The Lesson

Economics is a deeply contradictory field. At any given moment, you can find two experts arguing the opposite assertions. As an entire science, economics is difficult enough as is. But since money so deeply involves itself in our lives, and thus beholds itself to greed, economics is also hostage to ‘special interests’. Certain economic policies which would benefit one interest group are often not the problem–the problem occurs when these policies also negatively affect another interest group. These turn a science into a political playground.

Another problem is that economics is a considerably long-term science. Humans, however, are more concerned with their immediate life than the consequences of their short-termism on the next generation. This leads us into the ‘fallacy of overlooking secondary consequences’ of economic policies. These policies may benefit us in the short-term, but they will negatively affect us later on. Politics plays in this: championing immediately beneficial policies wins one considerable popularity, regardless of long-term consequences to a nation.

Most of the economic fallacies that harm us so much are the result of ignoring the aforementioned lesson: ‘The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy’ as Henry phrases it.

The Broken Window

Henry illustrates his principle with Bastiat’s broken-window: A young hoodlum takes a brick through the window of a bakers’ shop. A crowd gathers arounds the now broken window. ‘This is certainly a tragedy’, they think, but the money needed to repair the window–$250 or so–will now be spent into the ’economy’. It will go to the glazier, who will repair the window, and will spend the money on some other good or service himself, the whole process repeating ad infinitum, and resulting in net benefit for the town.

But that’s not the whole story, as Henry reminds us. They are right that the glazier will accrue some business. But the crowd forgot one other actor in this play: the tailor. Was not the baker intending to use that money–that he will now spend on the glazier–on something else? Perhaps, he wanted a new suit, but now he will have to repair a window instead. So, the glazier’s gain of business, in short, is merely the tailor’s loss of business. And so it is for all profit–it comes at someone’s loss of money.

The Blessings of Destruction

After the end of the Second World War, most nations involved were rendered desolate. Broken homes, bombed factories, accumulated demand, all the things that people wanted and needed, would fuel a reconstruction unparalleled, economists gleefully thought. You can probably put the example given in the last chapter to use here already–if we refer back to the broken window, we figure that every cent used to buy essential goods and services was one less cent gone to luxury goods and services.

But another problem is that this assertion confuses need with demand. Just because you need a house doesn’t mean you will buy a house–because you just may not have the purchasing power to buy a house. But a postwar ‘boom’ did occur, no? People had more money after the war, sure, but this money was worth less thanks to wartime inflation. This is purchasing power–$1 will always be $1, but the amount of things $1 can buy changes (decreases) over time.

Public Works Mean Taxes

When providing employment becomes the end, need becomes a subordinate consideration. Projects have to be invented. Instead of thinking only of where bridges must be built, the government spenders begin to ask themselves where bridges can be built.

Government spending is often seen as a one-size-fits-all cure for all economic illness. The spendthrifts ignore a simple fact: everything we get must be paid for in some way. This is not a law of capitalism or democracy–it’s a rule of nature. The accumulation of debt to aid government spending is not simply forgotten–often, the average citizen ends up paying all that debt off via inflationary costs, or just plain increases in tax.

Henry presents it in a simple way: ’either immediately or ultimately every dollar of government spending must be raised through a dollar of taxation’. Of course, Henry warns us off of thinking government spending is a complete evil. There is a certain amount and use of spending that is necessary–for our infrastructure, and public services. So how do we determine if a certain use of spending is worth it?

Henry gives us a simple metric: ‘[if the public work/service] is even more necessary to the taxpayers collectively than the things for which they would have individually spent their money if it had not been taxed away from them, there can be no objection [to the money’s use]’.

When presented with this line of thought, a common counter-argument concerns the benefit of the employment generated in supplying and building that public work. As Henry astutely observes, ’the implication is that these are jobs that would not otherwise have come into existence’. But if you go back to Bastiat’s broken window, you will notice that this is fallacious thought! That money would have been spent regardless by the taxpayers who funded this project. But again, the bridge created with our money is visible and so are the construction workers that build it–the jobs created by our grocery spending are not!

Taxes Discourage Production

Continuing on the topic of taxation, Henry argues that taxing people for public works is a net loss to the economy. Of course, there is the main consequence of such a policy–the reallocation of wealth. But asset transfers are not necessarily a negative to an economy, it’s just that they have little to no effect. But taxes have a secondary, psychological, effect. A company that spends so much on taxes that it can’t expand not only doesn’t expand, but it also discourages others from starting business in the first place. A person who loses half his wealth to taxes wonders why he spends as much time working for the government as he does for himself and his family. Thus, taxes craft mindsets that are absolutely harmful to the development of nations.

Credit Diverts Production

Government credit is often an extension of the belief in government spending. But Henry ignores that part of government credit, to raise another question. Private credit exists. Private credit exists, so why are these farmers and businessmen and whomever else government credit hopes to benefit not going to these private dealers? Well, the answer is they are. But the distinction between government and private credit is this: the private lender examines the risks of his investments closely–he checks backgrounds, the character of the person he’s lending to, his credit score. After all, if he makes a bad investment it would not just damage his finances, but dent his reputation.

The same is not true of the government, and in fact must not be true. If the government judiciously checked everyone it was lending to, then why would we even need government credit? This would be no different from how private lenders credit, after all. So we’re handing out cash to suspect individuals, but that’s not the only problem with this arrangement. The other thing is that supply–of both capital and the goods/services/land it is being used to purchase–is limited. So when the government lends capital to person A, a perhaps irresponsible or, at worst, reprehensible person, whom the private lenders wouldn’t deal with, they deprive person B. Regardless of if person B has been judicious and fiscally responsible, they deprive him of the same facilities, or at least make him pay more (whether in credit or his own cash) for the facilities.

Spread-the-Work Schemes

The previous chapter touches on the historical consequences upon machinery because of the belief that the more efficient way of doing things decreases employment. This fallacy is believed because there is a deeply held belief that there is a fixed amount of work in this world. It is impossible to increase the amount of work in this world–therefore we must divide it amongst the people more. This fallacious belief has led to the conception of a number of ‘spread-the-work’ schemes.

One of these is the minute subdivision of labor. By ensuring that the carpenter does not deal in any stone–only the stonemason does, and vice versa–we ensure sufficient employment for both. However, if we go back to Bastiat’s illustration (for the nth time), we realise that the homeowner who has to employ both for work on his house will spend that much less money on other amenities.

Another faulty scheme conceived is the idea of shortening the work week. This scheme comes in two flavours:

1. Reducing the work week, but nothing more.
2. Reducing the work week and increasing hourly pay (to compensate for lost hours).

The first flavour can be struck down quite easily. It definitely increases employment, but has no other (positive) effect. If we are optimistic, it leads to no negative effects either, but only if we are optimistic. This is because it simply leads to the reallocation of work–work is taken from the employed worker and given to the unemployed worker. This seems good, but without an allied pay increase, it functions as a ‘work’ redistribution. Only, the goal of a wealth redistribution is from the rich to the poor–not the working-class to the non-working class as in this example.

The second flavour is not much tougher to destroy, and actually much more disastrous in effect. If we increase pay to compensate for lost hours, the costs of production will increase. The consequences of this are obvious: the smaller and less efficient businesses (marginal producers who don’t benefit from economies of scale) will be put out of business by the larger corporations. In sum total, jobs will actually be lost.

Disbanding Troops and Bureaucrats

A common argument against downsizing government and the armed forces is based on the negative effect on employment and thus the potential social unrest generated by that effect. It does in fact take some time for the private sector to absorb the manpower ‘released’ by the government. But, as the reduction in government size results in a reduction of government expenditure, and taxpayers have to pay less tax, spending increases on the private sector. This generates employment enough, and actually leaves the country better off–previously, these soldiers did not work for goods or services (and, frankly, most of the bureaucrats didn’t either). Now, however, they will likely produce something for their work.

The Fetish of Full Employment

The goal in policymaking for a nation is to get the most for the least effort. This involves increasing employment and productivity–basically the $ worth of the goods and services produced by the mean worker. When all of its men are creating lots-of/high-quality things, a nation is at its highest. But this does not require that we be obsessed with full-employment–which is a byproduct of the aforementioned arrangement. If we confuse the two, it becomes a problem in and of itself. It is easy to create full-employment when we revert to primitive means of production–as discussed in chapter 8, but that confuses our goals–which should be prosperity–with the means (high productivity and employment).

Who’s “Protected” by Tariffs

The defence of free-trade is as much a moral matter as much as it is a economic matter. Tariffs increase the cost of goods, and as Adam Smith states succinctly, ‘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’. It is the connivance of merchants to say otherwise. Local manufacturers have an advantage regardless of tariff or tax and if they are still unsuccessful as compared to international competitors, it would be better perhaps for them to pivot to other industries than let the people suffer the increased costs of goods from their rent-seeking.

Assuming a particular industry has a disadvantage compared to international competitors, the withdrawal of the tariff protecting its advantage would mean the end of the industry and the unemployment of all those involved. If we consider the long-view, however, we notice that consumers will save more money on the purchase of the goods that were tariffed, and thus will have more money to spend on other goods, including those that are domestically produced.

The Drive for Exports

This is, as John Stuart Mill so clearly pointed out, that the real gain of foreign trade to any country lies not in its exports but in its imports. Its consumers are either able to get from abroad commodities at a lower price than they could obtain them for at home, or commodities that they could not get from domestic producers at all.

Exports pay for imports and vice versa. When an American exporter sells his goods to a British importer, he is not paid in the currency he uses everyday–the $–but the British pound. In order to gain some utility out of this foreign currency, he has two options:

1. Buy British exports with said pounds.
2. Sell these pounds for dollars to somebody else, who will likely use them to buy British exports.

And vice versa. What happens here is that the ’the dollar debts of foreigners’ (imports from countries that use the $) are cancelled out by ’their dollar credits’ (exports to countries that use the $).

Granted, this was not always true. Sometime (before Bretton Woods), when dollar debts (or whatever else) were not in fact cancelled out for some reason or the other, gold was used to make up the difference. The reason for using gold, instead of just exporting commodities, is because gold, as an international currency at the time, had no obstacles to being imported (tariffs, etc.) and was thus an efficient way of settling debts.

There are a couple common fallacies when it comes to foreign trade. The first suggests that if a nation–say, America–were to loan out its currency–the $–to another nation, the foreign exchange would be used to pay for American goods. Thus, even if the loans were not repaid, ‘America’ would still benefit because of the increase in exports. This is partially true, but misleading–if a British person were to buy an American good and pay for it with loaned American money that they have no intention to repay later, that’s simply free stuff for them! It would benefit the exporters that made the good, but it would harm whomever loaned the importer the money–if a private lender, then it would occur in their losses, and if the government loaned the money, then the burden would fall upon taxpayers. Export subsidies function the same–by subsidising goods for export, we are artificially making them cheaper than they cost us to make, for foreigners to buy. Export businesses benefit greatly, and so does the foreigner, but everybody else loses.

Parity Prices

Henry presents a general history of the idea of ‘parity prices’ (also known as the Doctrine of Parity). The parity price argument essentially argues that:

1. National prosperity is linked to the prosperity of farmers
2. If a farmer lacks the purchasing power to buy the products of industry, industry languishes and depression lay on the horizon

To prevent depression, it is necessary to link, or ensure parity between, the prices of industry-produced goods and the prices of farm-produced good. This will ensure that the farmer has enough purchasing power to spend on industry-produced goods, and thus ensure employment for city-workers.

There are many problems with this argument. Firstly, why limit the argument to just agricultural products? I’ll tell you why: because agricultural products do not increase or deplete in quality over-time as industrial goods do. The argument would seem farcical if this was taken into account in examples, so it’s not.

And what about the method utilised to ensure the parity? Obviously, it must be enforced by the government through either:

1. A simple, enforced edict (price controls)
2. The government can purchase all agricultural products at the parity price itself
3. The government can lend the farmers money while they withhold crops from the market, decreasing supply and thus increasing price, until parity price is reached

If any of these methods, or a combination of them is used, farmers will indeed get a higher-price for their goods. But the purchaser of agricultural products will lose their purchasing power in exchange–a reallocation of wealth. The whole scheme also means a destruction in supply to ensure high-prices, meaning less agricultural goods on the market. This would be a net loss to a country, and even the farmer would not benefit much if we take this into account. Because, while he does get more per, say, bushel of wheat sold, he sells less bushels of wheat in total–basically cancelling the benefit out.

Saving the X Industry

Essentially the previous chapter expanded to more general purpose.

How the Price System Works

When Robinson Crusoe found himself on a deserted island, he had a lot of needs (shelter, food, water, warmth). As a single person, he could only focus on one of these at a time, however. And, once done with one problem, he must move onto the next most pressing. If a family were stranded, then they would certainly have more leeway. They could assign tasks–the specialisation and division of labor. For example, the father was done gathering enough firewood, he wouldn’t gather more than they needed. He’d help find food instead. If he continued gathering firewood, it would be at the expense of food.

It is similar on a macro level. The prices of goods are determined by their supply and demand. You wouldn’t keep making firewood if there was no more demand for it. If you did, nobody would buy it, or they would get it for free. Price is partly determined by costs of production, yes, but that is the base–consider the demand/supply the filling. A common misconception–by a group Henry calls the ‘production-for-use’ school–is that, once the free market system/capitalists can not make money on a product, they will stop manufacturing it, thus leading to scarcity and harming many people. The problem in this argument is that if there were in fact such demand for said good, no manufacturer would stop producing it in the first place!

Another fault in the argument is that most of these manufacturers do not simply stop making goods. Usually, they pivot to making other goods. For example, car manufacturers some time from now may entirely pivot to EVs. This will not lead to scarcity as they will only pivot when demand for non-electric cars is (rightly) eradicated, and neither will it lead to a loss of production as the manufacturer now produces electric cars instead.

Government Price-Fixing

Price controls are a handy political tool for politicians, and a business opportunity for bureaucrats. They are often used in tandem with a blame game putting higher prices of goods on the greed of businessmen, thus diverting responsibility from officeholders. The argument goes thus: if the government does not intervene, the price for a certain good will inflate so much as to be unaffordable for the poor.

By intervening to decrease the price of a good, the government ensures two things:

1. Increase in demand for that good
2. Reduce supply for that good (because profit margins are reduced, or sometimes are deficits instead, less incentive to produce the good)

And there: we have a shortage of said good! The government at this point can either backtrack or double-down. For the latter, they have four choices: rationing, cost-control, subsidies and universal price-fixing. The first option is an extension of the blame game–before, blame was being put on rich producers for greedily inflating prices, now blame is put on rich consumers for greedily taking more than their fair share. Rationing usually involves everyone (equally) getting limited amounts of certain coupons–a double price system–that they can redeem for said good. Thus, everyone is deprived.

The second option is like playing whack-a-mole. Problems arising from price fixing a certain good are ‘solved’ by price-fixing another good that is used to manufacture our initial good, and so on and on forever. Eventually, we arrive at universal price fixing anyways. Subsidies make a little more sense: the government is buying goods from their manufacturers for market price and then selling it to people at a certain rate, usually less than it bought the goods for. The problem is this: the goods are subsidized for the rich as well (unless they are rationed). If the government forcibly intervenes to lower the price of a commodity, then the rich are actually who’ll purchase it the most and, thus, will utilize the subsidy the most.

What Rent Control Does

Rent control is oft imposed because the supply of housing is inelastic–it can not be immediately increased as supply demands. If in a war, for example, housing may be destroyed by bombs. Since production can’t be ramped up in even a normal economy–war economies divert resources to war production–the price of housing would skyrocket. Thus, rent control is argued to be necessary, at least until the construction industry gets its gears running.

There is already one negative consequence of imposing rent controls: if rent is increased in accord with war inflation and demand, then it is true that tenants would find it harder to rent their homes. However, this would urge them to economise–to take roommates, for example. And, this would not require any new housing.

Rent control is also discriminatory. Even if landlords did not raise their prices, and instead allowed tenants to bid for rent, prices would rise just as surely. Rent control essentially subsidises those out of homes that they can actually afford, for those in homes that they can not afford! And the argument that rent control does not affect construction is just plain-false. Construction costs rise in proportion to wartime inflation and the scarcity of resources, but if property builders are also forced to set a low-price for rent, then they will make little-to-no profit margins and be disincentivised from production. Even worse, property owners are not only disincentivised from creating new housing, they are disincentivised from maintaining housing, if they even have the funds to do so! Eventually, as property decays and taxes accrue, not only are landlords not making profits on housing, they are making losses. They can not even sell off their property, because who would buy a loss-making entity in a war economy? They abandon their properties, and whole areas turn to slums. Some cope by removing rent controls on luxury apartments–only, this makes things worse! Property builders are incentivised to build luxury housing, and low-cost housing is now even worse off.

City governments go bankrupt for the shrinkage of revenues from property related taxes. The result? The government doubles down, of course! It involves itself in public housing now (please take a rest, Mr. Government, you need it). Obviously, the public housing schemes are paid for by taxpayers and, as with all these farcical schemes, it would have been better in the end to let taxpayers just pay for rent at its actual price instead.

Minimum Wage Laws

A ‘wage’ is a price–the price for labor, to be more specific. If, as we have proven, it is pointless and damaging for the government to regulate prices, then the same holds true for wages. As explained before, this is because the negative consequences far outweigh the positive ones.

For instance, when a minimum wage law is passed, it effectively prices out anybody whose work is worth less than the minimum wage. If you’re disabled, for example, then it would be very hard for you to work at or above the minimum wage since you’d be competing with non-disabled people. Thus, most firms will simply refuse to hire you. Before, however, you could’ve made at least some money working somewhere, even if it was a pittance. To make up for your newfound unemployment, the government will have to pay a relief. A relief of around half the minimum wage might be fine if you were making less than that, but if you were making more? Thus, it is necessary to match the minimum wage. But then, if you’re working and earning minimum wage or slightly above, what point is there in working? You could earn the same amount of money idling, after all!

Let’s now look at the consequences upon employers. To make up for increased costs of production, firms will have to increase the prices of their products. Since minimum wage laws only apply nationally, industry loses a good chunk of its competitiveness to international competitors with cheaper labor costs. A real-life example of this is how Western countries lost their industry to China, which offered labor so cheap compared to the West that the costs of production and costs of transport still allowed for products vastly cheaper than locally-manufactured counterparts in Western grocery shelves.

Some respond to this with the argument that firms who underpay do not deserve to exist. But this ignorant argument completely throws consumers, and the employees themselves, under the bus. If the firm paid such bad wages, then why did it’s employees not flee to other firms, or even join this firm in the first place? It must have offered something to attract, and keep, the employees.

And finally, to the argument that some monopolies can afford to offer below-market wages because they have no other competitors: in order to become a monopoly in the first place, they will have to have offered high-wages initially to price out competitors. If they reversed this policy later, and started paying substandard wages, then this would only mean that the company would stop expanding as skilled labor would cease to be attracted. Therefore, to sustain expansion and attract labor, it would be necessary for the company to maintain high wages.

Do Unions Really Raise Wages?

The productivity of a worker determines his wages. This belief does not rest on the strawman often raised by unionists–that capitalists are decent and generous people. It is a simple reality out of the control of capitalists. If a high-tech worker–of a field where very few are in supply but in dire demand–finds a job at company X at $1/hour, company Y will not hesitate to offer him $2/hour that he come to their company instead. And then company X or maybe company Z will raise their wage offer in turn, and it becomes a sort of auction until the full worth of the employee is reached.

There is a limit to the auction, however–the workers labor productivity. If the worker does not produce more for the company than his income, he will not be worth employing except temporarily.

“Enough to Buy Back the Product”

Do not use ‘just’ to humanise economics–no ‘just wages’ or ‘just prices’–use ‘functional wages’ or ‘functional prices’ instead. Functional prices are the ones that ensure high production and sales. ‘Just’ wages are the flip end of extractive wages. They are often elaborated upon with the following phrase: wages should be such that the worker should have “enough to buy back the product [that they create]”.

There’s already one big problem here–that this is a simple rerun of the purchasing power argument. One persons salary is paid for by another persons salary–everybody’s income is somebody else’s cost. If we arbitrarily increase someones wages–meaning, no accompanying productivity increase–it increases the costs of production and thus the price of goods, passing the cost onto consumers. The same consequences as price control.

Another problem is this mindsets ignorance of the white collar class–the ones that don’t work manual labor, and pretty much everybody else. Since this class would have to pay for the increased labor costs, investment and enterprise (usually the domain of solely this class) would diminish, and everybody would be worse off in the long-term. To finish, a quote:

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 Function of Profits

There is a stigma against the mere mention of the word ‘profit’ in society, despite the fact that, in actuality, corporate profits do not actually amount to much as a % of GDP. Profit is accrued not by raising prices (which often reduces demand), but by introducing economies of scale and efficiency to cut costs of production. If all firms sell a certain good at the same price ($1), the firm that profits the most is the one that manufactures the good for the least cost.

The Mirage of Inflation

Henry has ignored the problem of inflation–until now–for this chapter, because it is a complicated, misunderstood, and controversial topic. The first common misconception has to do with the confusion of price (inflation) with currency (depreciation) or the mistake of confusing wealth with money. The logical conclusion to this confusion is the thought that if the government were to simply issue more money to everyone, we would all be richer! There is a more sophisticated group that argues only limited amounts of money be printed, to make up for ‘gaps’ in purchasing power.

And then, there are the actually sane who realise that more money = less purchasing power per unit currency. But they wish for this outcome–more inflation will decrease purchasing power, which will decrease imports and instead increase exports. It will make it easier to pay off debts as the principal and interest alike are worth less, they say.

The Assault on Saving

It is common sense (for the individual) to save money and not spend wastefully, as it is common sense to not spend more money than you have or earn. And yet, there are some who argue for people to save less, spend more, and stop ‘sitting on’ wealth.

This argument is ignorant. The prudent human is not harming society by withholding money–he has two options with the money:

1. He can store it in a savings or commercial bank account
2. He can invest it.

If he stores it with a bank, the bank usually lends it to businesses who use the money to expand operations. Otherwise, in option 2, he invests it directly into the aforementioned businesses. Either way, his money produces plenty value for the economy, and really his saving money is akin to spending it. Even better, as his net worth grows continuously both by the means of his investments and the money he saves, he compounds this cycle. He provides more of a benefit to the nation than the man who would squander all his income as soon as he gets it.

Granted, straight hoarding cash in your floorboards is harmful to the economy. But that is not ‘saving’, as that cash loses its value constantly due to inflation and thus, there is little incentive for anyone to actually do this except for illegal purposes.

The Lesson Restated

“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.”

Economics consists of recognizing the consequences of specific policies, especially to consider secondary–overlooked–consequences, and general consequences upon the interests of everyone. In essence, economics is the science of recognizing inevitable implications of policies–where the answer already lies in the question, you just have to find it.