groups leave to cruder minds the question whether existing
wages are "fair". The real question, they insist, is whether or not they
will work. And the only wages that will work, they tell us, the
only wages that will prevent an imminent economic crash, are wages that
will enable labor "to buy back the product it creates". The Marxist
and purchasing-power schools attribute every depression of the past to
a preceding failure to pay such wages. And at no matter what moment they
speak, they are sure that wages are still not high enough to buy back the
product.
The doctrine has proved particularly effective in the hands of union leaders.
Despairing of their ability to arouse the altruistic interest of the public
or to persuade employers (wicked by definition) ever to be "fair", they have
seized upon an argument calculated to 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.
Some sponsors of the theory seem to imply that the workers in each
industry should receive enough to buy back the particular product they make.
But they surely cannot mean that the makers of cheap dresses should have
enough to buy back cheap dresses and the makers of mink coats enough to buy
back mink coats; or that the men in the Ford plant should receive enough to
buy Fords and the men in the Cadillac plant enough to buy Cadillacs.
It is instructive to recall, however, that the unions in the automobile
industry, at a time when most of their members were already in the upper
third of the country's income receivers, and when their weekly wage,
according to government figures, was already 20 percent higher than the
average wage paid in factories and nearly twice as great as the average
paid in retail trade, 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."
What, then, of the average factory worker and the average retail worker?
If, under such circumstances, the automobile workers needed a 30 percent
increase to keep the economy from collapsing, would a mere 30 percent have
been enough for the others? Or would they have required increases of 55
to 160 percent to give them as much per capita purchasing power as the
automobile workers? (We may be sure, if the history of wage bargaining even
within individual unions is any guide, that the automobile workers,
if this last proposal had been made, would have insisted on the maintenance
of their existing differentials; for the passion for economic equality,
among union members as among the rest of us, is, with the exception of a
few rare philanthropists and saints, a passion for getting as much as those
above us in the economic scale already get rather than a passion for giving
those below us as much as we ourselves already get. But it is with the
logic and soundness of a particular economic theory, rather than with these
distressing weaknesses of human nature, that we are at present concerned.)
2
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. But it is just as true that everyone's income
-- the grocer's, the landlord's, the employer's -- is his purchasing
power for buying what others have to sell. And one of the most important
things for which others have to find purchasers is their labor services.
All this, moreover, has its reverse side. In an exchange economy
everybody's income is somebody else's cost. Every increase in
hourly wages, unless or until compensated by an equal increase in hourly
productivity, is an increase in costs of production. An increase in costs
of production, where the government controls prices and forbids any price
increase, takes the profit from marginal producers, forces them out of
business, means 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.
No doubt many will be inclined to dispute the contention that a 30 percent
increase in wages can force as great a percentage increase in prices. It is
true that this result can follow only in the long run and only if monetary
and credit policy permit it. If money and credit are so inelastic that they
do not increase when wages are forced up (and if we assume that the higher
wages are not justified by existing labor productivity in dollar terms),
then the chief effect of forcing up wage rates will be to force unemployment.
And it is probable, in that case, that total payrolls, both in dollar amount
and in real purchasing power, will be lower than before. For a drop in
employment (brought about by union policy and not as a transitional result
of technological advance) 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. For Paul H. Douglas in America and A.C. Pigou in
England, the first from analyzing a great mass of statistics, the second by
almost purely deductive methods, arrived independently at the conclusion
that the elasticity of the demand for labor is somewhere between -3 and -4.
This means, in less technical language, that "a 1 percent reduction in the
real rate of wage is likely to expand the aggregate demand for labor by not
less than 3 percent." Or, to put the matter the other way, "If wages are
pushed up above the point of marginal productivity, the decrease in
employment would normally be from three to four times as great as the
increase in hourly rates" so that the total income of the workers would
be reduced correspondingly.
Even if these figures are taken to represent only the elasticity of the
demand for labor revealed in a given period of the past, and not necessarily
to forecast that of the future, they deserve the most serious consideration.
3
But now let us suppose that the increase in wage rates is accompanied or
followed by a sufficient increase in money and credit to allow it to take
place without creating serious unemployment. If we assume that the previous
relationship between wages and prices was itself a "normal" long-run
relationship, then it is altogether probable that a forced increase of,
say, 30 percent in wage rates will ultimately lead to an increase in
prices of approximately the same percentage.
The belief that the price increase would be substantially less than that
rests on two main fallacies. The first is that of looking only at the
direct labor costs of a particular firm or industry and assuming 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. But this would
be to overlook 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, of course, 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
(depending upon our definition of "labor"). 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. But this 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.
It does not necessarily follow that wage earners would make no relative
gains. They would make a relative gain and other elements in the population
would suffer a relative loss, during the period of transition.
But it is improbable that this relative gain would mean an absolute gain.
For the kind of change in the relationship of costs to prices contemplated
here could hardly take place without bringing about unemployment and
unbalanced, interrupted, or reduced production. So that while labor might
get a broader slice of a smaller pie, during this period of transition and
adjustment to a new equilibrium, it may be doubted whether this would be
greater in absolute size (and it might easily be less) than the previous
narrower slice of a larger pie.
4
This brings us to the general meaning and effect of economic
equilibrium. Equilibrium wages and prices are the wages and prices
that equalize supply and demand. If, either through government or private
coercion, an attempt is made to lift prices above their equilibrium level,
demand is reduced and therefore production is reduced. If an attempt is
made to push prices below their equilibrium level, the consequent reduction
or wiping out of profits will mean a falling off of supply or 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.
To return, then, to the doctrine that labor must get "enough to buy back the
product". The national product, it should be obvious, is neither created
nor 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.
If we try to run the economy for the benefit of a single group or class,
we shall injure or destroy all groups, including the members of the very
class for whose benefit we have been trying to run it. We must run the
economy for everybody.
The indignation shown by many people today at the mention of the very word
"profits" indicates how little understanding there is of the vital function
that profits play in our economy. To increase our understanding, we shall
go over again some of the ground already covered in chapter 14 on the price
system, but we shall view the subject 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. It is significant that while there is a word "profiteer" to
stigmatize those who make allegedly excessive profits, there is no such
word as "wageer" -- or "losseer". Yet the profits of the owner of a barber
shop may average much less not merely than the salary of a motion picture
star or the hired head of a steel corporation, but less even than the
average wage for skilled labor.
The subject is clouded by all sorts of factual misconceptions. The total
profits of General Motors, the greatest industrial corporation in the world,
are taken as if they were typical rather than exceptional. Few people are
acquainted with the mortality rates for business concerns. They do not
know (to quote from the TNEC studies) that "should conditions of business
averaging the experience of the last fifty years prevail, about seven of
each ten grocery stores opening today will survive into their second year;
only four of the ten may expect to celebrate their fourth birthday."
They do not know that in every year from 1930 to 1938, in the income tax
statistics, the number of corporations that showed a loss exceeded the
number that showed a profit.
How much do profits, on the average, amount to? No trustworthy estimate
has been made that takes into account all kinds of activity, unincorporated
as well as incorporated business, and a sufficient number of good and bad
years. But some eminent economists believe that over a long period of
years, after allowance is made for all losses, for a minimum "riskless"
interest on invested capital, and for an imputed "reasonable" wage value
of the services of people who run their own business, no net profit at all
may be left over, and that there may even be a net loss. This is not at
all because entrepreneurs (people who go into business for themselves) are
intentional philanthropists, but because their optimism and self-confidence
too often lead them into ventures that do not or cannot succeed.
It is clear, in any case, that any individual placing venture capital runs
a risk not only of earning no return but of losing his whole principal.
In the past it has been the lure of high profits in special firms or
industries that has led him to take that great risk. But if profits are
limited to a maximum of, say, 10 percent or some similar figure, while the
risk of losing one's entire capital still exists, what is likely to be the
effect on the profit incentive, and hence on employment and production?
The wartime excess-profits tax has already shown us what such a limit
can do, even for a short period, in undermining efficiency.
Yet governmental policy almost everywhere today tends to assume that
production will go on automatically, no matter what is done to discourage
it. One of the greatest dangers to production today comes from government
price-fixing policies. 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
act so that some branches of production would make what government
officials would undoubtedly regard as "excessive" or "unreasonable" profits.
But that very fact would not only cause every firm in that line to expand
its production to the utmost, and to 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.
In a free economy, in which wages, costs, and prices are left to the free
play 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:
the value of the resources that must be used up in making the article is
greater than the value of the article itself.
One function of profits, in brief, is to guide and channel the factors of
production so as to apportion the relative output of thousands of different
commodities in accordance with demand. No bureaucrat, no matter how
brilliant, can solve this problem arbitrarily. Free prices and free
profits will maximize production and relieve shortages quicker than any
other system. Arbitrarily-fixed prices and arbitrarily-limited profits
can only prolong shortages and reduce production and employment.
The function of profits, finally, is to put constant and unremitting pressure
on the head of every competitive business to introduce further economies and
efficiencies, no matter to what stage these may already have been brought.
In good times he does this to increase his profits further; in normal times
he does it to keep ahead of his competitors; in bad times he may have to do
it to survive at all. 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, in short, resulting from the relationships of costs to prices,
not only tell us which goods it is most economical to make, but which are
the most economical ways to make them. These questions must be answered by
a socialist system no less than by a capitalist one; they must be answered
by any conceivable economic system; and for the overwhelming bulk of the
commodities and services that are produced, the answers supplied by profit
and loss under competitive free enterprise are incomparably superior to
those that could be obtained by any other method.
1
I have found it necessary to warn the reader from time to time that a
certain result would necessarily follow from a certain policy "provided
there is no inflation". In the chapters on public works and on credit
I said that a study of the complications introduced by inflation would
have to be deferred. But money and monetary policy form so intimate
and sometimes so inextricable a part of every economic process that this
separation, even for expository purposes, was very difficult; and in the
chapters on the effect of various government or union wage policies on
employment, profits, and production, some of the effects of differing
monetary policies had to be considered immediately.
Before we consider what the consequences of inflation are in specific cases,
we should consider what its consequences are in general. Even prior to that,
it seems desirable to ask why inflation has been constantly resorted to,
why it has had an immemorial popular appeal, and why its siren music has
tempted one nation after another down the path to economic disaster.
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
nearly 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, in short, are,
in common language, considered as in every respect synonymous.
Real wealth, of course, consists in what is produced and consumed: the food
we eat, the clothes we wear, the houses we live in. It is railways and
roads and motor cars; ships and planes and factories; schools and 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.
These are the most naive inflationists. There is a second group, less naive,
who see that if the whole thing were as easy as that the government could
solve all our problems merely by printing money. They sense that there
must be a catch somewhere; so 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".
Purchasing power is chronically deficient, they think, because industry
somehow does not distribute enough money to producers to enable them to buy
back, as consumers, the product that is made. There is a mysterious "leak"
somewhere. One group "proves" it 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.
2
The more knowing inflationists recognize that any substantial increase in
the quantity of money will reduce the purchasing power of each individual
monetary unit -- in other words, that it will lead to an increase in
commodity prices. But this does not disturb them. On the contrary, it is
precisely why they want the inflation. Some of them argue that this result
will improve the position of poor debtors as compared with rich creditors.
Others think it will stimulate exports and discourage imports. Still others
think it is an essential measure to cure a depression, to "start industry
going again", and to achieve "full employment".
There are innumerable theories concerning the way in which increased
quantities of money (including bank credit) affect prices. On the one hand,
as we have just seen, are those who 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. Either
they never stop to remind themselves that people collectively cannot buy
twice as much goods as before unless twice as much goods are produced, or
they imagine that the only thing that holds down an indefinite increase
in production is not a shortage of manpower, working hours or productive
capacity, but merely a shortage of monetary demand: if people want the
goods, they assume, and have the money to pay for them, the goods will
almost automatically be produced.
On the other hand is the group -- and it has included some eminent economists
-- that holds a rigid mechanical theory of the effect of the supply of money
on commodity prices. All the money in a nation, as these theorists picture
the matter, will be offered against all the goods. Therefore 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.
Therefore, further (assuming no change in "velocity of circulation"), the
value of the monetary unit must vary exactly and inversely with the amount
put into circulation. Double the quantity of money and bank credit and you
exactly double the "price level"; triple it and you exactly triple the price
level. 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.
An increased quantity of money comes into existence in a specific way.
Let us say that it comes into existence because the government makes larger
expenditures than it can or wishes to meet out of the proceeds of taxes
(or from the sale of bonds paid for by the people out of real savings).
Suppose, for example, that the government prints money to pay war
contractors. Then the first effect of these expenditures will be to raise
the prices of supplies used in war and to put additional money into the
hands of the war contractors and their employees. (As, in our chapter on
price-fixing, we deferred for the sake of simplicity some complications
introduced by an inflation, so, in now considering inflation, we may pass
over the complications introduced by an attempt at government price-fixing.
When these are considered it will be found that they do not change the
essential analysis. They lead merely to a sort of backed-up inflation
that reduces or conceals some of the earlier consequences at the expense
of aggravating the later ones.)
The war contractors and their employees, then, will have higher money
incomes. They will spend them for the particular 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.
Let us call the war contractors and their employees group A, and those from
whom they directly buy their added goods and services group B. Group B,
as a result of higher sales and prices, will now in turn buy more goods and
services from a still further group, C. Group C in turn will be able to
raise its prices and will have more income to spend on group D, and so on,
until the rise in prices and money incomes has covered virtually the whole
nation. 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, however, that everyone's relative or absolute wealth
and income will remain the same as before. On the contrary, the process
of inflation is certain to affect the fortunes of one group differently
from those of another. The first groups to receive the additional money
will benefit most. The money incomes of group A, for example, 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. Meanwhile, however,
the groups that have still had no advance whatever in their money
incomes will find themselves compelled to pay higher prices for the
things they buy, which means that they will be obliged to get along
on a lower standard of living than before.
We may clarify the process further by a hypothetical set of figures.
Suppose 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. Then when money incomes of group A have already increased
30 percent, the prices of the things they purchase 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. And when money incomes of group D have not yet
increased at all, 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, say, 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. But this will not cancel out the
gains and losses of the transition period. Group D, for example, 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 had not risen at all, though it had to pay 30 percent more for
the goods and services it bought from the other producing groups in the
community, A, B, and C.
3
So inflation turns out to be merely one more example of our central lesson.
It may indeed bring benefits for a short time to favored groups, but only
at the expense of others. And in the long run it brings disastrous
consequences to the whole community. Even a relatively mild inflation
distorts the structure of production. It leads to the overexpansion of
some industries at the expense of others. This involves 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, and so
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 impossible, moreover, to control the value of money under inflation.
For, as we have seen, the causation is never a merely mechanical one.
You cannot, for example, 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, as we have seen, depends upon the subjective
valuations of the people who hold it. And those valuations do not depend
solely on the quantity of it that each person holds. They depend also
on the quality of the money. In wartime the value of a nation's
monetary unit, not on the gold standard, will rise on the foreign exchanges
with victory and fall with defeat, regardless of changes in its quantity.
The present valuation will often depend upon what people expect the
future quantity of money to be. And, as with commodities on
the speculative exchanges, each person's valuation of money is
affected not only by what he thinks its value is but by what he
thinks is going to be everybody else's valuation of money.
4
All this explains why, when superinflation 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 our own day the most persistent argument put forward for inflation is
that it will "get the wheels of industry turning" that it will save us
from the irretrievable losses of stagnation and idleness and bring "full
employment". This argument in its cruder form rests on the immemorial
confusion between money and real wealth. It assumes that new "purchasing
power" is being brought into existence, and that the effects of this new
purchasing power multiply themselves in ever-widening circles, like the
ripples caused by a stone thrown into a pond. The real purchasing power
for goods, however, as we have seen, consists of other goods. It cannot
be wondrously increased merely by printing more pieces of paper called
dollars. 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. The most important change it is designed to bring about is to
raise commodity prices in relation to wage rates, and so to restore
business profits, and encourage a resumption of output at the points
where idle resources exist, by restoring a workable relationship
between prices and costs of production.
It should be immediately clear that this could be brought about more
directly and honestly by a reduction in wage rates. But the more
sophisticated proponents of inflation believe that this is now politically
impossible. Sometimes they go further, and charge that all proposals
under any circumstances to reduce particular wage rates directly in order
to reduce unemployment are "anti-labor". But what they are themselves
proposing, stated in bald terms, is to deceive labor by reducing
real wage rates (that is, wage rates in terms of purchasing power)
through an increase in prices.
What they forget is that labor itself has become sophisticated; that the
big unions employ labor economists who know about index numbers, and that
labor is not deceived. The policy, therefore, under present conditions,
seems unlikely to accomplish either its economic or its political aims.
For it is precisely the most powerful unions, whose wage rates are most
likely to be in need of correction, that will insist that their wage rates
be raised at least in proportion to any increase in the cost-of-living
index. The unworkable relationships between prices and key wage rates, if
the insistence of the powerful unions prevails, will remain. The wage-rate
structure, in fact, may become even more distorted; for the great mass of
unorganized workers, whose wage rates even before the inflation were not out
of line (and may even have been unduly depressed through union exclusionism),
will be penalized further during the transition by the rise in prices.
5
The more sophisticated advocates of inflation, in brief, are disingenuous.
They do not state their case with complete candor; and they end by deceiving
even themselves. They begin to talk of paper money, like the more naive
inflationists, as if it were itself a form of wealth that could be created
at will on 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.
In brief, they divert both the public attention and their own from the real
causes of any existing depression. For the real causes, most of the time,
are maladjustments within the wage-cost-price structure: maladjustments
between wages and prices, between prices of raw materials and prices of
finished goods, or between one price and another, or one wage and another.
At some point these maladjustments have removed the incentive to produce,
or have made it actually impossible for production to continue; and through
the organic interdependence of our exchange economy, depression spreads.
Not until these maladjustments are corrected can full production and
employment be resumed.
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. It is like getting people up an hour earlier only by making them
believe that it is eight o'clock when it is really seven. It is perhaps
no mere coincidence that a world which has to resort to the deception of
turning all its clocks ahead an hour in order to accomplish this result
should be a world that has to resort to inflation to accomplish an
analogous result in the economic sphere.
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. It is not easy to see
relationships always in terms of real goods and real welfare. Who among
us does not feel richer and prouder when he is told that our national
income has doubled (in terms of dollars, of course) compared with some
pre-inflationary period? Even the clerk who used to get $25 a week and now
gets $35 thinks that he must be in some way better off, though it costs him
twice as much to live as it did when he was getting $25. He is of course
not blind to the rise in the cost of living. But neither is he as fully
aware of his real position as he would have been if his cost of living had
not changed and if his money salary had been reduced to give him
the same reduced purchasing power that he now has, in spite of his salary
increase, because of higher prices. Inflation is the auto-suggestion,
the hypnotism, the anesthetic, that has dulled the pain of the operation
for him. Inflation is the opium of the people.
6
And this is precisely its political function. It is because inflation
confuses everything that it is so consistently resorted to by our modern
"planned economy" governments. 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.
But suppose the public works are 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. For the moment
the nation seems to have got something for nothing.
But now, in accordance with our lesson, let us look at the longer
consequences. The borrowing must someday be repaid. The government
cannot keep piling up debt indefinitely; for if it tries, it will
someday become bankrupt. 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.
Yet when the government comes to repay the debt it has accumulated
for public works, it must necessarily tax more heavily than it spends.
In this later period, therefore, it must necessarily destroy more jobs
than it creates. The extra heavy taxation then required does not merely
take away purchasing power; it also lowers or destroys incentives to
production, and so reduces the total wealth and income of the country.
The only escape from this conclusion is to assume (as of course the apostles
of spending always do) 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.
If no honest attempt is made to pay off the accumulated debt, and outright
inflation is resorted to instead, then the results follow that we have
already described. For the country as a whole cannot get anything without
paying for it. Inflation itself is a form of taxation. It is perhaps the
worst possible form, which usually bears hardest on those least able to pay.
On the assumption that inflation affected everyone and everything evenly
(which, we have seen, is never true), it would be tantamount to a flat
sales tax of the same percentage on all commodities, with the rate as high
on bread and milk as on diamonds and furs. Or it might be thought of as
equivalent to a flat tax of the same percentage, without exemptions,
on everyone's income. It is a tax not only on every individual's
expenditures, but on his savings account and life insurance.
It is, in fact, a flat capital levy, without exemptions, in
which the poor man pays as high a percentage as the rich man.
But the situation is even worse than this, because, as we have seen,
inflation does not and cannot affect everyone evenly. 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.
Like every other tax, inflation acts to determine the individual and business
policies we are all forced to follow. It discourages all prudence and
thrift. It encourages squandering, gambling, reckless waste of all kinds.
It often makes it more profitable to speculate than to produce. 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.
1
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 showed that the rational
saver, in making provision for his own future, was not hurting, but helping,
the whole community. But today the ancient virtue of thrift, as well as
its defense by the classical economists, is once more under attack, for
allegedly new reasons, while the opposite doctrine of spending is in fashion.
In order to make the fundamental issue as clear as possible, we cannot do
better, I think, than to start with the classic example used by Bastiat.
Let us imagine two brothers, then, one a spendthrift and the other a prudent
man, each of whom has inherited a sum to yield him an income of $50,000 a
year. We shall disregard the income tax, and the question whether both
brothers really ought to work for a living, because such questions are
irrelevant to our present purpose.
Alvin, then, the first brother, is a lavish spender. He spends not only by
temperament, but on principle. He is a disciple (to go no further back)
of Rodbertus, who declared in the middle of the nineteenth 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 is always seen at the nightclubs;
he tips handsomely; he maintains a pretentious establishment, with plenty
of servants; he has a couple of chauffeurs, and doesn't stint himself in
the number of cars he owns; he keeps a racing stable; he runs a yacht;
he travels; he loads his wife down with diamond bracelets and fur coats;
he gives expensive and useless presents to his friends.
To do all this he has to dig into his capital. But what of it? If saving
is a sin, dissaving must be a virtue; and in any case he is simply making up
for the harm being done by the saving of his pinchpenny brother Benjamin.
It need hardly be said that Alvin is a great favorite with the hat check
girls, the waiters, the restaurateurs, the furriers, the jewelers, the
luxury establishments of all kinds. They regard him as a public benefactor.
Certainly it is obvious to everyone that he is giving employment and
spreading his money around.
Compared with him brother Benjamin is much less popular. He is seldom seen
at the jewelers, the furriers, or the nightclubs, and he does not call the
headwaiters by their first names. Whereas Alvin spends not only the full
$50,000 income each year but is digging into capital besides, Benjamin lives
much more modestly and spends only about $25,000. Obviously, think the
people who see only what hits them in the eye, 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 let us see what Benjamin actually does with this other $25,000. On the
average he gives $5,000 of it to charitable causes, including help to friends
in need. The families who are helped by these funds in turn spend them on
groceries or clothing or living quarters. So the funds create as much
employment as if Benjamin had spent them directly on himself. The difference
is that more people are made happy as consumers, and that production is
going more into essential goods and less into luxuries and superfluities.
This last point is one that often gives Benjamin concern. His conscience
sometimes troubles him even about the $25,000 he spends. The kind of vulgar
display and reckless spending that Alvin indulges in, he thinks, not only
helps to breed dissatisfaction and envy in those who find it hard to make
a decent living, but actually increases their difficulties. At any given
moment, as Benjamin sees it, the actual producing power of the nation is
limited. The more of it that is diverted to producing frivolities and
luxuries, the less there is left for producing the essentials of life for
those who are in need of them. The less he withdraws from the existing
stock of wealth for his own use, the more he leaves for others. Prudence
in consumptive spending, he feels, mitigates the problems raised by the
inequalities of wealth and income. He realizes that this consumptive
restraint can be carried too far; but there ought to be some of it,
he feels, in everyone whose income is substantially above the average.
Now let us see, apart from Benjamin's ideas, what happens to the $20,000
that he neither spends nor gives away. He does not let it pile up in his
pocketbook, his bureau drawers, or in his safe. He either deposits it in
a bank or he invests it. If he puts it either into a commercial or a
savings bank, the bank either lends it to going businesses on short term
for working capital, or uses it to buy securities. In other words, Benjamin
invests his money either directly or indirectly. But when money is invested
it is used to buy capital goods -- houses or office buildings or factories
or ships or motor 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, Benjamin's "saving" and spending combined give
as much as Alvin's spending alone, and put as much money in circulation.
The chief difference is that the employment provided by Alvin's spending
can be seen by anyone with one eye; but it is necessary to look a little
more carefully, and to think a moment, to recognize that every dollar of
Benjamin's saving gives as much employment as every dollar that Alvin
throws around.
A dozen years roll by. Alvin is broke. He is no longer seen in the
nightclubs and at the fashionable shops; and those whom he formerly
patronized, when they speak of him, refer to him as something of a fool.
He writes begging letters to Benjamin. And Benjamin, who continues 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
also. Moreover, because of his investments, the national wealth and income
are greater; there are more factories and more production.
2
So many fallacies have grown up about saving in recent years that
they cannot all be answered by our example of the two brothers.
It is necessary to devote some further space to them. Many stem from
confusions so elementary as to seem incredible, particularly when found
in economic writers of wide repute. The word "saving", for example,
is used sometimes to mean mere hoarding of money, and sometimes
to mean investment, with no clear distinction, consistently
maintained, between the two uses.
Mere hoarding of hand-to-hand money, if it takes place irrationally,
causelessly, and on a large scale, is in most economic situations harmful.
But this sort of hoarding is extremely rare. Something that looks like this,
but should be carefully distinguished from it, often occurs after a
downturn in business has got under way. Consumptive spending and investment
are then both contracted. Consumers reduce their buying. They do
this partly, indeed, because they fear they may lose their jobs, and they
wish to conserve their resources: they have contracted their buying not
because they wish to consume less but because they wish to make sure that
their power to consume will be extended over a longer period if they do
lose their jobs.
But consumers reduce their buying for another reason. Prices of goods have
probably fallen, and they fear a further fall. If they defer spending, they
believe they will get more for their money. They do not wish to have their
resources in goods that are falling in value, but in money which they expect
(relatively) to rise in value.
The same expectation prevents them from investing. They have lost their
confidence in the profitability of business; or at least they believe that
if they wait a few months they can buy stocks or bonds cheaper. We may
think of them either as refusing to hold goods that may fall in value
on their hands, or as holding money itself for a rise.
It is a misnomer to call this temporary refusal to buy "saving". It does
not spring from the same motives as normal saving. And it is a still more
serious error to say that this sort of "saving" is the cause of
depressions. It is, on the contrary, the consequence of depressions.
It is true that this refusal to buy may intensify and prolong a depression
once begun. But it does not itself originate the depression. At times when
there is capricious government intervention in business, and when business
does not know what the government is going to do next, uncertainty is
created. Profits are not reinvested. Firms and individuals allow cash
balances to accumulate in their banks. They keep larger reserves against
contingencies. This hoarding of cash may seem like the cause of a subsequent
slowdown in business activity. The real cause, however, is the uncertainty
brought about by the government policies. The larger cash balances of firms
and individuals are merely one link in the chain of consequences from that
uncertainty. 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. But once people have decided to
deride a practice or an institution, any argument against it, no matter how
illogical, is considered good enough. It is said that the various consumers'
goods industries are built on the expectation of a certain demand, and that
if people take to saving they will disappoint this expectation and start
a depression. This assertion rests primarily on the error we have already
examined -- that of forgetting that what is saved on consumers' goods is
spent on capital goods, and that "saving" does not necessarily mean even
a dollar's contraction in total spending. The only element of truth
in the contention is that any change that is sudden may be
unsettling. It would be just as unsettling if consumers suddenly switched
their demand from one consumers' good to another. It would be even more
unsettling if former savers suddenly switched their demand from capital
goods to consumers' goods.
Still another objection is made against saving. It is said to be just
downright silly. The nineteenth century is derided for its supposed
inculcation of the doctrine that mankind through saving should go on
making itself a larger and larger cake without ever eating the cake.
This picture of the process is itself naive and childish. It can best
be disposed of, perhaps, by putting before ourselves a somewhat more
realistic picture of what actually takes place.
Let us picture to ourselves, then, a nation that collectively saves every
year about 20 percent of all it produces in that year. This figure greatly
overstates the amount of net saving that has occurred historically in the
United States, but it is a round figure that is easily handled, and it
gives the benefit of every doubt to those who believe that we have been
"over-saving".
Now as a result of this annual saving and investment, the total annual
production of the country will increase each year. (To isolate the problem
we are ignoring for the moment booms, slumps, or other fluctuations.)
Let us say that this annual increase in production is 2 1/2 percentage
points. (Percentage points are taken instead of a compounded percentage
merely to simplify the arithmetic.) The picture that we get for an
eleven-year period, say, would then run something like this in terms
of index numbers:
The first thing to be noticed about this table is that total production
increases each year because of the saving, and would not have
increased without it. (It is possible no doubt to imagine that improvements
and new inventions merely in replaced machinery and other capital
goods of a value no greater than the old would increase the national
productivity; but this increase would amount to very little, and the
argument in any case assumes enough prior investment to have made the
existing machinery possible.) The saving has been used year after year to
increase the quantity or improve the quality of existing machinery, and so
to increase the nation's output of goods. There is, it is true (if that for
some strange reason is considered an objection), a larger and larger "cake"
each year. Each year, it is true, not all of the currently produced
"cake" is consumed. But there is no irrational or cumulative consumer
restraint. For each year a larger and larger cake is in fact consumed;
until, at the end of eleven years (in our illustration), the annual
consumers' cake alone is equal to the combined consumers' and producers'
cakes of the first year. Moreover, the capital equipment, the ability
to produce goods, is itself 25 percent greater than in the first year.
Let us observe a few other points. The fact that 20 percent of the national
income goes each year for saving does not upset the consumers' goods
industries in the least. If they sold only the 80 units they produced in
the first year (and there were no rise in prices caused by unsatisfied
demand) they would certainly not be foolish enough to build their production
plans on the assumption that they were going to sell 100 units in the second
year. The consumers' goods industries, in other words, are already
geared to the assumption that the past situation in regard to the rate
of savings will continue. Only an unexpected sudden and substantial
increase in savings would unsettle them and leave them with unsold goods.
But the same unsettlement, as we have already observed, would be caused
in the capital goods industries by a sudden and substantial
decrease in savings. If money that would previously have been
used for savings were thrown into the purchase of consumers' goods, it
would not increase employment but merely lead to an increase in the price
of consumption goods and to a decrease in the price of capital goods.
Its first effect on net balance would be to force shifts in employment
and temporarily to decrease employment by its effect on the
capital goods industries. And its long-run effect would be to reduce
production below the level that would otherwise have been achieved.
3
The enemies of saving are not through. They begin by drawing a distinction,
which is proper enough, between "savings" and "investment". But then they
start to talk as if the two were independent variables and as if it were
merely an accident that they should ever equal each other. These writers
paint a portentous picture. On the one side are savers automatically,
pointlessly, stupidly continuing to save; on the other side are limited
"investment opportunities" that cannot absorb this saving. The result, alas,
is stagnation. The only solution, they declare, is for the government to
expropriate these stupid and harmful savings and to invent its own projects,
even if these are only useless ditches or pyramids, 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.
If money is kept either in savings banks or commercial banks, as
we have already seen, the banks are eager to lend and invest it. They
cannot afford to have idle funds. The only thing that will cause people
generally to increase their holdings of cash, or that will cause banks to
hold funds idle and lose the interest on them, is, as we have seen, either
fear that prices of goods are going to fall or the fear of banks that they
will be taking too great a risk with their principal. But this means that
signs of a depression have already appeared, and have caused the hoarding,
rather than that the hoarding has started the depression.
Apart from this negligible hoarding of cash, then (and even this exception
might be thought of as a direct "investment" in money itself) "savings" and
"investment" are brought into equilibrium with each other in the same way
that the supply of and demand for any commodity are brought into equilibrium.
For we may define "savings" and "investment" as constituting respectively
the supply of and demand for new capital. And just as the supply of and
demand for any other commodity are equalized by price, so the supply of and
demand for capital are equalized by interest rates. The interest rate is
merely the special name for the price of loaned capital. It is a price
like any other.
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 is a psychopathic fear of "excessive" interest rates. It is argued
that if interest rates are too high it will not be profitable for industry
to borrow and invest in new plants and machines. This argument has been
so effective that governments everywhere in recent decades have pursued
artificial "cheap money" policies. But the argument, in its concern with
increasing the demand for capital, overlooks the effect of these policies
on the supply of capital. It is one more example of the fallacy of looking
at the effects of a policy only on one group and forgetting the effects on
another.
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 the interest rate, because
the sated rich have nothing else that they can do with their money. They
do not stop to tell us at precisely what personal income level a man saves
a fixed minimum amount regardless of the rate of interest or the risk at
which he can lend it. The fact is that, though the volume of saving of the
very rich is doubtless affected much less proportionately than that of the
moderately well-off by changes in the interest rate, practically everyone's
saving is affected in some degree. To argue, on the basis of an extreme
example, that the volume of real savings would not be reduced by a
substantial reduction in the interest rate, is like arguing that the
total production of sugar would not be reduced by a substantial fall
of its price because the efficient, low-cost producers would still
raise as much as before. The argument overlooks the marginal saver,
and even, indeed, the great majority of savers.
The effect of keeping interest rates artificially low, in fact, is
eventually the same as that of keeping any other price below the natural
market. It increases demand and reduces supply. It increases the demand for
capital and reduces the supply of real capital. It brings about a scarcity.
It creates economic distortions. It is true, no doubt, that an artificial
reduction in the interest rate encourages increased borrowing. It tends,
in fact, to encourage highly speculative ventures that cannot continue
except under the artificial conditions that gave them birth. On the supply
side, the artificial reduction of interest rates discourages normal thrift
and saving. It brings about a comparative shortage of real capital.
The money rate can, indeed, be kept artificially low only by continuous
new injections of currency or bank credit in 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. But it is a policy of continuous
inflation. It is obviously a process involving cumulative danger.
The money rate will rise and a crisis will develop if the inflation is
reversed, or merely brought to a halt, or even continued at a diminished
rate. Cheap money policies, in short, eventually bring about far more
violent oscillations in business than those they are designed to remedy
or prevent. If no effort is made to tamper with money rates through
inflationary governmental policies, increased savings create their own
demand by lowering interest rates in a natural manner. The greater
supply of savings seeking investment forces savers to accept lower rates.
But lower rates also mean that more enterprises can afford to borrow because
their prospective profit on the new machines or plants they buy with the
proceeds seems likely to exceed what they have to pay for the borrowed funds.
4
We come now to the last fallacy about saving with which I intend to deal.
This is the frequent assumption that there is a fixed limit to the amount
of new capital that can be absorbed, or even that the limit of capital
expansion has already been reached. It is incredible that such a view
could prevail even among the ignorant, let alone that it could be held
by any trained economist. Almost the whole wealth of the modern world,
nearly everything that distinguishes it from the preindustrial world
of the seventeenth century, consists of its accumulated capital.
This capital is made up in part of many things that might better be called
consumers' durable goods -- automobiles, refrigerators, furniture, schools,
colleges, churches, libraries, hospitals, and above all 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 is what we may call capital proper.
It consists of the tools of production, including everything from the
crudest axe, knife, or plow to the finest machine tool, the greatest
electric generator or cyclotron, or the most wonderfully equipped factory.
Here, too, quantitatively and especially qualitatively, there is no limit
to the expansion that is possible and desirable. 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"? How can it be "paid for"?
If it is set aside and saved, it will absorb itself and pay for itself.
For producers invest in new capital goods -- that is, they buy new and
better and more ingenious tools -- because these tools reduce cost of
production. They either bring into existence goods that completely
unaided hand labor could not bring into existence at all (and this now
includes most of the goods around us -- books, typewriters, automobiles,
locomotives, suspension bridges); or they increase enormously the quantities
in which these can be produced; or (and this is merely saying these things
in a different way) they reduce unit costs of production. And as
there is no assignable limit to the extent to which unit costs of production
can be reduced -- until everything can be produced at no cost at all --
there is no assignable limit to the amount of new capital that can be
absorbed. The steady reduction of unit costs of production by the addition
of new capital does either one of two things, or both. It reduces the costs
of goods to consumers, and it increases the wages of the labor that uses
the new machines because it increases the productive power of that labor.
Thus a new machine benefits both the people who work on it directly and the
great body of consumers. In the case of consumers we may say either that
it supplies them with more and better goods for the same money, or, what is
the same thing, that it increases their real incomes. In the case of the
workers who use the new machines it increases their real wages in a double
way by increasing their money wages as well. A typical illustration is
the automobile business. The American automobile industry pays the
highest wages in the world, and among the very highest even in America.
Yet American motor car makers can undersell the rest of the world, because
their unit cost is lower. And the secret is that the capital used in making
American automobiles is greater per worker and per car than anywhere else
in the world.
And yet there are people who think we have reached the end of this process,
and still others who think that even if we haven't, the world is foolish
to go on saving and adding to its stock of capital.
It should not be difficult to decide, after our analysis, with whom the real
folly lies.
1
Economics, as we have now seen again and again, is a science of recognizing
secondary consequences. It is also a science of seeing general
consequences. It is the science of tracing the effects of some proposed or
existing policy not only on some special interest in the short
run, but on the general interest in the long run.
This is the lesson that has been the special concern of this book.
We stated it first in skeleton form, and then put flesh and skin on it
through more than a score of practical applications.
But in the course of specific illustration we have found hints of other
general lessons; and we should do well to state these lessons to ourselves
more clearly.
In seeing that economics is a science of tracing consequences, we must
have become aware that, like logic and mathematics, it is a science of
recognizing inevitable implications.
We may illustrate this by an elementary equation in algebra. Suppose we
say that if x=5 then x+y=12. The "solution" to this equation is that
y equals 7; but this is so precisely because the equation tells us
in effect that y equals 7. It does not make that assertion directly,
but it inevitably implies it.
What is true of this elementary equation is true of the most complicated and
abstruse equations encountered in mathematics. The answer already lies
in the statement of the problem. It must, it is true, be "worked out".
The result, it is true, may sometimes come to the man who works out the
equation as a stunning surprise. He may even have a sense of discovering
something entirely new -- a thrill like that of "some watcher of the skies,
when a new planet swims into his ken." His sense of discovery may be
justified by the theoretical or practical consequences of his answer.
Yet his answer was already contained in the formulation of the problem.
It was merely not recognized at once. For mathematics reminds us that
inevitable implications are not necessarily obvious implications.
All this is equally true of economics. In this respect economics might be
compared also to engineering. When an engineer has a problem, he must first
determine all the facts bearing on that problem. If he designs a bridge to
span two points, he must first know the exact distance between those two
points, their precise topographical nature, the maximum load his bridge
will be designed to carry, the tensile and compressive strength of the
steel or other material of which the bridge is to be built, and the stresses
and strains to which it may be subjected. Much of this factual research has
already been done for him by others. His predecessors, also, have already
evolved elaborate mathematical equations by which, knowing the strength of
his materials and the stresses to which they will be subjected, he can
determine the necessary diameter, shape, number, and structure of his
towers, cables, and girders.
In the same way the economist, assigned a practical problem, must know both
the essential facts of that problem and the valid deductions to be drawn from
those facts. The deductive side of economics is no less important than the
factual. One can say of it what Santayana says of logic (and what could be
equally well said of mathematics), that it "traces the radiation of truth",
so that "when one term of a logical system is known to describe a fact,
the whole system attaching to that term becomes, as it were, incandescent."
Now few people recognize the necessary implications of the economic
statements they are constantly making. When they say that the way to
economic salvation is to increase "credit", it is just as if they said that
the way to economic salvation is to increase debt: these are different names
for the same thing seen from opposite sides. When they say that the way to
prosperity is to increase farm prices, it is like saying that the way to
prosperity is to make food dearer for the city worker. When they say that
the way to national wealth is to pay out governmental subsidies, they are
in effect saying that the way to national wealth is to increase taxes.
When they make it a main objective to increase exports, most of them do
not realize that they necessarily make it a main objective ultimately to
increase imports. When they say, under nearly all conditions, that the
way to recovery is to increase wage rates, they have found only another
way of saying that the way to recovery is to increase costs of production.
It does not necessarily follow, because each of these propositions,
like a coin, has its reverse side, or because the equivalent proposition,
or the other name for the remedy, sounds much less attractive, that the
original proposal is under all conditions unsound. There may be times
when an increase in debt is a minor consideration as against the gains
achieved with the borrowed funds; when a government subsidy is unavoidable
to achieve a certain purpose; when a given industry can afford an increase
in production costs, and so on. But we ought to make sure in each
case that both sides of the coin have been considered, that all the
implications of a proposal have been studied. And this is seldom done.
2
The analysis of our illustrations has taught us another incidental lesson.
This is that, when we study the effects of various proposals, not merely
on special groups in the short run, but on all groups in the long run, the
conclusions we arrive at usually correspond with those of unsophisticated
common sense. 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 to create needless public projects;
that it is dangerous to let idle hordes 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." It is certainly true, however, that 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.
3
In the course of our study, also, we have rediscovered an old friend.
He is the Forgotten Man of William Graham Sumner. The reader will
remember that in Sumner's essay, which appeared in 1883:
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.
It is a historic irony that when this phrase, the Forgotten Man, was revived
in the 1930s, it was applied, not to C, but to X; and C, who was then being
asked to support still more X's, was 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.
4
Our study of our lesson would not be complete if, before we took leave of
it, we neglected to observe that the fundamental fallacy with which we have
been concerned arises not accidentally but systematically. It is an almost
inevitable result, in fact, 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.
This does not necessarily mean that I will restrict my own efforts or my
own output. In fact, if I am only one of a substantial number of people
supplying that commodity or service, and if free competition exists in
my line, this individual restriction will not pay me. On the contrary,
if I am a grower of wheat, say, I want my particular crop to be as large
as possible. But if I am concerned only with my own material welfare,
and 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.
Ordinarily these selfish feelings would have no effect on the total
production of wheat. Wherever competition exists, in fact, each producer
is compelled to put forth his utmost efforts to raise the highest possible
crop on his own land. In this way the forces of self-interest (which,
for good or evil, are more persistently powerful than those of altruism)
are harnessed to maximum output.
But if it is possible for wheat growers or any other group of producers to
combine to eliminate competition, and if the government permits or encourages
such a course, the situation changes. The wheat growers may be able to
persuade the national government -- or, better, a world organization --
to force all of them to reduce pro rata the acreage planted to wheat.
In this way they will bring about a shortage and raise the price of wheat;
and if the rise in the price per bushel is proportionately greater, as it
well may be, than the reduction in output, then the wheat growers as a whole
will be better off. They will get more money; they will be able to buy more
of everything else. Everybody else, it is true, will be worse off; because,
other things equal, everyone else will have to give more of what he produces
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 those who look only at the wheat farmers
will see a gain, and miss the more than offsetting loss.
And this applies in every other line. If because of unusual weather
conditions there is a sudden increase in the crop of oranges, all the
consumers will benefit. The world will be richer by that many more oranges.
Oranges will be cheaper. But that very fact may make the orange growers as
a group poorer than before, unless the greater supply of oranges compensates
or more than compensates for the lower price. Certainly if under such
conditions my particular crop of oranges is no larger than usual, then
I am certain to lose by the lower price brought about by general plenty.
And what 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.
Just as there is no technical improvement that would not hurt someone,
so there is no change in public taste or morals, even for the better, 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. If progress were completely even
all around the circle, this antagonism between the interests of the whole
community and of the specialized group would not, if it were noticed at all,
present any serious problem. If in the same year as the world wheat crop
increased, my own crop increased in the same proportion; if the crop of
oranges and all other agricultural products increased correspondingly, and
if the output of all industrial goods also rose and their unit cost of
production fell to correspond, then I as a wheat grower would not suffer
because the output of wheat had increased. The price that I got for a
bushel of wheat might decline. The total sum that I realized from my
larger output might decline. But if I could also because of increased
supplies buy the output of everyone else cheaper, then I should have no
real cause to complain. If the price of everything else dropped in exactly
the same ratio as the decline in the price of my wheat, I should be better
off, in fact, exactly in proportion to my increased total crop; and everyone
else, likewise, would benefit proportionately from the increased supplies
of all goods and services.
But economic progress never has taken place and probably never will take
place in this completely uniform way. Advance occurs now in this branch
of production and now in that. And if there is a sudden increase in the
supply of the thing I help to produce, or if a new invention or discovery
makes what I produce no longer necessary, then the gain to the world is
a tragedy to me and to the productive group to which I belong.
Now it is often not the diffused gain of the increased supply or new
discovery that most forcibly strikes even the disinterested observer, but
the concentrated loss. The fact that there is more and cheaper coffee for
everyone is lost sight of; what is seen is merely that some coffee growers
cannot make a living at the lower price. The increased output of shoes at
lower cost by the new machine is forgotten; what is seen is a group of men
and women thrown out of work. It is altogether proper -- it is, in fact,
essential to a full understanding of the problem -- that the plight of
these groups be recognized, that they be dealt with sympathetically, and
that we try to see whether some of the gains from this specialized progress
cannot be used to help the victims find a productive role elsewhere.
But the solution is never to reduce supplies arbitrarily, to prevent
further inventions or discoveries, or to support people for continuing
to perform a service that has lost its value. Yet this is what the world
has repeatedly sought to do by protective tariffs, by the destruction of
machinery, by the burning of coffee, by a thousand restriction schemes.
This is the insane doctrine of wealth through scarcity.
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.
And this is our lesson in its most generalized form. For many things that
seem to be true when we concentrate on a single economic group are seen
to be illusions when the interests of everyone, as consumer no less than
as producer, are considered.
To see the problem as a whole, and not in fragments: that is the goal
of economic science.
THE END
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 - Minimum Wage Laws
CHAPTER 19 - Do Unions Really Raise Wages?
CHAPTER 20 - "Enough to Buy Back the Product"
CHAPTER 21 - The Function of Profits
CHAPTER 22 - The Mirage of Inflation
CHAPTER 23 - The Assault on Saving
----------------------------------------------
Year Total Consumers' Capital
Production Goods Goods
Produced Produced
----------------------------------------------
First 100 80 20*
Second 102.5 82 20.5
Third 105 84 21
Fourth 107.5 86 21.5
Fifth 110 88 22
Sixth 112.5 90 22.5
Seventh 115 92 23
Eighth 117.5 94 23.5
Ninth 120 96 24
Tenth 122.5 98 24.5
Eleventh 125 100 25
----------------------------------------------
*This of course assumes the process of saving
and investment to have been already under way
at the same rate.
Part Three: The Lesson Restated
CHAPTER 24 - The Lesson Restated