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Introduction

Many volumes have been written about the Great Depression of 1929-1941 and its impact on the lives of millions of Americans. Historians, economists and politicians have all combed the wreckage searching for the “black box” that will reveal the cause of the calamity. Sadly, all too many of them decide to abandon their search, finding it easier perhaps to circulate a host of false and harmful conclusions about the events of seven decades ago. Consequently, many people today continue to accept critiques of free-market capitalism that are unjustified and support government policies that are economically destructive.

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How bad was the Great Depression? Over the four years from 1929 to 1933, production at the nation’s factories, mines and utilities fell by more than half. People’s real disposable incomes dropped 28 percent. Stock prices collapsed to one-tenth of their pre-crash height. The number of unemployed Americans rose from 1.6 million in 1929 to 12.8 million in 1933. One of every four workers was out of a job at the Depression’s nadir, and ugly rumors of revolt simmered for the first time since the Civil War.

“The terror of the Great Crash has been the failure to explain it,” writes economist Alan Reynolds. “People were left with the feeling that massive economic contractions could occur at any moment, without warning, without cause. That fear has been exploited ever since as the major justification for virtually unlimited federal intervention in economic affairs.”[1]

Old myths never die; they just keep showing up in economics and political science textbooks. With only an occasional exception, it is there you will find what may be the 20th century’s greatest myth: Capitalism and the free-market economy were responsible for the Great Depression, and only government intervention brought about America’s economic recovery.

A Modern Fairy Tale

According to this simplistic perspective, an important pillar of capitalism, the stock market, crashed and dragged America into depression. President Herbert Hoover, an advocate of “hands-off,” or laissez-faire, economic policy, refused to use the power of government and conditions worsened as a result. It was up to Hoover’s successor, Franklin Delano Roosevelt, to ride in on the white horse of government intervention and steer the nation toward recovery. The apparent lesson to be drawn is that capitalism cannot be trusted; government needs to take an active role in the economy to save us from inevitable decline.

But those who propagate this version of history might just as well top off their remarks by saying, “And Goldilocks found her way out of the forest, Dorothy made it from Oz back to Kansas, and Little Red Riding Hood won the New York State Lottery.” The popular account of the Depression as outlined above belongs in a book of fairy tales and not in a serious discussion of economic history.

The Great, Great,Great,Great Depression

To properly understand the events of the time, it is factually appropriate to view the Great Depression as not one, but four consecutive downturns rolled into one. These four “phases” are:[2]

I. Monetary Policy and the Business Cycle

II. The Disintegration of the World Economy

III. The New Deal

IV. The Wagner Act

The first phase covers why the crash of 1929 happened in the first place; the other three show how government intervention worsened it and kept the economy in a stupor for over a decade. Let’s consider each one in turn.

Phase I: The Business Cycle

The Great Depression was not the country’s first depression, though it proved to be the longest. Several others preceded it.

A common thread woven through all of those earlier debacles was disastrous intervention by government, often in the form of political mismanagement of the money and credit supply. None of these depressions, however, lasted more than four years and most of them were over in two. The calamity that began in 1929 lasted at least three times longer than any of the country’s previous depressions because the government compounded its initial errors with a series of additional and harmful interventions.

Central Planners Fail at Monetary Policy

A popular explanation for the stock market collapse of 1929 concerns the practice of borrowing money to buy stock. Many history texts blithely assert that a frenzied speculation in shares was fed by excessive “margin lending.” But Marquette University economist Gene Smiley, in his 2002 book “Rethinking the Great Depression”, explains why this is not a fruitful observation:

There was already a long history of margin lending on stock exchanges, and margin requirements — the share of the purchase price paid in cash — were no lower in the late twenties than in the early twenties or in previous decades. In fact, in the fall of 1928 margin requirements began to rise, and borrowers were required to pay a larger share of the purchase price of the stocks.

The margin lending argument doesn’t hold much water. Mischief with the money and credit supply, however, is another story.

Most monetary economists, particularly those of the “Austrian School,” have observed the close relationship between money supply and economic activity. When government inflates the money and credit supply, interest rates at first fall. Businesses invest this “easy money” in new production projects and a boom takes place in capital goods. As the boom matures, business costs rise, interest rates readjust upward, and profits are squeezed. The easy-money effects thus wear off and the monetary authorities, fearing price inflation, slow the growth of, or even contract, the money supply. In either case, the manipulation is enough to knock out the shaky supports from underneath the economic house of cards.

One prominent interpretation of the Federal Reserve System’s actions prior to 1929 can be found in “America’s Great Depression” by economist Murray Rothbard. Using a broad measure that includes currency, demand and time deposits, and other ingredients, he estimated that the Fed bloated the money supply by more than 60 percent from mid-1921 to mid-1928.[3]  Rothbard argued that this expansion of money and credit drove interest rates down, pushed the stock market to dizzy heights, and gave birth to the “Roaring Twenties.”

Reckless money and credit growth constituted what economist Benjamin M. Anderson called “the beginning of the New Deal”[4] — the name for the better-known but highly interventionist policies that would come later under President Franklin Roosevelt. However, other scholars raise doubts that Fed action was as inflationary as Rothbard believed, pointing to relatively flat commodity and consumer prices in the 1920s as evidence that monetary policy was not so wildly irresponsible.

Substantial cuts in high marginal income tax rates in the Coolidge years certainly helped the economy and may have ameliorated the price effect of Fed policy. Tax reductions spurred investment and real economic growth, which in turn yielded a burst of technological advancement and entrepreneurial discoveries of cheaper ways to produce goods. This explosion in productivity undoubtedly helped to keep prices lower than they would have otherwise been.

Regarding Fed policy, free-market economists who differ on the extent of the Fed’s monetary expansion of the early and mid-1920s are of one view about what happened next: The central bank presided over a dramatic contraction of the money supply that began late in the decade. The federal government’s responses to the resulting recession took a bad situation and made it far, far worse.

The Bottom Drops Out

By 1928, the Federal Reserve was raising interest rates and choking off the money supply. For example, its discount rate (the rate the Fed charges member banks for loans) was increased four times, from 3.5 percent to 6 percent, between January 1928 and August 1929. The central bank took further deflationary action by aggressively selling government securities for months after the stock market crashed. For the next three years, the money supply shrank by 30 percent. As prices then tumbled throughout the economy, the Fed’s higher interest rate policy boosted real (inflation-adjusted) rates dramatically.

The most comprehensive chronicle of the monetary policies of the period can be found in the classic work of Nobel Laureate Milton Friedman and his colleague Anna Schwartz, “A Monetary History of the United States”, 1867-1960. Friedman and Schwartz argue conclusively that the contraction of the nation’s money supply by one-third between August 1929 and March 1933 was an enormous drag on the economy and largely the result of seismic incompetence by the Fed. The death in October 1928 of Benjamin Strong, a powerful figure who had exerted great influence as head of the Fed’s New York district bank, left the Fed floundering without capable leadership — making bad policy even worse.[5]

At first, only the “smart” money — the Bernard Baruchs and the Joseph Kennedys who watched things like money supply and other government policies — saw that the party was coming to an end. Baruch actually began selling stocks and buying bonds and gold as early as 1928; Kennedy did likewise, commenting, “only a fool holds out for the top dollar.”[6]

The masses of investors eventually sensed the change at the Fed and then the stampede began. In a special issue commemorating the 50th anniversary of the stock market collapse, U.S. News & World Report described it this way:

Actually the Great Crash was by no means a one-day affair, despite frequent references to Black Thursday, October 24, and the following week’s Black Tuesday. As early as September 5, stocks were weak in heavy trading, after having moved into new high ground two days earlier. Declines in early October were called a “desirable correction.” The Wall Street Journal, predicting an autumn rally, noted that “some stocks rise, some fall.”

Then, on October 3, stocks suffered their worst pummeling of the year. Margin calls went out; some traders grew apprehensive. But the next day, prices rose again and thereafter seesawed for a fortnight.

The real crunch began on Wednesday, October 23, with what one observer called “a Niagara of liquidation.” Six million shares changed hands. The industrial average fell 21 points. “Tomorrow, the turn will come,” brokers told one another. Prices, they said, had been carried to “unreasonably low” levels.

But the next day, Black Thursday, stocks were dumped in even heavier selling. The ticker fell behind more than 5 hours, and finally stopped grinding out quotations at 7:08 p.m.[7]

At their peak, stocks in the Dow Jones Industrial Average were selling for 19 times their earnings — somewhat high, but hardly what stock market analysts regard as a sign of inordinate speculation. The distortions in the economy promoted by the Fed’s monetary policy had set the country up for a recession, but other impositions to come would soon turn the recession into a full-scale disaster. As stocks took a beating, Congress was playing with fire: On the very morning of Black Thursday, the nation’s newspapers reported that the political forces for higher trade-damaging tariffs were making gains on Capitol Hill.

The stock market crash was only a reflection — not the direct cause — of the destructive government policies that would ultimately produce the Great Depression: The market rose and fell in almost direct synchronization with what the Fed and Congress were doing. And what they did in the 1930s ranks way up there in the annals of history’s greatest follies.

Buddy, Can You Spare $20 Million?

Black Thursday shook Michigan harder than almost any other state. Stocks of auto and mining companies were hammered. Auto production in 1929 reached an all-time high of slightly more than 5 million vehicles, then quickly slumped by 2 million in 1930. By 1932, near the deepest point of the Depression, they had fallen by another 2 million to just 1,331,860 — down an astonishing 75 percent from the 1929 peak.

Thousands of investors everywhere, including many well-known people, were hit hard in the 1929 crash. Among them was Winston Churchill. He had invested heavily in American stocks before the crash. Afterward, only his writing skills and positions in government restored his finances.

Clarence Birdseye, an early developer of packaged frozen foods, had sold his business for $30 million and put all his money into stocks. He was wiped out.

William C. Durant, founder of General Motors, lost more than $40 million in the stock market and wound up a virtual pauper. (GM itself stayed in the black throughout the Depression under the cost-cutting leadership of Alfred P. Sloan.)

Phase II: Disintegration of the World Economy

Though modern myth claims that the free market “self-destructed” in 1929, government policy was the debacle’s principal culprit. If this crash had been like previous ones, the hard times would have ended in two or three years at the most, and likely sooner than that. But unprecedented political bungling instead prolonged the misery for over 10 years.

Unemployment in 1930 averaged a mildly recessionary 8.9 percent, up from 3.2 percent in 1929. It shot up rapidly until peaking out at more than 25 percent in 1933. Until March of 1933, these were the years of President Herbert Hoover — a man often depicted as a champion of noninterventionist, laissez-faire economics.

“The greatest spending administration in all of history”

Did Hoover really subscribe to a “hands-off-the-economy,” free-market philosophy? His opponent in the 1932 election, Franklin Roosevelt, didn’t think so. During the campaign, Roosevelt blasted Hoover for spending and taxing too much, boosting the national debt, choking off trade, and putting millions on the dole. He accused the president of “reckless and extravagant” spending, of thinking “that we ought to center control of everything in Washington as rapidly as possible,” and of presiding over “the greatest spending administration in peacetime in all of history.” Roosevelt’s running mate, John Nance Garner, charged that Hoover was “leading the country down the path of socialism.”[8] Contrary to the conventional view about Hoover, Roosevelt and Garner were absolutely right.

The crowning folly of the Hoover administration was the Smoot-Hawley Tariff, passed in June 1930. It came on top of the Fordney-McCumber Tariff of 1922, which had already put American agriculture in a tailspin during the preceding decade. The most protectionist legislation in U.S. history, Smoot-Hawley virtually closed the borders to foreign goods and ignited a vicious international trade war. Professor Barry Poulson describes the scope of the act:

The act raised the rates on the entire range of dutiable commodities; for example, the average rate increased from 20 percent to 34 percent on agricultural products; from 36 percent to 47 percent on wines, spirits, and beverages; from 50 to 60 percent on wool and woolen manufactures. In all, 887 tariffs were sharply increased and the act broadened the list of dutiable commodities to 3,218 items. A crucial part of the Smoot-Hawley Tariff was that many tariffs were for a specific amount of money rather than a percentage of the price. As prices fell by half or more during the Great Depression, the effective rate of these specific tariffs doubled, increasing the protection afforded under the act.[9]

Smoot-Hawley was as broad as it was deep, affecting a multitude of products. Before its passage, clocks had faced a tariff of 45 percent; the act raised that to 55 percent, plus as much as another $4.50 per clock. Tariffs on corn and butter were roughly doubled. Even sauerkraut was tariffed for the first time. Among the few remaining tariff-free goods, strangely enough, were leeches and skeletons (perhaps as a political sop to the American Medical Association, as one wag wryly remarked).

Tariffs on linseed oil, tungsten, and casein hammered the U.S. paint, steel and paper industries, respectively. More than 800 items used in automobile production were taxed by Smoot-Hawley. Most of the 60,000 people employed in U.S. plants making cheap clothing out of imported wool rags went home jobless after the tariff on wool rags rose by 140 percent.[10]

Officials in the administration and in Congress believed that raising trade barriers would force Americans to buy more goods made at home, which would solve the nagging unemployment problem. But they ignored an important principle of international commerce: Trade is ultimately a two-way street; if foreigners cannot sell their goods here, then they cannot earn the dollars they need to buy here. Or, to put it another way, government cannot shut off imports without simultaneously shutting off exports.

You Tax Me, I Tax You

Foreign companies and their workers were flattened by Smoot-Hawley’s steep tariff rates and foreign governments soon retaliated with trade barriers of their own. With their ability to sell in the American market severely hampered, they curtailed their purchases of American goods. American agriculture was particularly hard hit. With a stroke of the presidential pen, farmers in this country lost nearly a third of their markets. Farm prices plummeted and tens of thousands of farmers went bankrupt. A bushel of wheat that sold for $1 in 1929 was selling for a mere 30 cents by 1932.

With the collapse of agriculture, rural banks failed in record numbers, dragging down hundreds of thousands of their customers. Nine thousand banks closed their doors in the United States between 1930 and 1933. The stock market, which had regained much of the ground it had lost since the previous October, tumbled 20 points on the day Hoover signed Smoot-Hawley into law, and fell almost without respite for the next two years. (The market’s high, as measured by the Dow Jones Industrial Average, was set on Sept. 3, 1929, at 381. It hit its 1929 low of 198 on Nov. 13, then rebounded to 294 by April 1930. It declined again as the tariff bill made its way toward Hoover’s desk in June and did not bottom out until it reached a mere 41 two years later. It would be a quarter-century before the Dow would climb to 381 again.)

The shrinkage in world trade brought on by the tariff wars helped set the stage for World War II a few years later. In 1929, the rest of the world owed American citizens $30 billion. Germany’s Weimar Republic was struggling to pay the enormous reparations bill imposed by the disastrous Treaty of Versailles. When tariffs made it nearly impossible for foreign businessmen to sell their goods in American markets, the burden of their debts became massively heavier and emboldened demagogues like Adolf Hitler. “When goods don’t cross frontiers, armies will,” warns an old but painfully true maxim.

Free Markets or Free Lunches?

Smoot-Hawley by itself should lay to rest the myth that Hoover was a free market practitioner, but there is even more to the story of his administration’s interventionist mistakes. Within a month of the stock market crash, he convened conferences of business leaders for the purpose of jawboning them into keeping wages artificially high even though both profits and prices were falling. Consumer prices plunged almost 25 percent between 1929 and 1933 while nominal wages on average decreased only 15 percent — translating into a substantial increase in wages in real terms, a major component of the cost of doing business. As economist Richard Ebeling notes, “The ‘high-wage’ policy of the Hoover administration and the trade unions … succeeded only in pricing workers out of the labor market, generating an increasing circle of unemployment.”[11]

Hoover dramatically increased government spending for subsidy and relief schemes. In the space of one year alone, from 1930 to 1931, the federal government’s share of GNP soared from 16.4 percent to 21.5 percent.[12] Hoover’s agricultural bureaucracy doled out hundreds of millions of dollars to wheat and cotton farmers even as the new tariffs wiped out their markets. His Reconstruction Finance Corporation ladled out billions more in business subsidies. Commenting decades later on Hoover’s administration, Rexford Guy Tugwell, one of the architects of Franklin Roosevelt’s policies of the 1930s, explained, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.”[13]

Though Hoover at first did lower taxes for the poorest of Americans, Larry Schweikart and Michael Allen in their sweeping A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror stress that he “offered no incentives to the wealthy to invest in new plants to stimulate hiring.” He even taxed bank checks, “which accelerated the decline in the availability of money by penalizing people for writing checks.”[14]

In September 1931, with the money supply tumbling and the economy reeling from the impact of Smoot-Hawley, the Fed imposed the biggest hike in its discount rate in history. Bank deposits fell 15 percent within four months and sizable, deflationary declines in the nation’s money supply persisted through the first half of 1932.

Compounding the error of high tariffs, huge subsidies and deflationary monetary policy, Congress then passed and Hoover signed the Revenue Act of 1932. The largest tax increase in peacetime history, it doubled the income tax. The top bracket actually more than doubled, soaring from 24 percent to 63 percent. Exemptions were lowered; the earned income credit was abolished; corporate and estate taxes were raised; new gift, gasoline and auto taxes were imposed; and postal rates were sharply hiked.

Can any serious scholar observe the Hoover administration’s massive economic intervention and, with a straight face, pronounce the inevitably deleterious effects as the fault of free markets? Schweikart and Allen survey some of the wreckage:

By 1933, the numbers produced by this comedy of errors were staggering: national unemployment rates reached 25 percent, but within some individual cities, the statistics seemed beyond comprehension. Cleveland reported that 50 percent of its labor force was unemployed; Toledo, 80 percent; and some states even averaged over 40 percent. Because of the dual-edged sword of declining revenues and increasing welfare demands, the burden on the cities pushed many municipalities to the brink. Schools in New York shut down, and teachers in Chicago were owed some $20 million. Private schools, in many cases, failed completely. One government study found that by 1933 some fifteen hundred colleges had gone belly-up, and book sales plummeted. Chicago’s library system did not purchase a single book in a year-long period.[15]

Phase III: The New Deal

Franklin Delano Roosevelt won the 1932 presidential election in a landslide, collecting 472 electoral votes to just 59 for the incumbent Herbert Hoover. The platform of the Democratic Party, whose ticket Roosevelt headed, declared, “We believe that a party platform is a covenant with the people to be faithfully kept by the party entrusted with power.” It called for a 25 percent reduction in federal spending, a balanced federal budget, a sound gold currency “to be preserved at all hazards,” the removal of government from areas that belonged more appropriately to private enterprise and an end to the “extravagance” of Hoover’s farm programs. This is what candidate Roosevelt promised, but it bears no resemblance to what President Roosevelt actually delivered.

Washington was rife with both fear and optimism as Roosevelt was sworn in on March 4, 1933 — fear that the economy might not recover and optimism that the new and assertive president just might make a difference. Humorist Will Rogers captured the popular feeling toward FDR as he assembled the new administration: “The whole country is with him, just so he does something. If he burned down the Capitol, we would all cheer and say, well, we at least got a fire started anyhow.”[16]

“Nothing to fear but fear itself”

Roosevelt did indeed make a difference, though probably not the sort of difference for which the country had hoped. He started off on the wrong foot when, in his inaugural address, he blamed the Depression on “unscrupulous money changers.” He said nothing about the role of the Fed’s mismanagement and little about the follies of Congress that had contributed to the problem. As a result of his efforts, the economy would linger in depression for the rest of the decade. Adapting a phrase from 19th century writer Henry David Thoreau, Roosevelt famously declared in his address that, “We have nothing to fear but fear itself.” But as Dr. Hans Sennholz of Grove City College explains, it was FDR’s policies to come that Americans had genuine reason to fear:

In his first 100 days, he swung hard at the profit order. Instead of clearing away the prosperity barriers erected by his predecessor, he built new ones of his own. He struck in every known way at the integrity of the U.S. dollar through quantitative increases and qualitative deterioration. He seized the people’s gold holdings and subsequently devalued the dollar by 40 percent.[17]

Frustrated and angered that Roosevelt had so quickly and thoroughly abandoned the platform on which he was elected, Director of the Bureau of the Budget Lewis W. Douglas resigned after only one year on the job. At Harvard University in May 1935, Douglas made it plain that America was facing a momentous choice:

Will we choose to subject ourselves — this great country — to the despotism of bureaucracy, controlling our every act, destroying what equality we have attained, reducing us eventually to the condition of impoverished slaves of the state? Or will we cling to the liberties for which man has struggled for more than a thousand years? It is important to understand the magnitude of the issue before us. … If we do not elect to have a tyrannical, oppressive bureaucracy controlling our lives, destroying progress, depressing the standard of living … then should it not be the function of the Federal government under a democracy to limit its activities to those which a democracy may adequately deal, such for example as national defense, maintaining law and order, protecting life and property, preventing dishonesty, and … guarding the public against … vested special interests?[18]

New Dealing from the Bottom of the Deck

Crisis gripped the banking system when the new president assumed office on March 4, 1933. Roosevelt’s action to close the banks and declare a nationwide “banking holiday” on March 6 (which did not completely end until nine days later) is still hailed as a decisive and necessary action by Roosevelt apologists. Friedman and Schwartz, however, make it plain that this supposed cure was “worse than the disease.” The Smoot-Hawley tariff and the Fed’s unconscionable monetary mischief were primary culprits in producing the conditions that gave Roosevelt his excuse to temporarily deprive depositors of their money, and the bank holiday did nothing to alter those fundamentals. “More than 5,000 banks still in operation when the holiday was declared did not reopen their doors when it ended, and of these, over 2,000 never did thereafter,” report Friedman and Schwartz.[19]

Economist Jim Powell of the Cato Institute authored a splendid book on the Great Depression in 2003, titled “FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression”. He points out that “Almost all the failed banks were in states with unit banking laws” — laws that prohibited banks from opening branches and thereby diversifying their portfolios and reducing their risks. Powell writes: “Although the United States, with its unit banking laws, had thousands of bank failures, Canada, which permitted branch banking, didn’t have a single failure …”[20] Strangely, critics of capitalism who love to blame the market for the Depression never mention that fact.

Congress gave the president the power first to seize the private gold holdings of American citizens and then to fix the price of gold. One morning, as Roosevelt ate eggs in bed, he and Secretary of the Treasury Henry Morgenthau decided to change the ratio between gold and paper dollars. After weighing his options, Roosevelt settled on a 21 cent price hike because “it’s a lucky number.” In his diary, Morgenthau wrote, “If anybody ever knew how we really set the gold price through a combination of lucky numbers, I think they would be frightened.”[21] Roosevelt also single-handedly torpedoed the London Economic Conference in 1933, which was convened at the request of other major nations to bring down tariff rates and restore the gold standard.

Washington and its reckless central bank had already made mincemeat of the gold standard by the early 1930s. Roosevelt’s rejection of it removed most of the remaining impediments to limitless currency and credit expansion, for which the nation would pay a high price in later years in the form of a depreciating currency. Sen. Carter Glass put it well when he warned Roosevelt in early 1933: “It’s dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It is breaking its promise to redeem its paper money in gold coin of the present standard of value. It’s dishonor, sir.”[22]

Though he seized the country’s gold, Roosevelt did return booze to America’s bars and parlor rooms. On his second Sunday in the White House, he remarked at dinner, “I think this would be a good time for beer.”[23] That same night, he drafted a message asking Congress to end Prohibition. The House approved a repeal measure on Tuesday, the Senate passed it on Thursday and before the year was out, enough states had ratified it so that the 21st Amendment became part of the Constitution. One observer, commenting on this remarkable turn of events, noted that of two men walking down the street at the start of 1933 — one with a gold coin in his pocket and the other with a bottle of whiskey in his coat — the man with the coin would be an upstanding citizen and the man with the whiskey would be the outlaw. A year later, precisely the reverse was true.

In the first year of the New Deal, Roosevelt proposed spending $10 billion while revenues were only $3 billion. Between 1933 and 1936, government expenditures rose by more than 83 percent. Federal debt skyrocketed by 73 percent.

FDR talked Congress into creating Social Security in 1935 and imposing the nation’s first comprehensive minimum wage law in 1938. While to this day he gets a great deal of credit for these two measures from the general public, many economists have a different perspective. The minimum wage law prices many of the inexperienced, the young, the unskilled and the disadvantaged out of the labor market. (For example, the minimum wage provisions passed as part of another act in 1933 threw an estimated 500,000 blacks out of work).[24] And current studies and estimates reveal that Social Security has become such a long-term actuarial nightmare that it will either have to be privatized or the already high taxes needed to keep it afloat will have to be raised to the stratosphere.

Roosevelt secured passage of the Agricultural Adjustment Act, which levied a new tax on agricultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle. Federal agents oversaw the ugly spectacle of perfectly good fields of cotton, wheat and corn being plowed under (the mules had to be convinced to trample the crops; they had been trained, of course, to walk between the rows). Healthy cattle, sheep and pigs were slaughtered and buried in mass graves. Secretary of Agriculture Henry Wallace personally gave the order to slaughter 6 million baby pigs before they grew to full size. The administration also paid farmers for the first time for not working at all. Even if the AAA had helped farmers by curtailing supplies and raising prices, it could have done so only by hurting millions of others who had to pay those prices or make do with less to eat.

Blue Eagles, Red Ducks

Perhaps the most radical aspect of the New Deal was the National Industrial Recovery Act, passed in June 1933, which created a massive new bureaucracy called the National Recovery Administration. Under the NRA, most manufacturing industries were suddenly forced into government-mandated cartels. Codes that regulated prices and terms of sale briefly transformed much of the American economy into a fascist-style arrangement, while the NRA was financed by new taxes on the very industries it controlled. Some economists have estimated that the NRA boosted the cost of doing business by an average of 40 percent — not something a depressed economy needed for recovery.

The economic impact of the NRA was immediate and powerful. In the five months leading up to the act’s passage, signs of recovery were evident: factory employment and payrolls had increased by 23 and 35 percent, respectively. Then came the NRA, shortening hours of work, raising wages arbitrarily and imposing other new costs on enterprise. In the six months after the law took effect, industrial production dropped 25 percent. Benjamin M. Anderson writes, “NRA was not a revival measure. It was an antirevival measure. …  Through the whole of the NRA period industrial production did not rise as high as it had been in July 1933, before NRA came in.”[25]

The man Roosevelt picked to direct the NRA effort was General Hugh “Iron Pants” Johnson, a profane, red-faced bully and professed admirer of Italian dictator Benito Mussolini. Thundered Johnson, “May Almighty God have mercy on anyone who attempts to interfere with the Blue Eagle” (the official symbol of the NRA, which one senator derisively referred to as the “Soviet duck”). Those who refused to comply with the NRA Johnson personally threatened with public boycotts and “a punch in the nose.”

There were ultimately more than 500 NRA codes, “ranging from the production of lightning rods to the manufacture of corsets and brassieres, covering more than 2 million employers and 22 million workers.”[26] There were codes for the production of hair tonic, dog leashes, and even musical comedies. A New Jersey tailor named Jack Magid was arrested and sent to jail for the “crime” of pressing a suit of clothes for 35 cents rather than the NRA-inspired “Tailor’s Code” of 40 cents.

In “The Roosevelt Myth”, historian John T. Flynn described how the NRA’s partisans sometimes conducted “business”:

The NRA was discovering it could not enforce its rules. Black markets grew up. Only the most violent police methods could procure enforcement. In Sidney Hillman’s garment industry the code authority employed enforcement police. They roamed through the garment district like storm troopers. They could enter a man’s factory, send him out, line up his employees, subject them to minute interrogation, take over his books on the instant. Night work was forbidden. Flying squadrons of these private coat-and-suit police went through the district at night, battering down doors with axes looking for men who were committing the crime of sewing together a pair of pants at night. But without these harsh methods many code authorities said there could be no compliance because the public was not back of it.[27]

The Alphabet Commissars

Roosevelt next signed into law steep income tax increases on the higher brackets and introduced a 5 percent withholding tax on corporate dividends. He secured another tax increase in 1934. In fact, tax hikes became a favorite policy of Roosevelt for the next 10 years, culminating in a top income tax rate of 90 percent. Sen. Arthur Vandenberg of Michigan, who opposed much of the New Deal, lambasted Roosevelt’s massive tax increases. A sound economy would not be restored, he said, by following the socialist notion that America could “lift the lower one-third up” by pulling “the upper two-thirds down.”[28] Vandenberg also condemned “the congressional surrender to alphabet commissars who deeply believe the American people need to be regimented by powerful overlords in order to be saved.”[29]

Alphabet commissars spent the public’s money like it was so much bilge. They were what influential journalist and social critic Albert Jay Nock had in mind when he described the New Deal as “a nation-wide, State-managed mobilization of inane buffoonery and aimless commotion.”[30]

Roosevelt’s Civil Works Administration hired actors to give free shows and librarians to catalog archives. It even paid researchers to study the history of the safety pin, hired 100 Washington workers to patrol the streets with balloons to frighten starlings away from public buildings, and put men on the public payroll to chase tumbleweeds on windy days.

The CWA, when it was started in the fall of 1933, was supposed to be a short-lived jobs program. Roosevelt assured Congress in his State of the Union message that any new such program would be abolished within a year. “The federal government,” said the president, “must and shall quit this business of relief. I am not willing that the vitality of our people be further stopped by the giving of cash, of market baskets, of a few bits of weekly work cutting grass, raking leaves, or picking up papers in the public parks.” Harry Hopkins was put in charge of the agency and later said, “I’ve got four million at work but for God’s sake, don’t ask me what they are doing.” The CWA came to an end within a few months but was replaced with another temporary relief program that evolved into the Works Progress Administration, or WPA, by 1935. It is known today as the very government program that gave rise to the new term, “boondoggle,” because it “produced” a lot more than the 77,000 bridges and 116,000 buildings to which its advocates loved to point as evidence of its efficacy.[31]

With good reason, critics often referred to the WPA as “We Piddle Around.” In Kentucky, WPA workers catalogued 350 different ways to cook spinach. The agency employed 6,000 “actors” though the nation’s actors’ union claimed only 4,500 members. Hundreds of WPA workers were used to collect campaign contributions for Democratic Party candidates. In Tennessee, WPA workers were fired if they refused to donate 2 percent of their wages to the incumbent governor. By 1941, only 59 percent of the WPA budget went to paying workers anything at all; the rest was sucked up in administration and overhead. The editors of The New Republic asked, “Has [Roosevelt] the moral stature to admit now that the WPA was a hasty and grandiose political gesture, that it is a wretched failure and should be abolished?”[32] The last of the WPA’s projects was not eliminated until July of 1943.

Roosevelt has been lauded for his “job-creating” acts such as the CWA and the WPA. Many people think that they helped relieve the Depression. What they fail to realize is that it was the rest of Roosevelt’s tinkering that prolonged the Depression and which largely prevented the jobless from finding real jobs in the first place. The stupefying roster of wasteful spending generated by these jobs programs represented a diversion of valuable resources to politically motivated and economically counterproductive purposes.

A brief analogy will illustrate this point. If a thief goes house to house robbing everybody in the neighborhood, then heads off to a nearby shopping mall to spend his ill-gotten loot, it is not assumed that because his spending “stimulated” the stores at the mall he has thereby performed a national service or provided a general economic benefit. Likewise, when the government hires someone to catalog the many ways of cooking spinach, his tax-supported paycheck cannot be counted as a net increase to the economy because the wealth used to pay him was simply diverted, not created. Economists today must still battle this “magical thinking” every time more government spending is proposed — as if money comes not from productive citizens, but rather from the tooth fairy.

“An astonishing rabble of impudent nobodies”

Roosevelt’s haphazard economic interventions garnered credit from people who put high value on the appearance of being in charge and “doing something.” Meanwhile, the great majority of Americans were patient. They wanted very much to give this charismatic polio victim and former New York governor the benefit of the doubt. But Roosevelt always had his critics, and they would grow more numerous as the years groaned on. One of them was the inimitable “Sage of Baltimore,” H. L. Mencken, who rhetorically threw everything but the kitchen sink at the president. Paul Johnson sums up Mencken’s stinging but often-humorous barbs this way:

Mencken excelled himself in attacking the triumphant FDR, whose whiff of fraudulent collectivism filled him with genuine disgust. He was the ‘Fuhrer,’ the ‘Quack,’ surrounded by ‘an astonishing rabble of impudent nobodies,’ ‘a gang of half-educated pedagogues, nonconstitutional lawyers, starry-eyed uplifters and other such sorry wizards.’ His New Deal was a ‘political racket,’ a ‘series of stupendous bogus miracles,’ with its ‘constant appeals to class envy and hatred,’ treating government as ‘a milch-cow with 125 million teats’ and marked by ‘frequent repudiations of categorical pledges.’[33]

Signs of Life

The American economy was soon relieved of the burden of some of the New Deal’s worst excesses when the Supreme Court outlawed the NRA in 1935 and the AAA in 1936, earning Roosevelt’s eternal wrath and derision. Recognizing much of what Roosevelt did as unconstitutional, the “nine old men” of the Court also threw out other, more minor acts and programs which hindered recovery.

Freed from the worst of the New Deal, the economy showed some signs of life. Unemployment dropped to 18 percent in 1935, 14 percent in 1936, and even lower in 1937. But by 1938, it was back up to nearly 20 percent as the economy slumped again. The stock market crashed nearly 50 percent between August 1937 and March 1938. The “economic stimulus” of Franklin Delano Roosevelt’s New Deal had achieved a real “first”: a depression within a depression!

Phase IV:

The Wagner Act

The stage was set for the 1937-38 collapse with the passage of the National Labor Relations Act in 1935 — better known as the “Wagner Act” and organized labor’s “Magna Carta.” To quote Sennholz again:

This law revolutionized American labor relations. It took labor disputes out of the courts of law and brought them under a newly created Federal agency, the National Labor Relations Board, which became prosecutor, judge, and jury, all in one. Labor union sympathizers on the Board further perverted this law, which already afforded legal immunities and privileges to labor unions. The U.S. thereby abandoned a great achievement of Western civilization, equality under the law.

The Wagner Act, or National Labor Relations Act, was passed in reaction to the Supreme Court’s voidance of NRA and its labor codes. It aimed at crushing all employer resistance to labor unions. Anything an employer might do in self-defense became an “unfair labor practice” punishable by the Board. The law not only obliged employers to deal and bargain with the unions designated as the employees’ representative; later Board decisions also made it unlawful to resist the demands of labor union leaders.[34]

Armed with these sweeping new powers, labor unions went on a militant organizing frenzy. Threats, boycotts, strikes, seizures of plants and widespread violence pushed productivity down sharply and unemployment up dramatically. Membership in the nation’s labor unions soared: By 1941, there were two and a half times as many Americans in unions as had been the case in 1935. Historian William E. Leuchtenburg, himself no friend of free enterprise, observed, “Property-minded citizens were scared by the seizure of factories, incensed when strikers interfered with the mails, vexed by the intimidation of nonunionists, and alarmed by flying squadrons of workers who marched, or threatened to march, from city to city.”[35]

An Unfriendly Climate for Business

From the White House on the heels of the Wagner Act came a thunderous barrage of insults against business. Businessmen, Roosevelt fumed, were obstacles on the road to recovery. He blasted them as “economic royalists” and said that businessmen as a class were “stupid.”[36] He followed up the insults with a rash of new punitive measures. New strictures on the stock market were imposed. A tax on corporate retained earnings, called the “undistributed profits tax,” was levied. “These soak-the-rich efforts,” writes economist Robert Higgs, “left little doubt that the president and his administration intended to push through Congress everything they could to extract wealth from the high-income earners responsible for making the bulk of the nation’s decisions about private investment.”[37]

During a period of barely two months during late 1937, the market for steel — a key economic barometer — plummeted from 83 percent of capacity to 35 percent. When that news emblazoned headlines, Roosevelt took an ill-timed nine-day fishing trip. The New York Herald-Tribune implored him to get back to work to stem the tide of the renewed Depression. What was needed, said the newspaper’s editors, was a reversal of the Roosevelt policy “of bitterness and hate, of setting class against class and punishing all who disagreed with him.”[38]

Columnist Walter Lippmann wrote in March 1938 that “with almost no important exception every measure he [Roosevelt] has been interested in for the past five months has been to reduce or discourage the production of wealth.”[39]

As pointed out earlier in this essay, Herbert Hoover’s own version of a “New Deal” had hiked the top marginal income tax rate from 24 to 63 percent in 1932. But he was a piker compared to his tax-happy successor. Under Roosevelt, the top rate was raised at first to 79 percent and then later to 90 percent. Economic historian Burton Folsom notes that in 1941 Roosevelt even proposed a whopping 99.5-percent marginal rate on all incomes over $100,000. “Why not?” he said when an advisor questioned the idea.[40]

After that confiscatory proposal failed, Roosevelt issued an executive order to tax all income over $25,000 at the astonishing rate of 100 percent. He also promoted the lowering of the personal exemption to only $600, a tactic that pushed most American families into paying at least some income tax for the first time. Shortly thereafter, Congress rescinded the executive order, but went along with the reduction of the personal exemption.[41]

Meanwhile, the Federal Reserve again seesawed its monetary policy in the mid-1930s, first up then down, then up sharply through America’s entry into World War II. Contributing to the economic slide of 1937 was this fact: From the summer of 1936 to the spring of 1937, the Fed doubled reserve requirements on the nation’s banks. Experience has shown time and again that a roller-coaster monetary policy is enough by itself to produce a roller-coaster economy.

Still stinging from his earlier Supreme Court defeats, Roosevelt tried in 1937 to “pack” the Supreme Court with a proposal to allow the president to appoint an additional justice to the Court for every sitting justice who had reached the age of 70 and did not retire. Had this proposal passed, Roosevelt could have appointed six new justices favorable to his views, increasing the members of the Court from 9 to 15. His plan failed in Congress, but the Court later began rubber-stamping his policies after a number of opposing justices retired. Until Congress killed the packing scheme, however, business fears that a Court sympathetic to Roosevelt’s goals would endorse more of the old New Deal prevented investment and confidence from reviving.

Economic historian Robert Higgs draws a close connection between the level of private investment and the course of the American economy in the 1930s. The relentless assaults of the Roosevelt administration — in both word and deed — against business, property, and free enterprise guaranteed that the capital needed to jump-start the economy was either taxed away or forced into hiding. When FDR took America to war in 1941, he eased up on his anti-business agenda, but a great deal of the nation’s capital was diverted into the war effort instead of into plant expansion or consumer goods. Not until both Roosevelt and the war were gone did investors feel confident enough to “set in motion the postwar investment boom that powered the economy’s return to sustained prosperity.”[42]

This view gains support in these comments from one of the country’s leading investors of the time, Lammot du Pont, offered in 1937:

Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don’t know. Is labor to be union or non-union? . . . Are we to have inflation or deflation, more government spending or less? … Are new restrictions to be placed on capital, new limits on profits? … It is impossible to even guess at the answers.”[43]

Many modern historians tend to be reflexively anti-capitalist and distrustful of free markets; they find Roosevelt’s exercise of power, constitutional or not, to be impressive and historically “interesting.” In surveys, a majority consistently rank FDR near the top of the list for presidential greatness, so it is likely they would disdain the notion that the New Deal was responsible for prolonging the Great Depression. But when a nationally representative poll by the American Institute of Public Opinion in the spring of 1939 asked, “Do you think the attitude of the Roosevelt administration toward business is delaying business recovery?” the American people responded “yes” by a margin of more than 2-to-1. The business community felt even more strongly so.[44]

In his private diary, FDR’s very own Treasury Secretary, Henry Morgenthau, seemed to agree. He wrote: “We have tried spending money. We are spending more than we have ever spent before and it does not work. … We have never made good on our promises. … I say after eight years of this Administration we have just as much unemployment as when we started … and an enormous debt to boot!”[45]

At the end of the decade and 12 years after the stock market crash of Black Thursday, 10 million Americans were jobless. The unemployment rate was in excess of 17 percent. Roosevelt had pledged in 1932 to end the crisis, but it persisted two presidential terms and countless interventions later.

Whither Free Enterprise?

How was it that FDR was elected four times if his policies were deepening and prolonging an economic catastrophe? Ignorance and a willingness to give the president the benefit of the doubt explain a lot. Roosevelt beat Hoover in 1932 with promises of less government. He instead gave Americans more government, but he did so with fanfare and fireside chats that mesmerized a desperate people. By the time they began to realize that his policies were harmful, World War II came, the people rallied around their commander-in-chief, and there was little desire to change the proverbial horse in the middle of the stream by electing someone new.

Along with the holocaust of World War II came a revival of trade with America’s allies. The war’s destruction of people and resources did not help the U.S. economy, but this renewed trade did. A reinflation of the nation’s money supply counteracted the high costs of the New Deal, but brought with it a problem that plagues us to this day: a dollar that buys less and less in goods and services year after year. Most importantly, the Truman administration that followed Roosevelt was decidedly less eager to berate and bludgeon private investors and as a result, those investors re-entered the economy and fueled a powerful postwar boom. The Great Depression finally ended, but it should linger in our minds today as one of the most colossal and tragic failures of government and public policy in American history.

The genesis of the Great Depression lay in the irresponsible monetary and fiscal policies of the U.S. government in the late 1920s and early 1930s. These policies included a litany of political missteps: central bank mismanagement, trade-crushing tariffs, incentive-sapping taxes, mind-numbing controls on production and competition, senseless destruction of crops and cattle and coercive labor laws, to recount just a few. It was not the free market that produced 12 years of agony; rather, it was political bungling on a grand scale.

Those who can survey the events of the 1920s and 1930s and blame free-market capitalism for the economic calamity have their eyes, ears and minds firmly closed to the facts. Changing the wrong-headed thinking that constitutes much of today’s conventional wisdom about this sordid historical episode is vital to reviving faith in free markets and preserving our liberties.

The nation managed to survive both Hoover’s activism and Roosevelt’s New Deal quackery, and now the American heritage of freedom awaits a rediscovery by a new generation of citizens. This time we have nothing to fear but myths and misconceptions.

- END -

Postscript:

Have We Learned Our Lessons?

Eighty years after the Great Depression began, the literature on this painful episode of American history is undergoing an encouraging metamorphosis. The conventional assessment that so dominated historical writings for decades argued that free markets caused the debacle and that FDR’s New Deal saved the country. Surely, there are plenty of poorly-informed partisans, ideologues and quacks that still make these superficial claims. Serious historians and economists, however, have been busy chipping away at the falsehoods. The essay you have just read cites many recent works worth careful reading in their entirety.

At the very moment this latest edition of “Great Myths of the Great Depression” was about to go to press, Simon & Schuster published a splendid new volume I strongly recommend. Authored by the Foundation for Economic Education’s senior historian and Hillsdale College professor, Dr. Burton W. Folsom, the book is provocatively titled “New Deal or Raw Deal? — How FDR’s Economic Legacy Has Damaged America.” It’s one of the most illuminating works on the subject. It will help mightily to correct the record and educate our fellow citizens about what really happened in the 1930s.

Another great addition to the literature, appearing in 2007, is “The Forgotten Man: A New History of the Great Depression” by Amity Shlaes. The fact that it has been a New York Times bestseller suggests there is a real hunger for the truth about this period of history.

While Americans may be unlearning some of what they thought they knew about the Great Depression, that’s not the same as saying we have learned the important lessons well enough to avoid making the same mistakes again. Indeed, today we are no closer to fixing the primary cause of the business cycle — monetary mischief — than we were 80 years ago.

The financial crisis that gripped America in 2008 ought to be a wake-up call. The fingerprints of government meddling are all over it. From 2001 to 2005, the Federal Reserve revved up the money supply, expanding it at a feverish double-digit rate. The dollar plunged in overseas markets and commodity prices soared. With the banks flush with liquidity from the Fed, interest rates plummeted and risky loans to borrowers of dubious merit ballooned. Politicians threw more fuel on the fire by jawboning banks to lend hundreds of billions of dollars for subprime mortgages.

When the bubble burst, some of the very culprits who promoted the policies that caused it postured as our rescuers while endorsing new interventions, bigger government, more inflation of money and credit and massive taxpayer bailouts of failing firms. Many of them are also calling for higher taxes and tariffs, the very nonsense that took a recession in 1930 and made it a long and deep depression.

The taxpayer bailouts of agencies such as Fannie Mae and Freddie Mac, as well as a growing number of private firms in the early fall of 2008, represent more folly with a monumental price tag. Not only will we and future generations be paying those bills for decades, the very process of throwing good money after bad will pile moral hazard on top of moral hazard, fostering more bad decisions and future bailouts. This is the stuff that undermines both free enterprise and the soundness of the currency. Much more inflation to pay these bills is more than a little likely, sooner or later.

“Government,” observed the renowned Austrian economist Ludwig von Mises, “is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.” Mises was describing the curse of inflation, the process whereby government expands a nation’s money supply and thereby erodes the value of each monetary unit — dollar, peso, pound, franc or whatever. It often shows up  in the form of rising prices, which most people confuse with the inflation itself. The distinction is an important one because, as economist Percy Greaves explained so eloquently, “Changing the definition changes the responsibility.”

Define inflation as rising prices and, like the clueless Jimmy Carter of the 1970s, you’ll think that oil sheiks, credit cards and private businesses are the culprits, and price controls are the answer. Define inflation in the classic fashion as an increase in the supply of money and credit, with rising prices as a consequence, and you then have to ask the revealing question, “Who increases the money supply?” Only one entity can do that legally; all others are called “counterfeiters” and go to jail.

Nobel laureate Milton Friedman argued indisputably that inflation is always and everywhere a monetary matter. Rising prices no more cause inflation than wet streets cause rain.

Before paper money, governments inflated by diminishing the precious-metal content of their coinage. The ancient prophet Isaiah reprimanded the Israelites with these words: “Thy silver has become dross, thy wine mixed with water.” Roman emperors repeatedly melted down the silver denarius and added junk metals until the denarius was less than one percent silver. The Saracens of Spain clipped the edges of their coins so they could mint more until the coins became too small to circulate. Prices rose as a mirror image of the currency’s worth.

Rising prices are not the only consequence of monetary and credit expansion. Inflation also erodes savings and encourages debt. It undermines confidence and deters investment. It destabilizes the economy by fostering booms and busts. If it’s bad enough, it can even wipe out the very government responsible for it in the first place and then lead to even worse afflictions. Hitler and Napoleon both rose to power in part because of the chaos of runaway inflations.

All this raises many issues economists have long debated: Who or what should determine a nation’s supply of money? Why do governments so regularly mismanage it? What is the connection between fiscal and monetary policy? Suffice it to say here that governments inflate because their appetite for revenue exceeds their willingness to tax or their ability to borrow. British economist John Maynard Keynes was an influential charlatan in many ways, but he nailed it when he wrote, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

So, you say, inflation is nasty business but it’s just an isolated phenomenon with the worst cases confined to obscure nooks and crannies like Zimbabwe. Not so. The late Frederick Leith-Ross, a famous authority on international finance, observed: “Inflation is like sin; every government denounces it and every government practices it.” Even Americans have witnessed hyperinflations that destroyed two currencies — the ill-fated continental dollar of the Revolutionary War and the doomed Confederate money of the Civil War.

Today’s slow-motion dollar depreciation, with consumer prices rising at persistent but mere single-digit rates, is just a limited version of the same process. Government spends, runs deficits and pays some of its bills through the inflation tax. How long it can go on is a matter of speculation, but trillions in national debt and politicians who make misers of drunken sailors and get elected by promising even more are not factors that should encourage us.

Inflation is very much with us but it must end someday. A currency’s value is not bottomless. Its erosion must cease either because government stops its reckless printing or prints until it wrecks the money. But surely, which way it concludes will depend in large measure on whether its victims come to understand what it is and where it comes from. Meanwhile, our economy looks like a roller coaster because Congresses, Presidents and the agencies they’ve empowered never cease their monetary mischief.

Are you tired of politicians blaming each other, scrambling to cover their behinds and score political points in the midst of a crisis, and piling debts upon debts they audaciously label “stimulus packages”?  Why do so many Americans want to trust them with their health care, education, retirement and a host of other aspects of their lives? It’s madness writ large. The antidote is the truth. We must learn the lessons of our follies and resolve to fix them now, not later.

To that end, I invite the reader to join the education process. Support organizations like FEE that are working to inform citizens about the proper role of government and how a free economy operates. Help distribute copies of this essay and other good publications that promote liberty and free enterprise. Demand that your representatives in government balance the budget, conform to the spirit and letter of the Constitution and stop trying to buy your vote with other people’s money.

Everyone has heard the sage observation of philosopher George Santayana: “Those who cannot remember the past are condemned to repeat it.” It’s a warning we should not fail to heed.

Endnotes

1 Alan Reynolds, “What Do We Know About the Great Crash?” National Review, November 9, 1979, p. 1416.

2 Hans F. Sennholz, “The Great Depression,” The Freeman, April 1975, p. 205.

3 Murray Rothbard, America’s Great Depression (Kansas City: Sheed and Ward, Inc., 1975), p. 89.

4 Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States, 1914-46, 2nd edition (Indianapolis: Liberty Press, 1979), p. 127.

5 Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960 (New York: National Bureau of Economic Research, 1963; ninth paperback printing by Princeton University Press, 1993), pp. 411-415.

6 Lindley H. Clark, Jr., “After the Fall,” The Wall Street Journal, October 26, 1979, p. 18.

7 “Tearful Memories That Just Won’t Fade Away,” U. S. News & World Report, October 29, 1979, pp. 36-37.

8 “FDR’s Disputed Legacy,” Time, February 1, 1982, p. 23.

9 Barry W. Poulson, Economic History of the United States (New York: Macmillan Publishing Co., Inc., 1981), p. 508.

10 Reynolds, p. 1419.

11 Richard M. Ebeling, “Monetary Central Planning and the State-Part XI: The Great Depression and the Crisis of Government Intervention,” Freedom Daily (Fairfax, Virginia: The Future of Freedom Foundation, November 1997), p. 15.

12 Paul Johnson, A History of the American People (New York: HarperCollins Publishers, 1997), p. 740.

13 Ibid., p. 741.

14 Larry Schweikart and Michael Allen, A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror (New York: Sentinel, 2004), p. 553.

15 Ibid., p. 554.

16 “FDR’s Disputed Legacy,” p. 24.

17 Sennholz, p. 210.

18 From The Liberal Tradition: A Free People and a Free Economy by Lewis W. Douglas, as quoted in “Monetary Central Planning and the State, Part XIV: The New Deal and Its Critics,” by Richard M. Ebeling in Freedom Daily, February 1998, p. 12.

19 Friedman and Schwartz, p. 330.

20 Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (New York: Crown Forum, 2003), p. 32.

21 John Morton Blum, From the Morgenthau Diaries: Years of Crisis, 1928-1938 (Boston: Houghton Mifflin Company, 1959), p. 70.

22 Anderson, p. 315.

23 “FDR’s Disputed Legacy,” p. 24.

24 Anderson, p. 336.

25 Ibid., pp. 332-334.

26 “FDR’s Disputed Legacy,” p. 30.

27 John T. Flynn, The Roosevelt Myth (Garden City, N.Y.: Garden City Publishing Co., Inc., 1949), p. 45.

28 C. David Tompkins, Senator Arthur H. Vandenberg: The Evolution of a Modern Republican, 1884-1945 (East Lansing, MI: Michigan State University Press, 1970), p. 157.

29 Ibid., p. 121.

30 Albert J. Nock, Our Enemy, the State (online at www.barefootsworld.net/nockoets1.html), Chapter 1, Section IV.

31 Martin Morse Wooster, “Bring Back the WPA? It Also Had A Seamy Side,” Wall Street Journal, September 3, 1986, p. A26.

32 Ibid.

33 Johnson, p. 762.

34 Sennholz, pp. 212-213.

35 William E. Leuchtenburg, Franklin D. Roosevelt and the New Deal, 1932-1940 (New York: Harper and Row, 1963), p. 242.

36 Ibid., pp. 183-184.

37 Robert Higgs, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War,” The Independent Review, Volume I, Number 4: Spring 1997, p. 573.

38 Gary Dean Best, The Critical Press and the New Deal: The Press Versus Presidential Power, 1933-1938 (Westport, Connecticut: Praeger Publishers, 1993), p. 130.

39 Ibid., p. 136.

40 Burton Folsom, “What’s Wrong With The Progressive Income Tax?”, Viewpoint on Public Issues, No. 99-18, May 3, 1999, Mackinac Center for Public Policy, Midland, Michigan.

41 Ibid.

42 Higgs, p. 564.

43 Quoted in Herman E. Krooss, Executive Opinion: What Business Leaders Said and Thought on Economic Issues, 1920s-1960s (Garden City, N.Y.: Doubleday and Co., 1970), p. 200.

44 Higgs, p. 577.

45 Blum, pp. 24-25.

Photo Credits

Cover, Artwork based on a poster created by Works Progress Administration between 1941 and 1943.

Page 1, Library of Congress, Prints and Photographs Division, [LC-USF34-T01-018258-C DLC].

Page 2, Federal Reserve Building, Library of Congress, Prints and Photographs Division, Theodor Horydczak Collection [LC-H814-T-F03-003 DLC].

Page 3, Unemployment, Michigan State Archives.

Page 5, Farm Relief Act, Library of Congress, National Photo Company Collection, [LC-USZ62-111718 DLC].

Page 6, Roosevelt, Library of Congress, Prints and Photographs Division [LC-USZ62-117121 DLC].

Page 7, Roosevelt, Franklin D. Roosevelt Library and Museum.

Page 9, Bridge, Library of Congress, Prints and Photographs Division, Historic American Buildings Survey or Historic American Engineering Record, Reproduction Number [HAER,?TEX,42-VOS.V,4-].

Page 11, Steel Mill, Library of Congress, Prints and Photographs Division, Theodor Horydczak Collection [LC-H814-T-0601 DLC].

Page 12, Supreme Court Building, Library of Congress, Prints & Photographs Division, FSA-OWI Collection, [LC-USF34-005615-E DLC].

Page 13, Strikers, Archives of Labor and Urban Affairs, Wayne State University.

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One day in the House of Representatives, a bill was taken up appropriating money for the benefit of a widow of a distinguished naval officer. Several beautiful speeches had been made in its support. The Speaker was just about to put the question when Crockett arose:

“Mr. Speaker–I have as much respect for the memory of the deceased, and as much sympathy for the sufferings of the living, if suffering there be, as any man in this House, but we must not permit our respect for the dead or our sympathy for a part of the living to lead us into an act of injustice to the balance of the living. I will not go into an argument to prove that Congress has no power to appropriate this money as an act of charity. Every member upon this floor knows it. We have the right, as individuals, to give away as much of our own money as we please in charity; but as members of Congress we have no right so to appropriate a dollar of the public money. Some eloquent appeals have been made to us upon the ground that it is a debt due the deceased. Mr. Speaker, the deceased lived long after the close of the war; he was in office to the day of his death, and I have never heard that the government was in arrears to him.

Every man in this House knows it is not a debt. We cannot, without the grossest corruption, appropriate this money as the payment of a debt. We have not the semblance of authority to appropriate it as a charity. Mr. Speaker, I have said we have the right to give as much money of our own as we please. I am the poorest man on this floor. I cannot vote for this bill, but I will give one week’s pay to the object, and if every member of Congress will do the same, it will amount to more than the bill asks.”

He took his seat. Nobody replied. The bill was put upon its passage, and, instead of passing unanimously, as was generally supposed, and as, no doubt, it would, but for that speech, it received but few votes, and, of course, was lost.

Later, when asked by a friend why he had opposed the appropriation, Crockett gave this explanation:

“Several years ago I was one evening standing on the steps of the Capitol with some other members of Congress, when our attention was attracted by a great light over in Georgetown . It was evidently a large fire. We jumped into a hack and drove over as fast as we could. In spite of all that could be done, many houses were burned and many families made homeless, and, besides, some of them had lost all but the clothes they had on. The weather was very cold, and when I saw so many women and children suffering, I felt that something ought to be done for them. The next morning a bill was introduced appropriating $20,000 for their relief. We put aside all other business and rushed it through as soon as it could be done.

“The next summer, when it began to be time to think about the election, I concluded I would take a scout around among the boys of my district. I had no opposition there, but, as the election was some time off, I did not know what might turn up. When riding one day in a part of my district in which I was more of a stranger than any other, I saw a man in a field plowing and coming toward the road. I gauged my gait so that we should meet as he came to the fence. As he came up, I spoke to the man. He replied politely, but, as I thought, rather coldly.

“I began: ‘Well, friend, I am one of those unfortunate beings called candidates, and–’

“‘Yes, I know you; you are Colonel Crockett, I have seen you once before, and voted for you the last time you were elected. I suppose you are out electioneering now, but you had better not waste your time or mine. I shall not vote for you again.’

“This was a sockdolager . . . I begged him to tell me what was the matter.

“‘Well, Colonel, it is hardly worth-while to waste time or words upon it. I do not see how it can be mended, but you gave a vote last winter which shows that either you have not capacity to understand the Constitution, or that you are wanting in the honesty and firmness to be guided by it. In either case you are not the man to represent me. But I beg your pardon for expressing it in that way. I did not intend to avail myself of the privilege of the constituent to speak plainly to a candidate for the purpose of insulting or wounding you. I intend by it only to say that your understanding of the Constitution is very different from mine; and I will say to you what, but for my rudeness, I should not have said, that I believe you to be honest. . . . But an understanding of the Constitution different from mine I cannot overlook, because the Constitution, to be worth anything, must be held sacred, and rigidly observed in all its provisions. The man who wields power and misinterprets it is the more dangerous the more honest he is.’

“‘I admit the truth of all you say, but there must be some mistake about it, for I do not remember that I gave any vote last winter upon any constitutional question.’

“‘No, Colonel, there’s no mistake. Though I live here in the backwoods and seldom go from home, I take the papers from Washington and read very carefully all the proceedings of Congress. My papers say that last winter you voted for a bill to appropriate $20,000 to some sufferers by a fire in Georgetown . Is that true?’

“‘Well, my friend; I may as well own up. You have got me there. But certainly nobody will complain that a great and rich country like ours should give the insignificant sum of $20,000 to relieve its suffering women and children, particularly with a full and overflowing Treasury, and I am sure, if you had been there, you would have done just as I did.’

“‘It is not the amount, Colonel, that I complain of; it is the principle. In the first place, the government ought to have in the Treasury no more than enough for its legitimate purposes. But that has nothing to do with the question. The power of collecting and disbursing money at pleasure is the most dangerous power that can be intrusted to man, particularly under our system of collecting revenue by a tariff, which reaches every man in the country, no matter how poor he may be, and the poorer he is the more he pays in proportion to his means. What is worse, it presses upon him without his knowledge where the weight centers, for there is not a man in the United States who can ever guess how much he pays to the government. So you see, that while you are contributing to relieve one, you are drawing it from thousands who are even worse off than he. If you had the right to give anything, the amount was simply a matter of discretion with you, and you had as much right to give $20,000,000 as $20,000. If you have the right to give to one, you have the right to give to all; and, as the Constitution neither defines charity nor stipulates the amount, you are at liberty to give to any and everything which you may believe, or profess to believe, is a charity, and to any amount you may think proper. You will very easily perceive what a wide door this would open for fraud and corruption and favoritism, on the one hand, and for robbing the people on the other. No, Colonel, Congress has no right to give charity. Individual members may give as much of their own money as they please, but they have no right to touch a dollar of the public money for that purpose. If twice as many houses had been burned in this county as in Georgetown , neither you nor any other member of Congress would have thought of appropriating a dollar for our relief. There are about two hundred and forty members of Congress. If they had shown their sympathy for the sufferers by contributing each one week’s pay, it would have made over $13,000. There are plenty of wealthy men in and around Washington who could have given $20,000 without depriving themselves of even a luxury of life. The congressmen chose to keep their own money, which, if reports be true, some of them spend not very creditably; and the people about Washington , no doubt, applauded you for relieving them from the necessity of giving by giving what was not yours to give. The people have delegated to Congress, by the Constitution, the power to do certain things. To do these, it is authorized to collect and pay moneys, and for nothing else. Everything beyond this is usurpation, and a violation of the Constitution.

“‘So you see, Colonel, you have violated the Constitution in what I consider a vital point. It is a precedent fraught with danger to the country, for when Congress once begins to stretch its power beyond the limits of the Constitution, there is no limit to it, and no security for the people. I have no doubt you acted honestly, but that does not make it any better, except as far as you are personally concerned, and you see that I cannot vote for you.’

“I tell you I felt streaked. I saw if I should have opposition, and this man should go to talking, he would set others to talking, and in that district I was a gone fawn-skin. I could not answer him, and the fact is, I was so fully convinced that he was right, I did not want to. But I must satisfy him, and I said to him:

“‘Well, my friend, you hit the nail upon the head when you said I had not sense enough to understand the Constitution. I intended to be guided by it, and thought I had studied it fully. I have heard many speeches in Congress about the powers of Congress, but what you have said here at your plow has got more hard, sound sense in it than all the fine speeches I ever heard. If I had ever taken the view of it that you have, I would have put my head into the fire before I would have given that vote; and if you will forgive me and vote for me again, if I ever vote for another unconstitutional law I wish I may be shot.’

“He laughingly replied: ‘Yes, Colonel, you have sworn to that once before, but I will trust you again upon one condition. You say that you are convinced that your vote was wrong. Your acknowledgment of it will do more good than beating you for it. If, as you go around the district, you will tell people about this vote, and that you are satisfied it was wrong, I will not only vote for you, but will do what I can to keep down opposition, and, perhaps, I may exert some little influence in that way.’

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“‘If I don’t,’ said I, ‘I wish I may be shot; and to convince you that I am in earnest in what I say I will come back this way in a week or ten days, and if you will get up a gathering of the people, I will make a speech to them. Get up a barbecue, and I will pay for it.’

“‘No, Colonel, we are not rich people in this section, but we have plenty of provisions to contribute for a barbecue, and some to spare for those who have none. The push of crops will be over in a few days, and we can then afford a day for a barbecue. This is Thursday; I will see to getting it up on Saturday week. Come to my house on Friday, and we will go together, and I promise you a very respectable crowd to see and hear you.’

“‘Well, I will be here. But one thing more before I say good-by. I must know your name.’

“‘My name is Bunce.’

“‘Not Horatio Bunce?’

“‘Yes.’

“‘Well, Mr. Bunce, I never saw you before, though you say you have seen me, but I know you very well. I am glad I have met you, and very proud that I may hope to have you for my friend.’

“It was one of the luckiest hits of my life that I met him. He mingled but little with the public, but was widely known for his remarkable intelligence and incorruptible integrity, and for a heart brimful and running over with kindness and benevolence, which showed themselves not only in words but in acts. He was the oracle of the whole country around him, and his fame had extended far beyond the circle of his immediate acquaintance. Though I had never met him before, I had heard much of him, and but for this meeting it is very likely I should have had opposition, and had been beaten. One thing is very certain, no man could now stand up in that district under such a vote.

“At the appointed time I was at his house, having told our conversation to every crowd I had met, and to every man I stayed all night with, and I found that it gave the people an interest and a confidence in me stronger than I had every seen manifested before.

“Though I was considerably fatigued when I reached his house, and, under ordinary circumstances, should have gone early to bed, I kept him up until midnight, talking about the principles and affairs of government, and got more real, true knowledge of them than I had got all my life before.

“I have known and seen much of him since, for I respect him–no, that is not the word–I reverence and love him more than any living man, and I go to see him two or three times every year; and I will tell you, sir, if every one who professes to be a Christian lived and acted and enjoyed it as he does, the religion of Christ would take the world by storm.

“But to return to my story. The next morning we went to the barbecue, and, to my surprise, found about a thousand men there. I met a good many whom I had not known before, and they and my friend introduced me around until I had got pretty well acquainted–at least, they all knew me.

“In due time notice was given that I would speak to them. They gathered up around a stand that had been erected. I opened my speech by saying:

“‘Fellow-citizens–I present myself before you today feeling like a new man. My eyes have lately been opened to truths which ignorance or prejudice, or both, had heretofore hidden from my view. I feel that I can today offer you the ability to render you more valuable service than I have ever been able to render before. I am here today more for the purpose of acknowledging my error than to seek your votes. That I should make this acknowledgment is due to myself as well as to you. Whether you will vote for me is a matter for your consideration only.’

“I went on to tell them about the fire and my vote for the appropriation and then told them why I was satisfied it was wrong. I closed by saying:

“‘And now, fellow-citizens, it remains only for me to tell you that the most of the speech you have listened to with so much interest was simply a repetition of the arguments by which your neighbor, Mr. Bunce, convinced me of my error.

“‘It is the best speech I ever made in my life, but he is entitled to the credit for it. And now I hope he is satisfied with his convert and that he will get up here and tell you so.’

“He came upon the stand and said:

“‘Fellow-citizens–It affords me great pleasure to comply with the request of Colonel Crockett. I have always considered him a thoroughly honest man, and I am satisfied that he will faithfully perform all that he has promised you today.’

“He went down, and there went up from that crowd such a shout for Davy Crockett as his name never called forth before.

“I am not much given to tears, but I was taken with a choking then and felt some big drops rolling down my cheeks. And I tell you now that the remembrance of those few words spoken by such a man, and the honest, hearty shout they produced, is worth more to me than all the honors I have received and all the reputation I have ever made, or ever shall make, as a member of Congress.

“Now, sir,” concluded Crockett, “you know why I made that speech yesterday.

“There is one thing now to which I will call your attention. You remember that I proposed to give a week’s pay. There are in that House many very wealthy men–men who think nothing of spending a week’s pay, or a dozen of them, for a dinner or a wine party when they have something to accomplish by it. Some of those same men made beautiful speeches upon the great debt of gratitude which the country owed the deceased–a debt which could not be paid by money–and the insignificance and worthlessness of money, particularly so insignificant a sum as $10,000, when weighted against the honor of the nation. Yet not one of them responded to my proposition. Money with them is nothing but trash when it is to come out of the people. But it is the one great thing for which most of them are striving, and many of them sacrifice honor, integrity, and justice to obtain it.”

Holders of political office are but reflections of the dominant leadership–good or bad–among the electorate.

Horatio Bunce is a striking example of responsible citizenship. Were his kind to multiply, we would see many new faces in public office; or, as in the case of Davy Crockett, a new Crockett.

For either the new faces or the new Crocketts, we must look to the Horatio in ourselves!

CONTENTS

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About Leonard E. Read

Introduction by Lawrence W. Reed

I, Pencil

Afterword by Milton Friedman

Leonard E. Read (1898–1983) established the Foundation for Economic Education in 1946. For the next 37 years he served as FEE’s president and labored tirelessly to promote and advance liberty. He was a natural leader who, at a crucial moment in American history, roused the forces defending individual freedom and private property.

His life is a testament to the power of ideas. As President Ronald Reagan wrote: “Our nation and her people have been vastly enriched by his devotion to the cause of freedom, and generations to come will look to Leonard Read for inspiration.”

Read was the author of 29 books and hundreds of essays. “I, Pencil,” his most famous essay, was first published in 1958. Although a few of the manufacturing details and place names have changed, the principles endure.

This new edition of “I, Pencil” was made possible by the generosity of John A. Kasch, M.D.

***

Introduction

By Lawrence W. Reed

Eloquent. Extraordinary. Timeless. Paradigm-shifting. Classic. Half a century after it first appeared, Leonard Read’s “I, Pencil” still evokes such adjectives of praise. Rightfully so, for this little essay opens eyes and minds among people of all ages. Many first-time readers never see the world quite the same again.

Ideas are most powerful when they’re wrapped in a compelling story. Leonard’s main point—economies can hardly be “planned” when not one soul possesses all the know-how and skills to produce a simple pencil—unfolds in the enchanting words of a pencil itself. Leonard could have written “I, Car” or “I, Airplane,” but choosing those more complex items would have muted the message. No one person—repeat, no one, no matter how smartor how many degrees follow his name—could create from scratch a small, everyday pencil, let alone a car or an airplane.

This is a message that humbles the high and mighty. It pricks the inflated egos of those who think they know how to mind everybody else’s business. It explains in plain language why central planning is an exercise in arrogance and futility, or what Nobel laureate and Austrian economist
F. A. Hayek aptly termed “the pretence of knowledge.”

Indeed, a major influence on Read’s thinking in this regard was Hayek’s famous 1945 article, “The Use of Knowledge in Society.” In demolishing the spurious claims of the socialists of the day, Hayek wrote,“This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.”

Maximilien Robespierre is said to have blessed the horrific French Revolution with this chilling declaration: “On ne saurait pas faire une omelette sans casser des oeufs.” Translation: “One can’t expect to make an omelet without breaking eggs.” A consummate statist who worked tirelessly to plan the lives of others, he would become the architect of the Revolution’s bloodiest phase—the Reign of Terror of 1793–94.

Robespierre and his guillotine broke eggs by the thousands in a vain effort to impose a utopian society with government planners at the top and everybody else at the bottom. That French experience is but one example in a disturbingly familiar pattern. Call them what you will—socialists, interventionists, collectivists, statists—history is littered with their presumptuous plans for rearranging society to fit their vision of the common good, plans that always fail as they kill or impoverish other people in the process. If socialism ever earns a final epitaph, it will be this: Here lies a contrivance engineered by know-it-alls who broke eggs with abandon but never, ever created an omelet.

None of the Robespierres of the world knew how to make a pencil, yet they wanted to remake entire societies. How utterly preposterous, and mournfully tragic! But we will miss a large implication of Leonard Read’s message if we assume it aims only at the tyrants whose names we all know. The lesson of “I, Pencil” is not that error begins when the planners plan big. It begins the moment one tosses humility aside, assumes he knows the unknowable, and employs the force of the State against peaceful individuals. That’s not just a national disease. It can be very local indeed.

In our midst are people who think that if only they had government power on their side, they could pick tomorrow’s winners and losers in the marketplace, set prices or rents where they ought to be, decide which forms of energy should power our homes and cars, and choose which industries should survive and which should die. They should stop for a few moments and learn a little humility from a lowly writing implement.

While “I, Pencil” shoots down the baseless expectations for central planning, it provides a supremely uplifting perspective of the individual. Guided by Adam Smith’s “invisible hand” of prices, property, profits, and incentives, free people accomplish economic miracles of which socialist theoreticians can only dream. As the interests of countless individuals from around the world converge to produce pencils without a single “master mind,” so do they also come together in free markets to feed, clothe, house, educate, and entertain hundreds of millions of people at ever higher levels. With great pride, FEE publishes this new edition of “I, Pencil” to mark the essay’s 50th anniversary. Someday there will be a centennial edition, maybe even a millennial one. This essay is truly one for the ages.

—Lawrence W. Reed, President
Foundation for Economic Education

***

I, Pencil

By Leonard E. Read

I am a lead pencil—the ordinary wooden pencil familiar to all boys and girls and adults who can read and write.

Writing is both my vocation and my avocation; that’s all I do.

You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery —more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. This supercilious attitude relegates me to the level of the commonplace. This is a species of the grievous error in which mankind cannot too long persist without peril. For, the wise G. K. Chesterton observed, “We are perishing for want of wonder, not for want of wonders.”

I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that’s too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

Pick me up and look me over. What do you see? Not much meets the eye—there’s some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.

Innumerable Antecedents

Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents. But I would like to suggest enough of them to impress upon you the richness and complexity of my background.

My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!

The logs are shipped to a mill in San Leandro, California. Can you imagine the individuals who make flat cars and rails and railroad engines and who construct and install the communication systems incidental thereto? These legions are among my antecedents.

Consider the millwork in San Leandro. The cedar logs are cut into small, pencil-length slats less than one-fourth of an inch in thickness. These are kiln dried and then tinted for the same reason women put rouge on their faces. People prefer that I look pretty, not a pallid white. The slats are waxed and kiln dried again. How many skills went into the making of the tint and the kilns, into supplying the heat, the light and power, the belts, motors, and all the other things a mill requires? Sweepers in the mill among my ancestors? Yes, and included are the men who poured the concrete for the dam of a Pacific Gas & Electric Company hydroplant which supplies the mill’s power!

Don’t overlook the ancestors present and distant who have a hand in transporting sixty carloads of slats across the nation.

Once in the pencil factory—$4,000,000 in machinery and building, all capital accumulated by thrifty and saving parents of mine—each slat is given eight grooves by a complex machine, after which another machine lays leads in every other slat, applies glue, and places another slat atop—a lead sandwich, so to speak. Seven brothers and I are mechanically carved from this “wood-clinched” sandwich.

My “lead” itself—it contains no lead at all—is complex. The graphite is mined in Ceylon [Sri Lanka]. Consider these miners and those who make their many tools and the makers of the paper sacks in which the graphite is shipped and those who make the string that ties the sacks and those who put them aboard ships and those who make the ships. Even the lighthouse keepers along the way assisted in my birth—and the harbor pilots.

The graphite is mixed with clay from Mississippi in which ammonium hydroxide is used in the refining process. Then wetting agents are added such as sulfonated tallow—animal fats chemically reacted with sulfuric acid. After passing through numerous machines, the mixture finally appears as endless extrusions—as from a sausage grinder—cut to size, dried, and baked for several hours at 1,850 degrees Fahrenheit. To increase their strength and smoothness the leads are then treated with a hot mixture which includes candelilla wax from Mexico, paraffin wax, and hydrogenated natural fats.

My cedar receives six coats of lacquer. Do you know all the ingredients of lacquer? Who would think that the growers of castor beans and the refiners of castor oil are a part of it? They are. Why, even the processes by which the lacquer is made a beautiful yellow involve the skills of more persons than one can enumerate!

Observe the labeling. That’s a film formed by applying heat to carbon black mixed with resins. How do you make resins and what, pray, is carbon black?

My bit of metal—the ferrule—is brass. Think of all the persons who mine zinc and copper and those who have the skills to make shiny sheet brass from these products of nature. Those black rings on my ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the center of my ferrule has no black nickel on it would take pages to explain.

Then there’s my crowning glory, inelegantly referred to in the trade as “the plug,” the part man uses to erase the errors he makes with me. An ingredient called “factice” is what does the erasing. It is a rubber-like product made by reacting rapeseed oil from the Dutch East Indies [Indonesia] with sulfur chloride. Rubber, contrary to the common notion, is only for binding purposes. Then, too, there are numerous vulcanizing and accelerating agents. The pumice comes from Italy; and the pigment which gives “the plug” its color is cadmium sulfide.

No One Knows

Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me?

Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far-off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn’t a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than can the chemist at the factory or the worker in the oil field—paraffin being a by-product of petroleum.

Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items.

No Master Mind

There is a fact still more astounding: The absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred.

It has been said that “only God can make a tree.” Why do we agree with this? Isn’t it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable!

I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human masterminding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.

The above is what I meant when writing, “If you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing.” For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand— that is, in the absence of governmental or any other coercive master-minding—then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith.

Once government has had a monopoly of a creative activity such, for instance, as the delivery of the mails, most individuals will believe that the mails could not be efficiently delivered by men acting freely. And here is the reason: Each one acknowledges that he himself doesn’t know how to do all the things incident to mail delivery. He also recognizes that no other individual could do it. These assumptions are correct. No individual possesses enough know-how to perform a nation’s mail delivery any more than any individual possesses enough know-how to make a pencil. Now, in the absence of faith in free people—in the unawareness that millions of tiny know-hows would naturally and miraculously form and cooperate to satisfy this necessity—the individual cannot help but reach the erroneous conclusion that mail can be delivered only by governmental “masterminding.”

Testimony Galore

If I, Pencil, were the only item that could offer testimony on what men and women can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it’s all about us and on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine or to tens of thousands of other things. Delivery? Why, in this area where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person’s home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one’s range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard—halfway around the world—for less money than the government charges for delivering a one-ounce letter across the street!

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

***

Afterword

By Milton Friedman, Nobel Laureate, 1976

Leonard Read’s delightful story, “I, Pencil,” has become a classic, and deservedly so. I know of no other piece of literature that so succinctly, persuasively, and effectively illustrates the meaning of both Adam Smith’s invisible hand—the possibility of cooperation without coercion—and Friedrich Hayek’s emphasis on the importance of dispersed knowledge and the role of the price system in communicating information that “will make the individuals do the desirable things without anyone having to tell them what to do.”

We used Leonard’s story in our television show, “Free to Choose,” and in the accompanying book of the same title to illustrate “the power of the market” (the title of both the first segment of the TV show and of chapter one of the book). We summarized the story and then went on to say:

“None of the thousands of persons involved in producing the pencil performed his task because he wanted a pencil. Some among them never saw a pencil and would not know what it is for. Each saw his work as a way to get the goods and services he wanted—goods and services we produced in order to get the pencil we wanted. Every time we go to the store and buy a pencil, we are exchanging a little bit of our services for the infinitesimal amount of services that each of the thousands contributed toward producing the pencil.

“It is even more astounding that the pencil was ever produced. No one sitting in a central office gave orders to these thousands of people. No military police enforced the orders that were not given. These people live in many lands, speak different languages, practice different religions, may even hate one another—yet none of these differences prevented them from cooperating to produce a pencil. How did it happen? Adam Smith gave us the answer two hundred years ago.”

“I, Pencil” is a typical Leonard Read product: imaginative, simple yet subtle, breathing the love of freedom that imbued everything Leonard wrote or did. As in the rest of his work, he was not trying to tell people what to do or how to conduct themselves. He was simply trying to enhance individuals’ understanding of themselves and of the system they live in.

That was his basic credo and one that he stuck to consistently during his long period of service to the public—not public service in the sense of government service. Whatever the pressure, he stuck to his guns, refusing to compromise his principles. That was why he was so effective in keeping alive, in the early days, and then spreading the basic idea that human freedom required private property, free competition, and severely limited government.

***

FOUNDATION FOR ECONOMIC EDUCATION

Freedom’s Home Since 1946

The Foundation for Economic Education (FEE), the oldest free-market organization in the United States, was established in 1946 by Leonard E. Read to study and advance the freedom philosophy. FEE’s mission is to offer the most consistent case for the first principles of freedom: the sanctity of private property, individual liberty, the rule of law, the free market, and the moral superiority of individual choice and responsibility over coercion.

The Foundation’s periodicals The Freeman: Ideas on Liberty and Notes from FEE present timeless insights on the positive case for human liberty to thousands of people around the world. Throughout the year FEE’s lecture series, programs, and seminars bring together hundreds of individuals of all ages to explore the foundations of free enterprise and market competition. The Foundation plays a major role in publishing and promoting numerous essential books on the freedom philosophy.

Millions of people a year visit our state-of-the-art website, www.fee.org. Cybervisitors can read books and periodicals, listen to speakers, take a virtual tour of the Foundation, purchase books, register for events and programs, and much more. Our popular e-commentary, In Brief, remains an indispensable source of daily information for thousands of people.

The Foundation for Economic Education is a non-political, non-profit, tax-exempt educational foundation and accepts no taxpayer money. FEE is supported solely by contributions from private individuals and foundations.

***

OTHER BOOKS FROM THE FOUNDATION FOR ECONOMIC EDUCATION

Anything That’s Peaceful by Leonard E. Read

The Freedom Philosophy edited by Paul L. Poirot

The Free Market and Its Enemies by Ludwig von Mises

The Law by Frédéric Bastiat

The Mainspring of Human Progress by Henry Grady Weaver

And many more!

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Published by the Foundation for Economic Education

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Economics In One Lesson

By HENRY HAZLITT

SPECIAL EDITION FOR

THE FOUNDATION FOR ECONOMIC EDUCATION, INC.

POCKET BOOKS, INC., ROCKEFELLER CENTER, N. Y.

The Printing History of

ECONOMICS IN ONE LESSON

Harper & Brothers edition published July, 1946

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May, 1952

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This Pocket Book edition is published by arrangement with Harper & Brothers

Henry Hazlitt has been interpreting business trends for the American people for the past 35 years. Starting in the field of economics as a reporter on the Wall Street Journal, he has served on the financial and editorial staffs of several of the great New York newspapers, including the Sun, the Herald, and the Times. In addition, he has been associated with The Nation and edited American Mercury and the Freeman. Mr. Hazlitt has traveled extensively in Europe and South America for on- the-spot studies of world economic conditions. Since 1946, he has been a contributing editor to Newsweek magazine, where his weekly column, "Business Tides," is a regular feature. Born in Philadelphia, in 1894, he attended the College of the City of New York and served with Air Service, U. S. Army, in World War I. He is the author of many books and pamphlets dealing with economics, among which are Will Dollars Save the World? and The Great Idea. We is also well known as a lecturer and literally critic.

CONTENTS

Preface

PART ONE : THE LESSON

I. The Lesson

PART TWO: THE LESSON APPLIED

II. The Broken Window

III. The Blessings of Destruction

IV. Public Works Mean Taxes

V. Taxes Discourage Production

VI. Credit Diverts Production

VII. The Curse of Machinery

VIII. Spread-the-Work Schemes

IX. Disbanding Troops and Bureaucrats

X. The Fetish of Full Employment

XI. Who's "Protected" by Tariffs?

XII. The Drive for Exports

XIII. "Parity" Prices

XIV. Saving the X Industry

XV. How the Price System Works

XVI. "Stabilizing" Commodities

XVII. Government Price-Fixing

XVIII. Minimum Wage Laws

XIX. Do Unions Really Raise Wages?

XX. "Enough to Buy Back the Product"

XXI. The Function of Profits

XXII. The Mirage of Inflation

XXIII. The Assault on Saving

PART THREE: THE LESSON RESTATED

XXIV. The Lesson Restated

XXV. A Note on Books

PREFACE

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 touching 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 Frédéric Bastiat's essay Cequ'on voit et ce qu'on ne voit pas, 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 Common Sense 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 hook 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, interfering 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 hook 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.

H. H.

New York

March 25, 1946

PART ONE : THE LESSON

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Chapter One

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 thousand fold 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 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 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.

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 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.

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 he 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.

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PART TWO : THE LESSON APPLIED

THE BROKEN WINDOW

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 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.

Chapter Three

THE BLESSINGS OF DESTRUCTION

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 post-war 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 too are incomparably greater than the needs of America. But its 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-windows 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 post-war 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 post-war 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 post-war 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 post-war demand may be concealed from many people by the illusions caused by higher money wages that are more than offset by higher prices.

Post-war demand in most countries, to repeat, will shrink in absolute amount as compared with pre-war demand because post-war 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 thousand fold, might none the less 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 post-war 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 none the less a palpable fallacy.

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Chapter Four

PUBLIC WORKS MEAN TAXES

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."

An enormous literature is based on this fallacy, and, as so often happens with doctrines of this sort, it has become part of an intricate network of fallacies that mutually support each other. We cannot explore that whole network at this point; we shall return to other branches of it later. But we can examine here the mother fallacy that has given birth to this progeny, the main stem of the network.

Everything we get, outside of the free gifts of nature, must in some way be paid for. The world is full of so-called economists who in turn are full of schemes for getting something for nothing. They tell us that the government can spend and spend without taxing at all; that it can continue to pile up debt without ever paying it off, because "we owe it to ourselves." We shall return to such extraordinary doctrines at a later point. Here I am afraid that we shall have to be dogmatic, and point out that such pleasant dreams in the past have always been shattered by national insolvency or a runaway inflation. Here we shall have to say simply that all government expenditures must eventually be paid out of the proceeds of taxation; that to put off the evil day merely increases the problem, and that inflation itself is merely a form, and a particularly vicious form, of taxation.

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 he 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 bridge workers 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 non-existent 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.

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 chousing 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 get projects like the Tennessee Valley Authority. Here, because of sheer size, the danger of optical illusion greater than ever. Here is a mighty dam, a of steel and concrete, "greater than anything capital could have built," the fetish of photographers, heaven of socialists, the most often used miracles of public construction, ownership Here are mighty generators and power ho 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.

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.

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Chapter Five

TAXES DISCOURAGE PRODUCTION

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 per cent 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 a hundred 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 per cent. 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.

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Chapter Six

CREDIT DIVERTS PRODUCTION

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 he 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 entire 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 a 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 hank with him. That is why the hanker 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.

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 he permitted to take risks with the tax payers' money that no one is willing to take with his own./p>

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 "non-recourse" 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 had 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.

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 "bailed 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 he 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.

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Chapter Seven

THE CURSE OF MACHINERY

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 a 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 per cent unemployment. Could things be blacker?

Things could he 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 insofar 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 a hundred men fur 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 he 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 per cent.

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 bas 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 200,000,00 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.

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 laborsaving 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 on 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 h own capacity is engaged in trying to reduce the effort requires to accomplish a given result. Each of us is trying to save his own labor, to economize the means required 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 ambitions 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 wage 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 cutting 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.

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 other wise 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.

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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 auto mobile 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 hut 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 over-aged 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.

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.

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Chapter Eight

SPREAD-THE–WORK SCHEMES

I have 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 hack a tile incident to fixing a leak in the shower: that is the job of a tile-setter.

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 roads 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 tile-setter has meant a day's disemployment 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-over. time 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 per cent 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? 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, hut 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 he 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 per cent. 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 he 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 per cent 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 he 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.

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Chapter Nine

DISBANDING TROOPS AND BUREAUCRATS

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 tax payers 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 he 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.

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, night clubs, 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 tax payers 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 easy-going 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.

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Chapter Ten

THE FETISH OF FULL EMPLOYMENT

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 a hundred thousand 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 hills in Congress but Full Employment bills. Even committees of business men 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 for gotten.

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 virtually to 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 he 50,000,000 or 60,000,000 jobs in America in 1950, but how much shall we produce, and what, in consequence, will he 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.

Chapter Eleven

WHO'S "PROTECTED" BY TARIFFS?

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 common sense 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 shoe maker. 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.

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 their 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.

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.

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 a dollar cheaper to ship the sweaters, and then increase the tariff by two dollars 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.

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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, he no such symmetrical distribution of the loss; moreover, the sweater industry itself will doubtless he 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 he 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, hut 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.)

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 he 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.

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Chapter Twelve

THE DRIVE FOR EXPORTS

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 he traced mentally through a few more stages. One group may indeed make gainswhile 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 he 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 he helped. Even many concerns that did an export business would be hurt on net balance. American automobile companies, for example, sold about 10 per cent 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 per cent 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.

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Chapter Thirteen

PARITY PRICES

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 uniformed ,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, and 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.

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 clops. 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.

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 that 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. None the less, 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 he 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.

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Chapter Fourteen

SAVING THE X INDUSTRY

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 flim flam 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.

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 hut 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 he 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 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.

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 stand point 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.

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.

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Chapter Fifteen

HOW THE PRICE SYSTEM WORKS

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 practically unlimited amounts. But, alas, the world is not ruled by the engineers, thinking only of production, but by the business men, thinking only of profit. The business men give their orders to the engineers, instead of vice versa. These business men 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 business men 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, be 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.

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 he 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 foregoing 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 he allowed to grow. For the dying industries absorb labor and capital that should he 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.

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Chapter Sixteen

“STABILIZING” COMMODITIES

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 non-perishable 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 over-optimism 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.)

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 carry-overs 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.

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 hare 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 produce less efficiently than otherwise. The inefficient marginal producer thus artificially kept in that line of product continues to tie up land, labor, and capital that could much more profitably and efficiently he 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 over-priced 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 gravely 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 he 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 post-war world of super-international 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 he 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 he 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.

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Chapter Seventeen

GOVERNMENT PRICE-FIXING

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 hook 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 he 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 he 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 first 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.

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 slaughter houses 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 slaughter-house 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.

Price-fixing may often appear for a short period to he 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 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 over all 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."

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 good-will, 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 he 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.

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 he discussed in a later chapter. But one of the errors that lie 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 booked.

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 he 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 he a great deal more loss than gain, because price-fixing discourages and disrupts employment and production.

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Chapter Eighteen

MINIMUM WAGE LAWS

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 follows 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 effect.

The first thing that happens, for example, when a law is passed that no one shall he paid less than $30 for a forty-hour week is that no one who is not worth $30 a week to an employer will he 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 he 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 he 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 he thrown out of employment altogether. On the other hand, if the price of the product is 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 are 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.

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"; hut 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 difficult ties 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.

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 good will such an aim can he 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 rim 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.

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Chapter Nineteen

DO UNIONS REALLY RAISE WAGES?

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 be 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 dear. 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-aided labor legislation which puts compulsions solely on employers, to go beyond their legitimate functions, to act irresponsibly, and to embrace short-sighted and anti-social 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 non-union labor, hut 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 their 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 strike breakers 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 he maintained, in fact, only by the ever-present threat of force.

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 per cent, the clothing workers of 20 per cent, the coal miners of 30 per cent, the building trades of 40 per cent, and the railroad employees of 50 per cent.

On the assumptions we have made, this will mean that there has been an average increase in wages of 25 per cent. 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 per cent. 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 per cent, will be worse off than before the race began. Even the workers in the clothing trades, with a money-wage increase of 20 per cent, will be at a disadvantage compared with their previous position. The coal miners, with a money wage increase of 30 per cent, 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 he found, when their unemployed are averaged with their employed members, to he 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 he achieved, the unions could not possibly he 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.

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 per cent oil 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.

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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 (01 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 non-unionized workers, do not, in the long run and for the whole body of workers, at all.

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 base 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, hut 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 "speed-ups." 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 he 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 a 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.

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Chapter Twenty

“ENOUGH TO BUY BACK THE PRODUCT"

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 hack 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' income receivers, and when their weekly wage, accord' to government figures, was already 20 per cent higher than the average wage paid in factories and nearly twice as great as the average paid in retail trade, were demanding a 30 per cent 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 per cent increase to keep the economy from collapsing, would a mere 30 per cent have been enough for the others? Or would they have required increases of 55 to 160 per cent 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.)

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 per cent increase in hourly wages all around the circle forces a 30 per cent 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 per cent 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 per cent reduction in the real rate of wage is likely to expand the aggregate demand for labor by not less than 3 per cent.”* 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.

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 per cent wage rates will ultimately lead to an increase in price of approximately the same percentage.

The belief that the price increase would he 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 he less than a third, say, of the total costs; and this may lead the incautious to conclude that a 30 per cent increase in wages would lead to only a 10 per cent increase, or less, in automobile prices. But this would he 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' mark-up.

Government estimates show that in the fifteen-year period from 1929 to 1943, inclusive, wages and salaries in the United States averaged 69 per cent of the national income. These wages and salaries, of course, had to he 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 he 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 estimate*, and assume also that dollar profit margins would be unchanged, it is clear that an increase of 30 per cent in wage costs all around the circle would mean an increase of nearly 20 per cent 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 per cent 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 per cent increase in wages under the conditions assumed would eventually mean also a 30 per cent 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 he doubted whether this would be greater in absolute size (and it might easily be less) than the previous narrower slice of a larger pie.

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 he 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 hut 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.

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Chapter Twenty-One

THE FUNCTION OF PROFITS

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 XV 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 per cent 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 incorporate 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 selfconfidence 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 per cent or some similar figure, while the risk of losing one's entire capital still exists, what is likely to he 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, hut 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 so act 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 re- invest 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 he made, and in what quantities-and what articles will not he 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 he 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 hulk 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.

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Chapter Twenty-Two

THE MIRAGE OF INFLATION

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. . . . 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 hooks. 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.

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 rill 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 he 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 pot 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, wilt 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 in comes will find themselves compelled to pay higher price for the things they buy, which means that they will b 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 an D, who get the money–income benefit of the inflation in that order. Then when money incomes of group A ha already increased 30 per cent, the prices of the thing they purchase have not yet increased at all. By the time money incomes of group B have increased 20 per cent, prices have still increased an average of only 10 per cent. When money incomes of group C have increased only 10 per cent, however, prices have already gone up 15 per cent. 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 per cent. 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 per cent 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 per cent, 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 per cent more for the goods and services it bought from the other producing groups in the community, A, B and C.

So inflation turns out to he 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 over-expansion 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 per cent advance in prices by inflation without someone's contending that the, argument is twice as good for an advance of 50 per cent, and someone else's adding that it is four times as good for an advance of 100 per cent. 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 per cent increase in the quantity of money will mean a 50 per cent 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.

All this explains why, when super-inflation 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 he 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 a 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 has itself 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.

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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.

And this is precisely its political function. It is because inflation confuses everything that it is so consistently resolved to by our modern "planned economy" governments. We saw in Chapter IV, 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 resort 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 some day be repaid. The government cannot keep piling up debt indefinitely; for if it tries, it will some day 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 even 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 resort is had to outright inflation 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.

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Chapter Twenty-Three

THE ASSAULT ON SAVING

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 night clubs; 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 night clubs, and he does not call the head waiters 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 he 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 night clubs 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.

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 he 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 when 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' goods to another. It would he 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 "oversaving."

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 3. Historically 20 per cent would represent approximately the have been closer to 12 per rent.' 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:

* This of course assumes the process of saving and investment to have been already under way at the same ram.

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The first thing to be noticed about this table is that total production increases each year because of the sawing, 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 per cent greater than in the first year.

Let us observe a few other points. The fact that 20 per cent 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. Tire 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 goads 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.

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 hanks, 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, a s 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 he 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.

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 he 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 pre-industrial 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.

PART THREE:

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Chapter Twenty-Four

THE LESSON RESTATED

Economics, as we have now seen again and again, is a science of recognizing secondary consequences. I t 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, hut 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. Then 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 he 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, incandecent."*

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.

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 inclined 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.

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 suffering is, 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 an historic irony that when this phrase, the Forgotten Man, was revived in the nineteen thirties, 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.

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 1 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.

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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 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.

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Chapter Twenty-Five

A NOTE ON BOOKS

Those who desire to read further in economics should turn next to some work of intermediate length. Good volumes in this class, which will bring the reader abreast of recent refinements in economic thought, are Frederic Benham's Economics (525 pages) and Raymond T. Bye's Principles of Economics (632 pages). Both of these are widely used as college textbooks.

More readable and entertaining, though the reader may have to search for them in second-hand channels, are some of the older books, like Edwin Canaan's little manual on Wealth (274 pages). The same writer's book on Money has recently been reprinted. John Bates Clark's Essentials of Economic Theory will still be found remarkably clear and cogent.

After reading one or two of these volumes the student who aims at thoroughness will go on to some two-volume work. When Ludwig von Mises' new treatise on economics, now in preparation, appears, it will extend beyond any previous work the logical unity and precision of modern economic analysis. Taussig's Principles of Economics, though on older lines, will still be found clear, simple and sensible. Not to be missed is Philip Wicksteed's The Common Sense of Political Economy, as remarkable for the ease and lucidity of its style as for the penetration and power of its reasoning.

Those who are interested in working through the economic classics might find it more profitable to do this in the reverse of their historical order. Presented in this order, the chief works to be consulted, with the dates of their first editions, are: John Bates Clark, The Distribution of wealth, 1899; Alfred Marshall, Principles of Economics, 1890; Eugen von Bohm-Bawerk,The Positive Theory of Capital, 1888; W. Stanley Jevons, The Theory of Political Economy, 1871; John Stuart Mill, Principles of Political Economy, 1848; David Ricardo, Principles of Political Economy and Taxation,1817; and Adam Smith, The Wealth of Nations, 1776.

Among recent works which discuss current ideologies and developments from a point of view similar to that in the present volume are: Friedrich A. Hayek, The Road to Serfdom; Lionel Robbins, Economic Planning and International Order; Wilhelm Ropke, International Economic Disintegration; John Jewkes, Ordeal by Planning; and Ludwig von Mises, Planned Chaos. Mises' Socialism is the most thorough and devastating critique of collectivist doctrines ever written. The reader should not overlook, finally, Frederic Bastiat's classic Economic Sophisms, and particularly his essay on What Is Seen and What Is Not Seen.

Economics broadens out in a hundred directions. Whole libraries have been written on specialized fields alone, such as money and banking, foreign trade and foreign exchange, taxation and public finance, government control, capitalism and socialism, wages and labor relations, interest and capital, agricultural economics, rent, prices, profits, markets, competition and monopoly, value and utility, statistics, business cycles, wealth and poverty, Social insurance, housing, public utilities, mathematical economics, studies of special industries and of economic history. But no one will ever properly understand any of these specialized fields unless he has first of all acquired a firm grasp of basic economic principles and the complex interrelationship of all economic factors and forces. When he has done this by his reading in general economics, he can be trusted to find the right books in his special field of interest.

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* Reason and Nature (1931) p. X

* 'New York Times, Jan. 2, 1946 .

* Testimony of Dan H. Wheeler, director of the Bituminous Coal Division. Hearings on extension of the Bituminous Coal Act of 1937.

* 1. A . C. Pigou, The Theory o f Unemployment (1933), p. 96. 2.

¦ Paul H. Douglas, The Theory of Wages (1934), p. 501.

* 1. Cf. Frank H. Knight, Risk, Uncertainty and Profit (1921).

* The reader interested in an analysis of them should consult B. M. Anderson, The Value of Money (1917; new edition, 1936) or Ludwig von Mises, The Theory of Money and Credit (America edition, 1935).

* 2. Cf. John Stuart Mill, Principles of Political Economy (Book 3, Chap. 14, par. 2) ; Alfred Marshall, Principles of Economics (Book VI, Chap. XIII, sec. 10) ,and Benjamin M . Anderson , Refutation of Keynes' Attack on the Doctrine that Aggregate Su ply Creates Aggregate Demand," in Financing American Prosperity by a symposium of economists.

* 'Karl Rodbertus, Overproduction and Crises (18501, p . 51)

* 2. Cf. Hartley Withers, Poverty and Waste (1914).

* Historically 20 per cent would represent approximately the gross amount of the gross national product devoted each year to capital formation (excluding consumer equipment). When allowance is made for capital consumption. However, net annual savings have been closer to 12 percent. Cf. George Terbough, The Bogey of Economic Maturity (1945). For 1977 gross private domestic investment was officially estimated at 16 percent of the gross national product.

* Many of the differences between economists in the diverse views now expressed on this subject are merely the result of differences in definition. "Savings" and "investment" may be so defined as to be identical, and therefore necessarily equal. Here I am choosing to define "savings" in terms of money and "investment" in terms of goods. This corresponds roughly with the common use of the words, which is, however, not always consistent.

* 'For a statistical refutation of this fallacy consult George Terborgh, The Bogey of Economic Maturity (1945).

* 'George Santayana,The Realm of Truth (1938), p. 16

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-Lawrence W. Reed
President of FEE

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FOREWORD

If parliamentary maneuvering had prevented renewal of OPA powers in July 1946, would government price controls have ended? Or would they have been revived by state and local governments and by new Federal statutes?

In the case of rent control, at least, the answer is clear. During the lapse of Federal controls in July, one state and locality after another set up or planned to set up its own agencies for maintaining ceilings on rents.

Why?

Because so many citizens and government officials consider these controls to be necessary or desirable, for one reason or another. Even among those who oppose continuance of other forms of price and wage control, a large number make an exception in favor of rent control. It, at least, they say, should be retained.

Yet rent control, along with laws protecting tenants against eviction, involve partial expropriation of property rights. It limits the owner’s right to use and to profit from the use of his property. It also restricts the opportunity of everyone else who would like to bid for the use of the properties thus controlled by government.

This particular method of expropriating property rights and restricting opportunity in peace time is something new in the United States . How long will it continue and how far will its corrosive influence spread in American attitudes toward individual enterprise and private property in general?

“Military necessity” was used during the war as a reason for introducing numerous compulsions and restrictions into the American economy. Most supporters of rent control still justify its continuance merely as a temporary “emergency” measure. The war supposedly restricted residential building, while population continued to increase, with a consequent temporary “housing shortage.”

But what are the facts of the matter? Did the increase in population or number of families actually outstrip residential building?

And is government rent control serving the avowed purposes of its supporters? Is it helping veterans, former war workers, newlyweds, and lower income families to find housing at “reasonable” cost?

What is a “reasonable” rent? What are rents paid for—merely to give the land “lord” an income? Or does the rental market serve some other purpose which has been taken for granted so long that it has been forgotten?

Professors Friedman and Stigler have spent years in study and training so that they might be able better to deal with just such questions. Their answers may surprise you.

LEONARD E. READ

President

Roofs or Ceilings? The Current Housing Problem

By Milton Friedman and George J. Sigler

(1946)

The San Francisco earthquake of April 18, 1906 was followed by great fires which in 3 days utterly destroyed 3,40o acres of buildings in the heart of the city.

Maj. Gen. Greely, commander of the Federal troops in the area, described the situation in these terms:

“Not a hotel of note or importance was left standing. The great apartment houses had vanished . . . Two hundred and twenty-five thousand people were . . . homeless.”

In addition, the earthquake damaged or destroyed many other homes.

Thus a city of about 400,000 lost more than half of its housing facilities in three days.

Various factors mitigated the acute shortage of housing. Many people temporarily left the city—one estimate is as high as 75,000. Temporary camps and shelters were established and at their peak, in the summer of 1906, cared for about 30,000 people. New construction proceeded rapidly.

However, after the disaster, it was necessary for many months for perhaps one-fifth of the city’s former population to be absorbed into the remaining half of the housing facilities. In other words, each remaining house on the average had to shelter 40 percent more people.

Yet when one turns to the San Francisco Chronicle of May 24, 1906 the first available issue after the earthquake—Mere is not a single mention of a housing shortage! The classified advertisements listed 64 offers (some for more than one dwelling) of flats and houses for rent, and 19 of houses for sale, against 5 advertisements of flats or houses wanted. Then and thereafter a considerable number of all types of accommodation except hotel rooms were offered for rent.

The Housing Problem in 1946

Forty years later another housing shortage descended on San Francisco. This time the shortage was nation-wide. The situation in San Francisco was not the worst in the nation, but because of the migration westward it was worse than average. In 1940, the population of 635,000 had no shortage of housing, in the sense that only 93 percent of the dwelling units were occupied. By 1946 the population had increased by at most a third—about 200,000. Meanwhile the number of dwelling units had increased by at least a fifth.

Therefore, the city was being asked to shelter xo percent more people in each dwelling unit than before the war. One might say that the shortage in 1946 was one-quarter as acute as in 1906, when each remaining dwelling unit had to shelter 40 percent more people than before the earthquake.

In 1946, however, the housing shortage did not pass unnoticed by the Chronicle or by others. On January 8 the California state legislature was convened and the Governor listed the housing shortage as “the most critical problem facing California .” During the first five days of the year there were altogether only 4 advertisements offering houses or apartments for rent, as compared with 64 in one day in May 1906, and 9 advertisements offering to exchange quarters in San Francisco for quarters elsewhere. But in 1946 there were 30 advertisements per day by persons wanting to rent houses or apartments, against only 5 in 1906 after the great disaster. During this same period in 1946, there were about 6o advertisements per day of houses for sale, as against 19 in 1906.

In both 1906 and 1946, San Francisco was faced with the problem that now confronts the entire nation: how can a relatively fixed amount of housing be divided (that is, rationed) among people who wish much more until new construction can fill the gap? In 1906 the rationing was done by higher rents. In 1946, the use of higher rents to ration housing has been made illegal by the imposition of rent ceilings, and the rationing is by chance and favoritism. A third possibility would be for OPA to undertake the rationing.

What are the comparative merits of these three methods?

I. The 1906 Method: Price Rationing

War experience has led many people to think of rationing as equivalent to OPA forms, coupons, and orders.

But this is a superficial view; everything that is not as abundant as air or sunlight must, in a sense, be rationed. That is, whenever people want more of something than can be had for the asking, whether bread, theater tickets, blankets, or haircuts, there must be some way of determining how it shall be distributed among those who want it.

Our normal peace-time basis of rationing has been the method of the auction sale. If demand for anything increases, competition among buyers tends to raise its price. This rise in price causes buyers to use the article more sparingly, carefully, and economically, and thereby reduces consumption to the supply. At the same time, the rise in price encourages producers to expand output. Similarly, if the demand for any article decreases, the price tends to fall, expanding consumption to the supply and discouraging output.

In 1906 San Francisco used this free market method to deal with its housing problems, with a consequent rise of rents. Yet, although rents were higher than before the earthquake, it is cruel to present-day house seekers to quote a 1906 post-disaster advertisement: “Six-room house and bath, with 2 additional rooms in basement having fire-places, nicely furnished; fine piano; … $45.”

The advantages of rationing by higher rents are clear from our example:

1. In a free market, there is always some housing immediately available for rent—at all rent levels.

2. The bidding up of rents forces some people to economize on space. Until there is sufficient new construction, this doubling up is the only solution.

3. The high rents act as a strong stimulus to new construction.

4. No complex, expensive, and expansive machinery is necessary. The rationing is conducted quietly and impersonally through the price system.

The full significance of these advantages will be clearer when we have considered the alternatives.

Objections to Price Rationing

Against these merits, which before the war were scarcely questioned in the United States , three offsetting objections are now raised. The first objection is usually stated in this form: “The rich will get all the housing, and the poor none.”

This objection is false: At all times during the acute shortage in 1906 inexpensive flats and houses were available. What is true is that, under free market conditions, the better quarters will go to those who pay more, either because they have larger incomes or more wealth, or because they prefer better housing to, say, better automobiles.

But this fact has no more relation to the housing problem of today than to that of 1940. In fact, if inequality of income and wealth among individuals justifies rent controls now, it provided an even stronger reason for such controls in 1940. The danger, if any, that the rich would get all the housing was even greater then than now.

Each person or family is now using at least as much housing space, on the average, as before the war (see below). Furthermore, the total income of the nation is now distributed more equally among the nation’s families than before the war. Therefore, if rents were freed from legal control and left to seek their own levels, as much housing as was occupied before the war would be distributed more equally than it was then.

The fact that, under free market conditions, better quarters go to those who have larger incomes or more wealth is, if anything, simply a reason for taking long-term measures to reduce the inequality of income and wealth. For those, like us, who would like even more equality than there is at present, not alone for housing but for all products, it is surely better to attack directly existing inequalities in income and wealth at their source than to ration each of the hundreds of commodities and services that compose our standard of living. It is the height of folly to permit individuals to receive unequal money incomes and then to take elaborate and costly measures to prevent them from using their incomes.*

The second objection often raised to removing rent controls is that landlords would benefit. Rents would certainly rise, except in the so-called black market; and so would the incomes of landlords. But is this an objection? Some groups will gain under any system of rationing, and it is certainly true that urban residential landlords have benefited less than almost any other large group from the war expansion.

The ultimate solution of the housing shortage must come through new construction. Much of this new construction will be for owner-occupancy. But many persons prefer to or must live in rental properties. Increase or improvement of housing for such persons depends in large part on the construction of new properties to rent. It is an odd way to encourage new rental construction (that is, becoming a landlord) by grudging enterprising builders an attractive return!

The third current objection to a free market in housing is that a rise in rents means an inflation, or leads to one.

But price inflation is a rise of many individual prices, and it is much simpler to attack the threat at its source, which is the increased family income and liquid resources that finance the increased spending on almost everything. Heavy taxation, governmental economies, and control of the stock of money are the fundamental weapons to fight inflation. Tinkering with millions of individual prices—the rent of house A in San Francisco, the price of steak B in Chicago, the price of suit C in New York—means dealing clumsily and ineffectively with the symptoms and results of inflation instead of its real causes.

Yet, it will be said, we are not invoking fiscal and monetary controls, and are not likely to do so, so the removal of rent ceilings will, in fact, incite wage increases and then price increases—the familiar inflation spiral. We do not dispute that this position is tenable, but is it convincing? To answer, we must, on the one hand, appraise the costs of continued rent control, and, on the other hand, the probable additional contribution to inflation from a removal of rent controls. We shall discuss the costs of the present system next, and in the conclusion briefly appraise the inflationary threat of higher rents.

The Present Rationing of Houses for Sale

The absence of a ceiling on the selling price of housing means that at present homes occupied by their owners are being rationed by the 1906 method—to the highest bidder. The selling prices of houses is rising as the large and increasing demand encounters the relatively fixed supply. Consequently, many a landlord is deciding that it is better to sell at the inflated market price than to rent at a fixed ceiling price.

The ceiling on rents, therefore, means that an increasing fraction of all housing is being put on the market for owner-occupancy, and that rentals are becoming almost impossible to find, at least at the legal rents. In 1906, when both rents and selling prices were free to rise, the San Francisco Chronicle listed about 3 “houses for sale” for every to “houses or apartments for rent.” In 1946, under rent controls, about 730 “houses for sale” were listed for every to “houses or apartments for rent.”

The free market in houses for sale therefore permits a man who has enough capital to make the down payment on a house to solve his problem by purchase. Often this means that he must go heavily in debt, and that he puts into the down payment what he would have preferred to spend in other ways.

Nevertheless, the man who has money will find plenty of houses—and attractive ones at that—to purchase. The prices will be high—but that is the precise reason houses are available. He is likely to end up with less desirable housing, furnishings, and other things than he would like, or than his memories of prewar prices had led him to hope he might get, but at least he will have a roof over his family.

The methods of rent control used in 1946, therefore, do not avoid one of the chief criticisms directed against rationing by higher rents—that the rich have an advantage in satisfying their housing needs. Indeed, the 1946 methods make this condition worse. By encouraging existing renters to use space freely and compelling many to borrow and buy who would prefer to rent, present methods make the price rise in houses for-sale larger than it would be if there were no rent controls.

One way to avoid giving persons with capital first claim to an increasing share of housing would be to impose a ceiling on the selling price of houses. This would reduce still further the area of price rationing and correspondingly extend present rent-control methods of rationing rental property. This might be a wise move if the present method of rationing rented dwellings were satisfactory.

But what is the situation of the man who wishes to rent?

II. The 1946 Method: Rationing by Chance and Favoritism

The prospective renter is in a position very different from that of the man who is willing to buy. If he can find accommodations, he may pay a “reasonable,” that is, pre-war rent. But unless he is willing to pay a considerable sum on the side —for “furniture” or in some other devious manner—he is not likely to find anything to rent.

The legal ceilings on rents are the reason there are so few places for rent. National money income has doubled, so that most individuals and families are receiving far higher money incomes than before the war. They can afford to pay substantially higher rents than before the war, yet legally they need pay no more; they are therefore trying to get more and better housing.

But not all the millions of persons and families who have thus been trying to spread out since 1940 can succeed, since the supply of housing has increased only about as fast as population. Those who do succeed force others to go without housing. The attempt by the less fortunate and the newcomers to the housing market—returning service men, newlyweds, and persons changing residences—to get more housing space than is available and more than they used before the war, leads to the familiar spectacle of a horde of applicants for each vacancy.

Advertisements in the San Francisco Chronicle again document the effect of rent ceilings. In 1906, after the earthquake, when rents were free to rise, there was 1 “wanted to rent” for every 10 “houses or apartments for rent”; in 1946, there were 375 “wanted for rent” for every 10 “for rent.”

A Veteran Looks for a House

The New York Times for January 28, 1946 reports the experience of Charles Schwartzman, “a brisk young man in his early thirties,” recently released from the army. Mr. Schwartzman hunted strenuously for three months, “riding around in his car looking for a place to live . . . He had covered the city and its environs from Jamaica , Queens , to Larchmont and had registered with virtually every real estate agency. He had advertised in the newspapers and he had answered advertisements. He had visited the New York City Veterans Center at 500 Park Avenue and the American Veterans Committee housing sub-committee; he had spoken to friends, he had pleaded with relatives; he had written to Governor Dewey. The results?

“An offer of a substandard cold-water flat. An offer of four rooms at Central Park West and 101st Street at a rental of $300 a month provided he was prepared to pay $5,000 for the furniture in the apartment. An offer of one room in an old brownstone house, repainted but not renovated, at Eighty- eighth Street off Central Park West by a young woman (who was going to Havana) at a rental of $80 a month, provided he buy the furniture for $1,300 and reimburse her for the $100 she had to pay an agent to obtain the ‘apartment.’

“And a sublet offer of two commodious rooms in a West Side hotel at a rental of $75 a month only to find that the hotel owner had taken the suite off the monthly rental list and placed it on the transient list with daily (and higher) rates for each of the rooms.”

Who Gets the Housing?

Rental property is now rationed by various forms of chance and favoritism. First priority goes to the family that rented before the housing shortage and is willing to remain in the same dwelling.

Second priority goes to two classes among recent arrivals: first, persons willing and able to evade or avoid rent ceilings, either by some legal device or by paying a cash supplement to the OPA ceiling rent; second, friends or relatives of landlords or other persons in charge of renting dwellings.

Prospective tenants not in these favored classes scramble for any remaining places. Success goes to those who are lucky, have the smallest families, can spend the most time in hunting, are most ingenious in devising schemes to find out about possible vacancies, and are the most desirable tenants.

Last priority is likely to go to the man who must work to support his family and whose wife must care for small children. He and his wife can spend little time looking for the needle in the haystack. And if he should find a place, it may well be refused him because a family with small children is a less desirable tenant than a childless family.

Social Costs of Present Methods

Practically everyone who does not succeed in buying a house or renting a house or apartment is housed somehow. A few are housed in emergency dwellings—trailer camps, prefabricated emergency housing units, reconverted army camps. Most are housed by doubling-up with relatives or friends, a solution that has serious social disadvantages.

The location of relatives or friends willing and able to provide housing may bear little or no relation to the desired location. In order to live with his family, the husband must sacrifice mobility and take whatever position is available in the locality. If no position or only a very inferior position is available in that locality, he may have to be separated from his family for an unpredictable period to take advantage of job opportunities elsewhere. Yet there is a great social need for mobility, especially at present. The best distribution of population after the war certainly differs from the wartime distribution, and rapid reconversion requires that men be willing and able to change their location.

The spectre of current methods of doubling-up restricts the movement not only of those who double up but also of those who do not. The man who is fortunate enough to have a house or apartment will think twice before moving to another city where he will be one of the disfavored recent arrivals. One of the most easily predictable costs of moving is likely to be an extended separation from his family while he hunts for housing and they stay where they were or move in on relatives.

The rent ceilings also have important effects in reducing the efficiency with which housing is now being used by those who do not double up. The incentives to economize space are much weaker than before the war, because rents are now lower relatively to average money incomes. If it did not seem desirable to move to smaller quarters before the war, or to take in a roomer, there is no added reason to do so now, except patriotic and humanitarian impulses—or possibly the fear of relatives descending on the extra space.

Indeed, the scarcity resulting from rent ceilings imposes new impediments to efficient use of housing: a tenant will not often abandon his overly-large apartment to begin the dreary search for more appropriate quarters. And every time a vacancy does occur the landlord is likely to give preference in renting to smaller families or to single persons.

The removal of rent ceilings would bring about doubling-up in an entirely different manner. In a free rental market those persons would yield up space who considered the sacrifice of space repaid by the rent received. Doubling-up would be by those who had space to spare and wanted extra income, not, as now, by those who act from a sense of family duty or obligation, regardless of space available or other circumstances. Those who rented space from others would be engaging in a strictly business transaction, and would not feel that they were intruding, accumulating personal obligations, or imposing unfair or unwelcome burdens on benefactors. They would be better able to find rentals in places related to their job opportunities. Workers would regain their mobility, and owners of rental properties, their incentive to take in more persons.

III. The Method of Public Rationing

The defects in our present method of rationing by landlords are obvious and weighty. They are to be expected under private, personal rationing, which is, of course, why OPA assumed the task of rationing meats, fats, canned goods, and sugar during the war instead of letting grocers ration them. Should OPA undertake the task of rationing housing facilities? Those who advocate the rationing of housing facilities by a public agency argue that this would eliminate the discrimination against new arrivals, against families with children, and in favor of families with well-placed friends.

To be fair between owners and renters, however, OPA would have to be able to tell owners that they had excessive space and must either yield up a portion or shift to smaller quarters. One’s ear need not be close to the ground to know that it is utterly impracticable from a political viewpoint to order an American family owning its home either to take in a strange family (for free choice would defeat the purpose of rationing) or to move out.

Even if this basic difficulty were surmountable, how could the amount of space that a particular family deserves be determined? At what age do children of different sex require separate rooms? Do invalids need ground floor dwellings, and who is an invalid? Do persons who work in their own homes (physicians, writers, musicians) require more space? What occupations should be favored by handy locations, and what families by large yards? Must a mother-in-law live with the family, or is she entitled to a separate dwelling?

How long would it take an OPA board to answer these questions and to decide what tenants or owners must “move over” to make room for those who, in the board’s opinion, should have it?

The duration of the housing shortage would also be affected. In all fairness to both tenants and existing landlords, new construction would also be rationed and subject to rent control. If rents on new dwellings were set considerably higher than on comparable existing dwellings, in order to stimulate new construction, one of the main objectives of rent control and rationing—equal treatment of all—would be sacrificed. On the other hand, if rents on new dwellings were kept the same as rents on existing dwellings, private construction of rental properties would be small or non-existent.

We may conclude that rationing by a public agency is unlikely to be accepted on a thorough-going basis. Even if applied only to rented dwellings, it would raise stupendous administrative and ethical problems.

Sources and Probable Duration of the Present Shortage

The present housing shortage appears so acute, in the light of the moderate increase in population and the actual increase in housing facilities since 1940, that most people are at a loss for a general explanation. Rather they refer to the rapid growth of some cities—but all cities have serious shortages. Or they refer to many marriages and the rise of the birth rates—but these numbers are rarely measured, or compared with housing facilities.

Actually, the supply of housing has about kept pace with the growth of civilian non-farm population, as the following estimates based on government data show:

Certain areas will be more crowded in a physical sense than in 1940, and others less crowded, but the broad fact stands out that the number of people to be housed and the number of families have increased by about to per cent, and the number of dwelling units has also increased by about 10 per cent.

Two facts explain why the housing shortage seems so much more desperate now than in 1940, even though the amount of housing per person or family is about the same.

The first fact is that aggregate money income of the American public has doubled since 1940, so that the average family could afford larger and better living quarters even if rents had risen substantially.

The second fact is that rents have risen very little. They rose by less than 4 percent from June 1940 to September 1945, while all other items in the cost of living rose by 33 percent.

Thus, both the price structure and the increase in income encourage the average family to secure better living quarters than before the war. The very success of OPA in regulating rents has therefore contributed greatly to the demand for housing and hence to the shortage, for housing is cheap relative to other things.

Future Housing Problems

Rent ceilings do nothing to alleviate this shortage. Indeed, they are far more likely to perpetuate it: the implications of the rent ceilings for new construction are ominous. Rent is the only important item in the cost of living that has not risen greatly. Unless there is a violent deflation, which no one wants and no administration can permit, rents are out of line with all other important prices and costs, including building costs. New construction must therefore be disappointingly small in volume unless (1) an industrial revolution reduces greatly the cost of building housing, or (2) the government subsidizes the construction industry.

The industrial revolution in methods of building is devoutly wished for. But if it comes, it will come much faster if rents are higher. If it does not come, the existing construction methods will, for the most part, deliver houses only to those who can afford and wish to own their own homes. Rentals will become harder and harder to find.

The use of a building subsidy, in the midst of our high money incomes and urgent demand for housing, would be an unnecessary paradox. Now, if ever, people can afford to pay for their housing.

If the subsidy were successful in stimulating building, after some years rent ceilings could be removed without a rise of rents. But building cost would still be high—higher than if there had been no subsidy—so, housing construction would slump to low levels and remain there for a long period. Gradually, the supply of housing would fall sufficiently and the population rise sufficiently to raise rents to remunerative levels. A subsidy thus promises a depression of unprecedented severity in residential construction, and it would be irresponsible optimism to hope for a prosperous economy when this great industry was sick.

Unless, then, we are lucky (a revolutionary reduction in the cost of building apartments and houses), or unlucky (a violent deflation), or especially unwise (the use of subsidies), the “housing shortage” will remain as long as rents are held down by legal controls. As long as the shortage created by rent ceilings remains, there will be a clamor for continued rent controls. This is perhaps the strongest indictment of ceilings on rents. They, and the accompanying shortage of dwellings to rent, perpetuate themselves, and the progeny are even less attractive than the parents.

An incomplete and largely subconscious realization of this uncomfortable dilemma explains the frequent proposal that no rent ceilings or that more generous ceilings be imposed on new construction. This proposal involves a partial abandonment of rent ceilings. The retention of the rest can then be defended only on the grounds that the present method of rationing existing housing by chance and favoritism is more equitable than rationing by higher rents, but that rationing the future supply of housing by higher rents is more equitable than rationing by present methods.

Conclusion

Rent ceilings, therefore, cause haphazard and arbitrary allocation of space, inefficient use of space, retardation of new construction and indefinite continuance of rent ceilings, or subsidization of new construction and a future depression in residential building. Formal rationing by public authority would probably make matters still worse.

Unless removal of rent ceilings would be a powerful new stimulus to inflation, therefore, there is no important defense for them. Actually, higher rents would have little direct effect on inflationary pressure on other goods and services. The extra income received by landlords would be offset by the decrease in the funds available to tenants for the purchase of other goods and services.

The additional inflationary pressure from higher rents would arise indirectly; the higher rents would raise the cost of living and thereby provide an excuse for wage rises. In an era of direct governmental intervention in wage-fixing, the existence of this excuse might lead to some wage rises that would not otherwise occur and therefore to some further price rises.

How important would this indirect effect be?

Immediately on the removal of ceilings, rents charged new tenants and some existing tenants without leases would rise substantially. Most existing tenants would experience moderate rises, or, if protected by leases, none at all. Since dwellings enter the rental market only slowly, average rents on all dwellings would rise far less than rents charged new tenants and the cost of living would rise even less.

As more dwellings entered the rental market, the initial rise in rents charged new tenants would, in the absence of general inflation, be moderated, although average rents on all dwellings would continue to rise.

After a year or so, average rents might be up by as much as 30 percent. But even this would mean a rise of only about 5 percent in the cost of living, since rents account for less than one-fifth of the total cost of living. A rise of this magnitude —less than one-half of one percent per month in the total cost of living—is hardly likely to start a general inflation.

The problem of preventing general inflation should be attacked directly; it cannot be solved by special controls in special areas which may for a time bottle up the basic inflationary pressures but do not remove them. We do not believe, therefore, that rent ceilings are a sufficient defense against inflation to merit even a fraction of the great social costs they entail.

No solution of the housing problem can benefit everyone; some must be hurt. The essence of the problem is that some persons must be compelled or induced to use less housing than, they are willing to pay for at present legal rents. Existing methods of rationing housing are forcing a small minority—primarily released veterans and migrating war workers, along with their families, friends and relatives—to bear the chief sacrifice.

Rationing by higher rents would aid this group by inducing many others to use less housing and would, therefore, have the merit of spreading the burden more evenly among the population as a whole. It would hurt more persons immediately, but each less severely, than the existing methods. This is, at one and the same time, the justification for using high rents to ration housing and the chief political obstacle to the removal of rent ceilings.

A final note to the reader—we should like to emphasize as strongly as we can that our objectives are the same as yours: the most equitable possible distribution of the available supply of housing and the speediest possible resumption of new construction. The rise in rents that would follow the removal of rent control is not a virtue in itself. We have no desire to pay higher rents, to see others forced to pay them, or to see landlords reap windfall profits. Yet we urge the removal of rent ceilings because, in our view, any other solution of the housing problem involves still worse evils.

^*Editor’s Note: The authors fail to state whether the “long-term measures” which they would adopt go beyond elimination of special privilege, such as monopoly now protected by government. In any case, however, the significance of their argument at this point deserves special notice. It means that, even from the standpoint of those who put equality above justice and liberty, rent controls are “the height of folly.”

About the Authors

MILTON FRIEDMAN Ph.D. (Columbia)

Research: National Resources Committee (on Consumer Purchases Study), 1935-37; National Bureau of Economic Research, 1937-40; Division of Tax Research of U. S. Treasury, 1941-43; Statistical Research Group of Division of War Research at Columbia University, 1943-45.

Teaching: Wisconsin, Minnesota, and the University of Chicago (where he is Associate Professor of Economics).

Author: With C. Shoup and R. Mack, Taxing to Prevent Inflation; with S. Kuznets, Income from Independent Professional Practice; and articles on economic and statistical subjects.

GEORGE J. STIGLER Ph.D. (Chicago)

Research: National Resources Committee, 1935; Office of Price Administration, Division of Research, 194o-42; National Bureau of Economic Research; Statistical Research Group of Division of War Research of Columbia University, 1944.

Teaching: Iowa State College, Minnesota, and Brown University (where he is Professor of Economics).

Author:         Production and Distribution Theories; The Theory of Price; and articles on economic subjects.

Introduction by Richard M. Ebeling

1ST LECTURE: Mind, Materialism, and the Fate of Man

2ND LECTURE: Class Conflict and Revolutionary Socialism

3RD LECTURE: Individualism and the Industrial Revolution

4TH LECTURE: Nationalism, Socialism, and Violent Revolution

5TH LECTURE: Marxism and the Manipulation of Man

6TH LECTURE: The Making of Modern Civilization: Savings, Investment, and Economic Calculation

7TH LECTURE: Money, Interest, and the Business Cycle

8TH LECTURE: Profit and Loss, Private Property, and the Achievements of Capitalism

9TH LECTURE: Foreign Investments and the Spirit of Capitalism

Index

ACKNOWLEDGMENTS

The lectures by Ludwig von Mises contained in Marxism Unmasked were delivered at the San Francisco Public Library, June 23–July 3, 1952, under the sponsorship of The Freeman magazine. They were taken down, word for word, in shorthand and transcribed by Mrs. Bettina Bien Greaves. She has very kindly made these lectures available to the Foundation for Economic Education for publication. Mrs. Greaves worked as a senior staff member at FEE for practically 50 years, only retiring in 1999. Along with her late husband, Percy L. Greaves, Jr., she was a long-time friend and associate of Ludwig von Mises. Indeed, there are few people in the world today who are as conversant with Mises’s ideas and writings as she.

The publication of these lectures has been made possible through the kind and generous continuing support of Mr. Sheldon Rose of Farmington Hills, Michigan, and the Richard E. Fox Foundation of Pittsburgh, Pennsylvania. Special thanks are due to Mr. Michael Pivarnik, Executive Director of the Fox Foundation, for his dedicated interest in the ideas of the Austrian School of Economics and Ludwig von Mises in particular.

Mrs. Beth Hoffman, managing editor of FEE’s monthly magazine, The Freeman, has once again overseen the entire preparation of the manuscript. Her eye for detail in all things is reflected in the fine final product.

INTRODUCTION

by Richard M. Ebeling

AUSTRIAN ECONOMIST LUDWIG VON MISES delivered these nine lectures, which we have titled Marxism Unmasked, from June 23 to July 3, 1952, in San Francisco at a seminar sponsored by The Freeman. A history teacher who received a scholarship to attend the program later wrote to the magazine to say:

The lectures themselves I found provocative, stimulating and highly rewarding. As a classic exposition of the virtues of individualism and the evils of socialism, buttressed with an impressive array of scholarship, they were unmatched. …I am not trying to say that I became converted completely to the set of ideas that Dr. Mises and the Freeman represent. But I do say that any student or teacher of the social sciences who fails to think deeply on these ideas is negligent and ill-informed, if not worse. This feeling the seminar did leave me with. Certainly I personally appreciate some of these ideas far more than I did a month ago.¹

It is worth recalling the state of the world in 1952 when Ludwig von Mises gave these lectures. Everywhere around the globe Soviet socialism seemed to be on the march. World War II had left all of Eastern Europe in the grip of the Soviet Union. In 1949, mainland China had fallen under the control of Mao Zedong’s communist armies. In June of 1950 the Korean War had broken out, and in 1952 American armies under the UN flag were in a bloody stalemate along the 38th parallel against the forces of North Korea and Communist China. The French were immersed in a seemingly endless colonial conflict in Indochina against Ho Chi Minh’s communist guerrilla army.

In the West, large numbers of intellectuals were persuaded that “history” was inescapably on the side of socialism, under the leadership Comrade Stalin in the Kremlin. Communist parties in France and Italy had large memberships, and followed every ideological twist and turn made by Moscow. Even many of those who rejected the brutality of Soviet-style socialism still believed that economic planning was inevitable. A prominent political scientist at the University of Chicago even declared in 1950 that “Planning is coming. Of this there can be no doubt. The only question is whether it will be the democratic planning of a free society, or totalitarian in character.”²

In both Europe and the United States it was presumed that capitalism, when left unregulated, could only lead to exploitation, misery, and social injustice. Governments on both sides of the Atlantic were introducing ever more stringent interventionist and welfare statist policies meant to ameliorate the supposed cruelty of the market economy. And because of the “emergency” of the Korean War, the U.S. government had further burdened the American people with a comprehensive system of wage and price controls that hampered almost every aspect of economic activity.³

The primary source and impetus for the global bias toward socialism were the writings of Karl Marx (1818–1883). He claimed to have discovered the invariant “laws” of human historical development that would lead to the demise of capitalism and the triumph of socialism, followed by a final transition to a blissful, post-scarcity communist world. During the intermediary socialist stage leading to communism, Marx declared, there would be a “revolutionary dictatorship of the proletariat.” It would prevent remnants of the old capitalist ruling class from trying to return to power and would “reeducate” the workers into a “higher consciousness” free from the residues of the prior bourgeois mentality.⁴

What makes this entire process inescapable and irreversible, Marx insisted, is that the physical means of production follow technological transformations in a series of historical stages that are beyond man’s control. Each of these stages of transformation requires a particular set of human institutional relationships for the full blossoming of that technology’s potential. What men, in their limited and subjective views of the world, take to be the invariant foundations of human life—morality, family, property, religious faith, customs and traditions, and so on—are merely the temporary elements of a societal “superstructure” serving the ends of the objective material forces of production during each of these historical epochs. Therefore, even man’s “consciousness” about himself and the world around him is a product of his particular place and role in this process of historical evolution.⁵

Every man’s “class” position in society, according to Marx, is determined by his relationship to the ownership of the means of production. Those who own the means of production in capitalist society must, by historical necessity, “exploit” the others who offer their labor services to them for hire. The capitalist class lives off the labor of the working class by expropriating as “profit” a part of what the laborers in their employ have produced. Hence, these two social classes are in irreconcilable conflict with each other for the material rewards of human labor. This conflict reaches its climax with the violent overthrow of the exploiters by the proletariat, who experience an increasing economic misery during the final death throes of the capitalist system.⁶

In the new socialist order that replaces capitalism, the means of production will be nationalized and centrally planned for the economic betterment of the vast majority of humanity, and no longer will be used only for the profit-oriented benefit of the capitalist property owners. Economic planning will generate material prosperity far exceeding anything experienced under capitalism; technological advances and rising production will not only eliminate poverty but also push society to a level of material abundance at which all physical wants and worries will be a thing of the past. This final stage of communism will create a paradise on earth for all mankind.⁷

Ludwig von Mises as Critic of Socialism

There were many critics of socialism and Marxism in the nineteenth and early twentieth centuries. One of the most outstanding was the French economist Paul Leroy-Beaulieu, who in 1885 penned an extremely insightful and devastating analysis of collectivism, addressing its dangers to both personal liberty and economic prosperity.⁸ In 1896 one of Ludwig von Mises’s own professors at the University of Vienna, the internationally renowned Austrian economist Eugen von Böhm-Bawerk, published the most damaging critique of Marx’s labor theory of value and the accompanying idea of exploitation of labor under capitalism.⁹ There were even highly effective anti-utopian novels that depicted the disastrous effects to be expected if a socialist regime were to come to power and impose central planning on society.¹⁰

But none of these writers was as penetrating in demonstrating the inherent unworkability of a system of socialist central planning as Ludwig von Mises. During  World War I and its immediate aftermath there was an enthusiastic confidence that the age of government planning had finally arrived. The wartime price and wage controls and production planning boards imposed in virtually all the belligerent nations were considered by many the precursors of continued peacetime planning. Following the Bolshevik Revolution in Russia in 1917, Lenin’s Marxist regime imposed “war communism” in 1918, heralding it not only as an emergency device to fight the anti-communist White armies during the three-year civil war in Russia, but also as the great leap into the fully planned society. And following the end of the war in November 1918, new Social Democratic Party governments in Germany and Austria declared that the time for “socialization” and economic planning had finally arrived.¹¹

In 1919, at a meeting of the Austrian Economic Society, Mises delivered a paper on “Economic Calculation in the Socialist Commonwealth,” which was published in a leading German-language journal in 1920.¹² He incorporated this article as the centerpiece in a comprehensive treatise on collectivism that he published two years later in 1922, titled Socialism: An Economic and Sociological Analysis in its English translation.¹³

Mises observed that most of the earlier critics of socialism had rightly pointed out that a system of comprehensive government planning of economic affairs would create the worst tyranny ever experienced in human history. With all production, employment, and distribution of output completely under the monopoly control of the State, the fate and fortune of every individual would be at the mercy of the political authority. In addition, these earlier opponents of socialism had cogently argued that with the end of private property and freedom of enterprise, individuals would lose much of the self-interested motivation for industry, innovation, and work effort that exists in a market economy.

But, Mises said, what had not been thoroughly examined and challenged was whether a socialist economic system was even workable in practice. In other words, would the socialist central planners be able to rationally and efficiently manage the everyday affairs of economic life?

His answer was no. In the market economy production is guided by the expected consumer demand of the buying public. Businessmen and entrepreneurs, in the quest to earn profits and avoid losses, must direct the resources at their disposal in a way that minimizes their costs of production relative to the expected revenues from supplying goods and services that consumers want to purchase.

Money prices for both finished consumer goods and the means of production facilitate the process. The prices for consumer goods tell entrepreneurs what consumers want. The prices for the means of production—land, labor, and capital—tell them the costs of producing those goods with different types of resources and raw materials in different combinations. The entrepreneur’s task is to select that resource “mix” that minimizes the expense of bringing goods to market in the quantities and qualities demanded by consumers.

The price attached to any one of those resources (whether it be land, labor, or capital) reflects its value in alternative uses, as represented by the competing bids to purchase or hire it by rival entrepreneurs who also seek to employ it for some production purpose in the market. Unless the expected price for the finished good is able to cover the costs necessary to employ a variety of resources to produce it, it is uneconomical— wasteful—to devote those resources for its manufacture. As Mises later explained in his book on Bureaucracy, “To the entrepreneur of capitalist society a factor of production through its price sends out a warning: Don’t touch me, I am earmarked for the satisfaction of another, more urgent need” of the consuming public.¹⁴

This means that the price system of a competitive free market tends to assure that the scarce resources of society are allocated and used in a way that best reflects the wants and desires of all of us in our roles as consumers. Since one of the inescapable elements of the world in which we live is constant change, every shift in consumer demand and every modification in the availability and uses of those scarce resources are reflected in changes in the market structure of relative prices. Such changes in the structure of market prices provide new information to both producers and consumers that they may have to adjust their buying, selling, and production decisions, given the new circumstances.

Mises’s challenge to the socialists was to argue that this “rationality” of the market, which constantly coordinated selling prices with cost-prices, and supply with demand, would be totally absent under a system of central planning. Prices emerge out of the buying and selling of the market participants. But buying and selling are only possible with the institution of private property, under which goods and resources are owned, used, and transferred through voluntary exchange at the discretion of the owners.

Furthermore, under capitalism the complex network of market transactions is made possible through the use of a commonly accepted medium of exchange—money. With all goods and resources bought and sold in the market through a medium of exchange, their respective exchange values are all expressed in terms of the same common denominator: their money prices. This common denominator of money prices enables the process of “economic calculation,” i.e., the comparing of relative costs with selling prices.

The primary goal of practically all socialists in the nineteenth century and most of the twentieth century was the abolition of private property, market competition, and money prices. In their place, the State would nationalize the means of production, and as the “trustee” of the interests of the “working class” would centrally plan all of society’s economic activities. The central planning agency would determine what got produced, how and where it was produced, and then distribute the resulting output to the members of the new “workers’ paradise.”

Mises showed that the end of private property would mean the end to economic rationality. Without private ownership of the means of production—and no competitive market upon which rival entrepreneurs could bid for those resources based on their profit-motivated estimates of their respective values in producing goods desired by the consuming public—there would be no way to know real and actual opportunity costs among the potential alternative uses for which they might be applied. How, therefore, would the central planners know whether or not they were misusing and wasting the resources of society in their production decisions? As Mises summarized the dilemma, “It is not an advantage to be ignorant of whether or not what one is doing is a suitable means of attaining the ends sought. A socialist management would be like a man forced to spend his life blindfolded.”¹⁵

Even if a socialist system were not controlled by brutal dictators but instead by human “angels” who only wanted to do “good” for humanity, and even if the incentives for work and industry were not reduced or eliminated through the abolition of private property, Mises was able to demonstrate that the very institutional structure of a socialist regime made it impossible for it to produce a material “heaven on earth” for mankind superior to the productive and innovative efficiency of a functioning free-market economy.¹⁶ It is what enabled Mises to declare in the early 1930s, when the appeal of socialist planning around the world was reaching its zenith, that, “From the standpoint of both politics and history, this proof is certainly the most important discovery made by economic theory….It alone will enable future historians to understand how it came about that the victory of the socialist movement did not lead to the creation of the socialist order of society.”¹⁷

Mises’s San Francisco Lectures

Mises believed that any comprehensive critique of socialism had to deal with more than merely its unworkability as an economic system, however central this was to the case against socialism. It was also necessary to challenge and refute the philosophical and political underpinnings of the socialist and Marxian conceptions of man and society. His 1922 book on Socialism attempted to do this in great detail. And he returned to this theme a few years after he delivered these lectures in San Francisco in his work on Theory and History.¹⁸

What Mises offered those attending these lectures in late June and early July of 1952 was a clear understanding and insight into the fundamental errors and misconceptions to be found in Marx’s theories of dialectical materialism and class warfare, as well as a historical analysis of the real benefits from the Industrial Revolution that coincided with the emergence of modern capitalist society. He also explains the role of savings, investment, and the profit and loss system as the engines for economic and cultural progress, and which have helped eliminate the poverty that has plagued mankind through most of history.

In an especially insightful lecture, Mises discusses the nature and workings of capital markets and the importance of market-based interest rates free from government manipulation and inflation. In addition, he shows that foreign investment in underdeveloped parts of the world have not been the cause of poverty or exploitation, as socialists have constantly claimed, but the source of accelerated prosperity and human improvement for tens of millions of people in these countries.

All of these arguments and analyses are placed in the wider context of individualism versus collectivism, the importance of freedom for the dignity and betterment of every human being, and the dangers from surrendering liberty and property to the paternalistic state. Through it all, the reader is offered a vision of the classical-liberal ideal of the free and prosperous society.

As with an earlier series of lectures that Ludwig von Mises delivered in 1951, and which was published by FEE under the title The Free Market and Its Enemies,¹⁹ a unique quality of Marxism Unmasked is that it captures Mises as teacher. Unlike many of his longer, more formal writings, these lectures are peppered with numerous historical asides and common-sense examples that convey the ease and spirit of the spoken word.

These lectures, like the earlier ones, were taken down, word for word, in shorthand and then transcribed by Bettina Bien Greaves, a long-time former senior staff member at the Foundation for Economic Education. Mrs. Greaves is one of the leading experts on the ideas and writings of Ludwig von Mises, and her deep appreciation for his contributions to economic theory and policy is reflected in the care with which she transcribed these lectures for eventual publication. They would not be available now in print if not for her dedication and diligent scholarship, for which we are all especially grateful.

When Mises delivered these lectures Marxian socialism seemed to be conquering the world. Despite the fall of the Berlin Wall in 1989 and the collapse of the Soviet Union in 1991, Marxian criticisms of capitalist society still set the tone for those around the world who persistently hope for the end of human freedom and the market economy.²⁰ For that reason, what Mises had to say more than 50 years ago still has much meaning for us today.

But now, simply enjoy “listening” to the mind of one of the greatest economists of the twentieth century as you read this book.

1 Letter from Robert Miller, “From a History Teacher,” The Freeman (August 11, 1952), pp. 752, 782.

2 Charles E.Marriam,“The Place of Planning,”in Seymour E.Harris,ed., Saving American Capitalism (New York:Alfred A.Knopf,1950),p.161.

3 On the importance of a free-market pricing system even during a time of war emergency, see Ludwig von Mises, Human Action: A Treatise on Economics (New York: Foundation for Economic Education, 4th revised ed., 1996), pp. 825–28; also, F.A.Hayek,“Prices versus Rationing”and “The Economy of Capital”[1939] in Bruce Caldwell, ed., The Collected Works of F. A. Hayek, Vol. X: Socialism and War (Chicago: University of Chicago Press, 1997), pp. 151–60.

4 See Karl Marx, “Critique of the Gotha Program” [1875], in Robert C. Tucker, ed., The Marx-Engels Reader (New York:W.W. Norton, 1972),pp. 382–98.

5 Karl Marx, “A Contribution to the Critique of Political Economy” [1859], in ibid., pp. 4–5.

6 Karl Marx and Frederick Engels, “Manifesto of the Communist Party” [1848] in ibid., pp. 331–62.

7 On the appeal of paternalism, planning, and paradise on earth over the centuries, see Alexander Gray, The Socialist Tradition: Moses to Lenin [1946] (New York: Harper & Row, 1968); and Igor Shafarevich, The Socialist Phenomenon [1975] (New York: Harper & Row, 1980).

8 Paul Leroy-Beaulieu, Collectivism [1885] (London: John Murray, 1908); on Leroy-Beaulieu and other early critics of socialist economic planning, see Richard M. Ebeling, Austrian Economics and the Political Economy of Freedom (Northampton, Mass.: Edward Elgar, 2003), Chapter 4: “Economic Calculation Under Socialism: Ludwig von Mises and His Predecessors,” pp. 101–35.

9 Eugen von Böhm-Bawerk,“Karl Marx and the Close of His System” [1896] in Shorter Classics of Eugen von Böhm-Bawerk (South Holland, Ill.: Libertarian Press, 1962), pp. 201–302; see also H.W. B. Joseph, The Labor Theory of Value in Karl Marx (London: Oxford University Press, 1923).

10 Eugene Richter, Pictures of the Socialistic Future [1893] (London: Swan Sonnenschein, 1907).

11 On the failure of these first attempts at nationalization and planning in Russia, Germany, and Austria, see Arthur Shadwell, The Breakdown of Socialism (London: Ernest Benn,1926),pp.23–131.

12 Ludwig von Mises,“Economic Calculation in the Socialist Commonwealth” [1920] in F. A. Hayek, ed., Collectivist Economic Planning: Critical Studies on the Problem of Socialism (London: George Routledge, 1935), pp. 87–130; reprinted in Israel M. Kirzner, ed.,Classics in Austrian Economics: A Sampling in the History of a Tradition,Vol. III (London: William Pickering, 1994), pp. 3–30.

13 Ludwig von Mises, Socialism: An Economic and Sociological Analysis (Indianapolis: Liberty Classics [1922; English trans., 1936, revised ed., 1953], 1981); Mises later restated and refined his critique of socialist central planning in Human Action: A Treatise on Economics (Irvington-on-Hudson, N.Y.: Foundation for Economic Education [1949; revised eds., 1963,1966] 1996), pp. 200–31, 689–715.

14 Ludwig von Mises, Bureaucracy (New Haven: Yale University Press, 1944), p. 29.

15 Ibid., p. 30.

16 See also Richard M. Ebeling, “Why Socialism is ‘Impossible’,” The Freeman: Ideas on Liberty (October 2004), pp. 8–12.

17 Ludwig von Mises,“On the Development of the Subjective Theory of Value”[1931] in Epistemological Problems of Economics [1933] (New York: New York University Press, 1981),p.157.

18 Ludwig von Mises, Theory and History: An Interpretation of Social and Economic Evolution [1957] (Indianapolis: Liberty Fund, 2005).

19 Ludwig von Mises, The Free Market and Its Enemies: Pseudo-Science, Socialism, and Inflation (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 2004). 20 Richard M. Ebeling, “Is the ‘Specter of Communism’ Still Haunting the World?” Notes from FEE (March 2006).

1ST LECTURE

Mind, Materialism, and the Fate of Man

THE FIRST FIVE LECTURES IN THIS SERIES will be on philosophy, not on economics. Philosophy is important because everybody, whether or not he knows it, has a definite philosophy, and his philosophical ideas guide his actions.

The philosophy of today is that of Karl Marx [1818–1883]. He is the most powerful personality of our age. Karl Marx and the ideas of Karl Marx—ideas which he did not invent, develop, or improve, but which he combined into a system—are widely accepted today, even by many who emphatically declare that they are anti-communist and anti-Marxist. To a considerable extent, without knowing it, many people are philosophical Marxists, although they use different names for their philosophical ideas.

Marxists today speak of Marxism-Leninism-Stalinism. Volumes are written today in Russia about the contributions of [Vladimir Ilyich] Lenin [1870–1924] and [Josef] Stalin [1879–1953].Yet the system remains what it was in the days of Karl Marx; Marxism is in effect petrified. Lenin contributed only very strong invectives against his adversaries; Stalin contributed nothing. Thus, it is questionable to call any of these contributions “new,” when we realize that the most important contribution of Marx to this philosophy was published in 1859.¹

It takes a long time for ideas to conquer the world. When Marx died in 1883, his name was by and large unknown. A few newspapers reported in a couple of lines that Karl Marx, the author of various books, had died. Eugen von Böhm-Bawerk [1851–1914] published a critique of Marx’s economic ideas² in 1896, but it was only 20 years later that people began to consider Marx a philosopher.

The ideas of Marx and of his philosophy truly dominate our age. The interpretation of current events and the interpretation of history in popular books, as well as in philosophical writings, novels, plays, and so forth, are by and large Marxist. At the center is the Marxian philosophy of history. From this philosophy is borrowed the term “dialectical,” which is applied to all his ideas. But this is not so important as it is to realize what Marxist materialism means.

Materialism has two different meanings. The first refers exclusively to ethical problems. A material man is interested only in material things––food, drink, shelter––not in art, culture, and so forth. In this sense, the majority of men are materialists. The second meaning of materialism refers to a special group of solutions proposed to a basic philosophical problem––the relation between the human mind or soul on the one side, and the human body and the physiological functions of the body on the other side. Various answers to this problem have been offered––among them religious answers. We know very well that there is a connection between body and mind; surgery has proved that certain damages to the brain bring about certain changes in the function of the human mind. However, materialists of this second variety explain all manifestations of the human mind as products of the body.

Among these philosophical materialists, there are two schools of thought:

A. One school considers man as a machine. This machine variety of materialists say these problems are very simple––the human “machine” works precisely as any other machine works. A Frenchman, Julien de La Mettrie [1709–1751], wrote a book containing this idea, Man, the Machine; and today many people still want to explain all operations of the human mind, directly or indirectly, as if they were mechanical operations. For instance, see the Encyclopedia of the Social Sciences. One of the contributors, a teacher at the New School for Social Research, says the newborn child is like a Ford car, ready to run. Perhaps! But a machine, a newborn Ford, does not run by itself. A machine doesn’t achieve anything, doesn’t do anything alone––it is always men or a number of men who achieve something by means of the machine. Someone must run the machine. If the operation of the man ceases, the operation of the machine ceases too. We must ask this professor of the New School for Social Research, “Who runs the machine?” The answer would destroy the materialist machine doctrine.

People also talk sometimes about “feeding” the machine, as if it were alive. But, of course, it isn’t alive. Then too people sometimes say the machine suffers a “nervous breakdown.” But how can an object without nerves suffer a nervous breakdown? This machine doctrine has been repeated again and again, but it is not very realistic. We don’t have to deal with it because no serious men really believe it.

B. The physiological doctrine put forth by the second class of materialists is more important. This doctrine was formulated in a primitive way by Ludwig Feuerbach [1804–1872] and Karl Vogt [1817–1895] in the early days of Karl Marx. This idea was that thoughts and ideas are “simply” secretions of the brain. (No materialist philosopher ever fails to use the world “simply.” That means, “I know, but I can’t explain it.”) Today scientists know that certain pathological conditions cause certain secretions, and that certain secretions cause certain activities in the brain. But these secretions are chemically the same for all people in the same situation and condition. However, ideas and thoughts are not the same for all people in the same situation and condition; they are different.

First, ideas and thoughts are not tangible. And second, the same external factors do not produce the same reaction with everybody. An apple once fell from a tree and hit a certain young man [Isaac Newton]. This may have happened to many other young men before, but this particular happening challenged this particular young man and he developed some ideas from it.

But people do not always have the same thoughts when they are presented with the same facts. For instance, in school some learn; some don’t. There are differences in men.

Bertrand Russell [1872–1970] asked, “What is the difference between men and stones?” He said there was no difference except that men react to more stimuli than do stones. But actually there is a difference. Stones react according to a definite pattern which we can know; we can anticipate what will happen to a stone if it is treated in a certain way. But men don’t all react the same way when treated a certain way; we cannot establish such categories of actions for men. Thus, even though many people think physiological materialism is a solution, it actually leads to a dead end. If it were really the solution to this problem, it would mean that in any event we could know the way everyone would react. We cannot even imagine what the consequences would be if everybody knew what everybody else was going to do.

Karl Marx was not a materialist in the first sense––the machine sense. But the physiological idea was very popular in his day. It is not easy to know exactly what influenced Marx because he had personal hatreds and envies. Karl Marx hated Vogt, the exponent of physiological materialism. As soon as materialists like Vogt began to talk politics, Karl Marx said they had bad ideas; that meant Marx didn’t like them.

Marx developed what he thought was a new system. According to his materialist interpretation of history, the “material productive forces” (this is an exact translation of the German) are the bases of everything. Each stage of the material productive forces corresponds to a definite stage of production relations. The material productive forces determine the production relations, that is, the type of ownership and property which exists in the world. And the production relations determine the superstructure. In the terminology of Marx, capitalism or feudalism are production relations. Each of these was necessarily produced by a particular stage of the material productive forces. In 1859, Karl Marx said a new stage of material productive forces would produce socialism.

But what are these material productive forces? Just as Marx never said what a “class” was, so he never said exactly what the “material productive forces” are. After looking through his writings we find that the material productive forces are the tools and machines. In one of his books [Misère de la philosophie—The Poverty of Philosophy], written in French in 1847, Marx said “the hand mill produces feudalism––the steam mill produces capitalism.”³ He didn’t say it in this book, but in other writings he wrote that other machines will come which will produce socialism.

Marx tried hard to avoid the geographical interpretation of progress, because that had already been discredited. What he said was that “tools” were the basis of progress. Marx and [Friedrich] Engels [1820–1895] believed that new machines would be developed which would lead to socialism. They rejoiced at every new machine, thinking that meant socialism was just around the corner. In the French book of 1847, he criticized those who attached importance to the division of labor; he said the important thing was the tools.

We must not forget that tools don’t fall from heaven. They are the products of ideas. To explain ideas, Marx said the tools, the machines––the material productive forces––reflect themselves in the brains of men and in this way ideas come. But the tools and machines are themselves the product of ideas. Also, before there can be machines, there must be division of labor. And before there can be division of labor, definite ideas must be developed. The origin of these ideas cannot be explained by something which is possible only in a society, which is itself the product of ideas.

The term “material” fascinated people. To explain changes in ideas, changes in thoughts, changes in all those things which are the products of ideas, Marx reduced them to changes in technological ideas. In this he was not original. For example, Hermann Ludwig Ferdinand von Helmholtz [1821–1894] and Leopold von Ranke [1795-1886] interpreted history as the history of technology.

It is the task of history to explain why definite inventions were not put into practice by people who had all the physical knowledge required for their construction. Why, for instance, did the ancient Greeks, who had the technical knowledge, not develop railroads?

As soon as a doctrine becomes popular, it is simplified in such a way as to be understood by the masses. Marx said everything depends on economic conditions. As he stated in his 1847 French book [The Poverty of Philosophy], he meant that the history of factories and tools developed independently. According to Marx, the whole movement of human history appears as a corollary to the development of the material productive forces, the tools. With this development of tools, the construction of society changes and as a consequence everything else changes too. By everything else, he meant the superstructure. Marxian authors, writing after Marx, explained everything in the superstructure as due to definite changes in the production relations. And they explained everything in the production relations as due to changes in the tools and machines. This was a vulgarization, a simplification, of the Marxian doctrine for which Marx and Engels were not completely responsible. They created a lot of nonsense, but they are not responsible for all the nonsense today.

What is the influence of this Marxian doctrine on ideas? The philosopher René Descartes [1596–1650], who lived in the early seventeenth century, believed that man had a mind and that man thinks, but that animals were merely machines. Marx said, of course, Descartes lived in an age in which the “Manufakturperioden,” the tools and machines, were such that he was forced to explain his theory by saying that animals were machines. Albrecht von Hailer [1708–1777],a Swiss, said the same thing in the eighteenth century (he didn’t like liberal government’s equality under law). Between these two men, lived de La Mettrie, who also explained man as a machine. Therefore, Marx’s concept that ideas were a product of the tools and machines of a particular era is easily disproved.

John Locke [1632–1704], the well-known philosopher of empiricism, declared that everything in men’s minds comes from sensual experience. Marx says John Locke was a spokesman for the class doctrine of the bourgeoisie. This leads to two different deductions from the writings of Karl Marx:(1) The interpretation he gave to Descartes is that he was living in an age when machines were introduced and, therefore, Descartes explained the animal as a machine; and (2) The interpretation he gave to John Locke’s inspiration––that it came from the fact that he was a representative of bourgeois class interests. Here are two incompatible explanations for the source of ideas. The first of these two explanations, to the effect that ideas are based on material productive forces, the tools and machines, is irreconcilable with the second, namely that class interests determine ideas.

According to Marx, everybody is forced––by the material productive forces––to think in such a way that the result shows his class interests. You think in the way in which your “interests” force you to think; you think according to your class “interests.” Your “interests” are something independent of your mind and your ideas. Your “interests” exist in the world apart from your ideas. Consequently, the production of your ideas is not truth. Before the appearance of Karl Marx, the notion of truth had no meaning for the whole historical period. What the thinking of the people produced in the past was always “ideology,” not truth.

“Les idéologues” in France were well advertised by Napoleon [1769–1821], who said everything would be all right in France but for these “idéologues.” In 1812, Napoleon was defeated. He left the army in Russia, returned alone, incognito, and appeared at the end of December 1812 in Paris. He blamed the evils that happened to his country on the bad “idéologues” which influenced the country.

Marx used ideology in a different sense. According to Marx, ideology was a doctrine thought out by members of a class. These doctrines were necessarily not truths, but merely the expressions of the interests of the class concerned. Of course, one day there will be a classless society. One class––the proletarian class––prepares the way for the classless society. The truth of today is the idea of the proletarians. The proletarians will abolish all classes and then will come the Golden Age, the classless society.

Marx called Joseph Dietzgen [1828–1888] a proletarian, but Marx would have called him a petty bourgeois if he had known more about him. Officially Marx approved all the ideas of Dietzgen, but in his private correspondence with Ferdinand Lassalle [1825–1864] he expressed some disagreement. There is no universal logic. Every class has its own logic. But, of course, the logic of the proletariat is already the true logic of the future. (These people were offended when the racists took over the same ideas, claiming that the various races have different logics but the logic of the Aryans is the true logic.)

Karl Mannheim’s [1893–1947] sociology of knowledge grew out of Hitler’s ideas. Everybody thinks in ideologies––i.e., false doctrines. But there is one class of men which enjoys a special privilege––Marx called them the “unattached intellectuals.” These “unattached intellectuals” have the privilege of discovering truths which are not ideology.

The influence of this idea of “interests” is enormous. First of all, remember that this doctrine doesn’t say men act and think according to what they consider to be their interests. Secondly, remember that they consider “interests” as independent of the thoughts and ideas of men. These independent interests force men to think and to act in a definite way. As an example of the influence this idea has on our thinking today, I might mention a U.S. Senator––not a Democrat––who said that people vote according to their “interests”; he didn’t say in accordance with what they think to be their interests. This is Marx’s idea––assuming that “interests” are something definite and apart from a person’s ideas. This idea of class doctrine was first developed by Karl Marx in the Communist Manifesto.

Neither Engels nor Marx was of the proletariat. Engels was very wealthy. He hunted for fox in a red coat––this was the pastime of the rich. He had a girlfriend he considered too far beneath him to think of marrying. She died, and her sister became her successor. He finally married the sister, but just as she was dying––only two days before her death.

Karl Marx never made much money himself. He received some money as a regular contributor to The New York Tribune. But he was almost completely supported by his friend Engels. Marx was not a proletarian; he was the son of a well-to-do lawyer. His wife, Mrs. Karl Marx [Jenny von Westphalen, 1814–1881], was the daughter of a high Prussian Junker. And Marx’s brother-in-law was the head of the Prussian police.

Thus, these two men, Marx and Engels, who claimed that the proletarian mind was different from the mind of the bourgeoisie, were in an awkward position. So they included a passage in the Communist Manifesto to explain: “When the time comes, some members of the bourgeoisie join the rising classes.” However, if it is possible for some men to free themselves from the law of class interests, then the law is no longer a general law.

Marx’s idea was that the material productive forces lead men from one stage to another, until they reach socialism, which is the end and the height of it all. Marx said socialism cannot be planned in advance; history will take care of it. In Marx’s view, those who say how socialism will work are just “utopians.”

Socialism was already defeated intellectually at the time Marx wrote. Marx answered his critics by saying that those who were in opposition were only “bourgeois.” He said there was no need to defeat his opponents’ arguments, but only to unmask their bourgeois background. And as their doctrine was only bourgeois ideology, it was not necessary to deal with it. This would mean that no bourgeois could write anything in favor of socialism. Thus, all such writers were anxious to prove they were proletarians. It might be appropriate to mention at this time also that the ancestor of French socialism, Saint-Simon,⁴ was a descendant of a famous family of dukes and counts.

It is simply not true that inventions develop because people search for practical purposes and not for truths.

When Marx published his writings, German thought was dominated by George Wilhelm Friedrich Hegel [1770–1831], professor at the University of Berlin. Hegel had developed the doctrine of the philosophical evolution of history. In some respect his ideas were different from, even the very opposite to, those of Marx. Hegel was the man who destroyed German thinking and German philosophy for more than a century, at least. He found a warning in Immanuel Kant [1724–1804] who said the philosophy of history can only be written by a man who has the courage to pretend that he sees the world with the eyes of God. Hegel believed he had the “eyes of God,” that he knew the end of history, that he knew the plans of God. He said Geist (mind) develops itself and manifests itself in the course of historical evolution. Therefore, the course of history is inevitably progress from less satisfactory to more satisfactory conditions.

In 1825, Hegel said that we have reached a wonderful state of affairs. He considered the Prussian kingdom of Friedrich Wilhelm III [1770–1840] and the Prussian Union Church as the perfection of secular and spiritual government. Marx said, as Hegel had, that there was history in the past, but there will be no history anymore when we have reached a state that is satisfactory. Thus, Marx adopted the Hegelian system, although he used material productive forces instead of Geist. Material productive forces go through various stages. The present stage is very bad, but there is one thing in its favor––it is the necessary preliminary stage for the appearance of the perfect state of socialism. And socialism is just around the corner.

Hegel was called the philosopher of Prussian absolutism. He died in 1831. His school thought in terms of left and right wings. (The left didn’t like the Prussian government and the Prussian Union Church.) This distinction between the left and the right has existed since then. In the French Parliament, those who didn’t like the king’s government were seated on the left side of the assembly hall. Today no one wants to sit on the right.

Originally, i.e., before Karl Marx, the term “right” meant the supporters of representative government and civil liberties, as opposed to the “left” who favored royal absolutism and the absence of civil rights. The appearance of socialist ideas changed the meaning of these terms. Some of the “left” have been outspoken in expressing their views. For instance, Plato [427–347 BC] was frank in stating that a philosopher shall rule. And Auguste Comte [1798–1857] said that freedom was necessary in the past because it made it possible for him to publish his books, but now that these books have been published there is no longer any need for freedom. And in the same way Etienne Cabet [1788–1856] spoke of three classes of books––the bad books, which should be burned; the intermediate books, which should be amended; and the remaining “good” books. Therefore, there was great confusion as to the civil liberties to be assigned to the citizens of the socialist state. This was because Marxian ideas did not develop in countries which had civil liberties, but in countries in which the people did not have civil liberties.

Nikolai Bukharin [1888–1938], a Communist author who lived in a Communist country, wrote a pamphlet in 1917⁵, in which he said, we asked for freedom of the press, thought, and civil liberties in the past because we were in the opposition and needed these liberties to conquer. Now that we have conquered, there is no longer any need for such civil liberties. [Bukharin was tried and condemned to death in the Moscow Purge Trial of March 1938.] If Mr. Bukharin had been an American Communist, he would probably still be alive and free to write more pamphlets about why freedom is not necessary.

These peculiarities of Marxian philosophy can only be explained by the fact that Marx, although living in Great Britain, was not dealing with conditions in Great Britain, where he felt civil liberties were no longer needed, but with the conditions in Germany, France, Italy, and so on, where civil liberties were still needed. Thus we see that the distinction between right and left, which had meaning in the days of the French Revolution, no longer has any meaning.

1 [A Contribution to the Critique of Political Economy (Moscow: Progress Publishers, 1859).]

2 [“The Unresolved Contradiction in the Economic Marxian System” in Shorter Classics of Eugen von Böhm-Bawerk (South Holland, Ill.: Libertarian Press, 1962 [1896; Eng.Trans. 1898]), pp. 201–302.]

3 [“Le moulin à bras vous donnera la société avec le souzerain; le moulin à vapeur, la société avec le capitaliste industriel.” Karl Marx, Misère de la philosophie (Paris and Brussels, 1847), p. 100.—Ed.]

4 [Claude Henri de Rouvroy, Comte de Saint-Simon [1760–1825]—Ed.]

5 [“The Russian Revolution and Its Significance,” The Class Struggle, Vol. I, No. 1, May–June,1917.—Ed.]

2ND LECTURE

Class Conflict and
Revolutionary Socialism

MARX ASSUMED that “interests” were independent of human ideas and thoughts. He said that socialism was the ideal system for the proletariat. He said class interests determine the thinking of individuals and that this situation causes irreconcilable conflicts between the various classes. Marx then returned to the point at which he had started—namely, that socialism is the ideal state.

The fundamental concept of the Communist Manifesto (1848) was that of “class” and “class conflict.” But Marx didn’t say what a “class” was. Marx died in 1883, 35 years after the publication of the Communist Manifesto. In those 35 years he published many volumes, but in not one of them did he say what he meant by the term “class.” After Marx’s death, Friedrich Engels published the unfinished manuscript of the third volume of Marx’s Das Kapital. Engels said this manuscript, on which Marx had stopped work, many years before he died, had been found in Marx’s desk after his death. In one three-page chapter in that volume, Marx tells us what a “class” was not. But you may search through all his writings to learn what a “class” was without ever finding out. In fact, “classes” don’t exist in nature. It is our thinking—our arranging in categories—that constructs classes in our minds. The question is not whether social classes exist in the sense of Karl Marx; the question is whether we can use the concept of social classes in the way in which Karl Marx meant it. We can’t.

Marx did not see that the problem of the “interest” of an individual, or of a class, cannot be solved simply by referring to the fact that there is such an interest and that men must act according to their interests. Two questions must be asked: (1) Toward what ultimate ends do these “interests” lead people? (2) What methods do they want to apply in order to reach these ends?

The First International was a small group of people, a committee of a few men in London, friends and enemies of Karl Marx. Someone suggested that they cooperate with the British labor-union movement. In 1865, Karl Marx read at the meeting of the International Committee, a paper, Value, Price, and Profit, one of his few writings originally written in English. In this paper, he pointed out that the methods of the union movement were very bad and must be changed. Paraphrasing: “The unions want to improve the fate of the workers within the framework of the capitalist system—this is hopeless and useless. Within the framework of the capitalist system there is no possibility of improving the state of the workers. The best the union could achieve in this way would be some short-term success. The unions must abandon this ‘conservative’ policy; they must adopt the revolutionary policy. They must fight for the abolition of the wage society as such and work for the coming of socialism.” Marx didn’t have the courage to publish this paper during his lifetime; it was published only after his death by one of his daughters. He didn’t want to antagonize the labor unions; he still had hopes they would abandon their theory.

Here is an obvious conflict of opinions among the proletarians themselves concerning the right means to use. The proletarian unions and Marx disagreed as to what was in the “interest” of the proletarians. Marx said that the “interest” of a class was obvious—there could be no doubt about it—everyone would know it. Then here comes a man who doesn’t belong to this proletarian class at all, a writer and a lawyer who tells the unions they were wrong. “This is bad policy,” he said. “You must radically change your policy.” Here the whole idea of the class breaks down, the idea that an individual may sometimes err but that a class as a whole can never err.

Criticisms of Marxian doctrines have always been superficial. They haven’t pointed out how Marx contradicted himself and how he failed to explain his ideas. Böhm-Bawerk’s critique¹ was good but he didn’t cover the entire system. Critics of Marx didn’t even discover Karl Marx’s most manifest contradictions.

Marx believed in the “iron law of wages.” He accepted that as the fundamental basis of his economic doctrine. He didn’t like the German term for this law, the “brazen” law of wages, about which Ferdinand Lassalle [1825–1864] had published a pamphlet. Karl Marx and Ferdinand Lassalle were not friends; they were competitors, very serious competitors. Marx said Lassalle’s only contribution was the term itself, the “brazen” law of wages. And what was more, the term was borrowed, borrowed from the dictionary and from Goethe.²

The “iron law of wages” still survives in many textbooks, in the minds of politicians, and consequently in many of our laws. According to the “iron law of wages,” the wage rate is determined by the amount of food and other necessities required for the preservation and reproduction of life, to support the workers’ children until they can themselves work in the factories. If wage rates rise above this, the number of workers would increase and the increased number of workers would bring wage rates down again. Wages cannot drop below this point because there would then develop a shortage of labor. This law considers the worker to be some kind of microbe or rodent without free choice or free will.

If you think it is absolutely impossible under the capitalist system for wages to deviate from this rate, how then can you still talk, as Marx did, about the progressive impoverishment of the workers as being inevitable? There is an insoluble contradiction between the Marxian idea of the iron law of wage rates, according to which wages will remain at a point at which they are sufficient to support the progeny of workers until they can themselves become workers, and his philosophy of history, which maintains that the workers will be more and more impoverished until they are driven to open rebellion, thus bringing about socialism. Of course, both doctrines are untenable. Even 50 years ago the leading socialist writers were forced to resort to other elaborate schemes in the attempt to support their theories. What is amazing is that, during the century since Marx’s writings, no one has pointed out this contradiction. And this contradiction is not the only contradiction in Marx.

What really destroyed Marx was his idea of the progressive impoverishment of the workers. Marx didn’t see that the most important characteristic of capitalism was large-scale production for the needs of the masses; the main objective of capitalists is to produce for the broad masses. Nor did Marx see that under capitalism the customer is always right. In his capacity as a wage earner, the worker cannot determine what is to be made. But in his capacity as a customer, he is really the boss and tells his boss, the entrepreneur, what to do. His boss must obey the orders of the workers as they are members of the buying public. Mrs. Webb³, like other socialists, was the daughter of a well-to-do businessman. Like other socialists, she thought her father was an autocrat who gave orders to everybody. She didn’t see that he was subject to the sovereignty of the orders of the customers on the market. The “great” Mrs. Webb was no smarter than the dumbest messenger boy who sees only that his boss gives orders.

Marx had no doubt as to what the ends were toward which men aim. Nor did he have any doubts as to the best way to attain these ends. How is it that a man who read so much and interrupted his reading only to write, didn’t realize the discrepancy in his ideas?

To answer that question, we must go back to the thinking of his time. That was the time of Charles Darwin’s Origin of the Species [1859]. It was the intellectual fashion of that day to look upon men merely from the point of view of their membership in the zoological class of mammals, which acted on the basis of instincts. Marx didn’t take into account the evolution of mankind above the level of very primitive men. He considered unskilled labor to be the normal type of labor and skilled labor as the exception. He wrote in one of his books that progress in the technological improvement of machines causes the disappearance of specialists because the machine can be operated by anyone; it takes no special skill to operate a machine. Therefore, the normal type of man in the future will be the non-specialist.

With regard to many of his ideas, Marx belonged to much earlier ages, especially in constructing his philosophy of history. Marx substituted for Hegel’s evolution of Geist the evolution of the material factors of production. He didn’t realize that the material factors of production, i.e., the tools and machines, are actually products of the human mind. He said these tools and machines, the material productive forces, inevitably bring about the coming of socialism. His theory has been called “dialectical materialism,” abbreviated by the socialists to “diamet.”

[In an aside, Dr. Mises told of visiting a school in Mexico, an “escuela socialista,” a “socialist school.” Mises asked the school’s Mexican dean what “socialist school” meant. The dean explained that Mexican law required schools to teach the Darwinian doctrine of evolution and dialectical materialism. Then he commented on the provision in the law making this requirement and on the school system itself: “There is a great difference between the letter of the law and the practice. Ninety percent of the teachers in our schools are female and most of them are practicing Catholics.”]

Marx reasoned from the thesis to the negation of the thesis to the negation of the negation. Private ownership of the means of production by every individual worker was the beginning, the thesis. This was the state of affairs in a society in which every worker was either an independent farmer or an artisan who owned the tools with which he was working. Negation of the thesis—ownership under capitalism—when the tools were no longer owned by the workers, but by the capitalists. Negation of the negation was ownership of the means of production by the whole society. Reasoning in this way, Marx said he had discovered the law of historical evolution. And that is why he called it “scientific socialism.”

Marx branded all previous socialists “utopian socialists” because they tried to point out why socialism was better. They wanted to convince their fellow citizens to their view because they expected people would adopt the socialist social system if they were convinced it was better. They were “utopians,” Marx said, because they tried to describe the future earthly paradise. Among the forerunners of Marx whom he considered “utopians” were Saint-Simon, a French aristocrat; Robert Owen [1757–1858], a British manufacturer; and Charles Fourier [1772–1837], a Frenchman who was without doubt a lunatic. (Fourier was called the “fou [fool] du Palais-Royal.” He used to make such statements as “In the age of socialism, the ocean will no longer be salt but lemonade.”) Marx considered these three as great forerunners. But, he said, they didn’t realize that what they were saying was just “utopian.” They expected the coming of socialism because of a change in the opinions of the people. But for Marx, the coming of socialism was inevitable; it would come with the inevitability of nature.

On the one hand, Karl Marx wrote of the inevitability of socialism. But on the other hand, he organized a socialist movement, a socialist party, declared again and again that his socialism was revolutionary, and that the violent overthrow of the government was necessary to bring about socialism.

Marx borrowed his metaphors from the field of gynecology. The socialist party is like obstetrics, Marx said; it makes the coming of socialism possible. When asked if you consider the whole process inevitable, why do you not favor evolution instead of revolution, the Marxists reply, “There are no evolutions in life. Is not birth itself a revolution?”

According to Marx, the goal of the socialist party was not to influence, but only to help the inevitable. But obstetrics itself influences and changes conditions. Obstetrics has actually brought about progress in this branch of medicine, and even saved lives. And by saving lives it could be said obstetrics has actually changed the course of history.

The term “scientific” acquired prestige during the course of the nineteenth century. Engels’ Anti-Dühring (1878) became one of the most successful books among the writings of philosophical Marxists. One chapter in this book was reprinted as a pamphlet under the title “The Development of Socialism from Utopia to Science,” and it had enormous success. Karl Radek [1885–1939], a Soviet Communist, later wrote a pamphlet called “The Development of Socialism, from Science to Action.”

Marx’s doctrine of ideology was concocted to discredit the writings of the bourgeoisie. [Tomás] Masaryk [1850–1937] of Czechoslovakia was born of poor people, farmers and workers, and he wrote about Marxism. Yet the Marxians called him a bourgeois. How could he be considered “bourgeois” if Marx and Engels called themselves “proletarian”?

If the proletarians must think according to the “interests” of their class, what does it mean if there are disagreements and dissent among them? The confusion makes the situation very difficult to explain. When there is dissent among proletarians, they call a dissenter a “social traitor.” After Marx and Engels, the great man of the Communists was a German, Karl Kautsky [1854-1938]. In 1917, when Lenin tried to revolutionize the whole world, Karl Kautsky was opposed to the idea. And because of this disagreement, the former great man of the party became overnight a “social traitor,” and he was called that as well as many other names.

This idea is like that of the racists. The German racists declared that a definite set of political ideas were German and every real German must necessarily think according to this particular set of ideas. This was the Nazi idea. According to the Nazis, the best situation was to be in a state of war. But some Germans—Kant, Goethe, and Beethoven, for instance—had different “un-German” ideas. If not every German must think in a certain way, who is to decide which ideas are German and which are un-German? The answer can only be that an “inner voice” is the ultimate standard, the ultimate yardstick. This position necessarily leads to conflicts that must result in civil, or even international, war.

There were two groups of Russians, both of whom considered them-selves proletarians—the Bolsheviks and the Mensheviks. The only method to “settle” disagreements between them was to use force and liquidation. The Bolsheviks won. Then within the ranks of the Communist Bolsheviks there arose other differences of opinion—between Trotsky⁴ and Stalin— and the only way to resolve their conflicts was a purge. Trotsky was forced into exile, trailed to Mexico, and there in 1940 he was hacked to death. Stalin originated nothing; he went back to the revolutionary Marx of 1859—not to the interventionist Marx of 1848.

Unfortunately, purges are not something which happen just because men are imperfect. Purges are the necessary consequences of the philosophical foundation of Marxian socialism. If you cannot discuss philosophical differences of opinion in the same way you discuss other problems, you must find another solution—through violence and power. This refers not only to dissent concerning policies, economic problems, sociology, law, and so on. It refers also to problems of the natural sciences. The Webbs, Lord and Lady Passfield, were shocked to learn that Russian magazines and papers dealt even with problems of the natural sciences from the point of view of the philosophy of Marxism-Leninism-Stalinism. For instance, if there is a difference of opinion with regard to science or genetics, it must be decided by the “leader.” This is the necessary unavoidable consequence of the fact that, according to Marxist doctrine, you do not consider the possibility of dissent among honest people; either you think as I do, or you are a traitor and must be liquidated.

The Communist Manifesto appeared in 1848. In that document, Marx preached revolution; he believed the revolution was just around the corner.

He believed then that socialism was to be brought about by a series of interventionist measures. He listed ten interventionist measures—among them the progressive income tax, the abolition of the rights of inheritance, agricultural reform, and so on. These measures were untenable, he said, but necessary for socialism to come.

Thus, Karl Marx and Engels believed in 1848, that socialism could be attained by interventionism. By 1859, eleven years after the Communist Manifesto, Marx and Engels had abandoned the advocacy of interventions; they no longer expected socialism to come from legislative changes. They wanted to bring about socialism by a radical change overnight. From this point of view, followers of Marx and Engels considered later measures— the New Deal, the Fair Deal, and so forth—to be “petty bourgeois” policies. In the 1840s Engels had said British labor laws were a sign of progress and a sign of the breakdown of capitalism. Later they called such interventionist measures or interventionist policy (Sozialpolitik) very bad.

In 1888—40 years after the publication of the Communist Manifesto— a translation was made by an English writer. Engels added some comments to this translation. Referring to the ten interventionist measures advocated in the Manifesto, he said these measures were not only untenable, as the Manifesto claimed, but precisely because they were untenable, they would necessarily push further and further toward still more measures of this kind, until eventually these more advanced measures would lead to socialism.

1 [“The Unresolved Contradiction in the Economic Marxian System” in Shorter Classics of Eugen von Böhm-Bawerk, (South Holland, Ill.: Libertarian Press, 1962 [1896; Eng.Trans. 1898]), pp. 201–302.—Ed.]

2 [Marx also criticized Lassalle for using the term “Arbeiterstand” (state of work); Marx said Lassalle was confused, but Marx never explained how Lassalle was confused.—Ed.]

3 [Beatrice Webb (1858–1943), wife of Sidney Webb (1859–1947), later Lady and Lord Passfield, British Fabians.—Ed.]

4 [Leon Trotsky (1879–1940)]

3RD LECTURE

Individualism and the Industrial Revolution

LIBERALS STRESSED THE IMPORTANCE OF THE INDIVIDUAL. The nineteenth-century liberals already considered the development of the individual the most important thing. “Individual and individualism” was the progressive and liberal slogan. Reactionaries had already attacked this position at the beginning of the nineteenth century.

The rationalists and liberals of the eighteenth century pointed out that what was needed was good laws. Ancient customs that could not be justified by rationality should be abandoned. The only justification for a law was whether or not it was liable to promote the public social welfare. In many countries the liberals and rationalists asked for written constitutions, the codification of laws, and for new laws which would permit the development of the faculties of every individual.

A reaction to this idea developed, especially in Germany where the jurist and legal historian Friedrich Karl von Savigny [1779–1861] was active. Savigny declared that laws cannot be written by men; laws are developed in some mystical way by the soul of the whole unit. It isn’t the individual that thinks—it is the nation or a social entity which uses the individual only for the expression of its own thoughts. This idea was very much emphasized by Marx and the Marxists. In this regard the Marxists were not followers of Hegel, whose main idea of historical evolution was an evolution toward freedom of the individual.

From the viewpoint of Marx and Engels, the individual was a negligible thing in the eyes of the nation. Marx and Engels denied that the individual played a role in historical evolution. According to them, history goes its own way. The material productive forces go their own way, developing independently of the wills of individuals. And historical events come with the inevitability of a law of nature. The material productive forces work like a director in an opera; they must have a substitute available in case of a problem, as the opera director must have a substitute if the singer gets sick. According to this idea, Napoleon and Dante, for instance, were unimportant—if they had not appeared to take their own special place in history, someone else would have appeared on stage to fill their shoes.

To understand certain words, you must understand the German language. From the seventeenth century on, considerable effort was spent in fighting the use of Latin words and in eliminating them from the German language. In many cases a foreign word remained although there was also a German expression with the same meaning. The two words began as synonyms, but in the course of history, they acquired different meanings. For instance, take the word Umwälzung, the literal German translation of the Latin word revolution. In the Latin word there was no sense of fighting. Thus, there evolved two meanings for the word “revolution”—one by violence, and the other meaning a gradual revolution like the “Industrial Revolution.” However, Marx uses the German word Revolution not only for violent revolutions such as the French or Russian revolutions, but also for the gradual Industrial Revolution.

Incidentally, the term Industrial Revolution was introduced by Arnold Toynbee [1852–1883]. Marxists say that “What furthers the overthrow of capitalism is not revolution—look at the Industrial Revolution.”

Marx assigned a special meaning to slavery, serfdom, and other systems of bondage. It was necessary, he said, for the workers to be free in order for the exploiter to exploit them. This idea came from the interpretation he gave to the situation of the feudal lord who had to care for his workers even when they weren’t working. Marx interpreted the liberal changes that developed as freeing the exploiter of the responsibility for the lives of the workers. Marx didn’t see that the liberal movement was directed at the abolition of inequality under law, as between serf and lord.

Karl Marx believed that capital accumulation was an obstacle. In his eyes, the only explanation for wealth accumulation was that somebody had robbed somebody else. For Karl Marx the whole Industrial Revolution simply consisted of the exploitation of the workers by the capitalists. According to him, the situation of the workers became worse with the coming of capitalism. The difference between their situation and that of slaves and serfs was only that the capitalist had no obligation to care for workers who were no longer exploitable, while the lord was bound to care for slaves and serfs. This is another of the insoluble contradictions in the Marxian system. Yet it is accepted by many economists today without realizing of what this contradiction consists.

According to Marx, capitalism is a necessary and inevitable stage in the history of mankind leading men from primitive conditions to the millennium of socialism. If capitalism is a necessary and inevitable step on the road to socialism, then one cannot consistently claim, from the point of view of Marx, that what the capitalist does is ethically and morally bad. Therefore, why does Marx attack the capitalists?

Marx says part of production is appropriated by the capitalists and withheld from the workers. According to Marx, this is very bad. The consequence is that the workers are no longer in a position to consume the whole production produced. A part of what they have produced, therefore, remains unconsumed; there is “underconsumption.” For this reason, because there is underconsumption, economic depressions occur regularly. This is the Marxian underconsumption theory of depressions. Yet Marx contradicts this theory elsewhere.

Marxian writers do not explain why production proceeds from simpler to more and more complicated methods.

Nor did Marx mention the following fact: About 1700, the population of Great Britain was about five and a half million; by the middle of 1700, the population was six and a half million, about 500,000 of whom were simply destitute. The whole economic system had produced a “surplus” population. The surplus population problem appeared earlier in Great Britain than on continental Europe. This happened, first of all, because Great Britain was an island and so was not subject to invasion by foreign armies, which helped to reduce the populations in Europe. The wars in Great Britain were civil wars, which were bad, but they stopped. And then this outlet for the surplus population disappeared, so the numbers of surplus people grew. In Europe the situation was different; for one thing, the opportunity to work in agriculture was more favorable than in England.

The old economic system in England couldn’t cope with the surplus population. The surplus people were mostly very bad people—beggars and robbers and thieves and prostitutes. They were supported by various institutions, the poor laws,¹ and the charity of the communities. Some were impressed into the army and navy for service abroad. There were also superfluous people in agriculture. The existing system of guilds and other monopolies in the processing industries made the expansion of industry impossible. In those pre-capitalist ages, there was a sharp division between the classes of society who could afford new shoes and new clothes, and those who could not. The processing industries produced by and large for the upper classes. Those who could not afford new clothes wore hand-me-downs. There was then a very considerable trade in secondhand clothes—a trade which disappeared almost completely when modern industry began to produce also for the lower classes. If capitalism had not provided the means of sustenance for these “surplus” people, they would have died from starvation. Smallpox accounted for many deaths in pre-capitalist times; it has now been practically wiped out. Improvements in medicine are also a product of capitalism.

What Marx called the great catastrophe of the Industrial Revolution was not a catastrophe at all; it brought about a tremendous improvement in the conditions of the people. Many survived who wouldn’t have survived otherwise. It is not true, as Marx said, that the improvements in technology are available only to the exploiters and that the masses are living in a state much worse than on the eve of the Industrial Revolution. Everything the Marxists say about exploitation is absolutely wrong! Lies! In fact, capitalism made it possible for many persons to survive who wouldn’t have otherwise. And today many people, or most people, live at a much higher standard of living than that at which their ancestors lived 100 or 200 years ago.

During the eighteenth century, there appeared a number of eminent authors—the best known was Adam Smith [1723–1790]—who pleaded for freedom of trade. And they argued against monopoly, against the guilds, and against privileges given by the king and Parliament. Secondly, some ingenious individuals, almost without any savings and capital, began to organize starving paupers for production, not in factories but outside the factories, and not for the upper classes only. These newly organized producers began to make simple goods precisely for the great masses. This was the great change that took place; this was the Industrial Revolution. And this Industrial Revolution made more food and other goods available so that the population rose. Nobody saw less of what really was going on than Karl Marx. By the eve of the Second World War, the population had increased so much that there were 60 million Englishmen.

You can’t compare the United States with England. The United States began almost as a country of modern capitalism. But we may say by and large that out of eight people living today in the countries of Western civilization, seven are alive only because of the Industrial Revolution. Are you personally sure that you are the one out of eight who would have lived even in the absence of the Industrial Revolution? If you are not sure, stop and consider the consequences of the Industrial Revolution.

The interpretation given by Marx to the Industrial Revolution is applied also to the interpretation of the “superstructure.” Marx said the “material productive forces,” the tools and machines, produce the “production relations,” the social structure, property rights, and so forth, which produce the “superstructure,” the philosophy, art, and religion. The “superstructure,” said Marx, depends on the class situation of the individuals, i.e., whether he is a poet, painter, and so on. Marx interpreted everything that happened in the spiritual life of the nation from this point of view. Arthur Schopenhauer [1788–1860] was called a philosopher of the owners of common stock and bonds. Friedrich Nietzsche [1844–1900] was called the philosopher of big business. For every change in ideology, for every change in music, art, novel writing, play writing, the Marxians had an immediate interpretation. Every new book was explained by the “superstructure” of that particular day. Every book was assigned an adjective—“bourgeois” or “proletarian.” The bourgeoisie were considered an undifferentiated reactionary mass.

Don’t think it is possible for a man to practice all his life a certain ideology without believing in it. The use of the term “mature capitalism” shows how fully persons, who don’t think of themselves as Marxian in any way, have been influenced by Marx. Mr. and Mrs. Hammond, in fact almost all historians, have accepted the Marxian interpretation of the Industrial Revolution.² The one exception is Ashton.³

Karl Marx, in the second part of his career, was not an interventionist; he was in favor of laissez faire. Because he expected the breakdown of capitalism and the substitution of socialism to come from the full maturity of capitalism, he was in favor of letting capitalism develop. In this regard he was, in his writings and in his books, a supporter of economic freedom.

Marx believed that interventionist measures were unfavorable because they delayed the coming of socialism. Labor unions recommended interventions and, therefore, Marx was opposed to them. Labor unions don’t produce anything anyway and it would have been impossible to raise wage rates if producers had not actually produced more.

Marx claimed interventions hurt the interests of the workers. The German socialists voted against [Otto von] Bismarck’s social reforms that he instituted circa 1881 (Marx died in 1883). And in this country the Communists were against the New Deal. Of course, the real reason for their opposition to the government in power was very different. No opposition party wants to assign so much power to another party. In drafting socialist programs, everybody assumes tacitly that he himself will be the planner or the dictator, or that the planner or dictator will be intellectually completely dependent on him and that the planner or dictator will be his handyman. No one wants to be a single member in the planning scheme of somebody else.

These ideas of planning go back to Plato’s treatise on the form of the commonwealth. Plato was very outspoken. He planned a system ruled exclusively by philosophers. He wanted to eliminate all individual rights and decisions. Nobody should go anywhere, rest, sleep, eat, drink, wash, unless he was told to do so. Plato wanted to reduce persons to the status of pawns in his plan. What is needed is a dictator who appoints a philosopher as a kind of prime minister or president of the central board of production management. The program of all such consistent socialists—Plato and Hitler, for instance—planned also for the production of future socialists, the breeding and education of future members of society.

During the 2300 years since Plato, very little opposition has been registered to his ideas. Not even by Kant. The psychological bias in favor of socialism must be taken into consideration in discussing Marxian ideas. This is not limited to those who call themselves Marxian.

Marxians deny that there is such a thing as the search for knowledge for the sake of knowledge alone. But they are not consistent in this case either, for they say one of the purposes of the socialist state is to eliminate such a search for knowledge. It is an insult, they say, for persons to study things that are useless.

Now I want to discuss the meaning of the ideological distortion of truths. Class consciousness is not developed in the beginning, but it must inevitably come. Marx developed his doctrine of ideology because he realized he couldn’t answer the criticisms raised against socialism. His answer was, “What you say is not true. It is only ideology. What a man thinks, so long as we do not have a classless society, is necessarily a class ideology—that is, it is based on a false consciousness.” Without any further explanation, Marx assumed that such an ideology was useful to the class and to the members of the class that developed it. Such ideas had for their goal the pursuit of the aims of their class.

Marx and Engels appeared and developed the class ideas of the proletariat. Therefore, from this time on the doctrine of the bourgeoisie is absolutely useless. Perhaps one may say that the bourgeoisie needed this explanation to solve a bad conscience. But why should they have a bad conscience if their existence is necessary? And it is necessary, according to Marxian doctrine, for without the bourgeoisie, capitalism cannot develop. And until capitalism is “mature,” there cannot be any socialism.

According to Marx, bourgeois economics, sometimes called “apologetics for bourgeois production,” aided them, the bourgeoisie. The Marxians could have said that the thought the bourgeoisie gave to this bad bourgeois theory justified, in their eyes, as well as in the eyes of the exploited, the capitalist mode of production, thus making it possible for the system to exist. But this would have been a very un-Marxist explanation. First of all, according to Marxian doctrine, no justification is needed for the bourgeois system of production; the bourgeoisie exploit because it is their business to exploit, just as it is the business of the microbes to exploit. The bourgeoisie don’t need any justification. Their class consciousness shows them that they have to do this; it is the capitalist’s nature to exploit.

A Russian friend of Marx wrote him that the task of the socialists must be to help the bourgeoisie exploit better and Marx replied that that was not necessary. Marx then wrote a short note saying that Russia could reach socialism without going through the capitalist stage. The next morning he must have realized that, if he admitted that one country could skip one of the inevitable stages, this would destroy his whole theory. So he didn’t send the note. Engels, who was not so bright, discovered this piece of paper in the desk of Karl Marx, copied it in his own handwriting, and sent his copy to Vera Zasulich [1849–1919], who was famous in Russia because she had attempted to assassinate the Police Commissioner in St. Petersburg and been acquitted by the jury—she had a good defense counsel. This woman published Marx’s note, and it became one of the great assets of the Bolshevik Party.

The capitalist system is a system in which promotion is precisely according to merit. If people do not get ahead, there is bitterness in their minds. They are reluctant to admit that they do not advance because of their lack of intelligence. They take their lack of advancement out on society. Many blame society and turn to socialism. This tendency is especially strong in the ranks of intellectuals. Because professionals treat each other as equals, the less capable professionals consider themselves “superior” to non-professionals and feel they deserve more recognition than they receive. Envy plays an important role. There is a philosophical predisposition among persons to be dissatisfied with the existing state of affairs. There is dissatisfaction, also, with political conditions. If you are dissatisfied, you ask what other kind of state can be considered.

Marx had “anti-talent”—i.e., a lack of talent. He was influenced by Hegel and Feuerbach, especially by Feuerbach’s critique of Christianity. Marx admitted that the exploitation doctrine was taken from an anonymous pamphlet published in the 1820s. His economics were distortions taken over from [David] Ricardo [1772–1823].⁴

Marx was economically ignorant; he didn’t realize that there can be doubts concerning the best means of production to be applied. The big question is, how shall we use the available scarce factors of production. Marx assumed that what has to be done is obvious. He didn’t realize that the future is always uncertain, that it is the job of every businessman to provide for the unknown future. In the capitalist system, the workers and technologists obey the entrepreneur. Under socialism, they will obey the socialist official. Marx didn’t take into consideration the fact that there is a difference between saying what has to be done and doing what somebody else has said must be done. The socialist state is necessarily a police state.

The withering away of the state was just Marx’s attempt to avoid answering the question about what would happen under socialism. Under socialism, the convicts will know that they are being punished for the benefit of the whole society.

The third volume of Das Kapital was filled with lengthy quotations from the hearings of British Parliamentary Committees on money and banking, and they don’t make any sense at all.⁵ For instance, “The monetary system is essentially Catholic, the credit system essentially Protestant. . . . But the credit system does not emancipate itself from the basis of the monetary system any more than Protestantism emancipates itself from the foundations of Catholicism.”⁶ Utterly nonsensical!

1 [English legislation relating to public assistance for the poor, dating from the Elizabethan era and amended in 1834 in order to institute nationally supervised uniform relief.—Ed.]

2 [J. L. and Barbara Hammond, authors of the trilogy The Village Labourer (1911), The Town Labourer (1917),and The Skilled Labourer (1919)—Ed.]

3 [T.S. Ashton, The Industrial Revolution 1760-1830 (London: Oxford University Press, 1998 [1948, 1961])—Ed.]

4[On the Principles of Political Economy and Taxation (London: John Murray, 1821 [1817]).]

5[Capital: A Critique of Political Economy, III (Chicago: Charles H. Kerr, Chicago, 1909), pp. 17, 530–677ff.]

6 [Ibid., p. 696.]

4TH LECTURE

Nationalism, Socialism, and Violent Revolution

MARXIAN DOCTRINE DOESN’T DENY THE POSSIBILITY OF ABSOLUTE TRUTH, but it maintains that absolute truth can be attained only in the classless society. Or in the proletarian class society.

Lenin’s main book¹, or at least his most voluminous book (now available in the Collected Works of Lenin), led some people to call him a philosopher. Most of Lenin’s critique of the ideas of his adversaries consists of calling them “bourgeois.” Lenin’s philosophy is merely a restatement of the philosophical ideas of Marx; to some extent it is not even up to the level of other Russian writers on Marxism.

Marxist theory or philosophy had no development in countries where there were Communist parties. Persons whom we call Marxians consider themselves merely interpreters of Marx; they never tried to change anything in Marx. However, there are contradictions in Marx. So it is possible to quote passages from his writings from all points of view. The influence of Marx on all authors and writers who have lived since Marx died has been considerable, even though it is not usually admitted that these authors were influenced by Marx.

Although Marxians considered themselves solely interpreters of Marx, one Marxian, one writer, added something and had a strong influence, not only on the small group of his followers, but also on other authors. Georges Sorel [1847–1922]—not to be confused with Albert Sorel [1842–1906]— an important historian, developed a philosophy in many respects different from the Marxian philosophy. And it influenced political action and philosophic thinking. Sorel was a timid bourgeois intellectual, an engineer. He retired to discuss these things with his friends at a bookshop owned by Charles Péguy [1873–1914], a revolutionary socialist. In the course of the years, Péguy changed his opinions and at the end of his life he was a very ardent Catholic author. Péguy had serious conflicts with his family. Péguy was remarkable for his intercourse with Sorel. Péguy was a man of action; he died in action in 1914 in the first weeks of the war.

Sorel belonged psychologically to the group of people who dream of action but never act; he didn’t fight. As a writer, however, Sorel was very aggressive. He praised cruelty and deplored the fact that cruelty is more and more disappearing from our life. In one of his books, Reflections on Violence, he considered it a manifestation of decay that Marxian parties, calling themselves revolutionary, had degenerated into parliamentary parties. Where is the revolution if you are in Parliament? He also didn’t like labor unions. He thought the labor unions should abandon the hopeless venture of seeking higher wage rates and should adopt, instead of this conservative pattern, the revolutionary process.

Sorel saw clearly the contradiction in the system of Marx who spoke of revolution on the one hand and then said, “The coming of socialism is inevitable, and you cannot accelerate its coming because socialism cannot come before the material productive forces have achieved all that is possible within the frame of the old society.” Sorel saw that this idea of inevitability was contradictory to the idea of revolution. This is the contradiction all socialists ask themselves about—Kautsky, for one. Sorel completely adopted the idea of revolution.

Sorel asked of the labor unions a new tactic, action directe—attack, destroy, sabotage. He considered these aggressive policies only preliminary to the great day when the unions would declare a “general strike.” That is the day when the unions will declare “Now we don’t work at all. We want to destroy the life of the nation completely.” General strike is only a synonym for the live revolution. The idea of action directe is called “syndicalism.”

Syndicalism can mean ownership of the industry by the workers. Socialists mean by this term ownership by the state and operation for the account of the people. Sorel wanted to attain this by revolution. He didn’t question the idea that history leads toward socialism. There is a kind of instinct that pushes men toward socialism, but Sorel accepted this as superstition, an inner urge that cannot be analyzed. For this reason his philosophy has been compared with that of Henri Bergson’s élan vital (myths, fairy stories, fables, legends). However, in the doctrine of Sorel, “myth” means something else—a statement which cannot be criticized by reason.

1. Socialism is an end.

2. The general strike is the great means.

Most of Sorel’s writings date from 1890 to 1910. They had an enormous influence on the world, not only on the revolutionary socialists, but also on the royalists, supporters of the restoration of the House of Orange, the “Action française,” and in other countries the “Action nationale.” But all these parties gradually became a little bit more “civilized” than Sorel thought they should be.

It was the idea of French Syndicalism that influenced the most important movement of the twentieth century. Lenin, Mussolini, and Hitler were all influenced by Sorel, by the idea of action, by the idea not to talk but to kill. Sorel’s influence on Mussolini and Lenin has not been questioned. For his influence on Nazism, see the book by Alfred Rosenberg² titled The Myth of the 20th Century. The fundamental idea of racism was borrowed from Frenchmen. The only man who really contributed something to the Marxian idea was Sorel, along with a group of syndicalists—a comparatively small group composed exclusively of intellectuals and even of idle rich and intellectuals, like the “penthouse Bolshevists” of New York. They repeated again and again that only the workers have enough vigor and enough class consciousness in order to search out and to destroy the bourgeois system.

The center of Marxian activity shifted from Germany to France. The greatest portion of Marxian writings are in French. Sorel’s work was done in France. Outside of Russia, there are more Marxians in France than in any other country; there is, however, more discussion of communism in France than in Russia. The École Normale Supérieure in Paris was an important center of Marxian teachings. Lucien Herr [1864–1926], the librarian, had a great deal of influence. He was the father of French Marxism. As former students of École Normale Supérieure became more and more important, the school spread Marxism all over France.

By and large, the same condition prevailed in most European countries. When the universities seemed slow to accept Marxism, special schools were endowed to educate the rising generations in orthodox socialism. This was the goal of the London School of Economics, a Fabian institution founded by the Webbs. But it couldn’t avoid being invaded by persons of other ideas. For instance, [Friedrich A.] Hayek [1899–1992] taught for some years at the London School of Economics. This was the case in all countries—European countries had state universities. People generally ignored the fact that Marxians, not free traders, were appointed by the Tsar at the imperial universities in Russia. These professors were called legal, or better “loyal,” Marxians. When the Bolshevists came to power in Russia, it was not necessary to fire the professors.

Marx didn’t see any differences between the various parts of the world. One of his doctrines was that capitalism is one stage in the development of socialism. In this regard, there are some nations that are more backward than others. But capitalism was destroying the trade barriers and migration barriers that once prevented the unification of the world. Therefore, the differences in the evolution of the various countries with regard to their maturity toward socialism will disappear.

In the Communist Manifesto in 1848, Marx declared that capitalism was destroying all national peculiarities and unifying into one economic system all the countries of the world. The cheap prices of products were the means capitalism used to destroy nationalism. But in 1848, the average person didn’t know anything about Asia or Africa. Marx was even less informed than the average English businessman who knew something about business relations with China and India. The only attention Marx gave to this problem was his remark, later published by Vera Zasulich, to the effect that it might be possible for a country to skip the capitalist stage and proceed directly to socialism. Marx saw no distinction between various nations. Capitalism, feudalism, brings about progressive impoverishment everywhere. Everywhere there will be mature economies. And when the age of mature capitalism comes, the whole world will have reached socialism.

Marx lacked the ability to learn by observing political events and the political literature being published around him. For him practically nothing existed but the books of the classical economists, which he found in the library of the British Museum, and the hearings of the British Parliamentary Commissions. He didn’t even see what was going on in his own neighborhood. He didn’t see that many people were fighting, not for the interests of the proletariat, but for the principles of nationality.

Marx completely ignored this principle of nationality. The principle of nationality asked that every linguistic group form an independent state and that all the members of such a group should be recognized and unified. This was the principle which brought about the European conflicts, led to the complete destruction of the European system, and created the present-day chaos in Europe. The principle of nationality doesn’t take into account that there are large territories in which linguistic populations are mixed. Consequently there were struggles between the various linguistic groups which finally resulted in the situation we have today in Europe. I mention this because it is a principle of government which was unknown up to now.

According to this principle there is no such nation as India. It is possible that this principle of nationality will break India up into many independent states fighting one another. The Indian Parliament uses the English language. The members of the various states cannot communicate with one another, other than by employing the language of the government, a language which they have practically expelled from their country. But this situation will not last forever.

In 1848, when the Slavs of Europe met for a Panslavist Congress in Moscow, they had to speak with one another in German. But this didn’t prevent later developments in a different way.

Karl Marx and Engels didn’t like the nationalistic movement and never took notice of it. It didn’t fit into their plans or schemes. If, on account of the unfriendly remarks Marx and Engels made about various linguistic groups of Austria-Hungary and the Balkans, some authors, especially French authors, think Marx was a forerunner of National Socialism— Nazism—they are wrong. Marx said that what he wanted was to create a one-world state. And that was Lenin’s idea too.

By 1848 Marx had already assumed that socialism was just around the corner. Given such a theory, there was no reason to form a separate linguistic state. Such a state could only be very temporary. Marx simply assumed that the age of nationalities would come to an end, and that we were on the eve of an age in which there would no longer be differences between various types, classes, nations, linguistic groups, etc. Marx absolutely denied any differences among men. Men would all be of the same type. There was never any answer in Marx as to what language the people in his one-world state would use, or what the nationality of the dictator would be.

Marx was furious when someone said there were differences between men in the same nation, the same city, the same branch of business, just as all Marxists became furious when someone told them there were differences between Englishmen and Eskimos. According to Marx, the only difference was due to education. If an idiot and Dante had been educated in the same way, there would have been no difference between them. This idea influenced Marx’s followers, and it is still one of the guiding principles of American education. Why is not everybody equally intelligent? Many Marxians assume that in the future socialist commonwealth the average person will be equal in talents, gifts, intelligence, artistic attainments, to the greatest men of the past, such as Trotsky, Aristotle, Marx, and Goethe, although there will still be some more gifted people.

It never occurred to Marx that, in the best case, education can only transfer to the pupil what the teacher already knows. In the case of Marx, it wouldn’t have been enough for him to have been educated in a school by perfect Hegelian teachers because then everything he would have produced would have only been Hegelianism again. By educating people in the knowledge of the generation preceding motor cars, it wouldn’t have been possible to produce motor cars. Education can never bring about progress as such. That some people, thanks to their positions, inheritance, education, and so on, have the gift to go one step farther than preceding generations cannot be explained simply by education.

Similarly, it is impossible to explain great things and the great acts of some men simply by referring to their national affiliation. The problem is, why were these people different from their brothers and sisters? Marx simply assumed, without any reason, that we are now living in the age of internationalism and that all national traits will disappear. In the same way that he assumed that specialization would disappear, because machines can be operated by unskilled workers, he assumed there would no longer be any differences between various parts of the world and various nations. Every kind of conflict between nations was interpreted as the consequence of the machinations of the bourgeoisie. Why do Frenchmen and Germans fight? Why did they fight in 1870? Because the ruling classes of Prussia and the ruling classes of France wanted to fight. But this had nothing to do with the interests of nations.

In regard to his attitude toward war, Marx was, of course, influenced by the idea of the Manchester laissez-faire liberals. In using the term “Manchester liberalism” always as an insult, we tend to forget the essential statement in that famous declaration of the Manchester Congress where the term originated. It was said there that in the world of free trade there is no longer any reason for nations to fight one another. If there is free trade and every nation can enjoy the products of every other nation, the most important cause of war disappears. The princes are interested in increasing the territorial size of their princely province to get greater income and power, but nations as such are not interested, because it doesn’t make any difference under free trade. And in the absence of immigration barriers it doesn’t matter to the individual citizen whether his country is large or small. Therefore, according to the Manchester Liberals, war will disappear under popular democratic rule. The people will not then be in favor of war because they have nothing to win—they have only to pay and to die in the war.

It was this idea that was in the mind of President [Woodrow] Wilson [1856–1924] when he went to war against Germany. What President Wilson didn’t see was that all this about the uselessness of war is true only in a world when there is free trade between the nations. It is not true in a world of interventionism.

Sir Norman Angell [1872–1967] still argues in the same way. What did the individual Germans gain in 1870? This was almost true then, because there was comparatively free trade. But today the situation is different. Italy’s own policies made it impossible for Italians, in the world of interventionism, to get the raw materials they needed. It is not true in today’s interventionist world that the individual person does not gain something from war.

The League of Nations is one of the great failures in world history— and there have been many failures in world history. During the League’s 20 years the trade barriers had been more and more intensified. Tariffs became unimportant as trade barriers because embargoes were established.

Because the liberals said war was no longer economically advantageous because the people will not gain anything from it, therefore, a democratic nation will no longer be eager to fight wars. Marx assumed that this was true even in the interventionist world which was developing under his very eyes. This was one of the fundamental errors of Marxism. Marx was not a pacifist. He didn’t say war was bad. He only said—because the liberals said so—that war between nations had no importance or meaning at all.

He said war—i.e., revolution, by which he meant civil war—was necessary. Nor was Friedrich Engels a pacifist; he studied military science day in and day out in order to prepare himself for the position he had assigned himself as commander-in-chief of all nations, as commander-in-chief for the proletarians of all countries united. Remember that he participated in fox hunting in a red coat, which he told Marx this was the best exercise for a future general.

Because of this idea of revolution—civil war, not international war— the Marxian International began to discuss peace. In 1864 Marx founded in London the First International. A group of persons who had very little to do with the people and the masses met together. There was a secretary for every country. The secretary for Italy was Friedrich Engels and many of the other countries were represented by persons who only knew the countries they represented as tourists. Arguments between the members disrupted the whole International. Finally it was moved to the United States and then fell apart in 1876.

The Second International was formed in Paris in 1869. But this Second International didn’t know what to deal with. The unions had arisen and the unions were opposed to free trade and free migration. Under such conditions, how could you find subjects to be discussed at an international congress? Then they decided to discuss peace and war, but only on a national level. They said they were all proletarians and they agreed they would never fight the wars of the bourgeoisie. The Germans included Engels and Karl Kautsky. There were some “bad” Frenchmen in the group who asked, “What do you mean when you say we can’t defend our own country? We don’t like the Hohenzollerns.” The French at this time made an agreement with the Russians and the Germans didn’t like that. Every few years there was such an international congress and each time the newspapers said it heralded the end of war. But these “nice fellows” didn’t discuss the real causes of friction, migration barriers, etc. The outbreak of World War I disrupted the International Congresses.

What Marx planned was a revolution. But what really happened was that he created a bureaucratic organization in the European countries which was, by and large, innocent because it lacked the power to execute its theories. Then there developed in the East a Communist organization that unfortunately has the power to execute people and to threaten the whole world. And all this was started in the Reading Room of the British Museum in London by a man, who was not in this regard a man of action, but who was able to bring about violent action. It was the timid bourgeois characters, Karl Marx and Georges Sorel, who created all this mischief. Most of the violent ideas of our times have come from men who themselves wouldn’t have been able to resist any aggression.

Wilson accepted the doctrine of the Manchester Liberals, namely that so far as war was concerned, democracies don’t like to fight wars; democracies fight only wars of defense because the individual citizen cannot expect any improvement of his conditions from war, not even if his country is victorious. But Wilson didn’t see that this was true only in a world of free trade. He didn’t see that this was quite different already in the age in which he lived, which was an age of interventionism. He didn’t realize that an enormous change in economic policies had deprived this theory of the Manchester Liberals of its practicability. Trade barriers were comparatively innocent in 1914. But they were very much worsened during the years of the League of Nations. While free traders were meeting with the League in Geneva and talking about reducing trade barriers, people at home were increasing them. In 1933, there was a meeting in London to bring about cooperation among the nations. And precisely at this time the richest country, the United States, nullified the whole thing with monetary and financial regulations. After this the whole apparatus was absolutely useless.

Ricardo’s theory of comparative advantage is that it is to the advantage to a nation to have free trade even if all other nations cling to their trade barriers. If the United States alone today adopted free trade there would be certain changes. But if all other countries clung to protectionism with import barriers, it would not be possible for the United States to buy more goods from other countries.

There are isolationists not only in this country; there are also isolationists in other countries. Imports must be paid for by exports and exports have no other purpose than to pay for imports. Thus the establishment of free trade by the richest and most powerful nation only would not change the situation for the Italians, for instance, if they retained their trade barriers. It would not make any difference for other countries either. It is advantageous for any country to have free trade even if all other countries do not, but the problem is to remove the barriers of the other countries.

The term “socialism,” when it was new in the second part of the 1830s, meant exactly the same as “communism”—i.e., the nationalization of the means of production. “Communism” was the more popular term in the beginning. Slowly the term “communism” fell into oblivion and the term “socialism” came into use almost exclusively.

Socialist parties, social democratic parties, were formed and their fundamental dogma was the Communist Manifesto. In 1918, Lenin needed a new term to distinguish his group of socialists from those groups which he called “social traitors.” So he gave to the term “communism” a new meaning; he used it to refer, not to the final goal of socialism and communism, but only to the tactical means for attaining them. Until Stalin, communist meant simply a better method—the revolutionary method—as against the peaceful, socialist, method of the “socialist traitors.” At the end of the 1920s, without great success, Stalin in the Third International tried to give a different meaning to the term “communism.” However, Russia is still called the Union of the Soviet Socialist Republics (USSR).

In a letter, Karl Marx distinguished between two stages of socialism— the lower preliminary stage and the higher stage. But Marx didn’t give different names to these two stages. At the higher stage, he said, there will be such an abundance of everything that it will be possible to establish the principle “to everybody according to his needs.” Because foreign critics noticed differences in the standards of living of various members of the Russian Soviets, Stalin made a distinction. At the end of the 1920s he declared that the lower stage was “socialism” and the higher stage was “communism.” The difference was that at the lower socialist stage there was inequality in the rations of the various members of the Russian Soviets; equality will be attained only in the later, communist, stage.

1 [V.I. Lenin, Materialism and Empirio-criticism: Critical Comments on a Reactionary Philosophy (Moscow: Zveno Publishers, 1909).—Ed.]

2 [Rosenberg [1893–1946] was a Nazi ideologist condemned to death for war crimes at Nuremberg on October 1, 1946. He was executed on October 16, 1946.—Ed.]

5TH LECTURE

Marxism and the Manipulation of Man

IT IS AN ASTONISHING FACT that a philosophy like Marxism, which attacks the whole social system, remained for many decades more or less unattacked and uncontested. Karl Marx was not very well known in his life-time and his writings remained practically unknown to the greater part of his contemporaries. The great socialists of his age were other men—for instance, Ferdinand Lassalle. Lassalle’s agitations lasted only a year because he was killed in duel as a result of a private affair, but he was considered a great man in his age. Marx, on the other hand, was more or less unknown. People neither approved, nor criticized, his teachings. He died in 1883. After his death, there appeared the first part of Böhm-Bawerk’s critique of the economic doctrines of Karl Marx.¹ And later in the 1890s, when the last volume of Das Kapital was published, there appeared the second part of this critique, which completely killed Marx’s economic doctrines.²

The most orthodox Marxians tried to revive and restate his doctrines. But there was practically no sensible critique of the philosophical doctrines of Karl Marx.

Marx’s philosophical doctrines became popular in that people became familiar with some of his terms, slogans, and so forth, although they used them differently from the way they were used in the system of Karl Marx. Such simplification happens to many doctrines. For instance, Darwinism became known as the theory based on the idea that man is the grandson of an ape. What remains of Nietzsche is not much more than his term “superman,” which later acquired popularity in the United States without any connection to Nietzsche. Regarding Marx, people know his terms but they use them very loosely. But by and large, Marxian ideas have little or no opposition.

One of the reasons why the doctrine of Marx was so diluted in the public mind was the way Engels tried to explain Marxian theory. See his statement at the graveside of Marx: “Marx discovered the law of mankind’s historical evolution, i.e., the simple fact, hitherto hidden beneath ideological overgrowths, that men must first of all eat, drink, have shelter and clothing before they can pursue politics, science, art, religion, and the like.”³ Yet no one ever denied this. But now if someone says something against Marxian doctrine then they can be asked: “How can you be so stupid as to deny that one must first eat before one becomes a philosopher?”

Again there is the theory of the material productive forces. But no explanation is offered for their formation. Dialectical materialism states that the material productive forces come to the world—one doesn’t know how they come, nor where they come from—and it is these material productive forces that create everything else, i.e., the superstructure.

People sometimes believe that there has been a very sharp conflict between the various churches and Marxism. They consider Marxism and socialism as incompatible with the teachings of all Christian churches and sects. The early communist sects and early monastic communities were based on a peculiar interpretation of the Bible in general, and of the book of Acts especially. We don’t know much about these early communist sects but they existed in the Middle Ages and also in the early years of the Reformation. All these sects were in conflict with the established doctrines of their churches or denominations. So it would be absolutely wrong to make the Christian church responsible for them. I mention this to show that, at least in the minds of some groups, most of which the church considered heretical, there is no absolute conflict between socialism and the teachings of the church. The anti-Christian tendencies of the socialist forerunners of Karl Marx, of Karl Marx himself; and later of his followers, the Marxians, must first of all be understood within the whole framework which later gave rise to modern socialism.

The states, the governments, the conservative parties, were not always opposed to socialism. On the contrary; the personnel of a government has a tendency or a bias in favor of the expansion of government power; one could even say that there is an “occupational disease” on the part of government personnel to be in favor of more and more governmental activities. It was precisely this fact, this propensity of governments to adopt socialism—and many governments really did adopt socialism—that brought Marxism into conflict with the various governments.

I have pointed out that the worst thing that can happen to a socialist is to have his country ruled by socialists who are not his friends. This was the case with respect to Karl Marx and the Prussian government. The Prussian government was not against socialism. Ferdinand Lassalle attacked the liberal parties of Prussia, which were at that time fighting a great constitutional battle against the Hohenzollern kings, headed by Bismarck. The majority in Prussia at that time was against the government; the government couldn’t get a majority in the Prussian Parliament. The Prussian government was not very strong at that time. The King and the Prime Minister ruled the country without consent, without the cooperation of the Parliament. This was the case in the early 1860s. As an illustration of the weakness of the Prussian government, Bismarck, in his Memoirs, reported a conversation he had with the King. Bismarck said he would defeat the Parliament and the liberals. The King answered, “Yes, I know how that will end. Here in the square in front of the palace. First they will execute you and then they will execute me.”

Queen Victoria [1819–1901], whose oldest daughter [Victoria, 1840–1901] had married the royal prince of Prussia, was not very pleased by these developments; she was convinced that the Hohenzollerns would be defeated. At this critical moment Ferdinand Lassalle, who was at the head of a labor movement which was then still very modest, very small, came to the aid of the Hohenzollern government. Lassalle had meetings with Bismarck and they “planned” socialism. They introduced state aid, production cooperatives, nationalization, and general manhood suffrage. Later Bismarck really embarked on a program of social legislation. The greatest rival of the Marxians was the Prussian government, and they fought with every possible movement.

Now you must realize that in Prussia, the Prussian Church, the Protestant Church, was simply a department of the government, administered by a member of the Cabinet—the Minister of Education and Affairs of Culture. One of the councilors in the lower levels of the administration dealt with the problems of the church. The church in this regard was a state church; it was even a state church in its origin. Until 1817, there were Lutherans and Calvinists in Prussia. The Hohenzollerns didn’t like this state of affairs. The Lutherans were in the majority in the old Prussian territories, but in the newly acquired territories there were both groups. In spite of the fact that the majority of the whole Prussian people were Lutherans, the electorate of the Brandenburgs had changed from Lutherans to Calvinists. The Hohenzollerns were Calvinists, but they were the head of the Lutheran Church in their country. Then in 1817, under Frederick Wilhelm III of Prussia, the two churches were merged to form the Prussian Union Church. The Church was a branch of the country’s government.

From the seventeenth century on in Russia, the church was simply a department of the government. The church was not independent. Dependence of the church on the secular power was one of the characteristics of the Eastern Church at Constantinople. The head of the Eastern Empire was in fact the Superior of the Patriarch. This same system was to some extent carried over into Russia, but there the church was only a part of the government. Therefore, if you attacked the church, you also attacked the government.

The third country in which the problem was very critical was Italy, where the nationalist unification implied the abolition of the secular rule of the Pope. Until the second part of the nineteenth century the central part of Italy was ruled independently by the Pope. In 1860, the king of Sardinia conquered these states. The Pope retained only Rome, under the protection of a detachment of the French Army until 1860, when the French had to withdraw to fight Prussia. Therefore, there was a very violent feud between the Catholic Church and the Italian secular state. The struggle of the Church against the ideas of the Marxians concerning religion is something different from their struggle against the socialist program. Today it is complicated even more by the fact that the Russian Church, the Oriental Orthodox Church, came as it seems, to some agreement with the Bolsheviks. The struggle in the East is to a great extent a struggle between the Eastern Church and the Western Church—a continuation of the struggle that originated more than a thousand years ago between the two churches. Therefore, the conflicts in these countries, between Russia and the western boundaries of the Iron Curtain, are very complicated. It is not only a struggle against totalitarian economic methods for economic freedom; it is also a struggle of various nationalities, of different linguistic groups. Consider, for instance, the attempts of the present Russian government to make the various Baltic nationalities over into Russians—a continuation of something that had been started by the Tsars—and the struggle in Poland, Czechoslovakia, Hungary, and so on, against the attempts of the Russian Church to bring them back, as they say, to the Oriental Creed. To understand all these struggles one needs a special familiarity with these nationalities and with the religious histories of these parts of the world.

In the sixteenth and seventeenth centuries there were changes that expanded the size of the territory in which the Pope’s supremacy was acknowledged. Therefore, there existed a Russian Church, the Orthodox Church, and a Ukrainian or Russian Catholic Church which acknowledged the supremacy of the Pope. All these things together constituted the great religious struggles of the East. However, one must not confuse the events happening in these nationalistic and religious struggles with the fight against communism. For instance, the politicians fighting against the Russians today are not always, or at least not in most cases, fighters in favor of a free economic system. They are Marxians, socialists. They would probably like to have a totalitarian police state, but they don’t want it to be governed by the Russians.

From this point of view, one cannot say that there is any real opposition to the social teachings and social programs of Marxism. On the other hand, it is important to realize that there isn’t necessarily always a connection between anti-Marxism, an ideological philosophy, and economic freedom.

One of the outstanding contemporaries of Karl Marx in Germany was a philosopher, Friedrich Albert Lange [1828–1875]. He wrote a famous book, The History of Marxism, considered for many years, not only in Germany but also in English-speaking countries, one of the best introductions to philosophy. Lange was a socialist; he wrote another book about socialism. In his book he didn’t criticize Marx, but rather materialism. Marxian materialism is a very imperfect materialism because it traces all changes back only to something which is itself already the product of the human mind.

It is important to stress the fact that the critiques of Marxism were sometimes very wrong. I want to point to only one typical example. This is the popular propensity of anti-Marxians to consider dialectical materialism and Marxism as something belonging to the same group of ideas as Freudian psychoanalysis. I am not a psychologist, but I only have to point out how mixed up these people are who believe that materialism in general and Marxian materialism in particular have some connection with Freudian psychoanalysis.

Before Sigmund Freud [1856–1939] and Josef Breuer [1842–1925], who opened up this whole method of thinking, began to develop their doctrines, it was the generally uncontested assumption among all doctors that mental disabilities were caused by pathological changes in the human body. If a man had something that was called a nervous or mental disease they looked for some bodily factor that brought about this state of affairs. From the point of view of the doctor who deals with the human body this is the only possible interpretation. However, sometimes they were absolutely correct when they said, “We don’t know the cause.” Their only method was to look for a physical cause. One could give many examples. I want to cite only one. It happened in 1889, just a few years before the first book of Freud and Breuer was published. An eminent man in France committed suicide. For political reasons and because of his religion, the question was raised whether or not he was sane. His family wanted to prove that it was a mental disease. In order to prove his mental disease to the Church, they had to discover some physical cause. There was an autopsy by eminent doctors, and their report was published. “We discover certain things in the brain,” they said; “there is something that is not regular.” At that time, people thought that if a man doesn’t behave like other people has no physical sign of abnormality in his body, he is a malingerer. Sometimes this is unfortunate, because one can only discover whether or not a person is a malingerer after he is dead. In this regard, psychoanalysis brought about a great change. The case of Crown Prince Rudolf of Austria [1858–1889], who committed suicide at Mayerling, raised similar issues.⁴

The famous first case was that of a woman who was paralyzed. Yet nothing could be discovered in her body to explain her situation. The case was written up by a man who followed the advice of a Latin poet: wait nine years with your manuscript before you publish. Breuer got the idea that the origin of this bodily deficiency was not physical but that it was in the mind. This was a radical change in the field of the natural sciences; such a thing had never happened before—a discovery that mental factors, ideas, superstitions, fables, wrong ideas, what a man thinks, what he believes, can bring about changes in the body. This was something that all the natural sciences had denied and contested before.

Freud was a very conscientious and cautious man. He didn’t say, “I have completely discredited the old doctrines.” He said, “Perhaps one day, after a very long time, the pathological doctors will discover that ideas are already the product of some physical external bodily factor. Then psychoanalysis will no longer be needed or useful. But for the time being you must at least admit that there is a temporary value in Breuer’s and my discovery and that, from the point of view of present-day science, there is nothing that confirms the materialist thesis that every idea or every thought is the product of some external factor, just as urine is a product of the body. Psychoanalysis is the opposite of materialism; it is the only contribution to the problem of materialism vs. idealism that has come from empirical research in the human body.

We have to deal with the ways some people abuse psychoanalysis. I do not defend those psychoanalysts who try to explain everything from the point of view of certain urges, among which the sex urge is considered the most important. There was a book by a Frenchman dealing with Baudelaire [Charles Baudelaire, 1821–1867]. Baudelaire liked to spend money, but he didn’t earn money because publishers didn’t buy his poems during his lifetime. But his mother had money; she had married money and her husband died and left it to her. Baudelaire wrote his mother a lot of letters. This writer found all sorts of subconscious explanations for his letters. I don’t defend this attempt. But his letter writing doesn’t need any further explanation than that Baudelaire wanted money.

Freud said he didn’t know anything about socialism. In this regard he was very different from Einstein [1879–1955] who said, “I don’t know anything about economics, but socialism is very good.”

If we follow how Marxism became the leading philosophy of our age, we must mention Positivism and the school of Auguste Comte. Comte was a socialist similar to Karl Marx. In his youth, Auguste Comte had been the secretary of Saint-Simon. Saint-Simon was a totalitarian who wanted to rule the whole world by world council and, of course, he believed he would be the president of this world council. According to Comte’s idea of world history, it was necessary to search for the truth in the past. “But now, I, August Comte, have discovered the truth. Therefore, there is no longer any need for freedom of thought or freedom of the press. I want to rule and to organize the whole country.”

It is very interesting to follow the origin of certain terms which are today so familiar that we assume they must have been in the language from time immemorial. In French, the words “organize” and “organizer” were unknown before the end of the eighteenth century or the beginning of the nineteenth century. With regard to this term, “organize,” Balzac⁵ observed “This is a new-fangled Napoleonic term. This means you alone are the dictator and you deal with the individual as the builder works with stones.”

Another new term, “social engineering,” deals with the social structure. The social engineer deals with the social structure or with his fellowmen as the master builder deals with his bricks. Reasoning in this way, the Bolsheviks eliminate those individuals who are useless. In the term “social engineering” you have the idea of planning, the idea of socialism. Today we have many names for socialism. If a thing is popular, then the language has many expressions for it. These planners say in defense of their ideas, you must plan things; you cannot let things act “automatically.”

Sometimes “automatically” is used in a metaphorical sense to apply to things that happen on the market. If the supply of a product drops, then they say prices go up “automatically.” But this doesn’t mean that this is done without human consciousness, without some persons bidding and offering. Prices go up precisely because people are anxious to acquire these things. Nothing in the economic system happens “automatically.” Everything happens because certain people behave in a definite way.

Also the planners say, “How can you be so stupid as to advocate the absence of planning?” But no one advocates the absence of plan. The question is not “Plan, or no plan.” The question is “Whose plan? The plan of one dictator only? Or the plan of many individuals?” Everyone plans. He plans to go to work; he plans to go home; he plans to read a book; he plans a thousand other things. A “great” plan eliminates the plans of everybody else; then only one plan can be supreme. If the “great” plan and the plans of individuals come into conflict, whose plan is to be supreme? Who decides? The police decide! And they decide in favor of the “great” plan.

In the early days of socialism, some critics of socialism used to blame socialists for their ignorance of human nature. A man who must execute the plan of somebody else only would no longer be a man of the kind we call human. This objection was answered by those socialists who said, “If human nature is against socialism, then human nature will have to be changed.” Karl Kautsky said this many years before, but he didn’t give any details.

The details were provided by Behaviorism and by [Ivan] Pavlov [1849–1936], the psychologist mentioned in every book by a Marxist. The explanation was offered by Pavlov’s conditioned reflex. Pavlov was a Tsarist; he made his experiments in the days of the Tsar. Instead of human rights, Pavlov’s dog had canine rights. This is the future of education.

The Behaviorist philosophy wants to deal with human individuals as if there were no ideas or no faults in men. Behaviorism considers every human action as a reaction to a stimulus. Everything in the physical and physiological nature responds to certain reflexes. They say, “Man belongs to the same realm as animals. Why should he be different? There are certain reflexes and certain instincts that guide men to certain ends. Certain stimuli bring about certain reactions.” What the Behaviorists and the Marxists did not see was that you cannot even discredit such a theory of stimuli without entering into the meaning that the individual attaches to such stimuli. The housewife, when quoted the price of an object which she is considering buying, reacts differently to $5 than she does to $6. You cannot determine the stimulus without entering into the meaning. And the meaning itself is an idea.

The Behaviorists’ approach says, “We will condition the other people.” But who are the “we”? And who are the “other people?” “Today,” they say, “people are conditioned for capitalism by many things, by history, by good people, by bad people, by the church, etc., etc.”

This philosophy doesn’t give us any answer other than the answer we have already seen. The whole idea of this philosophy is that we must accept what Karl Marx told us because he had the great gift—he was entrusted by Providence, by the material productive forces, with discovering the law of historical evolution. He knows the end toward which history leads mankind. This leads eventually to the point where we must accept the idea that the party, the group, the clique, that has defeated the others by force of arms, is the right ruler, that he is called by the material productive forces to “condition” all other people. The fantastic thing is that the school which develops this philosophy calls itself “liberal” and calls its system a “people’s democracy,” “real democracy,” and so on. It is also fantastic that the Vice President of the United States [Henry Wallace, 1888–1965] one day declared, “We in the United States have only a civil rights democracy—but in Russia there is economic democracy.”

There was a socialist author, valued highly by the Bolsheviks in the beginning, who said the most powerful man in the world is the man in whose favor the greatest lies are told and believed. (Something similar was said by Adolf Hitler.) Here is the power of this philosophy. The Russians have the power to say, “We are a democracy and our people are happy and enjoy a full life under our system. “And other nations seem to be unable to find the right answer to this idea. If they had found the right answer, this philosophy wouldn’t be so popular.

There are people living here in the United States, at an American standard of living, who think they are unhappy because they do not live in Soviet Russia where, they say, there is a classless society and everything is better than it is here. But it seems that it is not very much fun to live in Russia, not only from the material point of view, but from the point of view of individual freedom. If you ask, “How is it possible that people say everything is wonderful in a country, Russia, in which everything is probably not very wonderful,” then we must answer, “Because our last three generations were unable to explode the contradictions and the failures of this philosophy of dialectic materialism.”

The greatest philosophy in the world today is that of dialectical materialism–the idea that it is inevitable that we are being carried toward socialism. The books that have been written up to now have not succeeded in countering this thesis. You must write new books. You must think of these problems. It is ideas that distinguish men from animals. This is the human quality of man. But according to the ideas of the socialists the opportunity to have ideas should be reserved to the Politburo only; all the other people should only carry out what the Politburo tells them to do.

It is impossible to defeat a philosophy if you do not fight in the philosophical field. One of the great deficiencies of American thinking— and America is the most important country in the world because it is here, not in Moscow, that this problem will be decided—the greatest short-coming, is that people think all these philosophies and everything that is written in books is of minor importance, that it doesn’t count. Therefore they underrate the importance and the power of ideas. Yet there is nothing more important in the world than ideas. Ideas and nothing else will determine the outcome of this great struggle. It is a great mistake to believe that the outcome of the battle will be determined by things other than ideas.

Russian Marxists, like all other Marxists, had the idea that they wanted to nationalize agriculture. That is, the theorists wanted to—the individual worker did not want to nationalize the farms; they wanted to take the big farms, break them up, and distribute the land among the small farmers. This has been called “agrarian reform.” The social revolutionaries wanted to distribute the farms to the poor peasants. In 1917, Lenin coined a new slogan, “You make revolution with the slogan of the day.” Therefore, they accepted something that was against Marxism. Later they started the nationalization of farm lands. Then they adopted this idea in the new countries they took over; they told every man that he would get his own farm.

They started this program in China. In China they took the big farms and abolished the rights of mortgage banks and landlords and freed the tenants from making any payments to the landlords. Therefore, it was not philosophy that made the Chinese peasants communistic, but the promise of a better life; people thought they would improve their conditions if they could get some farm land owned up to then by wealthier people. But this is not the solution for the Chinese problem. The advocates of this program were called agricultural reformers; they were not Marxians. The idea of land distribution is entirely un-Marxian.

* * * *

[Additional comments by Mises during the question-and-answer period]

Majorities are also not godlike. “The people’s voice is God’s” is an old German maxim, but it is not true. The basis of the idea of talking about pleasing the majority is that in the long run the majority will not tolerate rule by a minority; if the majority are not pleased there will be a violent revolution to change the government. The system of representative government is not radical; it is precisely a way to make a change of government possible without violence; many think that, with the approval of the people, they can change the government at the next election. Majority rule is not a good system but it is a system that assures peaceful conditions within the country. Newspapers, periodicals, books, and so on, are the opinion-makers.

The great progress of the modern age is that it led to representative government. The great pioneer of this idea was the British philosopher David Hume [1711–1776],⁶ who pointed out that in the long run government is not, as people believed, based on military power, but on opinion, on the opinion of the majority. What is needed is to convince the majority. It is not because the majority is always right. On the contrary, I would say the majority is very often wrong. But if you do not want to resort to a violent overthrow of the government, and this is impossible if you are the minority because if you are the minority they will overthrow you, you have only one method—to talk to the people, to write, and to talk again.

1 [Eugen von Böhm-Bawerk,“The Exploitation Theory” in Capital and Interest,Vol.1, History and Critique of Interest Theories (South Holland, Ill: Libertarian Press, 1959 [1884]), pp. 241–321—Ed.]

2 [Eugen von Böhm-Bawerk, “The Unresolved Contradiction in the Economic Marxian System” in Shorter Classics of Eugen von Böhm-Bawerk, (South Holland, Ill.: Libertarian Press,1962 [1896;Eng.Trans.1898]),pp.201–302—Ed.]

3 [Friedrich Engels, “Speech at the Grave of Karl Marx,” Highgate Cemetery, London. March 17, 1883 (a version of this eulogy was published in the newspaper La Justice, March 20, 1883)—Ed.]

4 [Carl Menger, founder of the Austrian School of Economics served as one of Rudolf’s tutors. See Erich W. Streissler and Monika Streissler, eds., Carl Menger’s Lectures to Crown Prince Rudolf of Austria (Brookfield, Vt.: Edward Elgar, 1994).—Ed.]

5 [Honoré de Balzac (1799–1850)]

6 [David Hume, “Of the First Principles of Government,” Chapter 4,in Eugene F.Miller, ed., Essays, Moral, Political, and Literary, (Indianapolis: Liberty Fund, 1987)—Ed.]

6TH LECTURE

The Making of Modern Civilization: Savings, Investment, and Economic Calculation

INSTITUTIONALISM¹ used to ridicule the classical economists because they started with “Crusoe economics.” In the beginning a fisherman got the idea that he could catch more fish one day than he needed and then he could have some leisure time to manufacture fishing nets. These nets and saved fish are “capital goods”; I don’t call them “capital.”

Capital goods are the intermediate factors between the given natural factors of production and consumer goods. Nature—given resources and human labor are the given natural factors. But if they are to produce, they must be guided. The produced, intermediary factors of production—capital goods—are not only tools; they are also all other intermediary goods, half-finished products, and supplies of consumer goods which are used for the support of those who are producing with the aid of capital goods. The production process which we are organizing and operating today started in the early ages of history, in the remotest ages of history. If the children used up the nets and fish produced by their parents, capital accumulation would have had to start all over again. There is a continuous progress from simpler conditions to more refined conditions. It is important to realize this because we must know that, from the early beginnings on, the first step toward this system of producing with the aid of capital goods was saving, and has always been saving.

The concept of “capital” must be distinguished from the concept of “capital goods.” It is impossible to think and to deal with the problems of capital goods without using and referring to the concepts which we have developed in the complicated modern system of capital calculation. Capital goods are something material—something that could be described in terms of physics and chemistry. The concept of “capital” refers to the valuation of a supply of these capital goods in terms of money. This valuation of capital goods in terms of money is what marks the beginning of what may be called a new and higher period in human endeavors to improve the external conditions of mankind. The problem is how to maintain or to preserve the amount of capital available and how to avoid consuming the available capital goods without replacing them. The problem is how not to consume more, or if possible, how to consume less, than the amount of newly produced products. It is the problem of capital preservation, maintenance, and of course of increasing the capital available.

Under some circumstances, it is possible to deal with this problem without any special calculation or computation. If a farmer continues to produce in the same way and if the methods of construction and method of living haven’t changed, he can estimate his condition because he can establish comparisons in physical and biological terms—two barns are more than one barn, a dozen head of cattle is more than two cows, and so on. But such simple methods of computation are insufficient in an economic system in which there is change and progress. Replacement may not be in the same form as the factors which are used up. Diesel engines may be substituted for steam engines, and so on. Replacement and maintenance of capital under such conditions require a method of computation and calculation which can only be figured in terms of money. The various physical and external factors of production cannot be compared in any other way than from the point of view of the services they render to men, calculated in terms of money.

It was one of the fundamental errors of Aristotle that he believed that in exchanges the things which were exchanged must have the same value. Since the days of Aristotle, for two or three thousand years, the same error has prevailed again and again, leading great thinkers, as well as simple men, astray. The same error appears in the first pages of Marx’s Das Kapital, making everything Marx said about these problems useless. This error was repeated even much later in the writings of Henri Bergson [1859-1941], the eminent French philosopher.

There is no equivalence in exchange. On the contrary, it is differences that bring about exchange. You cannot reduce the terms of exchange and of trade to equivalence; you can only reduce them to differences in evaluation. The buyer values what he gets more highly than what he gives away; the seller values what he gives less highly than what he gets. Therefore, the equivalence that we use in determining the importance the various capital goods have in our lives can only be expressed in terms of prices. In calculating in terms of prices you can establish a system of prices, and determine whether or not a price has increased or decreased— that is, in terms of money. Without a price system there cannot be any calculation. In the socialist system, which cannot have a price system as we have it in the market system, there cannot be established calculation and computation.

In the system of economic calculation, we have the terms “capital” and “income”—terms and notions that cannot be thought of outside this system. “Capital” is the sum of the prices that can be obtained on the market for a definite given supply of capital goods. The businessman employs economic calculation in a specific way; he could not operate without this system of economic calculation. At the beginning of his enterprise he establishes a total value of all the capital goods at his disposal and calls it his “capital,” or the “capital” of his firm or corporation. Periodically, he compares the value of the prices of all the capital goods available in the firm with the prices of these capital goods at the beginning. If there is an increase he calls it “profit.” If there is a decrease, he calls it “loss.” No other system would make it possible to establish whether what has been done has increased the capital available, improved it, or decreased it. From another point of view, the total surplus that he calls “profit” can also be called “income,” insofar as it makes it possible for the owner—corporation or individual—to consume this amount without reducing the amount of capital available and without, therefore, living at the expense of the future. Thus the concepts of “capital” and “income” developed only within this system of economic calculation.

If the total amount of “income” is consumed, then there is no change in the amount of capital available for the enterprise. If a part is saved, i.e., not consumed but reinvested—that is, if it is used to expand the stock of capital goods working in the enterprise—then we can say additional capital has been accumulated; the enterprise has earned some “income.” If the contrary is the case, if the amount consumed by the owner exceeds the income, then we have capital consumption, or capital decumulation, and there will be less available in the future for the production of consumer goods.

I don’t want to enter into how much knowledge the ancient Greeks and Romans had of these ideas. They had some knowledge at least, but by the Middle Ages it had entirely disappeared. Under the conditions of the Middle Ages, there was no need for such calculation. It developed slowly, step by step in the latter part of the Middle Ages in the countries in which at that time economic progress was much better than other countries, in Italy, for instance. As a result, some of the fundamental terms of accountancy preserve their Italian origin, for instance the word “capital” itself.

In the beginning, the terms of accountancy were not very clear. People were not very good at arithmetic, and we discover very bad errors simply in arithmetical problems even in the books of big fifteenth-century firms. Gradually these ideas developed more and more until the system of double-entry bookkeeping was developed. Our whole thinking is now influenced by these ideas, even the ideas of those who know nothing of the problems of accountancy and who are not in a position to read and interpret the balance sheet of a corporation. Accountants and bookkeepers are only the handymen in this fundamental way of dealing with all material and external problems. However, these problems concern others than accountants and bookkeepers. Goethe, who was a great poet, scientist, and a precursor of the science of evolution, described a merchant’s double-entry accounting system as “one of the most marvelous inventions of the human spirit.” Goethe realized these ideas were fundamental to the modern system of producing and acting and that these concepts were a kind of practical mathematics and logic in the way people deal with all these problems.

In our age, public opinion and legislation have completely lost all understanding of these problems. This is due to modern income-tax legislation. First of all, in the legislation concerning income taxes, the law-giver calls salaries and wages “income” or “earned income.” However, the main characteristic of “income” in the economic sense is that it is that surplus over a businessman’s costs that may be consumed without reducing capital, i.e., without living at the expense of the future. You cannot consume “income” without deteriorating your opportunities for future production. The concepts of “capital” and “income” developed only within the system of economic calculation.

These income-tax laws also deal with “profits” as if they were salaries. The income-tax authors are very astonished if a firm doesn’t have a profit every year. They don’t realize that there are good years and bad years for an enterprise. One consequence was that during the depression in the early 1930s people used to say, “How unjust that a man who owns a big factory doesn’t have to pay any income tax this year, while a man who makes only $300 a month has to pay.” It was not unjust from the point of view of the law; that year the big factory owner had no “income.”

The authors in promulgating these income-tax laws had not the slightest idea of what “capital” and “income” in the economic system really meant. What they didn’t see was that the greater part of the great profits and great incomes wasn’t spent by the businessmen, but reinvested in capital goods and plowed back into the enterprise to increase production. This was precisely the way in which economic progress, improvement in material conditions, took place. Fortunately I do not have to deal with the income-tax laws, nor with the mentality that led to these laws. It is enough to say that, from the point of view of the individual worker, it would be much more reasonable to tax only income spent, not income saved and reinvested.

In many cases, it is difficult for a man in the late years of his life to make a living, or at least to earn as much as he had earned in his prime. To make it simple, take the situation of singers whose years of big earning are definitely limited.

What I want to deal with is the idea that saving in general, or that saving under special circumstances, is supposedly bad from the point of view of the welfare of the commonwealth and, therefore, that something should be done to restrict saving or to direct it into special channels. In fact, we may say, and nobody can deny it, that all material progress, everything that distinguishes our conditions from those of earlier ages, is that more has been saved and accumulated as capital goods. This also distinguishes the United States from, let us say, India or China. The most important difference is only a difference in time. It is not too late for them. We just started earlier to save some of the excess of production over consumption.

The most important institutional factor in the development of nations was the establishment of a system of government and of legislation that made large-scale saving possible. Large-scale saving was impossible and still is impossible today in all those countries in which the governments believe that when one man has more it must necessarily be the cause of other people’s distress. This was once the idea of all people. And it is today the idea of the people in many countries outside the countries of Western civilization. It is the idea that is now jeopardizing Western civilization by introducing different methods of government into the constitutions which made possible the development of Western civilization. It was also the idea prevailing in most European countries until the rise of modern capitalism, that is, until the age very inappropriately called the “Industrial Revolution.”

To show how strong this idea was, I quote from Immanuel Kant [1724–1804], one of the most important philosophers—but he lived in the east, in Kaliningrad, then called Königsberg: “If one man has more than necessary, another man has less.” This is mathematically perfectly true, of course, but mathematics and economics are two different things. The fact is that in all those countries in which people believed in this dictum and in which governments believed that the best way to improve conditions was to confiscate the wealth of successful businessmen—it was not necessary to confiscate the wealth of those who were unsuccessful—in all those countries, it was not possible to save and invest.

If someone asked me why the ancient Greeks did not have railroads, I would answer, “Because there was a tendency in those days to confiscate wealth. Why should people then invest?” The Greek philosopher Isocrates [436–438 BC] made some speeches which are still available to us. He said if a wealthy citizen stood trial in Athens he had no chance to win because the judges wanted to confiscate his wealth, expecting this would improve their situation. Under such conditions there couldn’t be any question of large-scale savings.

Large-scale savings developed only from the eighteenth century on. And from that time on there developed also those institutions which made saving and investment possible, not only by the well-to-do, but also of small sums by the poor man. In the early days the poor man could save only by hoarding coins. But coins don’t bear any interest, and the advantage he got from his savings was not very great. Moreover, it was dangerous to have such small hoards in his regular home; they could be stolen easily and they didn’t earn anything. From the beginning of the nineteenth century on, we had a large-scale development that made saving possible for the broad masses.

One of the characteristic differences between a capitalistic and a pre-capitalistic system is that in the capitalistic system even those who are not very well off are owners of savings and have small investments. Many people do not recognize this difference. Still today, in dealing with the problem of interest, statesmen, or politicians, as well as public opinion, believe that creditors are the rich and the debtors are the poor. Therefore, they think that a policy of easy money, a policy of lowering interest rates artificially by government interference, is in favor of the poor and against the rich. In fact, the poor and the less well-to-do own deposits with savings banks, have bonds, insurance policies, and are entitled to pensions. According to a newspaper account today, there are 6¹/2 million owners of bonds (promises to pay) in this country. I don’t know whether or not this figure is accurate. But nevertheless these bonds are widely distributed, and so this means that the majority are not debtors but creditors. All these people are creditors. On the other hand, the owners of the common stock of a corporation that has issued bonds, or is indebted to banks, are not creditors, but debtors. Similarly the big real estate operator who has a big mortgage is also a debtor. Therefore, it is no longer true to say that the rich are creditors and the poor are debtors. Conditions in this regard have changed considerably.

One of Hitler’s great rallying cries was: “Do away with interest slavery. Long live the debtor; perish the creditor.” But one German newspaper recognized the error in this and wrote an article with the headline, “DO YOU KNOW THAT YOU YOURSELF ARE A CREDITOR?” I cannot say that this article was appreciated by Hitler.

There developed some years ago a hostility to saving and capital accumulation. This opposition to saving can’t be attributed to Marx, because Marx didn’t understand how capital was accumulated. Karl Marx didn’t foresee the development of large corporations and ownership by many small savers. A Russian economist who was influenced by Marx declared years ago that the whole economic system of capitalism was self-contradictory. Instead of consuming everything that was produced, a great part of the things produced is saved and accumulated as additional capital. There will be more and more for coming generations. What is the sense of this? For whom do they accumulate all this? Like a miser they accumulate, but who will enjoy what the saver earns? It is ridiculous; it is bad; something should be done about it.

John Maynard Keynes [1883–1946] succeeded with his anti-saving program. According to him, there is danger in over-saving. He believed, and many people accepted his view, that opportunities for investment were limited. There may not be sufficient investment opportunities to absorb all the income that is set aside as savings. Business will become bad because there is too much savings. Therefore, it was possible to save too much.

The same doctrine from another point of view had been prevalent for a very long time. People believed that a new invention—a labor-saving device—would produce what was called “technological unemployment.” This was the idea that led the early unions to destroy machines. Present-day unions still have the same idea, but they are not so unsophisticated as to destroy the machines—they have more refined methods.

As far as we can see, human wants are practically unlimited. What we need to fulfill satisfactions is more accumulation of capital goods. The only reason we don’t have a higher standard of living in this country is that we don’t have enough capital goods to produce all the things that people would like to have. I don’t want to say that people always make the best use of economic improvements. But whatever it is that you want, it requires more investment and more manpower to satisfy it. We could improve conditions, we could think of more ways to employ capital, even in the wealthiest parts of the United States, even in California. There will always be plenty of room for investment as long as there is scarcity of the material factors of production. We cannot imagine a state of affairs without this scarcity. We cannot imagine life in a “Land of Cockaigne,” where people have only to open their mouths and let food enter and where everything else people wanted was available.

Scarcity of the factors of production means a scarcity of capital goods. Therefore, the whole idea that we must stop saving and start spending is fantastic. In 1931 or 1932, Lord Keynes and a number of his friends published a declaration in which they stated there was only one means to avoid catastrophe and to improve economic conditions immediately— that was to spend, spend more, and still more. Economically we must realize that spending in this sense does not create jobs that investment wouldn’t have created just as much. It doesn’t matter whether you use your money for the purchase of a new machine or you spend it in a night club. According to Keynes’s theory the man who spends the money on a better life creates jobs, while the man who buys a machine and improves production is withholding something from the public.

It is not true that when Keynes wrote his book conditions in Great Britain justified his theory of government spending to create full employment. What created the unfavorable situation in Great Britain was that British industries after World War I did not have the means required to improve the material equipment in their factories. Therefore, the British machines were inefficient when compared with the machines in some other countries, especially in the United States. As a result, the marginal productivity of labor was lower in Britain. But as the unions would not tolerate any significant reduction of wage rates to make British industry more competitive, the result was unemployment. What Great Britain needed was more investment to improve the productivity of the factors of production, just as they need to do the same today.

Lord Keynes was very peculiar about this idea. An American friend published an article dealing with his personal friendship with Lord Keynes. He tells a story about visiting Keynes in a Washington hotel. In washing his hands, the friend was very careful not to soil more than a single towel. Keynes then crumpled all of the towels and said in that way he was making more jobs for American chambermaids. From this point of view, the best way to increase employment would be to destroy as much as possible. I would have thought that idea had been demolished once and for all by Frédéric Bastiat [1801–1850] in his broken window story.² But evidently Keynes didn’t understand this tale of Bastiat’s.

The fallacy that labor-saving machines create technological unemployment has not only been disproved by theoretical examination but also by the fact that the whole history of mankind consists precisely of the introduction of more and more labor-saving machines. Today we produce a greater amount of various amenities with a smaller amount of human labor. Yet there are more people and more employment. Therefore, it is not true that people are deprived of their jobs because some new machines are invented.

It is no less a fable, and it is also a very bad fable, that the accumulation of capital hurts the workers. The more capital goods available, the higher the marginal productivity of labor—other things being equal. If an employer considers the hiring of an additional worker or the firing of an additional worker, he asks himself what the employment of this man adds to the value of his products. If the employment of one worker more adds something to the quantities produced, the employer’s problem is, does his employment cost more than it brings from the sale of his production? The same problem arises when the employment of an additional amount of capital goods is considered. The greater amount of capital available per head of the worker, the greater the marginal productivity of the worker and consequently the higher the wages the employer can pay. The more capital accumulated—other things being equal—the more workers can be employed at the same rates, or at higher rates.

Two businessmen—J. Howard Pew [1882–1971] of Sunoco, and Irving Olds [1887–1963] of U. S. Steel—have tried, without too much success, to explain to other businessmen the effect of inflation on their capital accumulation, inventories, depreciation, and so forth. Inflation raises the businessmen’s selling prices, creating the illusion that they are making profits. The government then taxes and uses for current expenses these apparent “profits” which would otherwise have been used for investment or set aside for depreciation and replacement.

If an individual takes out a policy with a private insurance company, the insurance company invests this money. Later, of course, when the insurance has to be paid out, it has to disinvest. Individuals come to the point where they must disinvest, but insurance companies expand from year to year, and as there is capital accumulation taking place in the whole country, the insurance companies as a whole do not have to disinvest.

It is different with the Social Security system. The government talks about actuarial statistics but this does not mean what it means to an insurance company. What the individual pays, the government spends for current expenses. The government then gives to the “Social Security Fund” an IOU which it calls a “bond.” Thus the government “invests” in government bonds. When the government collects “Social Security” taxes, it says, “give me your money to spend and in return I promise that in 30 or 40 years the taxpayers will be willing to pay back the debt which we have incurred today.” Therefore the Social Security system is something very different from private insurance. It doesn’t mean something has been saved. On the contrary, the savings of individuals are collected by government for “social security” but they are used for current expenses. I am fully convinced the government will pay, but the question is, in what kind of dollars? The whole thing depends on the readiness of future Congresses and the future public to pay in good money. If people don’t like the paper money, they won’t use it. For instance, California stayed on hard currency during the Civil War era of the greenbacks.

Bismarck’s idea of social security was that he wanted everybody to receive something from the government. He compared the situation with that of the French, many of whom owned government bonds and received interest. He thought that was why the French were so patriotic; they were receiving something from the government. Bismarck wanted the individual German, too, to depend on the government. So he started an additional government bonus of 50 Marks to every old-age pensioner. This was called the Reichszuschuss [governmental supplementary allowance].

The problems of capital are problems of economic calculation. You cannot increase “capital goods” by inflation, although you can seemingly increase “capital.” The result is a discrepancy between capital goods and capital, as is pointed out by economic calculation.

1 [A school of thought that stresses the importance of social, historical, and institutional factors within the economic realm rather than individual human action.]

2 [See “What Is Seen and What Is Not Seen,” an excerpt from the first chapter of  Bastiat’s Selected Essays on Political Economy, translated by Seymour Cain and edited by George B. de Huszar (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995 [1964]), reprinted in The Freeman: Ideas on Liberty, June 2001.—Ed.]

7TH LECTURE

Money, Interest, and the Business Cycle

THERE ARE TWO PURELY THEORETICAL PROBLEMS which have had serious influences and serious consequences that cannot be exaggerated.

The first of these two problems relates to the taking of interest. This leads us back to Aristotle and his famous dictum, “Money cannot beget money.” Aristotle found interest a very difficult problem. He was responsible for the error that interest was paid for the use of money. For many centuries, for two thousand years, this was the theoretical basis of the legal prohibition of interest-taking on loans. People saw only the interest on loans; they didn’t see that interest stemmed from a general category of human action, that it arose out of the fact that all people by necessity, without any exception, valued present goods higher than future goods. Therefore, this meant that the discounted values and discounted prices of future goods as against present goods could not be eliminated simply by a government fiat, rule, or command. When the Roman Empire’s “capitalism” broke down and the highly developed Roman economic system was supplanted by the economy of the invading tribes—an economy that was purely agricultural and based on the self-sufficiency of every householder’s farm—the general prohibition against the taking of interest was increasingly enforced.

In many parts of Europe there was a struggle against the taking of interest. At the head of this struggle was the Church. For a thousand years, the councils of the Church repeated the unconditional prohibition of interest. But in order to find a theoretical basis for this prohibition they could not use the Gospels and the New Testament—they had to go back to the law of Moses. There they found a passage referring to the taking of interest on loans lent to Jews and not to Gentiles. Later at the beginning of the twelfth century the theologians found a passage in the Gospels¹ which could also be interpreted as being against interest taking. This, however, did not refer specifically to interest taking; it said, “lend, hoping for nothing again.” I think that translation is correct. This raised a problem which we needn’t go into, but which was contested by theologians and historians of law.

There was on the one hand the prohibition of the Church—the Canon Law—which the Church was very eager to enforce—but there was on the other hand reality, the practice of the people. Loans were needed. In the countries under the power of the Church, both religious and secular, modern banking was slowly developing. Theologians began to study the question of interest to determine whether or not there were reasons to justify the taking of interest. These studies were the beginning of economic law versus canonistic doctrine. They discussed many issues, and at least eliminated the erroneous belief that the lender extracts something unjust from the borrower by earning interest on money that is lent. Nevertheless that idea is still found in many American textbooks.

There was, however, another question and that question was this: If you increase the supply of money that is available for lending, then you bring about on the money market (the market for short-term loans) a tendency toward a drop in the rate of interest. If interest is not the reward for giving a man the use of a certain sum of money but in fact depends on the discount of present goods against future goods (and is independent of whether the supply of money is greater or smaller), how, then, and why does the initial drop in the rate of interest, caused by an increase in the supply of money, get reversed? In other words, notwithstanding this increased supply of money, what is the process that re-establishes a rate of interest that reflects people’s evaluations concerning the discount of future against present goods? Some people denied the existence of this phenomenon. Some people simply declared that if you increase the amount of money or money substitutes you can bring about a progressive tendency toward a further and further drop in the rate of interest until interest finally disappears completely. There are actually socialist authors who believe this is the right way to bring about abundance, to create plenty for all, and make everybody rich.

We must draw a sharp distinction between two types of bank transactions. The classical old definition of a banker, the businessman’s and economist’s definition, was that a banker was a man who loaned other people’s money. (A man who lends only his own money is a money-lender.) The banker is a person who gets deposits from people, who takes other people’s money, and lends this money to still other people. His business gains are derived from a difference in the rate of interest he pays to his depositors and the rate of interest he gets from those to whom he lends money. This is the genuine business of banking, of a banker.

The situation that came about in the nineteenth century with the development of modern methods of banking, with the issue of banknotes and of deposits subject to check, led to two serious problems: fiduciary media and credit expansion.

It was a historical evolution that took place first in Great Britain, and then also in other countries. People deposited money for safekeeping with persons whom they later called bankers—earlier these persons were the goldsmiths of London. From these goldsmiths the depositors got receipts for their money which they used in making payments. Today, we would call these receipts “banknotes.” When the goldsmith concerned enjoyed favor-able good will, there was no reason for another person not to accept such a receipt in payment of money due him. The goldsmiths and the early bankers very soon discovered that it was not necessary to keep as reserves in their vaults funds amounting to the total amount of the receipts they issued—they could issue more receipts, more banknotes, than they really had ready in their cash holdings. They discovered that they could lend a part of their reserves, that it was possible to give more credit by means of banking operations than the amount of money actually deposited with them would have permitted. Thus they discovered what we would call “fiduciary media.”

The second very questionable business consists of the institution of credit expansion, which may be called the most important economic problem of our age. This means that the banker lends more money to people than he receives from his depositors. This surplus of banknotes issued by the banker, or of deposits subject to check which he opens for his customers, is credit expansion. The question is, “What are the consequences of such operations?” At the beginning, credit expansion of this type was not very critical, not very dangerous, because it was done by individual bankers who had a good standing in the city and their notes could be taken by people, or they could be refused. You could go to the banker and receive from him a loan made up completely of additional banknotes, fiduciary media, made up completely of credit expansion. But then the question was, would your customers and your creditors really be ready to accept as payment the banknotes issued by this banker? We may assume that a creditor who has a questionable deal would answer, “It is better to take these notes than to wait any longer for payment.” But then, he would have gone immediately to the banker who issued the notes and would have redeemed them, thus reducing the number of surplus banknotes outstanding. Therefore, the dangers of credit expansion were not very great as long as the credit expansion was the business of private banks and private businesses subject to commercial laws. As long as the surplus banknotes could be returned to the bank of issue for redemption, there was a check on credit expansion, and there couldn’t be credit expansion of any considerable extent.

But very soon governments invaded this field of action. They invaded it under the erroneous idea that by issuing circulation credit, additional credit, fiduciary media, by issuing more money than they had received from the public, the banks were in a position, precisely on account of this credit expansion, to reduce the height of the rate of interest.

I pointed out before that a great mistake concerning interest was inherited from earlier ages. It was a correct description of the conditions in ancient times to say that the wealthy were the creditors and the poor were the debtors. And as a result of this, the idea prevailed that a high interest rate was bad. People were not prepared to accept the rate of interest as a market phenomenon that could not be influenced by the government. They considered the interest rate merely as an obstacle to economic development and progress. Many even believed that the rate of interest was something produced by the greed of selfish money-lenders and that it was the duty of the government to fight against it. The development of modern capitalism was due to the fact that governments, after centuries and centuries of making mistakes, finally abandoned the idea that they should interfere with market prices, wage rates, and so on. Capitalism wouldn’t have developed if government interference with prices and wages had not been abandoned in the eighteenth century. This development laid the way for the economic improvements of our age. However, it did not succeed completely with regard to the rate of interest.

It is true that the older government decrees fixing maximum rates of interest were abolished in the age of liberalism and capitalism. But they were abolished only because governments thought they had discovered a new means of making credit cheaper, i.e., through credit expansion by the banks. In the process, private bankers disappeared completely from this business. Governments gave privileges to governmental banks that had the monopoly of the issuance of fiduciary media. It was not easy for them to do this, because there was some resistance. Twice in the United States, the efforts to establish a United States bank of issue were thwarted by the majority of the population.

What the governments did was to introduce a very weak “middle of the road” procedure for dealing with the problem. A consistent supporter of this system of credit expansion would have said, “If you can reduce the interest rate by credit expansion, why should you not finally abolish it altogether and make the rate of interest disappear and give everybody loans without charging them any rate of interest at all? This would be a solution to the social problem of poverty—you could give to everybody. Why not?” But the governments did not believe they could abolish the rates of interest altogether.

There was a famous exchange of letters between the French socialist Pierre-Joseph Proudhon [1809–1865] and Frédéric Bastiat. Proudhon was an opponent of Bastiat. Proudhon maintained that if we established such credit-issuing banks, then we could make the rate of interest disappear completely. Bastiat disagreed, but he didn’t find precisely the correct position; he endorsed a “middle of the road” solution, namely that interest rates should be allowed to go up to certain points but that they should not be “too high.” This middle-of-the-road position became later the generally accepted doctrine of the world. Those who still maintained that it was possible to create riches for all by credit measures aimed at lowering or eliminating interest rates altogether were called “monetary cranks.” There was no reason to call them monetary cranks; they were only more consistent than those who advocated the official middle-of-the-road policy. Some of the advocates of lowering interest rates drastically were very eminent men, eminent in other fields. There was Ernest Solvay [1838–1922], a Belgian who was successful as a businessman and as a chemist, but who believed that it was possible to make all people happy by establishing comptabilisme social [compatibilism]. In Canada, there was the Alberta Experiment, the program of an Englishman, Major Clifford H. Douglas [1879–1952]. Douglas called it “social credit.”

How could people be so mistaken as to assume that there were no consequences from this credit expansion? A special doctrine was developed for this purpose. It was said that within the economic system there is a natural limit to credit expansion. The amount of money required for business transactions, they said, was determined by the “needs of business,” and if the banks did not expand credit more than called for by these “needs of business,” then no harm can be done. Their idea was this: The producer of raw materials sells raw materials to a manufacturer and issues a bill of exchange to him; the businessman who buys the raw materials takes the bill of exchange to the bank; the bank discounts it and gives him credit to pay for these raw materials; after three months the manufacturer has produced a finished product out of these raw materials; he sells the product and pays back the loan granted to him. Therefore, the proponents of this system say, there is no danger if the bank merely provides credit enabling the businessman to buy these raw materials. If the bank limits itself to granting credit to such business already transacted, they say, then the amount of credit asked from the bank for such purposes is limited by the “needs of business”—by the exact and real amount of business transacted in the country. Therefore, it doesn’t mean an increase in the supply of credit, because the increase in the supply of credit corresponds exactly to the increase in the demand for credit transactions based on real transactions on the part of business.

But what this doctrine did not see was that these “needs of business” depend on the amount of credit given by the bank. And the amount of credit it gives out depends on the interest rate it asks from borrowers. The higher the interest rate, the fewer borrowers will want loans; the lower the interest rate, the more borrowers will ask for credit.

Every businessman calculates the expected outgo and income of his projects. If his calculations show that the transaction, given the costs, including, of course, the cost of interest, will not pay, then the project is not undertaken. But if the bank of issue appears on the scene and creates additional circulation credit to give out for such purposes, thereby lowering the rate of interest below what it would have been in the absence of this new credit, even if only by a quarter or a fifth of one percent, a number of projects which would not have been undertaken at the higher rate of interest would now be done. The credit expansion of the bank creates its own demand; it gives the impression that more savings, more capital goods, are available than actually is the case. In fact what has been increased is only the amount of credit.

If the bank does not expand credit, if it does not give out new circulation credit for this purpose, that is, if it lends only money from someone’s savings, the consequence would be that the bank would have to charge a higher rate of interest than if it did create new credit. Then many transactions would not be conducted, precisely on account of the fact that the rate of interest was a little bit higher. However, if the bank gives out new credit, additional money, it must reduce the interest rate to attract new borrowers, as all available funds were already loaned out at the prevailing market rate of interest.

The banks very often expand credit for political reasons. There is an old saying that if prices are rising, if business is booming, the party in power has a better chance to succeed in an election campaign than it would otherwise. Thus the decision to expand credit is very often influenced by the government that wants to have “prosperity.” Therefore, governments all over the world are in favor of such a credit-expansion policy.

On the market, credit expansion creates the impression that more capital and savings are available than actually are, and that projects which yesterday were not practical because of the higher interest rate are feasible today because conditions have changed. Businessmen assume that the lower interest rate signals the availability of sufficient capital goods. This means that credit expansion falsifies the businessman’s economic calculations; it gives the impression to him, to the nation, and to the world, that there are more capital goods than there really are. By credit expansion, you can increase the accounting concept of “capital”; what you cannot do is create more real capital goods. As production is necessarily always limited by the amount of capital goods available, the result of credit expansion is to make businessmen believe that projects are feasible which actually cannot be executed on account of the existing scarcity of capital goods. Thus credit expansion misleads businessmen, results in distorting production and causes economic “malinvestment.” When the credit expansion causes businessmen to undertake such projects, the result is called a “boom.”

We must not overlook the fact that all during the nineteenth and twentieth centuries there was always an obsession, unfortunately not against credit expansion, but at least against giving the government too much power in matters of credit expansion. The main object was to limit the government’s influence with regard to the central banks.

In the course of history, governments have used the central banks again and again for borrowing money. The government can borrow money from the public. For instance, a person who has saved one hundred dollars could hold them as dollars or invest them. But instead of doing either of these things he can buy a new government bond; this purchase doesn’t change the amount of money in existence; the money he pays for the bond passes from his hands to those of the government. But if the government goes to the central bank to borrow the money, the bank can buy government bonds and lend money to the government simply by expanding credit, in effect creating new money. Governments have a lot of good ideas as to how to carry out this borrowing.

There has always been a struggle between parliaments and the executive concerning the government’s influence on the central banks. Most of the European legislatures said very clearly that their central banks must be separate from the government, that they must be independent. And in this country, you know there is a continual conflict between the Federal Reserve Board and the U.S. Treasury. This is a natural situation caused by economic laws and government legislation. Some governments have found it very easy to violate the legislation without violating the letter of the law. The German government, for instance, borrowed from the public during World War I because the Reichsbank had promised to give it loans. Private individuals who bought German government bonds needed to pay out only 17 percent of the amount of the bond, and this 17 percent gave them a yield of 6 or 7 percent. Hence, 83 percent of the price of the bond was supplied by the Bank. This meant that when the government borrowed from the public, it was actually borrowing indirectly from the German Reichsbank. The result was that in Germany the U. S. dollar went from 4.20 Marks pre-World War I, to 4.2 billion Marks by the end of 1923.²

There has always been resistance to giving power to the central banks, but in the last decades this resistance has been by and large completely defeated in all countries of the world. The U. S. government has used the power of the central bank, the Federal Reserve, to borrow from it to obtain a considerable part of the money it needs to fund its expenditures. The consequences have been inflation and a tendency for prices and wage rates to rise.

There is no doubt that the credit expansion brings about a drop in the rate of interest. Why then does this not mean that the rate of interest can always remain low and that interest could really disappear completely? If it is true that the rate of interest is not a monetary phenomenon but a general phenomenon of the market, which reflects the fact that future goods are traded at a discount as compared with present goods, we must ask ourselves, “What is the nature of the process which, after the initial drop of the interest rate due to credit expansion, finally brings about step by step a return of the rate of interest to that level which reflects market conditions and the general state of affairs?” That is, if the rate of interest is a general category of human action, and yet if an increased supply of money and bank credit can bring about a temporary drop in the rate of interest, how does the interest rate return once more to the rate that reflects the discount of future goods over present goods?

In answering this question, we are also answering a question that has occupied people for decades, even centuries in some countries that have had central banks and a system of credit expansion. This is the problem of the trade cycle—the regular return of periods of economic depression. In Great Britain from the end of the eighteenth century on, and later in those countries of the world that entered step by step into the system of modern capitalism and modern banking methods, we could observe from time to time an almost regular occurrence of events, i.e., the emergence of periods of economic depression, economic crises. We do not mean economic crises brought about by some obvious event that makes it possible to explain the emergence of this crisis. For instance, in the early 1860s the American Civil War made it impossible to ship cotton from the United States to Europe; and the U. S. Southern states were at that time the only suppliers of cotton to Europe. There was a very bad economic crisis, starting in the cotton-goods industries in Europe and as a consequence other industries suffered also. But everyone realized what was causing this crisis—it was the American Civil War and the stoppage of shipments of cotton to Europe. We do not deal with such crises due to a definite identifiable situation. We deal with a genuine crisis in all branches of business—although it is sometimes worse in some branches than in others—a crisis for which people couldn’t see any special reason.

From the beginning of the nineteenth century on, people began to consider these periodic crises as one of the most important problems of economic research. In the 1830s and 1840s British economists answered this question by saying, “What we have to study is not the economic depression. This depression is always the consequence of a preceding boom. We must ask ourselves not ‘What is the cause of the crisis?’— we must ask ‘What is the cause of the preceding boom?’ And we must ask ourselves what is the reason why the unquestionable and certain development of economic conditions that takes place in all countries with capitalism does not proceed steadily upward, but follows a wave-like movement, a movement in which there are repeated boom periods that always are followed by periods of depression.” In this way the crisis problem was transformed into the problem of the trade cycle. And for the problem of the trade cycle many more or less wrong explanations were offered.

I want to mention only one. This was the doctrine of an otherwise famous economist, William Stanley Jevons [1835–1882]. His doctrine acquired some fame. He attributed economic crises to sunspots. He said that sunspots bring about bad harvests, and this means bad business. If this was so, why then didn’t business adjust to this natural phenomenon as it learned to adjust to other natural phenomena?

If there is credit expansion, it must necessarily lower the rate of interest. If the banks are to find borrowers for additional credit, they must lower the rate of interest or lower the credit qualifications of would-be borrowers. Because all those who wanted loans at the previous rate of interest had gotten them, the banks must either offer loans at a lower interest rate or include in the class of businesses to whom loans are granted at the previous rate less-promising businesses, people of lower credit quality.

When individuals consume less than they produce, the surplus production is set aside as savings. Thus when the money given out in loans comes from savers, it represents actual goods which are available for further production. But when the loans are granted out of credit expansion, businessmen are misled; there are no goods standing behind them, only newly created credit. This leads to a falsification of economic calculation. Credit expansion brings about a systematic falsification—it gives to the individual businessman the impression that a project that couldn’t be executed yesterday because there were not enough capital goods, can now be executed on account of the credit expansion. As a result, there is an intensification of business activity, which means that higher prices are offered for the factors of production. But there has been no increase in the quantity of capital goods. Therefore the intensification of business activity means an artificial boom. Producers of factors of production are happy when they see that the prices they are getting are higher than they were yesterday. But this cannot go on forever, because no more material factors of production have been produced. The prices of these factors of production are going up more and more as borrowers of the new credit compete and bid up their prices. Then finally two alternatives are possible.

Business is asking for more and more credit. Either (1) the banks grant this demand by creating more and more credit (this happened in Germany in 1923, when it led to a complete breakdown of the currency). Or (2) one day, because they realize for some reason or other that they must stop credit expansion, the banks do stop creating new credit to lend. Then the firms that have expanded cannot get credit to pay for the factors of production necessary for the completion of the investment projects which they have already committed themselves. Because they cannot pay their bills, they sell off their inventories cheap. Then comes the panic, the breakdown. And the depression starts.

On account of the credit expansion the whole economic system of the country or of the world is in the situation of a man who has a limited supply of building materials available and wants to construct a home. But being poor in technological calculations, he makes some mistakes. He thinks he can build a bigger house out of his limited supply of building materials than he really can. Therefore, he starts by constructing too large a foundation. Only later does he discover that he has made a mistake and that he cannot finish the house in the way he had intended. Then he must either abandon the whole project, or use the materials still available to build a smaller house, leaving part of the foundation unused. This is the situation in which a country or in which the world finds itself at the end of a crisis caused by credit expansion. Because of the easy credit businessmen make mistakes in their economic calculations and find themselves with over-ambitious plans which cannot be completed because of insufficient factors of production.

In every boom period that precedes a crisis, in Great Britain and then later in other parts of the world, indeed, in every country in the world which has experienced credit expansion, you always find people who have said, “This is not a boom that will be followed by a crisis; only people who do not know what is going on can say such a thing. This is the final prosperity—an everlasting prosperity. We will never again have such a crisis.” The more people believe in this slogan of everlasting prosperity, the more desperate they become when they discover that the “everlasting” prosperity doesn’t last forever.

One thing that made matters worse following 1929, than in preceding periods of depression, was that the American unions were really very powerful and they would not tolerate that the crisis should bring about those results which were the consequence of earlier crises in this country and in other countries—i.e., they would not tolerate a considerable drop in money wage rates. In some branches of business, money wages went a little bit down. But by and large the unions were successful in maintaining the wage rates which had been developed artificially during the boom. Therefore, the number of unemployed remained considerable, and unemployment continued for a very long time. On the other hand, those workers who did not lose their jobs enjoyed a situation in which their wages did not drop to the same extent as commodity prices. The living conditions of some groups of labor even improved.³

This was the same situation that led to the conditions in England in the latter part of the 1920s, which were important in bringing about the doctrines of Lord Keynes and the ideas of credit expansion that have been practiced in recent years. The British government made a very serious mistake in the 1920s. It was necessary for Great Britain to stabilize the currency. But they did not simply stabilize. In 1925, they returned to the pre-war gold value of the pound. That meant that the pound was a heavier pound afterwards and had a greater purchasing power than the pound, of let us say, 1920. A country like Great Britain that imports raw materials and foodstuffs and exports manufactures should not have made the pound more expensive. As Hitler expressed it, “They must either export or starve.” In such a country, in which the unions did not tolerate a drop in wage rates, it meant that the costs in pounds of manufacturing British products were increased in relation to production costs in countries which had not made a similar return to the gold standard. With higher costs, you must ask higher prices to stay in business. So you can sell fewer units and must cut production. Therefore, unemployment increased, and there was permanent mass unemployment.

Because it was impossible to deal with the unions concerning this problem, the government proceeded in 1931 to devalue the pound much more than it had been revalued in 1925, in order, they said, to encourage export trade. Other countries did the same. Czechoslovakia did it twice. The United States followed in 1933.The countries of the French standard (France, Switzerland) followed in 1936. I mention this because it is necessary to realize why the crisis of 1929—it was merely a crisis of credit expansion—had much longer and more serious consequences than those crises in preceding times. Of course, the Marxians say, every crisis must be worse and worse; the Russians, they say, have no trade cycle. Of course the Russians don’t; they have a depression all the time.

We must realize the tremendous “psychological” importance, the enormous importance of the fact that in the history of the nineteenth and twentieth centuries, credit expansion was limited. Nevertheless, it was the general opinion of businessmen, economists, statesmen, and the people, that bank credit expansion was necessary, that the rate of interest was an obstacle to prosperity, and that an “easy money” policy was a good policy to have. Everyone, businessmen as well as economists, considered credit expansion necessary and they became very angry if somebody tried to say that it might have some drawbacks. At the end of the nineteenth century, it was considered practically indecent to support the British Currency School, which was opposed to credit expansion.

When I started to study the theory of money and credit I found in the whole world of literature only one living author, a Swedish economist, Knut Wicksell [1851–1926], who really saw the problems in credit expansion.⁴ The idea prevails even today that we cannot do without credit expansion. It will be impossible, without a very serious struggle which really has to be fought, to defeat all those ideological forces that are operating in favor of credit expansion. Most people, of course, don’t give any thought to credit expansion. But the governments have a very clear idea about it—they say, “We can’t do without it.”

Credit expansion is fundamentally really a problem of civil rights. Representative government is based on the principle that the citizens need to pay to the government only those taxes that have been legally promulgated in a constitutional way: “No taxation without representation.” However, governments believe they cannot ask their citizens to pay as much in taxes as is needed to cover the whole of government expenditures. When governments cannot cover their expenses out of legally enacted taxes, they borrow from the commercial banks and so expand credit. Therefore, representative government can actually be the instigator of credit expansion and inflation.

If the institution of credit expansion and other types of government inflation had been invented in the seventeenth century the history of the struggle of the Stuarts with the British Parliament would have been very different. Charles I [1600–1649] wouldn’t have had any problems in getting the money he needed if he could simply have ordered the Bank of England, which didn’t exist in his time, to grant him credit. He would then have been in a position to organize an army of the King and to defeat Parliament. This is only one aspect.

The second aspect—I don’t believe that this country could stand psychologically a recurrence of a crisis like that of 1929.And the only way to avoid such a crisis is by preventing the boom. We are already very far along in this boom, but we could still stop it in time. However, there is a great danger. While capital goods are limited in amount and are scarce and would, therefore, limit those projects which can be executed and make many projects appear impossible for the time being, credit expansion can hide by the illusion of an increase in the capital reported in dollars on the books. Credit expansion creates the illusion of available capital, while in fact there is not.

The fundamental problem of the nineteenth century was that people didn’t realize these things. As a result, capitalism was very much discredited, for people believed that the almost periodic occurrence of depressions was a phenomenon of capitalism. Marx and his followers expected the depressions to get progressively worse, and Stalin still says openly every day: “We have only to wait. There will be a very bad crisis in the capitalist countries.” If we want to thwart these plans we must realize that sound credit policies acknowledge the fact that there is a scarcity of capital goods, that capital cannot simply be increased by credit expansion. This must come to be recognized by our businessmen and politicians.

* * * *

[Additional comments by Mises during the question-and-answer period.]

What happened in the past with credit expansion has been, by and large, absorbed and adjusted to by the market. I would say, take as “given” the conditions as they have happened in the past, and say only that for the future there should be no more credit expansion. In the future no additional banknotes should be issued, no additional credit should be entered on a bank account subject to check, unless there is 100 percent coverage in money. This is the 100-percent plan. With respect to today’s situation, we should leave everything that has happened in the past alone— we should not attempt to reverse it because that would be deflationary. Deflation is not as dangerous, not as bad, as inflation. Deflation is expensive for the government, while inflation is profitable for the government. But deflation, too, must be avoided.

If there hadn’t been any privileged banks and if government had not forced citizens to take the banknotes by making them “legal tender,” banknotes would never have become popular. The average citizen today in every country of the world, with the exception of the most backward countries, considers as money every scrap of paper upon which the government or an institution privileged by the government has printed the magic words “legal tender.” But it was different in the past. It was not easy to make people accept banknotes. They took them because the banknotes were better than nothing. If a person didn’t want the banknotes he could take them back to the bank that issued them; and if the bank couldn’t redeem them the bank went broke. The “wonderful” thing about government-issued banknotes, from the point of view of the government and the banks, is that the bank is not required to redeem them, except perhaps in legal tender money, which is again banknotes.

If the governments had never interfered with money and banking, it would be possible to leave every citizen free to issue his own banknotes. I want to give everybody the right to issue his own banknotes. The problem then would be to get other men to accept such private banknotes; maybe nobody will take them. I am not against banknotes as such; I am only against banknotes that are protected by some government privilege. I want the banknotes issued in the past to retain their privilege, but no more legal tender banknotes and no more credit expansion!

If I say that the return to the gold standard is necessary it is because it makes inflation impossible. Under the gold standard the amount of money depends on geological factors that cannot be controlled by the government. It is not an unreasonable standard because it is the only alternative to making money completely dependent on the government. If King Charles I [1600–1649] had had the power to print paper money he would probably have been in a much better position in his fight against the government.

Under the gold standard, the supply of money is independent of the changing whims and political programs of governments and political parties. For centuries there were struggles on the part of the predecessors of our parliamentary bodies against the princes who wanted to debase the currency. The princes said, “What counts is only the name which I give to money.” But their silver money got a “red face” when the princes adulterated it with copper, all the while declaring that their new alloyed money, which contained less silver than the old money, still had the same purchasing power and the same legal tender power as the old money. If the government is in a position to provide for some of its expenditures by creating money, it no longer needs to depend, let us say, on Congress. Historically and politically the gold standard is an implement in the system of legislation that limits the power of government and makes government dependent on the will of the people.

1 [Luke VI, 35, King James Version: “But love ye your enemies, and do good, and lend, hoping for nothing again.”—Ed.]

2 [See Ludwig von Mises, “Business Under German Inflation,” The Freeman, November 2003.—Ed.]

3 [See Ludwig von Mises, “The Causes of the Economic Crisis” (1931) in Percy L. Greaves, Jr., ed., On the Manipulation of Money and Credit: Essays of Ludwig von Mises (Dobbs Ferry, N.Y.: Free Market Books, 1978), pp. 173–203, esp. pp. 186–92.—Ed.]

4 [Knut Wicksell, Interest and Prices (New York: Macmillan,[1898] 1936).—Ed.]

8TH LECTURE

Profit and Loss, Private Property, and the Achievements of Capitalism

IN DEALING WITH ALL MATTERS CONCERNING CAPITALISM, it is fundamental never to forget the difference between “capital goods” and “capital.” “Capital goods” are physical things. The concept of “capital” is purely a theoretical concept within the framework of a definite method of calculation and computation. The evolution of this concept of capital finally resulted in including in the accountant’s concept of capital, the auditor’s concept, and also those things that are not capital goods.

The system of accountancy started, of course, with businessmen. Anxious to know what the results of their transactions were they developed this method of accounting—double-entry bookkeeping and so on. The concept of capital that they applied referred to, and included, only those funds that they had diverted to the development of business. It did not include real estate or the private property of the head of the enterprise, of his family, and so on. You can still read in legal treatises and papers essays debating whether or not the private capital of the owner should be included in the balance sheet of a firm. According to the methods in practice in accountancy, the concept of capital as used today includes the real estate and all rights owned by the enterprise.

Agriculturists also began to pay attention to these problems, but only much later. In the beginning they developed methods of accounting which were limited to the operation of the farm only, without including the whole property of the owner. I mention these facts because if you look into the balance sheet of an enterprise there is room for the building, the real estate, owned by the enterprise. The concept of capital as used today includes more than capital goods; it includes all the things owned by the enterprise.

From this point of view we must raise the question also of whether or not there are other distinctions which may have greater importance for the practical problems of capital. If we speak of capital we discover that we have in mind all the total material factors of production as far as they may be used for production purposes.

If we talk about the decisions to be made concerning the employment of capital, we must take into account the fact that the greater part of the capital available is embodied in nonconvertible or not perfectly convertible goods. Capital goods are intermediary factors between the natural goods and the final consumer’s goods. In a changing world, in which the productive processes and other things are constantly changing, the question is whether we can use these intermediary products, which were originally designed for a specific end use, for any other end. Is it possible, even after a change in plans and intentions, to use for other purposes capital accumulated or produced in the past with different plans and different intentions in mind? This is the problem of the convertibility of capital goods.

For more than one hundred years, a movement popular in the whole world, today especially in California, is represented by a group of reformers who call themselves “technocrats.” Technocrats criticize the fact that we have still going on side by side with the most modern methods of production, processes of production of an outdated character. And they are not the only ones to criticize this fact. They point out how wonderful it would be if all that they call “economic backwardness” were eliminated, if we had all the factories located in the best places, and if all the factories were equipped with the most modern equipment. Then there wouldn’t be any backwardness, nor any machines and methods of production being used which are no longer up to date. There was a German, or a Russian— I had better say a Baltic—socialist who pointed out, for instance, how backward German agriculture was. He would abandon or diminish all existing farms and machines, substitute the most modern achievements of agriculture, and then it would be possible to produce everything cheaper.

The weak point of these plans is that the capital accumulated in the past was in the form of capital goods that represented the technical wisdom of the ages in which it was accumulated. Although the factories are out of date it does not necessarily mean that the old machines have to be sold as scrap iron and new machines substituted. It depends upon the superiority of the new machines. Unless it is impossible for the old factory to make any surplus over current expenses, it would be a waste, not only both from the point of view of the individual factory owner but also from the point of view of a socialistic system that had to deal with the same thing. The problem is similar to that of a man who must choose between buying a new typewriter or a new television set because better ones have now been invented, or buying something else that he doesn’t have at all. Just as not everybody will throw away his old typewriter or his car when a new model appears, so will a businessman have to make similar decisions in business. While in the household precise calculations are not needed, in business these decisions are made on the basis of more careful calculations.

The capital equipment that makes up the wealth of our age and that also makes one country richer as against poorer countries is embodied in capital goods created in the past by our ancestors, or created by ourselves under different technical conditions and for different purposes. If we want to use this old capital equipment in the future, too, in spite of the fact that it does not render as much service as new equipment, we do so because we consider the service it renders worth more than what we can gain by throwing away the old machines and replacing them with new machines.

The settlement of the world was done in other ages under other assumptions and other conditions with other technical knowledge. If we were to come to earth from another planet with perfect knowledge of today’s geographical conditions, we would settle the world with the use of that other knowledge, knowledge very different from that which was responsible for our present capital equipment. In the past our wealth consisted to a great extent of capital goods adjusted to conditions which are different from our conditions. Decisions of the past were based on conditions at that time. The fact that our ancestors made the decisions they did helps to influence us to keep things as they are; it wouldn’t be worthwhile to abandon the investments of the past. In every individual case we have to make a decision between continuing in the old ways, in spite of the fact that we now know better, or renouncing the old ways for some other employment of additional capital goods which we now consider more important.

In answer to the technocrats, we say we are not rich enough to scrap everything that was built in the past. Perhaps it would be better to have the industrial centers somewhere else than where they were built in the past. But this transfer, this shifting, is a very slow process. It depends on the superiority of the new sites. This is a refutation of the famous infant-industry argument, which says that the new industries must be protected against the old industries. In this case too—in the case of shifting industries from physically less favorable to more favorable sites—the decision must depend on the degree of superiority of the new sites. If the superiority of the new sites is sufficient the industries will move without any outside assistance at all. If it is not sufficient, it is a waste to assist industries to make such a move. (For instance, the textile industries developed in New England even though the cotton was grown in the south. More lately the textile mills have been shifting to the south, again without any outside assistance.) If the advantage to be derived from the abandonment of capital goods is great enough, the change will be made.

Technical backwardness is not the same as economic backwardness. If capital needed for eliminating this technical backwardness, from our point of view or from the point of view of the buying public, has a more urgent employment somewhere else, then it would be economically a very serious mistake to employ it in making changes to new equipment simply because there are already better machines.

Capital goods are scarce. The economic problem consists precisely in the fact that consumers seek to employ them for the satisfaction of their most urgent not-yet-satisfied demands. The economic problem is not to employ capital goods for producing something which is less important than another product, which cannot be started precisely on account of the fact that these capital goods are being employed in the production of the less important product. This is what unprofitability means. A businessman says, “This is unprofitable. The project could be undertaken but it would be unprofitable. Therefore, we do not want to start it.” What the socialists say is, “But businessmen are greedy; they want to produce only those things which are profitable, not those which are unprofitable.” However, what makes an enterprise unprofitable is that, given the prices of the factors of production and the rate of interest, the anticipated proceeds would lag behind the expenditures.

What does it mean if the price of copper is higher than it used to be? It means that consumers are ready to pay a higher price for the copper that goes into the making of other products; they are not ready to pay the higher price for copper in its present uses. They make some prices high enough to make the production of other products profitable. On the other hand, if there is an increase in the supply of copper, or if some branches of business which used to employ copper until now use something else instead of copper in production, then copper becomes more readily available, the price of copper drops, and it now becomes profitable to use copper to produce some things that yesterday were unprofitable. Ultimately it is the consumers, in their buying, who determine what should be produced and what should not be produced.

When aluminum was first introduced, many things could not be produced from aluminum because its price was very high. Napoleon III [1808–1873] immediately had the idea to give to his cavalry armor of aluminum, but it was so expensive then that it would have been cheaper to give them armor made of silver. When I was a child, aluminum was used for children’s toys, but the really serious industrial use of aluminum was then more or less out of the question. Slowly the production of aluminum improved and the use of aluminum for many articles became possible. Years ago, it was as unprofitable to use aluminum as it is today to use some high-grade metals for certain commercial purposes.

The slogan “Production for use and not for profit” is meaningless. A businessman produces for profit. But he can make profits only because consumers want to use the things he produces, because they want to use them more urgently than other things.

In the absence of profits and losses there wouldn’t be any guides for production. It is profits or losses that show the businessmen what the consumers are asking for most urgently, in what qualities and in what quantities. In a system in which there were no profits or losses, the businessman would not know what the wishes of the consumers were, and he wouldn’t be able to arrange his production processes according to the wishes of the consumers.

Besides this function of profit or loss there is the role they play in shifting ownership of the means of production into the hands of those who knew—in the past, of course, i.e., until yesterday—how best to employ them for the needs of the consumers. This is no guarantee that the means of production will be used in the best way tomorrow. But if they aren’t, the owners will suffer losses. And if they do not change their methods of production, they will lose their property and will be thrown out of their eminent position as the owners of factors of production. But this is something given, and it cannot be changed. Every judgment about people refers to the past. A candidate in an election can only be judged by what he has done in the past. The same applies also to the choice of a doctor, a shop, and so on, and also to producers. It is always good will referring to the past.

Past profits shift the ownership of the means of production from the hands of those who were less efficient in using them in the eyes of the public into the hands of those who are expected to be more efficient. Therefore, the meaning of ownership of the means of production is very different in a system based on the division of labor from its meaning in a feudal system. In a feudal system, private ownership was acquired by conquest or by the arbitrary appropriation of pieces of land. The proprietor was the conqueror; the supreme conqueror was the head of the army, the king, the “Führer.” Other people acquired private property as gifts from the supreme lord. There was a whole hierarchy—kings, dukes, knights, and so on, and at the bottom were the people with no property. The dukes and knights could lose their property by being deprived of their “gift” by the higher authority—the king—revoking his gift; or they might be defeated by a successful conqueror. This system prevailed until capitalism replaced it to varying degrees in many countries.

If you study the history of private ownership in land you can, of course, go back either to conquest or to appropriation of ownerless property by somebody. From this point of view, the older critics of private ownership said property does not have a legal origin; it was acquired by might, by conquest, without any legal basis. Hence, they say they want to take it away from the current private owners and give it to everybody. Whether the origin described here is right or wrong is one question. Another question is what to do now that property is privately owned.

The socialists took over this critique of the origin of property without realizing the enormous difference that existed between then and now. If you say that in the old days the owners of land did not depend on the market, that is true; there was no market; there was only an insignificant amount of trade. The feudal lord had only one real way to spend his great income in the products of the earth—to retain a great retinue of armed men in order to fight his battles. The court of a feudal lord consisted of an enormous household in which many people lived (boarders I would say), supported by the great estate. In Brandenburg in Berlin, for instance, there was one case of a councilor in the sixteenth century who was living in the king’s household. This is very different from the conditions in the market economy.

In the market economy, private ownership is, as it were, a social function because it can be retained and enlarged only by serving customers in the cheapest and best possible way. Those who do not know how to serve consumers in the cheapest and best possible way suffer losses. If they do not change their methods of production in time they are thrown out of their positions as owners, entrepreneurs, capitalists, and shifted to positions in which they no longer have entrepreneurial and capitalistic functions. Therefore, the meaning of private ownership in the capitalistic system is entirely different from the meaning of private ownership in the feudal system.

Critics of private ownership are still living mentally in the Middle Ages (like critics of interest and creditors). They don’t realize that the market determines every day who should own what and how much he should own. The market gives ownership to those people who are best fitted to use the means of production for the best possible satisfaction of the needs of the consumers. Therefore it is not correct to criticize the institutions of private property by citing conditions as they existed in the early days under feudal conditions, under absolute kings.

As President Franklin Roosevelt [1882–1945] said, capitalism has never been really tried.¹ There always remains something from the old days. But it is absolutely useless to tell us today, “Look how the wealth of many aristocratic families originated in the seventeenth century.” Some modern wealthy people may be descendants of wealthy aristocratic families, but what has that to do with the situation today? The Prussian Junkers were still privileged in the nineteenth century and early twentieth century; they could retain their property only because the whole apparatus of the imperial government was glad to preserve them, to protect them, and to prevent consumers from putting persons in their places who were better equipped to serve consumers.

We must realize that every governmental measure that lowers the amount of profit successful enterprises can make or which taxes away their profits is a measure that weakens the influence of the consumers over producers. For example, the great industrial fortunes of the nineteenth century were acquired by successful innovators in their business. Henry Ford [1863–1947] started with almost nothing; he made enormous profits which were plowed back in his enterprise; in this way over a comparatively short time he developed one of the biggest fortunes of the United States. The result was that something quite new happened, mass production of automobiles for the masses. At the beginning of the twentieth century there were some successful motor cars. The French Renault cost about $10,000 in gold; it was a luxury car for a few very rich men. The activities of Ford and of some other people made the motor car something for everybody. In this way great fortunes were developed. The great department stores and the great factories developed in this way. But now this cannot happen. If a man starts a small enterprise and makes huge profits, the greater part of this profit is absorbed by taxes. However, there are still some loopholes. If you have a good accountant you may avoid being expropriated 90 percent and may be expropriated only 70 percent. But the greater part of the profits which would have been reinvested are taken by the government and spent for current expenses.

In the case of department stores, formerly an old store had to compete for potential new consumers with new competitors. Today this is no longer the case. The small man will never develop into a big store because his profits are taken away by the government. It is true that the old and new stores operate under the same laws; the large old store also has to pay high income taxes. But the old store has already accumulated the capital needed for a big business, while the new man is prevented from accumulating the capital needed to expand into a big-scale enterprise. The consequence, therefore, is that the competitive spirit could easily disappear from the management of the big store. Without any danger to the old store in the conduct of its affairs, the old store may sometimes become “lazy.”

There are people who say capitalism is dying because the spirit of competition no longer exists as it used to and because great enterprises become bureaucratic. But capitalism is not dying; people are murdering it. There is a difference between dying by a disease that finally results in death and dying as a result of assault and assassination. It is fantastic to use as an argument against capitalism the fact that the competitive spirit in business is weakening and that businesses sometimes become bureaucratic. This is precisely due to the fact that people are fighting against the capitalistic system and don’t want to tolerate the institutions that are essential for its existence. Therefore, I must say something about the difference between profit and loss under business management on the one hand, and bureaucratic management on the other hand.

Profit-and-loss management is the sign of an enterprise, of an outfit, that is subject to the supremacy of the market, i.e., the supremacy of consumers. In such an outfit the determining factor is “Is it profitable or not?” This yardstick is applied not only to the whole enterprise but to every portion of the enterprise. This is the method of double-entry accounting which Goethe characterized in such a wonderful way by saying that it makes it possible for the man at the head of an organization to control every aspect of a business without becoming enmeshed in too much detail work.

Under such an accounting system you can establish whether or not any special department or branch pays. For instance, an enterprise in New York has a branch store in San Francisco. There is only one standard the head of the company in New York need apply: is it profitable? He has a special balance sheet for the store in San Francisco. He assigns to this branch on his books the necessary capital, compares the costs and the prices of this branch, and on this basis judges whether or not it is useful, whether or not it is profitable, for the total enterprise to continue this branch office in San Francisco. He can leave all the details to the head of the branch office in San Francisco because this man always knows that he is responsible. It is not necessary that the branch manager get a share of the profits. He knows very well that if the branch does not pay it will be discontinued and he will lose his job; his future depends on this branch. Therefore, the man in New York does not have to say to this branch manager in San Francisco anything more than, “Make profits!” The head in New York doesn’t interfere because if he does and the branch office has losses, the branch manager will be able to say it was because “You ordered me to do so and so.”

The consumers are supreme. The consumers are not always intelligent—not at all—but the consumers are sovereign. They can be stupid and they may change their minds, but we must accept the fact that they are sovereign. Businessmen are subject to the supremacy of the consumers. The same is, of course, true for the whole business establishment; the decisive voice is the voice of the consumers. It is not the problem of the producers or manufacturers to criticize consumers, to say, “These people have bad tastes—I recommend they buy something else.” This is the task of philosophers and artists. A great painter, a great leader, a man who wants to play a role in history must not yield to the bad taste of consumers. However, businessmen are subject to profit-and-loss management and are directed in every detail by the wishes of the consumers. The consumers are supreme; they are buying the product and this is justification for the producer. If it is not weakened by government interference, this is profit-and-loss management, production for consumers.

Now what is bureaucratic management? People often confuse bigness with bureaucracy. Even such an eminent man as Max Weber [1864–1920] thought that the essential factor of a bureaucracy was that people sat at desks and had a lot of paperwork to do. But this is not the essential feature of a bureaucracy. The characteristic of a bureaucracy is that it deals with things which are necessary but which cannot be sold and that do not have a price on the market. Such a thing, for instance, is the protection of individuals against gangsters and other criminals. This is the job of the police department. It is very important, indispensable. But the services of the police department cannot be sold on the market. Therefore, you cannot judge the results of these police operations in the same way as you can judge the operations of a shoe factory. The shoe factory can say, “The public approves of our operations because we make profits.” The police department can only say the public approves through the actions of its town council, congress, parliament, and so on. Therefore, the system of management which must be used for a police system is the bureaucratic system.

The nation, or the citizenry, elects parliamentary bodies and these parliamentary bodies determine how much should be spent for the various functions of the government, including the police department. You cannot evaluate in dollars and pennies the results of a police department. And, therefore, you cannot have bookkeeping and auditing of a police department in the same way you do in private businesses. In private businesses, the expenses are measured in terms of dollars against the proceeds. In the police department you cannot measure the expenses against the proceeds. The police department has only expenses. The “proceeds” of a police department are, for instance, the fact that you can walk safely through the town, even after midnight. Such proceeds cannot be evaluated in terms of money.

The parliaments set the budget for the police department; they determine the amount of money to be spent. They must also tell the police department what services they should perform. The FBI could no doubt be improved by increasing its appropriations, but it is the will of the people that it not go any further; the head of the Department of Justice tells the FBI what to do and what not to do; the Department of Justice head cannot leave these decisions to the “branch managers.” Therefore, the manager of a bureaucratic operation issues instructions on many things which appear unnecessary to the businessman—how often to clean the offices, how many telephones to have, how many men to watch a certain building, and so forth. These detailed instructions are necessary because in a bureaucracy what has to be done and what has not to be done must be determined by such rules. Otherwise the man on the spot would spend money without giving heed to the total budget. If there is a limited budget you must tell the employees what they can and what they cannot do. This refers to all branches of government administration.

This is bureaucracy, and in these areas it is indispensable. You cannot leave it to the individual employee; you cannot tell a man, “Here is a big hospital. Do what you want with it.” A limit is drawn by the parliament, the state, or the union and, therefore, it is necessary to limit the money spent in each department. This bureaucratic method of management does not apply under profit management. But, of course, if you weaken the profit motive of private businesses, bureaucratic ideas and bureaucratic management creeps in.

Given the present-day excess-profits tax, corporation taxes, and individual taxes on corporation shareholders, many enterprises say when calculating a new expenditure, “It means an expenditure of $100 more, of course. But considering the 82 percent tax I must pay on the firm’s earnings, it will cost much less. If I don’t spend this $100 on business, I will still have to pay a tax of $82.Therefore, spending this $100 will cost the firm only $18.” People calculating this way no longer compare the total expenditure with the advantages to be derived from it on the market; they compare only that part of the expenditures which affects their own income. In other words, in spending $100 on its business, the company could afford to be lavish, wasteful, or extravagant; it would no longer consider consumer wishes primarily.

If this tax system is continued, it could lead finally to complete government control. For instance, if government takes 100 percent of a company’s income, its business expenses would all be deductible and chargeable to the government. The company wouldn’t need to worry then about consumer sovereignty, about whether consumers would be willing to pay enough for their product to cover costs; it wouldn’t need to worry about keeping expenses down. But then the government couldn’t allow the business to do as it wished; the government would have to control all aspects of the business’s operations. Therefore, if you hear that business is becoming bureaucratic and wasteful, it is not the consequence of big business, of capitalism, of an unhampered market system; it is the consequence of government taxation and government interference with these things.

1 [“A program whose basic thesis is, not that the system of free enterprise for profit has failed in this generation, but that it has not yet been tried.” F. D. Roosevelt, as quoted in Chapter 1, Friedrich A. Hayek, The Road to Serfdom (Chicago: University of Chicago Press, 1944), p. 10.—Ed.]

9TH LECTURE

Foreign Investments and the Spirit of Capitalism

THREE HUNDRED YEARS AGO, economic conditions in the world were more uniform than at present. There were some savage tribes, of course, but except for them the greater part of the world by and large had reached the same level of technological development and civilization. Then there came a radical change in some countries. Capitalism developed in the West; there was an accumulation and investment of capital; tools were perfected; Western civilization developed. Today there is an immense difference between Western civilization in the “advanced” countries of the world and conditions in the “backward” countries.

This distinction was even somewhat sharper in the early and middle part of the nineteenth century. A man who visited England and Romania in 1700 would not have seen any remarkable differences in the methods of production. By the year 1850, these differences were enormous. These differences were then so considerable that one could say, and some people believed, that the disparities would never disappear, that they would remain forever.

These differences consisted in the fact that there was greater capital investment, very much greater capital investment, in the West. But this capital investment, these capital goods are nothing but intermediate products. The head start these countries had attained over the “backward” countries consisted only in the matter of time. The Western nations had started earlier on the road toward improving economic conditions. The “backward” countries had still to begin. But there was time. It would have been a slow process. However, these backward nations would have found enterprise much easier, for there was no need for them to make experiments with unsuccessful methods of production. They didn’t have to make the inventions anew; they could simply take them over from the Western countries. In time, this would have reduced the discrepancy in economic levels, but some difference would have remained.

There was no secrecy about the technological inventions of Western civilization. The most intelligent young men in the “backward” countries went to schools in the West to learn all they could about methods of production. Then they could bring Western technology to their own countries. But technology was not the only thing. What was lacking in the “backward” countries was the mentality that had produced capitalism in the West and the institutions brought about by that mentality.

Capitalism couldn’t develop in the “backward” nations because the people didn’t like capitalism, and because businessmen there were exposed to dangers which didn’t exist in the West where there was the Rule of Law. The important thing for these “backward” nations, which were mostly in the East, was to change radically their mentality, their idea of economics. They had to recognize that the greater the number of rich there are, the better it is for the poor, that the presence of rich people is necessary for the abolition of the poverty of the masses. But this idea didn’t enter into the minds of these people. The farther they were from Europe, the less they realized that the essence of capitalistic development was not the technological knowledge and capital goods but the mentality which had made it possible to accumulate large-scale capital and capital goods.

The people in the “backward” nations, especially those in Asia, saw only their technological backwardness. If these countries had powerful governments, powerful in dominating their own country, what they wanted first of all, what they envied most of all, was the better weaponry produced by the West. These kings of the East were interested first of all in getting better guns; they were little interested in other things. But the patriots who did not consider war as the most important manifestation of the human mind were interested in technology. So they sent their sons to technological universities in the West and invited professors and industrialists from the West to come to their countries. But they didn’t grasp the real difference between the East and the West, the difference in ideas.

If the people in the “backward” nations had been left alone, they would probably never have improved conditions in their own countries; they probably wouldn’t have adopted the ideologies necessary to transform their countries into “modern” countries. Even if they had done this, it would have been a very slow process. It would have been necessary for them to start from the grass roots. First, they would have had to accumulate capital to construct, let us say, equipment for the mines, in order to produce ore and from this ore to produce metals, and then the railroads. It would have been a very long, slow process.

But what really happened was a phenomenon that nobody in the eighteenth century had considered. What developed was foreign investment. Considered from the point of view of world history, foreign investment was a most important phenomenon. Foreign investment meant that the capitalists in the West provided the capital required for the transformation of a part of the economic system of the “backward” countries into a modern society. This was something entirely new, something unknown in earlier ages. In 1817, when Ricardo wrote his book On the Principles of Political Economy and Taxation, he simply assumed as a fact that there was no capital investment abroad.

The capital investment that developed in the nineteenth century was very different from what had taken place under the old colonial system as it developed from the fifteenth century on. Then it had been a search for agricultural materials, natural resources, and products that could not be obtained in Europe. A silly explanation of their desire to trade was that the colonial powers were interested in getting foreign markets for their production. Actually the colonial powers exploited the colonies in order to get materials; they were very happy when they didn’t have to give anything for the resources they wanted, when they could get the foreign products for nothing. These early colonists were more often pirates and robbers than tradesmen. They considered selling abroad only as a sort of emergency measure if they couldn’t get what they wanted without paying for it. They really had very little interest in investing—they only wanted the raw materials.

Of course, they couldn’t prevent some citizens from their own countries from settling in these colonies and starting agricultural production. As a by-product of these colonial ventures of the fifteenth– eighteenth centuries, some important colonies developed overseas. The most important, of course, was the United States, and secondly the Latin American countries. But from the point of view of the European merchants and tradesmen, there was little interest in the fact that some members of the lower classes migrated and settled in the United States. For a long time they probably considered the islands in the Caribbean more important because there they could produce something they wanted— sugar. The settlements in America were not a part of the old colonial policy; they developed in spite of the ideas of the government, at least not because of them.

In the eighteenth century there was already some investment in the North American colonies, but it was not yet a phenomenon of great historical importance. The real foreign investment started in the nineteenth century. This foreign investment was different from the earlier colonial investment insofar as it took place in territories owned and ruled by foreign governments.

This foreign investment was developed in two different ways. One development was the investment in colonies owned by the several colonial powers, i.e., in countries dependent on European nations, for instance, the British investments in India. But still more important were the investments in countries that were politically independent and some of which were highly developed, such as the United States. The American railroads, for instance, were built to a great extent with the aid of European capital. Investments in the United States, Canada, and Australia were different from investments in other foreign countries because those three countries were not “backward” in the sense that they lacked the business mentality. These investments had a very different history because they were really used in the best possible way, and also because they were later completely paid back. In the 1860s and 1870s one of the most important investment opportunities for Europeans was to invest in the United States.

Capital investment in a country means, of course, what is called an “unfavorable balance of trade.” The United States imported capital in the nineteenth century. Therefore, in the nineteenth century there was an excess, by and large, of imports to the United States over exports from the United States. But then from the last decade of the nineteenth century on, the United States began to pay back the investments the Europeans had made. Then there was an excess of exports over imports; the balance of trade became, therefore, “active.” The difference was paid for by the purchases by U.S. citizens of American shares and bonds that before had been sold to Europeans. This went on until after World War I. The United States then became the greatest money lender and investor in the world.

The capital from Europe, and later from North America, that came to these countries made it possible for European and North American countries to expand their economic systems. One result of these foreign investments was that certain branches of production were developed in countries where they wouldn’t have been developed at all, or where they would have been developed only much later and certainly not in the way in which they were actually developed. The consequences undoubtedly benefited both the countries that invested and the countries in which the investments had been made.

Very soon an attitude hostile to foreign investors and foreign creditors developed in many of the countries which had benefited from this foreign investment. Such things even happened to some extent in the United States. One reason why the Confederate States didn’t get more than one small loan from Europe during the Civil War was that in their files Jefferson Davis [1808–1889] had a black mark against him. Before he became president of the Confederacy, Davis had worked to repudiate a state loan in Mississippi, and the European bankers at that time had a good memory. However, such things happened more often in other countries than they did in the United States.

On the one hand some countries had a specific idea about how foreign investors and foreign creditors should be treated. On the other hand there were European governments waiting to intervene when such conflicts became acute, to protect the “rights” as they said, of their citizens. As a matter of fact, these European governments were not very much interested in the “rights” of their citizens. What they wanted was a pretext for colonial conquest. After the Congress of Vienna [1814–1815], it was a very disagreeable situation to be an army officer in Europe which was, by and large, at peace. The governments, and especially their armies and navies, were anxious to gain success abroad. They wanted victories, and some governments believed that public opinion expected such victories. If they went to war, they might be defeated and their prestige would suffer. This led some of them to seek colonial exploitation. For instance, the government of Napoleon III, which suffered from really bad treatment of French investors in the Republic of Mexico, embarked in the 1860s on a great adventure in Mexico. In the beginning, it brought some success to the French army, but it did not end as the French had hoped.

The countries which had been benefited from foreign investment misunderstood the meaning and advantages of foreign investment. There was a popular movement against foreign investors. Throughout the world, the principle of national sovereignty became accepted; it was maintained that an outside nation does not have the right to interfere if the rights of its citizens in another country are being violated. This was called the sovereignty doctrine. We are not interested in the legal excuses for placing obstacles in the path of foreign investors. But the result of the whole movement was that foreign investments and foreign loans granted to a country were completely at the mercy of every sovereign nation. These countries declared the foreigners to be exploiters and they tried to demonstrate the presence of exploitation by various theories which are not worth mentioning.

The Marxians provided several doctrines which related foreign investment to imperialism. They maintained imperialism is bad and must be abolished at any cost. These Marxian doctrines, especially those of Rosa Luxemburg [1871–1919], cannot be explained without entering into the whole value theory of Karl Marx. These Marxian doctrines of imperialism declared that foreign investment is both detrimental to the country from which capital is exported and detrimental to the country to which it is imported. Foreign investment is imperialism—imperialism means war— and therefore foreign countries are conquerors. The naïve reader of a newspaper is very astonished to learn that the United States, which is today practically the only country that can make foreign investments, is an imperialistic power and that a loan granted by the United States to another country means aggression against that country. This is a consequence of these ideas. But are they true? Did the capitalists of one country go into foreign countries, as this doctrine declares, in order to withhold capital and the advantages of additional capital investment from their own citizens?

Let us look at the motives of an individual capitalist entrepreneur. Why did he not invest at home? Because he believed that investing abroad was more profitable than investing at home. Why was this the case? Because the consumers on the domestic market were asking more urgently for products which could be produced only with the aid of foreign resources than they were asking for products which could have been produced by an expansion of domestic industries. For example, until a short time ago Europe had practically no oil production. Except for a very small quantity of inferior quality oil in Romania and in a part of the Austro-Hungarian Empire that later became a part of Poland one could produce practically no oil in Europe. Therefore, instead of expanding European industries when consumers began to ask for more oil products, it became profitable to go to foreign countries and invest there in order to produce oil. The same was true of many other articles. For instance, the greater part of the cooking fats and soaps produced in Europe were made from plants that couldn’t be grown in Europe. A great part of European consumption was consumption of things produced from raw materials that couldn’t be produced in Europe at all, or that could be produced there only at a much higher cost.

At the beginning of the nineteenth century, when the question was protectionism against free trade, the slogan of the free traders in Britain was the simple Englishman’s breakfast table for which all the products were either directly or indirectly imported from abroad. Even if some of them were produced at home, it was with the aid of fertilizer or fodder from abroad. In order to develop the products for the Englishman’s breakfast, European investors went abroad and in the process they developed a demand for the products of English manufacturers. They also had to establish transport systems, harbors, and so on. Therefore, it is simply not true that European consumers and then later American consumers were hurt by capital exports; the capital was exported to invest in the production of things that European and American consumers wanted. The domestic resources of the European nations were lamentably insufficient; it would have been impossible for them to feed and clothe their populations out of domestic resources. In spite of the fact that there are now seven times more people in England than at the start of the Industrial Revolution,¹ the standard of living is incomparably higher. This was possible only because capital had been invested and large-scale production had been started in England and abroad—railroads, mines, and so on.

On the eve of the Second World War, the economic structure of British life was characterized by the fact that Great Britain imported about £400,000,000 more than it exported. 50 percent of this surplus was paid for by the dividends and profits of British-owned enterprises abroad and by the interest on bonds of foreign countries owned by the British. The standard of living of Great Britain was determined by this fact. During World War II, a part of these British investments abroad were sold, mostly to the United States, in order to pay for the war and for the surplus of imports the British needed before Lend-Lease started.² Then after the war, when Lend-Lease came to an end, the British government declared that it was no longer possible to feed their people without the aid of an American loan which was, in fact, an American gift. But even this was not enough. The Argentine government expropriated the shares of the British-owned railroad and paid for these expropriations in British currency. The British government then taxed the money away from the people who got this indemnity from Argentina, and used this money to pay for wheat, meat, and other foodstuffs bought from Argentina. This is a typical case of capital consumption. Savings of the past which had been accumulated in the form of railroads were sold in order to get food (current consumption). This is very characteristic; it shows how these foreign investments were consumed.

But the greater part of European foreign investments, including British investments abroad, were simply expropriated. For the United States these expropriations and repudiations didn’t mean so much, because the United States is comparatively very rich and these investments didn’t play such a great role in the economy. Also, in my opinion, the United States is still accumulating additional capital. But for Great Britain, Germany, Switzerland, France, and other countries, this meant a considerable reduction in their wealth; they had invested abroad, not because they wanted to give away their wealth, but because they wanted income from the investments.

There are many different methods of expropriation.

1 The communistic method: If the country goes communistic, the government simply declares that there is no longer any private property; it takes and it doesn’t pay for what it takes. Sometimes they say they will pay, but in fact they find some excuse not to make this indemnification.

2 Confiscatory taxation: Of course, there are in some trade agreements provisions prohibiting any discrimination against foreigners and this includes discrimination by taxation. But laws can be written so as not to appear to be against foreigners.

3 Foreign-exchange control: This is the most popular method. The foreign corporation makes a profit in its dealings in a country but the foreign-exchange control laws prevent it from transferring these profits into another country. As an example, let us consider Hungary. There were foreigners who owned small or greater amounts of bonds and common stocks in Hungary. The Hungarian government said, “Of course, you are perfectly free. You have the right to receive your interest and dividends. But we have a law, not only for foreigners, also for Hungarians. The law says that the transfer of funds out of the country is forbidden. Come to Hungary and live here, and you can get your money.” Often a country with foreign-exchange controls does not even let a man spend all his money earned in a short period of time—it is portioned out in monthly payments. In effect, this means expropriation. What they really want is for the producer, if he should actually come to the country, to spend not only the money earned in the country but also his own money which he brings to the country. This practically means an end to foreign investment. In the past if people were willing to invest capital in foreign countries they expected an improvement in conditions. But now this is no longer the case.

In the Middle Ages, the wealthy kings and rulers traveled around their empires. They said they were judges and had to keep an eye on the country. But the real economic reason for their travels was that the prince, the German Kaiser, for instance, owned big estates in various parts of the country. They traveled with their retinue to consume what was produced there. It was easier to move the men to the commodities than to move the commodities to the prince’s palace. This is the same right that exchange controls give—to consume goods in the region of their origin.

The Chinese governments were very clever. They did not expropriate the British. First, they prohibited them from exporting profits. Then they forced them to operate in such a way that there was no profit. Then they asked for taxes also, so that the British had to send additional money to China. Finally they made the British realize that you cannot do business with the communists, you especially cannot invest with them.

The expropriation of the Mexican oil fields was accomplished by repudiation, by the nonpayment of bonds.

The story of foreign investment can be told in a few words. Investments went out but only the glory, or the fame of this glory, remains. The result is that today there is very little readiness of people to invest abroad.

It was amazing that during the interval between the first and second World Wars there were still investments in countries that had repudiated foreign investors openly or indirectly. American investors lost a lot of money when the German mark collapsed because the German bonds were Mark bonds, not gold bonds. Nevertheless, during this period there were many German municipalities that succeeded in getting loans from American investors. Sometimes these America investors were simply “babes in the woods”; they didn’t know what they were doing.

The Swedish government issued a gold dollar bond. They were paid for these bonds in gold dollars and promised to repay the loan in American gold dollars, defined as the American McKinley gold dollar. Then in 1933, the United States went off the gold standard. The provision in the Swedish loan had been formulated precisely for the unlikely event of a change in the American currency. But then the Swedish government declared, “We will repay the loan in new American dollars, Roosevelt dollars, not in McKinley dollars as specified in the bond.” Given such a situation it is very difficult to get foreign investment.

In some Latin American countries there is no market for government bonds. These countries got private loans in the United States. But they will no longer get such loans. What has been substituted for this system of private investment was, first, Lend-Lease and, now, foreign aid. That means the American taxpayer is making gifts, not loans, to these countries.

Institutions have been established, especially the International World Bank, for the purpose of giving loans, but under a guarantee. In the long run such a system is self-defeating. If the United States issues bonds at a definite rate, let us say 3 percent, then the United States is standing behind the bond. If a foreign government issues such a bond under the guarantee of the United States, then again the United States is behind this bond. If the United States will not pay, then this foreign government will certainly not pay either. Now if this foreign loan is at a higher rate, let us say 4 percent, then the American government competes with its own bonds. The American government will not be in a position to sell its own bonds at 3 percent if the foreign bond has an advantage over the American bonds— not only a higher interest rate but the guarantee of the American government besides. Therefore, such a system cannot prevail in the long run. The result of the whole thing is that there is no longer any private investment.

Public investment abroad means something quite different from private investment. When the Argentine railroads were owned by private individuals of Great Britain, there was no infringement on the sovereignty of the government of Argentina. But if the railroads or harbors, for instance, are owned by a foreign government, this means something entirely different. And it means political problems become more important than economic problems.

Point Four is a very lame attempt to do away with the disastrous consequences of the absence of foreign investment.³ Behind it is the idea of teaching these backward nations “know-how.” But in the United States, there are many gifted engineers with “know-how” who could be offered positions abroad where they could use the knowledge and experience they have acquired in this country. Therefore, Point Four is not necessary for that reason. Also, there are hundreds and even thousands of foreign citizens in the United States and in Western universities who learn all these things. The art of printing was invented 500 years ago, and there are now printed textbooks. For those who cannot read English there are translations of these books. There are many clever Chinese. If a factory in China is backward, it is not due to the inability to acquire “know-how,” but because it doesn’t have the capital required.

In 1948, there was a meeting of the World Council of Churches in Amsterdam. They issued a statement saying that it was unfair and unjust that only the countries of the West enjoyed the advantages of machines, while in Asia and Africa the methods of production were backward. If, on the eighth day of Creation, the Lord had made a limited amount of machines and hospitals to be distributed equally and the West had appropriated more than its share, then one could have said that the situation was unfair. But the capitalist countries actually gave very valuable equipment and machines as gifts to these “backward” countries and the “backward” countries simply expropriated them. These countries didn’t understand what capitalism means. They thought the machines and the hospitals were capitalism. But capitalism is the mentality from which the institutions could emerge making it possible for capital to develop in the West and then to construct all these things. It could be said that the West developed its method of production from capital it made at home. Capitalism is not things; it is a mentality.

Nehru [Jawaharlal Nehru, 1889–1964] has been quoted as saying: “We want to give every encouragement to private industry. We won’t expropriate private businesses for at least ten years—perhaps not even that soon.” You cannot expect people to invest if you tell them that you will expropriate them at some time in the future. Therefore, conditions in India are much worse now than when the British were there. Then you could still hope that the British would remain and that they would not expropriate your business. The conditions are again similar to those that prevailed before the British came to India. If an Indian has some savings, he invests in the precious metals or still better in jewels. First of all these cannot be confiscated so easily and you can try to hide them. If necessary, you can even swallow a diamond to keep it safe for some time. You can’t hide a railroad or a mine. And this is the catastrophe of the “backward” nations; people invest their savings in such things rather than in capital goods.

This situation has been made much worse because the Europeans brought to these countries modern medicines and modern methods of treating contagious diseases. In spite of the conditions that still prevail in China, and India especially, infant mortality figures have dropped considerably. As a result, these countries have an increasing population and a decreasing capital investment. The per capita capital is dropping instead of increasing. The Russian system also does not produce capital accumulation, i.e., it has insufficient capital accumulation. Thus, we have a situation in which the greater part of mankind in the world is living under conditions which mean a lowering of the standard of living. It is terrible to say this, but it is true; it would have been better for these people if the methods of fighting contagious diseases had not been imported for them.

I want to stress again that capitalism, modern machine production, and so on, is not something material! The tools and machines are the material results attained by a certain spiritual mentality, by a certain ideology. Capitalism or modern conditions, modern standards of living, are not simply the outcome of technology. They are the outcomes of certain ideas about social organization and about the cooperation of men under the division of labor and private ownership of the means of production. These ideas must be adopted in these “backward” countries if they want to change conditions.

I do not want to deal with happiness and other connected problems. I don’t want to say that the Africans are happy without machines, without clothes, and with very different methods of feeding. But certainly they are not enthusiastic about the various diseases that plague them and which they can fight only with the methods of modern capitalism. It is wonderful that Dr. Albert Schweitzer [1875–1965] went to the center of Africa to work for the improvement of conditions. But Dr. Schweitzer has had only a very limited effect compared to the effects of capitalism which made possible the modern means of production that provided all the things necessary to maintain a hospital in the middle of Africa. If you want to help the millions in Asia and Africa, then what is needed is capitalistic methods of production and capitalistic ideas. And they cannot be developed by the means which are today being applied in those countries.

It was the introduction of foreign investment in the nineteenth century that helped to make war and conquest superfluous. The situation which people had to face at that time, and are facing again today, was that there are countries in the world which nature has endowed with natural resources that are not available in other countries. From the point of view of natural resources, Europe is very poorly endowed by nature; Asia is much better endowed. If, on the one hand, the countries which have rich natural resources are so backward and so poor in capital that they cannot produce from these resources, and if, on the other hand, they do not permit foreigners to invest capital there and take advantage of the existence of these resources, both for their own and for the natives’ advantage, can anyone expect that the people of the civilized countries will forever tolerate this state of affairs? Do the inhabitants of a country, just because their ancestors, conquered the country 500 or 600 years ago, have a right to prevent the improvement of conditions and peace in the world?

We are going back to the situation when you couldn’t get these products without conquest, the situation which made the colonial system necessary. The nineteenth century developed a method which made it unnecessary. But now we have a state of affairs again in which these countries are preventing access by trade to raw materials. We can’t know but some day a new technological method may be discovered that depends on raw materials which are available only in very backward countries. The people will say, “We could improve our standard of living and that of all other countries if we had access to these raw materials; they are completely useless to the Dalai Lama of Tibet.” It was precisely foreign investment— the possibility of making use of all natural resources without political interference—that made war unnecessary. That doesn’t hurt the countries involved. The foreign investments really cooperated in the country’s development without hurting the country in any way. The peace of the world depends on this.

The disappearance of foreign investment is a very serious problem. What is most visible today is only the bad consequences, the bad standards of living, in India and China and some other countries. But this is not all; the whole system of world policies and international policies will be affected. And then if such real conflicts really arise, even the Boy Scouts of the United Nations will not prove any better than did the statutes of the League of Nations, the UN’s predecessor.

I thank you for the patience with which you have endured my lectures.

* * * *

[Additional comments by Mises during the question-and-answer period.]

Lenin tried to get foreign capital to invest in Russia, during the NEP period, but it didn’t amount to much.

Reciprocity in trade agreements is one method to destroy the market economy. The principle of buying only from those who buy from you ignores the existence of money. The idea of money, the use of money, the whole monetary system, is precisely for the purpose of making it unnecessary for you to buy only from those who buy from you. Triangular trade means trade with the aid of money. You buy from people who have bought from others. Not a single branch of business in this country could exist if this principle were to be applied here.

Frontiers don’t exist in nature or in economy; frontiers are government-made obstacles. Governments create these differences.

Capitalism is not the ideas of the capitalist; it is an economic system. The ideas of the individual capitalist may be contrary in many regards to the principles of the market economy. There have always been businessmen who ask for privileges, protection, and so on, and as public opinion was favorable to these things they got them. It was not the fault of the lobbyists. As there are always lobbyists in favor of some things, there are also always lobbyists against other things. It is not even necessary to protect infant industries; there are shifts in American industry without such protection. If some get privileges, those who do not get any privileges are jeopardized. If the non-privileged are asking for privileges also, it is easy to understand. The duty to make such a system of privileges disappear does not rest with the businessman but with public opinion, with the ideologists, statesmen, politicians, and political campaigns. If there are privileges, then everybody tries to get privileges.

The advantages of capitalism are not for the benefit and advantage of the capitalists, but for the benefit of the masses. Capitalism is primarily production, large-scale production, for the masses. The customer, who is always right, benefits from capitalism. The institution of capitalism is not a reward for good children; it is an institution for the benefit of nations and of the people. If an individual capitalist is bad, you should not punish him by abolishing capitalism. Therefore, all the writers and authors of the fictional stories, literature, and plays that give us pictures of very bad capitalists, and say capitalism should be abolished, miss the point.

I am not in favor of the market economy and against socialism because capitalists are very nice people. Some are; some are not. In that way they are no different from other people. I am for capitalism because it benefits mankind. I am not against socialism because socialists are bad people, but because it brings about a complete decline in everyone’s standard of living and destroys freedom.

1 [The population of England was 41,147,938 (1952 World Almanac), as compared with an estimated 6 million in 1750.—Ed.]

2 [The U.S. Lend-Lease Act of March 11, 1941, permitted the President of the United States to “sell, transfer title to, exchange, lease, lend, or otherwise dispose of, to any such government [whose defense the President deems vital to the defense of the United States] any defense article,” including weapons, munitions, aircraft and seagoing vessels, machinery, raw materials, and certain agricultural commodities. The United States thus could support the Allied nations’ war effort while remaining a neutral country.—Ed. ]

3 [A U.S. government foreign-aid program, announced January 20, 1949, by President Harry Truman, “for the improvement and growth of under-developed areas.” See Henry Hazlitt, Illusions of Point Four (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1950).—Ed.]

***

For index, please refer to pdf.

The Law

By Frederic Bastiat

Translated from the French by Dean Russell

Foreword by Walter E. Williams

Introduction by Richard Ebeling

Afterword by Sheldon Richman

Foundation for Economic Education

Irvington-on-Hudson , New York

Publisher’s Cataloging in Publication

(Prepared by Quality Books, Inc.)

Foreword

Walter E. Williams

I must have been forty years old before reading Frederic Bastiat’s classic The Law. An anonymous person, to whom I shall eternally be in debt, mailed me an unsolicited copy. After reading the book I was convinced that a liberal-arts education without an encounter with Bastiat is incomplete. Reading Bastiat made me keenly aware of all the time wasted, along with the frustrations of going down one blind alley after another, organizing my philosophy of life. The Law did not produce a philosophical conversion for me as much as it created order in my thinking about liberty and just human conduct.

Many philosophers have made important contributions to the discourse on liberty, Bastiat among them. But Bastiat’s greatest contribution is that he took the discourse out of the ivory tower and made ideas on liberty so clear that even the unlettered can understand them and statists cannot obfuscate them. Clarity is crucial to persuading our fellowman of the moral superiority of personal liberty.

Like others, Bastiat recognized that the greatest single threat to liberty is government. Notice the clarity he employs to help us identify and understand evil government acts such as legalized plunder. Bastiat says, “See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.” With such an accurate description of legalized plunder, we cannot deny the conclusion that most government activities, including ours, are legalized plunder, or for the sake of modernity, legalized theft.

Frederic Bastiat could have easily been a fellow traveler of the signers of our Declaration of Independence. The signers’ vision of liberty and the proper role of government was captured in the immortal words “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain Unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, governments are instituted among Men. . . .” Bastiat echoes the identical vision, saying, “Life, faculties, production— in other words individuality, liberty, property— that is man. And in spite of the cunning of artful political leaders, these three gifts from God precede all human legislation, and are superior to it.” Bastiat gave the same rationale for government as did our Founders, saying, “Life, liberty and property do not exist because men have made laws. On the contrary, it is the fact that life, liberty and property existed beforehand that caused men to make laws in the first place.” No finer statements of natural or God-given rights have been made than those found in our Declaration of Independence and The Law.

Bastiat pinned his hopes for liberty on the United States saying, “. . . look at the United States . There is no country in the world where the law is kept more within its proper domain: the protection of every person’s liberty and property. As a consequence of this, there appears to be no country in the world where the social order rests on a firmer foundation.” Writing in 1850, Bastiat noted two areas where the United States fell short: “Slavery is a violation, by law, of liberty. The protective tariff is a violation, by law, of property.”

If Bastiat were alive today, he would be disappointed with our failure to keep the law within its proper domain. Over the course of a century and a half, we have created more than 50,000 laws. Most of them permit the state to initiate violence against those who have not initiated violence against others. These laws range from anti-smoking laws for private establishments and Social Security “contributions” to licensure laws and minimum wage laws. In each case, the person who resolutely demands and defends his God-given right to be left alone can ultimately suffer death at the hands of our government.R

Bastiat explains the call for laws that restrict peaceable, voluntary exchange and punish the desire to be left alone by saying that socialists want to play God. Socialists look upon people as raw material to be formed into social combinations. To them—the elite—“the relationship between persons and the legislator appears to be the same as the relationship between the clay and the potter.” And for people who have this vision, Bastiat displays the only anger I find in The Law when he lashes out at do-gooders and would-be rulers of mankind, “Ah, you miserable creatures! You who think that you are so great! You who judge humanity to be so small! You who wish to reform everything! Why don’t you reform yourselves? That task would be sufficient enough.”

Bastiat was an optimist who thought that eloquent arguments in defense of liberty might save the day; but history is not on his side. Mankind’s history is one of systematic, arbitrary abuse and control by the elite acting privately, through the church, but mostly through government. It is a tragic history where hundreds of millions of unfortunate souls have been slaughtered, mostly by their own government. A historian writing 200 or 300 years from now might view the liberties that existed for a tiny portion of mankind’s population, mostly in the Western world, for only a tiny portion of its history, the last century or two, as a historical curiosity that defies explanation. That historian might also observe that the curiosity was only a temporary phenomenon and mankind reverted back to the traditional state of affairs—arbitrary control and abuse.

Hopefully, history will prove that pessimistic assessment false. The worldwide collapse of the respectability of the ideas of socialism and communism suggests that there is a glimmer of hope. Another hopeful sign is the technological innovations that make it more difficult for government to gain information on its citizens and control them. Innovations such as information access, communication, and electronic monetary transactions will make government attempts at control more costly and less probable. These technological innovations will increasingly make it possible for world citizens to communicate and exchange with one another without government knowledge, sanction, or permission.

Collapse of communism and technological innovations, accompanied by robust free-market organizations promoting Bastiat’s ideas, are the most optimistic things I can say about the future of liberty in the United States . Americans share an awesome burden and moral responsibility. If liberty dies in the United States , it is destined to die everywhere. A greater familiarity with Bastiat’s clear ideas about liberty would be an important step in rekindling respect and love, and allowing the resuscitation of the spirit of liberty among our fellow Americans.

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Introduction

Richard Ebeling

The defense of economic liberty has never been an easy task. Adam Smith expressed his own despair at this problem in The Wealth of Nations. After presenting his powerful criticisms of mercantilism—the eighteenth-century system of government regulation and planning—he despondently suggested that free trade in Great Britain was as unlikely as the establishment of a utopia.

He said that two factors made the success of economic liberty unpromising. “Not only the prejudices of the public,” Smith said, “but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it.”[1] By the prejudices of the public, Smith meant the apparent difficulty of many ordinary people to follow the often abstract and complex arguments of the economic theorist that demonstrate the superior workings of the free market over various forms of government intervention and control. And by the private interests of many individuals, Smith had in mind the wide variety of special interest groups that gain from, and would therefore always lobby hard to maintain, government regulations that limit or prevent open competition. In combination, Smith feared, these two factors would permanently prevent the logic of economic freedom from ever winning in the arenas of ideas and politics.

In the nineteenth century, however, there was one champion of freedom who mastered the art of making the complexities of economic reasoning understandable to the layman: the French classical-liberal economist Frederic Bastiat (1801–1850). More than one historian of economic thought has emphasized Bastiat’s special abilities in undermining the rationales for protectionism, socialism, and interventionism.

Sir Alexander Gray, for example, said that, “No one has ever been quite so skillful in making the case of his antagonist look extremely foolish. Even now his most ephemeral work remains a joy to read, by reason of its wit, its merciless satire and the neatness wherewith he pinks his opponents.”[2] Lewis Haney referred to Bastiat’s “pleasing and luminous style” and how, “brilliantly, with fable and irony, the masses are appealed to.”[3]

Eduard Heimann, a critic of the market economy, described him as, “A brilliant writer, [who] achieved world fame with his parable of the candle-makers, who petition for protection against the unfair competition of the sun in order that the community may become richer by the enrichment of their industry.”[4] Charles Gide and Charles Rist pointed out that “If modern Protectionists no longer speak of the ‘inundation of a country’ or of an ‘invasion of foreign goods’ . . . we too often forget that all this is due to the small but admirable pamphlets written by Bastiat . . . . No one could more scornfully show the laughable inconsistency of tunneling the mountains which divide countries, with a view to facilitating exchange, while at the same time setting up a customs barrier at each end.”[5] And even though Bastiat’s pen was sharp against the protectionist and collectivist ideas of his time, William Scott emphasized that the French liberal’s “attitude was calm and dignified and in spite of the incisiveness of his criticism he showed appreciation of the motives of his adversaries. He gave them full credit for a desire to promote the well-being of society, but wished simply to show that they were on the wrong path and, if possible, to set them right.”[6]

Those qualities led Joseph A. Schumpeter to call Bastiat “the most brilliant economic journalist who ever lived.”[7] And Ludwig von Mises praised him as a “brilliant stylist, so that the reading of his writings affords a quite genuine pleasure. . . . [H]is critique of all protectionist and related tendencies is even today unsurpassed. The protectionists and interventionists have not been able to advance a single word in pertinent and objective rejoinder.”[8]

Other authors have modeled some of their own works after him. At the beginning of the twentieth century, the French freemarket economist Yves Guyot said that his own little book, Economic Prejudices, was offered in the footsteps of Frederic Bastiat, with the purpose of “[setting] forth truths in a handy, convenient form that is easy to remember, to criticize errors by means of proof that any one can apply,” as Bastiat had done half a century earlier.[9] And surely the most famous and influential adaptation of Bastiat’s method and approach in the twentieth century was Henry Hazlitt’s Economics in One Lesson, in which the author said, “The present work may, in fact, be regarded as a modernization, extension and generalization of the approach found in Bastiat’s pamphlet,” known by the title “What Is Seen and What Is Not Seen.”[10]

R R  R

Claude Frederic Bastiat was born on June 30, 1801 , in Bayonne , France , the son of a prominent merchant.[11] His mother died when he was seven years old, and his father passed away two years later, when Frederic was only nine. He was brought up by an aunt, who also saw to it that he went to the College of Sorèze beginning when he was 14. But at 17 he left without finishing the requirements for his degree and entered his uncle’s commercial firm in Bayonne . Shortly afterward he came across the writings of the French classical-liberal economist Jean-Baptiste Say, and they transformed his life and thinking.[12] He began a serious study of political economy and soon discovered the works of many of the other classical-liberal writers in France and Great Britain .

In 1825 he inherited a modest estate in Mugron from his grandfather and remained there until 1846, when he moved to Paris . During these 20 years Bastiat devoted almost all his time to absorbing a vast amount of literature on a wide variety of subjects, sharing books and ideas with his friend Félix Coudroy. It seems that Coudroy had socialist leanings, and Bastiat began to refine his skills in clear thinking and writing by formulating the arguments that finally won over his friend to a philosophy of freedom.

In the late 1820s and 1830s he began writing monographs and essays on a variety of economic topics. But his real reputation as a writer began in 1844, when he published a lengthy article in defense of free trade and then a monograph on Cobden and the League: The English Movement for Free Trade. While writing these works Bastiat began a correspondence with Richard Cobden, one of the primary leaders of the British Anti-Corn Law League, the association working for the repeal of all barriers to free trade. The two proponents of economic freedom became fast friends, supporting each other in the cause of liberty.

The success of these writings, and the inspiration from the success of Cobden’s free-trade activities in bringing about the end of agricultural protectionism in Great Britain in 1846, resulted in Bastiat’s moving to Paris to establish a French free-trade association and to start Le Libre Échange, a newspaper devoted to this cause.[13] For two years Bastiat labored to organize and propagandize for free trade. At first he was able to attract a variety of people in commerce and industry to support his activities, including delivering speeches, designing legislation for the repeal of French protectionism, and preparing writings to change public opinion. But it was to no avail. There were too many special interests benefiting from privileges and favors given by the government, and he was unable to arouse a sustained interest in his cause among the general public. It appeared that Adam Smith had been right in lamenting the prejudices of the public and the power of the interests, at least in France .

Following the revolution of February 1848, Bastiat began a career in politics, serving first in the French Constituent Assembly and then in the Legislative Assembly. Having devoted most of his previous writings to demonstrating the fallacies in the arguments for protectionism, Bastiat turned his attention to a new enemy of economic liberty: socialism. In the Legislative Assembly he delivered powerful speeches against public-works programs, guaranteed national-employment schemes, wealth redistribution proposals, nationalization of industry, and rationales for the expansion of bureaucratic controls over social and economic life. But because of a worsening tuberculosis that weakened his voice, he turned to the written word, producing a large number of essays detailing the absurdities in the arguments of the socialists.

Bastiat made his last appearance in the Assembly in February 1850. By spring of that year his health had declined so dramatically that he was forced to step down from his legislative responsibilities and spend the summer in the Pyrénées mountains in the south of France . He returned to Paris in September and visited his friends in the cause for free trade, before setting out for Italy in search of a cure for his tuberculosis. He died in Rome on December 24, 1850 , at the age of 49.

Frederic Bastiat’s intellectual legacy in the fight for economic freedom is contained in three volumes. Two of them are collections of some of his most biting, witty, and insightful essays and articles, and are available in English under the titles Economic Sophisms[14] and Selected Essays on Political Economy.[15] In his last years, Bastiat devoted part of his time to a general work of social philosophy and economic principles, published under the name Economic Harmonies.[16]

As Henry Hazlitt rightly emphasized, the central idea in much of Bastiat’s writings is captured in his essay “What Is Seen and What Is Not Seen,” which was the last piece he wrote before his death in 1850.[17] He points out that the short-run effects of any action or policy can often be quite different from its longer-run consequences, and that these more remote consequences in fact may be the opposite from what one had hoped for or originally planned.

Bastiat was able to apply the principle of the seen and the unseen to taxes and government jobs. When government taxes, what is seen are the workers employed and the results of their labor: a road, a bridge, or a canal. What is unseen are all the other things that would have been produced if the tax money had not been taken from individuals in the private sector and if the resources and labor employed by the government had been free to serve the desires of those private citizens. Government, Bastiat explained, produces nothing independent from the resources and labor it diverts from private uses.

This simple but profoundly important insight is the theoretical weapon through which Bastiat is able to demonstrate the errors and contradictions in the ideas of both protectionists and socialists. Thus in such essays as “Abundance and Scarcity,” “Obstacle and Cause,” and “Effort and Result,” he shows that barriers and prohibitions to freedom of trade only lead to poverty.[18]

He points out that each of us is both a consumer and a producer. To consume a good we must either make it ourselves or make some other good that we think someone else will take in exchange for the good we want. As consumers we desire as many goods as possible at the lowest possible prices. In other words, we want abundance. But as producers we want a scarcity of the goods we bring to market. In open competition, in which all exchanges are voluntary, the only way to “capture” customers and earn the income that enables each of us, in turn, to be a consumer is to offer better, cheaper, and more goods than our competitors. The alternative to this method, Bastiat warns, is for each of us as a producer to turn to the government to gain from our neighbors what we are unable to obtain through peaceful, nonviolent trade on the market.

Herein lies Bastiat’s famous distinction between illegal and legal plunder, which is at the center of his analysis in The Law.[19] The purpose of government, he says, is precisely to secure individuals in their rights to life, liberty, and property. Without such security men are reduced to a primitive life of fear and self-defense, with every neighbor a potential enemy ready to plunder what another has produced. If a government is strictly limited to protecting men’s rights, then peace prevails, and men can go about working to improve their lives, associating with their neighbors in a division of labor and exchange.

But government can also be turned against those whom it is meant to protect in their property. There can arise legal plunder, in which the powers of government are used by various individuals and groups to prevent rivals from competing, to restrict the domestic and foreign trading opportunities of other consumers in the society, and therefore to steal the wealth of one’s neighbors. This, Bastiat argues, is the origin and basis of protectionism, regulation, and redistributive taxation.

But the consequences of legal plunder are not only the political legitimizing of theft and the breakdown of morality through the blurring of the distinction between right and wrong—however crucially important and dangerous these may be for the long-term stability and well-being of society. Such policies also, by necessity, reduce the prosperity of the society.

Every trade protection, every domestic regulatory restriction, every redistributive act of taxation above that minimal amount necessary to secure the equal protection of each individual’s rights, Bastiat insisted, reduces production and competition in society. Scarcity replaces abundance. Limiting competition reduces the supply of goods available to all members of the society. Imposing protectionist barriers on foreign trade or domestic regulations on production decreases the general availability of goods and makes them more expensive. Everyone is, in the end, made worse off. And thus Bastiat reached his famous conclusion that the state is the great fiction through which everyone tries to live at the expense of everyone else.

Why does legal plunder come about? Bastiat saw its origin in two sources. First, as we have just seen, some people see it as an easier means of acquiring wealth than through work and production. They use political power to redistribute from others what they are unwilling or unable to obtain from their neighbors through the voluntary exchanges of the marketplace. One basis for legal plunder, in other words, is the misguided spirit of theft.

The second, and far more dangerous, source of legal plunder is the arrogant mentality of the social engineer. Through the ages, Bastiat showed, social and political philosophers have viewed the multitude of humanity as passive matter, similar to clay, waiting to be molded and shaped, arranged and moved about according to the design of an intellectually superior elite.

With a timeless relevance, Bastiat points out that the political elite praises the ideal of democracy, under which “the people” select those who will hold political office. But once the electoral process is finished, those elected to high political office arrogate to themselves the planning, directing, and controlling of every aspect of social and economic life. The task of modern democracy, apparently, is to periodically appoint those who shall be our societal dictators.

Is this the way men have to live? Was illegal and legal plunder the only form of social existence? Bastiat answered no. In Economic Harmonies he tried to explain the nature and logic of a system of peaceful human association through production and trade. Historians of economic thought and other critics of Bastiat have said this work demonstrates that, despite his brilliant journalistic talents, he failed as a serious economic theorist. They point to his use of a form of a labor theory of value or his faulty theory of savings, capital, and interest.[20]

But beyond these errors and limitations is an aspect of Economic Harmonies that still makes it insightful. Harmonies attempts to offer a grand vision of the causal relationships among work, the division of labor, voluntary exchange, and mutual improvement of men’s condition, as well as the importance of private property, individual freedom, and domestic and foreign free trade. In freedom there is social harmony, since each man sees his neighbor not as an enemy but as a partner in the ongoing processes of human improvement. Where relationships are based on consent and mutual agreement there can be no plunder, only reinforcing prosperity, as each works to trade with his neighbors and acquire all the things that make life better for each and all.

If one looks at the period during which Bastiat devoted his efforts to fight for freedom and free trade, the conclusion would appear to be that his life ended in failure. Both during his lifetime and following his death France remained in the grip of the protectionist and interventionist spirit, never achieving the degree of economic liberty enjoyed in Great Britain through the second half of the nineteenth century.

And yet Bastiat’s life should be seen as a glorious success. For the 150 years since his passing, each new generation of advocates of economic liberty has been inspired by his writings. His fables and essays read as fresh as if they were written yesterday, because they address the underlying nature of human association and the dangers from political encroachment on the social and market orders.

1. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book Four, chapter two (New York: Modern Library, 1937 [1776]), pp. 437–38.

2. Sir Alexander Gray, The Development of Economic Doctrine: An Introductory Survey (London: Longmans, Green, 1931), pp. 244–45.

3. Lewis H. Haney, History of Economic Thought (New York: Macmillan, 1936), pp. 331–32.

4. Eduard Heimann, History of Economic Doctrines: An Introduction to Economic Theory (London: Oxford University Press, 1945), p. 124.

5. Charles Gide and Charles Rist, A History of Economic Doctrines, From the Time of the Physiocrats to the Present Day (Boston: D.C. Heath, 1915), pp. 329–30.

6. William A. Scott, The Development of Economics (New York: The Century Co., 1933), p. 244.

7. Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), p. 500.

8. Ludwig von Mises, Liberalism: The Classical Tradition (Irvington-on- Hudson, N.Y.: Foundation for Economic Education, 1996 [1927]), p. 197.

9. Yves Guyot, Economic Prejudices (London: Swan Sonnenschein, 1910), p. v.

10. Henry Hazlitt, Economics in One Lesson (New York: Harper & Brothers, 1946).

11. The following brief summary of Bastiat’s life and professional activities is drawn primarily from Dean Russell, Frédéric Bastiat: Ideas and Influence (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1965); also Dean Russell, Frédéric Bastiat and the Free Trade Movement in France and England, 1840–1850 (Geneva: Imprimarie Albert Kundig, 1959); and George C. Roche, Frederic Bastiat: A Man Alone (Hillsdale, Mich.: Hillsdale College Press, 1977).

12. Jean-Baptiste Say, A Treatise on Political Economy, or the Production, Distribution and Consumption of Wealth [1921] (N.Y.: Augustus M. Kelley, 1971); Say, Letters to Mr. Malthus on Several Subjects of Political Economy [1821] (N.Y.: Augustus M. Kelley, 1967); and R. R. Palmer, ed., J.-B. Say: An Economist in Troubled Times (Princeton, N.J.: Princeton University Press, 1997).

13. For a brief account of the free-trade movement in Great Britain and its triumph in the middle of the nineteenth century, see Richard M. Ebeling, Austrian Economics and the Political Economy of Freedom (Northampton, Mass.: Edward Elgar, 2005), ch. 10: “The Global Economy and Classical Liberalism: Past, Present and Future,” pp. 247–281, and especially pp. 248–252.

14. Economic Sophisms, trans. and ed. Arthur Goddard, with introduction by Henry Hazlitt (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996 [1845]).

15. Selected Essays on Political Economy, trans. Seymour Cain, ed. George B. de Huszar, with introduction by F. A. Hayek (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995 [1964]).

16. Economic Harmonies, trans. W. Hayden Boyers, ed. George B. de Huszar, with introduction by Dean Russell (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996 [1850]).

17. In Selected Essays, pp. 1–50.

18. Economic Sophisms, pp. 7–27.

19. “The Law,” in Selected Essays, pp. 51–96; and, “The Physiology of Plunder,” in Economic Sophisms, pp. 129–46.

20. See, for example, Eugen von Böhm-Bawerk, Capital and Interest, vol. 1: History and Critique of Interest Theories (South Holland, Ill.: Libertarian Press, 1959), pp. 191–94.

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The Law

The law perverted! And the police powers of the state perverted along with it! The law, I say, not only turned from its proper purpose but made to follow an entirely contrary purpose! The law become the weapon of every kind of greed! Instead of checking crime, the law itself guilty of the evils it is supposed to punish!

If this is true, it is a serious fact, and moral duty requires me to call the attention of my fellow-citizens to it.

Life Is a Gift from God

We hold from God the gift which includes all others. This gift is life—physical, intellectual, and moral life.

But life cannot maintain itself alone. The Creator of life has entrusted us with the responsibility of preserving, developing, and perfecting it. In order that we may accomplish this, He has provided us with a collection of marvelous faculties. And He has put us in the midst of a variety of natural resources. By the application of our faculties to these natural resources we convert them into products, and use them. This process is necessary in order that life may run its appointed course.

Life, faculties, production—in other words, individuality, liberty, property—this is man. And in spite of the cunning of artful political leaders, these three gifts from God precede all human legislation, and are superior to it. Life, liberty, and property do not exist because men have made laws. On the contrary, it was the fact that life, liberty, and property existed beforehand that caused men to make laws in the first place.

What Is Law?

What, then, is law? It is the collective organization of the individual right to lawful defense. Each of us has a natural right—from God—to defend his person, his liberty, and his property. These are the three basic requirements of life, and the preservation of any one of them is completely dependent upon the preservation of the other two. For what are our faculties but the extension of our individuality? And what is property but an extension of our faculties? If every person has the right to defend—even by force—his person, his liberty, and his property, then it follows that a group of men have the right to organize and support a common force to protect these rights constantly. Thus the principle of collective right—its reason for existing, its lawfulness—is based on individual right. And the common force that protects this collective right cannot logically have any other purpose or any other mission than that for which it acts as a substitute. Thus, since an individual cannot lawfully use force against the person, liberty, or property of another individual, then the common force—for the same reason—cannot lawfully be used to destroy the person, liberty, or property of individuals or groups. Such a perversion of force would be, in both cases, contrary to our premise. Force has been given to us to defend our own individual rights. Who will dare to say that force has been given to us to destroy the equal rights of our brothers? Since no individual acting separately can lawfully use force to destroy the rights of others, does it not logically follow that the same principle also applies to the common force that is nothing more than the organized combination of the individual forces? If this is true, then nothing can be more evident than this: The law is the organization of the natural right of lawful defense. It is the substitution of a common force for individual forces. And this common force is to do only what the individual forces have a natural and lawful right to do: to protect persons, liberties, and properties; to maintain the right of each, and to cause justice to reign over us all.

A Just and Enduring Government

If a nation were founded on this basis, it seems to me that order would prevail among the people, in thought as well as in deed. It seems to me that such a nation would have the most simple, easy to accept, economical, limited, non-oppressive, just, and enduring government imaginable—whatever its political form might be.

Under such an administration, everyone would understand that he possessed all the privileges as well as all the responsibilities of his existence. No one would have any argument with government, provided that his person was respected, his labor was free, and the fruits of his labor were protected against all unjust attack. When successful, we would not have to thank the state for our success. And, conversely, when unsuccessful, we would no more think of blaming the state for our misfortune than would the farmers blame the state because of hail or frost. The state would be felt only by the invaluable blessings of safety provided by this concept of government.

It can be further stated that, thanks to the non-intervention of the state in private affairs, our wants and their satisfactions would develop themselves in a logical manner. We would not see poor families seeking literary instruction before they have bread. We would not see cities populated at the expense of rural districts, nor rural districts at the expense of cities. We would not see the great displacements of capital, labor, and population that are caused by legislative decisions.

The sources of our existence are made uncertain and precarious by these state-created displacements. And, furthermore, these acts burden the government with increased responsibilities.

The Complete Perversion of the Law

But, unfortunately, law by no means confines itself to its proper functions. And when it has exceeded its proper functions, it has not done so merely in some inconsequential and debatable matters. The law has gone further than this; it has acted in direct opposition to its own purpose. The law has been used to destroy its own objective: It has been applied to annihilating the justice that it was supposed to maintain; to limiting and destroying rights which its real purpose was to respect. The law has placed the collective force at the disposal of the unscrupulous who wish, without risk, to exploit the person, liberty, and property of others. It has converted plunder into a right, in order to protect plunder. And it has converted lawful defense into a crime, in order to punish lawful defense.

How has this perversion of the law been accomplished? And what have been the results?

The law has been perverted by the influence of two entirely different causes: stupid greed and false philanthropy. Let us speak of the first.

A Fatal Tendency of Mankind

Self-preservation and self-development are common aspirations among all people. And if everyone enjoyed the unrestricted use of his faculties and the free disposition of the fruits of his labor, social progress would be ceaseless, uninterrupted, and unfailing.

But there is also another tendency that is common among people. When they can, they wish to live and prosper at the expense of others. This is no rash accusation. Nor does it come from a gloomy and uncharitable spirit. The annals of history bear witness to the truth of it: the incessant wars, mass migrations, religious persecutions, universal slavery, dishonesty in commerce, and monopolies. This fatal desire has its origin in the very nature of man—in that primitive, universal, and insuppressible instinct that impels him to satisfy his desires with the least possible pain.

Property and Plunder

Man can live and satisfy his wants only by ceaseless labor; by the ceaseless application of his faculties to natural resources. This process is the origin of property.

But it is also true that a man may live and satisfy his wants by seizing and consuming the products of the labor of others. This process is the origin of plunder.

Now since man is naturally inclined to avoid pain—and since labor is pain in itself—it follows that men will resort to plunder whenever plunder is easier than work. History shows this quite clearly. And under these conditions, neither religion nor morality can stop it.

When, then, does plunder stop? It stops when it becomes more painful and more dangerous than labor. It is evident, then, that the proper purpose of law is to use the power of its collective force to stop this fatal tendency to plunder instead of to work. All the measures of the law should protect property and punish plunder.

But, generally, the law is made by one man or one class of men. And since law cannot operate without the sanction and support of a dominating force, this force must be entrusted to those who make the laws.

This fact, combined with the fatal tendency that exists in the heart of man to satisfy his wants with the least possible effort, explains the almost universal perversion of the law. Thus it is easy to understand how law, instead of checking injustice, becomes the invincible weapon of injustice. It is easy to understand why the law is used by the legislator to destroy in varying degrees among the rest of the people, their personal independence by slavery, their liberty by oppression, and their property by plunder. This is done for the benefit of the person who makes the law, and in proportion to the power that he holds.

Victims of Lawful Plunder

Men naturally rebel against the injustice of which they are victims. Thus, when plunder is organized by law for the profit of those who make the law, all the plundered classes try somehow to enter—by peaceful or revolutionary means—into the making of laws. According to their degree of enlightenment, these plundered classes may propose one of two entirely different purposes when they attempt to attain political power: Either they may wish to stop lawful plunder, or they may wish to share in it.

Woe to the nation when this latter purpose prevails among the mass victims of lawful plunder when they, in turn, seize the power to make laws!

Until that happens, the few practice lawful plunder upon the many, a common practice where the right to participate in the making of law is limited to a few persons. But then, participation in the making of law becomes universal. And then, men seek to balance their conflicting interests by universal plunder. Instead of rooting out the injustices found in society, they make these injustices general. As soon as the plundered classes gain political power, they establish a system of reprisals against other classes. They do not abolish legal plunder. (This objective would demand more enlightenment than they possess.) Instead, they emulate their evil predecessors by participating in this legal plunder, even though it is against their own interests.

It is as if it were necessary, before a reign of justice appears, for everyone to suffer a cruel retribution—some for their evilness, and some for their lack of understanding. .

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The Results of Legal Plunder

It is impossible to introduce into society a greater change and a greater evil than this: the conversion of the law into an instrument of plunder.

What are the consequences of such a perversion? It would require volumes to describe them all. Thus we must content ourselves with pointing out the most striking.

In the first place, it erases from everyone’s conscience the distinction between justice and injustice.

No society can exist unless the laws are respected to a certain degree. The safest way to make laws respected is to make them respectable. When law and morality contradict each other, the citizen has the cruel alternative of either losing his moral sense or losing his respect for the law. These two evils are of equal consequence, and it would be difficult for a person to choose between them.

The nature of law is to maintain justice. This is so much the case that, in the minds of the people, law and justice are one and the same thing. There is in all of us a strong disposition to believe that anything lawful is also legitimate. This belief is so widespread that many persons have erroneously held that things are “just” because law makes them so. Thus, in order to make plunder appear just and sacred to many consciences, it is only necessary for the law to decree and sanction it. Slavery, restrictions, and monopoly find defenders not only among those who profit from them but also among those who suffer from them.

The Fate of Non-Conformists

If you suggest a doubt as to the morality of these institutions, it is boldly said that “You are a dangerous innovator, a utopian, a theorist, a subversive; you would shatter the foundation upon which society rests.”

If you lecture upon morality or upon political science, there will be found official organizations petitioning the government in this vein of thought: “That science no longer be taught exclusively from the point of view of free trade (of liberty, of property, and of justice) as has been the case until now, but also, in the future, science is to be especially taught from the viewpoint of the facts and laws that regulate French industry (facts and laws which are contrary to liberty, to property, and to justice). That, in government-endowed teaching positions, the professor rigorously refrain from endangering in the slightest degree the respect due to the laws now in force.”

Thus, if there exists a law which sanctions slavery or monopoly, oppression or robbery, in any form whatever, it must not ever be mentioned. For how can it be mentioned without damaging the respect which it inspires? Still further, morality and political economy must be taught from the point of view of this law; from the supposition that it must be a just law merely because it is a law.

Another effect of this tragic perversion of the law is that it gives an exaggerated importance to political passions and conflicts, and to politics in general.

I could prove this assertion in a thousand ways. But, by way of illustration, I shall limit myself to a subject that has lately occupied the minds of everyone: universal suffrage.

Who Shall Judge?

The followers of Rousseau’s school of thought—who consider themselves far advanced, but whom I consider twenty centuries behind the times—will not agree with me on this. But universal suffrage—using the word in its strictest sense—is not one General Council of Manufacturers, Agriculture, and Commerce, May 6, 1850 . of those sacred dogmas which it is a crime to examine or doubt. In fact, serious objections may be made to universal suffrage.

In the first place, the word universal conceals a gross fallacy. For example, there are 36 million people in France . Thus, to make the right of suffrage universal, there should be 36 million voters. But the most extended system permits only 9 million people to vote. Three persons out of four are excluded. And more than this, they are excluded by the fourth. This fourth person advances the principle of incapacity as his reason for excluding the others. Universal suffrage means, then, universal suffrage for those who are capable. But there remains this question of fact: Who is capable? Are minors, females, insane persons, and persons who have committed certain major crimes the only ones to be determined incapable?

The Reason Why Voting Is Restricted

A closer examination of the subject shows us the motive which causes the right of suffrage to be based upon the supposition of incapacity. The motive is that the elector or voter does not exercise this right for himself alone, but for everybody.

The most extended elective system and the most restricted elective system are alike in this respect. They differ only in respect to what constitutes incapacity. It is not a difference of principle, but merely a difference of degree.

If, as the republicans of our present-day Greek and Roman schools of thought pretend, the right of suffrage arrives with one’s birth, it would be an injustice for adults to prevent women and children from voting. Why are they prevented? Because they are presumed to be incapable. And why is incapacity a motive for exclusion? Because it is not the voter alone who suffers the consequences of his vote; because each vote touches and affects everyone in the entire community; because the people in the community have a right to demand some safeguards concerning the acts upon which their welfare and existence depend.

The Answer Is to Restrict the Law

I know what might be said in answer to this; what the objections might be. But this is not the place to exhaust a controversy of this nature. I wish merely to observe here that this controversy over universal suffrage (as well as most other political questions) which agitates, excites, and overthrows nations, would lose nearly all of its importance if the law had always been what it ought to be.

In fact, if law were restricted to protecting all persons, all liberties, and all properties; if law were nothing more than the organized combination of the individual’s right to self defense; if law were the obstacle, the check, the punisher of all oppression and plunder—is it likely that we citizens would then argue much about the extent of the franchise?

Under these circumstances, is it likely that the extent of the right to vote would endanger that supreme good, the public peace? Is it likely that the excluded classes would refuse to peaceably await the coming of their right to vote? Is it likely that those who had the right to vote would jealously defend their privilege? If the law were confined to its proper functions, everyone’s interest in the law would be the same. Is it not clear that, under these circumstances, those who voted could not inconvenience those who did not vote?

The Fatal Idea of Legal Plunder

But on the other hand, imagine that this fatal principle has been introduced: Under the pretense of organization, regulation, protection, or encouragement, the law takes property from one person and gives it to another; the law takes the wealth of all and gives it to a few—whether farmers, manufacturers, shipowners, artists, or comedians. Under these circumstances, then certainly every class will aspire to grasp the law, and logically so.

The excluded classes will furiously demand their right to vote—and will overthrow society rather than not to obtain it. Even beggars and vagabonds will then prove to you that they also have an incontestable title to vote. They will say to you:

“We cannot buy wine, tobacco, or salt without paying the tax. And a part of the tax that we pay is given by law—in privileges and subsidies—to men who are richer than we are. Others use the law to raise the prices of bread, meat, iron, or cloth. Thus, since everyone else uses the law for his own profit, we also would like to use the law for our own profit. We demand from the law the right to relief, which is the poor man’s plunder. To obtain this right, we also should be voters and legislators in order that we may organize Beggary on a grand scale for our own class, as you have organized Protection on a grand scale for your class. Now don’t tell us beggars that you will act for us, and then toss us, as Mr. Mimerel proposes, 600,000 francs to keep us quiet, like throwing us a bone to gnaw. We have other claims. And anyway, we wish to bargain for ourselves as other classes have bargained for themselves!”

And what can you say to answer that argument!

Perverted Law Causes Conflict

As long as it is admitted that the law may be diverted from its true purpose—that it may violate property instead of protecting it—then everyone will want to participate in making the law, either to protect himself against plunder or to use it for plunder. Political questions will always be prejudicial, dominant, and all-absorbing. There will be fighting at the door of the Legislative Palace , and the struggle within will be no less furious. To know this, it is hardly necessary to examine what transpires in the French and English legislatures; merely to understand the issue is to know the answer.

Is there any need to offer proof that this odious perversion of the law is a perpetual source of hatred and discord; that it tends to destroy society itself? If such proof is needed, look at the United States [in 1850]. There is no country in the world where the law is kept more within its proper domain: the protection of every person’s liberty and property. As a consequence of this, there appears to be no country in the world where the social order rests on a firmer foundation. But even in the United States , there are two issues—-and only two—that have always endangered the public peace.

Slavery and Tariffs Are Plunder

What are these two issues? They are slavery and tariffs. These are the only two issues where, contrary to the general spirit of the republic of the United States , law has assumed the character of a plunderer.

Slavery is a violation, by law, of liberty. The protective tariff is a violation, by law, of property.

It is a most remarkable fact that this double legal crime—a sorrowful inheritance from the Old World —should be the only issue which can, and perhaps will, lead to the ruin of the Union . It is indeed impossible to imagine, at the very heart of a society, a more astounding fact than this: The law has come to be an instrument of injustice. And if this fact brings terrible consequences to the United States—where the proper purpose of the law has been perverted only in the instances of slavery and tariffs —what must be the consequences in Europe, where the perversion of the law is a principle; a system?

Two Kinds of Plunder

Mr. de Montalembert [politician and writer] adopting the thought contained in a famous proclamation by Mr. Carlier, has said: “We must make war against socialism.” According to the definition of socialism advanced by Mr. Charles Dupin, he meant: “We must make war against plunder.”

But of what plunder was he speaking? For there are two kinds of plunder: legal and illegal.

I do not think that illegal plunder, such as theft or swindling —which the penal code defines, anticipates, and punishes —can be called socialism. It is not this kind of plunder that systematically threatens the foundations of society. Anyway, the war against this kind of plunder has not waited for the command of these gentlemen. The war against illegal plunder has been fought since the beginning of the world. Long before the Revolution of February 1848—long before the appearance even of socialism itself—France had provided police, judges, gendarmes, prisons, dungeons, and scaffolds for the purpose of fighting illegal plunder. The law itself conducts this war, and it is my wish and opinion that the law should always maintain this attitude toward plunder.

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The Law Defends Plunder

But it does not always do this. Sometimes the law defends plunder and participates in it. Thus the beneficiaries are spared the shame, danger, and scruple which their acts would otherwise involve. Sometimes the law places the whole apparatus of judges, police, prisons, and gendarmes at the service of the plunderers, and treats the victim—when he defends himself—as a criminal. In short, there is a legal plunder, and it is of this, no doubt, that Mr. de Montalembert speaks.

This legal plunder may be only an isolated stain among the legislative measures of the people. If so, it is best to wipe it out with a minimum of speeches and denunciations—and in spite of the uproar of the vested interests.

How to Identify Legal Plunder

But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.

Then abolish this law without delay, for it is not only an evil itself, but also it is a fertile source for further evils because it invites reprisals. If such a law—which may be an isolated case— is not abolished immediately, it will spread, multiply, and develop into a system.

The person who profits from this law will complain bitterly, defending his acquired rights. He will claim that the state is obligated to protect and encourage his particular industry; that this procedure enriches the state because the protected industry is thus able to spend more and to pay higher wages to the poor workingmen.

Do not listen to this sophistry by vested interests. The acceptance of these arguments will build legal plunder into a whole system. In fact, this has already occurred. The present day delusion is an attempt to enrich everyone at the expense of everyone else; to make plunder universal under the pretense of organizing it.

Legal Plunder Has Many Names

Now, legal plunder can be committed in an infinite number of ways. Thus we have an infinite number of plans for organizing it: tariffs, protection, benefits, subsidies, encouragements, progressive taxation, public schools, guaranteed jobs, guaranteed profits, minimum wages, a right to relief, a right to the tools of labor, free credit, and so on, and so on. All these plans as a whole—with their common aim of legal plunder—constitute socialism.

Now, since under this definition socialism is a body of doctrine, what attack can be made against it other than a war of doctrine? If you find this socialistic doctrine to be false, absurd, and evil, then refute it. And the more false, the more absurd, and the more evil it is, the easier it will be to refute. Above all, if you wish to be strong, begin by rooting out every particle of socialism that may have crept into your legislation. This will be no light task.

Socialism Is Legal Plunder

Mr. de Montalembert has been accused of desiring to fight socialism by the use of brute force. He ought to be exonerated from this accusation, for he has plainly said: “The war that we must fight against socialism must be in harmony with law, honor, and justice.”

But why does not Mr. de Montalembert see that he has placed himself in a vicious circle? You would use the law to oppose socialism? But it is upon the law that socialism itself relies. Socialists desire to practice legal plunder, not illegal plunder. Socialists, like all other monopolists, desire to make the law their own weapon. And when once the law is on the side of socialism, how can it be used against socialism? For when plunder is abetted by the law, it does not fear your courts, your gendarmes, and your prisons. Rather, it may call upon them for help.

To prevent this, you would exclude socialism from entering into the making of laws? You would prevent socialists from entering the Legislative Palace ? You shall not succeed, I predict, so long as legal plunder continues to be the main business of the legislature. It is illogical—in fact, absurd—to assume otherwise.

The Choice Before Us

This question of legal plunder must be settled once and for all, and there are only three ways to settle it:

1. The few plunder the many.

2. Everybody plunders everybody.

3. Nobody plunders anybody.

We must make our choice among limited plunder, universal plunder, and no plunder. The law can follow only one of these three.

Limited legal plunder: This system prevailed when the right to vote was restricted. One would turn back to this system to prevent the invasion of socialism.

Universal legal plunder: We have been threatened with this system since the franchise was made universal. The newly enfranchised majority has decided to formulate law on the same principle of legal plunder that was used by their predecessors when the vote was limited.

No legal plunder: This is the principle of justice, peace, order, stability, harmony, and logic. Until the day of my death, I shall proclaim this principle with all the force of my lungs (which alas! is all too inadequate).

The Proper Function of the Law

And, in all sincerity, can anything more than the absence of plunder be required of the law? Can the law—which necessarily requires the use of force—rationally be used for anything except protecting the rights of everyone? I defy anyone to extend it beyond this purpose without perverting it and, consequently, turning might against right. This is the most fatal and most illogical social perversion that can possibly be imagined. It must be admitted that the true solution—so long searched for in the area of social relationships—is contained in these simple words: Law is organized justice. Translator’s note: At the time this was written, Mr. Bastiat knew that he was dying of tuberculosis. Within a year, he was dead.

Now this must be said: When justice is organized by law— that is, by force—this excludes the idea of using law (force) to organize any human activity whatever, whether it be labor, charity, agriculture, commerce, industry, education, art, or religion. The organizing by law of any one of these would inevitably destroy the essential organization—justice. For truly, how can we imagine force being used against the liberty of citizens without it also being used against justice, and thus acting against its proper purpose?

The Seductive Lure of Socialism

Here I encounter the most popular fallacy of our times. It is not considered sufficient that the law should be just; it must be philanthropic. Nor is it sufficient that the law should guarantee to every citizen the free and inoffensive use of his faculties for physical, intellectual, and moral self-improvement. Instead, it is demanded that the law should directly extend welfare, education, and morality throughout the nation.

This is the seductive lure of socialism. And I repeat again: These two uses of the law are in direct contradiction to each other. We must choose between them. A citizen cannot at the same time be free and not free.

Enforced Fraternity Destroys Liberty

Mr. de Lamartine once wrote to me thusly: “Your doctrine is only the half of my program. You have stopped at liberty; I go on to fraternity.” I answered him: “The second half of your program will destroy the first.”

In fact, it is impossible for me to separate the word fraternity from the word voluntary. I cannot possibly understand how fraternity can be legally enforced without liberty being legally destroyed, and thus justice being legally trampled underfoot. Legal plunder has two roots: One of them, as I have said before, is in human greed; the other is in false philanthropy. At this point, I think that I should explain exactly what I mean by the word plunder.

Plunder Violates Ownership

I do not, as is often done, use the word in any vague, uncertain, approximate, or metaphorical sense. I use it in its scientific acceptance—as expressing the idea opposite to that of property [wages, land, money, or whatever]. When a portion of wealth is transferred from the person who owns it—without his consent and without compensation, and whether by force or by fraud— to anyone who does not own it, then I say that property is violated; that an act of plunder is committed.

I say that this act is exactly what the law is supposed to suppress, always and everywhere. When the law itself commits this act that it is supposed to suppress, I say that plunder is still com- Translator’s note: The French word used by Mr. Bastiat is spoliation. mitted, and I add that from the point of view of society and welfare, this aggression against rights is even worse. In this case of legal plunder, however, the person who receives the benefits is not responsible for the act of plundering. The responsibility for this legal plunder rests with the law, the legislator, and society itself. Therein lies the political danger.

It is to be regretted that the word plunder is offensive. I have tried in vain to find an inoffensive word, for I would not at any time—especially now—wish to add an irritating word to our dissentions. Thus, whether I am believed or not, I declare that I do not mean to attack the intentions or the morality of anyone. Rather, I am attacking an idea which I believe to be false; a system which appears to me to be unjust; an injustice so independent of personal intentions that each of us profits from it without wishing to do so, and suffers from it without knowing the cause of the suffering.

Three Systems of Plunder

The sincerity of those who advocate protectionism, socialism, and communism is not here questioned. Any writer who would do that must be influenced by a political spirit or a political fear. It is to be pointed out, however, that protectionism, socialism, and communism are basically the same plant in three different stages of its growth. All that can be said is that legal plunder is more visible in communism because it is complete plunder; and in protectionism because the plunder is limited to specific groups and industries. Thus it follows that, of the three systems, socialism is the vaguest, the most indecisive, and, consequently, the most sincere stage of development.

But sincere or insincere, the intentions of persons are not here under question. In fact, I have already said that legal plunder is based partially on philanthropy, even though it is a false philanthropy. With this explanation, let us examine the value—the origin and the tendency—of this popular aspiration which claims to accomplish the general welfare by general plunder.

Law Is Force

Since the law organizes justice, the socialists ask why the law should not also organize labor, education, and religion.

Why should not law be used for these purposes? Because it could not organize labor, education, and religion without destroying justice. We must remember that law is force, and that, consequently, the proper functions of the law cannot lawfully extend beyond the proper functions of force. If the special privilege of government protection against competition— a monopoly—were granted only to one group in France, the iron workers, for instance, this act would so obviously be legal plunder that it could not last for long. It is for this reason that we see all the protected trades combined into a common cause. They even organize themselves in such a manner as to appear to represent all persons who labor. Instinctively, they feel that legal plunder is concealed by generalizing it.

When law and force keep a person within the bounds of justice, they impose nothing but a mere negation. They oblige him only to abstain from harming others. They violate neither his personality, his liberty, nor his property. They safeguard all of these. They are defensive; they defend equally the rights of all.

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Law Is a Negative Concept

The harmlessness of the mission performed by law and lawful defense is self-evident; the usefulness is obvious; and the legitimacy cannot be disputed.

As a friend of mine once remarked, this negative concept of law is so true that the statement, the purpose of the law is to cause justice to reign, is not a rigorously accurate statement. It ought to be stated that the purpose of the law is to prevent injustice from reigning. In fact, it is injustice, instead of justice, that has an existence of its own. Justice is achieved only when injustice is absent.

But when the law, by means of its necessary agent, force, imposes upon men a regulation of labor, a method or a subject of education, a religious faith or creed—then the law is no longer negative; it acts positively upon people. It substitutes the will of the legislator for their own wills; the initiative of the legislator for their own initiatives. When this happens, the people no longer need to discuss, to compare, to plan ahead; the law does all this for them. Intelligence becomes a useless prop for the people; they cease to be men; they lose their personality, their liberty, their property.

Try to imagine a regulation of labor imposed by force that is not a violation of liberty; a transfer of wealth imposed by force that is not a violation of property. If you cannot reconcile these contradictions, then you must conclude that the law cannot organize labor and industry without organizing injustice.

The Political Approach

When a politician views society from the seclusion of his office, he is struck by the spectacle of the inequality that he sees. He deplores the deprivations which are the lot of so many of our brothers, deprivations which appear to be even sadder when contrasted with luxury and wealth.

Perhaps the politician should ask himself whether this state of affairs has not been caused by old conquests and lootings, and by more recent legal plunder. Perhaps he should consider this proposition: Since all persons seek well-being and perfection, would not a condition of justice be sufficient to cause the greatest efforts toward progress, and the greatest possible equality that is compatible with individual responsibility? Would not this be in accord with the concept of individual responsibility which God has willed in order that mankind may have the choice between vice and virtue, and the resulting punishment and reward?

But the politician never gives this a thought. His mind turns to organizations, combinations, and arrangements—legal or apparently legal. He attempts to remedy the evil by increasing and perpetuating the very thing that caused the evil in the first place: legal plunder. We have seen that justice is a negative concept. Is there even one of these positive legal actions that does not contain the principle of plunder?

The Law and Charity

You say: “There are persons who have no money,” and you turn to the law. But the law is not a breast that fills itself with milk. Nor are the lacteal veins of the law supplied with milk from a source outside the society. Nothing can enter the public treasury for the benefit of one citizen or one class unless other citizens and other classes have been forced to send it in. If every person draws from the treasury the amount that he has put in it, it is true that the law then plunders nobody. But this procedure does nothing for the persons who have no money. It does not promote equality of income. The law can be an instrument of equalization only as it takes from some persons and gives to other persons. When the law does this, it is an instrument of plunder.

With this in mind, examine the protective tariffs, subsidies, guaranteed profits, guaranteed jobs, relief and welfare schemes, public education, progressive taxation, free credit, and public works. You will find that they are always based on legal plunder, organized injustice.

The Law and Education

You say: “There are persons who lack education” and you turn to the law. But the law is not, in itself, a torch of learning which shines its light abroad. The law extends over a society where some persons have knowledge and others do not; where some citizens need to learn, and others can teach. In this matter of education, the law has only two alternatives: It can permit this transaction of teaching-and-learning to operate freely and without the use of force, or it can force human wills in this matter by taking from some of them enough to pay the teachers who are appointed by government to instruct others, without charge. But in this second case, the law commits legal plunder by violating liberty and property.

The Law and Morals

You say: “Here are persons who are lacking in morality or religion,” and you turn to the law. But law is force. And need I point out what a violent and futile effort it is to use force in the matters of morality and religion?

It would seem that socialists, however self-complacent, could not avoid seeing this monstrous legal plunder that results from such systems and such efforts. But what do the socialists do? They cleverly disguise this legal plunder from others—and even from themselves—under the seductive names of fraternity, unity, organization, and association. Because we ask so little from the law—only justice—the socialists thereby assume that we reject fraternity, unity, organization, and association. The socialists brand us with the name individualist.

But we assure the socialists that we repudiate only forced organization, not natural organization. We repudiate the forms of association that are forced upon us, not free association. We repudiate forced fraternity, not true fraternity. We repudiate the artificial unity that does nothing more than deprive persons of individual responsibility. We do not repudiate the natural unity of mankind under Providence.

A Confusion of Terms

Socialism, like the ancient ideas from which it springs, confuses the distinction between government and society. As a result of this, every time we object to a thing being done by government, the socialists conclude that we object to its being done at all.

We disapprove of state education. Then the socialists say that we are opposed to any education. We object to a state religion. Then the socialists say that we want no religion at all. We object to a state-enforced equality. Then they say that we are against equality. And so on, and so on. It is as if the socialists were to accuse us of not wanting persons to eat because we do not want the state to raise grain.

The Influence of Socialist Writers

How did politicians ever come to believe this weird idea that the law could be made to produce what it does not contain —the wealth, science, and religion that, in a positive sense, constitute prosperity? Is it due to the influence of our modern writers on public affairs?

Present-day writers—especially those of the socialist school of thought—base their various theories upon one common hypothesis: They divide mankind into two parts. People in general —with the exception of the writer himself—form the first group. The writer, all alone, forms the second and most important group. Surely this is the weirdest and most conceited notion that ever entered a human brain!

In fact, these writers on public affairs begin by supposing that people have within themselves no means of discernment; no motivation to action. The writers assume that people are inert matter, passive particles, motionless atoms, at best a kind of vegetation indifferent to its own manner of existence. They assume that people are susceptible to being shaped—by the will and hand of another person—into an infinite variety of forms, more or less symmetrical, artistic, and perfected.

Moreover, not one of these writers on governmental affairs hesitates to imagine that he himself—under the title of organizer, discoverer, legislator, or founder—is this will and hand, this universal motivating force, this creative power whose sublime mission is to mold these scattered materials—persons— into a society.

These socialist writers look upon people in the same manner that the gardener views his trees. Just as the gardener capriciously shapes the trees into pyramids, parasols, cubes, vases, fans, and other forms, just so does the socialist writer whimsically shape human beings into groups, series, centers, sub-centers, honeycombs, labor-corps, and other variations. And just as the gardener needs axes, pruning hooks, saws, and shears to shape his trees, just so does the socialist writer need the force that he can find only in law to shape human beings. For this purpose, he devises tariff laws, tax laws, relief laws, and school laws.

The Socialists Want to Play God

Socialists look upon people as raw material to be formed into social combinations. This is so true that, if by chance, the socialists have any doubts about the success of these combinations, they will demand that a small portion of mankind be set aside to experiment upon. The popular idea of trying all systems is well known. And one socialist leader has been known seriously to demand that the Constituent Assembly give him a small district with all its inhabitants, to try his experiments upon.

In the same manner, an inventor makes a model before he constructs the full-sized machine; the chemist wastes some chemicals—the farmer wastes some seeds and land—to try out an idea.

But what a difference there is between the gardener and his trees, between the inventor and his machine, between the chemist and his elements, between the farmer and his seeds! And in all sincerity, the socialist thinks that there is the same difference between him and mankind!

It is no wonder that the writers of the nineteenth century look upon society as an artificial creation of the legislator’s genius. This idea—the fruit of classical education—has taken possession of all the intellectuals and famous writers of our country. To these intellectuals and writers, the relationship between persons and the legislator appears to be the same as the relationship between the clay and the potter.

Moreover, even where they have consented to recognize a principle of action in the heart of man—and a principle of discernment in man’s intellect—they have considered these gifts from God to be fatal gifts. They have thought that persons, under the impulse of these two gifts, would fatally tend to ruin themselves. They assume that if the legislators left persons free to follow their own inclinations, they would arrive at atheism instead of religion, ignorance instead of knowledge, poverty instead of production and exchange.

The Socialists Despise Mankind

According to these writers, it is indeed fortunate that Heaven has bestowed upon certain men—governors and legislators —the exact opposite inclinations, not only for their own sake but also for the sake of the rest of the world! While mankind tends toward evil, the legislators yearn for good; while mankind advances toward darkness, the legislators aspire for enlightenment; while mankind is drawn toward vice, the legislators are attracted toward virtue. Since they have decided that this is the true state of affairs, they then demand the use of force in order to substitute their own inclinations for those of the human race.

Open at random any book on philosophy, politics, or history, and you will probably see how deeply rooted in our country is this idea—the child of classical studies, the mother of socialism. In all of them, you will probably find this idea that mankind is merely inert matter, receiving life, organization, morality, and prosperity from the power of the state. And even worse, it will be stated that mankind tends toward degeneration, and is stopped from this downward course only by the mysterious hand of the legislator. Conventional classical thought everywhere says that behind passive society there is a concealed power called law or legislator (or called by some other terminology that designates some unnamed person or persons of undisputed influence and authority) which moves, controls, benefits, and improves mankind.

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A Defense of Compulsory Labor

Let us first consider a quotation from Bossuet [tutor to the Dauphin in the Court of Louis XIV]:

One of the things most strongly impressed (by whom?) upon the minds of the Egyptians was patriotism. . . . No one was permitted to be useless to the state. The law assigned to each one his work, which was handed down from father to son. No one was permitted to have two professions. Nor could a person change from one job to another. . . . But there was one task to which all were forced to conform: the study of the laws and of wisdom. Ignorance of religion and of the political regulations of the country was not excused under any circumstances. Moreover each occupation was assigned (by whom?) to a certain district. . . . Among the good laws, one of the best was that everyone was trained (by whom?) to obey them. As a result of this, Egypt was filled with wonderful inventions, and nothing was neglected that could make life easy and quiet.

Thus, according to Bossuet, persons derive nothing from themselves. Patriotism, prosperity, inventions, husbandry, science —all of these are given to the people by the operation of the laws, the rulers. All that the people have to do is to bow to leadership.

A Defense of Paternal Government

Bossuet carries this idea of the state as the source of all progress even so far as to defend the Egyptians against the charge that they rejected wrestling and music. He said:

How is that possible? These arts were invented by Trismegistus [who was alleged to have been Chancellor to the Egyptian god Osiris].

And again among the Persians, Bossuet claims that all comes from above:

One of the first responsibilities of the prince was to encourage agriculture. . . . Just as there were offices established for the regulation of armies, just so were there offices for the direction of farm work. . . . The Persian people were inspired with an overwhelming respect for royal authority.

And according to Bossuet, the Greek people, although exceedingly intelligent, had no sense of personal responsibility; like dogs and horses, they themselves could not have invented the most simple games:

The Greeks, naturally intelligent and courageous, had been early cultivated by the kings and settlers who had come from Egypt . From these Egyptian rulers, the Greek people had learned bodily exercises, foot races, and horse and chariot races. . . . But the best thing that the Egyptians had taught the Greeks was to become docile, and to permit themselves to be formed by the law for the public good.

The Idea of Passive Mankind

It cannot be disputed that these classical theories [advanced by these latter-day teachers, writers, legislators, economists, and philosophers] held that everything came to the people from a source outside themselves. As another example, take Fenelon [archbishop, author, and instructor to the Duke of Burgundy].

He was a witness to the power of Louis XIV. This, plus the fact that he was nurtured in the classical studies and the admiration of antiquity, naturally caused Fenelon to accept the idea that mankind should be passive; that the misfortunes and the prosperity—vices and virtues—of people are caused by the external influence exercised upon them by the law and the legislators. Thus, in his Utopia of Salentum, he puts men—with all their interests, faculties, desires, and possessions—under the absolute discretion of the legislator. Whatever the issue may be, persons do not decide it for themselves; the prince decides for them. The prince is depicted as the soul of this shapeless mass of people who form the nation. In the prince resides the thought, the foresight, all progress, and the principle of all organization. Thus all responsibility rests with him.

The whole of the tenth book of Fenelon’s Telemachus proves this. I refer the reader to it, and content myself with quoting at random from this celebrated work to which, in every other respect, I am the first to pay homage.

Socialists Ignore Reason and Facts

With the amazing credulity which is typical of the classicists, Fenelon ignores the authority of reason and facts when he attributes the general happiness of the Egyptians, not to their own wisdom but to the wisdom of their kings:

We could not turn our eyes to either shore without seeing rich towns and country estates most agreeably located; fields, never fallowed, covered with golden crops every year; meadows full of flocks; workers bending under the weight of the fruit which the earth lavished upon its cultivators; shepherds who made the echoes resound with the soft notes from their pipes and flutes. “Happy,” said Mentor , “is the people governed by a wise king. . . .”

Later, Mentor desired that I observe the contentment and abundance which covered all Egypt , where twenty-two thousand cities could be counted. He admired the good police regulations in the cities; the justice rendered in favor of the poor against the rich; the sound education of the children in obedience, labor, sobriety, and the love of the arts and letters; the exactness with which all religious ceremonies were performed; the unselfishness, the high regard for honor, the faithfulness to men, and the fear of the gods which every father taught his children. He never stopped admiring the prosperity of the country. “Happy,” said he, “is the people ruled by a wise king in such a manner.”

Socialists Want to Regiment People

Fenelon’s idyl on Crete is even more alluring. Mentor is made to say:

All that you see in this wonderful island results from the laws of Minos. The education which he ordained for the children makes their bodies strong and robust. From the very beginning, one accustoms the children to a life of frugality and labor, because one assumes that all pleasures of the senses weaken both body and mind. Thus one allows them no pleasure except that of becoming invincible by virtue, and of acquiring glory. . . . Here one punishes three vices that go unpunished among other people: ingratitude, hypocrisy, and greed. There is no need to punish persons for pomp and dissipation, for they are unknown in Crete . . . . No costly furniture, no magnificent clothing, no delicious feasts, no gilded palaces are permitted.

Thus does Mentor prepare his student to mold and to manipulate—doubtless with the best of intentions—the people of Ithaca . And to convince the student of the wisdom of these ideas, Mentor recites to him the example of Salentum.

It is from this sort of philosophy that we receive our first political ideas! We are taught to treat persons much as an instructor in agriculture teaches farmers to prepare and tend the soil.

A Famous Name and an Evil Idea

Now listen to the great Montesquieu on this same subject:

To maintain the spirit of commerce, it is necessary that all the laws must favor it. These laws, by proportionately dividing up the fortunes as they are made in commerce, should provide every poor citizen with sufficiently easy circumstances to enable him to work like the others. These same laws should put every rich citizen in such lowered circumstances as to force him to work in order to keep or to gain.

Thus the laws are to dispose of all fortunes!

Although real equality is the soul of the state in a democracy, yet this is so difficult to establish that an extreme precision in this matter would not always be desirable. It is sufficient that here be established a census to reduce or fix these differences in wealth within a certain limit. After this is done, it remains for specific laws to equalize inequality by imposing burdens upon the rich and granting relief to the poor.

Here again we find the idea of equalizing fortunes by law, by force.

In Greece , there were two kinds of republics, One, Sparta , was military; the other, Athens , was commercial. In the former, it was desired that the citizens be idle; in the latter, love of labor was encouraged.

Note the marvelous genius of these legislators: By debasing all established customs—by mixing the usual concepts of all virtues—they knew in advance that the world would admire their wisdom.

Lycurgus gave stability to his city of Sparta by combining petty thievery with the soul of justice; by combining the most complete bondage with the most extreme liberty; by combining the most atrocious beliefs with the greatest moderation. He appeared to deprive his city of all its resources, arts, commerce, money, and defenses. In Sparta , ambition went without the hope of material reward. Natural affection found no outlet because a man was neither son, husband, nor father. Even chastity was no longer considered becoming. By this road, Lycurgus led Sparta on to greatness and glory.

This boldness which was to be found in the institutions of Greece has been repeated in the midst of the degeneracy and corruption of our modern times. An occasional honest legislator has molded a people in whom integrity appears as natural as courage in the Spartans.

Mr. William Penn, for example, is a true Lycurgus. Even though Mr. Penn had peace as his objective —while Lycurgus had war as his objective—they resemble each other in that their moral prestige over free men allowed them to overcome prejudices, to subdue passions, and to lead their respective peoples into new paths.

The country of Paraguay furnishes us with another example [of a people who, for their own good, are molded by their legislators].

Now it is true that if one considers the sheer pleasure of commanding to be the greatest joy in life, he contemplates a crime against society; it will, however, always be a noble ideal to govern men in a manner that will make them happier.

Those who desire to establish similar institutions must do as follows: Establish common ownership of property as in the republic of Plato; revere the gods as Plato commanded; prevent foreigners from mingling with the people, in order to preserve the customs; let Translator’s note: What was then known as Paraguay was a much larger area than it is today. It was colonized by the Jesuits who settled the Indians into villages, and generally saved them from further brutalities by the avid conquerors. the state, instead of the citizens, establish commerce. The legislators should supply arts instead of luxuries; they should satisfy needs instead of desires.

A Frightful Idea

Those who are subject to vulgar infatuation may exclaim: “Montesquieu has said this! So it’s magnificent! It’s sublime!” As for me, I have the courage of my own opinion. I say: What! You have the nerve to call that fine? It is frightful! It is abominable! These random selections from the writings of Montesquieu show that he considers persons, liberties, property—mankind itself—to be nothing but materials for legislators to exercise their wisdom upon.

The Leader of the Democrats

Now let us examine Rousseau on this subject. This writer on public affairs is the supreme authority of the democrats. And although he bases the social structure upon the will of the people, he has, to a greater extent than anyone else, completely accepted the theory of the total inertness of mankind in the presence of the legislators:

If it is true that a great prince is rare, then is it not true that a great legislator is even more rare? The prince has only to follow the pattern that the legislator creates. The legislator is the mechanic who invents the machine; the prince is merely the workman who sets it in motion.

And what part do persons play in all this? They are merely the machine that is set in motion. In fact, are they not merely considered to be the raw material of which the machine is made?

Thus the same relationship exists between the legislator and the prince as exists between the agricultural expert and the farmer; and the relationship between the prince and his subjects is the same as that between the farmer and his land. How high above mankind, then, has this writer on public affairs been placed? Rousseau rules over legislators themselves, and teaches them their trade in these imperious terms:

Would you give stability to the state? Then bring the extremes as closely together as possible. Tolerate neither wealthy persons nor beggars.

If the soil is poor or barren, or the country too small for its inhabitants, then turn to industry and arts, and trade these products for the foods that you need. . . . On a fertile soil—if you are short of inhabitants— devote all your attention to agriculture, because this multiplies people; banish the arts, because they only serve to depopulate the nation. . . .

If you have extensive and accessible coast lines, then cover the sea with merchant ships; you will have a brilliant but short existence. If your seas wash only inaccessible cliffs, let the people be barbarous and eat fish; they will live more quietly—perhaps better—and, most certainly, they will live more happily.

In short, and in addition to the maxims that are common to all, every people has its own particular circumstances. And this fact in itself will cause legislation appropriate to the circumstances.

This is the reason why the Hebrews formerly— and, more recently, the Arabs—had religion as their principle objective. The objective of the Athenians was literature; of Carthage and Tyre , commerce; of Rhodes , naval affairs; of Sparta , war; and of Rome , virtue. The author of The Spirit of Laws has shown by what art the legislator should direct his institutions toward each of these objectives. . . . But suppose that the legislator mistakes his proper objective, and acts on a principle different from that indicated by the nature of things? Suppose that the selected principle sometimes creates slavery, and sometimes liberty; sometimes wealth, and sometimes population; sometimes peace, and sometimes conquest? This confusion of objective will slowly enfeeble the law and impair the constitution. The state will be subjected to ceaseless agitations until it is destroyed or changed, and invincible nature regains her empire.

But if nature is sufficiently invincible to regain its empire, why does not Rousseau admit that it did not need the legislator to gain it in the first place? Why does he not see that men, by obeying their own instincts, would turn to farming on fertile soil, and to commerce on an extensive and easily accessible coast, without the interference of a Lycurgus or a Solon or a Rousseau who might easily be mistaken.

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Socialists Want Forced Conformity

Be that as it may, Rousseau invests the creators, organizers, directors, legislators, and controllers of society with a terrible responsibility. He is, therefore, most exacting with them:

He who would dare to undertake the political creation of a people ought to believe that he can, in a manner of speaking, transform human nature; transform each individual—who, by himself, is a solitary and perfect whole—into a mere part of a greater whole from which the individual will henceforth receive his life and being. Thus the person who would undertake the political creation of a people should believe in his ability to alter man’s constitution; to strengthen it; to substitute for the physical and independent existence received from nature, an existence which is partial and moral. In short, the would-be Translator’s note: According to Rousseau, the existence of social man is partial in the sense that he is henceforth merely a part of society. Knowing himself as such—-and thinking and feeling from the point of view of the whole— he thereby becomes moral. creator of political man must remove man’s own forces and endow him with others that are naturally alien to him.

Poor human nature! What would become of a person’s dignity if it were entrusted to the followers of Rousseau?

Legislators Desire to Mold Mankind

Now let us examine Raynal on this subject of mankind being molded by the legislator:

The legislator must first consider the climate, the air, and the soil. The resources at his disposal determine his duties. He must first consider his locality. A population living on maritime shores must have laws designed for navigation. . . . If it is an inland settlement, the legislator must make his plans according to the nature and fertility of the soil. . . .

It is especially in the distribution of property that the genius of the legislator will be found. As a general rule, when a new colony is established in any country, sufficient land should be given to each man to support his family. . . .

On an uncultivated island that you are populating with children, you need do nothing but let the seeds of truth germinate along with the development of reason. . . . But when you resettle a nation with a past into a new country, the skill of the legislator rests in the policy of permitting the people to retain no injurious opinions and customs which can possibly be cured and corrected. If you desire to prevent these opinions and customs from becoming permanent, you will secure the second generation by a general system of public education for the children. A prince or a legislator should never establish a colony without first arranging to send wise men along to instruct the youth. . . .

In a new colony, ample opportunity is open to the careful legislator who desires to purify the customs and manners of the people. If he has virtue and genius, the land and the people at his disposal will inspire his soul with a plan for society. A writer can only vaguely trace the plan in advance because it is necessarily subject to the instability of all hypotheses; the problem has many forms, complications, and circumstances that are difficult to foresee and settle in detail.

Legislators Told How to Manage Men

Raynal’s instructions to the legislators on how to manage people may be compared to a professor of agriculture lecturing his students: “The climate is the first rule for the farmer. His resources determine his procedure. He must first consider his locality. If his soil is clay, he must do so and so. If his soil is sand, he must act in another manner. Every facility is open to the farmer who wishes to clear and improve his soil. If he is skillful 47 enough, the manure at his disposal will suggest to him a plan of operation. A professor can only vaguely trace this plan in advance because it is necessarily subject to the instability of all hypotheses; the problem has many forms, complications, and circumstances that are difficult to foresee and settle in detail.”

Oh, sublime writers! Please remember sometimes that this clay, this sand, and this manure which you so arbitrarily dispose of, are men! They are your equals! They are intelligent and free human beings like yourselves! As you have, they too have received from God the faculty to observe, to plan ahead, to think, and to judge for themselves!

A Temporary Dictatorship

Here is Mably on this subject of the law and the legislator. In the passages preceding the one here quoted, Mably has supposed the laws, due to a neglect of security, to be worn out. He continues to address the reader thusly:

Under these circumstances, it is obvious that the springs of government are slack. Give them a new tension, and the evil will be cured. . . . Think less of punishing faults, and more of rewarding that which you need. In this manner you will restore to your republic the vigor of youth. Because free people have been ignorant of this procedure, they have lost their liberty! But if the evil has made such headway that ordinary governmental procedures are unable to cure it, then resort to an extraordinary tribunal with considerable powers for a short time. The imagination of the citizens needs to be struck a hard blow.

In this manner, Mably continues through twenty volumes. Under the influence of teaching like this—which stems from classical education—there came a time when everyone wished to place himself above mankind in order to arrange, organize, and regulate it in his own way.

Socialists Want Equality of Wealth

Next let us examine Condillac on this subject of the legislators and mankind:

My Lord, assume the character of Lycurgus or of Solon. And before you finish reading this essay, amuse yourself by giving laws to some savages in America or Africa . Confine these nomads to fixed dwellings; teach them to tend flocks. . . . Attempt to develop the social consciousness that nature has planted in them. . . . Force them to begin to practice the duties of humanity. . . . Use punishment to cause sensual pleasures to become distasteful to them. Then you will see that every point of your legislation will cause these savages to lose a vice and gain a virtue.

All people have had laws. But few people have been happy. Why is this so? Because the legislators themselves have almost always been ignorant of the purpose of society, which is the uniting of families by a common interest.

Impartiality in law consists of two things: the establishing of equality in wealth and equality in dignity among the citizens. . . . As the laws establish greater equality, they become proportionately more precarious to every citizen. . . . When all men are equal in wealth and dignity—and when the laws leave no hope of disturbing this equality—how can men then be agitated by greed, ambition, dissipation, idleness, sloth, envy, hatred, or jealously?

What you have learned about the republic of Sparta should enlighten you on this question. No other state has ever had laws more in accord with the order of nature; of equality.

The Error of the Socialist Writers

Actually, it is not strange that during the seventeenth and eighteenth centuries the human race was regarded as inert matter, ready to receive everything—form, face, energy, movement, life—from a great prince or great legislator or a great genius. These centuries were nourished on the study of antiquity. And antiquity presents everywhere—in Egypt, Persia, Greece, Rome—the spectacle of a few men molding mankind according to their whims, thanks to the prestige of force and fraud. But this does not prove that this situation is desirable. It proves only that since men and society are capable of improvement, it is naturally to be expected that error, ignorance, despotism, slavery, and superstition should be greatest towards the origins of history. The writers quoted above were not in error when they found ancient institutions to be such, but they were in error when they offered them for the admiration and imitation of future generations. Uncritical and childish conformists, they took for granted the grandeur, dignity, morality, and happiness of the artificial societies of the ancient world. They did not understand that knowledge appears and grows with the passage of time; and that in proportion to this growth of knowledge, might takes the side of right, and society regains possession of itself.

What Is Liberty ?

Actually, what is the political struggle that we witness? It is the instinctive struggle of all people toward liberty. And what is this liberty, whose very name makes the heart beat faster and shakes the world? Is it not the union of all liberties—liberty of conscience, of education, of association, of the press, of travel, of labor, of trade? In short, is not liberty the freedom of every person to make full use of his faculties, so long as he does not harm other persons while doing so? Is not liberty the destruction of all despotism—including, of course, legal despotism? Finally, is not liberty the restricting of the law only to its rational sphere of organizing the right of the individual to lawful self-defense; of punishing injustice?

It must be admitted that the tendency of the human race toward liberty is largely thwarted, especially in France . This is greatly due to a fatal desire—learned from the teachings of antiquity—that our writers on public affairs have in common: They desire to set themselves above mankind in order to arrange, organize, and regulate it according to their fancy.

Philanthropic Tyranny

While society is struggling toward liberty, these famous men who put themselves at its head are filled with the spirit of the seventeenth and eighteenth centuries. They think only of subjecting mankind to the philanthropic tyranny of their own social inventions. Like Rousseau, they desire to force mankind docilely to bear this yoke of the public welfare that they have dreamed up in their own imaginations.

This was especially true in 1789. No sooner was the old regime destroyed than society was subjected to still other artificial arrangements, always starting from the same point: the omnipotence of the law.

Listen to the ideas of a few of the writers and politicians during that period:

SAINT-JUST: The legislator commands the future. It is for him to will the good of mankind. It is for him to make men what he wills them to be.

ROBESPIERRE: The function of government is to direct the physical and moral powers of the nation toward the end for which the commonwealth has come into being.

BILLAUD-VARENNES: A people who are to be returned to liberty must be formed anew. A strong force and vigorous action are necessary to destroy old prejudices, to change old customs, to correct depraved affections, to restrict superfluous wants, and to destroy ingrained vices. . . . Citizens, the inflexible austerity of Lycurgus created the firm foundation of the Spartan republic. The weak and trusting character of Solon plunged Athens into slavery. This parallel embraces the whole science of government.

LE PELLETIER: Considering the extent of human degradation, I am convinced that it is necessary to effect a total regeneration and, if I may so express myself, of creating a new people.

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The Socialists Want Dictatorship

Again, it is claimed that persons are nothing but raw material. It is not for them to will their own improvement; they are incapable of it. According to Saint-Just, only the legislator is capable of doing this. Persons are merely to be what the legislator wills them to be. According to Robespierre, who copies Rousseau literally, the legislator begins by decreeing the end for which the commonwealth has come into being. Once this is determined, the government has only to direct the physical and moral forces of the nation toward that end. Meanwhile, the inhabitants of the nation are to remain completely passive. And according to the teachings of Billaud-Varennes, the people should have no prejudices, no affections, and no desires except those authorized by the legislator. He even goes so far as to say that the inflexible austerity of one man is the foundation of a republic.

In cases where the alleged evil is so great that ordinary governmental procedures cannot cure it, Mably recommends a dictatorship to promote virtue: “Resort,” he says, “to an extraordinary tribunal with considerable powers for a short time. The imagination of the citizens needs to be struck a hard blow.” This doctrine has not been forgotten. Listen to Robespierre:

The principle of the republican government is virtue, and the means required to establish virtue is terror. In our country we desire to substitute morality for selfishness, honesty for honor, principles for customs, duties for manners, the empire of reason for the tyranny of fashion, contempt of vice for contempt of poverty, pride for insolence, greatness of soul for vanity, love of glory for love of money, good people for good companions, merit for intrigue, genius for wit, truth for glitter, the charm of happiness for the boredom of pleasure, the greatness of man for the littleness of the great, a generous, strong, happy people for a good-natured, frivolous, degraded people; in short, we desire to substitute all the virtues and miracles of a republic for all the vices and absurdities of a monarchy.

Dictatorial Arrogance

At what a tremendous height above the rest of mankind does Robespierre here place himself! And note the arrogance with which he speaks. He is not content to pray for a great reawakening of the human spirit. Nor does he expect such a result from a well-ordered government. No, he himself will remake mankind, and by means of terror.

This mass of rotten and contradictory statements is extracted from a discourse by Robespierre in which he aims to explain the principles of morality which ought to guide a revolutionary government. Note that Robespierre’s request for dictatorship is not made merely for the purpose of repelling a foreign invasion or putting down the opposing groups. Rather he wants a dictatorship in order that he may use terror to force upon the country his own principles of morality. He says that this act is only to be a temporary measure preceding a new constitution. But in reality, he desires nothing short of using terror to extinguish from France selfishness, honor, customs, manners, fashion, vanity, love of money, good companionship, intrigue, wit, sensuousness, and poverty. Not until he, Robespierre, shall have accomplished these miracles, as he so rightly calls them, will he permit the law to reign again.

The Indirect Approach to Despotism

Usually, however, these gentlemen—the reformers, the legislators, and the writers on public affairs do not desire to impose direct despotism upon mankind. Oh no, they are too moderate and philanthropic for such direct action. Instead, they turn to the law for this despotism, this absolutism, this omnipotence. They desire only to make the laws.

To show the prevalence of this queer idea in France , I would need to copy not only the entire works of Mably, Raynal, Rousseau, and Fenelon—plus long extracts from Bossuet and Montesquieu—but also the entire proceedings of the Convention. I shall do no such thing; I merely refer the reader to them.

Napoleon Wanted Passive Mankind

It is, of course, not at all surprising that this same idea should have greatly appealed to Napoleon. He embraced it At this point in the original French text, Mr. Bastiat pauses and speaks thusly to all do- gooders and would-be rulers of mankind: “Ah, you miserable creatures! You who think that you are so great! You who judge humanity to be so small! You who wish to reform everything! Why don’t you reform yourselves? That task would be sufficient enough.” ardently and used it with vigor. Like a chemist, Napoleon considered all Europe to be material for his experiments. But, in due course, this material reacted against him.

At St. Helena , Napoleon—greatly disillusioned—seemed to recognize some initiative in mankind. Recognizing this, he became less hostile to liberty. Nevertheless, this did not prevent him from leaving this lesson to his son in his will: “To govern is to increase and spread morality, education, and happiness.”

After all this, it is hardly necessary to quote the same opinions from Morelly, Babeuf, Owen, Saint-Simon, and Fourier. Here are, however, a few extracts from Louis Blanc’s book on the organization of labor: “In our plan, society receives its momentum from power.”

Now consider this: The impulse behind this momentum is to be supplied by the plan of Louis Blanc; his plan is to be forced upon society; the Society referred to is the human race. Thus the human race is to receive its momentum from Louis Blanc.

Now it will be said that the people are free to accept or to reject this plan. Admittedly, people are free to accept or to reject advice from whomever they wish. But this is not the way in which Mr. Louis Blanc understands the matter. He expects that his plan will be legalized, and thus forcibly imposed upon the people by the power of the law:

In our plan, the state has only to pass labor laws (nothing else?) by means of which industrial progress can and must proceed in complete liberty. The state merely places society on an incline (that is all?). Then society will slide down this incline by the mere force of things, and by the natural workings of the established mechanism.

But what is this incline that is indicated by Mr. Louis Blanc? Does it not lead to an abyss? (No, it leads to happiness.) If this is true, then why does not society go there of its own choice? (Because society does not know what it wants; it must be propelled.) What is to propel it? (Power.) And who is to supply the impulse for this power? (Why, the inventor of the machine— in this instance, Mr. Louis Blanc.)

The Vicious Circle of Socialism

We shall never escape from this circle: the idea of passive mankind, and the power of the law being used by a great man to propel the people.

Once on this incline, will society enjoy some liberty? (Certainly.) And what is liberty, Mr. Louis Blanc?

Once and for all, liberty is not only a mere granted right; it is also the power granted to a person to use and to develop his faculties under a reign of justice and under the protection of the law.

And this is no pointless distinction; its meaning is deep and its consequences are difficult to estimate. For once it is agreed that a person, to be truly free, must have the power to use and develop his faculties, then it follows that every person has a claim on society for such education as will permit him to develop himself. It also follows that every person has a claim on society for tools of production, without which human activity cannot be fully effective. Now by what action can society give to every person the necessary education and the necessary tools of production, if not by the action of the state?

Thus, again, liberty is power. Of what does this power consist? (Of being educated and of being given the tools of production.) Who is to give the education and the tools of production? (Society, which owes them to everyone.) By what action is society to give tools of production to those who do not own them? (Why, by the action of the state.) And from whom will the state take them?

Let the reader answer that question. Let him also notice the direction in which this is taking us.

The Doctrine of the Democrats

The strange phenomenon of our times—one which will probably astound our descendants—is the doctrine based on this triple hypothesis: the total inertness of mankind, the omnipotence of the law, and the infallibility of the legislator. These three ideas form the sacred symbol of those who proclaim themselves totally democratic.

The advocates of this doctrine also profess to be social. So far as they are democratic, they place unlimited faith in mankind. But so far as they are social, they regard mankind as little better than mud. Let us examine this contrast in greater detail.

What is the attitude of the democrat when political rights are under discussion? How does he regard the people when a legislator is to be chosen? Ah, then it is claimed that the people have an instinctive wisdom; they are gifted with the finest perception; their will is always right; the general will cannot err; voting cannot be too universal.

When it is time to vote, apparently the voter is not to be asked for any guarantee of his wisdom. His will and capacity to choose wisely are taken for granted. Can the people be mistaken? Are we not living in an age of enlightenment? What! are the people always to be kept on leashes? Have they not won their rights by great effort and sacrifice? Have they not given ample proof of their intelligence and wisdom? Are they not adults? Are they not capable of judging for themselves? Do they not know what is best for themselves? Is there a class or a man who would be so bold as to set himself above the people, and judge and act for them? No, no, the people are and should be free. They desire to manage their own affairs, and they shall do so.

But when the legislator is finally elected—ah! then indeed does the tone of his speech undergo a radical change. The people are returned to passiveness, inertness, and unconsciousness; the legislator enters into omnipotence. Now it is for him to initiate, to direct, to propel, and to organize. Mankind has only to submit; the hour of despotism has struck. We now observe this fatal idea: The people who, during the election, were so wise, so moral, and so perfect, now have no tendencies whatever; or if they have any, they are tendencies that lead downward into degradation.

The Socialist Concept of Liberty

But ought not the people be given a little liberty?

But Mr. Considerant has assured us that liberty leads inevitably to monopoly!

We understand that liberty means competition. But according to Mr. Louis Blanc, competition is a system that ruins the businessmen and exterminates the people. It is for this reason that free people are ruined and exterminated in proportion to their degree of freedom. (Possibly Mr. Louis Blanc should observe the results of competition in, for example, Switzerland , Holland , England , and the United States .)

Mr. Louis Blanc also tells us that competition leads to monopoly. And by the same reasoning, he thus informs us that low prices lead to high prices; that competition drives production to destructive activity; that competition drains away the sources of purchasing power; that competition forces an increase in production while, at the same time, it forces a decrease in consumption. From this, it follows that free people produce for the sake of not consuming; that liberty means oppression and madness among the people; and that Mr. Louis Blanc absolutely must attend to it.

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Socialists Fear All Liberties

Well, what liberty should the legislators permit people to have? Liberty of conscience? (But if this were permitted, we would see the people taking this opportunity to become atheists.)

Then liberty of education? (But parents would pay professors to teach their children immorality and falsehoods; besides, according to Mr. Thiers, if education were left to national liberty, it would cease to be national, and we would be teaching our children the ideas of the Turks or Hindus; whereas, thanks to this legal despotism over education, our children now have the good fortune to be taught the noble ideas of the Romans.)

Then liberty of labor? (But that would mean competition which, in turn, leaves production unconsumed, ruins businessmen, and exterminates the people.)

Perhaps liberty of trade? (But everyone knows—and the advocates of protective tariffs have proved over and over again— that freedom of trade ruins every person who engages in it, and that it is necessary to suppress freedom of trade in order to prosper.)

Possibly then, liberty of association? (But, according to socialist doctrine, true liberty and voluntary association are in contradiction to each other, and the purpose of the socialists is to suppress liberty of association precisely in order to force people to associate together in true liberty.)

Clearly then, the conscience of the social democrats cannot permit persons to have any liberty because they believe that the nature of mankind tends always toward every kind of degradation and disaster. Thus, of course, the legislators must make plans for the people in order to save them from themselves.

This line of reasoning brings us to a challenging question: If people are as incapable, as immoral, and as ignorant as the politicians indicate, then why is the right of these same people to vote defended with such passionate insistence?

The Superman Idea

The claims of these organizers of humanity raise another question which I have often asked them and which, so far as I know, they have never answered: If the natural tendencies of mankind are so bad that it is not safe to permit people to be free, how is it that the tendencies of these organizers are always good? Do not the legislators and their appointed agents also belong to the human race? Or do they believe that they themselves are made of a finer clay than the rest of mankind? The organizers maintain that society, when left undirected, rushes headlong to its inevitable destruction because the instincts of the people are so perverse. The legislators claim to stop this suicidal course and to give it a saner direction. Apparently, then, the legislators and the organizers have received from Heaven an intelligence and virtue that place them beyond and above mankind; if so, let them show their titles to this superiority.

They would be the shepherds over us, their sheep. Certainly such an arrangement presupposes that they are naturally superior to the rest of us. And certainly we are fully justified in demanding from the legislators and organizers proof of this natural superiority.

The Socialists Reject Free Choice

Please understand that I do not dispute their right to invent social combinations, to advertise them, to advocate them, and to try them upon themselves, at their own expense and risk. But I do dispute their right to impose these plans upon us by law—by force—and to compel us to pay for them with our taxes.

I do not insist that the supporters of these various social schools of thought—the Proudhonists, the Cabetists, the Fourierists, the Universitarists, and the Protectionists—renounce their various ideas. I insist only that they renounce this one idea that they have in common: They need only to give up the idea of forcing us to acquiesce to their groups and series, their socialized projects, their free-credit banks, their Graeco-Roman concept of morality, and their commercial regulations. I ask only that we be permitted to decide upon these plans for ourselves; that we not be forced to accept them, directly or indirectly, if we find them to be contrary to our best interests or repugnant to our consciences.

But these organizers desire access to the tax funds and to the power of the law in order to carry out their plans. In addition to being oppressive and unjust, this desire also implies the fatal supposition that the organizer is infallible and mankind is incompetent. But, again, if persons are incompetent to judge for themselves, then why all this talk about universal suffrage?

The Cause of French Revolutions

This contradiction in ideas is, unfortunately but logically, reflected in events in France . For example, Frenchmen have led all other Europeans in obtaining their rights—or, more accurately, their political demands. Yet this fact has in no respect prevented us from becoming the most governed, the most regulated, the most imposed upon, the most harnessed, and the most exploited people in Europe . France also leads all other nations as the one where revolutions are constantly to be anticipated. And under the circumstances, it is quite natural that this should be the case.

And this will remain the case so long as our politicians continue to accept this idea that has been so well expressed by Mr. Louis Blanc: “Society receives its momentum from power.” This will remain the case so long as human beings with feelings continue to remain passive; so long as they consider themselves incapable of bettering their prosperity and happiness by their own intelligence and heir own energy; so long as they expect everything from the law; in short, so long as they imagine that their relationship to the state is the same as that of the sheep to the shepherd.

The Enormous Power of Government

As long as these ideas prevail, it is clear that the responsibility of government is enormous. Good fortune and bad fortune, wealth and destitution, equality and inequality, virtue and vice—all then depend upon political administration. It is burdened with everything, it undertakes everything, it does everything; therefore it is responsible for everything.

If we are fortunate, then government has a claim to our gratitude; but if we are unfortunate, then government must bear the blame. For are not our persons and property now at the disposal of government? Is not the law omnipotent?

In creating a monopoly of education, the government must answer to the hopes of the fathers of families who have thus been deprived of their liberty; and if these hopes are shattered, whose fault is it?

In regulating industry, the government has contracted to make it prosper; otherwise it is absurd to deprive industry of its liberty. And if industry now suffers, whose fault is it?

In meddling with the balance of trade by playing with tariffs, the government thereby contracts to make trade prosper; and if this results in destruction instead of prosperity, whose fault is it?

In giving the maritime industries protection in exchange for their liberty, the government undertakes to make them profitable; and if they become a burden to the taxpayers, whose fault is it?

Thus there is not a grievance in the nation for which the government does not voluntarily make itself responsible. Is it surprising, then, that every failure increases the threat of another revolution in France ?

And what remedy is proposed for this? To extend indefinitely the domain of the law; that is, the responsibility of government.

But if the government undertakes to control and to raise wages, and cannot do it; if the government undertakes to care for all who may be in want, and cannot do it; if the government undertakes to support all unemployed workers, and cannot do it; if the government undertakes to lend interest-free money to all borrowers, and cannot do it; if, in these words that we regret to say escaped from the pen of Mr. de Lamartine, “The state considers that its purpose is to enlighten, to develop, to enlarge, to strengthen, to spiritualize, and to sanctify the soul of the people” —and if the government cannot do all of these things, what then? Is it not certain that after every government failure— which, alas! is more than probable—there will be an equally inevitable revolution?

Politics and Economics

[Now let us return to a subject that was briefly discussed in the opening pages of this thesis: the relationship of economics and of politics—political economy.] Translator’s note: Mr. Bastiat has devoted three other books and several articles to the development of the ideas contained in the three sentences of the following paragraph.

A science of economics must be developed before a science of politics can be logically formulated. Essentially, economics is the science of determining whether the interests of human beings are harmonious or antagonistic. This must be known before a science of politics can be formulated to determine the proper functions of government.

Immediately following the development of a science of economics, and at the very beginning of the formulation of a science of politics, this all-important question must be answered: What is law? What ought it to be? What is its scope; its limits? Logically, at what point do the just powers of the legislator stop?

I do not hesitate to answer: Law is the common force organized to act as an obstacle to injustice. In short, law is justice.

Proper Legislative Functions

It is not true that the legislator has absolute power over our persons and property. The existence of persons and property preceded the existence of the legislator, and his function is only to guarantee their safety.

It is not true that the function of law is to regulate our consciences, our ideas, our wills, our education, our opinions, our work, our trade, our talents, or our pleasures. The function of law is to protect the free exercise of these rights, and to prevent any person from interfering with the free exercise of these same rights by any other person.

Since law necessarily requires the support of force, its lawful domain is only in the areas where the use of force is necessary. This is justice.

Every individual has the right to use force for lawful self-defense. It is for this reason that the collective force—which is only the organized combination of the individual forces—may lawfully be used for the same purpose; and it cannot be used legitimately for any other purpose.

Law is solely the organization of the individual right of self-defense which existed before law was formalized. Law is justice.

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Law and Charity Are Not the Same

The mission of the law is not to oppress persons and plunder them of their property, even though the law may be acting in a philanthropic spirit. Its mission is to protect persons and property.

Furthermore, it must not be said that the law may be philanthropic if, in the process, it refrains from oppressing persons and plundering them of their property; this would be a contradiction. The law cannot avoid having an effect upon persons and property; and if the law acts in any manner except to protect them, its actions then necessarily violate the liberty of persons and their right to own property.

The law is justice—simple and clear, precise and bounded. Every eye can see it, and every mind can grasp it; for justice is measurable, immutable, and unchangeable. Justice is neither more than this nor less than this.

If you exceed this proper limit—if you attempt to make the law religious, fraternal, equalizing, philanthropic, industrial, literary, or artistic—you will then be lost in an uncharted territory, in vagueness and uncertainty, in a forced utopia or, even worse, in a multitude of utopias, each striving to seize the law and impose it upon you. This is true because fraternity and philanthropy, unlike justice, do not have precise limits. Once started, where will you stop? And where will the law stop itself?

The High Road to Communism

Mr. de Saint-Cricq would extend his philanthropy only to some of the industrial groups; he would demand that the law control the consumers to benefit the producers.

Mr. Considerant would sponsor the cause of the labor groups; he would use the law to secure for them a guaranteed minimum of clothing, housing, food, and all other necessities of life.

Mr. Louis Blanc would say—and with reason—that these minimum guarantees are merely the beginning of complete fraternity; he would say that the law should give tools of production and free education to all working people.

Another person would observe that this arrangement would still leave room for inequality; he would claim that the law should give to everyone—even in the most inaccessible hamlet —luxury, literature, and art.

All of these proposals are the high road to communism; legislation will then be—in fact, it already is—the battlefield for the fantasies and greed of everyone.

The Basis for Stable Government

Law is justice. In this proposition a simple and enduring government can be conceived. And I defy anyone to say how even the thought of revolution, of insurrection, of the slightest uprising could arise against a government whose organized force was confined only to suppressing injustice.

Under such a regime, there would be the most prosperity —and it would be the most equally distributed. As for the sufferings that are inseparable from humanity, none would even think of blaming the government for them. This is true because, if the force of government were limited to suppressing injustice, then government would be as innocent of these sufferings as it is now innocent of changes in the temperature.

As proof of this statement, consider this question: Have the people ever been known to rise against the Court of Appeals, or mob a Justice of the Peace, in order to get higher wages, free credit, tools of production, favorable tariffs, or government-created jobs? Everyone knows perfectly well that such matters are not within the jurisdiction of the Court of Appeals or a Justice of the Peace. And if government were limited to its proper functions, everyone would soon learn that these matters are not within the jurisdiction of the law itself.

But make the laws upon the principle of fraternity—proclaim that all good, and all bad, stem from the law; that the law is responsible for all individual misfortunes and all social inequalities—then the door is open to an endless succession of complaints, irritations, troubles, and revolutions.

Justice Means Equal Rights

Law is justice. And it would indeed be strange if law could properly be anything else! Is not justice right? Are not rights equal? By what right does the law force me to conform to the social plans of Mr. Mimerel, Mr. de Melun, Mr. Thiers, or Mr. Louis Blanc? If the law has a moral right to do this, why does it not, then, force these gentlemen to submit to my plans? Is it logical to suppose that nature has not given me sufficient imagination to dream up a utopia also? Should the law choose one fantasy among many, and put the organized force of government at its service only?

Law is justice. And let it not be said—as it continually is said—that under this concept, the law would be atheistic, individualistic, and heartless; that it would make mankind in its own image. This is an absurd conclusion, worthy only of those worshippers of government who believe that the law is mankind.

Nonsense! Do those worshippers of government believe that free persons will cease to act? Does it follow that if we receive no energy from the law, we shall receive no energy at all? Does it follow that if the law is restricted to the function of protecting the free use of our faculties, we will be unable to use our faculties? Suppose that the law does not force us to follow 72 certain forms of religion, or systems of association, or methods of education, or regulations of labor, or regulations of trade, or plans for charity; does it then follow that we shall eagerly plunge into atheism, hermitary, ignorance, misery, and greed? If we are free, does it follow that we shall no longer recognize the power and goodness of God? Does it follow that we shall then cease to associate with each other, to help each other, to love and succor our unfortunate brothers, to study the secrets of nature, and to strive to improve ourselves to the best of our abilities?

The Path to Dignity and Progress

Law is Justice. And it is under the law of justice—under the reign of right; under the influence of liberty, safety, stability, and responsibility—that every person will attain his real worth and the true dignity of his being. It is only under this law of justice that mankind will achieve slowly, no doubt, but certainly—God’s design for the orderly and peaceful progress of humanity.

It seems to me that this is theoretically right, for whatever the question under discussion—whether religious, philosophical, political, or economic; whether it concerns prosperity, morality, equality, right, justice, progress, responsibility, cooperation, property, labor, trade, capital, wages, taxes, population, finance, or government—at whatever point on the scientific horizon I begin my researches, I invariably reach this one conclusion: The solution to the problems of human relationships is to be found in liberty.

Proof of an Idea

And does not experience prove this? Look at the entire world. Which countries contain the most peaceful, the most moral, and the happiest people? Those people are found in the countries where the law least interferes with private affairs; where government is least felt; where the individual has the greatest scope, and free opinion the greatest influence; where administrative powers are fewest and simplest; where taxes are lightest and most nearly equal, and popular discontent the least excited and the least justifiable; where individuals and groups most actively assume their responsibilities, and, consequently, where the morals of admittedly imperfect human beings are constantly improving; where trade, assemblies, and associations are the least restricted; where labor, capital, and populations suffer the fewest forced displacements; where mankind most nearly follows its own natural inclinations; where the inventions of men are most nearly in harmony with the laws of God; in short, the happiest, most moral, and most peaceful people are those who most nearly follow this principle: Although mankind is not perfect, still, all hope rests upon the free and voluntary actions of persons within the limits of right; law or force is to be used for nothing except the administration of universal justice.

The Desire to Rule over Others

This must be said: There are too many “great” men in the world—legislators, organizers, do-gooders, leaders of the people, fathers of nations, and so on, and so on. Too many persons place themselves above mankind; they make a career of organizing it, patronizing it, and ruling it.

Now someone will say: “You yourself are doing this very thing.”

True. But it must be admitted that I act in an entirely different sense; if I have joined the ranks of the reformers, it is solely for the purpose of persuading them to leave people alone. I do not look upon people as Vancauson looked upon his automaton. Rather, just as the physiologist accepts the human body as it is, so do I accept people as they are. I desire only to study and admire.

My attitude toward all other persons is well illustrated by this story from a celebrated traveler: He arrived one day in the midst of a tribe of savages, where a child had just been born. A crowd of soothsayers, magicians, and quacks—armed with rings, hooks, and cords—surrounded it. One said: “This child will never smell the perfume of a peace-pipe unless I stretch his nostrils.” Another said: “He will never be able to hear unless I draw his ear-lobes down to his shoulders.” A third said: “He will never see the sunshine unless I slant his eyes.” Another said: “He will never stand upright unless I bend his legs.” A fifth said: “He will never learn to think unless I flatten his skull.”

“Stop,” cried the traveler. “What God does is well done. Do not claim to know more than He. God has given organs to this frail creature; let them develop and grow strong by exercise, use, experience, and liberty.”

Let Us Now Try Liberty

God has given to men all that is necessary for them to accomplish their destinies. He has provided a social form as well as a human form. And these social organs of persons are so constituted that they will develop themselves harmoniously in the clean air of liberty. Away, then, with quacks and organizers! Away with their rings, chains, hooks, and pincers! Away with their artificial systems! Away with the whims of governmental administrators, their socialized projects, their centralization, their tariffs, their government schools, their state religions, their free credit, their bank monopolies, their regulations, their restrictions, their equalization by taxation, and their pious moralizations!

And now that the legislators and do-gooders have so futilely inflicted so many systems upon society, may they finally end where they should have begun: May they reject all systems, and try liberty; for liberty is an acknowledgment of faith in God and His works. .

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Afterword

Sheldon Richman

The state is that great fiction by which everyone tries to live at the expense of everyone else.

—Frederic Bastiat

Frederic Bastiat holds a special place in the hearts and minds of the friends of liberty. There is no mystery here to be solved. The key to Bastiat’s appeal is the integrity and elegance of his message. His writing exhibits a purity and a reasoned passion that are rare in the modern world. He always wrote to be understood, to persuade, not to impress or to obfuscate.

Through the device of the fable, Bastiat deftly shattered the misconceptions about economics for his French contemporaries. When today, in modern America , we continue to be told, by intellectuals as well as by politicians, that the free entry of foreign-made products impoverishes us or that destructive earthquakes and hurricanes create prosperity by creating demand for rebuilding, we are seeing the results of a culture ignorant of Frederic Bastiat.

But to think of Bastiat as just an economist is to insufficiently appreciate him. Bastiat was a legal philosopher of the first rank. What made him so is The Law. Writing as France was being seduced by the false promises of socialism, Bastiat was concerned with law in the classical sense; he directs his reason to the discovery of the principles of social organization best suited to human beings.

He begins by recognizing that individuals must act to maintain their lives. They do so by applying their faculties to the natural world and transforming its components into useful products. “Life, faculties, production—in other words, individuality, liberty, property—this is man,” Bastiat writes. And since they are at the very core of human nature, they “precede all human legislation, and are superior to it.” Too few people understand that point. Legal positivism, the notion that there is no right and wrong prior to the enactment of legislation, sadly afflicts even some advocates of individual liberty (the utilitarian descendants of Bentham, for example). But, Bastiat reminds us, “Life, liberty, and property do not exist because men have made laws. On the contrary, it was the fact that life, liberty, and property existed beforehand that caused men to make laws in the first place.”

For Bastiat, law is a negative. He agreed with a friend who pointed out that it is imprecise to say that law should create justice. In truth, the law should prevent injustice. “Justice is achieved only when injustice is absent.” That may strike some readers as dubious. But on reflection, one can see that a free and just society is what results when forcible intervention against individuals does not occur; when they are left alone.

The purpose of law is the defense of life, liberty, and property. It is, says Bastiat, “the collective organization of the individual right of lawful defense.” Each individual has the right to defend his life, liberty, and property. A group of individuals, therefore, may be said to have “collective right” to pool their resources to defend themselves. “Thus the principle of collective right—its reason for existing, its lawfulness—is based on individual right. And this common force that protects this collective right cannot logically have any other purpose or any other mission than that for which it acts as a substitute.” If the very purpose of law is the protection of individual rights, then law may not be used—without contradiction—to accomplish what individuals have no right to do. “Such a perversion of force would be . . . contrary to our premise.” The result would be unlawful law.

A society based on a proper conception of law would be orderly and prosperous. But unfortunately, some will choose plunder over production if the former requires less effort than the latter. A grave danger arises when the class of people who make the law (legislation) turns to plunder. The result, Bastiat writes, is “lawful plunder.” At first, only the small group of lawmakers practices legal plunder. But that may set in motion a process in which the plundered classes, rather than seeking to abolish the perversion of law, instead strive to get in on it. “It is as if it were necessary, before a reign of justice appears, for everyone to suffer a cruel retribution—some for their evilness, and some for their lack of understanding.”

The result of generalized legal plunder is moral chaos precisely because law and morality have been set at odds. “When law and morality contradict each other, the citizen has the cruel alternative of either losing his moral sense or losing his respect for the law.” Bastiat points out that for many people, what is legal is legitimate. So they are plunged into confusion. And conflict.

As long as it is admitted that the law may be diverted from its true purpose—that it may violate property instead of protecting it—then everyone will want to participate in making the law, either to protect himself against plunder or to use it for plunder. Political questions will always be prejudicial, dominant, and all-absorbing. There will be fighting at the door of the Legislative Palace , and the struggle within will be no less furious.

Sound familiar?

Bastiat finds another motive—besides the desire for booty— behind legal plunder: “false philanthropy.” Again, he sees a contradiction. If philanthropy is not voluntary, it destroys liberty and justice. The law can give nothing that has not first been taken from its owner. He applies that analysis to all forms of government intervention, from tariffs to so-called public education.

Bastiat’s words are as fresh as if they were written today. He explains that one can identify legal plunder by looking for laws that authorize that one person’s property be given to someone else. Such laws should be abolished “without delay.” But, he warns, “the person who profits from such law will complain bitterly, defending his acquired rights,” his entitlements. Bastiat’s advice is direct: “Do not listen to this sophistry by vested interests. The acceptance of these arguments will build legal plunder into a whole system. In fact, this has already occurred. The present- day delusion is an attempt to enrich everyone at the expense of everyone else.”

The world view that underlies the distortion of law, Bastiat writes, holds man as a passive entity, lacking a motor of his own and awaiting the hand and plan of the wise legislator. He quotes Rousseau: “The legislator is the mechanic who invents the machine.” Saint-Just: “The legislator commands the future. It is for him to will the good of mankind. It is for him to make men what he wills them to be.” And the razor-sharp Robespierre: “The function of government is to direct the physical and moral powers of the nation toward the end for which the commonwealth has come into being.”

Bastiat echoes Adam Smith’s condemnation of the “man of system,” who sees people as mere pieces to be moved about a chessboard. To accomplish his objectives, the legislator must stamp out human differences, for they impede the plan. Forced conformity (is there any other kind?) is the order of the day. Bastiat quotes several writers in this vein, then replies:

Oh, sublime writers! Please remember sometimes that this clay, this sand, and this manure which you so arbitrarily dispose of, are men! They are your equals! They are intelligent and free human beings like yourselves! As you have, they too have received from God the faculty to observe, to plan ahead, to think, and to judge for themselves!

After quoting several of those writers who are so willing to devote themselves to reinventing people, Bastiat can no longer control his outrage: “Ah, you miserable creatures! You think you are so great! You who judge humanity to be so small! You who wish to reform everything! Why don’t you reform yourselves? That would be sufficient enough.”

Nor does Bastiat allow unrestrained democracy to escape his grasp. With his usual elegance, he goes right to the core of the issue. The democrat hails the people’s wisdom. In what does that wisdom consist? The ability to pick all-powerful legislators —and that is all. “The people who, during the election, were so wise, so moral, so perfect, now have no tendencies whatever; or if they have any, they are tendencies that lead downward to degradation. . . . If people are as incapable, as immoral, and as ignorant as the politicians indicate, then why is the right of these same people to vote defended with such passionate insistence?” And “if the natural tendencies of mankind are so bad that it is not safe to permit people to be free, how is it that the tendencies of these organizers are always good?”

Bastiat closes his volume with a clarion call for freedom and a rejection of all proposals to impose unnatural social arrangements on people. He implores all “legislators and do-gooders [to] reject all systems, and try liberty.”

In the years since The Law was first published, little has been written in the classical liberal tradition that can approach its purity, its power, its nearly poetic quality. Alas, the world is far from having learned the lessons of The Law. Bastiat would be saddened by what America has become. He warned us. He identified the principles indispensable for proper human society and made them accessible to all. In the struggle to end the legalized plunder of statism and to defend individual liberty, how much more could be asked of one man?

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