The first edition of Human Action was 889 pages. It was, after all, a treatise on economics. Galbraith, however, barely mentions this. Instead he concentrates his review on Mises’s view of the State. Written in a tone of “Can you believe how irrational this is?,” Galbraith shows how Mises paints the government to be the enemy of the market. There is no need to deny Mises’s distrust of the State. As Galbraith points out, to Mises “Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing and imprisoning.”

Galbraith does seem to show some respect for Mises’s defense of the market. As Galbraith put it, “The market, even more than the wheel, is one of the great commonplace servants of man. Professor Mises powerfully defends it against those who would subvert it to the service of the selfish or shortsighted ends.” But, he continues, “it is possible that the defense is stronger when in the hands of somewhat more moderate men.”

Should the defense of the market, and liberty, be left to more moderate men? I would argue no, it should not. What is moderate will depend on what is popular. Liberty and free markets are not in fashion, just as they were not when Human Action was written. Moderate men would compromise liberty away, just as Mises had warned. And a major reason for this is that many do not see the State for what it truly is. It may make one a radical to claim, as Frederic Bastiat did one hundred years before Mises wrote Human Action, that “the state is the great fiction by which everyone tries to live at the expense of everyone else.” And the State does this through the use of coercion. What the State gives it must take violently away from someone else. One need not be an anarchist to recognize this. (Neither Mises nor Bastiat was an anarchist). If someone doesn’t recognize the danger of fire, we shouldn’t be surprised when he gets burned (which is not to claim that the state is as necessary or useful as fire).

The critics of Human Action should take more time to carefully read it. Mises builds a system of economics from the ground up; thus his beliefs expressed about the State do not appear out of thin air. Perhaps if they read more carefully, those who share Galbraith’s view would realize that such a blind faith in the State to cure the ills of society is really the naive position.

Download Galbraith’s review of Human Action here. 

It is no surprise that the ideas contained in The Road to Serfdom would raise a certain passion in those who still held on to a belief in a free society. It represented a viable alternative to the zeitgeist of the time, which was defined by socialism and scientism. By World War II, both ideas had become presumptions for all Progressive intellectuals. In other words, positivism and formalism had become the norm for scientific discourse, and this paved the way for a “science” of control. The result was a marriage of science and statism. Denying either was tantamount to rejecting logic and reason.

During a book tour, Hayek spoke in Switzerland with businessmen who asked him to recommend ways to propagate a free society in spite of the zeitgeist. “The professor wisely responded that it was not his job to make propaganda – that he could only concentrate on the search for truth,” Hunold said. In other words, it is not the task of the intellectual to publicize the ideas; this is a job for others. It does not mean, however, that there is nothing to be done. Hayek, by gathering like-minded intellectuals together, as well as a few businessmen and activists such as FEE’s Leonard E. Read, was able to spread classical liberals ideas, bringing them back to a greater prominence.

Hunold notes one result: When Ludwig Erhard lifted price controls, shooting Western Germany into prosperity. Hunold credits the intellectual seeds sewn by Walter Eucken and Wilhelm Röpke. The increase in popularity of free markets in the 1980s can also be considered another example. Both Ronald Reagan in the United States and Margaret Thatcher in the Great Britain espoused the ideals of free markets (at least rhetorically). The roots, however, lie in intellectual efforts years earlier by groups such as the Mont Pelerin Society and the FEE.

Now such intellectual movements may not by themselves explain the changes in policy and may not guarantee success, but they are undoubtedly important for social change in any direction. When fighting for unpopular ideas, we are bound to be ridiculed, ignored, and treated with downright hostility. Hunold showed how Joseph Schumpeter mocked the Mont Pelerin Society in its early day when he said that the best proof his thesis that liberal ideas no longer played any role whatsoever in public life was that meeting of liberal economists “on the top of a Swiss mountain of which I have forgotten the name.” Similar mocks and jeers occur today from economists and other intellectuals, but this should not be discouraging. After all, it is always time to stand up for what we believe to be the truth. It is always time to defend and work for a free society.

Download Albert Hunold’s “The Story of the Mont Pelerin Society” here. 

What seems to be motivating the protests? At least in part the goal seems to be equality. The protesters apparently think it as unfair that only a small percentage, the very rich, has so much while everyone else has much less. Today’s document, an article from 1948 by economist Wilhelm Ropke titled “Crusade Against Luxuries,” is relevant. Ropke’s article shows the fallacies related to the prohibiting of luxuries in order to provide more for the poor. Similarly the protesters are revolting against the wealth of the “fat cat” bankers and other large corporations, while most people can’t get simple jobs, afford health care, or pay off their student loans. True, there are individuals with yachts while others barely making a living. The fallacy, however, is in the solution.

Ropke shows that prohibiting certain luxuries does not translate into more for the poor but instead “substitutes” certain luxuries for other less desired luxuries. What we end up with is the same amount of luxuries, or only slightly less, with lower utility throughout society. If the Wall Street protesters get their way, however, things could be even worse. The socialization of industry and banking would be a disaster and overregulating would simply incentivize businesses to produce less, which would mean higher not lower prices. Again we would all be worse off, not better.

So what is the solution? It’s all in the institutions. As David Hume put it, we need to assume all men are knaves. Thus we should want a society were bad men can do the least harm. Right now government power is backing the large corporations and large banks, protecting them from the difficulties of competition. This is the “capitalism” libertarians are attacking. It is crony capitalism, the use of government coercion to back certain individuals and businesses at the expense of everyone else. We want to eliminate this cooperation between government and business. Let free markets and real competition reign. This competition will result in a process that will produce more and more products at lower and lower prices.

The hurdle we need to get over is exactly what Ropke brought up back in 1948: Public Choice problems. There are a lot of vested interests that will not give up their power without a fight. But as a first step we need to recognize the true enemy to progress and freedom: government involvement in the economy. We need to realize that voluntary interactions are superior to any form of coercion, including by government. The protesters want to fight fire with fire and in doing so, they ignore Public Choice issues to their own detriment.

Download “Crusade Against Luxuries” by Wilhelm Ropke here. 

Just to quote Hoover, “We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and the Congress of the most gigantic program of economic defense and counter attack ever evolved in the history of the Republic.” In fact, many of the New Deal’s programs stem directly from Hoover’s efforts.

Despite the obvious evidence that Herbert Hoover was anything but free market, it is not difficult to see why the truth is often blurred. Hoover’s rhetoric, at least leading up to his presidency, was to move towards limiting the regulatory power of the federal bureaucracy, which is common among Republican presidential candidates.

FEE founder Leonard E. Read was an early supporter of Herbert Hoover. When Hoover was elected president, Read organized a large crowd (16 cars large, no small sum in the 1920s) of Californians to travel across the country to participate in the inauguration. And as today’s document is proof of, Read and Hoover occasionally corresponded and saw each other until Hoover’s death in 1964.

Is Read’s early support and subsequent friendship with Herbert Hoover evidence of Hoover’s free market leanings as a president? No, of course not. Read was, of course, an unyielding supporter of free markets, but he did not start out that way. He did not gain a classical liberal/libertarian perspective until he met William Mullendore in the mid-30s. In fact, in the beginning, Read believed in Roosevelt and the New Deal, albeit not completely. Soon, though, thanks to Mullendore, Read became one of the few lone voices of opposition to such policies, which as stated above, clearly have their roots in Hoover.

Once FEE got off the ground Read often sent many of the Foundation’s articles to Hoover, such as today’s document (though what article Read sent is sadly lost), but their correspondence tended to be very brief. There is a story, however, that Hoover once submitted an article for The Freeman, which Leonard Read rejected. Of course we can only speculate why but maybe because, just as his presidency illustrated, Herbert Hoover was not as free market as many like to claim.

Download the March 4, 1950 Letter from Herbert Hoover to Leonard E. Read here.

These opponents of the free market see liberty in a different light, almost wholly separate from personal responsibility, because they view responsibility as a job for society as a whole. Material needs become a human right and society, through its agent the state, is responsible for providing such needs. In such a system, equality is material and justice distributive. Metcalf and others have attacked libertarian thought by showing so-called flaws in Robert Nozick’s entitlement theory (with his famous example of Wilt Chamberlain). But as Steven Horwitz points out, this completely misses the point Nozick was making.

Nozick wasn’t attempting to justify, morally or otherwise, the free market but instead used the example to show how you cannot have a theory of distributive justice and allow individuals to use their private property as they see fit. The point then is that if you believe in a distributive theory of justice you must also advocate the restraint of liberty to dispose of individuals’ income. A consequence of liberty is an inequality of material well-being. So we must choose what type of equality we want. Do we want equality of outcomes? If so we must treat people unequally. Or do we want to be treated equally? If so, then we must put up with some level of unequal outcomes.

What is interesting, though, is that, countries that attempt to create equality of outcomes end up with much less of both equality of outcomes and equality under the law. Freedom in these countries is greatly curtailed and major wealth gaps exist with the majority in relative poverty. Countries, on the other hand, that put the responsibility in the hands of the individuals, find more freedom and equality under the law and more equality of outcomes. True it is not perfect, no system can achieve that (at least not without creating equality in poverty) but those societies tend to be wealthier overall, even for those in the lowest economic positions. As Leonard Read points out in the article, it is the countries that attempt to provide free shoes for the poor that have many more individuals without shoes.

Why is that? In a way it could seem counter-intuitive but the reason is that, yes people are working for their own self-interest but in order to make oneself better off they must make others better off. And the more people you make better off, the more you can achieve for yourself. Through the market process competition lowers prices so more individuals can have more material things at lower costs. In this sense, the market far from ignores the poor, it helps lift them up out of poverty.

Take away the incentives embedded in the free market system and efficiency will go with it. As Read noted, “Agreement with the idea of state absolutism follows socialization, appallingly.” Once this happens it becomes hard to remember how well the market works because in stomping out real entrepreneurship we have also crushed our imaginations. And despite what the critics think, with their wholly inaccurate caricature of libertarianism and the free market, I believe that is not just sad, it is abhorrent.

Download The Cliches of Socialism Number 8 “The free market ignores the poor” by Leonard E. Read here.

Yet, Public Choice economics, which applies the tools of economics to the political realm, can present an interesting problem. What if
businessmen could make money without competing within the free market? Now self-interest may indeed become a problem. If businessmen are able to operate free from competition then they can charge monopoly prices, squeezing every penny they can from the hapless consumers. After all, what can the consumer to do? Their choices have been restricted.

This problem is sadly far from the work of science fiction and very much steeped in reality. But, it is not an outcome of free markets; it is a product of government intervention. Governments restrict competition through various laws and regulations creating special interests which will do anything to keep their advantageous positions. This system also creates incentives for others to try and spend their way into gaining favors through additional lobbying. This process is known as rent seeking. It is the use of resources in a non-productive manner, i.e. the few are gaining at the expense of everyone else.

This is why businessmen are typically against free markets and in favor of regulations. Society would be better off without such policies but businesses stand to gain big from them. So, why are they enacted? The answer is in the concentrated benefits and dispersed costs. Businessmen gain greater profits from the reduced competition and thus lobby politicians, through financial kickbacks. Politicians, on the other hand, love the greater political campaign funds this process creates for them. The rest of us end up picking up the tab, but we barely notice because each of us pays only a tiny fraction of the whole cost.

Recently the billionaire Koch brothers have come under attack for supporting free market policies, “just to help their business.” It is true the Koch’s have been funding free market policies and research, but as the above shows, this hardly would be the best way to help their business in the short run. Yet, the Koch’s are not the first, and probably won’t be the last, businessmen to support free markets.

The free market movement since the early 20^th century has seen many virtuous benefactors who have used their wealth to spread economic liberty. Today’s document, entitled Why Liberty?, was written by a businessman, who was also a founder of Liberty Fund, Inc., Pierre F. Goodrich for the 1958 Mont Pelerin Society’s meeting in Princeton, New Jersey. Goodrich understood why we needed liberty. Why it was a good idea in the long run, for not only businessmen, but for everyone, to embrace liberty as much as possible. He asked the right questions as this pamphlet shows. And the answers all point to liberty.

Many businessmen deserve the criticisms, but they should receive criticisms them for the right reasons. The blame is often placed on the free market notion, rather than on government interventions. The public needs to understand better the process public choice economics studies, and then maybe we will get more of the type of businessmen we need. Its never too late to get more Pierre F. Goodrich’s.

Download Why Liberty? By Pierre F. Goodrich here.

The problem is that it can’t be both. Are interventions into the market economy the cause of prosperity? If they are, then free markets cannot be blamed when things go wrong because we don’t have free markets on first place! It could, of course, be argued that there are not enough regulations but there are two problems with this. First, the flaw is still not that free markets failed us. And second, it is empirically not true.

The evidence tends to point to the importance of free markets for achieving high sustainable economic growth. Recently two empirical papers, Harvard University economist Andrei Shleifer’s “The Age of Milton Friedman” and George Mason University economist Peter Leeson’s “Two Cheers for Capitalism?”, analyze economic growth throughout the world in the last quarter century. Both find similar results. Countries that became more “capitalist” during this period, meaning the freer the markets were, became wealthier, healthier, more educated, and politically freer. On the opposite, countries that restricted markets endured stagnating income, shorter lives, less education, and oppressive political regimes.

In other words, when it is appropriate to say, “we have never had it so good,” the reason is because markets have produced wealth in spite of the regulations and restrictions. In times of trouble the appropriate response should be to blame the regulations, which distorted the markets that were responsible for the wealth in the first place. What is needed in both good and bad economic times is not calls for the state to intervene, but instead calls for freer markets. The empirical evidence for pure free markets are a lot stronger than many give it credit for. As my colleague Daniel J. Smith once said, “It doesn’t make one dogmatic to embrace these facts, it makes one dogmatic to refuse to acknowledge them.” The world needs more individuals to fully embrace these facts, and maybe the world needs more market fundamentalism.

Download the Cliché of Socialism Number 32 by Leonard E. Read here.

For the audio file of this lecture click here.

One reason economists often misdiagnose the importance of advertising can be found in the neo-classical models they use. In a general equilibrium model there is no need for advertising due to assumptions such as perfect competition, homogeneous goods, and full information, i.e. markets clear, each particular product is identical so there is no quality competition, and individuals have full information.

Now, of course, in the real world this is not true. Which is why, in looking at a question like this, Austrian models paint a more accurate picture. The market is a competitive process where individuals do not have full information and entrepreneurs compete on more than just price. This makes advertising necessary. For example, a hamburger sold on the market is going to differ from other hamburgers in regards to the grade of meat, toppings put on it, type of bread, etc. But the product is not only just the actual burger. The atmosphere of where you purchase it also matters, whether it is eaten at a restaurant or taken to go, the product is the whole package. Finding this information increases consumer satisfaction. Advertising helps consumers do this. Essentially, advertising entrepreneurs are picking up big bills on the sidewalk by matching the subjective preferences of consumers with what they desire but previously did not see.

If advertising is loud, big, and in your face it is only because it needs to be. We live an “affluent society.” Meaning a society were many, many opportunities are placed before consumers who must choose for themselves. Producers must fight to be heard over each other to get consumers the information they need to get the products they want.

If there is a distaste or moral repugnance to the advertising we receive, well it is our own fault. As Ludwig von Mises has noted, the consumer is king. The market is like an efficient democracy where each dollar is like a vote. In a free market, entrepreneurs would only provide the things consumers desire, this goes for advertising as well. H.L. Mencken once said democracy is the theory that people know what they want and deserve to get it, good and hard. And the market, as a democracy, is very good at doing just that.

Of course there will always be the cheats and the liars but in time the market will weed them out. For the market is a discovery process and advertising does play a vital role. So, we should raise our glasses of whiskey, or whatever we’re drinking, in thanks to the real life Donald Drapers of the world, for helping us find what we desire.

Download the Israel Kirzner lecture of Advertising here.

Cast Your Vote for Freedom Here!

November 22, 2010

Dear Friends,

What a year of success 2010 has been! FEE is on the move—in every respect and on all fronts.

Financially, we turned a corner. When our fiscal year ends in March 2011, I expect we will have generated the first positive bottom line in three years and begun to rebuild reserves. Programs are expanding. More students than ever are learning the life-changing lessons of freemarket economics, personal liberty, and moral character development. Additions of young, energetic staff are infusing new levels of professionalism and vitality into the organization.

We are especially proud of sponsoring an impressive schedule of week-long summer seminars for high school and college students. We held seven seminars in three places—Irvington, New York; Atlanta, Georgia; and Estes Park, Colorado—featuring many of the best speakers in the country. The nearly 700 students who participated represented 42 states and 40 countries. But this is about more than numbers; it’s about impact and outcomes. This was sent by a grateful mother of two daughters who attended our program:

“Thank you FEE staff and supporters – My daughters, Kelsey and Mary Kate, attended the seminar at Estes Park last week and they came home completely on fire to pursue the economic principles of a free society! Your program is life-changing and we so appreciate you!”

Your support empowers FEE to pass these principles we hold dear to our next generation of civic leaders, entrepreneurs, and thoughtful, engaged voters. There is plenty of room to grow: We had to turn away 350 qualified applicants for budget reasons. We gathered this level of enthusiasm by relying solely on our website and word of mouth for advertising.

You can see why we are devoted to spreading the word about FEE’s programs. Parents and students alike thirst for ideas about liberty and how a free economy works. Students appreciate our unique way of blending economics with moral character. A free society requires private property, the rule of law, and open markets, but none of those can arise or endure unless people practice high standards of honesty, patience, courage, responsibility, and self-reliance. Character is indispensable—that lesson resonates with our students, but it’s a lesson not being taught in government schools. (For more, visit FEE.org and click on Seminars.)

Visitors to the revamped FEE websites have tripled since last year. FEE has 15,000 Facebook fans generating conversation and bringing in new friends by the hundreds every month. Repostings and reprints of FEE materials and articles from our magazine, The Freeman, are soaring. Just in the past year we’ve seen articles reprinted in the Dallas Morning News, The Daily Reckoning, UnMondeLibre, Reason’s Hit & Run, Libertad Digital, Gizmodo, Indiana Policy Review, the Campaign for Liberty website, and many more.

Large crowds for FEE programs around the country, including our high school debate events, are encouraging evidence of a rekindled interest in the ideas of liberty and free-market economics. In August we held our largest “Evening at FEE” in history at our Irvington, New York, headquarters. Over 170 people gathered to hear me discuss “The Origin, History and Nature of Money.” People are craving more education on the tenets of a free society, and FEE is providing it to them!

In late September FEE launched The Informant, a web-based resource for home-school parents and high school teachers of economics. It supplies recommendations for text materials and curriculum guides while providing a forum for free-market educators to discuss their plans. In this way FEE is able to speak directly with those who instruct young people. We are already receiving excellent feedback on this new resource, including thousands of page views and this endorsement from a home-schooling mother:

“Wow, this is really fantastic. I’ve promoted it to our local home school network. The links, cross-referencing, key topics, skill levels–you couldn’t ask for more! THANK YOU FEE!”

Though I have already mentioned our magazine, The Freeman, I want to share with you some further observations about it. It’s been our flagship publication for half a century and a highly acclaimed leader among free-enterprise journals. No publication has covered the financial crisis from a pro-freedom perspective as thoroughly and as clearly as The Freeman. Issue after issue applied solid analysis to all aspects of the recession and has explained the free-market solution in banking and housing.

Likewise, we have relentlessly offered the case for the free market in health care and exposed the prevalent statist fallacies and proposals. Intellectual ammunition from FEE on these issues has become an important weapon in the arsenal for the pro-liberty side of the debate.

We have jumped on every major political-economic issue with clarity and consistency, while also attending to lesser-known threats to liberty and important episodes in economic history. We keep readers informed of the most important new books of relevance to champions of freedom.

The most respected names in the broad free-market movement grace our pages: Peter Boettke, James Bovard, Richard Epstein, Roger Garrison, Jeffrey Rogers Hummel, Sandy Ikeda, Israel Kirzner, Wendy McElroy, Gerald O’Driscoll, Ben Powell, Murray Weidenbaum, Lawrence White, Bruce Yandle—not to mention the best of the up-and-coming pro-freedom scholars and writers.

Our regular columnists are an all-star cast and include Charles Baird, Don Boudreaux, Steve Davies, Burt Folsom, David Henderson, Robert Higgs, editor Sheldon Richman, John Stossel, Thomas Szasz, and Walter Williams. All of this comes in the most attractive packaging in The Freeman’s history—and I don’t mean just the print version. The newly redesigned website, TheFreemanOnline.org, attracts hundreds of thousands of readers, who continue the lively debates by posting comments, emailing articles to friends and sharing The Freeman through social networking sites. We launched a Kindle edition in October and it met with immediate and unreserved enthusiasm. Please visit TheFreemanOnline.org at your earliest opportunity! And remember that contributors to FEE of $50 or more receive the magazine for a year.

So there in a nutshell is the good news about our work this past year. But you should know that we practice what we preach in every respect. We don’t think we’re entitled to anything, but we do hope we have earned your support. Ask yourself these questions as you ponder your year-end giving:

I hope you will answer all five questions with a resounding YES! Since our founding in 1946 FEE has relied exclusively on the voluntary, generous, and tax-deductible contributions of friends of liberty everywhere. We can’t do our work without you. Remember, we will never, ever pursue or accept any government funding.

Moreover, it is my hope that you will place great value on these crucial elements that define what FEE is all about:

Your generous support now will help us immensely as we prepare the budget for the next year. How many summer seminars should we plan for? How many students can we accept? Those questions are greatly affected by how our supporters respond in the final weeks of the calendar year. Funds permitting, we would also like to produce instructional videos for classroom use, expand the readership of The Freeman, schedule more speakers around the country, and provide educational materials to as many students as possible.

The work of FEE in promoting liberty, free markets, and personal character has never been more critical than it is today. We need your help to reach even more students next summer, when we will celebrate the 50th anniversary of FEE’s commencement of seminars! This year you can pledge support that will directly, profoundly, and indelibly impact the lives of our student participants! I urge you to take a moment and complete the pledge form in the envelope provided. Better yet, you can make your contribution quickly and securely online. Simply go to FEE.org and click on the Donate button.

Liberty—it makes all the difference in the world! Help us spread the word with a contribution today. We would be honored once again to count you as a friend of FEE!

With the deepest appreciation,

Lawrence W. Reed

President

P.S. – This remark from Benjamin Franklin is especially appropriate for this time of year. It expresses the wishes of the FEE staff for you and your family in this holiday season: “Be at war with your vices, at peace with your neighbors, and let every new year find you a better man.”

P.P.S – Don’t forget, anyone within the United States who contributes $50 or more receives The Freeman for one year. And, as an added thank you for your generosity, anyone who contributes $200 or more will receive a copy of one of the following books:

Cast Your Vote for Freedom Here!

Summer Seminars Donor Book

“I want my son or daughter to be exposed to free market economics after high school. What colleges or universities do you recommend?”

If I’ve been asked that question once, I’ll bet I’ve been asked it a thousand times. Parents who cherish the values of freedom, limited government and private enterprise have good reason to be concerned about where they send their offspring for higher “education.” Academia is full of statist bias, and statists usually aren’t comfortable when the first non-statist is accidentally hired for a teaching position (they think it’s a takeover). So when you find an economics program in which free market ideas are treated with respect and given a prominent forum, it’s news to celebrate.

Keep in mind that I am talking here about economics, period. If a college or university has a good econ program, that doesn’t mean it also has a good offering or even a decent balance in its other social science programs.

On that occasion, I wrote about Florida Gulf Coast University.

The school I want to acquaint readers with this time is one I’ve become familiar with over the last academic year, Mercer University. Mercer has campuses in Atlanta, Macon, and Savannah. Its core undergraduate campus, which consistently ranks in the Top 10 for beautiful campuses in America, is located in Macon, Georgia. It’s an urban campus with an extremely active student body and great Southern cuisine nearby.

Some libertarian-leaning professors teach in the history, philosophy, and political science departments, but it’s the group of economists on Mercer’s Macon campus, all of whom are solid free market economists, that I’m most familiar with. A brief biography of each is provided below.

SCOTT A. BEAULIER, BB&T Distinguished Professor of Capitalism and Department Chair of Economics, earned his undergraduate degree in economics and history from Northern Michigan University (2000) and his M.A. (2002) and Ph.D. (2004) from George Mason University. Much of his research has focused on issues of economic development; in particular, he is one of the leading experts on Botswana’s growth miracle. His research maintains that Botswana’s rapid growth can be attributed to their being economically free and open. He has also published research in the areas of Austrian economics, law & economics, public choice economics, and economic education. Some of his popular press publications have appeared in leading newspapers, such as the Atlanta Journal Constitution and the Wall Street Journal. He has been active with Liberty Fund, has taught for the Institute for Humane Studies, and will soon be teaching for the Foundation for Economic Education.

Professor Beaulier is also directing the Center for Undergraduate Research in Public Policy & Capitalism. The new center supports collaborative research between undergraduates and faculty members that addresses themes related to capitalism. This spring he will teach a course titled, “The Economic and Moral Foundations of Capitalism.”

WILLIAM S. MOUNTS, Associate Dean of the Stetson School of Business and Economics and Professor of Economics, earned his Ph.D. in Economics from the University of Georgia. Dr. Mounts has over 50 academic articles, books, and presentations. His presentations have been at national and international conferences including the Southern Economics Association, the Western Economics Conference, and the central bank of Switzerland. Journals in which he has published include the Economics of Governance, Journal of Macroeconomics, Southern Economic Review, Public Choice, Journal of Sports Economics, Journal of Money, Banking and Credit and the Swiss Journal of Economics and Statistics.

His current research interests include an examination of monetary regimes using extreme value estimation techniques, the aging of men and women, the economics of teamwork, and banking in the Great Depression. Much of this work focuses on how free market incentives create socially-desired outcomes and that governmentally-determined incentives do not.

Recently, Dr. Mounts and Dr. Beaulier have published opinion pieces in The Wall Street Journal and the Atlanta Journal Constitution.

ALLEN K. LYNCH, Director of Graduate Programs and Associate Professor of Economics, earned his earned his bachelor’s degree at the University of North Florida and his master’s and doctorate degrees at Florida State University. While at FSU, he was greatly influenced by many renowned public choice economists, such as Bruce Benson, Randy Holcombe, Jim Gwartney and David Rasmussen. He has taught at the University of North Florida and worked as a Senior Demographic Research Analyst for Blockbuster Entertainment Group prior to joining the Mercer University faculty in 2000.

He has published numerous journal articles, ranging from “Identifying the NCAA Tournament Dance Card,” a statistical model which accurately predicted 94 percent of college basketball teams that earned at-large bids for the NCAA tournament over the last 10 years (coauthored by B. Jay Coleman of the University of North Florida), to “Proximity, Neighborhood and the Efficacy of Exclusion,” recently published in Urban Studies (coauthored by David W. Rasmussen). While research related to the public choice aspects of real estate markets and crime dominate his research agenda, interest in the NCAA article resulted in substantial media attention. Over the last several years, stories related to this research appeared in The New York Times, Investors’ Business Daily, The Wall Street Journal, as well as several Associated Press outlets.

With so many campuses devoid of solid teaching that stresses the critical role of free markets and private property in economic progress, Mercer University is another welcome island in a sea of confusion.

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.

>>Listen to Audio Book version of Great Myths of the Great Depression<<
>>Download PDF Version of Great Myths of the Great Depression.<<

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.

Cashing in on the common notion that anything unregulated is bad, advocates of government regulation argue that an unregulated market is to be abhorred. This view is captured by twin sculptures outside the Federal Trade Commission building in Washington, D.C. (One is on the Constitution Ave. side, the other on the Pennsylvania Ave. side.) The sculptures, which won an art contest sponsored by the U.S. government during the New Deal, depict a man using all his strength to keep a wild horse from going on a rampage.

The title? “Man Controlling Trade.”

Since trade is not really a wild horse but rather a peaceful and mutually beneficial activity between people, the Roosevelt administration’s propaganda purpose is clear. A more honest title would be “Government Controlling People.” But that would have sounded a little authoritarian even in New Deal America, hence the wild horse metaphor.

What’s overlooked—intentionally or not—is that the alternative to a government-regulated economy is not an unregulated one. As a matter of fact, “unregulated economy,” like square circle, is a contradiction in terms. If it’s truly unregulated it’s not an economy, and if it’s an economy, it’s not unregulated. The term “free market” does not mean free of regulation. It means free of government interference.

Ludwig von Mises and F. A. Hayek pointed out years ago that the real issue regarding economic planning is not: To plan or not to plan? But rather: Who plans (centralized state officials or decentralized private individuals in the market)?

Likewise, the question is not: to regulate or not to regulate. It is, rather, who (or what) regulates?

All markets are regulated. In a free market we all know what would happen if someone charged, say, $100 per apple. He’d sell few apples because someone else would offer to sell them for less or, pending that, consumers would switch to alternative products. “The market” would not permit the seller to successfully charge $100.

Similarly, in a free market employers will not succeed in offering $1 an hour and workers will not succeed in demanding $20 an hour for a job that produces only $10 worth of output an hour. If they try, they will quickly see their mistake and learn.

And again, in a free market an employer who subjected his employees to perilous conditions without adequately compensating them to their satisfaction for the danger would lose them to competitors.

Market Forces

What regulates the conduct of these people? Market forces. (I keep specifying “in a free market” because in a state-regulated economy, market forces are diminished or suppressed.) Economically speaking, people cannot do whatever they want in a free market because other people are free to counteract them. Just because the government doesn’t stop a seller from charging $100 for an apple doesn’t mean he or she can get that amount. Market forces regulate the seller as strictly as any bureaucrat could—even more so, because a bureaucrat can be bribed. Whom would you have to bribe to be exempt from the law of supply and demand?

It is no matter of indifference whether state operatives or market forces do the regulating. Bureaucrats, who necessarily have limited knowledge and perverse incentives, regulate by threat of physical force. In contrast, market forces operate peacefully through millions of participants, each with intimate knowledge of his or her own personal circumstances, looking out for their own well-being. Bureaucratic regulation is likely to be irrelevant or inimical to what people in the market care about. Not so regulation by market forces.

If this is correct, there can be no unregulated, or unfettered, markets. We use those terms in referring to markets that are unregulated or unfettered by government. As long as we know what we mean, the expressions are unobjectionable.

But not everyone knows what we mean. Someone unfamiliar with the natural regularities of free markets can find the idea of an unregulated economy terrifying. So it behooves market advocates to be capable of articulately explaining the concept of spontaneous market order—that is, order (to use Adam Ferguson’s felicitous phrase) that is the product of human action but not human design. This is counterintuitive, so it takes some patience to explain it.

Order grows from market forces. But where do impersonal market forces come from? These are the result of the nature of human action. Individuals select ends and act to achieve them by adopting suitable means. Since means are scarce and ends are abundant, individuals economize in order to accomplish more rather than less. And they always seek to exchange lower values for higher values (as they see them) and never the other way around. In a world of scarcity tradeoffs are unavoidable, so one aims to trade up rather than down. The result of this and other features of human action and the world at large is what we call market forces. But really, it is just men and women acting rationally in the world.

The natural social order greatly concerned Frederic Bastiat, the nineteenth-century French liberal economist. In Economic Harmonies he analyzed that order, but did not feel he needed to prove its existence—he needed only to point it out. “Habit has so familiarized us with these phenomena that we never notice them until, so to speak, something sharply discordant and abnormal about them forces them to our attention,” he wrote.

…So ingenious, so powerful, then, is the social mechanism that every man, even the humblest, obtains in one day more satisfactions than he could produce for himself in several centuries…. We should be shutting our eyes to the facts if we refused to recognize that society cannot present such complicated combinations in which civil and criminal law play so little part without being subject to a prodigiously ingenious mechanism. This mechanism is the object of study of political economy….

In truth, could all this have happened, could such extraordinary phenomena have occurred, unless there were in society a natural and wise order that operates without our knowledge?

This is the same lesson taught by FEE’s founder, Leonard Read, in I, Pencil.

Most people value order. Chaos is inimical to human flourishing. Thus those who fail to grasp that, as Bastiat’s contemporary Proudhon put it, liberty is not the daughter but the mother of order will be tempted to favor state-imposed order. How ironic, since the state is the greatest creator of disorder of all.

Those of us who understand Bastiat’s teachings realize how urgent it is that others understand them, too.

We are aware of Paul Krugman’s semi-weekly New York Times complaints that the Obama administration is not profligate enough in borrowing, printing money, and spending.  (Such missives even have earned him a coveted spot on the cover of Newsweek in which he expanded his criticisms of the president’s economic “plan.”)

However, former George W. Bush economic adviser Gregory Mankiw, also of Harvard, has done Krugman and Feldstein one better: he has endorsed the proposals of perhaps the most famous “crank” in history, Silvio Gesell.  It was Gesell, a German economist of the late 19th Century who advocated that governments issue money which would officially depreciate via a tax on people who held money instead of spending it quickly.

John Maynard Keynes, in his General Theory, went as far as to call Gesell a “prophet,” and while Mankiw does not bestow such an august label upon Gesell, nonetheless he implicitly endorses this scheme, but relying on the old friend of money-monopolizing governments: inflation.  He writes in the April 18 New York Times:

If all of this seems too outlandish (taxing people who hold money), there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

Keep in mind that Mankiw is a “respected” economist, and is considered to be, relatively speaking, a “free-market economist,” as is Feldstein.  Yet, in a time of crisis, Mankiw, Feldstein, and others instinctively turn to inflation as a solution.

As I see it, this latest “mad scientist” scheme exposes a greater weakness in mainstream economics, and that is the lack of a real understanding of how an economy works.  It seems ironic, and perhaps arrogant on my part, for me to accuse economists – and prominent ones at that – of being ignorant of economics, but that is what I am doing.

It is not just that economic journals are full of esoteric mathematical models that can be deciphered only by someone with training in math, nor is it just that economists depend upon models that are full of “givens” which are not “given” at all, such as factor prices.  The larger problem is that many “prominent” economists cannot explain the real nature of exchange, they do not understand money at all, and they lack a coherent theory on capital.

Most economics textbooks give the standard definitions of money (medium of exchange, store of value, etc.), but fail to understand that money itself is a good used exclusively for exchange and that it, too, is subject to the same laws of economics as other goods.  Instead, they tend to see it as a quantity variable that can and should be manipulated by government in order to ensure “sufficient aggregate demand.”

What they don’t see is that manipulating and inflating money creates numerous dislocations within the economy itself, especially in capital markets, driving the fundamentals out of balance and furthering malinvestments.  Furthermore, the latest Mankiw scheme would ensure the deterioration of current capital stock and retard future capital investment.

The Austrians, however, have not drunk the Gesell-brand Kool-Aid, and one hopes that their theories of capital development, free markets, and sound money someday will resonate with the public and policy-makers.  The alternative is depression and inflation.

By last count, I’ve given this address in about 100 different places, including probably 20 states and a dozen foreign countries. The text has been translated into at least 12 foreign languages, including Chinese, Korean, Spanish and Kiswahili. In a twist stranger than fiction, I was invited to deliver this speech at the People’s University in Beijing. Readers familiar with my views or with the seven principles will no doubt be struck by the irony — and the victory — inherent in my espousing these principles in the heart of the world’s largest communist state.

Why has interest in the “Seven Principles of Sound Public Policy” exceeded all expectations? Looking back, I think it was due to a gamble I took when I first wrote and delivered this address. At the time, I began by telling the audience:

“I know that (the Detroit Economic Club) has heard many policy addresses by many leaders in government, business and academia — policy addresses that dealt in some detail with specific pressing issues of the day, from transportation to education to health care and countless other important topics. At the Mackinac Center for Public Policy, our specialty is researching and recommending detailed prescriptions for today’s policy questions, and I thought about doing that very thing here today.

“But upon reflection, I decided instead to step back from the minutiae of any particular issue and offer you something a little different: a broad-brush approach that is applicable to every issue. I’d like us all to think about some very critical fundamentals, some bedrock concepts that derive from centuries of experience and economic knowledge. They are, in my view, eternal principles that should form the intellectual backdrop to what we do as policymakers inside and outside of government.”

The reception the speech received that day and in the years since suggests that at bottom, people value a serious attempt to deal with issues that matter. They recognize that principles that can be expressed in simple words are not necessarily simplistic.

Moreover, they realize that approaching issues with an open mind does not mean approaching them with an empty one. After all, we’ve learned a few things over the centuries. It’s not uninformed bias that prompts us without debate to accept the notion that the sun comes up in the east. It isn’t blind ideology that tells us that a representative republic is superior to dictatorship or monarchy. The general assumption that private property and free-market economies are superior to state ownership and central planning is no longer just an opinion; rather, it is now a settled truth for people who value reason, logic, facts, evidence, economics and experience.

The seven principles of sound public policy that I want to share with you are pillars of a free economy. We can differ on exactly how any one of them may apply to a given issue, but the principles themselves, I believe, are settled truths.

These principles are not original with me; I’ve simply collected them in one place. They are not the only pillars of a free economy or the only settled truths, but they do provide a solid foundation. In my view, if the cornerstone of every state and federal building were emblazoned with these principles — and more importantly, if every legislator understood and attempted to be faithful to them — we’d be a much stronger, much freer, more prosperous and far better-governed people.

One

Free people are not equal, and equal people are not free.

First, I should clarify the kind of “equalness” to which I refer in this statement. I am not referring to equality before the law — the notion that you should be judged innocent or guilty of an offense based upon whether or not you did it, with your race, sex, wealth, creed, gender or religion having nothing to do with the outcome. That’s an important foundation of Western civilization, and though we often fall short of it, I doubt that anyone here would quarrel with the concept.

No, the “equalness” to which I refer is all about income and material wealth — what we earn and acquire in the marketplace of commerce, work and exchange. I’m speaking of economic equality. Let’s take this first principle and break it into its two halves.

Free people are not equal. When people are free to be themselves, to be masters of their own destinies, to apply themselves in an effort to improve their well-being and that of their families, the result in the marketplace will not be an equality of outcomes. People will earn vastly different levels of income; they will accumulate vastly different levels of wealth. While some lament that fact and speak dolefully of “the gap between rich and poor,” I think people being themselves in a free society is a wonderful thing. Each of us is a unique being, different in endless ways from any other single being living or dead. Why on earth should we expect our interactions in the marketplace to produce identical results?

We are different in terms of our talents. Some have more than others, or more valuable talents. Some don’t discover their highest talents until late in life, or not at all. Magic Johnson is a talented basketball player. Should it surprise anyone that he makes infinitely more money at basketball than I ever could? Will Kellogg didn’t discover his incredible entrepreneurial and marketing talent until age 46; before he struck out on his own to start the Kellogg Company, he was making about $25 a week doing menial jobs for his older brother in a Battle Creek sanitarium.

We are different in terms of our industriousness, our willingness to work. Some work harder, longer and smarter than others. That makes for vast differences in how others value what we do and in how much they’re willing to pay for it.

We are different also in terms of our savings. I would argue that if the president could somehow snap his fingers and equalize us all in terms of income and wealth tonight, we would be unequal again by this time tomorrow because some of us would save our money and some of us would spend it. These are three reasons, but by no means the only three reasons, why free people are simply not going to be equal economically.

Equal people are not free, the second half of my first principle, really gets down to brass tacks. Show me a people anywhere on the planet who are indeed equal economically, and I’ll show you a very unfree people. Why?

The only way in which you could have even the remotest chance of equalizing income and wealth across society is to put a gun to everyone’s head. You would literally have to employ force to make people equal. You would have to give orders, backed up by the guillotine, the hangman’s noose, the bullet or the electric chair. Orders that would go like this: Don’t excel. Don’t work harder or smarter than the next guy. Don’t save more wisely than anyone else. Don’t be there first with a new product. Don’t provide a good or service that people might want more than anything your competitor is offering.

Believe me, you wouldn’t want a society where these were the orders. Cambodia under the communist Khmer Rouge in the late 1970s came close to it, and the result was that upwards of 2 million out of 8 million people died in less than four years. Except for the elite at the top who wielded power, the people of that sad land who survived that period lived at something not much above the Stone Age.

What’s the message of this first principle? Don’t get hung up on differences in income when they result from people being themselves. If they result from artificial political barriers, then get rid of those barriers. But don’t try to take unequal people and compress them into some homogenous heap. You’ll never get there, and you’ll wreak a lot of havoc trying.

Confiscatory tax rates, for example, don’t make people any more equal; they just drive the industrious and the entrepreneurial to other places or into other endeavors while impoverishing the many who would otherwise benefit from their resourcefulness. Abraham Lincoln is reputed to have said, “You cannot pull a man up by dragging another man down.”

Two

What belongs to you, you tend to take care of;
what belongs to no one or everyone tends to fall into disrepair.

This essentially illuminates the magic of private property. It explains so much about the failure of socialized economies the world over.

In the old Soviet empire, governments proclaimed the superiority of central planning and state ownership. They wanted to abolish or at least minimize private property because they thought that private ownership was selfish and counterproductive. With the government in charge, they argued, resources would be utilized for the benefit of everybody.

What was once the farmer’s food became “the people’s food,” and the people went hungry. What was once the entrepreneur’s factory became “the people’s factory,” and the people made do with goods so shoddy there was no market for them beyond the borders.

We now know that the old Soviet empire produced one economic basket case after another, and one ecological nightmare after another. That’s the lesson of every experiment with socialism: While socialists are fond of explaining that you have to break some eggs to make an omelette, they never make any omelettes. They only break eggs.

If you think you’re so good at taking care of property, go live in someone else’s house, or drive their car, for a month. I guarantee you neither their house nor their car will look the same as yours after the same period of time.

If you want to take the scarce resources of society and trash them, all you have to do is take them away from the people who created or earned them and hand them over to some central authority to manage. In one fell swoop, you can ruin everything. Sadly, governments at all levels are promulgating laws all the time that have the effect of eroding private property rights and socializing property through “salami” tactics — one slice at a time.

Three

Sound policy requires that we consider long-run effects and all people, not simply short-run effects and a few people.

It may be true, as British economist John Maynard Keynes once declared, that “in the long run, we’re all dead.” But that shouldn’t be a license to enact policies that make a few people feel good now at the cost of hurting many people tomorrow.

I can think of many such policies. When Lyndon Johnson cranked up the Great Society in the 1960s, the thought was that some people would benefit from a welfare check. We now know that over the long haul, the federal entitlement to welfare encouraged idleness, broke up families, produced intergenerational dependency and hopelessness, cost taxpayers a fortune and yielded harmful cultural pathologies that may take generations to undo. Likewise, policies of deficit spending and government growth — while enriching a few at the start — have eaten at the vitals of the nation’s economy and moral fiber for decades.

This principle is actually a call to be thorough in our thinking. It says that we shouldn’t be superficial in our judgments. If a thief goes from bank to bank, stealing all the cash he can get his hands on, and then spends it all at the local shopping mall, you wouldn’t be thorough in your thinking if all you did was survey the store owners to conclude that this guy stimulated the economy.

We should remember that today is the tomorrow that yesterday’s poor policymakers told us we could ignore. If we want to be responsible adults, we can’t behave like infants whose concern is overwhelmingly focused on self and on the here-and-now.

Four

If you encourage something, you get more of it; if you discourage something, you get less of it.

You and I as human beings are creatures of incentives and disincentives. We respond to incentives and disincentives. Our behavior is affected by them, sometimes very powerfully. Policymakers who forget this will do dumb things like jack up taxes on some activity and expect that people will do just as much of it as before, as if taxpayers are sheep lining up to be sheared.

Remember when George Bush (the first one) reneged under pressure on his 1988 “No New Taxes!” pledge? We got big tax hikes in the summer of 1990. Among other things, Congress dramatically boosted taxes on boats, aircraft and jewelry in that package. Lawmakers thought that since rich people buy such things, we should “let ‘em have it” with higher taxes. They expected $31 million in new revenue in the first year from the new taxes on those three things. We now know that the higher levies brought in just $16 million. We shelled out $24 million in additional unemployment benefits because of the people thrown out of work in those industries by the higher taxes. Only in Washington, D.C., where too often lawmakers forget the importance of incentives, can you aim for 31, get only 16, spend 24 to get it and think that somehow you’ve done some good.

Want to break up families? Offer a bigger welfare check if the father splits. Want to reduce savings and investment? Double-tax ‘em, and pile on a nice, high capital gains tax on top of it. Want to get less work? Impose such high tax penalties on it that people decide it’s not worth the effort.

Right now in both state and federal legislatures, much attention is being given to the question of how to deal with deficits due to recession and declining revenues. At the Mackinac Center, we believe that government ought to deal with such circumstances the way you and I and families all across the state deal with similar circumstances: curtail spending. That’s especially true if we want to stimulate a weak economy so it will produce more jobs and more revenue. When the patient is ill, the doctor doesn’t bleed him.

Five

Nobody spends somebody else’s money as carefully as he spends his own.

Ever wonder about those stories of $600 hammers and $800 toilet seats that the government sometimes buys? You could walk the length and breadth of this land and not find a soul who would say he’d gladly spend his own money that way. And yet this waste often occurs in government and occasionally in other walks of life, too. Why? Because invariably, the spender is spending somebody else’s money.

Economist Milton Friedman elaborated on this some time ago when he pointed out that there are only four ways to spend money. When you spend your own money on yourself, you make occasional mistakes, but they’re few and far between. The connection between the one who is earning the money, the one who is spending it and the one who is reaping the final benefit is pretty strong, direct and immediate.

When you use your money to buy someone else a gift, you have some incentive to get your money’s worth, but you might not end up getting something the intended recipient really needs or values.

When you use somebody else’s money to buy something for yourself, such as lunch on an expense account, you have some incentive to get the right thing but little reason to economize.

Finally, when you spend other people’s money to buy something for someone else, the connection between the earner, the spender and the recipient is the most remote — and the potential for mischief and waste is the greatest. Think about it — somebody spending somebody else’s money on yet somebody else. That’s what government does all the time.

But this principle is not just a commentary about government. I recall a time, back in the 1990s, when the Mackinac Center took a close look at the Michigan Education Association’s self-serving statement that it would oppose any competitive contracting of any school support service (like busing, food or custodial) by any school district anytime, anywhere. We discovered that at the MEA’s own posh, sprawling East Lansing headquarters, the union did not have its own full-time, unionized workforce of janitors and food service workers. It was contracting out all of its cafeteria, custodial, security and mailing duties to private companies, and three out of four of them were nonunion!

So the MEA — the state’s largest union of cooks, janitors, bus drivers and teachers — was doing one thing with its own money and calling for something very different with regard to the public’s tax money. Nobody — repeat, nobody — spends someone else’s money as carefully as he spends his own.

Six

Government has nothing to give anybody except what it first takes from somebody, and a government that’s big enough to give you everything you want is big enough to take away everything you’ve got.

This is not some radical, ideological, anti-government statement. It’s simply the way things are. It speaks volumes about the very nature of government. And it’s perfectly in keeping with the philosophy and advice of America’s Founders.

It’s been said that government, like fire, is either a dangerous servant or a fearful master. Think about that for a moment. Even if government is no bigger than our Founders wanted it to be, and even if it does its work so well that it indeed is a servant to the people, it’s still a dangerous one! As Groucho Marx once said of his brother Harpo, “He’s honest, but you’ve got to watch him.” You’ve got to keep your eye on even the best and smallest of governments because, as Jefferson warned, the natural tendency is for government to grow and liberty to retreat. You can’t wind it up and walk away from it; it takes eternal vigilance to keep it in its place and keep our liberties secure.

The so-called “welfare state” is really not much more than robbing Peter to pay Paul, after laundering and squandering much of Peter’s wealth through an indifferent, costly bureaucracy. The welfare state is like feeding the sparrows through the horses, if you know what I mean. Put yet another way, it’s like all of us standing in a big circle, with each of us having one hand in the next guy’s pocket. Somebody once said that the welfare state is so named because in it, the politicians get well and the rest of us pay the fare.

A free and independent people do not look to government for their sustenance. They see government not as a fountain of “free” goodies, but rather as a protector of their liberties, confined to certain minimal functions that revolve around keeping the peace, maximizing everyone’s opportunities and otherwise leaving us alone. There is a deadly trade-off to reliance upon government, as civilizations at least as far back as ancient Rome have painfully learned.

When your congressman comes home and says, “Look what I brought for you!” you should demand that he tell you who’s paying for it. If he’s honest, he’ll tell you that the only reason he was able to get you something was that he had to vote for the goodies that other congressmen wanted to take home — and you’re paying for all that, too.

Seven

Liberty makes all the difference in the world.

Just in case the first six principles didn’t make the point clearly enough, I’ve added this as my seventh and final one.

Liberty isn’t just a luxury or a nice idea. It’s much more than a happy circumstance or a defensible everyday concept. It’s what makes just about everything else happen. Without it, life is a bore at best. At worst, there is no life at all.

Public policy that dismisses liberty or doesn’t preserve or strengthen it should be immediately suspect in the minds of a vigilant people. They should be asking, “What are we getting in return if we’re being asked to give up some of our freedom?” Hopefully, it’s not just some short-term handout or other “mess of pottage.” Ben Franklin went so far as to advise us, “Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.”

Too often today, policymakers give no thought whatsoever to the general state of liberty when they craft new policies. If it feels good or sounds good or gets them elected, they just do it. Anyone along the way who might raise liberty-based objections is ridiculed or ignored. Today, government at all levels consumes more than 42 percent of all that we produce, compared with perhaps 6 percent or 7 percent in 1900. Yet few people seem interested in asking the advocates of still more government such cogent questions as, “Why isn’t 42 percent enough?”; “How much more do you want?”; or, “To what degree do you think a person is entitled to the fruits of his labor?”

I yearn for the day when all Americans practice these seven principles. I think they are profoundly important. Our past devotion to them, in one form or another, explains how and why we fed, clothed and housed more people at higher levels than any other nation in the history of the planet. And these principles are key to preserving that crucial element of life we call liberty. Thanks for the opportunity to share them with you today and thanks for whatever you may do from this day forward to put these principles into common practice.

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The aim of this brief essay is to present a hypothesis that a major change in social and economic policy is preceded by a shift in the climate of intellectual opinion. The intellectual tide is spread to the public by all manner of intellectual retailers: teachers and preachers, journalists in print and on television, pundits and politicians.

There are powerful tides in the affairs of men, interpreted as the collective entity we call society, just as in the affairs of individuals. The tides in the affairs of society are slow to become apparent, as one tide begins to overrun its predecessor. Each tide lasts a long time—decades, not hours—once it begins to flood and leaves its mark on its successor even after it recedes.

In almost every tide a crisis can be identified as the catalyst for a major change in the direction of policy.

The Rise of Laissez Faire: The Adam Smith Tide

The first tide we will examine begins in 18th-century Scotland with a reaction against mercantilism expressed in the writings of David Hume, Adam Smith’s Theory of Moral Sentiments (1759), and above all The Wealth of Nations (1776). On the other side of the Atlantic 1776 also saw the proclamation of the Declaration of Independence, in many ways the political twin of Smith’s economics. Smith’s work quickly became common currency to the Founding Fathers. By the early 19th century the ideas of laissez faire, of the operation of the invisible hand, of the undesirability of government intervention into economic matters, had swept first the intellectual world and then public policy. Reinforced by pressures arising out of the Industrial Revolution, these ideas were beginning to affect public policy.

The repeal of the mercantilist Corn Laws in Britain in 1846 is generally regarded as the final triumph of Adam Smith after a 70-year delay. In fact some reductions in trade barriers had started much earlier, and many nonagricultural items continued to be protected by tariffs until 1874. So it took nearly a century for the completing of one response to Adam Smith.

American Experience

The other countries of Europe and the United States did not follow the British lead by establishing complete free trade in goods. However during most of the 19th century, U.S. duties on imports were primarily for revenue (not protection). Except for a few years after the War of 1812, customs provided between 90 and 100% of total Federal revenues up to the Civil War. And except for a few years during and after the Civil War, customs provided half or more of Federal revenues until the Spanish- American War at the end of the century. Nontariff barriers such as quotas were nonexistent. Movement of people and capital was hardly impeded at all.

In the triumphant ideas of Adam Smith offered both an explanation and an obvious alternative option; tariffs aside, near complete laissez faire and nonintervention reigned into the next century.

Measuring the role of government in the economy is not easy. One readily available, though admittedly imperfect, measure is the ratio of government spending to national income. At the height of laissez faire, peacetime government spending was less than 10% of national income in both the United States and Great Britain. Federal spending was generally less than 3% of national income, with half of that for the military.

On the broader scale the tide that swept the 19th century brought greater political as well as economic freedom. Despite occasional financial panics and crises, Britain and the United States experienced remarkable economic growth. The United States in particular became a Mecca for the poor of all lands. This was a result of the increasing adoption of laissez faire as the guiding principle of government policy.

The Rise of the Welfare State

This remarkable progress did not prevent the intellectual tide from turning away from individualism and toward collectivism. How can we explain this shift in the intellectual tide when the growing pains of laissez-faire policies had long been overcome and impressive positive gains had been achieved?

Two effects of the success of laissez faire fostered a reaction.

• First, success made residual evils stand out all the more sharply, both encouraging reformers to press for governmental solutions and making the public more sympathetic to their appeals.
• Second, it became more reasonable to anticipate that government would be effective in attacking the residual evils. A severely limited government has few favors to give. Hence there is little incentive to corrupt government officials, and government service has few attractions for people intent on personal enrichment.

Government was engaged primarily in enforcing laws against murder, theft, and the like and in providing municipal services such as local police and fire protection—activities that engendered almost unanimous citizen support. Britain, which went furthest toward complete laissez faire, became legendary in the late 19th and early 20th centuries for its incorruptible civil service and law-abiding citizenry—precisely the reverse of its reputation a century earlier.

But by 1900, the doctrine of laissez faire had more or less lost its hold upon the English people. In the United States the development was similar, though somewhat delayed. As late as 1929 Federal spending amounted to only 3.2% of the national income; one-half of this was spent on the military plus interest on the public debt. Spending by federal, state, and local governments on what today is described as income support, Social Security, and welfare totaled less than 1% of national income.

The world of ideas, however, was different. By 1929 socialism became the dominant ideology on the nation’s campuses. The New Republicand The Nation were the intellectuals’ favorite journals and [the socialist] Norman Thomas their political hero. The critical catalyst for a major change was, of course, the Great Depression, which shattered the public’s confidence in private enterprise, leading it to regard government involvement as the only effective recourse in time of trouble and to treat government as a potential benefactor rather than simply a policeman and umpire. The effect was dramatic. By the 1980s federal government spending grew to 30%, and total government spending was over 40% of national income. But spending alone cannot illustrate the role government came to play. Many intrusions into people’s lives involve little or no spending: tariffs and quotas, price and wage controls, ceilings on interest rates, local ceilings on rents, zoning regulations, building codes, and so on.

The Resurgence of Free Markets: The Hayek Tide

Throughout the ascendancy of socialist ideas there had, of course, been counter-currents—kept alive by Friedrich Hayek and some of his colleagues in Britain; by Ludwig von Mises and his disciples in Austria; and by Albert Jay Nock, H. L. Mencken, and others in the United States.

Hayek’s Road to Serfdom in 1944 was probably the first real inroad in the dominant intellectual view. Yet, at first, the impact of the free market on the dominant tide of intellectual opinion was minute. Even for those of us who were actively promoting free markets in the 1950s and 1960s it is difficult to recall how strong and pervasive was the intellectual climate of the times.

The tale of two books by the present authors, both directed at the general public and both promoting the same policies, provides striking evidence of the change in the climate of opinion. The first, Capitalism and Freedom, published in 1962 and destined to sell more than 400,000 copies in the next eighteen years, was not reviewed at the time in a single popular American periodical. The second, Free to Choose, published in 1980, was reviewed by every major publication and became the year’s best-selling nonfiction book in the United States with worldwide attention.

Further evidence of the change in the intellectual climate is the proliferation of think tanks promoting the ideas of limited government and reliance on free markets.

Translating Ideas into Action

The same contrast is true of publications. FEE’s Freeman was the only one we can think of that was promoting the ideas of freedom 30 to 40 years ago. Today numerous publications promote these ideas, though with great differences in specific areas: The Freeman, National Review, Human Events, The American Spectator, Policy Review, and Reason. Even the New Republic and The Nation are no longer the undeviating proponents of socialist orthodoxy that they were three decades ago.

Why this great shift in public attitudes? The persuasive power of such books as Friedrich Hayek’s Road to Serfdom, Ayn Rand’s Fountainhead and Atlas Shrugged, our own Capitalism and Freedom, and numerous others led people to think about the problem in a different way and to become aware that government failure was real.

Experience turned the great hopes that the collectivists and socialists had placed in Russia and China to ashes. Indeed, the only hope in those countries comes from recent moves toward the free market. Similarly, experience dampened, to put it mildly, the extravagant hopes placed in Fabian socialism and the welfare state in Britain and in the New Deal in the United States. One major government program after another, each started with the best of intentions, resulted in more problems than solutions.

Few today still regard nationalization of enterprises as a way to promote more efficient production. Few still believe that every social problem can be solved by throwing government (that is, taxpayer) money at it. In these areas liberal ideas—in the original nineteenth century meaning of liberal—have won the battle. The rising burden of taxation caused the general public to react against the growth of government and its spreading influence.

Ideas played a significant part, as in earlier episodes, by keeping options open, providing alternative policies to adopt when changes had to be made.

As in the two earlier waves, practice has lagged far behind ideas, so that both Britain and the United States are further from the ideal of a free society than they were 30 to 40 years ago in almost every dimension. In 1950 spending by U.S. federal, state, and local governments was 25% of national income; in 1985 it was 44%. In the past 30 years a host of new government agencies has been created: a Department of Education, a National Endowment for the Arts and another for the humanities, EPA, OSHA, and so on. Civil servants in these and many additional agencies decide for us what is in our best interest.

In both the United States and Britain respect for the law declined in the 20th century under the impact of the widening scope of government, strongly reinforced in the United States by Prohibition. The growing range of favors governments could give led to a steady increase in what economists call rent-seeking and what the public refers to as special-interest lobbying. Britain went further in the direction of collectivism than the United States and still remains more collectivist—with both a higher ratio of government spending to national income and far more extensive nationalization of industry.

Nonetheless, practice has started to change. The catalytic crisis sparking the change was, we believe, the worldwide wave of inflation during the 1970s, originating in excessively expansive monetary growth in the United States in the 1960s.

The episode was catalytic in two respects:

• First, stagflation destroyed the credibility of Keynesian monetary and fiscal policy and hence of the government’s capacity to fine-tune the economy;
• Second, it brought into play so-called “weight of taxation” through bracket creep and the implicit repudiation of government debt.

Already in the 1970s military conscription was terminated, airlines deregulated, and regulation Q, which limited the interest rates that banks could pay on deposits, eliminated. In 1982 the Civil Aeronautics Board that regulated the airlines was eliminated.

As in earlier waves, the tides of both opinion and practice have swept worldwide. The contrast between the stagnation of those poorer countries that engaged in central planning (India, the former African colonies, Central American countries) and the rapid progress of the few that followed a largely free-market policy (notably the Four Tigers of the Far East: Hong Kong, Singapore, Taiwan, and South Korea) strongly reinforced the experience of the advanced countries of the West.

All in all the force of ideas, propelled by the pressure of events, is clearly no respecter of geography or ideology or party label.

In Conclusion

Two new pairs of tides are now in their rising phases: in public opinion, toward renewed reliance on markets and more limited government. If the completed tides are any guide, the current wave in opinion is approaching middle age and in public policy is still in its infancy. Both are therefore still rising and the flood stage, certainly in affairs, is yet to come.

For those who believe in a free society and a narrowly limited role for government, that is reason for optimism, but it is not a reason for complacency. Nothing is inevitable about the course of history—however it may appear in retrospect. Because we live in a largely free society, we tend to forget how limited is the span of time and the part of the globe for which there has ever been anything like political freedom: the typical state of mankind is tyranny, servitude, and misery.

Once a tide in opinion or in affairs is strongly set, it tends to overwhelm counter-currents and to keep going for a long time in the same direction. The tides are capable of ignoring geography, political labels, and other hindrances to their continuance.

Yet it is also worth recalling that their very success tends to create conditions that may ultimately reverse them. The encouraging tide in affairs that is in its infancy can be still overwhelmed by a renewed tide of collectivism. The expanded role of government even in Western societies that pride themselves in being part of the free world has created many vested interests that will strongly resist the loss of privileges that they have come to regard as their right.

As a young economist, fresh from his Ph.D. studies at Columbia, Milton Friedman and George Stigler (a future fellow Nobel laureate) co-wrote one of FEE’s first monographs, Roofs or Ceilings? Widely regarded as the leader of the Chicago school of monetary economics, Friedman was senior research fellow at the Hoover Institution and Paul Snowden Russell Distinguished Service Professor of Economics, Emeritus, at the University of Chicago. He was awarded the Presidential Medal of Freedom in 1988 and received the National Medal of Science the same year. Milton Friedman and Rose D. Friedman were co-authors of Capitalism and Freedom, Free to Choose, and their memoirs, Two Lucky People.

CONTENTS

Download PDF

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!

***

For a complete list of titles, please visit our online store at www.fee.org.

Published by the Foundation for Economic Education

Printed in the United States of America

©2006 Foundation for Economic Education. All rights reserved.

ISBN 1-57246-209-4

09 08 07 06 4 3 2 1

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

1ST PRINTING………………….……………… JULY, 1946

2ND PRINTING………………….……………… JULY, 1946

3RD PRINTING………………….……………… AUGUST, 1946

4TH PRINTING………………….……………… OCTOBER, 1946

5TH PRINTING………………….……………… FEBRUARY,1947

6TH PRINTING………………….……………… FEBRUARY, 1948

Reader's Digest condensed version published August, 1946: February, 1948

Spanish edition (Editorial Kraft, Buenos Aires ) published December, 1947

Pocket Book edition published November, 1948

1ST PRINTING………………….……………… October,1948

Special edition for:

The Foundation for Economic Education, Inc.

May, 1952

BUY ME!

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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The term republic had a significant meaning for all early Americans. The form of government secured by the Declaration of Independence, the American Revolution, and the Constitution was unique, requiring strict limitation of government power. Powers that were permitted would be precisely defined and delegated by the people, with all public officials being bound by their oath of office to uphold the Constitution. The Constitution made it clear that the government was not to interfere with productive nonviolent human energy. This is the key element that has permitted America’s great achievements and made America the political and economic envy of the world. We have truly been blessed.

Today, however, the nature of a republic and the current status of our own form of government are of little concern to most Americans. But there is a small minority, ignored by politicians, academics, and the media, who do spend time thinking about the importance of the proper role of government. The comparison of today’s government with the one established by our Constitution is a matter worthy of deep discussion for those who concern themselves with the future and look beyond the coming election. Understanding the principles that were used to establish our nation is crucial to its preservation and something we cannot neglect.

In our early history, it was understood that a free society embraced both personal civil liberties and economic freedom. During the 20th century, this unified concept of freedom was undermined. Today we have one group talking about economic freedom while interfering with our personal liberty and the other group condemning economic liberty, while preaching the need to protect civil liberties. Both groups reject liberty fifty percent of the time. Sadly, there are very few in this country who today understand and defend liberty in both areas.

The Constitution Today

Many Americans wonder why Congress pays little attention to the Constitution and are bewildered as to how so much inappropriate legislation gets passed. But the Constitution is not entirely ignored. It is used correctly at times when it’s convenient and satisfies a particular goal, but never consistently across the board on all legislation. The Constitution is all too frequently made to say exactly what the authors of special legislation want it to say. That’s the modern way: language can be made relative to our times. But without a precise understanding and respect for the supreme law of the land, the Constitution no longer serves as the guide for the rule of law. In its place come the rule of man and special interests.

That’s how we have arrived in the 21st century without a clear understanding or belief in the cardinal principles of the Constitution—the separation of powers and the tenets of federalism. Instead, we are rushing toward centralized control. Executive Orders, agency regulations, federal court rulings, and unratified international agreements direct our government, economy, and foreign policy.

Congress has truly been reduced in status and importance over the past hundred years. And when the people’s voices are heard, it’s done indirectly through polling, allowing our leaders to decide how far they can go without stirring up their constituents. This is opposite to what the Constitution was supposed to do: protect the rights of the minority from the abuses of the majority. The majority vote of the powerful and the influential was never meant to rule the people. 

In a free society individuals should control their own lives, receiving the benefits and suffering the consequences of their actions. Once the individual becomes a pawn of the state, whether a monarch or a majority is in charge, a free society can no longer endure. We are dangerously close to that happening in America, even in the midst of plenty and with the appearance of contentment. If individual freedom is carelessly snuffed out, the creative energy needed for productive pursuits will dissipate. Government produces nothing, and in its effort to redistribute wealth, can only destroy it.

Freedom too often is rejected when there is a belief that government largesse will last forever. This is true because it is tough to accept personal responsibility, practice the work ethic, and follow the rules of peaceful coexistence with our fellow man. The temptation is great to accept the notion that everyone can be a beneficiary of the caring state and a winner of the lottery or a class-action lawsuit. But history has proven there is never a shortage of authoritarians—benevolent, of course—quite willing to tell others how to live for their own good.

Worth the Effort

Some of my good friends suggest that it is a waste of time and effort to try to change the direction in which we are going. No one will listen, they argue, and the development of a strong centralized authoritarian government is too far along to reverse the trends of the last century. Why waste time in Congress when so few people care about liberty? The masses, they point out, are interested only in being taken care of, and the elites want to keep receiving the benefits allotted to them through special-interest legislation.

I am not naive enough to believe the effort to preserve liberty is a cakewalk. But ideas, based on sound and moral principles, do have consequences. Our Founders clearly understood this, knowing they would be successful, even against overwhelming odds. They described this steady confidence, which they shared with each other when hopes were dim, as “divine providence.”

The good news today is that our numbers are growing. More Americans than ever before are very much aware of what’s going on in Washington and how, on a daily basis, their liberties are being undermined. There are more think tanks than ever before promoting the market economy, private property ownership, and personal liberty. Millions of Americans are sick and tired of being overtaxed and despise the income tax and the inheritance tax. The majority of Americans know government programs fail to achieve their goals and waste huge sums of money. Sentiment is moving in the direction of challenging the status quo of the welfare and international warfare state. The Internet has given hope to millions who have felt their voices were not being heard. And this influence is just beginning. The three major networks and conventional government propaganda no longer control the information now available to anyone with a computer.

We face tough odds, but to avoid battle or believe there is a place to escape to someplace else in the world would concede victory to those who endorse authoritarian government. The grand experiment in human liberty must not be abandoned. A renewed hope and understanding of liberty are what we need today.

An Agenda for Achieving Freedom

We know that the idea of perfect socialism is an oxymoron. Pursuing utopia throughout the last century has already caused untold human suffering. That’s why the clear goal of a free society must be understood and sought or the vision of the authoritarians will face little resistance and will easily fill the void. There are precise goals we should work for, even under today’s difficult circumstances. We must legalize freedom to the maximum extent possible:

1. Complete police protection is impossible; therefore we must preserve the right to own weapons in self defense.
2. In order to maintain economic protection against government debasement of the currency, gold ownership must be preserved—something taken away from the American people during the Great Depression.
3. Adequate retirement protection by the government is limited, if not ultimately impossible. We must allow every citizen the opportunity to control all his or her retirement funds.
4. Government education has clearly failed. We must guarantee the right of families to homeschool or send their kids to private schools and help them with tax credits.
5. Government snooping must be stopped. We must work to protect all our privacy, especially on the Internet, prevent the National ID Card, and stop the development of all government data banks.
6. Federal police functions are unconstitutional and increasingly abusive. We should disarm all federal bureaucrats and return the police function to local authorities.
7. The army was never meant to be used in local policing activities. We must firmly prohibit our presidents from using the military in local law-enforcement operations, which is now being implemented under the guise of fighting terrorism.
8. Foreign military intervention by our presidents in recent years is a costly failure. Foreign military intervention should not be permitted without explicit congressional approval.
9. Competitions in all elections should be guaranteed, and the monopoly powers gained by the two major parties through unfair signature requirements, high fees, and campaign donation controls should be removed. Competitive parties should be allowed in all government-sponsored debates.
10. We must do whatever is possible to help instill a spiritual love for freedom and recognize that our liberties depend on responsible individuals, not the group or the collective or society as a whole. The individual is the building block of a free and prosperous social order.

The Founders knew full well that the concept of liberty was fragile and could easily be undermined. They worried about the dangers that lay ahead. As we face today’s extraordinary challenges it is an appropriate time to rethink the principles upon which a free society rests. 

Thomas Jefferson, concerned about the future, wrote: “Yes, we did produce a near-perfect republic. But will they keep it? Or will they, in the enjoyment of plenty, lose the memory of freedom? Material abundance without character is the path of destruction.” “They” that he refers to are “ we.” And the future is now. Freedom, Jefferson knew, would produce “plenty,” and with “material abundance” it’s easy to forget the responsibility the citizens of a free society must assume if freedom and prosperity are to continue. The key element for the Republic’s survival for Jefferson was the “character” of the people, something no set of laws can instill. The question today is not that of abundance, but of character, respect for others, their liberty and their property. It is the character of the people that determines the proper role for government in a free society.

Samuel Adams, likewise, warned future generations. He referred to “good manners” as the vital ingredient a free society needs to survive. Adams said: “Neither the wisest Constitution nor the wisest laws will secure the liberty and happiness of a people whose manners are universally corrupt.”

The message is clear-if we lose our love of liberty and our manners become corrupt, character is lost and so is the Republic.

But character is determined by free will and personal choice by each of us individually. Character can be restored or cast aside at a whim. The choice is ours alone and our leaders should show the way.

Character and good manners are not a government problem. They reflect individual attitudes that can only be changed by individuals themselves. Freedom allows virtue and excellence to blossom. When government takes on the role of promoting virtue, illegitimate government force is used, and tyrants quickly appear on the scene to do the job. Virtue and excellence become illusive, and we find instead that the government officials become corrupt and freedom is lost—the very ingredient required for promoting virtue, harmony, and the brotherhood of man.

Let’s hope and pray that our focus will shift toward preserving liberty and individual responsibility and away from authoritarianism. The future of the American Republic depends on it. Let us not forget the American dream depends on keeping alive the spirit of liberty.

Congressman Ron Paul of Texas is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies. Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the “one exception to the Gang of 535” on Capitol Hill. Dr. Paul is the author of several books, including The Case for Gold and A Republic, If You Can Keep It.

It’s a great pleasure to join FEE for their “Saturday Night Live” and to be among both old friends and many new ones. Several years ago Candace and I taught one of the FEE student seminars here together. The experience was so wonderful that I married her!

My message today is an optimistic one. It is about exchange and markets, which allow us to engage in task and knowledge specialization. It is this specialization that is the secret of all wealth creation and the only source of sustainable human betterment. This is the essence of globalization.

The challenge is that we all function simultaneously in two overlapping worlds of exchange. First, we live in a world of personal, social exchange based on reciprocity and shared norms in small groups, families, and communities. The phrase “I owe you one” is a human universal across many languages in which people voluntarily acknowledge indebtedness for a favor. From primitive times, personal exchange allowed specialization of tasks (hunting, gathering, and tool making) and laid the basis for enhanced productivity and welfare. This division of labor made it possible for early men to migrate all over the world. Thus, specialization started globalization long before the emergence of formal markets.

Second, we live in a world of impersonal market exchange where communication and cooperation gradually developed through long-distance trade between strangers. In acts of personal exchange we usually intend to do good for others. In the marketplace this perception is often lost as each of us tends to focus on our own personal gain. However, our controlled laboratory experiments demonstrate that the same individuals who go out of their way to cooperate in personal exchange strive to maximize their own gain in a larger market. Without intending to do so, in their market transactions they also maximize the joint benefit received by the group. Why? Because of property rights. In personal exchange the governing rules emerge by voluntary consent of the parties. In impersonal market exchange, the governing rules—such as property rights, which prohibit taking without giving in return—are encoded in the institutional framework. Hence the two worlds of exchange function in a similar way: you have to give in order to receive.

The Foundation of Prosperity

Commodity and service markets, which are the foundation of wealth creation, determine the extent of specialization. In organized markets, producers experience relatively predictable costs of production, and consumers rely on a relatively predictable supply of valued goods. These constantly repeated market activities are incredibly efficient, even in very complex market relationships with multiple commodities being traded.

We have also discovered through our market experiments that people generally deny that any kind of model can predict their final trading prices and the volume of goods they will buy and sell. In fact, market efficiency does not require a large number of participants, complete information, economic understanding, or any particular sophistication. After all, people were trading in markets long before there existed any economists to study the market process. All you have to know is when you are making more money or less money and whether you have a chance to modify your actions.

The hallmark of commodity and service markets is diversity—a diversity of tastes, human skills, knowledge, natural resources, soil, and climate. But diversity without freedom to exchange implies poverty. No human being, even if abundantly endowed with a single skill or a single resource, can prosper without trade. Through free markets we depend on others whom we do not know, recognize, or even understand. Without markets we would indeed be poor, miserable, brutish, and ignorant.

Markets require consensual enforcement of the rules of social interaction and economic exchange. No one has said it better than David Hume over 250 years ago—there are just three laws of nature: the right of possession, transference by consent, and the performance of promises. These are the ultimate foundations of order that make possible markets and prosperity.

Hume’s laws of nature derive from the ancient commandments: thou shalt not steal, thou shalt not covet thy neighbor’s possessions, and thou shalt not bear false witness. The “stealing” game consumes wealth and discourages its reproduction. Coveting the property of others invites a coercive state to redistribute wealth, thus endangering incentives to produce tomorrow’s harvest. Bearing false witness undermines community, management credibility, investor trust, long-term profitability, and the personal exchanges that are most humanizing.

Only Markets Deliver the Goods

Economic development is linked with free economic and political systems nurtured by the rule of law and private property rights. Strong centrally planned regimes, wherever attempted, have failed to deliver the goods. There are, however, plenty of examples of both big and small countries (from China to New Zealand and Ireland) where governments have removed at least some barriers to economic freedom. These countries have witnessed remarkable economic growth by simply letting people pursue their own economic betterment.

China has moved considerably in the direction of economic freedom. Just over a year ago China revised its constitution to allow people to own, buy, and sell private property. Why? One of the problems the Chinese government encountered was that people were buying and selling property even though those transactions were not recognized by the government. This invited local officials to collect from those who were breaking the law by trading. By recognizing property rights, the central government is trying to undercut the source of power that supports local bureaucratic corruption, which is very hard to centrally monitor and control. This constitutional change, as I see it, is a practical means to limit rampant government corruption and political interference with economic development.

Though this change has not resulted from any political predisposition for liberty, it may very well pave the way toward a freer society. The immediate benefits are already there: 276 of the Fortune 500 companies are currently investing in a huge R&D park near Beijing, based on very favorable 50-year lease terms from the Chinese government.

The case of Ireland illustrates the principle that you don’t have to be a big country to grow wealthy through liberalizing government economic policy. In the past, Ireland was a major exporter of people. This worked to the advantage of the United States and Great Britain, who received many bright Irish immigrants fleeing the stultifying life of their homeland. Only two decades ago Ireland was mired in third-world poverty, but has now surpassed its former colonial master in income per capita, becoming a committed European player. According to World Bank statistics, Ireland’s growth rate of Gross Domestic Product (GDP) jumped from 3.2% in the 1980s to 7.8% in the 1990s. Ireland recently was the eighth highest in GDP per capita in the world, while the United Kingdom was 15th. By fostering direct foreign investment (including venture capital) and promoting financial services and information technology, Ireland has experienced a formidable brain-drain reversal—young people are coming back home.

These young people are returning because of new opportunities made possible by expansion of economic freedom in their homeland. They are examples of “can-do” knowledge-based entrepreneurs who are creating wealth and human betterment not only for their native country, but also for the United States and all other countries around the world. These people’s stories demonstrate how bad government policies can be changed to create new economic opportunities that can dramatically reverse a country’s brain drain.

We Have Nothing to Fear

An essential part of the process of change, growth, and economic betterment is to allow yesterday’s jobs to follow the path of yesterday’s technology. Preventing domestic companies from outsourcing will not stop their foreign competitors from doing so. Through outsourcing, foreign competitors will be able to lower their costs, use the savings to lower prices and upgrade technology, and thus gain a big advantage in the market.

One of the best-known examples of outsourcing was the New England textile industry’s move to the South after World War II in response to lower wages in the Southern states. (As was to be expected, this raised wages in the South, and the industry eventually had to move on to lower-cost sources in Asia.)

But the jobs did not vanish in New England. The textile business was replaced by high-tech industries: electronic information and biotechnology. This resulted in huge net gains to New England even though it lost what had once been an important industry. In 1965 Warren Buffett gained control of Berkshire-Hathaway, one of those fading textile makers in Massachusetts. He used the company’s large but declining cash flow as a launch pad for reinvesting the money in a host of undervalued business ventures. They became famously successful, and 40 years later Buffett’s company has a market capitalization of $113 billion. The same transition is occurring today with K-Mart and Sears Roebuck. Nothing is forever: as old businesses decline, their resources are diverted to new ones.

The National Bureau of Economic Research has just reported a new study of domestic and foreign investment by U.S. multinational corporations. The study demonstrated that for every dollar invested in a foreign country, they invest three and a half dollars in the United States. This proves that there is a complementary relationship between foreign and domestic investment: when one increases, the other increases as well. McKinsey and Company estimates that for every dollar U.S. companies outsource to India, $1.14 accrues to benefit of the United States. About half of this benefit is returned to investors and customers and most of the remainder is spent on new jobs that have been created. By contrast, in Germany every Euro invested abroad only generates an 80% benefit to the domestic economy, mainly because the reemployment rate of displaced German workers is so much lower due to the vast number of government regulations.

I believe that as long as the United States remains number one on the world innovation index, we have nothing to fear from outsourcing and much to fear if our politicians succeed in opposing it. According to the Institute for International Economics, more than 115,000 higher-paying computer software jobs were created in 1999–2003, while 70,000 jobs were eliminated due to outsourcing. Similarly in the service sector 12 million new jobs were being created while 10 million old jobs were being replaced. This phenomenon of rapid technological change and the replacement of old jobs with new ones is what economic development is all about.

By outsourcing to foreign countries, American businesses save money that enables them to invest in new technologies and new jobs in order to remain competitive in the world market. Unfortunately we cannot enjoy the benefits without incurring the pain of transition. Change is certainly painful. It is painful for those who lose their jobs and must seek new careers. It is painful for those who risk investment in new technologies and lose. But the benefits captured by winners generate great new wealth for the economy as a whole. These benefits, in turn, are consolidated across the market through the discovery process and competitive learning experience.

Globalization is not new. It is a modern word describing an ancient human movement, a word for mankind’s search for betterment through exchange and the worldwide expansion of specialization. It is a peaceful word. In the wise pronouncement of the great French economist Frederic Bastiat, if goods don’t cross borders, soldiers will.

^*Dr. Vernon Smith, Professor of Economics and Law at George Mason University, grew up on a farm in Kansas, during the Great Depression. His dream always was to go to college. His diligence was rewarded, and he became a Caltech student majoring in electrical engineering. As a senior, he became intrigued by economics and stumbled upon his first free-market book—Mises’ Human Action. Economics became his calling, and he earned an economics Ph.D. at Harvard in 1955—and the rest is history. In 2002 Dr. Vernon L. Smith was awarded the Nobel Prize in Economics for laying "the foundation for experimental economics."

If the wonders of the physical world and the complexities of our own biology often seem miraculous to us, we should be no less awestruck at the miracle of the marketplace. Just as the forces of gravity and the internal chemistry of our bodies operate without conscious human intervention and control to direct or regulate them, so too the market brings together the actions of multitudes of producers with the desires and demands of an equivalent multitude of buyers with no central directing and commanding hand overseeing the processes at work. Just as most of nature and much of human biology are “self-regulating,” so too is the greater part of our economic activities in society.

The Market Knows More than We Can Ever Master

Day in and day out we give little thought to the vast and complex array of economic processes, which if they were to stop or severely malfunction would mean hardship or even disaster for many of us. The supermarkets are daily replenished with wide varieties of fruits, vegetables, meats, canned and packaged goods, dairy products, and many other items. We crowd the shopping malls and find them filled with practically every conceivable commodity we can imagine, with each of them offered in attractive and diverse varieties. Just think of the wide spectrum of shoes and clothes placed at our disposal in those malls as an example of this. And if we do not want the inconveniences and irritations of crowded shopping areas, a growing number of us now do an increasing amount of our shopping over the internet with the mere click of the “mouse.”

Even if we wanted to fully understand how all those goods are actually brought to the marketplace for our various wants and desires, virtually none of us would be able to trace through all the intricate ways by which our demands are satisfied. Back in 1958, Leonard Read, the founder of FEE, wrote a famous essay titled “I, Pencil.” He outlined a history of manufacturing a simple old-fashioned wooden pencil, from a tree being cut down in a forest and the mining of the graphite in a faraway country to its assembly and finished form so that it might be readily available for purchase by any of us in some neighborhood store. Read’s central insight was to remind us that no one individual or even wise and informed group of us possesses all the knowledge or information that has gone into that pencil’s manufacture.

Furthermore, it is not necessary for anyone to fully understand the processes involved in making that pencil for it to be available to us and our uses for such a writing instrument. Indeed, if it were required for some mastermind to know all that is needed to know to make all of the goods offered to us everyday on the market, the variety of goods available to us would be both fewer in number and poorer in quality.

Market Competition and the Price System

How are the activities of an increasingly larger group of individuals successfully coordinated, so that all the multitudes of demands and supplies are brought into balance and harmony? The Austrian economist and Nobel Laureate Friedrich Hayek showed how all of the knowledge and information in society can be encapsulated in the price system of the free-market economy. In our roles as both consumers and producers we communicate to one another what we think goods, resources, capital, and labor services are worth to us in their various and competing uses through the prices we are willing to pay for them. These “price signals” serve as the means for all of us to decide and coordinate what we want and are willing to do together with other members of society.

Thus, and indeed quite miraculously, it is not necessary for an “economic czar” to rule over and command us in our everyday market activities to assure that a vast quantity of food gets to the supermarkets or that thousands of different varieties of goods are constantly available in the shopping malls or other stores and businesses throughout the land. Each individual finds his own corner of specialization — guided by those opportunities, expressed in market prices, that seem to offer the greatest likelihood of earning an income that will enable him to buy from others all of the goods he himself desires.

Competition in these voluntary interactions of the market helps us to discover where each of us can best serve our fellow men within the system of division of labor while pursuing our own personal interests. The competitive process tests us through the reward of profits and the penalties of losses. Profits lure us into those production activities that our neighbors, as consumers, want us to do more of. Losses warn us that we have undertaken production actions that those same neighbors think are not worth the costs of our continuing to do them in the same way.

No overseer’s whip is needed to prod people to do more of some things and less of others. No paternalistic planner is needed to assure that everything that is wanted is produced and in the most economically cost-efficient way. No restraining regulations and controls are needed to hamper the free choices and actions of the multitudes of millions in society — other than the crucial and general legal rules against murder, theft, and fraud in our dealings with one another.

Mutual agreement and voluntary consent are the bases of these market relationships. It is not the police power of the government, with its use or the threat of violence and force, that compels the cooperation and collaboration of humanity.

The Morality of Market Relationships

There is also an important moral element in this functioning free-market economy. There are none who are only masters and others who are simply servants. In the market society we are all both servants and masters, but without either force or its threat. In our roles as producers — be it as men who hire out our labor for wages, resource owners who rent out or sell our property for a price, or entrepreneurs who direct production for anticipated profits — we serve our fellow men in attempting to make the products and provide the services we think they may be willing and interested in buying from us.

“Service with a smile” and “the customer is always right” are hallmarks of the seller’s deference to those to whom they offer their supplies. What motivates such attitudes is the fact that in an open, competitive market no one can compel us to buy from a seller who offers something less attractive or more costly than what some rival of his is presenting to us for our consideration. And why are we interested in not offending or driving away some potential customer into the arms of our rival suppliers? Because only by successfully making the better and less expensive product can we hope to earn the income that then enables us to re-enter the market, now in the role of consumer and demander of what our neighbors are offering to sell to us.

As consumers, we become the “masters” who those same neighbors attempt to satisfy with newer, better, and cheaper products. Now those whom we have served defer to us. We “command” them, not through the use of force but through the attraction of our demand and the money we offer for the goods they bring to the market. By how much we can “command” the service of others in the market in our role as consumer is directly related to the extent we have been successful in our service to our neighbors as reflected in the money income we have earned from satisfying their wants and desires.

In a free society, no man is required to do work or supply any good he considers morally wrong and ethically questionable. He may earn less from choosing to supply something that is valued less highly in the market, but he cannot be forced to produce anything that God and/or conscience dictates to be wrong. On the other hand, we cannot prevent others from supplying a good or service we find morally objectionable. The ethics of liberty and the free market require that we use only morally justifiable means to stop our neighbors from demanding and supplying something that offends us. We must use reason, persuasion, and example of a better and more right way to live.

Unfortunately, too many of our fellow men want to preserve or extend a return to a form of a slave society — regardless of the name under which it is presented. Too many want to dictate how others may make a living, or at what price and under what terms they may peacefully and voluntarily interact with their fellow human beings for purposes of mutual material, cultural, and spiritual betterment.

Moral Courage for Winning Freedom

Our task, for those of us who understand and care deeply about human liberty, is to reawaken in our fellow men an awareness of the miracle and morality of the market. The task, I know, seems daunting. But it must have seemed that way to our American Founding Fathers when they heralded the truth of the unalienable rights of man for which they fought and then won a revolution, or when advocates of economic freedom first made the case for the free market.

The world was transformed by these ideals of the morality of free men in free markets. What is most important is that each of us understands as best we can the miracle and the morality of the market economy. Too often the friends of freedom allow the advocates of various forms of government regulation, control, and redistribution to set the terms of the debate. Freedom will not win if we do not put those proponents of political paternalism on the defensive.

By what moral right do they claim to tell other men how to peacefully go about their private and market affairs — as long as those men do not use murder, theft, or fraud in their dealings with others? By what ethical norm do those political paternalists declare their right to take that which others have honestly acquired through production and trade, and redistribute it without the voluntary consent of those from whom it has been taken? By what assertion of superior wisdom and knowledge do they presume to know more than the individual minds of all the members of society about how the market should go about the business of manufacturing all the things we want, and matching the demands with the supplies?

Defenders of individual freedom and the market economy have nothing to be ashamed or fearful of in advocating the free society. The American system of limited government, personal liberty, and free enterprise liberated the individual creativity and energies of many millions of people. It provided the greatest opportunity for individual betterment and the highest standard of living ever experienced in human history. It also generated the most charitable and philanthropic society in the world. Therefore, it should be the critics and opponents of this system of individual freedom that should have to justify their continuing calls for reducing our liberty.

It was clear thinking and moral courage that won men liberty in the past. Liberty can triumph again, if each of us is willing but to try. We need to take to heart the words of the free-market Austrian economist and long-time FEE senior adviser, Ludwig von Mises: “Everyone carries a part of society on his shoulders; no one is relieved of his share of responsibility by others. And no one can find a safe way out for himself if society is sweeping towards destruction…. What is needed to stop the trend toward socialism and despotism is common sense and moral courage.”

Dr. Richard Ebeling, the president of the Foundation for Economic Education, has been a long-time friend of liberty. He has not only written and lectured about the cause of freedom, he has also lived it. In 1991, while consulting on market reform and privatization in the former Soviet Union, he joined the defenders of freedom and faced Soviet tanks in Vilnius, Lithuania, and again in Moscow, Russia, during the attempted hard-line communist coup d’état.

The aim of this brief essay is to present a hypothesis that a major change in social and economic policy is preceded by a shift in the climate of intellectual opinion. The intellectual tide is spread to the public by all manner of intellectual retailers: teachers and preachers, journalists in print and on television, pundits and politicians.

There are powerful tides in the affairs of men, interpreted as the collective entity we call society, just as in the affairs of individuals. The tides in the affairs of society are slow to become apparent, as one tide begins to overrun its predecessor. Each tide lasts a long time—decades, not hours—once it begins to flood and leaves its mark on its successor even after it recedes.

In almost every tide a crisis can be identified as the catalyst for a major change in the direction of policy.

The Rise of Laissez Faire: The Adam Smith Tide

The first tide we will examine begins in 18th-century Scotland with a reaction against mercantilism expressed in the writings of David Hume, Adam Smith’s Theory of Moral Sentiments (1759), and above all The Wealth of Nations (1776). On the other side of the Atlantic 1776 also saw the proclamation of the Declaration of Independence, in many ways the political twin of Smith’s economics. Smith’s work quickly became common currency to the Founding Fathers. By the early 19th century the ideas of laissez faire, of the operation of the invisible hand, of the undesirability of government intervention into economic matters, had swept first the intellectual world and then public policy. Reinforced by pressures arising out of the Industrial Revolution, these ideas were beginning to affect public policy.

The repeal of the mercantilist Corn Laws in Britain in 1846 is generally regarded as the final triumph of Adam Smith after a 70-year delay. In fact some reductions in trade barriers had started much earlier, and many nonagricultural items continued to be protected by tariffs until 1874. So it took nearly a century for the completing of one response to Adam Smith.

American Experience

The other countries of Europe and the United States did not follow the British lead by establishing complete free trade in goods. However during most of the 19th century, U.S. duties on imports were primarily for revenue (not protection). Except for a few years after the War of 1812, customs provided between 90 and 100% of total Federal revenues up to the Civil War. And except for a few years during and after the Civil War, customs provided half or more of Federal revenues until the Spanish- American War at the end of the century. Nontariff barriers such as quotas were nonexistent. Movement of people and capital was hardly impeded at all.

In the triumphant ideas of Adam Smith offered both an explanation and an obvious alternative option; tariffs aside, near complete laissez faire and nonintervention reigned into the next century.

Measuring the role of government in the economy is not easy. One readily available, though admittedly imperfect, measure is the ratio of government spending to national income. At the height of laissez faire, peacetime government spending was less than 10% of national income in both the United States and Great Britain. Federal spending was generally less than 3% of national income, with half of that for the military.

On the broader scale the tide that swept the 19th century brought greater political as well as economic freedom. Despite occasional financial panics and crises, Britain and the United States experienced remarkable economic growth. The United States in particular became a Mecca for the poor of all lands. This was a result of the increasing adoption of laissez faire as the guiding principle of government policy.

The Rise of the Welfare State

This remarkable progress did not prevent the intellectual tide from turning away from individualism and toward collectivism. How can we explain this shift in the intellectual tide when the growing pains of laissez-faire policies had long been overcome and impressive positive gains had been achieved?

Two effects of the success of laissez faire fostered a reaction.

• First, success made residual evils stand out all the more sharply, both encouraging reformers to press for governmental solutions and making the public more sympathetic to their appeals.
• Second, it became more reasonable to anticipate that government would be effective in attacking the residual evils. A severely limited government has few favors to give. Hence there is little incentive to corrupt government officials, and government service has few attractions for people intent on personal enrichment.

Government was engaged primarily in enforcing laws against murder, theft, and the like and in providing municipal services such as local police and fire protection—activities that engendered almost unanimous citizen support. Britain, which went furthest toward complete laissez faire, became legendary in the late 19th and early 20th centuries for its incorruptible civil service and law-abiding citizenry—precisely the reverse of its reputation a century earlier.

But by 1900, the doctrine of laissez faire had more or less lost its hold upon the English people. In the United States the development was similar, though somewhat delayed. As late as 1929 Federal spending amounted to only 3.2% of the national income; one-half of this was spent on the military plus interest on the public debt. Spending by federal, state, and local governments on what today is described as income support, Social Security, and welfare totaled less than 1% of national income.

The world of ideas, however, was different. By 1929 socialism became the dominant ideology on the nation’s campuses. The New Republicand The Nation were the intellectuals’ favorite journals and [the socialist] Norman Thomas their political hero. The critical catalyst for a major change was, of course, the Great Depression, which shattered the public’s confidence in private enterprise, leading it to regard government involvement as the only effective recourse in time of trouble and to treat government as a potential benefactor rather than simply a policeman and umpire. The effect was dramatic. By the 1980s federal government spending grew to 30%, and total government spending was over 40% of national income. But spending alone cannot illustrate the role government came to play. Many intrusions into people’s lives involve little or no spending: tariffs and quotas, price and wage controls, ceilings on interest rates, local ceilings on rents, zoning regulations, building codes, and so on.

The Resurgence of Free Markets: The Hayek Tide

Throughout the ascendancy of socialist ideas there had, of course, been counter-currents—kept alive by Friedrich Hayek and some of his colleagues in Britain; by Ludwig von Mises and his disciples in Austria; and by Albert Jay Nock, H. L. Mencken, and others in the United States.

Hayek’s Road to Serfdom in 1944 was probably the first real inroad in the dominant intellectual view. Yet, at first, the impact of the free market on the dominant tide of intellectual opinion was minute. Even for those of us who were actively promoting free markets in the 1950s and 1960s it is difficult to recall how strong and pervasive was the intellectual climate of the times.

The tale of two books by the present authors, both directed at the general public and both promoting the same policies, provides striking evidence of the change in the climate of opinion. The first, Capitalism and Freedom, published in 1962 and destined to sell more than 400,000 copies in the next eighteen years, was not reviewed at the time in a single popular American periodical. The second, Free to Choose, published in 1980, was reviewed by every major publication and became the year’s best-selling nonfiction book in the United States with worldwide attention.

Further evidence of the change in the intellectual climate is the proliferation of think tanks promoting the ideas of limited government and reliance on free markets.

Translating Ideas into Action

The same contrast is true of publications. FEE’s Freeman was the only one we can think of that was promoting the ideas of freedom 30 to 40 years ago. Today numerous publications promote these ideas, though with great differences in specific areas: The Freeman, National Review, Human Events, The American Spectator, Policy Review, and Reason. Even the New Republic and The Nation are no longer the undeviating proponents of socialist orthodoxy that they were three decades ago.

Why this great shift in public attitudes? The persuasive power of such books as Friedrich Hayek’s Road to Serfdom, Ayn Rand’s Fountainhead and Atlas Shrugged, our own Capitalism and Freedom, and numerous others led people to think about the problem in a different way and to become aware that government failure was real.

Experience turned the great hopes that the collectivists and socialists had placed in Russia and China to ashes. Indeed, the only hope in those countries comes from recent moves toward the free market. Similarly, experience dampened, to put it mildly, the extravagant hopes placed in Fabian socialism and the welfare state in Britain and in the New Deal in the United States. One major government program after another, each started with the best of intentions, resulted in more problems than solutions.

Few today still regard nationalization of enterprises as a way to promote more efficient production. Few still believe that every social problem can be solved by throwing government (that is, taxpayer) money at it. In these areas liberal ideas—in the original nineteenth century meaning of liberal—have won the battle. The rising burden of taxation caused the general public to react against the growth of government and its spreading influence.

Ideas played a significant part, as in earlier episodes, by keeping options open, providing alternative policies to adopt when changes had to be made.

As in the two earlier waves, practice has lagged far behind ideas, so that both Britain and the United States are further from the ideal of a free society than they were 30 to 40 years ago in almost every dimension. In 1950 spending by U.S. federal, state, and local governments was 25% of national income; in 1985 it was 44%. In the past 30 years a host of new government agencies has been created: a Department of Education, a National Endowment for the Arts and another for the humanities, EPA, OSHA, and so on. Civil servants in these and many additional agencies decide for us what is in our best interest.

In both the United States and Britain respect for the law declined in the 20th century under the impact of the widening scope of government, strongly reinforced in the United States by Prohibition. The growing range of favors governments could give led to a steady increase in what economists call rent-seeking and what the public refers to as special-interest lobbying. Britain went further in the direction of collectivism than the United States and still remains more collectivist—with both a higher ratio of government spending to national income and far more extensive nationalization of industry.

Nonetheless, practice has started to change. The catalytic crisis sparking the change was, we believe, the worldwide wave of inflation during the 1970s, originating in excessively expansive monetary growth in the United States in the 1960s.

The episode was catalytic in two respects:

• First, stagflation destroyed the credibility of Keynesian monetary and fiscal policy and hence of the government’s capacity to fine-tune the economy;
• Second, it brought into play so-called “weight of taxation” through bracket creep and the implicit repudiation of government debt.

Already in the 1970s military conscription was terminated, airlines deregulated, and regulation Q, which limited the interest rates that banks could pay on deposits, eliminated. In 1982 the Civil Aeronautics Board that regulated the airlines was eliminated.

As in earlier waves, the tides of both opinion and practice have swept worldwide. The contrast between the stagnation of those poorer countries that engaged in central planning (India, the former African colonies, Central American countries) and the rapid progress of the few that followed a largely free-market policy (notably the Four Tigers of the Far East: Hong Kong, Singapore, Taiwan, and South Korea) strongly reinforced the experience of the advanced countries of the West.

All in all the force of ideas, propelled by the pressure of events, is clearly no respecter of geography or ideology or party label.

In Conclusion

Two new pairs of tides are now in their rising phases: in public opinion, toward renewed reliance on markets and more limited government. If the completed tides are any guide, the current wave in opinion is approaching middle age and in public policy is still in its infancy. Both are therefore still rising and the flood stage, certainly in affairs, is yet to come.

For those who believe in a free society and a narrowly limited role for government, that is reason for optimism, but it is not a reason for complacency. Nothing is inevitable about the course of history—however it may appear in retrospect. Because we live in a largely free society, we tend to forget how limited is the span of time and the part of the globe for which there has ever been anything like political freedom: the typical state of mankind is tyranny, servitude, and misery.

Once a tide in opinion or in affairs is strongly set, it tends to overwhelm counter-currents and to keep going for a long time in the same direction. The tides are capable of ignoring geography, political labels, and other hindrances to their continuance.

Yet it is also worth recalling that their very success tends to create conditions that may ultimately reverse them. The encouraging tide in affairs that is in its infancy can be still overwhelmed by a renewed tide of collectivism. The expanded role of government even in Western societies that pride themselves in being part of the free world has created many vested interests that will strongly resist the loss of privileges that they have come to regard as their right.

Milton Friedman, one of the 20th century’s most eloquent spokesmen for liberty, died on November 16, 2006. His long and successful life was a celebration of the American Dream. Born in 1912 to poor Jewish immigrants in New York City, Friedman received the best education America could offer: a B.A. from Rutgers University, an M.A. from the University of Chicago, and a Ph.D. from Columbia University. In 1976 Milton Friedman won the Nobel Prize in Economics.

As a young economist, fresh from his Ph.D. studies at Columbia, Milton Friedman and George Stigler (a future fellow Nobel laureate) co-wrote one of FEE’s first monographs, Roofs or Ceilings? Widely regarded as the leader of the Chicago school of monetary economics, Friedman was senior research fellow at the Hoover Institution and Paul Snowden Russell Distinguished Service Professor of Economics, Emeritus, at the University of Chicago. He was awarded the Presidential Medal of Freedom in 1988 and received the National Medal of Science the same year. Milton Friedman and Rose D. Friedman were co-authors of Capitalism and Freedom, Free to Choose, and their memoirs, Two Lucky People.

Friedman’s evaluation corresponds to Hong Kong’s consistent ranking at the top of both the Heritage Foundation’s Index of Economic Freedom and the Fraser Institute’s Economic Freedom of the World reports. In the 2008 Index, for example, Hong Kong scored 90 percent or better on seven of the ten measures of economic freedom. Impressively, Hong Kong’s weakest score (freedom from corruption, where it ranks 13th of the 180 countries rated in 2006 by Transparency International) put it well ahead of the United States (fifth most free overall, 20th on freedom from corruption).

Why has Hong Kong been so free?

Hong Kong never would have become the economic powerhouse it is today if either British or Chinese senior politicians had had any say in the matter. Britain acquired Hong Kong island in 1842 (additional territory came later) through a deal between the British representative, Captain Charles Elliot, and the Chinese negotiator, the Marquis Ch’i-ying, to settle a small war that had broken out over trade issues. (Compensation for a Chinese seizure of British opium was one issue, but the dispute was broader than the issue of opium, and recent scholarship tends to cast doubt on the conventional labeling of the dispute an “opium war.”)

The resulting deal was unpopular both with the Chinese Imperial Court and the British government. The Chinese authorities disliked any cession of territory to the British and worried about the impact on tariff revenues of creating a British-controlled port. Moreover, the Chinese disdained the British obsession with trade. The British government thought Hong Kong a poor location compared to the possible alternatives, such as Formosa. Nonetheless, the limits to communication in the nineteenth century had forced the two governments to delegate the authority to resolve the dispute to their representatives on the scene, so they were left with what Frank Welsh’s excellent one-volume history, A History of Hong Kong, terms “a source of embarrassment and annoyance to its progenitors since it first appeared on the international scene.” (Unless otherwise indicated, quotations are from Welsh’s book.)

Early History

Early assessments of Hong Kong’s potential were pessimistic. Lord Palmerston, in possibly the worst prediction ever made by a British diplomat, concluded that it was “a barren island, which will never be a mart of trade.” The colonial treasurer, Robert Montgomery Martin, a prolific writer on Britain’s overseas possessions (including a five-volume History of the British Colonies published in 1840), echoed Lord Palmerston’s assessment in 1844, finding that “there is no trade of any noticeable extent in Hong Kong. . . . There is scarcely a firm in the island but would . . . be glad to get back half the money they have expended in the colony and retire from the place. . . . There does not appear the slightest probability that, under any circumstances, Hong Kong will ever become a place of trade.”

Some trade did begin, however, as a result of the establishment of British merchants’ warehouses. But early British policies concerning their new territory did little to promote economic growth. An 1847 Parliamentary investigation of the economic situation in Hong Kong found that British rule had initially brought with it a government bent on raising “as large a revenue as possible” and that this had damaged trade, concluding that the restrictions on trade instituted by the early British administration to raise revenue meant that “[f]rom this time may be dated the reverses of Hong Kong.”

Hong Kong physically expanded twice during the nineteenth century. Territory on the mainland opposite Hong Kong island, Kowloon, was acquired in a “casual way” for 500 taels during a Sino–British conflict in 1859 in a deal between a British Consul and a Ch’ing official. And in 1898 Britain leased for 99 years the New Territories, additional mainland territory plus some islands. In both cases, the rationale for expansion was to protect the harbor from the range of guns located on the mainland. Although the British hoped to eventually make the New Territories lease a more permanent arrangement, their agreement to the lease rather than a permanent cession of control played an important role in the eventual return of the entire territory to the People’s Republic of China in 1997.

Britain did relatively little with its new colony, beyond establishing public order and extending the rule of law. The result was essentially a treaty port, much like those that European powers established on the mainland under the Treaty of Nanking in 1842–43. One reason for Britain’s relatively hands-off policy was the persistence of the view formed by early colonial officials that the Chinese residents did not want or appreciate British lawmaking. This attitude is clear in the testimony to a mid-nineteenth-century Parliamentary committee looking into administration of the colony by Col. John Malcolm, an aide to the governor, who told the British M.P.s that “the Chinese are a peculiar people, and they do not like being interfered with. They do not understand us; they cannot understand our ways; and when they are told that they are to do first one thing and then another, they get frightened and will not come to us.” Whether it was a characteristic “peculiar” to the Chinese to dislike arbitrary government or not, the avoidance of conflicting mandates and general tendency to leave people alone—policies adopted in pursuit of trade—gave the colony the benefit of the rule of law from the start.

A Natural Trading Center

What did Britain create in Hong Kong? The combination of the excellent harbor and the rule of law meant Hong Kong was a natural trading center. But it was not the best place to trade in China, and by the early twentieth century Shanghai was successfully winning trade away from Hong Kong. Shanghai offered a more educated population, a more convenient location, access to European protection under treaty concessions by the Chinese government, and relatively little Chinese-government interference due to the decline of imperial power. By the 1910s Shanghai had become a significantly more important center of trade than Hong Kong. With the British choosing the more defensible Singapore as the center of British naval power in the region, Hong Kong also lost importance for the British government. As a result, the colony languished as a backwater, becoming known as a center for prostitution and gambling rather than the economic powerhouse it is today.

One thing Britain did not create in Hong Kong was a democratic government. No local democratic institutions were permitted to develop, as were allowed in most other British colonies, because the British were unwilling to give the Chinese majority a real voice in administration. As a result, as Welsh concludes, “Hong Kong was to continue as authoritarian an administration as any Chinese government, but the final authority was to be the law, rather than individual whim.”

China’s imperial central government rarely favored economic freedom, and the late nineteenth and early twentieth centuries were no exceptions. As the central government’s power ebbed away, regional warlords began to establish rival, but equally predatory centers of power. European, American, and Japanese power in China also expanded, focusing on access to the Chinese market for their nationals, but not creating economic freedom for the Chinese within their spheres of influence. Hong Kong’s stability increasingly drew migrants from elsewhere in China. Population grew from 600,000 in 1920 to over a million in 1938. As conditions worsened in China with the Japanese invasion and fighting between regional warlords, the Kuomintang (Nationalists), and communists, 5,000 migrants a day began to pour into Hong Kong. By March 1950 the city had 2.3 million people, which brought Hong Kong both a significantly increased workforce and the human capital of Chinese entrepreneurs who escaped ahead of Mao’s armies. Moreover, the communist victory on the mainland meant that Shanghai ceased to be a serious competitor.

Finding Freedom in Hong Kong

Life on the edge of communist China was not easy. During the Korean War, embargoes on trade hurt the city’s entrepot business, forcing many Hong Kong traders to reinvent themselves as manufacturers. The continuing influx of refugees from the mainland strained the colony’s infrastructure. But the flood brought refugees like Jimmy Lai, one of the millions of penniless individuals who sought freedom in Hong Kong.

While working in the Shanghai railway station as a porter, Lai was given his first chocolate bar by a traveler. Hungry, Lai immediately ate it. Running after the man, he asked where this wonderful food came from and the answer was “Hong Kong.” Determined to get to the place where such wonders were available, Lai eventually persuaded his mother to allow him to escape and was smuggled out of China in the bottom of a fishing boat. On his arrival in Hong Kong, he went to work the same night in a garment factory. Today, Lai is a billionaire, owner of one of the most successful media companies in Asia. His drive and entrepreneurial skills played a major role in his success, of course. (Lai movingly tells his story in the Acton Institute’s documentary The Call of the Entrepreneur.) But it was the freedom available in Hong Kong that allowed him to put his talents to work. That freedom took many forms, including an absence of the currency restrictions in force at the time in the United Kingdom and much of Europe, and few laws regulating businesses. As a result, Hong Kong began to flourish.

Why? As Hong Kong’s last British governor, Christopher Patten, wrote in his memoir, East and West, the refugees from communism who flooded into Hong Kong arrived in China’s only free city; it was indeed (in the words of Chinese journalist Tsang Ki-fan) “the only Chinese society that, for a brief span of 100 years, lived through an ideal never realized at any time in the history of Chinese society—a time when no man had to live in fear of the midnight knock on the door.” Hong Kong had a competent government, pursuing market economics under the rule of law. It was a government that fully met the Confucian goal—“Make the local people happy and attract migrants from afar.”

The laissez-faire attitude of the Hong Kong government on economic matters was cemented by Sir John Cowperthwaite, the colony’s financial secretary from 1961 to 1971, whom Welsh called a “political economist in the tradition of Gladstone or John Stuart Mill” and the personification of “unreconstructed Manchester-school free traders.” Cowperthwaite had almost complete control of Hong Kong government finances and used it to implement his policy of “positive nonintervention.” Friedman gave Cowperthwaite a great deal of the credit for Hong Kong’s success, citing approvingly Cowperthwaite’s refusal to collect most economic statistics on the grounds that “[i]f I let them compute those statistics, they’ll want to use them for planning.” Jimmy Lai has a bronze bust of Cowperthwaite at his company’s entrance (as well as ones of Friedman and F. A. Hayek).

Cowperthwaite deserves the accolades he has received. During his decade as financial secretary, real wages rose by 50 percent and the portion of the population in acute poverty fell from 50 to 15 percent. What is remarkable is that Hong Kong accomplished this with no resource other than its people. The colony had no real agricultural land, no natural resources, and even the one resource it did have—people—lacked much education. Indeed, few at the time thought that the masses of refugees who reached Hong Kong during the 1950s would amount to anything other than a burden for the state.

Most remarkably, Hong Kong’s transformation occurred when social democrats ruled Europe and Lyndon Johnson’s Great Society dominated American politics, both reflecting the consensus among the political elites in Europe and North America that the welfare state and interventionist economic policies were the only sensible direction for advanced societies. Even in the developing world, interventionist economic policies like industrialization through import substitution, which relied on high tariff walls to protect domestic industries, were widely accepted. Tiny Hong Kong thus managed to adopt and hold to free-market and free-trade policies that ran counter to the policies of the British government and the consensus of policy analysts and development economists everywhere, and did it while perched precariously on the edge of a massive communist dictatorship in the midst of self-destructive policies like the Great Leap Forward and the Cultural Revolution.

No Libertarian Paradise

While consistently freer than most places, Hong Kong has never been a libertarian paradise. Government-subsidized housing has long dominated Hong Kong’s residential market, with 60 percent of residents living in it at one time. And the government manipulated (and continues to do so) the land market to maximize sales revenues for public coffers, which plays an important role in causing the housing shortages that required the public housing “solution.” Medical care has also long been socialized. Moreover, Hong Kong had serious corruption problems even during the height of the Cowperthwaite era, with the police in the 1960s and early 1970s “riddled with corruption,” according to former Governor Patten.

Then there is Hong Kong’s persistent “democratic deficit.” Hong Kong managed to escape the post-World War II wave of democratization in the rapidly dwindling British Empire because, as one British official put it in a radio interview in 1968, “the electorate of Britain didn’t care a brass farthing about Hong Kong.” Indeed, Britain showed almost no interest in expanding representative government in the colony until it became clear that Hong Kong would “return” to China in 1997 when the lease on the New Territories expired.

In some sense this democratic deficit served Hong Kong well, for men like Cowperthwaite and Patten held classical-liberal ideas on economic freedom and so largely refrained from actions that might have won popular approval (and certainly would have in Britain). But the lack of representative government also allowed Britain to treat Hong Kong’s residents shamefully when Britain rejected allowing Hong Kong passport holders the right of residence in Britain, fearing a flood of refugees in advance of the return to China. (The rest of Europe behaved no better.)

“One Country, Two Systems”

Hong Kong returned to China in 1997 under an agreement negotiated between Britain and the People’s Republic which provided a guarantee that for at least 50 years Hong Kong and China would be “one country, two systems.” (Formally, Hong Kong and the former Portuguese colony of Macau are both “Special Administrative Regions” of China.) The return itself was inevitable, as was China’s willingness to preserve capitalism in its midst. Not only were Hong Kong island and Kowloon unsustainable without the leased New Territories, where much of the water supply was located, but British voters still didn’t care a farthing for Hong Kong in the 1990s. China’s interest in the preservation of the goose that laid the golden eggs was also clear. The People’s Republic had long made use of Hong Kong—which it could have seized by force at any time—as a means of accessing foreign markets and sources of capital. At times 80 percent of China’s foreign income came through Hong Kong. China also wanted to demonstrate to Taiwan that peaceful reunification was possible.

The danger was that China’s leadership would not understand what Patten, in his book, termed “the relationship between Hong Kong’s hardware—a capitalist economy—and its software—a pluralist society—and yet it was the latter that enabled the former to function so well.” Thus far Hong Kong’s new rulers have shown themselves remarkably adept at continuing the smooth functioning of both the hardware and the software. Whether that will remain true in the long run is still an open question, of course.

Chinese Emperor Tao-kuang’s initial reaction to the British had been that “these barbarians are wanting in any high purposes of striving for territorial acquisition; they always look on trade as their first occupation.” Frank Welsh concluded his history by noting that Hong Kong “proved the Emperor’s point.” It is not just the British who made Hong Kong a success. It is the people of Hong Kong, from factory workers to entrepreneurs, who turned Hong Kong from a barren island to an economic powerhouse. They were able to do so because the Hong Kong government generally left them sufficiently alone. Hong Kong is far from perfect, and far from a libertarian dream world. But it remains a dramatic example of how far human ingenuity and entrepreneurial talent can take a society.

Why has Hong Kong been so free? Partly, Hong Kong has been fortunate to be ruled by men who understood their role as quite limited. Not quite the classical-liberal ideal, even under Cowperthwaite, but nonetheless significantly closer than any other twentieth-century society. And the combination of Britain’s failure to provide any real democratic institutions and its lack of interest in Hong Kong allowed those men to hold to those policies, even as Britain herself experienced economic disaster under the socialism of the 1950s–70s. Hong Kong also benefited from the example of China’s disastrous 1960s economic policies. With so many residents having come as refugees from communism, demand for freedom in Hong Kong was high. Freedom made possible the success of Jimmy Lai, and that of the millions who did not become billionaires but who had a higher standard of living than most of the world through their own efforts.

Hong Kong was lucky that freedom was tried. But Hong Kong’s people proved that freedom worked.

—

Foundation for Economic Education

30 S. Broadway

Irvington-on-Hudson , New York 10533

ACKNOWLEDGMENTS

These lectures, delivered by Ludwig von Mises at the Foundation for Economic Education in the summer of 1951,would not exist if not for Bettina Bien Greaves, who took them down word for word in shorthand, and who kindly made the transcriptions available to FEE. Mrs. Greaves served as a senior staff member at the Foundation for almost 50 years, until her retirement in 1999. She and her late husband, Percy L. Greaves, Jr., were among Mises’s closest friends. Her appreciation and understanding of Mises’s works have helped keep his legacy alive for a new generation of friends of freedom.

The publication of these lectures has been made possible through the kind generosity of Mr. Sheldon Rose of Farmington Hills , Michigan , and the Richard E. Fox Foundation of Pittsburgh, Pennsylvania, and especially the unstinting support of the Fox Foundation’s senior executor, Mr. Michael Pivarnik.

Mrs. Beth Hoffman, managing editor of FEE’s monthly publication, The Freeman, has overseen the preparation of the manuscript from beginning to end with her usual professional care.

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INTRODUCTION

by Richard M. Ebeling

OVER A TWELVE-DAY PERIOD, from June 25 to July 6, 1951 , the internationally renowned Austrian economist Ludwig von Mises delivered a series of lectures at the Foundation for Economic Education (FEE) at its headquarters in Irvington-on-Hudson , New York . Bettina Bien Greaves, a FEE staff member at that time, took down Mises’s lectures in shorthand, word for word, and then transcribed them into a full manuscript. It has remained unpublished until now.

FEE is proud to finally make these lectures available to a new generation. Mises was almost 70 years old when he spoke the words that are in this text, but they reveal a vitality of mind that is youthful in its clarity and vision of the free market and its critical analysis of freedom’s enemies.

Ludwig von Mises: His Life and Contributions

During the decades before Mises gave these lectures at FEE he had established himself as one of the leading voices of freedom in the Western world.[i]

Ludwig von Mises was born on September 29, 1881 , in Lemberg, the capital of the province of Galicia in the old Austro-Hungarian Empire (now known as Lvov in western Ukraine ). He graduated from the University of Vienna in 1906 with a doctoral degree in jurisprudence, and a specialization in economics. After briefly working as a law clerk, he was hired by the Vienna Chamber of Commerce, Crafts, and Industry in 1909, and within a few years was promoted to the position of one of the Chamber’s senior economic analysts.

Mises was soon recognized as one of the most insightful and penetrating minds in Austria . In 1912, he published The Theory of Money and Credit, a book that was quickly hailed as a major work on monetary theory and policy, in which he first presented what became known as the Austrian Theory of the Business Cycle. Inflations and depressions were not inherent within a free-market economy, Mises argued, but were caused by government mismanagement of the monetary and banking systems.[ii]

His scholarly work was interrupted in 1914, however, with the coming of the First World War. For the next four years, Mises served as an officer in the Austrian Army, most of that time on the eastern front against the Russian Army. He was three times decorated for bravery under fire. After Lenin and the Bolsheviks signed a separate peace with Imperial Germany and Austria-Hungary in March 1918 that withdrew Russia from the war, Mises was appointed the officer in charge of currency control in that part of the Ukraine occupied by the Austrian Army under the terms of the peace treaty, with his headquarters in the port city of Odessa on the Black Sea. During the last several months of the war, before the armistice of November 11, 1918 , Mises was stationed in Vienna serving as an economic analyst for the Austrian High Command.

After being mustered out of the army at the end of 1918, he returned to his duties at the Vienna Chamber of Commerce, with the additional responsibility, until 1920, of being in charge of a branch of the League of Nations ’ Reparations Commission overseeing the settlement of prewar debt obligations.

In the years immediately following the war, Austria was in a state of chaos. The old Austro-Hungarian Empire broke up, leaving a new, much smaller Republic of Austria . Hyperinflation and aggressive trade barriers by neighboring countries soon reduced much of the Austrian population to near-starvation conditions. In addition, there were several attempts to violently establish a revolutionary socialist regime in Austria , as well as border wars with Czechoslovakia , Hungary , and Yugoslavia .

From his position at the Vienna Chamber of Commerce, Mises fought day and night to ward off the collectivist destruction of his homeland. He was influential in stopping the full nationalization of Austrian industry by the government in 1918–1919. He also played a leading role in bringing the hyperinflation in Austria to a halt in 1922, and then was a guiding voice in reorganizing the Austrian National Bank under a re-established gold standard under League of Nations supervision. He also forcefully made the case for drastically lowering the income and business taxes that were strangling all private-sector activities, and assisted in bringing to an end the government’s foreign-exchange controls that were ruining Austria ’s trade with the rest of the world.[iii]

Throughout the 1920s and early 1930s, while in his native Austria , Mises was an uncompromising defender of the ideals of individual liberty, limited government, and the free market. Besides his work at the Vienna Chamber of Commerce, he taught a seminar every semester at the University of Vienna on various aspects of economic theory and policy, which attracted not only many of the brightest Austrian students but attendees from the rest of Europe and the United States as well. He also led a “private seminar” that met twice a month from October to June in his Chamber offices, from 1920 to 1934, with many of the best Viennese minds in economics, political science, history, philosophy, and sociology regularly participating.

Mises also founded the Austrian Institute for Business Cycle Research in 1926. He served as acting vice-president, with a young Friedrich A. Hayek appointed as the Institute’s first director.

His international stature as a champion of classical liberalism continued to grow during this period, as well, through a series of books that challenged the rising tide of socialism and the interventionist-welfare state. In 1919, Mises published Nation, State and Economy, in which he traced out the causes of the First World War in the nationalist, imperialist, and socialist ideas of the preceding decades.[iv] But it was in a 1920 article on “Economic Calculation in the Socialist Commonwealth ”[v] and his 1922 book on Socialism: An Economic and Sociological Analysis that his reputation as the leading opponent of collectivism in the twentieth century was firmly established.[vi] Mises demonstrated that with the nationalization of the means of production, and the resulting abolition of money, market competition, and the price system, socialism would lead to economic chaos and not to social prosperity. Thus, besides the tyranny that socialism would create due to the government’s domination over all aspects of human life, it was also inherently unworkable as an economic system.

This was followed in 1927 with his defense of all facets of individual freedom in his book on Liberalism, by which he meant classical liberalism and the market economy. He presented a clear and persuasive case for individual liberty, private property, free markets, and limited government.[vii] Finally, in 1929, Mises published a collection of essays offering a Critique of Interventionism, in which he showed that government piecemeal regulations over prices and production inevitably lead to distortions and imbalances that threaten the effective functioning of a free and competitive market society.[viii] In addition, he penned a series of essays on the philosophy of science and the nature of man and the social order that appeared in 1933 under the title Epistemological Problems of Economics.[ix]

Mises had clearly understood during this time that Hitler’s National Socialism would lead Germany down the road to destruction. In fact, in the mid-1920s, he had already warned that too many Germans were hoping for the coming of the tyrant who would rule over and plan their lives.[x] When the Nazis came to power in Germany in 1933, Mises understood that the future of his native Austria was now threatened. As a classical liberal and a Jew, Mises also knew that a Nazi takeover would probably mean his arrest and death. So, in 1934 he accepted a position as professor of international economic relations at the Graduate Institute of International Studies in Geneva , Switzerland , a position that he held until he came to the United States in the summer of 1940.[xi]

It was during those six years in Switzerland that Mises wrote his greatest work, the German-language edition of which was published in Geneva in 1940,[xii] and which then appeared in 1949 in a revised English language version as Human Action: A Treatise on Economics.[xiii] In a volume of almost 900 pages, Mises summarized the ideas and reflections of a lifetime on the issues of man, society, and government; on the nature and workings of the competitive market process and the impossibilities of socialist central planning and the interventionist state; and on the central role and importance of a sound monetary system for all market activities, and the harmful effects from government’s manipulation of money and credit.

In the summer of 1940, as the German Army was overrunning France, Mises and his wife, Margit, left neutral Switzerland and made their way through southern France and across Spain to Lisbon , Portugal , from where they then sailed to the United States . Living in New York City , he received research grants from the Rockefeller Foundation in the early 1940s that enabled him to do a number of studies on postwar economic and political reconstruction, as well as write several books.[xiv] In 1945, he was appointed to a visiting professorship at New York University , a position that he held until his retirement in 1969 at the age of 87.

During his years in America, Mises continued his prolific writing career, publishing Bureaucracy (1944),[xv] Omnipotent Government (1944),[xvi] Planned Chaos (1947),[xvii] Planning for Freedom (1952),[xviii] The Anti-Capitalistic Mentality (1956),[xix] Theory and History (1957),[xx] The Ultimate Foundation of Economic Science (1962),[xxi] and The Historical Setting of the Austrian School of Economics (1969).[xxii] There also appeared, posthumously, his memoirs, Notes and Recollections (1978),[xxiii] and Interventionism: An Economic Analysis (1998),[xxiv] both originally written in 1940. And many of his other articles and essays have been collected in two anthologies.[xxv]

Mises also attracted around him a new generation of young Americans dedicated to the ideal of liberty and economic freedom, and who were encouraged and assisted by Mises in their intellectual activities. He passed away on October 10, 1973 , at the age of 92.

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Ludwig von Mises and FEE

There was a long relationship between Ludwig von Mises and the Foundation for Economic Education. The late Leonard E. Read, the founder and first president of FEE, met Mises in the early 1940s. Read told the story of their meeting in an essay he wrote in honor of Mises’s 90th birthday:

Professor Ludwig von Mises arrived in America during 1940. My acquaintance with him began a year or two later when he addressed a luncheon meeting of the Los Angeles Chamber of Commerce of which I was General Manager. That evening he dined at my home with renowned economists Dr. Benjamin M. Anderson and Professor Thomas Nixon Carver, and several businessmen such as W. C. Mullendore, all first-rate thinkers in political economy. What I would give for a recording of that memorable discussion!

The final question was posed at midnight : “Professor Mises, I agree with you that we are headed for troublous times. Now, let us suppose you were the dictator of these United States . What would you do?”

Quick as a flash came the reply, “I would abdicate!” Here we have the renunciation side of wisdom: man knowing he should not lord it over his fellows and rejecting even the thought.

Few among us are wise enough to know how little we know.

. . . A rare individual weighs his finite knowledge on the scale of infinite truth, and his awareness of his limitation tells him never to lord it over others. Such a person would renounce any position of authoritarian rulership he might be proffered or, if accidentally finding himself in such a position, would abdicate—forthwith! . . .

Professor Mises knows that he does not or cannot rule; thus, he abdicates from even the idea of rulership. Knowing what phase of life to renounce is one side of wisdom.[xxvi]

From FEE’s founding in 1946, Ludwig von Mises served as a senior adviser, lecturer, writer, and part-time staff member for the Foundation. It was through Mises’s influence and that of free-market economist and journalist Henry Hazlitt (one of FEE’s original trustees) that the Foundation has always had a special “ Austrian School ” orientation to its economic analysis of free markets and collectivism.[xxvii]

It was also through the assistance of Leonard Read and a few others among Mises’s friends that funding was arranged to underwrite his teaching position at NYU, until his retirement in 1969. And following his departure from NYU, Leonard Read brought Mises onto FEE’s staff for the remainder of his life.

Mises’s wife, Margit, described his appreciation of FEE and the opportunity to lecture at the Foundation:

In October 1946, Lu was made a regular member of the FEE staff, and in later years he promised to give a series of lectures in Irvington every year. The spiritual and intellectual atmosphere there was completely to his taste.

* * *

One of the regular tasks of the Foundation was to arrange seminars for teachers, journalists and students. Lu enjoyed speaking there. He knew the participants were carefully questioned about their education and interests and were eager to hear him. It was interesting to note how many women attended these seminars.

Before the classes started, Lu regularly made the rounds. First, he had a little talk with Read; then he went to see Edmund Opitz, for whom he had a special appreciation; then he visited with W. Marshall Curtiss and Paul Poirot. Paul usually had to discuss an article he was about to publish in The Freeman, FEE’s monthly magazine. Finally, Lu went into Bettina Bien’s office. As a rule, Bettina had a pile of his books ready for him to autograph or letters to sign, which were typed for him in his office. On his way down to the lecture hall—all these offices, with the exception of that of Dr. Opitz, were on the second floor—he had a friendly word for every one of the employees.

His lectures were calculated for a special Irvington audience. He was able to evaluate his listeners immediately by asking one or the other question. . . . Though the content of his lectures in Irvington was lighter, his mode of delivery was the same as at New York University . The interest was great and so was the demand for Lu’s books, which Leonard Read always kept in print and ready for distribution.[xxviii]

Mises’s last public lecture was delivered at FEE on March 26, 1971 . As Margit von Mises explained: “He always loved lecturing in Irvington , and he continued doing so as long as he felt able.”[xxix]

When Mises passed away, Leonard Read delivered a brief eulogy at the memorial service for him on October 16, 1973 . He said, in part:

The proudest tribute mankind can pay to one it would most honor is to call him Teacher. The man who releases an idea which helps men understand themselves and the universe puts mankind forever in his debt. . . . Ludwig von Mises is truly—and I use this in the present tense—a Teacher. More than two generations have studied under him and countless thousands of others have learned from his books. Books and students are the enduring monuments of a Teacher and these monuments are his. . . . We have learned more from Ludwig Mises than economics. We have come to know an exemplar of scholarship, a veritable giant of erudition, steadfastness, and dedication. Truly one of the great Teachers of all time! And so, all of us salute you, Ludwig Mises, as you depart this mortal life and join the immortals.[xxx]

The FEE Lectures of 1951

For those readers who are already familiar with some of Mises’s works, his 1951 lectures at FEE will offer them a slightly different style to his analysis. Here is Mises the teacher. The form of exposition that Bettina Bien Greaves has captured in her detailed shorthand of his lectures is more colloquial, and full of many historical examples and references. The reader is able to feel, at least a bit, what Mises was like face to face in the classroom, and not simply the Olympian theorist in his great tomes.

One of Mises’s students who studied with him at New York University once said that “Every lecture was a mind-stretching experience.” Another student declared that “I have never known a man as erudite as was Dr. Mises. He was extraordinarily learned in every field of knowledge. In discussing economics he would bring in examples from history to illustrate  the points he was making.”[xxxi] His FEE lectures from 1951 give a taste of this side of Mises as a scholar-teacher.

For the readers who are relatively unfamiliar with Mises writings, these lectures offer an excellent starting point. Indeed, in many ways the lectures present an encapsulated version of most of the themes that Mises devoted his life to formulating, a summary of many of the central themes to be found in Human Action. He explains the nature of man as a purposeful actor who gives meaning to his actions in the context of ends chosen and means selected to achieve his goals. It is the intentionality of man that makes the human sciences inherently different from the subject matter of the natural sciences. This also enables Mises to demonstrate why Karl Marx’s theory of dialectical materialism and historical determinism is fundamentally myth and fantasy.

Instead, he shows the actual workings of the market process through which economic freedom provides the incentives and the personal liberty for individuals to work, save, and invest. He explains how it is the consumer-driven demand for goods and services that provides the stimulus and profit opportunities for entrepreneurs to creatively arrange and guide production in ways that serve the wants and desires of the buying public.

He also demonstrates that the market process is dependent upon and would be impossible without the emergence of a medium of exchange— money—through which all the myriad of goods and resources can be reduced to a common denominator in the form of money prices. Economic calculation in the form of market prices provides the method through which entrepreneurs are able to estimate potential profits and possible losses from alternative lines and methods of production. Through this process, waste and misuse of scarce resources are kept to a minimum, so that as many of the most highly valued goods and services desired by consumers may be brought to market.

This also leads Mises to explain why socialist central planning means the end of all economic rationality. With the abolition of markets and prices under socialism, the central planners are clueless about how to efficiently apply the resources, capital, and labor under their control. Hence, socialism in practice means planned chaos.

At the same time, Mises shows why government mismanagement of the monetary and banking system brings about inflations and depressions. By distorting the price signals of the marketplace—including interest rates—government-generated inflations bring about a misdirection of resources and labor and a malinvestment of capital, which finally must lead to a depression.

Through these lectures, the reader will see why Ludwig von Mises was one of the most effective proponents of freedom and free enterprise in the twentieth century. And why his contributions will remain as one of the great legacies in the cause of liberty in the many decades to come.

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1^ST LECTURE

Economics and Its Opponents

AMONG THE GREAT BOOKS OF MANKIND are the immortal writings by the Greek philosopher Plato. The Republic and The Laws, written 2300 to 2400 years ago, dealt not only with philosophy, the theory of knowledge, epistemology, but also with social conditions. The treatment of these problems was typical of the approach which philosophical and sociological problems, discussions of state, government, and so on, continued to receive for more than 2000 years.

Although this approach is familiar to us, a new point of view toward social philosophy, the sciences, economics, and praxeology has developed during the last hundred years. Plato had said that a leader is called on by “ Providence ” or by his own eminence, to reorganize and to construct the world in the same way that a builder constructs a building—without bothering with the wishes of his fellowmen. Plato’s philosophy was that most men are “tools” and “stones” to be worked with for the construction of a new social entity by the “superman” in control. The cooperation of the “subjects” is unimportant for the success of the plan. The only requirement is that the dictator have the requisite power to force the people. Plato assigns to himself the specific task of being adviser to the dictator, the specialist, the “social engineer” reconstructing the world according to his plan. A comparable situation today may be seen in the position of the college professor who goes to Washington .

The Platonic pattern remained the same for almost 2,000 years. All the books of that era were written from this point of view. Each author was convinced that men were merely pawns in the hands of the princes, the police, and so on. Anything could be done, provided the government was strong enough. Strength was considered the greatest asset of government.

An indication of the success of this thinking may be realized in reading the adventures of Télémaque by Bishop Fénelon [François de Salignac de la Mothe Fénelon, 1651–1715]. Bishop Fénelon, a contemporary of Louis XIV, was an eminent and great philosopher, a critic of government, and tutor to the Duke of Burgoyne, heir to the French throne. Télémaque, written for the young Duke’s education, was used in French schools until recently. The book tells of world travels. In each country visited, all that is good is credited to the police; everything of value is attributed to the government. This is known as the “science of the police”—or in German Polizeiwissenschaft.

The eighteenth century saw a new discovery—the discovery of a different approach to social problems. The idea developed that there was a regularity in the sequence of social problems similar to the regularity in the sequence of natural phenomena. It was learned that legal decrees and their enforcement alone would not remove an ill. The regular sequence or concatenation of social phenomena must be studied to find out what can be done, and what should be done. Although regularity had been recognized in the field of the natural sciences, the existence of order and of regular sequences also in the field of social problems had not been recognized before.

The Utopian conditions of the natural state, as described by Jean Jacques Rousseau [1712–1778], are transformed, it was held, by “wicked” men and by their evil social institutions to produce the destitution and misery that exists. It was believed that the happiest man—the one living under the most satisfactory conditions—was the Indian of North America. North American Indians were idealized in European literature of that time; they were considered happy because they were not acquainted with modern civilization.

Then came Thomas Robert Malthus [1766–1834] with the discovery that nature does not provide the means of existence for everybody. Malthus pointed out that there prevails for all humans a scarcity of the requirements of subsistence. All men are in competition for the means of survival and for a share of the world’s wealth. The aim of man was to remove the scarcity and make it possible for a greater number of persons to survive.

Competition leads to the division of labor and to the development of cooperation. The discovery that the division of labor is more productive than isolated labor was the happy accident that made social cooperation, social institutions, and civilization possible.

If all production is consumed immediately, any improvement of conditions would be impossible. Improvement is possible only because some production is saved for use in later production—that is only if capital is accumulated. Savings are important!

In the eyes of all reformers such as Plato, the “body politic” could not operate without interference from the top. Intervention by the “king,” by government, and by the police was necessary to obtain action and results. Remember that this was also the theory of Fénelon; he described the streets, factories, and all progress as being due to the police.

In the eighteenth century, it was discovered that even in the absence of the police—even if no one gives orders—people naturally act in such a way that the fruits of production finally appear. Adam Smith [1723–1790] cited the shoemaker. The shoemaker doesn’t make shoes from an altruistic motive; the shoemaker provides us with shoes because of his own selfish interest. Shoemakers produce shoes because they want the products of others which they can get in exchange for shoes. Every man, in serving himself, of necessity serves the interest of others. The “king” doesn’t have to issue orders. Action is brought about, therefore, by the autonomous actions of people in the market.

The eighteenth century’s discoveries with respect to social problems were closely connected with, and inseparable from, the political changes brought about during that period—the substitution of representative for autocratic government, free trade for protection, the tendency toward international peace instead of aggressiveness, the abolition of serfdom and slavery, and so on. The new political philosophy also led to substituting liberty for monarchism and absolutism. And it brought about changes in industrial life and social life which altered the fact of the world in a very short time. This transformation is customarily called the Industrial Revolution. And this “revolution” resulted in changes in the whole structure of the world, populations multiplied, the average length of life expectancy increased, and standards of living rose.

With specific reference to the population, it is four times greater today [1951] than it was more than 250 years ago. If Asia and Africa are eliminated, the growth is even more startling. Great Britain , Germany , and Italy , three countries that were completely settled and where every bit of land was already in use by 1800, found room to support 107 million more people by 1925. (This seems all the more remarkable when compared with the United States —many times the area of these three countries—which increased its population by only 109 million in that same period.) At the same time, the standard of living was raised everywhere as a result of the Industrial Revolution by the introduction of mass production.

Of course, there are still unsatisfactory conditions; there are still situations that can be improved. To this, the new philosophy responds: There is only one way to improve the standard of living of the population—increase capital accumulation as against the increase in population. Increase the amount of capital invested per capita.

Although this new doctrine of economic theory was true, it was unpopular for many reasons with certain groups—monarchs, despots, and nobles—because it endangered their vested interests. In the nineteenth and twentieth centuries, these opponents of this eighteenth-century philosophy developed a number of objections, epistemological objections which attacked the basic foundation of the new philosophy and raised many very serious and important problems. Their attack was more or less a philosophical attack, directed at the epistemological foundations of the new science. Almost all their criticism was motivated by political bias; it was not brought forth by searchers for the truth. However, this does not alter the fact that we should study seriously the objections to the various truths of the eighteenth century—sound philosophy and economics— without reference to the motives of those who bring them forth. Some were well founded.

During the last hundred years, opposition to sound economics has arisen. This is a very serious matter. The objections raised have been used as arguments against the whole bourgeois civilization. These objections cannot be simply called “ridiculous” and dismissed. They must be studied and critically analyzed. As far as the political problem is concerned, some people who supported sound economics did so in order to justify, or to defend, the bourgeois civilization. But these defenders didn’t know the whole story. They limited their fighting to a very small territory, similar to the situation today in Korea where one army is forbidden to attack the strongholds of the other army.[xxxii] In the intellectual struggle, the same situation exists; the defenders are fighting without attacking the real foundation of their adversaries. We must not be content to deal with the external paraphernalia of a doctrine; we must attack the basic philosophical problem.

The distinction between “left” and “right” in politics is absolutely worthless. This distinction has been inadequate from the very beginning and has brought about a lot of misunderstanding. Even objections to the basic philosophy are classified from that point of view.

Auguste Comte [1798–1857] was one of the most influential philosophers of the nineteenth century, and probably one of the most influential men of the last hundred years. In my own private opinion, he was a lunatic as well. Although the ideas he expounded were not even his own, we must deal with his writings because he was influential and especially because he was hostile to the Christian church. He invented his own church, with its own holidays. He advocated “real freedom,” more freedom, he said, than was offered by the bourgeoisie. According to his books, he had no use for metaphysics, for freedom of science, for freedom of the press, or for freedom of thought. All these were very important in the past because they gave him the opportunity to write his books, but in the future there would be no need for such freedom because his books had already been written. So the police must repress these freedoms.

This opposition to freedom, the Marxian attitude, is typical of those on the “left” or “progressive” side. People are surprised to learn that the so-called “liberals” are not in favor of freedom. Georg Wilhelm Friedrich Hegel [1770–1831], the famous German philosopher, gave rise to two schools—the “left” Hegelians and the “right” Hegelians. Karl Marx [1818–1883] was the most important of the “left” Hegelians. The Nazis came from the “right” Hegelians.

The problem is to study basic philosophy. One good question is why have the Marxists been to a certain extent familiar with the great philosophical struggle, while the defenders of freedom were not? The failure of the defenders of freedom to recognize the basic philosophical issue explains why they have not been successful. We must first understand the basis for the disagreement; if we do, then the answers will come. We will now proceed to the objections that have been raised to the eighteenth century philosophy of freedom.

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2ND LECTURE

Pseudo-Science and Historical Understanding

IN THE ENGLISH LANGUAGE, the word “science” is usually applied only to the natural sciences. There is no doubt that there are fundamental differences between the natural sciences and the science of human action, sometimes called social science or history. Among these fundamental differences is the way in which knowledge is acquired.

In the natural sciences knowledge comes from experiment; a fact is something experimentally established. Natural scientists, in contrast to students of human action, are in a position of being able to control changes. They can isolate the various factors involved, as in a laboratory experiment, and observe changes when one factor is changed. The theory of a natural science must conform to these experiments—they must never contradict such an established fact. Should they contradict such a fact, a new explanation must be sought. In the field of human action, we are never in a position of being able to control experiments. We can never talk of facts in the field of social sciences in the same sense in which we refer to facts in the natural sciences. Experience in the field of human action is complicated, produced by the cooperation of various factors, all effecting change.

In the field of nature we have no knowledge of final causes. We do not know the ends for which some “power” is striving. Some persons have attempted to explain the universe as if it had been intended for the use of man. But questions can then be raised: What is the value to man of flies, for instance, or of germs? In the natural sciences we know nothing but experience. We are familiar with certain phenomena and on the basis of experiments a science of mechanics has been developed. But we do not know what electricity is. We don’t know why things happen the way they do; we don’t ask. And if we do ask, we don’t receive an answer. To say we know the answer implies that we have ideas of “God.” To assert that we can find the reason implies that we have certain “God-like” characteristics.

There is always a point beyond which the human mind can go—a realm into which inquiry brings no more information. Through the years this frontier has been pushed farther and farther back. Natural forces have been traced back beyond what was formerly considered “ultimate” human knowledge. But human knowledge must always stop at some “ultimate given.” The French physiologist Claude Bernard [1813–1878] said in his book on experimental science that life itself is something “ultimately given”; biology can only establish the fact that there is such a phenomenon as life, but it can say nothing more about it. The situation is different in the field of history or of human action. There we can trace our knowledge back to something behind the action; we can trace it back to the motive. Human actions imply that men are aiming at definite goals. The “ultimate given” in the field of human action is the point at which an individual or a group of individuals, inspired by definite judgments of value and by definite ideas as to the procedures to be applied to attain a chosen end, acted. This “ultimate given” is individuality.

Being human we know something about human evaluations, doctrines, and theories concerning the methods used to reach these ends. We know there is some purpose behind the various moves of individuals. We know there is conscious action on the part of each person. We know there is a sense, a reason. We can establish that there are definite judgments of value, definite ends aimed at, and definite means applied in the attempt to gain these ends. For example a stranger, dropped suddenly into a primitive tribe, although ignorant of the language, can nevertheless interpret the actions of the people about him to some extent, the ends toward which they are working, and the means used to attain the ends. Through logic he interprets their running around building fires and putting objects in kettles as preparing food for dinner.

Dealing with judgments of value and methods is not peculiar to the science of human action. The logic of the scientist, the brainwork, is no different from the logic practiced by everybody in his daily life. The tools are the same. The aim is not peculiar to social scientists. Even a child crying and screaming has a motive and is acting to get something he wants. Businessmen also act to get things they want. They understand the science of human action and in dealing with their fellowmen they act on that understanding every day, especially in planning for the future. This epistemological interpretation of the experience of understanding is not the invention of a new method. It is only the discovery of knowledge everybody has been using since time began. Economist Philip H. Wicksteed [1844–1927], who published The Common Sense of Political Economy, chose for his motto a quotation from Goethe: Ein jeder lebt’s, nicht vielen ist’s bekannt. (“We are all doing it; very few of us understand what we are doing.”)

According to the French philosopher Henri Bergson [1859–1941], understanding, l’intelligence sympathique, is the basis of the historical sciences. The historian collects his materials to assist his interpretation just as a policeman seeks the facts to enable him to reach a decision in court. The historian, the judge, the entrepreneur, all begin work when they have collected as much information as possible.

Auguste Comte, who contributed nothing to the development of the natural sciences, described what he believed to be the task of all sciences: he said that to be able to forecast and to act it was necessary to know. The natural sciences give us definite methods for accomplishing this. With the aid of the various branches of physics, chemistry, and so on, mechanics are able to design buildings and machines and to forecast the results of their operations. If a bridge collapses, it will be recognized that an error was made. In human action, no such definite error may be recognized, and this Comte considered a failing.

Auguste Comte considered history to be non-scientific and consequently valueless. In his mind, there was a certain hierarchy of the various sciences. According to him, scientific study began with the simplest science and progressed to the more complicated; the most complicated science was still to be developed. Comte said history was the raw material out of which this complicated study was to develop. This new study was to be a science of laws, equivalent to the laws of mechanics developed by scientists. He called this new science “sociology.” His new word “sociology,” has had enormous success; people in all parts of the world now study and write about sociology.

Comte knew very well that a general science of human action had been developed during the previous hundred years—the science of economics, political economy. But Comte didn’t like its conclusions; he wasn’t in a position to refute them, nor to refute the basic laws from which they were derived. So he ignored them. This hostility or ignorance was also displayed by the sociologists who followed Comte.

Comte had in mind the development of scientific laws. He blamed history for dealing only with individual instances, with events that happened in a definite period of history and in a specific geographical environment. History did not deal with things done by men in general, Comte said, but with things done by individuals. But sociologists have not done what Comte said they should; they have not developed general knowledge. What they have done is just what Comte considered worthless, they have dealt with individual events and not with generalities. For instance, a sociological report was published on “Leisure in Westchester .” Sociologists have also studied juvenile delinquency, methods of punishment, forms of property, and so on. They have written an enormous amount of material about the customs of primitive people. True, this literature does not deal with kings or wars; it deals principally with the “common man.” But still it doesn’t deal with scientific laws; it deals with historical facts, with historical investigations of what happened at one spot at a certain time. Such sociological studies are valuable, however, precisely because they deal with historical investigations, investigations of various aspects of human everyday life often neglected by other historians. Comte’s program is self-contradictory because no general laws can be determined from the study of history. Observations of history are always complex phenomena, interconnected in such a way that it is impossible to assign to specific causes, with unquestioned accuracy, a certain part of the final result. Therefore, the method of the historian has nothing in common with the methods of the natural scientist.

The program of Auguste Comte to develop scientific laws from history has never been realized. So-called “sociology” is either history or psychology. By psychology I do not mean the natural sciences of perception. I mean the literary psychology described by the philosopher George Santayana [1863–1952] as the science of the understanding of historical facts, human evaluations dealing with human strivings.

Max Weber [1864–1920] called himself a sociologist, but he was a great historian. His book Gesammelte Aufsätze zur Religionssoziologie (Sociology of the Great Religions) deals in the first part, “The Protestant Ethic and the Spirit of Capitalism,” with the origin of capitalism. He attributed the development of capitalism to Calvinism and he wrote very interestingly about it. But whether his theory can be logically supported is another question.

One essay on “the town”—which has not been translated into English[xxxiii]—aimed at treating the city or town as such, at trying to give ideas about the town in general. He was very explicit in one regard, however, namely in maintaining that this approach was more valuable than dealing with the history of one town at a specific time. As a matter of fact, the situation may be the very opposite; it may be that the more general historical information is, the less material of value it contains.

With respect to the future, we must form certain opinions about the understanding of future events. The statesman, the entrepreneur, and, to a certain extent, everyone is in the same position. Each of us must deal with uncertain future conditions that cannot be anticipated. The statesman, the politician, the entrepreneur, and so on, are, so to speak, “historians of the future.”

There exist in nature constant quantitative relationships—specific weights, and so on, which may be established in the laboratory. Thus we are in a position to measure and assign quantities of magnitudes to various physical objects. With the advance of the natural sciences, their study has become more and more quantitative—viz., the development of quantitative from qualitative chemistry. As Comte said, “Science is measurement.”

In the field of human action, however, especially in the field of economics, there are no such constant relationships between magnitudes. Opinions to the contrary have been maintained, however, and even today many people fail to see that accurate quantitative explanations in the field of economics are impossible. In the field of human action, we can make explanations only with specific reference to individual cases.

Take the French Revolution, for instance. Historians search for explanations of the factors which brought it about. Many factors cooperated. They assign values to each factor—the financial situation, the queen, her influence on the weak king, and so on. All may be suggested as contributing. Through the use of mental tools, historians attempt to understand the several factors and to assign to each a definite relevance. But how much each of the various factors influenced the outcome cannot be answered precisely.

In the natural sciences, the establishment of experimental facts does not depend on the judgment of individuals. Nor on the idiosyncrasies, or individuality, of the specific scientist. A judgment in the field of human action is colored by the personality of the man doing the understanding and offering the explanation. I do not speak of biased persons, nor of those who are politically partial, nor of persons who attempt to falsify facts. I refer only to those who are personally sincere. I do not refer to differences due to developments in other sciences that affect historical facts. I do not refer to changes in knowledge which affect historical interpretations. Nor am I concerned with differences influencing men due to scientific, philosophical, or theological points of view. I am dealing only with how two historians, who agree in every other regard, may nevertheless have different opinions, for instance, as to the relevance of the factors which brought about the French Revolution. The same unanimity will not be attained in the field of human action as there will be, for instance, with respect to the atomic weight of a certain metal. And with regard to the understanding of the future operations of an entrepreneur or a politician, only later events will prove whether certain prognostications based on their evaluations were, or were not, correct.

There are two functions involved in understanding: to establish the values, the judgments of people, their aims, their goals; and to establish the methods which they use to attain their ends. The relevance of the various factors and the way in which they influence results can only be matters of value judgments. In a discussion of the Crusades, for instance, it would appear that the principal causes were religious. But there were other causes. For example, Venice profited by establishing her commercial supremacy. It is the historian’s task to decide the relevance of the various factors involved in a course of events.

The historical school of economics wanted to apply to economics the same general rules that Comte aimed at in sociology. There were people who recommended substituting something else for history—a science of laws derived from experience in the same way physics acquires knowledge in the laboratory. It was also held that the historical method was the only method for dealing with problems in the field of human action.

In the late eighteenth century, some reformers wanted to revise the existing system of laws. They pointed to the lack of success and shortcomings of the existing system. They wanted government to substitute new codes for old laws. They recommended reforms in conformity with “natural law.” The idea developed that laws cannot be written, that they originate in the nature of individuals. This theory was personified by Britain ’s Edmund Burke [1729–1797], who took the side of the colonies and who later became a radical opponent of the French Revolution. In Germany , the Prussian jurist Friedrich Karl von Savigny [1779–1861] was the advocate of this mode of thinking. With reference to the soul of the people, this group of reactionaries agreed with the school of Burke . This program was executed to some extent, and sometimes very well, in many European countries— Prussia , France , Austria , and finally in 1900 in the German Reich. In time opposition developed to this desire to write new laws. Yet these groups were the forerunners of the present-day world.

The school of the historical method says that if you want to study a problem, you must study its history. There are no general laws. Historical investigation is the study of the problem as it exists. One must first know the facts. To study free trade or protection, you can only study the history of its development. This is the opposite approach from that advocated by Comte.

All this is not to disparage history. To say that history is not theory, nor theory history, disparages neither history nor theory. It is only necessary to point out the difference. If a historian studies a problem he discovers that there are certain trends in history that prevailed in the past. But nothing can be said as to the future.

Men are individuals and, therefore, unpredictable. Mathematical laws of probability tell us nothing about any specific case. Nor does mass psychology tell us anything but that crowds are made up of individuals. They are not homogeneous masses. As a result of the study of masses of people and crowds it has been learned that a small change can bring about important and far-reaching results. For example, if someone yells “Fire!” in a crowded hall, the results are different from what they would have been in a small group. Also in a crowd, the prestige of the police and the threat of the penal code and of the penal courts are less powerful. But if we can’t deal with individuals, we can’t deal with masses.

If a historian establishes that a trend existed, it doesn’t mean that the trend is good or bad. The establishment of a trend and its evaluation are two different things. Some historians have said that what is in agreement with the trends of evolution is “good,” even moral. But the fact that there is an evolutionary trend today in the United States toward more divorces than formerly, or the fact that there is a trend toward increased literacy, for instance, doesn’t make either trend “good,” just because it is evolutionary.

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3RD LECTURE

Acting Man and Economics

PEOPLE GENERALLY BELIEVE that economics is of interest only to businessmen, bankers, and the like and that there is a separate economics for every group, segment of society, or country. As economics is the latest science to have been developed, it is no wonder that there are many erroneous ideas about the meaning and content of this branch of knowledge.

It would take hours to point out how common misunderstandings developed, which writers were responsible, and how political conditions contributed. It is more important to enumerate the misunderstandings and discuss the consequences of their acceptance by the public.

This first misunderstanding is the belief that economics does not deal with the way men really live and act, but with a specter created by economics, a phantom that has no counterpart in real life. The criticism is made that real man is different from the specter of the “economic man.”

Once this first misunderstanding is removed, a second misunderstanding arises—the belief that economics supposes that people are driven by one ambition and intention only—to improve their material conditions and their own well-being. Critics of this belief say that not all men are egoistic.

A third misunderstanding is that economics assumes all men to be reasonable, rational, and guided by reason only, while in fact, the critics maintain, people may be guided by “irrational” forces.

These three misunderstandings are based on entirely false assumptions. Economics does not suppose that economic man is different from what man is in everyday life. The only supposition of economics is that there are conditions in the world with regard to which man is not neutral, and that he wants to change the situation by purposeful action. So far as man is neutral, indifferent, content, he takes no action, he does not act. But when a man distinguishes between states of various affairs and sees an opportunity to improve conditions from his point of view, he acts.

Action is the search for improvement of conditions from the point of view of the personal value judgments of the individual concerned. This does not mean improvement from a metaphysical view, nor from God’s point of view. Man’s aim is to substitute what he considers a better state of affairs for a less satisfactory one. He strives for the substitution of a more satisfactory state of affairs in place of a less satisfactory state of affairs. And in the satisfaction of this desire, he becomes happier than he was before. This implies nothing with reference to the content of the action, nor whether he acts for egoistic or altruistic reasons.

To eliminate the misunderstanding that arises when a distinction is attempted between “rationalism” and” irrationalism,” it must be realized that what man does consciously is done under the influence of some force or power which we call reason. Any action aimed at a definite goal is in this sense “rational.” The popular distinction between “rational” and “irrational” is entirely without meaning. Examples of “irrationalism” cited are patriotism or the purchase of a new coat or a symphony ticket when something else might have appeared a more sensible action. The theoretical science of human action presupposes only one thing—that there is action, i.e., the conscious striving of individuals to remove uneasiness and to substitute a more satisfactory state of affairs for one that is less satisfactory. No judgment of value is made as to the reason or content of the action. Economics is neutral. Economics deals with the results of value judgments, but economics itself is neutral.

Nor is there any sense in trying to distinguish between “economic” and “non-economic” actions. Some actions deal with the preservation of man’s own vital senses and necessities—food, shelter, and so on. Others are considered to be driven by “higher” motivations. But the value placed on these various goals vary from man to man, and differ for the same man from time to time. Economics deals merely with the action; it is the task of history to describe the differences in goals. Our knowledge of economic laws is derived from reason and cannot be learned from historical experience because historical experience is always complex and cannot be studied as in a laboratory experiment. The source of economic facts is man’s own reason, i.e., which we call in epistemology a priori knowledge, what one knows already; a priori knowledge is distinguished from a posteriori knowledge, knowledge which is derived from experience.

Regarding a priori knowledge, the English philosopher John Locke [1632–1704] developed the theory that the human mind is born a blank slate on which experience writes. He said there was no such thing as inherent knowledge. Gottfried Wilhelm von Leibniz [1646–1716], a German philosopher and mathematician, made an exception in the case of the intellect itself. According to Leibniz, experience does not write on empty white pages in the human mind; there is a mental apparatus present in the human mind, a mental apparatus that does not exist in the minds of animals, which makes it possible for men to convert experience into human knowledge.

I am not going to enter into the argument between “rationalism” and “empiricism,” the distinction between experience and knowledge, which the British philosopher and economist John Stuart Mill [1806–1873] called a prioristic knowledge. However, even Mill and the American pragmatists believed that a prioristic knowledge comes in some way from experience.

The way in which economic knowledge, economic theory, and so on relate to economic history and everyday life is the same as the relation of logic and mathematics to our grasp of the natural sciences. Therefore, we can eliminate this anti-egoism and accept the fact that the teachings of economic theory are derived from reason. Logic and mathematics are derived in a similar way from reason; there is no such thing as experiment and laboratory research in the field of mathematics. According to one mathematician, the only equipment a mathematician needs is a pencil, a piece of paper, and a wastebasket—his tools are mental.

But, we may ask, how is it possible for mathematics, which is something developed purely from the human mind without reference to the external world and reality, to be used for a grasp of the physical universe that exists and operates outside of our mind? Answers to this question have been offered by the French mathematician Henri Poincaré [1854–1912] and physicist Albert Einstein [1879–1955]. Economists can ask the same question about economics. How is it possible that something developed exclusively from our own reason, from our own mind, while sitting in an armchair, can be used for a grasp of what is taking place on the market and in the world?

The activities of every individual—all actions—stem from reason, the same source from which come our theories. Man’s actions on the market, in the government, at work, at leisure, in buying and selling, are all guided by reason, guided by choice between what a person prefers as against what he does not prefer. Reason is the method by which a solution (whether good or bad) is reached. Every action can be called an exchange insofar as it means substituting one state of affairs for another. Hopefully the actor is substituting a situation he prefers for one which he likes less.

The starting points for the natural sciences are the various facts established by experiment. From these facts, theories are built to more and more abstractions, to more and more generalities. Final theories are so abstract that they are practically inaccessible to the general multitude. That doesn’t make them less valuable; it is enough that they are accessible to the few scientists.

In an a prioristic science, we start with a general supposition—action is taken to substitute one state of affairs for another. This theory—meaningless to many—leads to other ideas that become more and more understandable and less abstract.

Natural sciences progress from the less general to the more general; economics proceeds in the opposite direction. Natural sciences are in a position to establish constant relations of magnitude. In the field of human action, no such constant relations prevail, so there is no opportunity for measurement. The value judgments which spur men to act, which lead to prices and market activity, do not measure; they establish distinctions of degree; they grade. They do not say “A” is equal to, or is more or less than “B.” They say, “I prefer A to B.” They don’t establish judgments. This has been misunderstood for 2000 years. Even today there are many persons, even eminent philosophers, who misunderstand this completely. It is from the system of values and preferences that the price system of the market arises.

Aristotle wrote, among other things, about the various attributes of men and women. He was often mistaken. Had he asked Mrs. Aristotle about women, he would have found he was mistaken in some respects; he would have learned differently. He was also mistaken in stating that if two things were to be exchanged on the market, they must have something in common, that they were being exchanged because they were equal. Now if they were equal, why was it necessary to exchange them? If you have a dime and I have a dime, we don’t exchange them because they are the same. It follows, therefore, that if there is an exchange, there must be some inequality in the items being traded, not equality.

Karl Marx [1818–1883] based his theory of value on this fallacy. In Capital and Interest, by Eugen von Böhm-Bawerk [1851–1914], see Chapter XII dealing with Marx (“The Exploitation Theory” in Volume I, History and Critique of Interest Theories). Long after Marx, Henri Bergson, in a much-admired book about the two sources of morals in religion, accepted the same fallacy—if two things are exchanged on the market they must be equal in some way. But things that are “equal” are not exchanged; exchanges take place only because things are unequal. You take the trouble of going to the market because you value the loaf of bread more highly than the money you give for it. People exchange things because at that time they prefer other things to money. An exchange never occurs with the intention of a loss. The acting man is never pessimistic because his action is inspired by the idea that conditions can be improved.

The aim of action is to substitute a state of affairs better suiting the men taking the action than the previous situation. The value of any change in their situation is called a “gain” if it is positive, a “loss” if it is negative. This value is purely psychic, it cannot be measured. You can say only that it is greater or less. It becomes measurable only insofar as things are exchanged on the market against money. As far as the action itself is concerned, it has no mathematical value.

But, you say, this contradicts our daily experience. Yes, because our social environment makes calculations possible insofar as things are exchanged for a common medium of exchange, money. When things are exchanged against money, it is possible to use monetary terms for economic calculations, but only when three conditions are filled:

1. There must be private ownership, not only of the products, but also of the means of production;

2. There must be division of labor and, therefore, production for the needs of others;

3. There must be indirect exchange in the terms of a common denominator.

By and large, given these three conditions some mathematical values may be established, although not precisely. These measurements are not exact because they deal with what took place yesterday, historically. Business financial statements may look precise, but even the money value of an inventory entered at “so many dollars” is a speculative value of future anticipations; the value credited to equipment and other assets also is speculative. The real problem of inflation is that it falsifies these calculations and brings about tragic problems.

Monetary calculations do not necessarily exist in all kinds of organizations or societies. They did not exist when economics began. The earliest humans acted; humans have always acted; but it was thousands of years before the evolution of the division of labor and of a financial apparatus made monetary calculations possible. Monetary calculations developed step by step during the Middle Ages. In their early development they lacked many features we think of today as necessary. (In a socialist system, these conditions would again disappear and make such calculations and measurements impossible.)

The quantitative nature of the natural sciences enables mechanics to make plans and build bridges. If you know what must be built, technology based on the knowledge of the natural sciences is sufficient. The questions are, however: What should be constructed? What should be done? Technologists cannot answer these questions.

In life the materials of production are scarce. No matter what we do there will always be other projects for which the necessary factors of production cannot be spared. There will always be other urgent demands. This is the factor that businessmen take into account in calculating loss and success. When a businessman decides against a certain project because the cost is too high, it means the public is not prepared to pay the price to use raw materials in that manner. Use is made of the available factors of production for the realization of the greatest number of those projects that satisfy the most urgent needs without wasting factors of production by withdrawing them from more urgent to less urgent employment.

To establish this it is necessary to be in a position to compare the outlays of various factors of production. For example, let it be assumed that it is necessary to build a railroad between two towns—A and B. Let u s assume that there is a mountain between A and B. T h e re are three possibilities—to go over, through, or around the mountain. A common denominator is necessary to calculate the comparative value. But this can give only a picture of the monetary situation; it is not a measurement. It is an evaluation in the light of present-day needs and situations. Tomorrow conditions will be different. The success or failure of every business project depends upon its success in anticipating future possibilities.

The problem with trying to develop a quantitative science of economics is that many persons imagine that theoretical economics must follow the evolution of other branches of science. The natural sciences developed from being qualitative to being quantitative in nature and many people are inclined to believe that the same trend must take place in economics also. However, there are no constant relationships in economics, so no measurement is possible. And without measurement, the quantitative development of economics cannot take place. Quantitative facts in economics belong to economic history—not to economic theory.

A book titled Measurement of the Elasticity of Demand was reviewed recently by a man now in the U. S. Senate, Paul Douglas [1892–1976], who may even be hoping for higher political office sometime. Douglas said economics should become an exact science with fixed values like atomic weights in chemistry. But this book itself does not refer to fixed values; it refers to the economic history of one definite period of time in one particular country, the United States . The results would have been different if another period of time or if another country had been considered. Within the framework of the universe in which we operate, atomic weights do not change from one period of time or from one country to another. On the other hand, economic values and economic quantities do change from time to time and from place to place.

Economics is the theory of human action. It is a historical fact of great importance, for example, that the usefulness of the potato was discovered by the natives of Mexico , brought to Europe by a British gentleman, and that its use spread all over the world. This historical fact has had important effects on Ireland , for instance, but from the point of view of economic theory it was just an accident.

When you introduce figures into economics you are no longer in the field of economic theory, but in the field of economic history. Economic history is also, of course, a very important field. Statistics in the field of human action is a method of historical study. Statistics give a description of a fact, but they cannot prove any more than that fact. (It is true that some statisticians are “swindlers” and, as a matter of fact, some statisticians in the government were probably appointed merely for that purpose.)

Some people may misinterpret these statements and conclude that the purpose of economics, being a purely a prioristic science, is to develop a program for a future science, and that economics is a theory practiced only by “armchair gentlemen.” Both these statements are wrong. Economics is not a program for a science that doesn’t yet exist. And it is not a science merely for purists. Therefore, we must reject the ideas of some people that one must learn history to study human action. History is important. But you cannot deal with present-day conditions by studying the past. Conditions change.

As an example of what I mean. The National Bureau of Economic Research published a report on the subject of installment selling which appeared on the eve of World War II, on the eve of inflation, and on the eve of government credit restrictions. At the moment when the study was made, it was already “dead”; it dealt with matters that were already past. I don’t mean to say that it was useless. With good brains one can learn a lot from it. But don’t forget it is not economics—it is economic history. What they were really studying was the economic history of the most recent past.

Darwin realized this too. He saw that in studying animals, the animal was killed at the moment when it was dissected for study, so that one could never actually study the animal—one can never study life itself.

The same is true of economics. One cannot describe the present economic system—one can only describe the past. One cannot predict about the future as a result of studying the past. Very often economic historians teach history under the label of “economics.” Even though you know everything about the past, you know nothing about the future.

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4TH LECTURE

Marxism, Socialism, and Pseudo-Science

TODAY I WILL DEAL WITH SOME OF THE ASPECTS of the theories of Karl Marx. I want to contribute a little bit to the materialistic interpretation of history. First of all, I must say something about the general philosophy and history of Marx.

In general, philosophical doctrines concerning historical problems are doctrines of a very special type. They try to point out not only what history was in the past but they presume to know what the future has in store for mankind and to offer a solution for future problems. Most philosophers reject this method of thinking. For example, Immanuel Kant [1724–1804] declared that a man who tried to do this would be allocating to himself the ability to see things with the eyes of God.

Nevertheless, in the 1820s Hegel gave such a philosophical interpretation of history. According to Hegel, the driving force of the Industrial Revolution was an entity called Geist, i.e., spirit or mind. Geist has certain aims which it wants to fulfill. The evolution of the Geist of history has now reached its final goal. This final goal, according to Hegel, was the establishment of the kingdom of Prussia of Friedrich Wilhelm III [1770–1840], and of the Prussian Union Church. Critics of this doctrine say this would mean there would be no history in the future because evolution had reached its final end.

In the middle of the nineteenth century, Karl Marx, on his own, developed a philosophy different from that of Hegel. The driving force of Karl Marx was not Geist or spirit but something called the “material 21 Marxism, Socialism, and Pseudo-Science productive forces.” These forces push the history of mankind through various successive stages, the next to the last of which is capitalism. After capitalism comes inexorably the last stage—socialism. Therefore, according to this theory, the coming of socialism is inevitable, determined by the forces of history.

The predecessors of Marx, the historic socialists, believed that to realize socialism it was necessary to convince the majority of the people that socialism was the better, or the best system; then the people themselves would bring about the substitution. Karl Marx said nothing about the desirability of socialism; he pretended not to be speaking in favor of socialism. He claimed to have discovered a law of social evolution indicating that socialism was bound to come with the inexorability of a law of nature.

But is socialism better? This question had already been answered by Hegel and Comte. According to their doctrines, it was tacitly assumed that each successive stage of evolution must of necessity be “better” and “higher” than the previous stages. Therefore, to raise the question of whether or not a later evolutionary stage is better is beyond the point. It was obvious. Because socialism would be a later stage, it must of necessity be better.

Marx believed that socialism was just around the corner. After that, all history would come to an end. After that there could be no further development because once the class conflict was eliminated we would be living in a state in which no longer anything important could happen. Here is a quotation illustrating that point from Friedrich Engels [1820–1895], who considered himself not only a great economist but also a great expert on military problems:

In the first place the weapons used have reached such a stage of perfection that further progress which would have any revolutionizing influence is no longer possible. . . . The era of evolution is therefore, in essentials, closed in this direction.[xxxiv]

Since then, today’s modern weapons have all been developed.

The most important problem for the doctrine of the inevitability of socialism to explain is how a superhuman entity such as Geist or the “material productive forces” can force individuals to act so that a certain irresistible result must prevail. People have their own individual plans— they aim at various ends. But the inevitability-of-socialism theory maintains that whatever people do they must finally produce the results which Geist or the “material productive forces” wanted to have produced. Two explanations have been suggested.

One group had a very simple solution. This group maintained that people will be forced by “Führers” or supermen to go the way that Geist or the material productive forces indicate. There have always been kings and dictators who have assigned to themselves this superhuman mission. So Stalins, Hitlers, and Mussolinis are elected by history; those who don’t obey their commands must be liquidated because they are against “historical evolution.”

This was not Marx’s idea. The Marxian doctrine was based on the much-discussed “economic dialectic historical materialism.” Materialism is one of the ways in which people try to solve one of the most fundamental and insoluble problems, the relation between the functions of the individual’s soul or mind, on the one hand, and the functions of the body, on the other. Precisely what this relation is remains controversial. There is no doubt that there is some connection, and many attempts have been made to explain it. However, our only interest in such a materialistic explanation at the moment is because of its relation to Karl Marx’s theory.

The materialistic philosopher says that all mental functions of men are simply produced by their bodily organs—by their physical brains. Some eighteenth-century philosophers suggested this idea. In the nineteenth century it was expressed more crudely by some of Marx’s contemporaries, among them the German philosopher Ludwig Andreas Feuerbach [1804–1870], who said bluntly, “Man is what he eats.” This is interesting, but somewhat difficult to accept. Chemically, the secretion of the organs of all normal men is the same. Insofar as they are not, insofar as there are irregularities, these variations indicate a pathological condition and these irregularities are the same for all men in the same pathological condition. Ideas and thoughts, however, are different. Two boys may take the same exam, but their answers to the same questions will be different. The Italian poet Dante wrote beautiful words, while others may have difficulty writing anything at all. Therefore, there is something “fishy” about this doctrine.

Marx rejected this type of materialism, saying these materialistic philosophers were weak in dealing with social problems. In spite of the fact that superficial knowledge of Marx’s own brand of materialism requires very little time, it is not very well known. His particular brand of materialism is expressed on a very few pages of his Critique of Political Economy, the original draft for the first chapter of Das Kapital:

In the social production of their subsistence men enter into determined and necessary relations with each other which are independent of their wills – production – relations which correspond to a definite stage of development of their material productive forces.[xxxv]

The material productive forces produce, independently of the will of the people, definite legal and institutional systems called “production relations.” Production-relations are the necessary consequences of the material productive forces.

Over and above the production-relations there is a super-structure which includes everything ideological—art, literature, science, religion, and so on. These super-structures are the necessary products of the existing production-relations. The production-relations are, in turn, the necessary consequences of the existing material productive forces, which are the real thing. The material productive forces alone have an individual effect. When the material productive forces change, they inevitably bring about, independently of the will of man, corresponding changes in the production- relations of the social organ, of society. They also bring about changes in the super-structure. Therefore, the important question is: What are the material productive forces?

Here we are faced with Marx’s peculiar technique of not giving definitions of the terms he uses. However, his occasional examples are helpful. Most important is the example which appears in The Poverty of Philosophy (1847). The hand mill gives you “feudal society”; the steam mill gives you “industrial society.” This means that the material productive forces are the tools and machines. It is the tools and machines that are the real things. The tools and machines change; they have a history of their own; they produce first of all the production-relations and the social structure, and above the social structure they produce the super-structure—the literature, religion, and so forth. Other instances lead us to the same conclusions, that what Marx meant by the “material productive forces” were the tools and machines.

But two important questions arise. Tools and machines do not appear in the universe independent of the human mind. They are products of human thought and ideas—they are products of the human mind. Secondly, these tools and machines can only be introduced into practice when the social conditions make it possible—there must first be a certain degree of division of labor in order to apply and to use machines. Without the division of labor, machinery, the product of ideas is useless. Is this really materialism? Thus the evolution of Marx’s ideological factors—the source of ideas, the basic material productive forces—is traced back to products which are themselves the result of the human mind. Therefore, the whole scheme is unsatisfactory.

Marx wanted to show how new ideas originated. He attacked the theories of the eighteenth century, especially those of Scottish historian and philosopher David Hume [1711–1776], that ideas that are the important thing, that changing ideas result in changing conditions. Marx said that ideas are nothing but the necessary outcomes of material factors, products of the material productive forces. But we see that the material productive forces are themselves the products of ideas. Marx’s thinking moves in a circle.

There were others besides Marx who attached enormous importance to inventions and improvements in machines. A little later in the 1870s, Leopold von Ranke [1795–1886] declared that the history of technology is the most important aspect of human history; everything is continued by technology. Marx went farther in saying that everything really and literally depends on changes in technology. But he couldn’t explain everything from the materialistic point of view because tools and machines are themselves products of the human soul.

When Marx died, his friend and collaborator, Friedrich Engels, addressed his friends at the grave. In this speech he tried to condense into a short statement what he considered the great immortal ideas of Marx. This speech contains a slightly new interpretation of Karl Marx. Engels declared that “Like Darwin , who discovered the law of evolution of organic nature, 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. . . .” This, said Engels, had been unknown before Marx discovered it. But it is obvious; nobody has ever denied it. As a matter of fact, there is an old Latin dictum or saying of the early Middle Ages: “First you must live, then you can be a philosopher.”

It was a wonderful trick of Engels to give this interpretation to Marx because since then, whenever anyone tries to contradict Marx’s theory, he is asked whether he denies that one must first eat and drink before one can write. It is obvious that one must. So you are forced to accept the basis of the Marxian theory.

Marx continues. Society is divided into classes and every member of a class is bound by the laws of history to think according to his class interests. The class allegiance, not only in the present state of society but also in preceding stages when the classes developed, determines the content of a person’s ideas. A person thinks in a certain way because he is a member of a definite class. And as all class members think according to their own class interest, the result is that the interests of those classes which history has selected must finally triumph. Marx’s idea is that the class, not the individual, thinks.

Classes do not create themselves. We make classes by classifying. If a classification is correct and logical, then the classification cannot be attacked. Marx classified people and assumed that there existed an irreconcilable conflict of interests among the several classes. The question is, does such a conflict exist? Marx never proved this. He first presented the theory of classes in the Communist Manifesto of 1848. Later he published lots of other books. But he never told us what a “class” was; he only explained what classes were not.

In one of the volumes of Das Kapital, published by Engels after Marx’s death, there is a chapter titled “Classes.” Here Marx starts out by telling what classes are not. Then the manuscript ends. A note by Engels says the work was never finished. We could feel very sad if we did not know that Marx’s writing was not interrupted by his death; he stopped writing these volumes many years before.

Marx gives examples of class conflict, but they all refer to conditions of status in a caste society, when one is born into a certain caste—nobility, bourgeoisie, serfdom, and so on. Under such circumstances, there is a conflict of interests. Anyone born a member of a definite caste has only as much right and privilege as his father. And then it is correct to say that there are class conflicts. But a society in which there is equality under law and in which everybody is free to do what he wants—in such a society there are no rigid “classes” and no irreconcilable “class” interests.

It follows, therefore, that to talk of the “bourgeoisie” implies that one group has special interests over and above those of the multitudes. This is the philosophy implicit in the U.S. policy that we should grant subsidies to farmers, or special privileges to labor, provide assistance to the “Ruritanians” to keep them from going Communist, and so on. If they want to go Communist, that is best for them. We are living in a world dominated by this “class” philosophy. Referring to the bourgeoisie assumes the Marxian theory of classes.

Even if we assume Marx’s other theses, it is difficult to accept his class argument. Marx admits in the Communist Manifesto that there are people who are class-conscious and those who are not, that the interests of some individual are opposed to the interests of their “class.” Why should an individual think according to the interest of his class if the class interests are different from his own interests? It is said that the workers in the United States are extremely backward in the development of class consciousness. If a lack of class consciousness can exist, how is it possible to say there is such a thing as a class interest?

There are also differences of opinion among various persons as to what the interests of the class really are. The question is, which is right? The Marxians say, “It is very easy to know. If a member of the class thinks differently, he is a class-traitor, a social-traitor. If another man, not a member of the class, thinks differently, there is no need for an explanation.” The difficulty with this is that there are in fact some class members who don’t think along the lines prescribed by their “class interests.”

Another difficulty is that Karl Marx himself, who presumed to speak for the proletarians, was not a proletarian. He was the son of a well-to-do lawyer; he married the daughter of a Prussian Junker; and his brother-in-law was chief of the Prussian police. Then too, his associate, Friedrich Engels, was not a proletarian; he was the son of a manufacturer and he was himself a manufacturer. Their answer to this criticism is:

Finally, in times when the class-struggle nears the decisive hour, the process of dissolution going on within the ruling class—in fact, within the whole range of an old society—assumes such a violent, glaring character that a small section of the ruling class cuts itself adrift and joins the revolutionary class, the class that holds the future in its hand.[xxxvi]

But Marx and Engels were not in the rear of the movement—they were in the forefront of the movement. They and other leaders of the movement were also bourgeois.

In England when the Fabian movement developed, continental socialists visiting that country to meet their eminent friends and admirers were often amazed to find that the Fabians were a very socially eminent set. At their dinners they appeared in white tie and tails and the ladies wore jewelry and all the paraphernalia of Victorian society. It is at least questionable that socialism was an outcome of the proletarian mind.

How could a man like Marx fail to realize that it is not “interests” that create ideas, but rather that ideas teach people what their “interests” are? How could he fail to see this? I believe it was because he was fully dominated by the idea that economics is merely food, clothing, and shelter. It was his idea that the starving masses were intent only upon getting food. He was fully convinced that the trend of capitalism was, inevitably, to cause impoverishment of the masses and concentration of the wealth in the hands of a small group. He was convinced that nothing could prevent this trend, and that this trend would finally bring about socialism.

Everybody knows this is not true. But, people answer, it is not true because something happened that Karl Marx could not have foreseen. He did not foresee the union movement and social legislation. But one short paper published by Marx did discuss labor unions and it said it was hopeless for them to try to improve the condition of the workers because the trend of history was in another direction. Real wages inevitably go down and down. Unions should abandon their effort for higher wages and substitute a “conservative” aim—to do away forever with the wage system. Marx was opposed to social legislation—social security and so forth— at least after the 1850s when he affirmed his belief that the material productive forces would bring about changes. If the material productive forces change, the whole structure must necessarily change, because the material productive forces can no longer develop in the old relationship. On the advice of Marx himself and, after his death, of Friedrich Engels, the German Reichstag voted against socialized medicine, social insurance, and labor legislation, calling them frauds to exploit the laboring classes even more than before.

No social formation ever disappears before all the productive forces are developed for which it has room, and new higher relations of production never appear before the material conditions of their existence are matured in the womb of the old society.[xxxvii]

Therefore, it was Marx’s thesis that in order to accelerate the coming of socialism, capitalism must first reach maturity. (This is comparable to the “mature capitalism” of the New Deal.) All these methods to “improve” capitalism such as social security, labor legislation, and so forth, are just petty bourgeois policies; they are detrimental to the interests of the workers because they only postpone the maturity of capitalism.

If it is true that the coming of socialism—a blessing for the workers— is independent of the will of men, if it depends exclusively on the maturity of capitalism and the development of the productive forces within capitalism, what is the use of a Socialist Party? Isn’t it preposterous, according to this theory, for man, who has nothing to say as to the future, to attempt to reach a goal? The answer made to that question is that, just as a midwife is necessary to aid a mother give birth, so is the Socialist Party necessary to bring socialism into the world. Sometimes the midwife may interfere and the situation changes, but she serves a purpose.

Thus we see that Marx’s attempt to show that ideas are the products of something material was not too conclusive. He demonstrated only that ideas are produced by forces which are themselves already the products of other ideas. All his theories teach is that among ideas some are more important than others. According to him, the idea that brings about the construction of a new machine, for instance, is more important than the ideas that bring about a poem or a philosophical system. The value of all these mental activities is attacked by Marx. What is the use of poetry, the value of religion, if these are merely consequences of the fact that we have certain tools of production? I wouldn’t even call this theory of Marx’s “materialism.”

In the 1840s and the 1850s, recognized sociologists and economists devastated the teachings of the socialist authors with their criticism. But their critiques did not touch the most important problems. There was no reason for them to do so because they abolished the assertions of their socialistic contemporaries. Karl Marx realized that he couldn’t answer these critiques, and his socialistic doctrines took another turn. First of all he elaborated the theory that everybody is bound by the laws of nature to think in such a way as the interests of his class force him to think. He believed that a man’s theory, no matter with what it deals—whether religion, philosophy, or law—can never give us truth so long as there are classes. Class ideologies, he felt, are obviously false because of their deficiencies and biased to serve the interests of the author. Marxians, even today, believe that they have proved their thesis simply by asserting that there is no such thing as an unbiased search for truth, that man doesn’t search for truth but only for practical results.

For the sake of the argument, if we accept the thesis that all mental activities are motivated by the desire for practical results, we must admit that if a man wanted results, he would aim at a theory which was correct. Pragmatists say “truth” is something that works when applied. Ludwig Boltzmann [1844–1906], a positivist philosopher, said that the proof that our physical theories are correct rests on the fact that machines constructed according to these theories operate as expected. Because people wanted to kill one another by firearms they developed the theory of ballistics. According to Marx, the theory of ballistics was not developed because people wanted to kill other people, but the theories are correct because they wanted to kill. Marx developed his theory because he wanted to say that the proletarians needn’t worry about the bourgeois point of view; what the bourgeois economists said about socialism was of no concern to the workers.

The second point he developed was the theory of the inevitability of the coming of socialism because of the progressive impoverishment of the workers by the capitalists. As socialism is a later stage, Marx said, it is necessarily also a higher stage. It is, therefore, beside the point to develop plans for the future socialistic state. Critics have demolished these ideas saying they cannot work. But Marx said that we do not have to do it; the productive forces will make the plans when everything is ripe.

Marx’s success was enormous. Today, many people who believe that socialism is inevitable consider themselves young Marxists and young Communists. There has been resistance to his historical materialism, but there has been little resistance to the theory of the inevitability of socialism.

The main deficiency of the present-day mentality is precisely the fact that people are rather weak in criticizing the fundamental thesis of Marxism. A book by Alexander Miller on The Christian Significance of Karl Marx (New York: Macmillan, 1947) recommends the use of the Christian religion to endorse not only Marxism itself but also Marxian materialism.

Marx was consistent in rejecting attempts at labor legislation. His theory was that the world must follow a certain sequence of events: (1) feudalism; (2) capitalism; and (3) socialism. Because it was incompatible with his theory, he rejected the theory that one stage could be skipped over. However, when Marx died, Engels found among his belongings a note by Marx on a scrap of paper suggesting that this might be possible. Evidently Marx had scribbled this note one night—in the morning he had thought better of it, realizing that if he agreed to this it would destroy his basic theory. Engels copied the note in his own handwriting and sent it to a woman in Russia who had won some fame because she had killed the police commissar and had been acquitted—such things happened in Russia then. She published it in the 1880s. The Bolsheviks thought this was a wonderful idea—they knew Russia was backward and seized upon this as grounds for believing they wouldn’t have to go through capitalism before attaining socialism, but could skip over that stage.

The importance of Marx is that he branded the doctrines of other humanists as ideologies, false theories which precisely on account of their incorrectness are useful to the class from which they emanate. As an economist Marx was completely dominated by the doctrines of the British classical economists. They developed the important system of political economy, but they failed to solve one fundamental problem—the paradox of value. Their theory seems obvious—people value external things and services because of their utility, because these things can bring about certain useful services—the more useful the service, the greater the value. But they couldn’t explain why one unit weight of gold, which is less useful than iron, is exchanged against a number of such units of iron.

In 1870, the solution to this paradox was discovered independently three different times by three different persons—William Stanley Jevons [1835–1882] in England , Carl Menger [1840–1921] in Austria-Hungary , and Léon Walras [1834–1910] in Switzerland . These three men recognized that only a definite limited quantity of something is traded in any particular exchange. People don’t exchange the total available supply, for instance, of iron or gold. If a man gives several units of iron for one of gold, he doesn’t behave as if he were exchanging the entire stock of iron against the entire stock of gold. The greater the quantity available, the smaller the value per unit, the smaller the satisfaction per unit. This was the marginal utility theory.

The theory of the classical economists was responsible for the fact that values weren’t traced to the ultimate consumer. This explains why so much value was attached to the theory of buying cheap and selling dear and it led to the misunderstanding of the specter of “the economic man.” This theory dealt only with the businessman, not with the consumer. That would have required starting from the utility, which was not easy for the ordinary person to understand. The important fact is that the two great socialists of the nineteenth century, the radical revolutionary socialist Marx and the parlor socialist, philosopher, and economist John Stuart Mill [1806–1873], were so convinced of the classical theory of value that they never had any doubts about it. That theory of value had already been criticized among others by Ferdinand Lassalle [1825–1864], who had more influence in his day than did Marx. But this classical theory, as perfected by Ricardo, was adopted by Marx. And Mill, in his Principles of Political Economy, published in 1848, stated that the theory of value is solved for all time to come—coming generations could make no further improvement on it.

Marx called the system of the classical economics a bourgeois ideology. Yet what he developed as economic theory was nothing but the classical system shaped a little bit differently and expressed in slightly different words. Marx’s addition to economics is of very little importance. As an economist he more or less repeated what he had heard from others— sometimes calling them idiots, sycophants, and so on—but never deviating very far from their teachings.

Marx explains history as the result of economic class interests. Every situation contains groups who are profiting or suffering in the short run, and it is to these interests that Marx points. For example, if there were a plague or an epidemic, the drug manufacturers and the doctors would profit. Long-run interests are not so obvious and can be determined only by ideas.

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5TH LECTURE

Capitalism and Human Progress

I WANT TO START TONIGHT WITH THE RELATION between economics and human practical life, and the consequences of the development of the theory of economics.

Kipling said, “East is East, and West is West, and never the twain shall meet.” Differences between the East and the West have certainly existed for thousands of years. The East never developed the idea of scientific research—the search for knowledge and truth for its own sake—which the Greeks gave to civilization. A second achievement of the Greeks, which has always been foreign to the East, is the idea of political liberty of government—of political responsibility of the individual citizen. These ideas, widely accepted in the West, never found counterparts in the East. Even today, only a small group of Eastern intellectuals follow these ideas. Nevertheless, the world was more or less one world, in spite of these ideas, until about 250 years ago.

Social relations and living conditions were more or less the same all over the world until 250 years ago. The average standard of living varied little between East and West. Modern methods of production and standards of consumption, technological knowledge, and equality under the law were unknown. Today we would consider most unsatisfactory the conditions that prevailed then. Aside from its political meaning, Wendell Willkie’s word, “One World,” was more applicable then than now.

The general improvement in political tranquility, which had reached a certain degree about 250 years ago, contributed to an increase in population. This additional population was too much for the social system of those ages. The countries where political conditions were most favorable became infested with robbers, thieves, and murderers—people for whom there was no place under the existing economic situation.

Then something occurred in Europe —first in western Europe, Great Britain , and the Netherlands —which spread over the rest of the Western world. It was this movement that led to considerable differences between the East and the West. This movement is called by historians the Industrial Revolution. Radical changes were brought about by preceding radical intellectual changes, that is, by the intellectual movement that produced economics as an autonomous branch of human knowledge. These radical changes multiplied population figures and changed the face of the world.

Some of these ideas had been developing during earlier generations. For instance, Gresham ’s law, the “law” of Sir Thomas Gresham [1519?–1579] which points out that a legally overvalued (bad) money ends up driving a legally undervalued (good) money out of circulation . This regularity in the field of money had been noted earlier by the Greek comic dramatist Aristophanes [448?–?380 B.C.] in The Frogs and by the French bishop Nicolas Oresme [1320?–1382]. However, t h e re had been no realization that similar regularity existed also in relation to the concatenation and sequence of phenomena in the marketplace. The recognition of regularity in the broader field of market activities was an achievement of the human mind, a mental accomplishment. As a result of this new knowledge of regularity in the marketplace, people began to look on all productive activities from a different viewpoint.

The question has been raised as to why the ancient Greeks, for example, whose knowledge of science was so far advanced, did not make practical use of their discoveries. It has been said that they had the scientific knowledge to develop railroads, but they didn’t. Why not? Their progress was handicapped by certain ideas. One idea that held them back, an idea which still prevails today, is that of “technological unemployment,” the idea that improved methods of production lead to unemployment. Because of this, it was considered a crime to deviate from traditional methods of production, no matter how unsatisfactory the old methods were. The idea did not occur to them that reducing the amount of labor required for the production of a certain amount of goods or items would make possible the freeing up of materials and labor for the production of other items.

The second idea that handicapped the Greeks’ development was that they looked on a business deal as one-sided—the seller profits, the buyer loses. This attitude was especially important in its effect on international trade. This old superstition that foreign trade will create unemployment still prevails today. Many people still believe that the advantage to be derived from foreign trade comes from exporting, not from importing. If this were the case, it would mean that the advantage to be derived from buying a loaf of bread would come from “exporting” the money, from spending the money to obtain the bread, and not from getting the bread itself.

Because it was considered a crime to depart from traditional methods of production and trade—and any changes are necessarily always innovations —we are apt to ignore another development, a new idea heretofore unknown. We are blind to the great changes that took place, not only in production, but also in consumption. We see the mass production, but fail to see that this mass production was produced for the satisfaction of the needs of the masses. The guilds and handicraftsmen of the Middle Ages had produced for the well-to-do. Before the Industrial Revolution, and in the early days of the Industrial Revolution, there was a great trade in secondhand clothing. Clothes that were made to order for the well-to-do were bought secondhand by the poor. This trade in secondhand clothing, a really important part of the economy, disappeared as a result of the development of modern methods of production.

The Industrial Revolution started by producing for the needs of the poor, of the masses. Mass production started by producing the cheapest and the poorest things. The cotton industry was one of the early developments of the Industrial Revolution. Cotton was a poor man’s material—no member of the upper or middle classes wanted cotton. The quality of mass production improved only when the conditions of the masses improved to the extent that they also became biased against cheap products. Not so long ago no lady or gentlemen would have bought factory-made shoes, or ready-made clothes. Not until 100 or 120 years ago could one even buy a ready-made shirt in Germany . All these industries have developed during the last 100 to 150 years.

As a consequence of the Industrial Revolution in the West, an enormous gulf developed, a gulf which today separates the West from the East. The East still clings to the idea that once hindered the development of capital in the Western world, the idea that one man’s wealth is the cause of the poverty of others. The concept of the “underdeveloped nations” has arisen and the idea that it is necessary to give them technological advice, i.e., “know-how.” This is really ridiculous! There are lots of Indians, Chinese, and students from other countries in our universities who are very capable persons and who are acquiring know-how. And even if they weren’t, many Americans would be willing to go to those countries to work and to give advice. What they really need is the capital. What is lacking is capitalism.

What is the use of economics, of theoretical economic discussions? All the achievements of the physical and chemical sciences would have remained a “dead letter,” without any significance for real life if the ideas spread by the economists of the eighteenth century about the division of labor, freedom of exchange, and so on, had not paved the way for the practical application of those scientific discoveries. And yet some people today still look askance at innovations. For instance, a German professor, who was considered an eminent economic historian and was an honorary member of many societies, said in one of his last books that it was a very serious drawback that our social institutions permitted everyone the opportunity of producing an invention to put it into practical use. He believed that no harm could come from putting inventions in museums, but unless they were military inventions, that is where they should remain. (This was the basis of the Führerprinzip—the idea that the all-knowing Führer should give the orders and that the Führer receives his orders directly from God, who is the Führer of the Universe.) Scientific advance may be hindered to a certain extent but, by and large, it is impossible to stop it completely.

Some people consider scientific progress “material.” To aim at nothing but improvement of the material or external conditions of life—better food, clothing, homes, and so forth—they called “materialism.” They said people who have such goals care only for the “mean” necessities of daily life. On the other hand, they think they are ethical and that they display idealism by disparaging such material improvements. But let us see.

One of the consequences of the Industrial Revolution was that the world is now populated by many more people than could have been supported before. Each individual in the capitalist countries also lives at a much higher standard of living than before. This means that the average length of life is much longer. The growth in population was not achieved by an increase in the birth rate, but by a decrease in the mortality rate, especially of infants. Queen Anne of England, the last reigning member of the Stuarts, had seventeen children, but not a single one lived to reach adulthood. This situation had serious significance for England ; it created the historical and religious problem of the Protestant succession. As further evidence of the extent of infant mortality, most of the charming children in the Habsburg families that Velásquez painted died in childhood. You may call the improvement of living standards brought about by the Industrial Revolution “materialism.” But from the point of view of the parents, the improved life expectancy of their children may not have seemed merely materialistic.

Engels said people must eat before they can develop philosophical ideas. With this I can agree. The Europeans are now claiming that they are fighting the “Coca-Cola civilization,” but it would be a mistake to say that capitalism has developed nothing but Coca-Cola. Capitalism has certainly led to philosophical and theological improvements also. In the light of the great scientific discoveries of the nineteenth and twentieth centuries, to say that the capitalist economy is the “Coca-Cola civilization” would not seem to be an “unbiased” statement.

Several rights and liberties developed with the Industrial Revolution—policies of economic freedom both in domestic and foreign trade, of sound money and of abstention from government interference. These are policies, not scientific truths; they are policies based on value judgments that arose because of knowledge that had been developed. We must realize the relation between knowledge and values.

It is easier to grasp this distinction in the field of medicine or chemistry. Scientists may establish the fact, for instance, that drug A is a poison, but they do not issue a value judgment on the drug. Pathology and chemistry do not say how a chemical should be used. Their task is accomplished when they determine whether it will, or will not, prolong human life. The decision whether or not to use the poison, and how, must come from somewhere else, not from the chemist or pathologist; that decision must come from a value judgment. If a doctor cannot save the life of both mother and child, a dilemma results: Whose life should be saved? The answer does not come from medical science; it must come from a judgment of value.

In the field of social relations and human conduct, science provides us with existential propositions, statements as to the consequences of certain causes. There is a fundamental difference between such statements of fact and the judgment of value which tells us what alternative is more desirable, more preferable. A value judgment tells us what ought to be from the point of view of those who share the same values.

It would appear that the importance of economics for daily life is small. But that is not true. Actually economic theory is very important. In order to take the proper steps to attain a specific goal, we must first be familiar with the actual state of affairs—the existential situation. But then we need economic knowledge, economic understanding, to make decisions, to act, to make value judgments. To judge the importance of economic knowledge, consider the case of Iran . When she confiscated the property of the Anglo-Iranian Oil Company recently and nationalized the oil industry, she wanted to improve the situation of her people.[xxxviii] The question is whether or not the policy she is following will have that effect.

The classical economists introduced the term “the rightly understood interests.” There are various “runs” of different lengths of time. To determine “the rightly understood interests,” one must consider all possibilities because the short-run end is often different from the long-run end. One of the most popular attacks on economics is that economists take only the long run, not the short run, into consideration. But that is not true. Economists simply point out that there is a distinction between the two. One is apt to prefer short-run interests to interests in the long run, but this doesn’t mean one must consider only the long run. Governments seeking to remedy economic ills by various interventions may not destroy the capitalistic countries in the short run. Some poisons act quickly, others more slowly. Like a slow poison, government interventions may bring about consequences in the long run which are disastrous, even from the point of view of precisely those persons who wanted to resort to these measures. John Maynard Keynes [1883–1946] said, “In the long run, we are all dead.” This is my only point of agreement with Keynes. Even though this idea is correct, it means no more than does the remark of Madame de Pompadour, mistress to King Louis XV, whose role it was to console the king when his armies were threatened—“There is no reason to worry. ‘Après nous le déluge,’” Fortunately for her, Madame de Pompadour died early. But her successor as Louis XV’s mistress, Madame du Barry, was not so fortunate—she survived the short run but lived to be executed in the long run.

But Keynes’s ideas are unsatisfactory even from his point of view. His credit expansion theories bring about an artificial boom which eventually must turn into a depression and crisis. The unwanted consequences may appear several times during one’s lifetime, not only after one’s death. A man living today may have seen the depressions of 1907, 1921, 1929, 1937, and he may live to see yet another.

Economics merely states that there are both short-run and long-run consequences. One must consider both. Decisions should be made in the light of all knowledge available. Economics doesn’t say, for instance, that free trade is better than protection. Economics merely points out the differences between the consequences of the two. Economics merely states that protection is not a way to improve the general standard of living. But this does not apply to cases in which a protective tariff is advocated for other reasons. For example, when the United States realized the threat to her supply lines on the eve of World War II, she could have introduced an import duty on natural rubber and subsidized synthetic rubber manufacturers. But this would then have been considered a “defense” expenditure, not a choice based on economics, and it would have been judged from the point of view of defense.

What the economist provides is not judgments of value, which no science may issue, but the information one needs to make value judgments and decisions. The valuation, the judgment, rests with the individual, with the people, and with the voters.

The idea of the neutrality of science has been criticized, especially by those who wish to elevate certain judgments of value to a higher degree, to the dignity of a rule which everybody must obey. In Germany , especially after the War of 1870, the German professors who taught the economic aspects of political science considered it regrettable that there should be tolerance, understanding, peace, and good will among the nations.

The idea of the neutrality of science (Wertfreiheit—freedom from value) is the most characteristic development of science. Because economic science is neutral, this does not mean that it doesn’t deal with practical problems; it only means that it doesn’t explain the meaning of human action. But it is precisely because of its neutrality that people with different evaluations are able to live peaceably together. This is one of the most important ideas that came out of the Industrial Revolution and the development of modern science. It was an idea that was absolutely foreign to the most eminent minds of the sixteenth century. Very few persons then could have understood that people with different religions, values, and ideas, could live together in the same city, the same country, or the same world.

The peaceful exchange of ideas and the peaceful coexistence of people with various ideas were in triumphal progress at the beginning of the nineteenth century. There was then a development toward freedom and peace, especially toward intellectual freedom for ideas, toward the elimination of government cruelty in punishment and of government torture in criminal procedure, and also toward an improvement in the standard of living. People came to believe that this development toward freedom and peace was inevitable. In the nineteenth century they were fully convinced that nothing could stop this trend toward more freedom. The Manchester Chamber of Commerce in Great Britain even declared in the 1820s that the age of war was gone forever. That was the bloodless economic theory. There need be no war if there was free trade and representative government. But these same people failed to realize that a reaction had already started. A movement was developing in the opposite direction.

Among the opponents of the idea of freedom was Auguste Comte. It is this reaction against freedom that splits the world into two camps today. Paradoxically, those who support the groups that favor imprisonment, persecution for deviations, and so on, are called “progressives.”

The “ethical economists” who opposed the “materialism” of the bloodless economic theory of the British, became the predecessors of what was later called Nazism. The Nazis, imitating the Marxists, would tolerate no opposition. A good German could have only German ideas; everybody should be forced by the laws of nature to think according to the “natural” interests of his race or nation. The Nazis had difficulty explaining such persons as Beethoven, Goethe, Kant, and so on, all Germans, but Germans who had un-German ideas. Now, in view of later events, we can ask whether or not these Nazi ideas, imposed on the German people ostensibly for their own good, were really so useful to them in the long run.

Some modern communists allege that they anticipated the success of Nazism. But they did not! On the contrary, not a single one foresaw it. In Germany at the end of the 1920s and the beginning of the 1930s, the Nazi party first made its appearance. Neutral observers said, “It is true; they are getting some votes, but it is impossible for Germany to go Nazi. Look at the statistics. A majority of the Germans are workers and Marxists. They will never give their votes to the Nazis.” This shows that one cannot anticipate history. One can make prognostications, but whether or not these prognostications will be correct is questionable.

A group with special interests is likely to be in the minority. Cattlemen, dairy farmers, cotton growers, wheat farmers, and so on, are all minorities with special interests. But if government intervenes, alliances may be formed among such groups, even though their interests are not identical, even though they may be in opposition to one another. The same situation exists with respect to labor—garment workers, railroad men, coal miners, and so on. In political life, the thing we have to face is not pressure groups formed because of natural common interests but pressure groups made up of government-promoted alliances of several minorities.

Privileges are of benefit only when they are granted to a minority. Under certain circumstances minorities may secure certain privileges for a time but eventually the advantages will deteriorate, especially for farmers when people begin to realize the various consequences. It is not difficult to convince the various minority groups that they are losing more on the one side than they are receiving on the other, so such alliances can be only temporary. In a representative government a minority can never secure for itself a privilege except in alliance with other groups. Only when people have true knowledge, will they reap the benefits.

Before the Nazis, Germany was called the nation of the poets and thinkers. The Nazis developed a theory of all-round protection, protection for every kind of national organization and for all national production. They did not realize that if you protect everybody to the same degree everybody wins exactly as much as a consumer as he loses on the other end as a producer. If this happened in Germany , the land of poets and thinkers, what can you expect of other countries? The consequences lead to the desire for another system, so the people vote for a government that will protect them from their own ignorance.

In the long run, every country must be ruled in agreement with the ideas of the majority. If the country’s government is against the people’s ideas, then sooner or later the majority will cause a revolutionary upheaval and eliminate the leaders. In “First Principles of Government,” an essay by David Hume, he states that in the long run it is opinion that makes government powerful. For this reason, representative government is good; it reflects opinion. And the next election removes the disagreement.

If the majority is dominated by bad ideas, nothing can be done about it except to try to change the bad ideas. This is the business of writers, authors, economists, and so on. Unfortunately there are many bad writers, bad authors, and bad economists. Still, there is no substitute for trying to substitute good ideas for bad ideas. In the field of state, government, and economic organizations, the consequences of a policy appear only after a very long time and when they appear they are only historical facts. Since it is difficult to ascribe them to one definite cause, changing ideas may be very difficult. Still the only way to deal with bad ideas is to try to substitute good ones.

The social philosophers and the economists of the eighteenth and early nineteenth centuries especially were imbued with the idea that progress toward better conditions and toward more freedom would go on forever. They did not anticipate the events of our age.

All we can know about the future is through the methods of historical understanding and this does not give us certainty. However, the fact that the future is uncertain and that we are free acting individuals are one and the same fact. If the future were known, then we wouldn’t be men, we wouldn’t be free and we wouldn’t be able to make decisions and to act. We would only be ants in an anthill. There are pressures in the present world which are trying to convert men into ants, but I don’t think these tendencies will succeed!

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6TH LECTURE

Money and Inflation

ONE OF THE PROBLEMS WITH WHICH AN ECONOMIST MUST STRUGGLE is the fact that the terminology of business was developed prior to the development of economic theory, so that the language is not particularly appropriate for dealing with economic problems. One such case, which has resulted in real difficulty, is that of the money market.

At the end of the eighteenth century the British economists found the “money market,” which was concerned with the lending of money to businesses. The terms “demand for money” and “supply of money” were already in use to signify the demand for, and supply of, loans. These terms were so firmly established that they could not be used for dealing with monetary problems, that is, for dealing with the demand for, and supply of, money as such. On the contrary economists had to point out that the rate of interest and the demand for loans on the market did not depend on the amount, or quantity, of money in existence. They had to point out that there was a demand for money, for cash money, independent of the demand for loans. As the stock market and the money market became more and more familiar to the people through newspaper reports, this was difficult for them to understand. Almost every newspaper used this business terminology to report on the state of the money market, i.e., the loan market.

Economists pointed out that there exists on the market a demand for money and a supply of money similar to the demand for, and supply of, any other article. It should be noted parenthetically, however, that this demand for, and supply of, money has nothing to do with the demand for, and supply of, loans. It is significant also that while the demand for most goods is a demand for consumption, the demand for money is not a demand for consumption; the demand for money does not consume or destroy the individual piece. The demand for money per se is a demand to hold money, a demand for “cash holding.”

Because future conditions are necessarily uncertain, people must keep a definite amount of cash on hand. Should things be certain, they could invest every bit of money for a definite time. Knowing exactly when they would need cash, they could plan to have their investments mature at that time. But because one cannot estimate exactly when money will be needed, one must keep a certain amount of cash on hand or in a checking account; one cannot lend or invest all one’s cash money.

Money in circulation is the sum of all cash holdings. Concerning the history of an individual money piece, there is no money piece that is not held by somebody, i.e., no cash that does not occur in somebody’s cash holding. It goes from one person’s cash holding to another person’s cash holding. In the case of any particular money piece, there is no instant between these two situations. There is no such thing as money that is not owned by someone and the disappearance of which in some way, for instance by fire, would not hurt the individual whose money it was.

False definitions, incorrect explanations and interpretations, of money fall into two classes, namely that money is either (1) something more than a commodity, or (2) something less than a commodity. But in reality money is neither more than, nor less than, a commodity; it is everything that a commodity is. Like any other commodity, the supply available influences its market value and like any other commodity, it is in demand because people consider it useful.

Because there is a demand for money for cash holdings, and because people are ready to part with goods to get money, the value of the object used for money is enhanced by this demand. The value of gold increased when it came into demand for monetary purposes. Similarly, the value of silver rose when it was demanded as money. When money conditions changed in the course of the nineteenth century and silver became less important for use as money, its value per unit, its purchasing power, tended to go down.

Inflation is an increase in the quantity of money without a corresponding increase in the demand for money, i.e., for cash holdings. I do not mean to say that inflation in itself does not influence the demand for money. The quantity of money and the demand for money are not absolutely independent magnitudes. The demand for money for cash holdings depends on the individual’s specific understanding of future conditions—his speculation and his ideas about the future.

At the start of an inflation, that is, at the beginning of an increase in the quantity of money without a corresponding increase in the demand for money, it causes a rise in prices. Then, if the people have learned something from theory or from history, they may anticipate still further price increases. In that case, they expect prices to rise and the purchasing power of each money piece to decline and they will tend to restrict their cash holdings, as compared with what they would have in the absence of such speculation as to the future purchasing power of money. This depends on the speculative reaction of the public. On the other hand, if people think prices will drop, there will be a tendency for them to increase their cash holdings in the expectation that the purchasing power of money will rise.

By and large, an inflationary change in the purchasing power of money is caused by the fact that a few people are quick enough to realize what is going on and to adjust their activities to the inflationary policy of the government. They do not always have great minds. Nor are they necessarily more intelligent than others. They just react more quickly than others. In Germany and Austria when there was inflation after the first World War, some “silly speculators” were pushed by accident into buying stocks on margin. It was not that they were clever, but the bankers were less clever. The banks held the common stocks, financed the sales, and sold the stocks to some speculators on margin. In a very short time, the speculators became extremely rich. And then very soon they lost what they had gained because they didn’t know what was going on.

Not everyone distrusts their government in this respect, as these quick ones must have. So long as those who are quick in anticipating inflation are in the minority and the slower ones are in the majority, so long as the housewife postpones purchases in the belief that prices will drop, telling herself that everybody, the government especially, says prices will go down, the inflation can continue. This mentality is the basis for inflation, the rock on which it is built. As more and more people discover there is something “fishy” about the government’s statements and then when one day everybody discovers it, the whole thing begins to break down. This change comes overnight. It comes when the housewife decides it is better to buy immediately rather than to wait until tomorrow, or until next year, because then prices will be still higher. In Germany after the first World War this was called Flucht in die Sachwerte—flight into true values.

This is a characteristic of every inflation that is not stopped in time. The first period may last many years; the government is then triumphant. The second period lasts for only a very short time. In Germany the first period lasted from August 1, 1914 , until the end of September 1923; the second period lasted only three or four weeks. The second period in Germany was characterized by the fact that the workers were paid every morning in advance. Their wives would go with them to work; each man received his money, handed it immediately to the Mrs., and then she went to the nearest shop to buy something—anything—just to get rid of the money. To buy something was better than to keep the money which would lose value by tomorrow.

Such inflationary adventures have happened several times in the course of history. Most have been stopped by the governments before the second period. The three most important times when inflation has run its course are (1) the United States with the Continental currency in 1781, (2) France in 1796, and (3) Germany in 1923. There have been inflations in other smaller countries too, such as Hungary , but they were not so important.

The situation of the southern states with their Confederate currency in 1865, was another matter. It could be said it was different because the Confederate government itself broke down with the defeat of its forces.

In the twentieth century, Karl Helfferich [1872–1924], an excellent writer and a gifted economist but who lacked the qualities that make a man stand up for his opinions in public, invented a slogan: the money of the victorious nation will prove to be the best and will retain its value after a war. But this has not been the case in history. In the United States in 1781, the colonies were victorious; they had just defeated a great country, Great Britain , and yet the Continental currency degenerated. Also in 1796, France had been successful in military campaigns, and yet she suffered inflation. Helfferich was doubly wrong when it came to Germany —first, in thinking Germany would be victorious in World War I, and secondly, in believing that its money, as the money of a victorious nation, would necessarily be good. Helfferich failed to realize that whether a country is rich or poor doesn’t matter—when it comes to inflation what is important is its basis for putting additional money into circulation.

Every inflation that isn’t stopped in time consists of two periods—the catastrophic crack-up boom, which is very unwelcome, and the runaway inflation. It is an economic law that things happen in this way. The length of the first period depends on conditions which we may call psychological; it depends on the minds of the people, on their judgment, on their trust in their government. And it depends on their ideas, on the pseudo-economics with which they have been indoctrinated. So it is impossible to estimate how long the first period will last.

The Germans were definitely indoctrinated. They had confidence in their government. Even as late as October 19, 1918 , they believed they would be victorious in the war and they thought their money was safe. They blamed the speculators for raising the cost of the U.S. dollar. The unsophisticated eighteenth-century farmers in the United States and in France had better judgment in these matters than did the sophisticated bankers in Germany . Let us not forget that the German banks broke down in this period because they were ignorant of the problems involved in the inflation.

This leads us to an explanation of why price controls cannot work. The government increases the amount of money. This is the inflation. Everybody has more cash in their cash holdings than before. The result is that the individual has a surplus of money which he hasn’t spent for daily consumption. In his eyes this is a surplus cash holding. If he doesn’t prefer to buy some luxury goods, he wants to invest a part. The small man invests it in savings banks or insurance policies. The big business enterprise appears with this amount directly or indirectly on the loan market. For a while the government succeeds in keeping prices down. Price control doesn’t remove the danger. But by making it easier for people to buy at low prices what they would have bought anyway, it increases the amount of money in their pockets, in their cash holdings, which is available for other purchases.

The inflations of the two World Wars in this country were comparatively mild because a great part of those workers who had earned additional money tended to increase their cash holdings during the war. The small worker really did increase his cash holdings in anticipation of a post-war move and because some goods were not obtainable during the war—radios, refrigerators, automobiles, and so forth. This is a characteristic of the first period of inflation. Remember the housewife who says, “let us keep the money; next year prices will be lower.” But as soon as people discover that things may be otherwise, the catastrophe may occur. These explanations of the simple man make the situation critical and dangerous.

Today [1951] there is still powerful resistance to inflation. There is still a lot of talk about the necessity of restricting inflation. It is true that 90 percent of this talk is just nonsense consisting, for instance, of plans to conceal the inevitable effects of the inflation by price control. But nevertheless, as long as there is such a resistance and as long as the government and Congress are forced to concede that there is danger in inflation, the danger is not yet great. The breakdown occurs when government officials no longer care what happens and fear that they may not be in control later.

During the last World War in most of the countries the economists were prevented from saying what was happening in their own country because of censorship. Or they were prevented from talking because they were in the army. But in the first World War, not all the countries were involved. In Sweden , which was neutral, there was an economist, Professor Gustav Cassel [1866 –1945]. As a neutral, he had the privilege of visiting Germany one week, England the next, and in between of stopping in the Netherlands and Belgium . He wrote about what he saw. Cassel told the Germans, “You are inflating your currency and your profits are not real profits but illusionary profits.” He told them they must take the additional money out of the system (1) by taxes and (2) by loans. But the Germans did not have the courage to tax those who had received the extra part of the money. They tried an excess profit tax, which removed only a small part. They tried loans in this way—in order to buy 100 Marks of such a loan, the citizen had to pay only 17 Marks and the remaining 83 Marks to pay for the loan were provided by the government’s printing new banknotes. Thus, every new issue of bonds meant an increase in the amount of money. This shows how even the best advice is useless in the hands of people who have such ideas.

Now I want to deal with the second problem. In the second part of the eighteenth century, Great Britain was on the gold standard. This was evident to everybody because there were gold coins in use every day in daily business transactions. Also in use were notes of the Bank of England and, at that time already, the beginning of checkbook money. The banknotes were used as money substitutes and were redeemable immediately, without any delay or excuse. This was the gold standard as it existed in England in the eighteenth century, and as it was adopted in the course of the nineteenth century by the more important continental countries of Europe—F r a n c e, Germany, the Netherlands, Belgium, and the Scandinavian countries.

Adam Smith had suggested that if all travel could be done by air, the land then used for roads could be put to more productive use such as farming. In this same vein, economists began to ask whether or not it was really necessary that mankind devote a part of its toil and trouble to the production of precious metals in order to have a good currency. If one could construct a currency with less expense, it would be advantageous. In 1819, Ricardo reasoned that one could do away with gold coins and have only banknotes which should be redeemable, not in coins, but in ingots, bullion. This gold bullion could be used for international transactions. This would save the money involved in making gold coins in smaller denominations. For more than 60 years Ricardo’s suggestion remained a “dead letter.”

In the 1870s, countries, that were having a hard time financially and yet wanted to get on the gold standard in the cheapest way, discovered this solution of Ricardo’s. It was called the “gold-exchange standard.” Toward the end of the nineteenth century and the beginning of the twentieth, many countries adopted this type of gold-exchange standard. It differed only in degree from the classical gold standard. On behalf of the American public, Professor Jeremiah Jenks [1856–1929] of New York University studied this gold-exchange standard in the Far East—the Malayas, the British West Indies , and so on. He was enthusiastic, as was his assistant, Professor Edwin Walter Kemmerer [1875–1945]. People didn’t see anything questionable in this theory. I can’t say that I was enthusiastic myself, but I couldn’t see any reason why it shouldn’t be adopted. One German economist said that by concentrating all the gold in the hands of the government, it would make things easier in time of war. What it does is to make it easy for the government to manipulate the currency, which always means to manipulate it downward, thus preparing the way for inflation. When a country has a gold-exchange standard and no gold in daily circulation, no one realizes what it means when the government declares that banknotes are no longer redeemable.

When the first World War broke out all the countries went on the gold-exchange standard. There was still a little gold in circulation, but not very much. Even the countries on the gold standard had gradually approached the gold-exchange standard more and more. Soon in place of the gold-exchange standard fiat money standards came in all countries. After the war, all countries were eager to return as quickly as possible to the gold standard. But most only returned to the gold-exchange standard by making the domestic currency redeemable in foreign exchange, and giving that to the people instead of gold. But in 1929, with the crisis, people began to advocate something else.

The gold-exchange standard with a flexible parity was known as the flexible standard. When the banks had issued banknotes they really redeemed the money; a discrepancy of one-tenth in the parity at which the notes were redeemed was considered disgraceful. (Incidentally, in the 1870s, French banking was centered in Paris and the gold was in Paris , which was in the hands of the Communists. Yet even then a deviation from parity of 5 percent in the currency was considered terrible. Today [1951] a currency is considered stable if it deviates no more than 20 percent.) The redemption of their notes by the central banks was controlled by the public, because the central banks were obliged to publish a statement every week telling the public the whole situation.

Step by step, governments acquired the opportunity to replace the gold-exchange standard with the flexible standard, which meant parity was no longer determined by law but perhaps by a bureaucrat. Bank transactions were transferred from the bank to a new agency. In Britain , this was the Exchange Equalization Account. First of all, parity was no longer fixed in the same way as before; it was surrounded by secrecy. From time to time the newspapers printed a statement that the currency was weaker, which meant that the bureaucrats had changed the parity a little bit. From time to time it was changed to a greater extent depending on the country and so forth. Devaluation could occur even in a country ostensibly governed by democratic methods. In Switzerland in 1936, even though assurances had been given that the Swiss franc would not be devalued, it was accomplished in half an hour by a meeting of Parliament. They really had no choice—the preceding policies, such as subsidies to agriculture, the watch industry, the hotels, and so on—had put them on the spot. And even in such a democracy, the change was accomplished by administrative action.

The flexible standard was defended by Keynes and his followers as a great thing, but it disappeared when something even “greater” was substituted. Great Britain ’s return to the gold standard at US$4.86 in April 1925, had led to higher import prices, declining exports and unemployment. In 1931 [September 21], Britain abandoned the gold standard and the value of the pound sterling was left to fluctuate. It declined. Money is like any other commodity. As there is no custom line between Manhattan and Brooklyn , prices increase between the two boroughs only by the amount of transportation charges. If there were a custom barrier, conditions would be different. So it is with money. If Brooklyn had a separate coin system from Manhattan , the exchange ratio between these two moneys would be established at such a height that it would make no difference whether the commodity was bought in one place or the other, with one money or the other. Should a difference appear, immediately there would arise an opportunity to make an advantageous deal. This advantage would continue until the difference disappeared.

We speak in the same way of Great Britain ’s devaluation in 1931 when it went off gold, and her devaluation of two years ago [ September 18, 1949 ] when the rate was changed from $4.03 to $2.80. But these are two absolutely different things—they have nothing in common. In 1931, when the British abandoned the gold standard, the amount of foreign money or gold that the owner of a British banknote had been able to obtain was reduced. It was intended by this means to keep the British currency stable with reference to foreign currency. The British government assumed a monopoly in the trade of gold and foreign exchange and the right also to expropriate foreign exchange. In revaluing, what they had had in mind was changing the rate at which British holders of foreign money would be indemnified on the one hand, and on the other hand the rate at which the importer would get his foreign exchange from the British government.

Two years ago in Great Britain , the $4.03 parity was a historical fact like any other historical fact. It was a parity de facto—it was the legal norm for the expropriation of Britishers who owed foreign money, and the price they had to pay for foreign money. But in fact the pound on the world market was worth only $3.00, more or less. In a treaty with the United States the British government promised that on a certain date they would again begin to redeem their currency against gold, dollars, and so on. But the British government no longer had clever bank-economist advisers. They had not considered what it would mean if it should be possible to redeem the money in London in the relation of three to four; anybody in the world would be able to buy a pound for $3.00 outside the United Kingdom and then sell the same pound to Great Britain at $4.00. After four or six weeks they discovered that this was completely unrealistic.

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7TH LECTURE

The Gold Standard: Its Importance and Restoration

THE QUESTION WHICH I WANT TO TREAT TONIGHT presents an excellent opportunity to illustrate one of the points made in the epistemological lectures—to explain the difference between economic ideas and judgments of values. As an individual I have a very definite idea of the political problem involved. The important point is that everybody who wants to arrive at such a judgment of value should know why he is doing this and he should understand the consequences of his action.

The question is how to return to the gold standard. And at what parity the return of the United States to a gold standard should be effected. We assume that we should return to a gold standard. A fiat money system cannot go on forever and must one day come to an end. The gold standard under present conditions is the only standard which makes the determination of the purchasing power of money independent of the changing ideas of political parties, governments, and pressure groups. The question is how should this return be effected—by accepting a gold price of $35 an ounce? Or by determining the price of the ounce of gold according to the market conditions at the time of the transition?

First of all, we must know why such problems are important. They are important because changes in the purchasing power of the monetary unit must necessarily bring about social consequences with respect to the income and wealth of various members of society. If the changes brought about by a shift in the money relation, that is by an increase or decrease in the quantity of money in relation to goods and services, would affect the various commodities and services to the same extent and at the same time, then the only consequences would be its repercussions on the content of old contracts concerning deferred payments, loans, and so on.

Let us deal with the social consequences due to the unevenness and lack of synchronization in the change of purchasing power brought about by inflation or deflation. Should these changes occur everywhere at the same time and to the same extent, people would discover one morning that the purchasing power of the monetary unit had changed overnight. But otherwise there would be no difference; the prices of the services they had been selling would also have changed by the same amount and in the same direction.

In inflation, the additional quantity of money enters the economic system through the wealth or income of definite individuals. If the government prints the money, the government is the first to get the new money. Additional demands and offers raise the prices for the products the government wants to acquire. The persons selling the commodities and services the government wants sell at higher prices. Then munitions workers, munitions entrepreneurs, and the soldiers all receive more than they did yesterday. These persons, in whose cash holdings this additional money appears, are in the position of being able to offer more money for their purchases. They have more money and larger incomes. Consequently they can spend more and they offer higher prices for the commodities they purchase. But these people don’t buy everything. Perhaps they buy beverages but not books.

There is now a second group favored by the increase in the amount of money, let us say the beverage producers who are getting more for the services and commodities they sell. The members of this second group are now in a favorable position because the services and commodities that they wish to purchase have not yet been affected. But other individuals— teachers and ministers, for instance—are still paid the former rate; in spite of the fact that the additional money has not affected the services they are selling, they must pay more for commodities that others have bid up in price.

In such an inflationary period there are losers and winners. The winners are the munitions workers, those selling products which go up in price at an earlier date than the commodities they are buying. As long as this continues there are problems every day. The winners are satisfied and keep silent; they don’t write letters to the editor to say that this is a wonderful thing. The entertainers, beverage salesmen, and others do good business at the time—they are the winners—they don’t talk, but they enjoy prosperity and spend. The losers are the other way round. Those at a disadvantage feel it. The housewife whose husband is still earning the same salary and has a number of children to feed is at a disadvantage. Until the inflation ends and for a long time afterwards there are losers and winners because such maladjustments exist. One hears in public only the voices of the losers.

In deflation, the same thing happens, but the other way round. There is a decrease in the amount of money. Those whose selling prices drop first of all are the losers; the winners are those whose selling prices drop at the end. These price changes are the most spectacular effects of inflationary and deflationary changes in the amount of money. Another characteristic of inflation is that all deferred payments are changed in their importance. If on the eve of the inflation you had borrowed $100 which could at that time buy ten A’s and if after six months as the result of the inflation, $100 can buy only five A’s, what you pay back to the creditor is worth less than before. You could, therefore, borrow money, buy ten units of A, wait six months and sell five units of A for $100 to pay back your loan; your net inflation profit would be five units of A worth $100; you, as the debtor, profit. The man who saved, the creditor, is hurt by the inflation. In order to deal with today’s problems, these things must be kept in mind.

Before the war of Great Britain against Napoleon from the beginning of the nineteenth century to 1815, there had existed in England the classical gold standard—there were gold coins, and there were banknotes of the Bank of England in use as money substitutes. The Bank of England notes were redeemable in gold on demand; the paper was a gold substitute. Because people could get gold without delay, Englishmen took the notes without any hesitancy. This gave the government the idea of borrowing from the Bank of England and the British government found that was the easiest way to get money. As a consequence of their borrowing the quantity of domestic money increased and prices rose. With the rise of prices in Great Britain and not in foreign countries, merchants found it advantageous to import. In order to pay for these imports it was necessary to export gold. So more people asked for redemption of the banknotes. The managers of the Bank of England became alarmed and feared bankruptcy. The government suggested a very easy remedy; they passed a law relieving the Bank of England of the obligation of redeeming their banknotes; they suspended the payment of specie. The law made meaningless the statement on the banknotes that they could be redeemed.

The government borrowed more and more. A higher price for gold resulted. Gold coins were handled at an additional premium. The official rate before the Napoleonic Wars was one ounce of gold to £3 17s 10½d. In 1814, shortly before the end of the war, the actual price in terms of the Bank of England notes was £5 4s. The gold price had risen almost 50 percent in terms of British pounds; in other words, the value of the British pound had declined. After the war of Great Britain against France ended, Great Britain decided to return to the gold standard. The only method considered was to deflate and return to the pre-war parity—£3 17s 10½d per ounce of gold. So they reduced the amount of money; they contracted. To deflate the government must borrow from the public—not from the banks. And it must not spend the money which comes in; it must destroy it. This is difficult as you can imagine. You will rarely find Ministers of Finance who are ready to do this. But at that time it occurred—because they believed it was the only “honest” and “just” way.

Now, let us see how “just” and “fair” such a method is. If a man had contracted a loan before 1797, and had not yet paid it back, it would have been correct to say he should pay the pre-war value. But don’t forget that many people had borrowed money during the period of the suspension of specie payment on the part of the Bank of England. Many British farmers especially, who wanted to improve their property to assist England to survive the war when imports were not easy, had mortgaged their farms and received the devalued or “light” pounds. And now came a law which required them to pay back “heavy” pounds. Is this “fair”? Is this “just”?

For these farmers there was still another complication. When peace returned, imports increased and they had to compete against more imports than before the war. While their debts and their payments of interest and principal increased, the price of their products dropped. These two factors contributed to a tremendous agricultural crisis in Great Britain in the 1820s. Among the important consequences of this crisis was an intensification of the Corn Laws, which were later abolished in the 1840s.

The government was also a borrower and had borrowed “light” pounds. Yet according to the new law the government—which was the taxpayers—had to pay back “heavy” pounds. Thus a privilege was granted those persons who had bought government bonds with “light” pounds and who were repaid in “heavy” pounds.

There also resulted all the consequences of price changes. There were winners and losers. This brought about a very great powerful drive for inflation in Great Britain , led by the so-called group of “Birmingham Little Shilling Men.” After some years, when all the changes had been effected, the crisis disappeared. Part of the nation had been enriched at the expense of others who were impoverished. Finally Great Britain enjoyed stable money again.

During the first World War, the British government again embarked on an inflation. The pound was devalued against its gold equivalent. Then after the war the government wanted to return to the gold standard. But again they didn’t realize that to return to the gold standard at the pre-war parity of the pound would bring a sequence of events similar to that which occurred after the Napoleonic Wars. It was inexcusable that the great British Empire did not know how to go about it. They didn’t understand the theory, nor did they know the history. They had had the experience but didn’t recognize it. The situation was once aptly described by a Swedish man [Count Oxenstierna] who said, “Dost thou not know, my son, with how little wisdom the world is ruled.”

In 1922, Lord Keynes had already written a book in which he pointed out that domestic stability is more important than the stability of foreign exchange rates. I remember when I had a talk several years before this occurred with a British banker, not a socialist agitator, who told me, “Never again will the British people have to pay a higher rate of interest to the usurers of the world market for gold in order to keep a British currency at parity.” These were the ideas that prevailed, you know. And it was the same in this country.

When Britain returned to the gold standard after World War I, the Chancellor of the Exchequer at the time [1925], Mr. Winston Churchill, returned to the pre – war parity of the pound. He didn’t know that conditions were different in Great Britain than in other countries. London was the banking center of the world before the first World War, and for this reason foreign nations kept considerable amounts of deposits with the British banks. When war comes, these foreign deposits are called “hot money,” because depositors fear inflation and devaluation of the pound. They are anxious to withdraw their money but will wait if they believe that Great Britain will return to the pre-war parity.

The British didn’t know what they were doing in 1925 in returning to the gold standard. Even the most stupid man in England should have known that the British labor unions were adamant in their demands for higher wages and that wages had been raised to such a point that there was permanent unemployment, with millions of persons out of work. Yet, in the face of such a situation, the British government increased the value of the pound. They made the “light” pound the “heavy” pound, thus increasing the real wages of workers without any change in the number of jobs. The result was that British production costs, which were already high under the existing wage rates, too high for the world market, were enhanced even more.

Great Britain made a bad mistake by returning to the pre-war parity of the pound in 1925. This added to the income of persons who had bought bonds or otherwise lent money in “light” pounds. The government had to collect more taxes to repay those bonds in “heavy” pounds. A catastrophe resulted. The United Kingdom cannot feed and clothe its population out of domestic resources; it must import food and raw materials and pay for these with manufactured goods, most of them produced from imported raw materials. They found themselves in a situation where they were unable to export enough to preserve their standard of living. Labor unions would not consider a reduction in wages.

To avoid hurting the interests of those who lent “heavy” pounds, it would not have been necessary to return to the pre-war parity. It could have been arranged that a loan contracted in 1910 would be paid back in a higher number of pounds than when contracted. Although this might have helped, it wouldn’t necessarily have been “just” or “fair,” because the bond might have changed hands several times.

Because of the problems that developed, the government capitulated in 1931, by devaluing the pound four times more than it had been devalued before 1925. This meant that Great Britain , still a great creditor nation, made a gift of hundreds of pounds to foreign debtors who, after 1931, could pay their debts to Britain in “light” pounds. What kind of statesmen were these? Winston Churchill, as Chancellor of the Exchequer, was badly advised.

Now in the United States , we have the question of how to return to the gold standard. In my opinion, there can be no question as to the necessity for doing that. But the question is at what parity we should return. Should it be determined through stabilization, by abolition of the laws against holding gold, and stopping the increase in the quantity of money? Within a short time after some haggling, there would be more or less a price for gold which would not affect the purchasing power. One could then return to the gold standard. Leaving aside the problem of old debts, this wouldn’t change anything—this wouldn’t destroy the whole economic system.

But there are among the minority favoring a return to the gold standard very eminent men who favor resumption of specie payment at the rate of $35 an ounce. They say this is the only “honest” solution. I don’t know why these gentlemen are precisely in favor of $35. One must stabilize at the present-day gold value of the money without deflation. To return to the gold standard at $35 per ounce of gold would cause a deflation, because today [1951] $35 is no longer considered the equivalent of an ounce of gold. The price of gold is much higher, as can be seen from the quotation of the American dollar in Switzerland and other neutral countries. If the American government redeems the dollar at $35 there would be a tremendous withdrawal of gold from this country, which would make the whole thing unpopular.

If one wants to deflate after considering all of the tremendous disadvantages of deflation, if one wants to go back to an old value which has only a theoretical value, why go back to the New Deal value, which was never anything but a specter in the law books and never had any real significance to Americans? Why not go back to the original old United States dollar—$20.67? Why just the New Deal dollar? They say it is a statutory dollar. Of course, $35 is the rate for foreigners, not for Americans—it is a criminal offense for Americans to own gold—at which governmental international dealings are made. [The prohibition against owning gold in this country has since been repealed. In January 1975, U.S. citizens regained the freedom to buy and own gold.] Many gold producers have been forced to sell gold. But US$35 is not the real market parity for gold. I don’t see why anyone should want to take on the disaster of a deflationary movement. Deflation is so very unpopular. Its unpopularity is exaggerated, but it couldn’t work because people are so opposed to it.

I see only one way to return to the gold standard—abolish laws against holding gold, re-establish the gold market and see what rate establishes itself. This would cause the least possible disruption. The greater part of gold is outside of this country. The U. S. government could keep quiet for a time, and not enter the gold market. There would be a drop in the price of gold on the black market. Nobody can know in advance how much the free gold price would be—but I would guess somewhere between $38 and $40. Then we could have a gold standard.

As a citizen I have my opinion. I don’t say it is wrong or dishonest to advocate a return to gold at $35 per ounce, but I say you are living in an illusory world if you believe it is possible to present the American people with a deflationary program such as returning to the $35 rate would mean. $35 is nothing but the rate of Mr. Morgenthau [Secretary of the Treasury under FDR’s New Deal]. Why take the New Deal dollar? If I know these advocates, they are not very enthusiastic New Dealers. The $35 an ounce gold ratio started in 1934, but eighteen years have elapsed since then.

Some people believe you cure inflation by causing deflation. This is a little like suggesting that to cure a man who has been run over by an automobile going from north to south, you should run the car back over him again from south to north.

I agree it will be difficult to return to the gold standard. But the first step is to re-establish the gold market. Eventually there will be a gold price. At first the government could say it wouldn’t sell more gold at this price than it had sold on the average, for instance, over the last ten years.

The United States went off the gold standard because it was believed that inflation was beneficial. We wanted to adjust the standard according to prices. We imitated Great Britain , which went off the old parity in 1931. There was the depression and unemployment in the United States , and consequently it was necessary to adjust wages downward. This was not done. The devaluations of 1931 in Great Britain , of 1934 in the United States , and of 1935 in the Latin Monetary Union took place because the governments and the people were too weak to resist the labor unions. The labor unions believed that the higher the wages are, the better it is for labor. But if wages are raised above the market rate the result is permanent unemployment. Don’t believe that I am in favor of low wage rates. However, low wage rates were the necessary, inevitable consequence of the fact that there were more and more trade barriers in the world and more and more capital consumption. Tariffs reduce production all over the world and wage rates must go down. Prices are adjusted according to the standard. Trade barriers shift. Production goes from those places in which a smaller input produces a greater output to places where it is the other way around.

Let us say this, for instance: If the Portuguese government raises the tariff for something that the British used to export to Portugal, and consequently there develops in Portugal an industry of this type for which conditions in Portugal are very unfavorable and where, therefore, the costs of production are higher, and the British are forced to restrict their exports and must develop other industries for which the conditions in Great Britain are very unfavorable, the result is a general drop in productivity all over the world. Along with this there is the necessity to consume less, which means, for the worker, lower wage rates. And you cannot change lower wage rates by picketing. Pickets don’t keep wages up.

Therefore, if you say it was for the first time that a country walked off the gold standard when there was no reason to do it in world history, I would say it was not precisely for the first time.

The quantity of gold reserves doesn’t matter. If there is not a special reason to reduce the reserves, you must effect this transition to a gold standard at a rate at which current transactions do not change the amount of gold. The main thing is to find the parity at which the market can maintain without the transfer of gold.

The black market is a market. There is nothing “black” about it. A black market price takes into consideration the risk. When the blackness is taken away from this market, then prices will probably drop. So will it be with gold.

I don’t believe the danger of a runaway inflation is imminent because there are enough powerful people who are opposed to it to prevent it.

I am in favor of gold coins so that the individual will be involved, so one will realize when the slightest inflation takes place. The fact that the individual citizen can see when the situation changes is one of the most important checks of the Constitution against inflation.

The world is on a gold standard, but the United States is on a paper standard. A return to the gold standard is possible economically, but not politically. The present government is built on such tremendous domestic expenditures that if the people are not actively opposed, the government will always inflate. The advantage of the gold standard is that the purchasing power depends on conditions which are not subject to governments, political parties, and changing codes, creeds, and desires.

There is nothing divine about the gold standard but there are some reasons for it. The gold standard is a human institution. It has come into use through the course of history. The gold standard prevents the government from increasing the amount of money through inflation.

It is impossible to keep a fiat money stable. A very able economist, who was sometimes rather fantastic, the late Irving Fisher [1867–1947], was convinced that you could measure the purchasing power of money. He talked about the housewife’s basket filled with $10 worth of purchases. He believed that the purpose of keeping the purchasing power stable was to make the monetary unit such that it always buys the same assortment of various commodities. This is wonderful if you pick out as the standard lady of the world, a certain lady at a certain time. But for only a short time, for each person’s purchases are different, and each person’s purchases vary from time to time during a lifetime. How much gasoline did grandmother buy? How about baby food when the children are in college?

Irving Fisher neglected the unevenness and dealt only with markets as a standard of deferred payments. He started his movement in the field of monetary stability at a time when the drop in purchasing power was not very great. He started it because he was in favor of the creditors, which is remarkable in itself because very few people are in favor of creditors. Generally people are in favor of a steady slow downward movement of the purchasing power which favors debtors.

Sound money is that money the changes in purchasing power of which are very slow so that they do not affect business seriously. Gladstone said, not even love had made so many people crazy as money.

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8TH LECTURE

Money, Credit, and the Business Cycle

THE BEGINNING OF MONEY SUBSTITUTES is very well known. People in Great Britain used to keep deposits of gold with the goldsmiths in London . Later they began to use the receipts from the goldsmiths as substitutes for money in transactions and cash holdings. The difference between a ticket entitling a person to a definite amount of money and a ticket entitling him to a certain amount of bread is that if he wants to get the bread he must cash the bread ticket, although he may use the money ticket itself to get the bread provided the baker considers the money ticket of value and wants to use it as cash holding.

Goldsmiths soon discovered that they could issue more money tickets, more money substitutes, than they had gold in reserve. This meant an addition to the nation’s quantity of money in the form of fiduciary media and money certificates, over and above the quantity of gold in reserves. A problem arises because fiduciary media may be created out of nothing; theoretically there is no limit—or so it appears.

The creation of fiduciary media represents a factor that brings about a rise in prices. If the fiduciary media appear on the loan market, as an additional supply of loan money, there is another effect also; the increased supply causes, immediately and temporarily, a reduction in the rate of interest. There cannot be any argument that the rate of interest is a real market phenomenon that arises out of the time preferences of individuals; it is not solely a monetary phenomenon. However, the rate of interest is affected by an increase in the amount of money appearing on the loan market. An increase in the amount of money appearing on the loan market brings about a drop in the monetary rate of interest. How does this readjustment take place? This is the problem of the trade cycle.

In dealing with money substitutes and fiduciary media, i.e., that amount of money substitutes in excess over the reserves of the bank, we must never forget that the position of the banker or of the bank issuing such fiduciary media is delicate. Only if the banker has the good will of the people can it be assumed that they will be willing to hold these excess money substitutes and not present them for redemption, which would push the bank into bankruptcy. It is even more important to realize in the first place that it is not very easy to make the people accept money substitutes as money. Originally money substitutes were looked on with suspicion; people were not very enthusiastic about accepting them in place of gold. It is difficult for our contemporaries to realize this, because money substitutes protected by the government have appeared in recent years and been forced on the people by the government. Moreover, today these money substitutes have been declared to be legal tender, so that if a debtor wants to repay a debt, the creditor is bound by law to accept the money substitutes as if they were real money.

Propagandists who wanted to make the government pre-eminent in the issuance of money substitutes have publicized many stories about private money substitutes. These tales were condensed by an anonymous American who is credited with the dictum “Free trade in banking is free trade in swindling.” Economists, however, think differently; they consider free trade in banking as the only protection against the government’s issuance of bad banknotes.

The main problem is that unfortunately all people, even in the age of liberalism and classical economists, consider the rate of interest as a monetary, not a market, phenomenon. The classical economists explained that prices and wages were market phenomena, but they were not so anxious to say that the rate of interest was also a market phenomenon. This is one of the weaknesses of Adam Smith’s The Wealth of Nations. He refuted the idea that a scarcity of money can make business bad. But he was not prepared to attack the age-old laws against high interest rates, the laws against “usury.” Jeremy Bentham, in his Defense of Usury [1787], which is still in use today, was the first to refute these old ideas of interest.

People considered high interest rates a barrier to economic trade and progress, and felt that anything that might lower the rate of interest a blessing. Consequently an increase in money substitutes was considered a blessing because with it came a lowering of the rate of interest. All other things remaining equal, if an additional offer of loans by the person making the money, by the bank of issue, is made, the would-be lender must drop the rate of interest to attract additional borrowers. This was considered advantageous and there was enthusiasm for it on the part of public opinion.

It is tragic and fateful that not all liberals realized that the rate of interest was an economic, not a monetary, phenomenon. These liberals not only failed to fight, but they even aided the foundation of additional government central banks with special privileges because they thought these banks would lower the rate of interest. The consequence was a lowering of the interest rate in the short run, a short-run boom—but later, inevitably, after some time, the appearance of an economic crisis, a depression. People began to consider periodical depressions and the trade cycle as inherent characteristics of capitalism. This has been one of the main arguments for socialism and one of the main causes of making people anti-capitalistic. The effect of the 1929 depression in this county is still evident in the erroneous interpretation of this experience by the people.

As a consequence of the belief in the advantages of low interest rates, credit expansion became very popular—at first in those countries where there was capitalism and a banking system. At the end of the eighteenth century, Great Britain was already suffering from the consequences of recurring economic crises. Later these crises began to affect other countries—at first the European countries that were more advanced in capitalism—the Netherlands , France , and the most advanced city-states of Germany , Hamburg , and Bremen . These periodical crises came to other countries only with the spread of capitalism. For instance, in the depression of 1857, Austria was still rather backward in the capitalistic development so that she was affected only very slightly. The Austrian government did something which was very spectacular for those days. For political reasons, Austria wanted to aid Hamburg . She shipped a full trainload of silver under heavy soldier guard to Hamburg to support Hamburg ’s banking system. At that time, Austria was still out of the world. But in 1873, when the next depression came, Austria was so much involved that Vienna was the center of the crisis.

Economists began to raise the question as to what caused these crises. Say’s Law demonstrated only what could not be considered the cause— overproduction. A little later a group of English economists and bankers began to realize that the problem was the boom-bust trade cycle and that the cause of the bust, the depression, was the preceding boom. To eliminate the depression the preceding boom and credit expansion by the banks must be eliminated.

But this was not a complete explanation. It was an explanation of conditions in Great Britain and the few countries already equipped at that time with such a banking system. This was an explanation under the assumption that the rest of the world did not have such a credit expansion. For example, the Currency School argued that if there is credit expansion in England , which results in a boom and higher prices in Great Britain while conditions hold prices in other parts of the world stable, exports diminish and the balance of payment becomes such that gold bullion is shipped out of England to other parts of the world. The holders of the banknotes seek to redeem their notes. The reserve of the British banks drops so that the banks must restrict their issue of notes in order to protect their own solvency. This brings about the depression. This is correct as far as it goes, but it does not take into account the fact that all countries might expand their currency, so that then there would be no explanation for an outflow of money.

The Currency School ’s theory made one great mistake—it failed to realize that it made no difference whether inflation was caused by banknotes or by checkbook money. Legislation in 1844, Peel’s Act, made it impossible to expand money by means of banknotes in England and other countries adopting similar legislation. But the legislation limiting banknotes said nothing about checkbook money. Consequently, this law of 1833 didn’t stop booms. Another boom, based on checkbook money, appeared already the next year, leading people to feel the whole theory was worthless.

This Currency School ’s theory was the basis of the Banking School ’s quantity theory of money. The British Banking School developed the theory that there is a certain demand by business for money. If the bank restricts its creation of bank money, checkbook money, and banknotes, to the “needs of business,” they say it can never bring about an inflation. Let us assume that the bank of issue discounts only bills of exchange which are the result of an actual business transaction. The cotton merchant sells a quantity of cotton to a cotton spinner, and the spinner needs money to pay for it. He draws the bill, which is discounted by the bank, which creates additional money. After three months when the raw cotton has been converted into cotton yarn and is sold, the loan is paid back and the money disappears. Under this system it was believed that the “needs of business” automatically produce the amount of money business needs.

This theory was as popular in the second part of the nineteenth century as it was false. The idea that the “needs of business” would automatically limit the creation of additional money is mistaken. When it has been applied in practice it has resulted periodically in inflationary booms. No one minded the booms. But the booms were succeeded by depressions which the people didn’t like.

For 50 years there was no progress at all in this study. Then, at the end of the nineteenth century there was published a book by the Swedish economist Knut Wicksell [1851–1926], Geldzins und Güterpreise [1898, English translation, Interest and Prices, 1936]. Wicksell pointed out that the amount of such business transactions is not independent of the behavior of the bank. If the banker reduces its rate of discount, the amount the purchaser must pay for his raw material is less, and the transaction seems more profitable than it would otherwise. Thus, banks may increase the “needs of business” by lowering the interest rate. And when the interest rate is lower, the banks expand, which is inflationary. Thus, the demolition of this theory was due to Wicksell. And then in 1912,my book, The Theory of Money and Credit, came out. The foundation of this theory can be traced to the originators of the theory of interest—W. Stanley Jevons and Böhm-Bawerk. This is the monetary theory, the circulation theory, or the Austrian theory, of the trade cycle.

Peel’s Act was in 1844. The next boom was in 1845 and 1846. The depression followed in 1847. In 1848 came the Communist Manifesto, which said that the capitalistic system leads to periodical crises. Each crisis, the Manifesto said, would be progressively worse until it would lead eventually to the breakdown of the capitalistic system. In 1857, 1866, 1873, and again in 1929, the Marxists were awaiting the day, “der Tag.” And today in Moscow , Stalin waits for the final crisis of the capitalistic system in the belief that it is just around the corner. What is worse is that so many economists think this way too. This is the philosophy of the League of Nations and of the many “disunited” peoples in the United Nations. They do not believe that the occurrence of depressions has anything to do with credit expansion; they believe that trade cycles are inherent in the capitalistic system, and that a special committee must be formed to fight the trade cycle.

At the beginning, the popularity of credit expansion was due to the idea that it is a blessing for every country and for the whole world to have a low interest rate. Credit expansion was considered a vehicle to lower the rate of interest. The politician wanted prosperity for his country, and for the people. Governments wanted to keep interest rates low; even Coolidge in 1924 wanted low interest rates. It seems to me astonishing that attempts have been made to raise and lower wages, to raise and lower prices, but you will never find an occasion when a government or politician was in favor of raising interest rates. I don’t mean to say I am in favor of a high interest rate—I am for the market rate.

When governments first fathered central banks, the aim was to create prosperity by lowering the interest rate. But later governments favored the central banks with special privileges because they wanted to borrow money themselves and they considered the central banks a source of cheap money. This was a wonderful discovery by the governments. First of all, the governments granted the central bank legal-tender status for their banknotes and freed them from the obligation of keeping their contracts to redeem their banknotes in gold or silver, banknotes which people had accepted voluntarily. (How different would have been Charles I’s fate—he was beheaded in 1649—if he had been able to finance his military ventures without worrying about Parliament and the taxpayers.)

Now I want to discuss the consequences of artificially cheap interest rates. It is agreed that the problem is the trade cycle, the credit expansion, that we must fear the boom which results in a depression. The League of Nations made a report, prepared by Professor Gottfried Haberler [1901–1995], on the trade cycle. On its first pages it is clearly stated that the boom which causes the following depression could not occur if the banks did not expand credit. Therefore, one would think the solution would be easy—we have only to prevent the banks from expanding credit or at least from adopting governmental institutions and policies which invite the bank to expand credit. But no—they began to look for another explanation of the cycle. Marxists recognize that one cannot do away with interest entirely by credit expansion, but they deny that lowering it artificially will have evil consequences. They ignore the fact that the rate of interest is the expression of the difference between the market valuation of present goods as against that of future goods.

What really takes place in a credit expansion? Why do we say that certain things may not be done because capital is lacking? Certain projects not feasible today could be effected by cutting down present consumption enough to permit more producers to build more durable investment goods. Everyone contributes a share to the determination of how much is to be consumed and how much is to be invested. The individual entrepreneur is aware of this fact because of the rate of interest. If people are more willing to save, the interest rate will drop. On the contrary, if they are ready to spend, the rate goes up. The entrepreneur in planning estimates anticipated costs and prices, takes into consideration costs of labor, material, and the rate of interest. If he decides a certain project cannot be done profitably, then it is not done. There are always projects which are not undertaken because the money is used for consumption.

The rate of interest is lowered artificially by credit expansion, so that a project which appeared unfeasible yesterday may today appear profitable. Therefore, the effect of credit expansion and of the lowering of the interest rate is that certain projects which would not have been undertaken are now started. If we think it over, we realize this is not good. There has been no increase in material goods. The only difference is that the bank has created out of nothing additional banknotes or additional checkbook money.

The consequence is that the businessman’s calculation is falsified. While before it reflected precisely the conditions of the available factors of production and demonstrated what could be done and what could not be done, it is now falsified, for there exists an additional amount of money substitutes and fiduciary media. The businessman is led, by artificially low interest rates, to embark on projects for which the available supply of capital goods is insufficient. (Suppose a man owns a limited amount of building materials. The contractor makes an error in estimating so that the foundation is too large for the material actually on hand. He should have realized before that the amount of material would not suffice. A crisis results for the master builder.)

It is more difficult in life. The additional demand for projects which would not have been undertaken earlier raises the prices asked for the materials. True, the rate of interest is lower. But prices are higher. The whole thing must stop if the bank’s credit expansion comes to an end. But bank credit is elastic, and the banks give more credit.

As wage rates go up, the demand for consumer goods goes up also. But because the boom seems general, the entrepreneur decides to go ahead with the project. Higher prices for the factors of production, including labor, result. And there is a further increase in consumption.

Also of importance is the fact that the banks, when faced with this increased demand, begin to raise their interest rates. In every crisis cautious people tell the bankers, “It is an over-expansion. The expansion should be cut down and you should not give credit at such easy terms.” But the bank says, “Look, we have higher interest rates and there is still an additional demand in spite of this higher rate. Therefore, you can’t say our cheap money policy is responsible for the boom.”

The relation between price movements and the rate of interest was contributed by Irving Fisher. In a period of rising prices the money lender can make a profit by not lending, by refraining from lending, and by buying goods and selling them himself. On the other hand, the borrower makes an additional profit because when he repays the loan the prices of the goods he made with the borrowed money are higher. Therefore, when there is a tendency for prices to go up, the interest rate is increased by more than the true interest rate. This additional increase in the interest rate is the “price premium.” Therefore, a rate which is considered mathematically higher in comparison with the prior rate is still too low for what it should be in consideration of both the interest rate plus the price premium. (In 1923 in Germany , the Reichsbank increased the discount rate to the unheard-of rate of 90 percent, but the price premium at that time was such that the discount rate should have been something like 10,000 percent.)

During a period of speculation stock market prices move up. Everyone becomes enthusiastic and people who know nothing about it enter the stock market. Credit is given to anybody. All these symptoms are well known. Also well known is how such a boom breaks and the consequences and features of such a boom. The problem is what is going on and what makes the whole situation unsound.

In 1929, there was credit expansion in this country and money was cheap. So loans were made to other countries causing the balance of trade to be active. There were more exports from the United States than imports because the other countries didn’t have to pay for them—they could pay with bonds. The “wicked” Mr. Schacht[xxxix] was more aware of what was going on than the great Bank of New York. Anybody who wanted to borrow money could get it. (Money was so easy to get from the United States that one small town in Silesia , for instance, built a heated outdoor lake for tropical plants.)

It is said that the characteristic of a boom is general overinvestment. This is an impossibility. The amounts available for investment are (1) the savings of past years, and (2) that part of the previous year’s production equal to the equipment used up in the past years and available for replacement of worn-out tools. (The replacement of old machinery may be made by substituting better or different machines. In this way, many producers have completely changed their production.) Nothing else is available for investment, so there cannot be general overinvestment.

When the available past savings (1) and capital available for replacements (2) are invested according to a plan that overestimates the amount of investment goods available, the result for the whole national economy is malinvestment. Construction is started calling for more material than is available. It has been said that the 1857 crisis in Great Britain was due to the fact that they had built too many railroads. At that time those railroads were unprofitable and capital was lacking for other requirements. Too much circulating capital had been converted into fixed capital. In the crisis, goods for consumption are available at very low prices as there is a surplus of consumer goods.

An individual can overexpand. One can say, “My personal financial situation is very bad. I spent too much money in expanding my business, in building my new factory.” The overinvestment idea appeared when this situation, applicable to an individual, was transferred to a nation. But it cannot be true for the whole economic system because only those goods which are available for investment can be used for that purpose. Money can be invested in the wrong plans, and too many projects can be started so that some of them cannot be finished, or if finished they can be used only at a loss.

It is obvious what happens. The question is why the situation is suddenly discovered in only a few days, so that the crisis comes overnight. Where there was confidence and optimism, there is depression and despair. Of course, it is only the insight that comes overnight, not the real crisis, which has been building over time.

Because there was no uniformity in credit expansion in various countries in the past, the extent of the credit varied in the different countries. With the demand for foreign exchange and credits, there was a drain of money from some countries. Bankers became frightened. A government official announced, “Maybe we will be forced to restrict credit.” The businessmen became frightened: “We need credit. Let us, therefore, get credit as long as there is any possibility.” The demand for credit increased overnight and the banks then had to restrict it. If one bank started, all the others had to restrict it also. Once it started in one country, all other countries had to do the same, so that the restrictions spread all over the world.

If the banks did not restrict credit, could such prosperity be made to last forever? The fact is that in every period of prosperity businessmen have declared, “This is not a temporary boom—this is the final great prosperity of mankind. It will never be followed by a crisis.” But it is not possible to make the boom last forever because the boom is built upon paper, on banknotes and checkbook money. It is based on the assumption that there are more goods available than there really are. If the banks did not stop at the last minute, then the credit expansion would have proceeded more and more rapidly until the complete breakdown of the currency occurred, as it did in Germany in 1923. The inflationary movement must come to an end either by a complete breakdown or by voluntary restrictions on the part of the banks involved.

If people were not so optimistic, the crisis would not be so bad, for people would prepare for it. The reasons that make the boom collapse are individual historical facts. The problem when the boom comes to an end is decided by accidental factors. But it cannot be avoided. And the later the crisis comes, the more capital has been squandered, and the worse the consequences.

I want to say something about the relation between inflation and credit expansion. Both are very similar, in fact almost the same. The difference is this. In the case of credit expansion, the total additional amount of newly created money goes first into the loan market. It is not spent for consumption, but lent to business. Therefore, the first consequence of credit expansion is that an expansion of business is brought about. And all the other effects come from this stimulation of business. In the case of inflation, the additional money goes first into the hands of a spender—for instance, the government spending for arms or other reasons. Thus, the course of the inflation is different. In essence the two are the same, but their sequences are different, and the characters of the two booms are different. But sooner or later, the spending money from the inflation reaches the investment market also, just as the credit expansion money also finally reaches the spending market.

The idea of qualitative credit control has been popular. We want to give additional credit for good things, for additional industrial plants and for agriculture, but not for bad people and bad purposes, not for frivolous things. In the final analysis, it doesn’t matter where it starts. If the additional money goes first to farmers, the demand for credit among farmers drops and the amount that they would have absorbed without credit expansion is available for creating a boom somewhere else. A boom cannot be directed. No segment of the economy is separate.

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9TH LECTURE

The Business Cycle and Beyond

ABOUT THE END OF THE NINETEENTH CENTURY, when people began to realize that there was something questionable about credit expansion, the defenders of this policy found a new excuse. They declared that credit expansion could work in an isolated country which did not connect with the rest of the world through the medium of the gold standard. By abolishing the gold standard and establishing a free-of-gold currency or fiat money system it would be possible to expand credit, lower the rate of interest, and make the country prosperous forever. This attitude was evident among the German Junkers who suffered in the 1880s and 1890s from the importation of American cereals. However, they ascribed their misfortune to the gold standard, not to their poor soil and the low yield per acre. They said if it were not for the gold standard they could enjoy a low rate of interest and prosperity.

The influence of these ideas was apparent when the Italian minister of finance declared that a conference of the banks was needed. Toward the end of World War II, these ideas led to the establishment of the International Monetary Fund (IMF). The British government suggested an international bank and in order to create favorable public opinion for an “International Clearing Union” published a pamphlet written by Lord Keynes. This pamphlet, distributed in this country by the British propaganda office, declared that credit expansion was most desirable. In Keynes’s own words, credit expansion had brought about the miracle of “converting stones into bread” within nations and it was now necessary to do this on an international scale. They wanted an international monetary unit. The Bretton Woods Conference produced a document and also an institute with members, a board, and so on. But it is very well known that otherwise they produced nothing. From the beginning, the Conference was abortive and useless.

Why can’t credit be expanded on an international basis? The failure of credit expansion is due not to the fact that it has been done on a national basis only, but to the fact that it is impossible to substitute paper for non-existing capital goods. It was not realized that what is needed for an economic expansion is more capital goods, more previous savings. It is true that in the past credit expansion of individual countries came to an end because the pace of the expansion was not the same in other countries. But it would have come to an end anyway.

The real reason why such an international bank cannot succeed is the impossibility of answering this question: “Who should profit from this credit expansion in the short run?” Suppose there was one central bank—let us assume that all political rivalries are forgotten. Such an international bank could increase the amount of credit available either by printing additional banknotes or by giving additional bank credits by checkbook money. But then the problem appears for which no solution is possible—to whom will the new credit, the “easy money,” be offered? Let us assume that the whole additional amount is loaned to one country. This country will enjoy the first boom. Its people will have more money and will bid up the prices of the things they want to buy. Having more money at their disposal, they will be in the favorable position of being able to buy from other countries not yet adjusted to the credit expansion. This first country will be the winner, and the others will be the losers. The other countries will still sell at the old prices but they will have to buy at the new, higher prices.

The questions to be asked are: “Who will get the loans? How will the additional money be distributed?” Every group of countries will propose a system of distribution. The Far East will favor distribution according to population. The advanced countries, for instance, will suggest distribution according to the total amount of yearly production or according to national income. Therefore, such plans are more or less useless. The only value of the IMF, which has been one of the most conspicuous failures of world policies of the last twenty years, is that it occupies office space in Washington .

As all these things proved useless, the defenders of credit expansion, that is, those people who with Marx and the Banking School theorists do not believe that the source of a depression is the credit expansion that precedes it, have proposed elaborate countercyclical methods for minimizing depressions. Considering depressions unavoidable, they want to make them as smooth and as mild as possible by means of government interference. Their idea is that the cycle comes from business or from laissez faire, and the government should interfere with countercyclical programs to make it milder. But this is just the opposite of the case.

The idea of countercyclical measures is that when there is a crisis, business is bad and there are unemployed. The government then should step in with public works. The members of the League of Nations and United Nations committees believe they have discovered something new, but this is nothing new.

The boom comes to an end because the factors of production have been malinvested. The existence of unused capacity in times of depression is an indication of malinvestment, because errors in judgment were made in the past. The solution would be to let wages and prices drop until things started up again. But then someone suggests that the government step in with public works. But why should the government take the factors away from the private works where they are needed? The answer made is that the government should restrict government expenditures as long as there is a boom, and then, when the depression comes, embark on great projects. In a rather childish way these reports always say that there should be a number of projects “on the shelf,” already elaborated by the technologists. As soon as the crisis appears, the government should take them off the shelf and start work.

This idea is erroneous because it is based on comparing the individual’s situation to that of the whole nation. An individual is cautious; he saves for a rainy day; he may realize that he is prosperous now, but he remembers that his business may not always be successful. When the rainy day comes and he wants to consume, he must sell his savings to others who make use of them.

What should the government do with the taxes it collects if such a public works scheme is anticipated? Should it hoard the money in advance? Should it withdraw money from the system by taxation, thus neutralizing the credit expansion? Advocates of public works feel the government should abstain from spending during the expansion, hoard the money, and when the depression comes spend the money, thus making a new inflation. Perhaps, they reason, it will be possible in this way to prolong the boom for a few weeks. But it is also possible that the economic system won’t cooperate and the pump-priming will fail to work as it failed in the early New Deal.

The other suggestion is that the government hoard, not the money, but the means of production—the machines, tools, and raw materials. This would mean that during the boom the government would make the boom still more “boomy” by appearing on the market as a purchaser of machines, tools, and raw materials.

Sweden boasted that she had solved the problem of the depression by following countercyclical policies. In the 1930s her position was rather peculiar. Sweden exports precisely those things that Germany was consuming for her rearmament effort—iron, lumber, machinery, etc. Sweden ’s situation in this rearmament boom was like that which Pittsburgh or the entertainment section of Broadway would have enjoyed if they had been independent countries during the war. They would have sold steel and provided amusement to soldiers and munitions works; they would have enjoyed the advantages and had none of the disadvantages of a boom. They would have been the most flourishing sections of the Western hemisphere. This was the situation in Sweden . To say that it was her wonderful policy is another thing. Then, when the war was over, her lead over the whole world was due to her neutrality. You know, it would have been a different story if Hitler had gone into Sweden . One of the Swedish economists was made head of the reconstruction of Europe , which has been a rather miserable experiment.

No boom is possible without credit expansion, and credit expansion must result in catastrophe. When the end of the boom comes and the depression begins, the psychology of the people may make the depression last longer than it would have. (The depression of 1929, for instance, lasted as long as it did because the unions would not accept any substantial lowering of wage rates. This important cost factor of the boom remained for many years and could be remedied only by a new inflation.) The boom is illusory; it is based on the assumption that we are richer than we really are. The boom started projects which could not be executed. The depression means the readjustment of conditions to the real state of affairs. In the depression, the main activity of business consists of salvaging what can be rescued from the boom. The depression lasts as long as necessary to accumulate, by new savings, the capital needed for the continuation of as many enterprises as possible that were started during the boom. The depression does not mean an impoverishment of the country. Actually it reflects a more accurate picture than the preceding boom. But due to psychological reasons and the political situation caused by the depression, by the drop in prices, and the decline in production, it may go much farther than necessary to re-establish the preceding conditions.

Literature on the trade cycle, especially the earlier material, took sadistic pleasure in describing in detail all the phenomena of the depression. Sometimes paradoxical phenomena appear. But we must not fail to realize that the depression is the return to reality and the attempt to make well, as far as possible, the deficiencies produced by the preceding boom.

During the nineteenth century there was an almost regular recurrence of booms and depressions. This is what has been called the “trade cycle.” As soon as conditions begin to be normal, the people and the government call for a new credit expansion and the boom begins again.

The people came to consider the trade cycle as an inevitable trade phenomenon, and they began to study the length of the cycle. All efforts to estimate the length of the trade cycle are more or less fantastic. Because some economists declared that the length of the cycle is eleven years, the idea arose that it is not caused by social and human events, but by cosmic events. The sunspot theory was developed. Such theories are merely guesswork. In the first place the cycle is not eleven years. Also, if true, why does business, which adjusts itself to nature, climate, fertility, and other conditions, never realize that and adjust its activities to the sunspots? There is not the slightest empirical proof that the cycles and sunspots coincide.

But a regularity of some kind was recognized. There is some feeling that the trade cycles are a new development which came with the banking and money system of modern times. But is the trade cycle inevitable? If capitalism continues, will this phenomenon prevail in the future as it has prevailed in the past? The science of human action should not be confused with the natural sciences. Trade cycles originate as the outcome of a human action—credit expansion. Will the trade cycle remain if this knowledge becomes general? Certainly not! If everybody realizes that the credit expansion is the cause of the following depression, governments and people will probably learn that credit expansion is not to their advantage and it will be discontinued.

On the other hand, let us assume that governments and public opinion, in spite of this insight, stubbornly cling to a policy of credit expansions from time to time. Would it not be probable that the reaction of the individual businessman to credit expansion would be different? Might not business itself, in spite of the governmental incentives, make adjustments so that business would be more stable? Suppose the government embarks on credit expansion and the businessmen feel it is questionable. Instead of expanding their operations because expansion was possible, they might become rather cautious and not expand to the extent possible. This is not such an impossible idea. Remember the New Deal pump-priming. The New Deal wanted a boom but no depression. They wanted to make only the initial movement and then stop expanding credit. But the businessmen realized that the government was planning to stop once the businessmen had started expanding and they did not fall into that trap.

This makes me think the trade cycles which have occurred in capitalistic countries from 1780 on may eventually disappear. It would be a mistake, therefore, to say that the trade cycle belongs to the market economy and will not disappear as long as there is a market economy. First of all, the trade cycle is not a market phenomenon but a phenomenon of the credit expansion which is inserted into the market economy because governments and public opinion believe that the normal operation of the market economy doesn’t produce enough bridges and wealth. They believe they have discovered the method for “converting stones into bread.” I would say the trade cycle may be only a passing phenomenon, one evidence of the difference between the science of human action and the natural sciences.

What is wrong in the boom may be described as disproportionality between the various branches of production, between the producer goods and consumer goods. Those who try to explain a general boom or general nationwide losses as due to this disproportionality in business production point out that there are durable consumer goods and producer goods. When a new invention, such as a refrigerator, comes on the market, everyone wants to buy. That particular industry booms and expands. But, it is asked, when everybody has bought a new refrigerator, how can the industry continue to expand? The same situation applies, they say, to other businesses—to the building trade, and so on. After everybody who wants these durable and producer goods has bought, the demand falls off and there is the depression. This idea is really fantastic because economic expansion doesn’t take place in this way.

The monetary theory of the trade cycle explains the disproportionality in this way. At first only a few buy the new gadget, and then more and more. When the last ones buy, those who bought the early production need replacements. Businessmen are not so stupid as to say that a business which was good yesterday will necessarily be good tomorrow also. A man embarking on a new business asks himself if there are already enough plants. People do not enter into business as morons. This explains the proportionate sizes of the various industries and the reason why the number of loaves of bread produced and sold on the market is more than the number of coffins. This is why the size of industries is adjusted to the life of their production. It isn’t necessary for the government to tell the people what would be surplus production. The calculations of an individual businessman may be erroneous and that man may go bankrupt. Perhaps he increased production in the motor car industry when he should have increased it in the refrigerator industry. He caused a surplus of automobiles and a deficiency of refrigerators. Every day there is loss to some business and gain to others. This means that some businesses will be overstaffed and some understaffed. But it doesn’t mean a general boom or a general nationwide loss. A general boom can only be brought about by the illusion which is inherent in the credit expansion.

All attempts to explain the crisis by referring to the mistakes and insufficiencies of businessmen are in error; they fail to take into consideration that such mistakes counteract one another. If one sector of business has made the mistake of overexpansion, there is necessarily underproduction and good business in other branches. Only by general credit expansion can a boom be caused.

The idea that what is wrong with business is that the businessman doesn’t see the whole field but only a small segment and, therefore, is bound to make mistakes is Marx’s idea of the anarchy of production. Adam Smith and others have answered this in their books. Marx failed to account for the fact that, even if no dictator tells men what to do, there is a tendency in the economic system to give every branch of industry precisely that amount of capital, labor, and products that the consumers demand. Those who guess right make profits; those who are wrong incur losses. The result is that eventually control of the factors of production gets into the hands of those who best satisfy the needs of consumers.

If government, by means of a tax on production, tries to eliminate the profits, to confiscate them, and, therefore, to prevent them from bringing about the consequences which would ensue without these taxes, the operation of the market is considerably weakened. The result is that economic progressiveness and the tendency toward improvement which are inherent in the capitalistic system are eliminated and rigidity enters into the system.

As an example, let us consider a department store developed years ago by an ambitious young man who started in business with “two shoelaces” [on a “shoestring”]. The market economy prevents the old department store from becoming rigid, conservative, and bureaucratic. If it does, and if the founder’s grandchildren operate the store inefficiently, other small shops around the corner will make profits, consume only a part of their profits, and invest the balance. In time the business of the old store will shrink until it may be absorbed by the newcomer, or perhaps sold to new management. Then one of the small shops will be the big department store.

But today things are different. Modern taxation prevents the newcomer from reinvesting the greater part of his funds. The government doesn’t legally and officially discriminate against the newcomer; if he makes $250,000 he is taxed the same as an old business making $250,000. But the future business capital is taxed away before the newcomer can build the big store. Therefore, the old department store is somewhat protected; it doesn’t need to compete so actively with the gifted newcomer, and it may become negligent. These conditions make it difficult for newcomers to challenge established businesses, the “vested interests.” People think the tax laws are extremely progressive, but in reality they are extremely conservative, favoring the existing structure against newcomers. Rigidity results. But this has nothing to do with our subject, credit expansion. However, if there is a credit expansion, the banks prefer to lend to the old rather than to the new firms. This also means that the existing structure tends to be petrified.

I want to say something about the banks and their connection with credit expansion. We must never confuse two very different things which have nothing in common except for the fact that the business is done by the same person, the banker. In one case, the banker may lend his own money; he who lends his own money is a money-lender. In this case, there is no question of credit expansion.

In the other case, the banker may lend other people’s money. The banker who receives deposits from customers and lends this money, other people’s money, is a savings bank, an intermediary. The banker may also create fiduciary media, banknotes, and lend them also, usually by crediting his customers’ checking accounts. As these two banking functions— lending the deposits of customers and lending fiduciary media—are generally connected in the same enterprises, the government, which controls the business of the fiduciary media, has gained control of the whole lending business. This has given tremendous powers to the government. If there had never been government interference with the banks, the whole problem would never have appeared.

The defenders of government interference with the issuance of banknotes and checkbook money justify this policy by declaring that “free trade in banking is free trade in swindling.” The poor, ignorant people must be protected, they say, against bad banknotes. But no one would be forced to take banknotes if they had not been declared legal tender by the government. The German literature of the mid-nineteenth century considered it really necessary to protect the poor people of Germany from the banks. But the German central bank, the Reichsbank, devalued from 1914, when one U. S. dollar equaled 4.20 marks, to 1923, when it took 4,200,000,000 marks to buy one dollar. The situation today in this country is not that bad, but it is bad enough. The interference of the government in money and banking has made government supreme in devaluing the money. The results today are fantastic compared with the promises and reasons for giving the government this power. Could anything be worse than to have the money in the people’s hands shrink from day to day?

Lord Keynes called the gold standard a “barbarous relic.” Many books say that the government had to step in because the gold standard failed. But the gold standard didn’t fail! The government abolished the gold standard by making it illegal to hold gold. But even today, all international trade is calculated in gold. It is not because gold is yellow and heavy, but because gold alone makes the determination of the purchasing power of the monetary unit independent of the changes in ideas of governments and political parties.

The essence of the market economy is that the economic actions of the individuals are not performed by order of the government but spontaneously by the individuals. This requires also that the money, the medium of exchange, be independent of political influence. If not, the coming years will be nothing but a series of failures of various governmental monetary and credit policies. To prevent this, it is necessary to make everybody realize that there are no Keynesian miracles possible, and that you cannot improve the situation of the people by credit expansion. I thank you.

Miscellaneous References Cited During Discussions

1. Anderson, Benjamin McAlester. Economics and the Public Welfare: Financial and Economic History of the United States, 1914–1946. New York : D. Van Nostrand Co., 1949.

2. Cannan, Edwin. Money: Its Connexion with Rising and Falling Prices. London : P. S. King & Son, Ltd., 1935. (Reprinted by Staples Press, Inc., New York, 1945)

3. Cortney, Phillip. The Economic Munich : The I. T.O. Charter, Inflation or Liberty , The 1929 Lesson. New York : The Philosophical Library, 1949.

4. Hume, David. Essays, Moral, Political and Literary. First published in 1741, many reprints.

5. Weber, Max. Gesammelte Aufsätze zur Religionssoziologie (Collected Essays on the Sociology of the Great Religions). The first study in this book has been translated into English under the title of The Protestant Ethic and the Spirit of Capitalism. London : George Allen Unwin Ltd., 1930. 2nd ed., 1948.

6. Wicksteed, Philip H. The Common Sense of Political Economy and Selected Papers and Reviews on Economic Theory. London : George Routledge & Sons, Ltd., 1935.

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