Economics in One Lesson

Henry Hazlitt

When one is asked by friends and family for a recommended introductory course to free market economics, this short book is often mentioned. This is a primer to market economics written for lay people untrained in finance or economics. Not a professional economist by training, Hazlitt has an incredible gift of exposition and persuasive writing. He has written line by line critiques of opposing schools of thought as well as authored short stories along the lines of market economics. His works are easily comprehended and leave the reader with either a sense of confirmation in his or her beliefs or leaves the reader with an appreciation for well-articulated opposing views. The short book is written in a series of short discussions that build on a general theme delineated in the beginning.

The Lesson

More so than most other fields of study, economics is plagued by special interest pleading. Small concentrated groups are boisterous in their clamoring for special legislation and privileged. The members of these special interest groups stand to gain much from these government policies and the costs are spread over a large tax base of hundreds of millions of unknowing taxpayers. Along with this public choice dynamic, another source of many economic fallacies is the failure to look at the long term implications of a policy or its effect on all groups. Thus, the lesson of economics that separates clear economic thinking from bad is, as Hazlitt puts it, “….looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups”.

The book then applies this timeless lesson to a wide range of policies. We will discuss some of these below.

1.     “The Blessings of Destruction”

At the outset, Hazlitt discusses the “broken window fallacy” highlighted by Bastiat and early classical economists. Hazlitt believes this is both one of the most common and destructive economic fallacies pervading all aspects of society today. Are we economically better off in war than in peace? The destructive blessing of war confuses need with demand. According to Hazlitt, “effective economic demand requires not merely need but corresponding purchasing power.” The concept of pent up demand merely redirects demand to specific and particular industries after a war. According to Hazlitt, demand, rather than being increased, was diverted from some industries to other industries. Many economic fallacies arise from a propensity to think in terms of an abstraction. Demand and supply are two sides of the same coin. War destroys accumulated capital.

2.     “Credit Diverts Production”

Government encouragement to business is a much suspect as hostility. “Encouragement” takes the form of credit, guaranteed loans and subsidies. All credit is debt. Increased credit is simultaneously increased debt. There is a fundamental difference between private and government credit. The riskiness of private credit is subject to greater scrutiny and stress testing than government credit. Hazlitt raises the following question: Why should the government, “do precisely what private agencies already do?” The question answers itself-> to make loans to people who could not get them from private lenders. “Government lenders will take risks with other people’s money that private lenders will not take with their own money.” Private investors generally want to get their money back with appropriate rate of return. Past success should lead to increased future action.

3.     “The Fetish of Full Employment”

Economic goal should be to get the greatest result with the least inputs/effort. Full employment is a necessary byproduct of maximal production. Full employment is merely the means to the end of maximal production. Nothing is easier than full employment. Maximal production is more elusive. According to Hazlitt, “The progress of civilization has meant the reduction of employment, not its increase.” The issue of distribution is made easier the more there is to distribute.

4.     “Who’s ‘Protected’ by Tariffs?”

Smith’s fundamental proposition that, “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.” When considering the public policy of tariffs, one must more than the immediate effects of a tariff on special groups in the short run. Labor productivity is reduced under a tariff regime. Tariffs reduce real wages. As a result of tariffs, capital and labor are diverted from what they can do more efficiently to what they do less efficiently reducing productivity. Tariffs change the structure of production by altering the relative sizes of one industry to another. Tariffs benefit one or few concentrated groups in a visible and poignant manner. However, the costs of tariffs are diffuse.

5.     “How the Price System Works”

When considering economic policy, it is crucial to consider the long run effects on all groups rather than the myopia of the short run effects on special interest groups. The price system is an attempt to solve the composition of the alternative applications of labor and capital. The price system represents the constantly fluctuating interrelationships of production costs, prices, and profits. Prices both determine and are determined by the interplay between supply and demand. Demand is determined by how intensely people want a particular good or service and what they have to offer in exchange for it. In competitive markets, there is a tendency for the price of a commodity to equal its marginal cost of production. In equilibrium, a specific industry can expand only at the expense of other industries. Everything is produced at the expense of forgoing something else. The price system operates better than any bureaucratic central plan.

6.     “Government Price-Fixing”

Price controls are interesting only to the extent that they fix prices to levels different from where they would arrive without the influence of the controls. Fixed price levels BELOW market level brings about two consequences: 1. increased demand and 2. reduced supply. Fixing a maximum price for a particular good or service brings about shortages. Maximum price controls arise as a result of either good scarcity or money surplus. Price ceilings cannot sure either cause.

A consumer purchases a myriad good and services. As a producer, individuals produce one. As a manufacturer wants a higher price for his particular product, each worker desires a higher wage or salary. Each economic agent has a multiple personality disorder. Each agent is a producer, taxpayer, and consumer and therefore, “The policies he advocates depend upon the particular aspect under which he thinks of himself at the moment.”

7.     “Minimum Wage Laws”

It is interesting to note that the price of labor’s services was given a term (wage) distinct from other prices. Why the special distinction?

According to Hazlitt, “You cannot make a man worth a given amount by making it illegal for anyone to offer him anything less.” For a low wage, minimum wage legislation substitutes unemployment. Where competitive forces are weak to nonexistent (such as in monopsony), minimum wage legislation may not exacerbate unemployment.

A priori, as bad as wages may be in X industry, the mere fact that the worker accepted the position is demonstrated proof that these wages are the best among all perceived alternatives available. Promoting marginal labor productivity is the best way to raise long run sustainable wages.

8.     “Do Unions Really Raise Wages?”

In competitive markets, wages are largely determined by labor productivity. This rests on the assumption that employers are eager to increase profits to the maximum. To the extent striker use force and intimidation to obstruct work, they insist on a position of privilege and use force to maintain this privilege against other workers. Union policies distribute unemployment in relation to the relative elasticity of demand for different kinds of labor. If wages are forced up, this increase will come out of profits. In the absence of foreign competition, the wage increases may result in higher consumer prices. The rise in wages in the 20^th century is due to the growth of capital investment and to scientific and technological advance. In a free enterprise system, everybody’s money income is somebody else’s cost.

“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.”

9.     “The Function of Profits”

What does it mean to make a profit? Far from a rhetorical question, few people fundamentally grasp the implications of profits and loss in either an economic and accounting sense. It means the result of the combination of factors of production in such a way and in such amount so that the output is valued greater than the sum of the inputs. Although succinctly modeled in accounting rules, turning an economic profit, generating free cash flow, making money, or whichever title you want to give it is extremely difficult. As my career has developed and progressed, I have truly come to appreciate the difficulty of “making money”.

Also, few people are familiar with the mortality rates of business, large or small. The absence of profits is a telltale sign that the labor and capital devoted to its production are misdirected. A crucial function of profits is to guide and channel the factors of production to their most valued (profitable) uses. According to Hazlitt, “The function of profits is to put constant and unremitting pressure on the head of every competitive business to introduce further economies and efficiencies.” Profits are often achieved not by raising prices but by introducing economies and efficiencies that cut production costs. Profits result from the relationship of costs to prices.

10.  “The Mirage of Inflation”

Especially germane as this entry is written (summer 2021), inflation is arguably the most misunderstood yet ubiquitous economic phenomenon. An increase in the supply of money inevitability and inexorably reduces the purchasing power of the currency medium. Some economists posit a “rigid mechanical theory of the effect of the supply of money on commodity prices.” The total money supply multiplied by its velocity must equal the value of the goods bought. These economists hold that “the value of the monetary unit must vary exactly and inversely with the amount put into circulation.”

Itself a form of taxation, inflation is especially pernicious. The burden of inflation falls hardest on precisely those people that are less able to mitigate its effects and/or are more downstream from the monetary expansion. These Cantillon effects are key to understanding the regressive nature of the inflation tax.