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Title: One Lesson in Economics Author: anonymous Date: 1/1/1963 Language: en Topics: Mutualism, economics
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 economics and bad.
The bad economist sees only what immediately strikes the eye; the good
economist also looks beyond. The bad economist sees only the direct
consequences of a proposed course; the good economist looks also at the
longer and indirect consequences. The bad economist sees only what the
effect of a given policy has been or will be on one particular group;
the good economist inquires also what the effect of the policy will be
on all groups.
The distinction may seem obvious. The precaution of looking for all the
consequences of a given policy to everyone may seem elementary. Doesn’t
everybody know, in his personal life, that there are all sorts of
indulgences delightful at the moment but disastrous in the end? Doesn’t
every little boy know that if he eats enough candy he will get sick?
Doesn’t the fellow who gets drunk know that he will wake up next morning
with a ghastly stomach and a horrible head? Doesn’t the dipsomaniac know
that he is ruining his liver and shortening his life? Doesn’t the Don
Juan know that he is letting himself in for every sort of risk, from
blackmail to disease? Finally, to bring it to the economic though still
personal realm, do not the idler and the spendthrift know, even in the
midst of their glorious fling, that they are heading for a future of
debt and poverty?
Yet when we enter the field of public economics, these elementary truths
are ignored. There are men regarded today as brilliant economists, who
deprecate saving and recommend squandering on a national scale as the
way of economic salvation; and when anyone points to what the
consequences of these policies will be in the long run, they reply
flippantly, as might the prodigal son of a warning father: “In the long
run we are all dead.” And such shallow wisecracks pass as devastating
epigrams and the ripest wisdom.
But the tragedy is that, on the contrary, we are already suffering the
long-run consequences of the policies of the remote or recent past.
Today is already the tomorrow which the bad economist yesterday urged us
to ignore. The long-run consequences of some economic policies may
become evident in a few months. Others may not become evident for
several years. Still others may not become evident for decades. But in
every case those long-run consequences are contained in the policy as
surely as the hen was in the egg, the flower in the seed.
From this aspect, therefore, the whole of economics can be reduced to a
single lesson, and that lesson can be reduced to a single sentence. The
art of economics consists in looking not merely at the immediate 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 a certain callousness toward the
fate of groups that were immediately hurt by policies or developments
which proved to be beneficial on net balance and in the long run.
But comparatively few people today make this error; and those few
consist mainly of professional economists. The most frequent fallacy by
far today, the fallacy that emerges again and again in nearly every
conversation that touches on economic affairs, the error of a thousand
political speeches, the central sophism of the “new” economics, is to
concentrate on the short-run effects of policies on special groups and
to ignore or belittle the long-run effects on the community as a whole.
The “new” economists flatter themselves that this is a great, almost a
revolutionary advance over the methods of the “classical” or “orthodox”
economists, because the former take into consideration short-run effects
which the latter often ignored. But in themselves ignoring or slighting
the long run effects, they are making the far more serious error. They
overlook the woods in their precise and minute examination of particular
trees. Their methods and conclusions are often profoundly reactionary.
They are sometimes surprised to find themselves in accord with
seventeenth-century mercantilism. They fall, in fact, into all the
ancient errors (or would, if they were not so inconsistent) that the
classical economists, we had hoped, had once for all got rid of.
It is often sadly remarked that the bad economists present their errors
to the public better than the good economists present their truths. It
is often complained that demagogues can be more plausible in putting
forward economic nonsense from the platform than the honest men who try
to show what is wrong with it. But the basic reason for this ought not
to be mysterious. The reason is that the demagogues and bad economists
are presenting half-truths. They are speaking only of the immediate
effect of a proposed policy or its effect upon a single group. As far as
they go they may often be right. In these cases the answer consists in
showing that the proposed policy would also have longer and less
desirable effects, or that it could benefit one group only at the
expense of all other groups. The answer consists in supplementing and
correcting the half-truth with the other half. But to consider all the
chief effects of a proposed course on everybody often requires a long,
complicated, and dull chain of reasoning. Most of the audience finds
this chain of reasoning difficult to follow and soon becomes bored and
inattentive. The bad economists rationalize this intellectual debility
and laziness by assuring the audience that it need not even attempt to
follow the reasoning or judge it on its merits because it is only
“classicism” or “laissez faire” or “capitalist apologetics” or whatever
other term of abuse may happen to strike them as effective.
We have stated the nature of the lesson, and of the fallacies that stand
in its way, in abstract terms. But the lesson will not be driven home,
and the fallacies will continue to go unrecognized, unless both are
illustrated by examples. Through these examples we can move from the
most elementary problems in economics to the most complex and difficult.
Through them we can learn to detect and avoid first the crudest and most
palpable fallacies and finally some of the most sophisticated and
elusive. To that task we shall now proceed.
Let us begin with the simplest illustration possible: let us, emulating
Bastiat, choose a broken pane of glass.
A young hoodlum, say, heaves a brick through the window of a baker’s
shop. The shopkeeper runs out furious, but the boy is gone. A crowd
gathers, and begins to stare with quiet satisfaction at the gaping hole
in the window and the shattered glass over the bread and pies. After a
while the crowd feels the need for philosophic reflection. And several
of its members are almost certain to remind each other or the baker
that, after all, the misfortune has its bright side. It will make
business for some glazier. As they begin to think of this they elaborate
upon it. How much does a new plate glass window cost? Fifty dollars?
That will be quite a sum. After all, if windows were never broken, what
would happen to the glass business? Then, of course, the thing is
endless. The glazier will have $50 more to spend with other merchants,
and these in turn will have $50 more to spend with still other
merchants, and so ad infinitum. The smashed window will go on providing
money and employment in ever-widening circles. The logical conclusion
from all this would be, if the crowd drew it, that the little hoodlum
who threw the brick, far from being a public menace, was a public
benefactor.
Now let us take another look. The crowd is at least right in its first
conclusion. This little act of vandalism will in the first instance mean
more business for some glazier. The glazier will be no unhappy to learn
of the incident than an undertaker to learn of a death. But the
shopkeeper will be out $50 that he was planning to spend for a new suit.
Because he has had to replace a window, he will have to go without the
suit (or some equivalent need or luxury). Instead of having a window and
$50 he now has merely a window. Or, as he was planning to buy the suit
that very afternoon, instead of having both a window and a suit he must
be content with the window and no suit. If we think of him as a part of
the community, the community has lost a new suit that might otherwise
have come into being, and is just that much poorer.
The glazier’s gain of business, in short, is merely the tailor’s loss of
business. No new “employment” has been added. The people in the crowd
were thinking only of two parties to the transaction, the baker and the
glazier. They had forgotten the potential third party involved, the
tailor. They forgot him precisely because he will not now enter the
scene. They will see the new window in the next day or two. They will
never see the extra suit, precisely because it will never be made. They
see only what is immediately visible to the eye.
So we have finished with the broken window. An elementary fallacy.
Anybody, one would think, would be able to avoid it after a few moments’
thought. Yet the broken window fallacy, under a hundred disguises, is
the most persistent in the history of economics. It is more rampant now
than at any time in the past. It is solemnly reaffirmed every day by
great captains of industry, by chambers of commerce, by labor union
leaders, by editorial writers and newspaper columnists and radio
commentators, by learned statisticians using the most refined
techniques, by professors of economics in our best universities. In
their various ways they all dilate upon the advantages of destruction.
Though some of them would disdain to say that there are net benefits in
small acts of destruction, they see almost endless benefits in enormous
acts of destruction. They tell us how much better off economically we
all are in war than in peace. They see “miracles of production” which it
requires a war to achieve. And they see a 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
today are incomparably greater than the needs of America. But its
purchasing power, and therefore the “new business” that it can
stimulate, are incomparably smaller.
But if we get past this point, there is a chance for another fallacy,
and the broken-windowites usually grab it. They think of “purchasing
power” merely in terms of money. Now money can be run off by the
printing press. As this is being written, in fact, printing money is the
world’s biggest industry—if the product is measured in monetary terms.
But the more money is turned out in this way, the more the value of any
given unit of money falls. This falling value can be measured in rising
prices of commodities. But as most people are so firmly in the habit of
thinking of their wealth and income in terms of money, they consider
themselves better off as these monetary totals rise, in spite of the
fact that in terms of things they may have less and buy less. Most of
the “good” economic results which people attribute to war are really
owing to wartime inflation. They could be produced just as well by an
equivalent peacetime inflation. We shall come back to this money
illusion later.
Now there is a half-truth in the “backed-up” demand fallacy, just as
there was in the broken-window fallacy. The broken window did make more
business for the glazier. The destruction of war will make more business
for the producers of certain things. The destruction of houses and
cities will make more business for the building and construction
industries. The inability to produce automobiles, radios, and
refrigerators during the war will bring about a cumulative 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.
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 housing that exists? As a
character in Bernard Shaw’s Saint Joan replies when told of the theory
of Pythagoras that the earth is round and revolves around the sun: “What
an utter fool! Couldn’t he use his eyes?”
We must apply the same reasoning, once more, to great projects like the
Tennessee Valley Authority. Here, because of sheer size, the danger of
optical illusion is greater than ever. Here is a mighty dam, a
stupendous arc of steel and concrete, “greater than anything that
private capital could have built,” the fetish of photographers, the
heaven of socialists, the most often used symbol of the miracles of
public construction, ownership and operation. Here are mighty generators
and power houses. Here is a whole region lifted to a higher economic
level, attracting factories and industries that could not otherwise have
existed. And it is all presented, in the panegyrics of its partisans, as
a net economic gain without offsets.
We need not go here into the merits of the TVA or public projects like
it. But this time we need a special effort of the imagination, which few
people seem able to make, to look at the debit side of the ledger. If
taxes are taken from people and corporations, and spent in one
particular section of the country, why should it cause surprise, why
should it be regarded as a miracle, if that section becomes
comparatively richer? Other sections of the country, we should remember,
are then comparatively poorer. The thing so great that “private capital
could not have built it” has in fact been built by private capital—the
capital that was expropriated in taxes (or, if the money was borrowed,
that eventually must be expropriated in taxes). Again we must make an
effort of the imagination to see the private power plants, the private
homes, the typewriters and radios that were never allowed to come into
existence because of the money that was taken from people all over the
country to build the photogenic Norris Dam.
I have deliberately chosen the most favorable examples of public
spending schemes—that is, those that are most frequently and fervently
urged by the government spenders and most highly regarded by the public.
I have not spoken of the hundreds of boondoggling projects that are
invariably embarked upon the moment the main object is to “give jobs”
and “to put people to work.” For then the usefulness of the project
itself, as we have seen, inevitably becomes a subordinate consideration.
Moreover, the more wasteful the work, the more costly in manpower, the
better it becomes for the purpose of providing more employment. Under
such circumstances it is highly improbable that the projects thought up
by the bureaucrats will provide the same net addition to wealth and
welfare, per dollar expended, as would have been provided by the
taxpayers themselves, if they had been individually permitted to buy or
have made what they themselves wanted, instead of being forced to
surrender part of their earnings to the state.
There is a still further factor which makes it improbable that the
wealth created by government spending will fully compensate for the
wealth destroyed by the taxes imposed to pay for that spending. It is
not a simple question, as so often supposed, of taking something out of
the nation’s right-hand pocket to put into its left-hand pocket. The
government spenders tell us, for example, that if the national income is
$200,000,000,000 (they are always generous in fixing this figure) then
government taxes of $50,000,000,000 a year would mean that only 25 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.
Government “encouragement” to business is sometimes as much to be feared
as government hostility. This supposed encouragement often takes the
form of a direct grant of government credit or a guarantee of private
loans.
The question of government credit can often be complicated, because it
involves the possibility of inflation. We shall defer analysis of the
effects of inflation of various kinds until a later chapter. Here, for
the sake of simplicity, we shall assume that the credit we are
discussing is non-inflationary. Inflation, as we shall later see, while
it complicates the analysis, does not at bottom change the consequences
of the policies discussed.
The most frequent proposal of this sort in Congress is for more credit
to farmers. In the eyes of most Congressmen the farmers simply cannot
get enough credit. The credit supplied by private mortgage companies,
insurance companies or country banks is never “adequate.” Congress is
always finding new gaps that are not filled by the existing lending
institutions, no matter how many of these it has itself already brought
into existence. The farmers may have enough long-term credit or enough
short-term credit, but, it turns out, they have not enough
“intermediate” credit; or the interest rate is too high; or the
complaint is that private loans are made only to rich and
well-established farmers. So new lending institutions and new types of
farm loans are piled on top of each other by the legislature.
The faith in all these policies, it will be found, springs from two acts
of shortsightedness. One is to look at the matter only from the
standpoint of the farmers that borrow. The other is to think only of the
first half of the transaction.
Now all loans, in the eyes of honest borrowers, must eventually be
repaid. All credit is debt. Proposals for an increased volume of credit,
therefore, are merely another name for proposals for an increased burden
of debt. They would seem considerably less inviting if they were
habitually referred to by the second name instead of by the first.
We need not discuss here the normal loans that are made to farmers
through private sources. They consist of mortgages; of installment
credits for the purchase of automobiles, refrigerators, radios, tractors
and other farm machinery, and of bank loans made to carry the farmer
along until he is able to harvest and market his crop and get paid for
it. Here we need concern ourselves only with loans to farmers either
made directly by some government bureau or guaranteed by it.
These loans are of two main types. One is a loan to enable the farmer to
hold his crop off the market. This is an especially harmful type; but it
will be more convenient to consider it later when we come to the
question of government commodity controls. The other is a loan to
provide capital—often to set the farmer up in business by enabling him
to buy the farm itself, or a mule or tractor, or all three.
At first glance the case for this type of loan may seem a strong one.
Here is a poor family, it will be said, with no means of livelihood. It
is cruel and wasteful to put them on relief. Buy a farm for them; set
them up in business; make productive and self-respecting citizens of
them; let them add to the total national product and pay the loan off
out of what they produce. Or here is a farmer struggling along with
primitive methods of production because he has not the capital to buy
himself a tractor. Lend him the money for one; let him increase his
productivity; he can repay the loan out of the proceeds of his increased
crops. In that way you not only enrich him and put him on his feet; you
enrich the whole community by that much added output. And the loan,
concludes the argument, costs the government and the taxpayers less than
nothing, because it is “self-liquidating.”
Now as a matter of fact this is what happens every day under the
institution of private credit. If a man wishes to buy a farm, and has,
let us say, only half or a third as much money as the farm costs, a
neighbor or a savings bank will lend him the rest in the form of a
mortgage on the farm. If he wishes to buy a tractor, the tractor company
itself, or a finance company, will allow him to buy it for one-third of
the purchase price with the rest to be paid off in installments out of
earnings that the tractor itself will help to provide.
But there is a decisive difference between the loans supplied by private
lenders and the loans supplied by a government agency. Each private
lender risks his own funds. (A banker, it is true, risks the funds of
others that have been entrusted to him; but if money is lost he must
either make good out of his own funds or be forced out of business.)
When people risk their own funds they are usually careful in their
investigations to determine the adequacy of the assets pledged and the
business acumen and honesty of the borrower.
If the government operated by the same strict standards, there would be
no good argument for its entering the field at all. Why do precisely
what private agencies already do? But the government almost invariably
operates by different standards. The whole argument for its entering the
lending business, in fact, is that it will make loans to people who
could not get them from private lenders. This is only another way of
saying that the government lenders will take risks with other people’s
money (the taxpayers’) that private lenders will not take with their own
money. Sometimes, in fact, apologists will freely acknowledge that the
percentage of losses will be higher on these government loans than on
private loans. But they contend that this will be more than offset by
the added production brought into existence by the borrowers who pay
back, and even by most of the borrowers who do not pay back.
This argument will seem plausible only as long as we concentrate our
attention on the particular borrowers whom the government supplies with
funds, and overlook the people whom its plan deprives of funds. For what
is really being lent is not money, which is merely the medium of
exchange, but capital. (I have already put the reader on notice that we
shall postpone to a later point the complications introduced by an
inflationary expansion of credit.) What is really being lent, say, is
the farm or the tractor itself. Now the number of farms in existence is
limited, and so is the production of tractors (assuming, especially,
that an economic surplus of tractors is not produced simply at the
expense of other things). The farm or tractor that is lent to A cannot
be lent to B. The real question is, therefore, whether A or B shall get
the farm.
This brings us to the respective merits of A and B, and what each
contributes, or is capable of contributing, to production. A, let us
say, is the man who would get the farm if the government did not
intervene. The local banker or his neighbors know him and know his
record. They want to find employment for their funds. They know that he
is a good farmer and an honest man who keeps his word. They consider him
a good risk. He has already, perhaps, through industry, frugality and
foresight, accumulated enough cash to pay 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 bank with him. That is why the banker makes
him the loan. The banker is not giving something for nothing. He feels
assured of repayment. He is merely exchanging a more liquid form of
asset or credit for a less liquid form. Sometimes he makes a mistake,
and then it is not only the banker who suffers, but the whole community;
for values which were supposed to be produced by the lender are not
produced and resources are wasted.
Now it is to A, let us say, who has credit, that the banker would make
his loan. But the government goes into the lending business in a
charitable frame of mind because, as we saw, it is worried about B. B
cannot get a mortgage or other loans from private lenders because he
does not have credit with them. He has no savings; he has no impressive
record as a good farmer; he is perhaps at the moment on relief. Why not,
say the advocates of government credit, make him a useful and productive
member of society by lending him enough for a farm and a mule or tractor
and setting him up in business?
Perhaps in an individual case it may work out all right. But it is
obvious that in general the people selected by these government
standards will be poorer risks than the people selected by private
standards. More money will be lost by loans to them. There will be a
much higher percentage of failures among them. They will be less
efficient. More resources will be wasted by them. Yet the recipients of
government credit will get their farms and tractors at the expense of
what otherwise would have been the recipients of private credit. Because
B has a farm, A will be deprived of a farm. A may be squeezed out either
because interest rates have gone up as a result of the government
operations, or because farm prices have been forced up as a result of
them, or because there is no other farm to be had in his neighborhood.
In any case the net result of government credit has not been to increase
the amount of wealth produced by the community but to reduce it, because
the available real capital (consisting of actual farms, tractors, etc.)
has been placed in the hands of the less efficient borrowers rather than
in the hands of the more efficient and trustworthy.
The case becomes even clearer if we turn from farming to other forms of
business. The proposal is frequently made that the government ought to
assume the risks that are “too great for private industry.” This means
that bureaucrats should be permitted to take risks with the tax payers’
money that no one is willing to take with his own.
Such a policy would lead to evils of many different kinds. It would lead
to favoritism: to the making of loans to friends, or in return for
bribes. It would inevitably lead to scandals. It would lead to
recriminations whenever the taxpayers’ money was thrown away on
enterprises that failed. It would increase the demand for socialism:
for, it would properly be asked, if the government is going to bear the
risks, why should it not also get the profits? What justification could
there possibly be, in fact, for asking the taxpayers to take the risks
while permitting private capitalists to keep the profits? (This is
precisely, however, as we shall later see, what we already do in the
case of “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 bad or at best dubious projects. They will throw it into
the hands of persons who are less competent or less trustworthy than
those who would otherwise have got it. For the amount of real capital at
any moment (as distinguished from monetary tokens run off on a printing
press) is limited. What is put into the hands of B cannot be put into
the hands of A.
People want to invest their own capital. But they are cautious. They
want to get it back. Most lenders, therefore, investigate any proposal
carefully before they risk their own money in it. They weigh the
prospect of profits against the chances of loss. They may sometimes make
mistakes. But for several reasons they are likely to make fewer mistakes
than government lenders. In the first place, the money is either their
own or has been voluntarily entrusted to them. In the case of
government-lending the money is that of other people, and it has been
taken from them, regardless of their personal wish, in taxes. The
private money will be invested only where repayment with interest or
profit is definitely expected. This is a sign that the persons to whom
the money has been lent will be expected to produce things for the
market that people actually want. The government money, on the other
hand, is likely to be lent for some vague general purpose like “creating
employment;” and the more inefficient the work—that is, the greater the
volume of employment it requires in relation to the value of product—the
more highly thought of the investment is likely to be.
The private lenders, moreover, are selected by a cruel market test. If
they make bad mistakes they lose their money and have no more money to
lend. It is only if they have been successful in the past that they have
more money to lend in the future. Thus private lenders (except the
relatively small proportion that have got their funds through
inheritance) are rigidly selected by a process of survival of the
fittest. The government lenders, on the other hand, are either those who
have passed civil service examinations, and know how to answer
hypothetical questions hypothetically, or they are those who can give
the most plausible reasons for making loans and the most plausible
explanations of why it wasn’t their fault that the loans failed. But the
net result remains: private loans will utilize existing resources and
capital far better than government loans. Government loans will waste
far more capital and resources than private loans. Government loans, in
short, as compared with private loans, will reduce production, not
increase it.
The proposal for government loans to private individuals or projects, in
brief, sees B and forgets A. It sees the people in whose hands the
capital is put; it forgets those who would otherwise have had it. It
sees the project to which capital is granted; it forgets the projects
from which capital is thereby withheld. It sees the immediate benefit to
one group; it overlooks the losses to other groups, and the net loss to
the community as a whole. It is one more illustration of the fallacy of
seeing only a special interest in the short run and forgetting the
general interest in the long run.
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 be repaid out of the proceeds of taxes. When the government
makes loans or subsidies to business, what it does is to tax successful
private business in order to support unsuccessful private business.
Under certain emergency circumstances there may be a plausible argument
for this, the merits of which we need not examine here. But in the long
run it does not sound like a paying proposition from the standpoint of
the country as a whole. And experience has shown that it isn’t.
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 be blacker, for the Industrial Revolution was just in its
infancy. Let us look at some of the incidents and aspects of that
revolution. Let us see, for example, what happened in the stocking
industry. New stocking frames as they were introduced were destroyed by
the handicraft workmen (over 1,000 in a single riot), houses were
burned, the inventors were threatened and obliged to fly for their
lives, and order was not finally restored until the military had been
called out and the leading rioters had been either transported or
hanged.
Now it is important to bear in mind that insofar as the rioters were
thinking of their own immediate or even longer futures their opposition
to the machine was rational. For William Felkin, in his History of the
Machine-Wrought Hosiery Manufactures (1867), tells us that the larger
part of the 50,000 English stocking knitters and their families did not
fully emerge from the hunger and misery entailed by the introduction of
the machine for the next forty years. But 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 for every man it employed at the beginning of the century.
Arkwright invented his cotton-spinning machinery in 1760. At that time
it was estimated that there were in England 5,200 spinners using
spinning wheels, and 2,700 weavers—in all, 7,900 persons engaged in the
production of cotton textiles. The introduction of Arkwright’s invention
was opposed on the ground that it threatened the livelihood of the
workers, and the opposition had to be put down by force. Yet in
1787—twenty-seven years after the invention appeared—a parliamentary
inquiry showed that the number of persons actually engaged in the
spinning and weaving of cotton had risen from 7,900 to 320,000, an
increase of 4,400 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 has been increased fourfold, with no increase but
rather a diminution of the involved labor.
The power capacity already being exerted by the steam engines of the
world in existence and working in the year 1887 has been estimated by
the Bureau of Statistics at Berlin as equivalent to that of 200,000,000
horses, representing approximately 1,000,000,000 men; or at least three
times the working population of the earth....
One would think that this last figure would have caused Mr. Wells to
pause, and wonder why there was any employment left in the world of 1889
at all; but he merely concluded, with restrained pessimism, that “under
such circumstances industrial overproduction ... may become chronic.”
In the depression of 1932, the game of blaming unemployment on the
machines started all over again. Within a few months the doctrines of a
group calling themselves the Technocrats had spread through the country
like a forest fire. I shall not weary the reader with a recital of the
fantastic figures put forward by this group or with corrections to show
what the real facts were. It is enough to say that the Technocrats
returned to the error in all its native purity that machines permanently
displace men except that, in their ignorance, they presented this error
as a new and revolutionary discovery of their own. It was simply one
more illustration of Santayana’s aphorism that those who cannot remember
the past are condemned to repeat it.
The Technocrats were finally laughed out of existence; but their
doctrine, which preceded them, lingers on. It is reflected in hundreds
of make-work rules and feather-bed practices by labor unions; and these
rules and practices are tolerated and even approved because of the
confusion on this point in the public mind.
Testifying on behalf of the United States Department of Justice before
the Temporary National Economic Committee (better known as the TNEC) in
March 1941, Corwin Edwards cited innumerable examples of such practices.
The electrical union in New York City was charged with refusal to
install electrical equipment made outside of New York State unless the
equipment was disassembled and reassembled at the job site. In Houston,
Texas, master plumbers and the plumbing union agreed that piping
prefabricated for installation would be installed by the union only if
the thread were cut off one end of the pipe and new thread were cut at
the job site. Various locals of the painters’ union imposed restrictions
on the use of spray-guns, restrictions in many cases designed merely to
make work by requiring the slower process of applying paint with a
brush. A local of the teamsters’ union required that every truck
entering the New York metropolitan area have a local driver in addition
to the driver already employed. In various cities the electrical union
required that if any temporary light or power was to be used on a
construction job there must be a full-time maintenance electrician, who
should not be permitted to do any electrical construction work. This
rule, according to Mr. Edwards, “often involves the hiring of a man who
spends his day reading or playing solitaire and does nothing except
throw a switch at the beginning and end of the day.”
One could go on to cite such make-work practices in many other fields.
In the railroad industry, the unions insist that firemen be employed on
types of locomotives that do not need them. In the theaters unions
insist on the use of scene shifters even in plays in which no scenery is
used. The musicians’ union requires so-called “stand-in” musicians or
even whole orchestras to be employed in many cases where only phonograph
records are needed.
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 only
should we have to regard all further technical progress as a calamity;
we should have to regard all past technical progress with equal horror.
Every day each of us in his own capacity is engaged in trying to reduce
the effort it requires to accomplish a given result. Each of us is
trying to save his own labor, to economize the means required to achieve
his ends. Every employer, small as well as large seeks constantly to
gain his results more economically and efficiently—that is, by saving
labor. Every intelligent workman tries to cut down the effort necessary
to accomplish his assigned job. The most ambitious of us try tirelessly
to increase the results we can achieve in a given number of hours. The
technophobes, if they were logical and consistent, would have to dismiss
all this progress and ingenuity as not only useless but vicious. Why
should freight be carried from New York to Chicago by railroads when we
could employ enormously more men, for example, to carry it all on their
backs?
Theories as false as this are never held with logical consistency, but
they do great harm because they are held at all. Let us, therefore, try
to see exactly what happens when technical improvements and labor-saving
machinery are introduced. The details will vary in each instance,
depending upon the particular conditions that prevail in a given
industry or period. But we shall assume an example that involves the
main possibilities.
Suppose a clothing manufacturer learns of a machine that will make men’s
and women’s overcoats for half as much labor as previously. He installs
the machines and drops half his labor force.
This looks at first glance like a clear loss of employment. But the
machine itself required labor to make it; so here, as one offset, are
jobs that would not otherwise have existed. The manufacturer, however,
would have adopted the machine only if it had either made better suits
for half as much labor, or had made the same kind of suits at a smaller
cost. If we assume the latter, we cannot assume that the amount of labor
to make the machines was as great in terms of payrolls as the amount of
labor that the clothing manufacturer hopes to save in the long run by
adopting the machine; otherwise there would have been no economy, and he
would not have adopted it.
So there is still a net loss of employment to be accounted for. But we
should at least keep in mind the real possibility that even the first
effect of the introduction of labor-saving machinery may be to increase
employment on net balance; because it is usually only in the long run
that the clothing manufacturer expects to save money by adopting the
machine: it may take several years for the machine to “pay for itself.”
After the machine has produced economies sufficient to offset its cost,
the clothing manufacturer has more profits than before. (We shall assume
that he merely sells his coats for the same price as his competitors,
and makes no effort to undersell them.) At this point, it may seem,
labor has suffered a net loss of employment, while it is only the
manufacturer, the capitalist, who has gained. But it is precisely out of
these extra profits that the subsequent social gains must come. The
manufacturer must use these extra profits in at least one of three ways,
and possibly he will use part of them in all three: (1) he will use the
extra profits to expand his operations by buying more machines to make
more coats; or (2) he will invest the extra profits in some other
industry; or (3) he will spend the extra profits on increasing his own
consumption. Whichever of these three courses he takes, he will increase
employment.
In other words, the manufacturer, as a result of his economies, has
profits that he did not have before. Every dollar of the amount he has
saved in direct wages to former coat makers, he now has to pay out in
indirect wages to the makers of the new machine, or to the workers in
another capital industry, or to the makers of a new house or motor car
for himself, or of jewelry and furs for his wife. In any case (unless he
is a pointless hoarder) he gives indirectly as many jobs as he ceased to
give directly.
But the matter does not and cannot rest at this stage. If this
enterprising manufacturer effects great economies as compared with his
competitors, either he will begin to expand his operations at their
expense, or they will start buying the machines too. Again more work
will be given to the makers of the machines. But competition and
production will then also begin to force down the price of overcoats.
There will no longer be as great profits for those who adopt the new
machines. The rate of profit of the manufacturers using the new machine
will begin to drop, while the manufacturers who have still not adopted
the machine may now make no profit at all. The savings, in other words,
will begin to be passed along to the buyers of overcoats—to the
consumers.
But as overcoats are now cheaper, more people will buy them. This means
that, though it takes fewer people to make the same number of overcoats
as before, more overcoats are now being made than before. If the demand
for overcoats is what economists call “elastic”—that is, if a fall in
the price of overcoats causes a larger total amount of money to be spent
on overcoats than previously—then more people may be employed even in
making overcoats than before the new labor-saving machine was
introduced. We have already seen how this actually happened historically
with stockings and other textiles.
But the new employment does not depend on the elasticity of demand for
the particular product involved. Suppose that, though the price of
overcoats was almost 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 otherwise not even exist. But in the
foregoing illustration we have taken precisely the kind of machine that
has been the special object of modern technophobia.
It is possible, of course, to push too far the argument that machines do
not on net balance throw men out of work. It is sometimes argued, for
example, that machines create more jobs than would otherwise have
existed. Under certain conditions this may be true. They can certainly
create enormously more jobs in particular trades. The eighteenth century
figures for the textile industries are a case in point. Their modern
counterparts are certainly no less striking. In 1910, 140,000 persons
were employed in the United States in the newly created 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 but our very lives to machines.
Yet it is a misconception to think of the function or result of machines
as primarily one of creating jobs. The real result of the machine is to
increase production, to raise the standard of living, to increase
economic welfare. It is no trick to employ everybody, even (or
especially) in the most primitive economy. Full employment—very full
employment; long, weary, back-breaking employment—is characteristic of
precisely the nations that are most retarded industrially. Where full
employment already exists, new machines, inventions and discoveries
cannot—until there has been time for an increase in population-bring
more employment. They are likely to bring more unemployment (but this
time I am speaking of voluntary and not involuntary unemployment)
because people can now afford to work fewer hours, while children and
the 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.
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 back 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-overtime provision in the existing
Federal Wage-Hour Law. The previous legislation in the States,
forbidding the employment of women or minors for more, say, than
forty-eight hours a week, was based on the conviction that longer hours
were injurious to health and morale. Some of it was based on the belief
that longer hours were harmful to efficiency. But the provision in the
Federal law, that an employer must pay a worker a 50 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, but with a sufficient increase in hourly wage rates to
maintain the same weekly pay for the individual workers already
employed.
Let us take the first case. We assume that the working week is cut from
forty hours to thirty, with no change in hourly pay. If there is
substantial unemployment when this plan is put into effect, the plan
will no doubt provide additional jobs. We cannot assume that it will
provide sufficient additional jobs, however, to maintain the same
payrolls and the same number of man-hours as before, unless we make the
unlikely assumptions that in each industry there has been exactly the
same percentage of unemployment and that the new men and women employed
are no less efficient at their special tasks on the average than those
who had already been employed. But suppose we do make these assumptions.
Suppose we do assume that the right number of additional workers of each
skill is available, and that the new workers do not raise production
costs. What will be the result of reducing the working week from forty
hours to thirty (without any increase in hourly pay)?
Though more workers will be employed, each will be working fewer hours,
and there will, therefore, be no net increase in man-hours. It is
unlikely that there will be any significant increase in production.
Total payrolls and “purchasing power” will be no larger. All that will
have happened, even under the most favorable assumptions (which would
seldom be realized) is that the workers previously employed will
subsidize, in effect, the workers previously unemployed. For in order
that the new workers will individually receive three-fourths as many
dollars a week as the old workers used to receive, the old workers will
themselves now individually receive only three-fourths as many dollars a
week as previously. It is true that the old workers will now work fewer
hours; but this purchase of more leisure at a high price is presumably
not a decision they have made for its own sake: it is a sacrifice made
to provide others with jobs.
The labor union leaders who demand shorter weeks to “spread the work”
usually recognize this, and therefore they put the proposal forward in a
form in which everyone is supposed to eat his cake and have it too.
Reduce the working week from forty hours to thirty, they tell us, to
provide more jobs; but compensate for the shorter week by increasing the
hourly rate of pay by 33 1/3 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 be a sign that they were
already getting even more than this), then the increase in production
costs as a result of the 33 1/3 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 be on
everybody.
The spread-the-work schemes rest also, as we began by pointing out, on
the false assumption that there is just a fixed amount of work to be
done. There could be no greater fallacy. There is no limit to the amount
of work to be done as long as any human need or wish that work could
fill remains unsatisfied. In a modern exchange economy, the most work
will be done when prices, costs and wages are in the best relations to
each other. What these relations are we shall later consider.
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 be
maintained as before by simply reducing taxes by the amount previously
spent in supporting the wartime army.
But the demobilization will not leave us economically just where we were
before it started. The soldiers previously supported by civilians will
not become merely civilians supported by other civilians. They will
become self-supporting civilians. If we assume that the men who would
otherwise have been retained in the armed forces are no longer needed
for defense, then their retention would have been sheer waste. They
would have been unproductive. The taxpayers, in return for supporting
them, would have got nothing. But now the taxpayers turn over this part
of their funds to them as fellow civilians in return for equivalent
goods or services. Total national production, the wealth of everybody,
is higher.
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.
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 bills 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 be 50,000,000 or 60,000,000 jobs in America in
1950, but how much shall we produce, and what, in consequence, will be
our standard of living? The problem of distribution, on which all the
stress is being put today, is after all more easily solved the more
there is to distribute.
We can clarify our thinking if we put our chief emphasis where it
belongs—on policies that will maximize production.
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 shoemaker.
The shoemaker does not attempt to make his own clothes, but employs a
tailor. The farmer attempts to make neither the one nor the other, but
employs those different artificers. All of them find it for their
interest to employ their whole industry in a way in which they have some
advantage over their neighbors, and to purchase with a part of its
produce, or what is the same thing, with the price of a part of it,
whatever else they have occasion for. What is prudence in the conduct of
every private family can scarce be folly in that of a great kingdom.
But what ever 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.
The tariff has been described as a means of benefiting the producer at
the expense of the consumer. In a sense this is correct. Those who favor
it think only of the interests of the producers immediately benefited by
the particular duties involved. They forget the interests of the
consumers who are immediately injured by being forced to pay these
duties. But it is wrong to think of the tariff issue as if it
represented a conflict between the interests of producers as a unit
against those of consumers as a unit. It is true that the tariff hurts
all consumers as such. It is not true that it benefits all producers as
such. On the contrary, as we have just seen, it helps the protected
producers at the expense of all other American producers, and
particularly of those who have a comparatively large potential export
market.
We can perhaps make this last point clearer by an exaggerated example.
Suppose we make our tariff wall so high that it becomes absolutely
prohibitive, and no imports come in from the outside world at all.
Suppose, as a result of this, that the price of sweaters in America goes
up only $5. Then American consumers, because they have to pay $5 more
for a sweater, will spend on the average five cents less in each of a
hundred other American industries. (The figures are chosen merely to
illustrate a principle: there will, of course, be no such symmetrical
distribution of the loss; moreover, the sweater industry itself will
doubtless be hurt because of protection of still other industries. But
these complications may be put aside for the moment.)
Now because foreign industries will find their market in America totally
cut off, they will get no dollar exchange, and therefore they will be
unable to buy any American goods at all. As a result of this, American
industries will suffer in direct proportion to the percentage of their
sales previously made abroad. Those that will be most injured, in the
first instance, will be such industries as raw cotton producers, copper
producers, makers of sewing machines, agricultural machinery,
typewriters and so on.
A higher tariff wall, which, however, is not prohibitive, will produce
the same kind of results as this, but merely to a smaller degree.
The effect of a tariff, therefore, is to change the structure of
American production. It changes the number of occupations, the kind of
occupations, and the relative size of one industry as compared with
another. It makes the industries in which we are comparatively
inefficient larger, and the industries in which we are comparatively
efficient smaller. Its net effect, therefore, is to reduce American
efficiency, as well as to reduce efficiency in the countries with which
we would otherwise have traded more largely.
In the long run, notwithstanding the mountains of argument pro and con,
a tariff is irrelevant to the question of employment. (True, sudden
changes in the tariff, either upward or downward, can create temporary
unemployment, as they force corresponding changes in the structure of
production. Such sudden changes can even cause a depression.) But a
tariff is not irrelevant to the question of wages. In the long run it
always reduces real wages, because it reduces efficiency, production and
wealth.
Thus all the chief tariff fallacies stem from the central fallacy with
which this book is concerned. They are the result of looking only at the
immediate effects of a single tariff rate on one group of producers, and
forgetting the long-run effects both on consumers as a whole and on all
other producers.
(I hear some reader asking: “Why not solve this by giving tariff
protection to all producers?” But the fallacy here is that this cannot
help producers uniformly, and cannot help at all domestic producers who
already “outsell” foreign producers: these efficient producers must
necessarily suffer from the diversion of purchasing power brought about
by the tariff.)
On the subject of the tariff we must keep in mind one final precaution.
It is the same precaution that we found necessary in examining the
effects of machinery. It is useless to deny that a tariff does
benefit—or at least can benefit—special interests. True, it benefits
them at the expense of everyone else. But it does benefit them. If one
industry alone could get protection, while its owners and workers
enjoyed the benefits of free trade in everything else they bought, that
industry would benefit, even on net balance. As an attempt is made to
extend the tariff blessings, however, even people in the protected
industries, both as producers and consumers, begin to suffer from other
people’s protection, and may finally be worse off even on net balance
than if neither they nor anybody else had protection.
But we should not deny, as enthusiastic free traders have so often done,
the possibility of these tariff benefits to special groups. We should
not pretend, for example, that a reduction of the tariff would help
everybody and hurt nobody. It is true that its reduction would help the
country on net balance. But somebody would be hurt. Groups previously
enjoying high protection would be hurt. That in fact is one reason why
it is not good to bring such protected interests into existence in the
first place. But clarity and candor of thinking compel us to see and
acknowledge that some industries are right when they say that a removal
of the tariff on their product would throw them out of business and
throw their workers (at least temporarily) out of jobs. And if their
workers have developed specialized skills, they may even suffer
permanently, or until they have at long last learnt equal skills. In
tracing the effects of tariffs, as in tracing the effects of machinery,
we should endeavor to see all the chief effects, in both the short run
and the long run, on all groups.
As a postscript to this chapter I should add that its argument is not
directed against all tariffs, including duties collected mainly for
revenue, or to keep alive industries needed for war; nor is it directed
against all arguments for tariffs. It is merely directed against the
fallacy that a tariff on net balance “provides employment,” “raises
wages,” or “protects the American standard of living.” It does none of
these things; and so far as wages and the standard of living are
concerned, it does the precise opposite. But an examination of duties
imposed for other purposes would carry us beyond our present subject.
Nor need we here examine the effect of import quotas, exchange controls,
bilateralism and other devices in reducing, diverting or preventing
international trade. Such devices have, in general, the same effects as
high or prohibitive tariffs, and often worse effects. They present more
complicated issues, but their net results can be traced through the same
kind of reasoning that we have just applied to tariff barriers.
Exceeded only by the pathological dread of imports that affects all
nations is a pathological yearning for exports. Logically, it is true,
nothing could be more inconsistent. In the long run imports and exports
must equal each other (considering both in the broadest sense, which
includes such “invisible” items as tourist expenditures and ocean
freight charges). It is exports that pay for imports, and vice versa.
The greater exports we have, the greater imports we must have, if we
ever expect to get paid. The smaller imports we have, the smaller
exports we can have. Without imports we can have no exports, for
foreigners will have no funds with which to buy our goods. When we
decide to cut down our imports, we are in effect deciding also to cut
down our exports. When we decide to increase our exports, we are in
effect deciding also to increase our imports.
The reason for this is elementary. An American exporter sells his goods
to a British importer and is paid in British pounds sterling. But he
cannot use British pounds to pay the wages of his workers, to buy his
wife’s clothes or to buy theater tickets. For all these purposes he
needs American dollars. Therefore his British pounds are of no use to
him unless he either uses them himself to buy British goods or sells
them to some American importer who wishes to use them to buy British
goods. Whichever he does, the transaction cannot be completed until the
American exports have been paid for by an equal amount of imports.
The same situation would exist if the transaction had been conducted in
terms of American dollars instead of British pounds. The British
importer could not pay the American exporter in dollars unless some
previous British exporter had built up a credit in dollars here as a
result of some previous sale to us. Foreign exchange, in short, is a
clearing transaction in which, in America, the dollar debts of
foreigners are cancelled against their dollar credits. In England, the
pound sterling debts of foreigners are cancelled against their sterling
credits.
There is no reason to go into the technical details of all this, which
can be found in any good textbook on foreign exchange. But it should be
pointed out that there is nothing inherently mysterious about it (in
spite of the mystery in which it is so often wrapped), and that it does
not differ essentially from what happens in domestic trade. Each of us
must also sell something, even if for most of us it is our own services
rather than goods, in order to get the purchasing power to buy. Domestic
trade is also conducted in the main by crossing off checks and other
claims against each other through clearing houses.
It is true that under an international gold standard discrepancies in
balances of imports and exports are sometimes settled by shipments of
gold. But they could just as well be settled by shipments of cotton,
steel, whisky, perfume, or any other commodity. The chief difference is
that the demand for gold is almost indefinitely expansible (partly
because it is thought of and accepted as a residual international
“money” rather than as just another commodity), and that nations do not
put artificial obstacles in the way of receiving gold as they do in the
way of receiving almost everything else. (On the other hand, of late
years they have taken to putting more obstacles in the way of exporting
gold than in the way of exporting anything else: but that is another
story.)
Now the same people who can be clearheaded and sensible when the subject
is one of domestic trade can be incredibly emotional and muddleheaded
when it becomes one of foreign trade. In the latter field they can
seriously advocate or acquiesce in principles which they would think it
insane to apply in domestic business. A typical example is the belief
that the government should make huge loans to foreign countries for the
sake of increasing our exports, regardless of whether or not these loans
are likely to be repaid.
American citizens, of course, should be allowed to lend their own funds
abroad at their own risk. The government should put no arbitrary
barriers in the way of private lending to countries with which we are at
peace. We should give generously, for humane reasons alone, to peoples
who are in great distress or in danger of starving. But we ought always
to know clearly what we are doing. It is not wise to bestow charity on
foreign peoples under the impression that one is making a hardheaded
business transaction purely for one’s own selfish purposes. That could
only lead to misunderstandings and bad relations later.
Yet among the arguments put forward in favor of huge foreign lending one
fallacy is always sure to occupy a prominent place. It runs like this.
Even if half (or all) the loans we make to foreign countries turn sour
and are not repaid, this nation will still be better off for having made
them, because they will give an enormous impetus to our exports.
It should be immediately obvious that if the loans we make to foreign
countries to enable them to buy our goods are not repaid, then we are
giving the goods away. A nation cannot grow rich by giving goods away.
It can only make itself poorer.
No one doubts this proposition when it is applied privately. If an
automobile company lends a man $1,000 to buy a car priced at that
amount, and the loan is not repaid, the automobile company is not better
off because it has “sold” the car. It has simply lost the amount that it
cost to make the car. If the car cost $900 to make, and only half the
loan is repaid, then the company has lost $900 minus $500, or a net
amount of $400. It has not made up in trade what it lost in bad loans.
If this proposition is so simple when applied to a private company, why
do apparently intelligent people get confused about it when applied to a
nation? The reason is that the transaction must then be traced mentally
through a few more stages. One group may indeed make gains—while the
rest of us take the losses.
It is true, for example, that persons engaged exclusively or chiefly in
export business might gain on net balance as a result of bad loans made
abroad. The national loss on the transaction would be certain, but it
might be distributed in ways difficult to follow. The private lenders
would take their losses directly. The losses from government lending
would ultimately be paid out of increased taxes imposed on everybody.
But there would also be many indirect losses brought about by the effect
on the economy of these direct losses.
In the long run business and employment in America would be hurt, not
helped, by foreign loans that were not repaid. For every extra dollar
that foreign buyers had with which to buy American goods, domestic
buyers would ultimately have one dollar less. Businesses that depend on
domestic trade would therefore be hurt in the long run as much as export
businesses would be helped. Even many concerns that did an export
business would be hurt on net balance. American automobile companies,
for example, sold about 10 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.
Special interests, as the history of tariffs reminds us, can think of
the most ingenious reasons why they should be the objects of special
solicitude. Their spokesmen present a plan in their favor; and it seems
at first so absurd that disinterested writers do not trouble to expose
it. But the special interests keep on insisting on the scheme. Its
enactment would make so much difference to their own immediate welfare
that they can afford to hire trained economists and “public relations
experts” to propagate it in their behalf. The public hears the argument
so often repeated, and accompanied by such a wealth of imposing
statistics, charts, curves and pie-slices, that it is soon taken in.
When at last disinterested writers recognize that the danger of the
scheme’s enactment is real, they are usually too late. They cannot in a
few weeks acquaint themselves with the subject as thoroughly as the
hired brains who have been devoting their full time to it for years;
they are accused of being uninformed, and they have the air of men who
presume to dispute axioms.
This general history will do as a history of the idea of “parity” prices
for agricultural products. I forget the first day when it made its
appearance in a legislative bill; but with the advent of the New Deal in
1933 it had become a definitely established principle, enacted into law;
and as year succeeded year, and its absurd corollaries made themselves
manifest, they were enacted too.
The argument for “parity” prices ran roughly like this. Agriculture is
the most basic and important of all industries. It must be preserved at
all costs. Moreover, the prosperity of everybody else depends upon the
prosperity of the farmer. If he does not have the purchasing power to
buy the products of industry, industry languishes. This was the cause of
the 1929 collapse, or at least of our failure to recover from it. For
the prices of farm products dropped violently, while the prices of
industrial products dropped very little. The result was that the farmer
could not buy industrial products; the city workers were laid off and
could not buy farm products, and the depression spread in ever-widening
vicious circles. There was only one cure, and it was simple. Bring back
the prices of the farmer’s products to a “parity” with the prices of the
things the farmer buys. This parity existed in the period from 1909 to
1914, when farmers were prosperous. That price relationship must be
restored and preserved perpetually.
It would take too long, and carry us too far from our main point, to
examine every absurdity concealed in this plausible statement. There is
no sound reason for taking the particular price relationships that
prevailed in a particular year or period and regarding them as
sacrosanct, or even as necessarily more “normal” than those of any other
period. Even if they were “normal” at the time, what reason is there to
suppose that these same relationships should be preserved a generation
later in spite of the enormous changes in the conditions of production
and demand that have taken place in the meantime? The period of 1909 to
1914, as the basis of “parity,” was not selected at random. In terms of
relative prices it was one of the most favorable periods to agriculture
in our entire history.
If there had been any sincerity or logic in the idea, it would have been
universally extended. If the price relationships between agricultural
and industrial products that prevailed from August, 1909 to July, 1914
ought to be preserved perpetually, why not preserve perpetually the
price relationship of every commodity at that time to every other? A
Chevrolet six-cylinder touring car cost $2,150 in 1912; an incomparably
improved six-cylinder Chevrolet sedan cost $907 in 1942: adjusted for
“parity” on the same basis as farm products, however, it would have cost
$3,270 in 1942. A pound of aluminum from 1909 to 1913 inclusive averaged
22 1/2 cents; its price early in 1946 was 14 cents; but at “parity” it
would then have cost, instead, 41 cents.
I hear immediate cries that such comparisons are absurd, because
everybody knows not only that the present-day automobile is incomparably
superior in every way to the car of 1912, but that it costs only a
fraction as much to produce, and that the same is true also of aluminum.
Exactly. But why doesn’t somebody say something about the amazing
increase in productivity per acre in agriculture? In the five-year
period 1939 to 1943 an average of 260 pounds of cotton was raised per
acre in the United States as compared with an average of 188 pounds in
the five-year period 1909 to 1913. Costs of production have been
substantially lowered for farm products by better applications of
chemical fertilizer, improved strains of seed and increasing
mechanization—by the gasoline tractor, the corn husker, the cotton
picker. “On some large farms which have been completely mechanized and
are operated along mass production lines, it requires only one-third to
one-fifth the amount of labor to produce the same yields as it did a few
years back.”[1] 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 crops. Their
“purchasing power” is thereby increased. They are for the time being
more prosperous themselves, and they buy more of the products of
industry. All this is what is seen by those who look merely at the
immediate consequences of policies to the groups directly involved.
But there is another consequence, no less inevitable. Suppose the wheat
which would otherwise sell at $1 a bushel is pushed up by this policy to
$1.50. The farmer gets 50 cents a bushel more for wheat. But the city
worker, by precisely the same change, pays 50 cents a bushel more for
wheat in an increased price of bread. The same thing is true of any
other farm product. If the farmer then has 50 cents more purchasing
power to buy industrial products, the city worker has precisely that
much less purchasing power to buy industrial products. On net balance
industry in general has gained nothing. It loses in city sales precisely
as much as it gains in rural sales.
There is of course a change in the incidence of these sales. No doubt
the agricultural-implement makers and the mail-order houses do a better
business. But the city department stores do a smaller business.
The matter, however, does not end here. The policy results not merely in
no net gain, but in a net loss. For it does not mean merely a transfer
of purchasing power to the farmer from city consumers, or from the
general taxpayer, or from both. It also means a forced cut in the
production of farm commodities to bring up the price. This means a
destruction of wealth. It means that there is less food to be consumed.
How this destruction of wealth is brought about will depend upon the
particular method pursued to bring prices up. It may mean the actual
physical destruction of what has already been produced, as in the
burning of coffee in Brazil. It may mean a forced restriction of
acreage, as in the American AAA plan. We shall examine the effect of
some of these methods when we come to the broader discussion of
government commodity controls.
But here it may be pointed out that when the farmer reduces the
production of wheat to get “parity,” he may indeed get a higher price
for each bushel, but he produces and sells fewer bushels. The result is
that his income does not go up in proportion to his prices. Even some of
the advocates of “parity prices” recognize this, and use it as an
argument to go on to insist upon “parity income” for farmers. But this
can only be achieved by a subsidy at the direct expense of taxpayers. To
help the farmers, in other words, it merely reduces the purchasing power
of city workers and other groups still more.
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 be the same dollar amount?) of tariff protection
or subsidy, and we could never be sure when we were duplicating payments
to some groups or leaving gaps with others.
But suppose we could solve this fantastic problem? What would be the
point? Who gains when everyone equally subsidizes everyone else? What is
the profit when everyone loses in added taxes precisely what he gains by
his subsidy or his protection? We should merely have added an army of
needless bureaucrats to carry out the program, with all of them lost to
production.
We could solve the matter simply, on the other hand, by ending both the
parity-price system and the protective-tariff system. Meanwhile they do
not, in combination, even out anything. The joint system means merely
that Farmer A and Industrialist B both profit at the expense of
Forgotten Man C.
So the alleged benefits of still another scheme evaporate as soon as we
trace not only its immediate effects on a special group but its long-run
effects on everyone.
The lobbies of Congress are crowded with representatives of the X
industry. The X industry is sick. The X industry is dying. It must be
saved. It can be saved only by a tariff, by higher prices, or by a
subsidy. If it is allowed to die, workers will be thrown on the streets.
Their landlords, grocers, butchers, clothing stores and local motion
picture theaters will lose business, and depression will spread in
ever-widening circles. But if the X industry, by prompt action of
Congress, is saved—ah then! it will buy equipment from other industries;
more men will be employed; they will give more business to the butchers,
bakers and neon-light makers, and then it is prosperity that will spread
in ever-widening circles.
It is obvious that this is merely a generalized form of the case we have
just been considering. There the X industry was agriculture. But there
are an endless number of X industries. Two of the most notable examples
in recent years have been the coal and silver industries. To “save
silver” Congress did immense harm. One of the arguments for the rescue
plan was that it would help “the East.” One of its actual results was to
cause deflation in China, which had been on a silver basis, and to force
China off that basis. The United States Treasury was compelled to
acquire, at ridiculous prices far above the market level, hoards of
unnecessary silver, and to store it in vaults. The essential political
aims of the “silver Senators” could have been as well achieved, at a
fraction of the harm and cost, by the payment of a frank subsidy to the
mine owners or to their workers; but Congress and the country would
never have approved a naked steal of this sort unaccompanied by the
ideological flimflam regarding “silver’s essential role in the national
currency.”
To save the coal industry Congress passed the Guffey Act, under which
the owners of coal mines were not only permitted, but compelled, to
conspire together not to sell below certain minimum prices fixed by the
government. Though Congress had started out to fix “the” price of coal,
the government soon found itself (because of different sizes, thousands
of mines, and shipments to thousands of different destinations by rail,
truck, ship and barge) fixing 350,000 separate prices for coal![2] 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
hydro-electric 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 but a generalized case of
the argument put forward for “parity” prices for farm products or for
tariff protection for any number of X industries. The argument against
artificially higher prices applies, of course, not only to farm products
but to any other product, just as the reasons we have found for opposing
tariff protection for one industry apply to any other.
But there are always any number of schemes for saving X industries.
There are two main types of such proposals in addition to those we have
already considered, and we shall take a brief glance at them. One is to
contend that the X industry is already “overcrowded,” and to try to
prevent other firms or workers from getting into it. The other is to
argue that the X industry needs to be supported by a direct subsidy from
the government.
Now if the X industry is really overcrowded as compared with other
industries it will not need any coercive legislation to keep out new
capital or new workers. New capital does not rush into industries that
are obviously dying. Investors do not eagerly seek the industries that
present the highest risks of loss combined with the lowest returns. Nor
do workers, when they have any better alternative, go into industries
where the wages are lowest and the prospects for steady employment least
promising.
If new capital and new labor are forcibly kept out of the X industry,
however, either by monopolies, cartels, union policy or legislation, it
deprives this capital and labor of liberty of choice. It forces
investors to place their money where the returns seem less promising to
them than in the X industry. It forces workers into industries with even
lower wages and prospects than they could find in the allegedly sick X
industry. It means, in short, that both capital and labor are less
efficiently employed than they would be if they were permitted to make
their own free choices. It means, therefore, a lowering of production
which must reflect itself in a lower average living standard.
That lower living standard will be brought about either by lower average
money wages than would otherwise prevail or by higher average living
costs, or by a combination of both. (The exact result would depend upon
the accompanying monetary policy.) By these restrictive policies wages
and capital returns might indeed be kept higher than otherwise within
the X industry itself; but wages and capital returns in other industries
would be forced down lower than otherwise. The X industry would benefit
only at the expense of the A, B and C industries.
Similar results would follow any attempt to save the X industry by a
direct subsidy out of the public till. This would be nothing more than a
transfer of wealth or income to the X industry. The taxpayers would lose
precisely as much as the people in the X industry gained. The great
advantage of a subsidy, indeed, from the standpoint of the public, is
that it makes this fact so clear. There is far less opportunity for the
intellectual obfuscation that accompanies arguments for tariffs,
minimum-price fixing or monopolistic exclusion.
It is obvious in the case of a subsidy that the taxpayers must lose
precisely as much as the X industry gains. It should be equally clear
that, as a consequence, other industries must lose what the X industry
gains. They must pay part of the taxes that are used to support the X
industry. And consumers, because they are taxed to support the X
industry, will have that much less income left with which to buy other
things. The result must be that other industries on the average must be
smaller than otherwise in order that the X industry may be larger.
But the result of this subsidy is not merely that there has been a
transfer of wealth or income, or that other industries have shrunk in
the aggregate as much as the X industry has expanded. The result is also
(and this is where the net loss comes in to the nation considered as a
unit) that capital and labor are driven out of industries in which they
are more efficiently employed to be diverted to an industry in which
they are less efficiently employed. Less wealth is created. The average
standard of living is lowered compared with what it would have been.
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.
The whole argument of this book may be summed up in the statement that
in studying the effects of any given economic proposal we must trace not
merely the immediate results but the results in the long run, not merely
the primary consequences but the secondary consequences, and not merely
the effects on some special group but the effects on everyone. It
follows that it is foolish and misleading to concentrate our attention
merely on some special point—to examine, for example, merely what
happens in one industry without considering what happens in all. But it
is precisely from the persistent and lazy habit of thinking only of some
particular industry or process in isolation that the major fallacies of
economics stem. These fallacies pervade not merely the arguments of the
hired spokesmen of special interests, but the arguments even of some
economists who pass as profound.
It is on the fallacy of isolation, at bottom, that the
“production-for-use-and-not-for-profit” school is based, with its attack
on the allegedly vicious “price system.” The problem of production, say
the adherents of this school, is solved. (This resounding error, as we
shall see, is also the starting point of most currency cranks and
share-the-wealth charlatans.) The problem of production is solved. The
scientists, the efficiency experts, the engineers, the technicians, have
solved it. They could turn out almost anything you cared to mention in
huge and practically unlimited amounts. But, alas, the world is not
ruled by the engineers, thinking only of production, but by the 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, he must turn to finding
food before he tries to improve this. He can try to fish; but to do this
he needs either a hook and line, or a net, and he must set to work on
these. But everything he does delays or prevents him from doing
something else only a little less urgent. He is faced constantly by the
problem of alternative applications of his time and labor.
A Swiss Family Robinson, perhaps, finds this problem a little easier to
solve. It has more mouths to feed, but it also has more hands to work
for them. It can practice division and specialization of labor. The
father hunts; the mother prepares the food; the children collect
firewood. But even the family cannot afford to have one member of it
doing endlessly the same thing, regardless of the relative urgency of
the common need he supplies and the urgency of other needs still
unfilled. When the children have gathered a certain pile of firewood,
they cannot be used simply to increase the pile. It is soon time for one
of them to be sent, say, for more water. The family too has the constant
problem of choosing among alternative applications of labor, and, if it
is lucky enough to have acquired guns, fishing tackle, a boat, axes,
saws and so on, of choosing among alternative applications of labor and
capital. It would be considered unspeakably silly for the wood-gathering
member of the family to complain that they could gather more firewood if
his brother helped him all day, instead of getting the fish that were
needed for the family dinner. It is recognized clearly in the case of an
isolated individual or family that one occupation can expand only at the
expense of all other occupations.
Elementary illustrations like this are sometimes ridiculed as “Crusoe
economics.” Unfortunately, they are ridiculed most by those who most
need them, who fail to understand the particular principle illustrated
even in this simple form, or who lose track of that principle completely
when they come to examine the bewildering complications of a great
modern economic society.
Let us now turn to such a society. How is the problem of alternative
applications of labor and capital, to meet thousands of different needs
and wants of different urgencies, solved in such a society? It is solved
precisely through the price system. It is solved through the constantly
changing interrelationships of costs of production, prices and profits.
Prices are fixed through the relationship of supply and demand, and in
turn affect supply and demand. When people want more of an article, they
offer more for it. The price goes up. This increases the profits of
those who make the article. Because it is now more profitable to make
that article than others, the people already in the business expand
their production of it, and more people are attracted to the business.
This increased supply then reduces the price and reduces the profit
margin, until the profit margin on that article once more falls to the
general level of profits (relative risks considered) in other
industries. Or the demand for that article may fall; or the supply of it
may be increased to such a point that its price drops to a level where
there is less profit in making it than in making other articles; or
perhaps there is an actual loss in making it. In this case the
“marginal” producers, that is, the producers who are least efficient, or
whose costs of production are highest, will be driven out of business
altogether. The product will now be made only by the more efficient
producers who operate on lower costs. The supply of that commodity will
also drop, or will at least cease to expand.
This process is the origin of the belief that prices are determined by
costs of production. The doctrine, stated in this form, is not true.
Prices are determined by supply and demand, and demand is determined by
how intensely people want a commodity and what they have to offer in
exchange for it. It is true that supply is in part determined by costs
of production. What a commodity has cost to produce in the past cannot
determine its value. That will depend on the present relationship of
supply and demand. But the expectations of business men 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
inaggregate 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 be allowed to grow. For the dying industries absorb
labor and capital that should be released for the growing industries. It
is only the much vilified price system that solves the enormously
complicated problem of deciding precisely how much of tens of thousands
of different commodities and services should be produced in relation to
each other. These otherwise bewildering equations are solved
quasi-automatically by the system of prices, profits and costs. They are
solved by this system incomparably better than any group of bureaucrats
could solve them. For they are solved by a system under which each
consumer makes his own demand and casts a fresh vote, or a dozen fresh
votes, every day; whereas bureaucrats would try to solve it by having
made for the consumers, not what the consumers themselves wanted, but
what the bureaucrats decided was good for them.
Yet though the bureaucrats do not understand the quasi-automatic system
of the market, they are always disturbed by it. They are always trying
to improve it or correct it, usually in the interests of some wailing
pressure group. What some of the results of their intervention is, we
shall examine in succeeding chapters.
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 have before,
to spend on other things. The consumers, therefore, will obviously be
better off. But their increased spending in other directions will give
increased employment in other lines, which will then absorb the former
marginal farmers in occupations in which their efforts will be more
lucrative and more efficient.
A uniform proportional restriction (to return to our government
intervention scheme) means, on the one hand, that the efficient low-cost
producers are not permitted to turn out all the output they can at a low
price. It means, on the other hand, that the inefficient high-cost
producers are artificially kept in business. This increases the average
cost of producing the product. It is being produced less efficiently
than otherwise. The inefficient marginal producer thus artificially kept
in that line of production continues to tie up land, labor, and capital
that could much more profitably and efficiently be devoted to other
uses.
There is no point in arguing that as a result of the restriction scheme
at least the price of farm products has been raised and “the farmers
have more purchasing power.” They have got it only by taking just that
much purchasing power away from the city buyer. (We have been over all
this ground before in our analysis of “parity” prices.) To give farmers
money for restricting production, or to give them the same amount of
money for an artificially restricted production, is no different from
forcing consumers or taxpayers to pay people for doing nothing at all.
In each case the beneficiaries of such policies get “purchasing power.”
But in each case someone else loses an exactly equivalent amount. The
net loss to the community is the loss of production, because people are
supported for not producing. Because there is less for everybody,
because there is less to go around, real wages and real incomes must
decline either through a fall in their monetary amount or through higher
living costs.
But if an attempt is made to keep up the price of an agricultural
commodity and no artificial restriction of output is imposed, unsold
surpluses of the 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 be unreasonable. Fixed
prices will necessarily involve “just” allotments and allocations for
production and consumption as among nations, but only cynics will
anticipate any unseemly international disputes regarding these. Finally,
by the greatest miracle of all, this 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 be sure of some of the things they do not
mean. They do not mean the freedom of ordinary people to buy and sell,
lend and borrow, at whatever prices or rates they like and wherever they
find it most profitable to do so. They do not mean the freedom of the
plain citizen to raise as much of a given crop as he wishes, to come and
go at will, to settle where he pleases, to take his capital and other
belongings with him. They mean, I suspect, the freedom of bureaucrats to
settle these matters for him. And they tell him that if he docilely
obeys the bureaucrats he will be rewarded by a rise in his living
standards. But if the planners succeed in tying up the idea of
international cooperation with the idea of increased State domination
and control over economic life, the international controls of the future
seem only too likely to follow the pattern of the past, in which case
the plain man’s living standards will decline with his liberties.
We have seen what some of the effects are of governmental efforts to fix
the prices of commodities above the levels to which free markets would
otherwise have carried them. Let us now look at some of the results of
government attempts to hold the prices of commodities below their
natural market levels.
The latter attempt is made in our day by nearly all governments in
wartime. We shall not examine here the wisdom of wartime price-fixing.
The whole economy, in total war, is necessarily dominated by the State,
and the complications that would have to be considered would carry us
too far beyond the main question with which this book is concerned. But
wartime price-fixing, wise or not, is in almost all countries continued
for at least long periods after the war is over, when the original
excuse for starting it has disappeared.
Let us first see what happens when the government tries to keep the
price of a single commodity, or a small group of commodities, below the
price that would be set in a free competitive market.
When the government tries to fix maximum prices for only a few items, it
usually chooses certain basic necessities, on the ground that it is most
essential that the poor be able to obtain these at a “reasonable” cost.
Let us say that the items chosen for this purpose are bread, milk and
meat.
The argument for holding down the price of these goods will run
something like this. If we leave beef (let us say) to the mercies of the
free market, the price will be pushed up by competitive bidding so that
only the rich will get it. People will get beef not in proportion to
their need, but only in proportion to their purchasing power. If we keep
the price down, everyone will get his fair share.
The first thing to be noticed about this argument is that if it is valid
the policy adopted is inconsistent and timorous. For if purchasing power
rather than need determines the distribution of beef at a market price
of 65 cents a pound, it would also determine it, though perhaps to a
slightly smaller degree, at, say, a legal “ceiling” price of 50 cents a
pound. The purchasing-power-rather-than-need argument, in fact, holds as
long as we charge anything for beef whatever. It would cease to apply
only if beef were given away.
But schemes for maximum price-fixing usually begin as efforts to “keep
the cost of living from rising.” And so their sponsors unconsciously
assume that there is something peculiarly “normal” or sacrosanct about
the market price at the moment from which their control starts. That
starting price is regarded as “reasonable,” and any price above that as
“unreasonable,” regardless of changes in the conditions of production or
demand since that starting price was first established.
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 be successful. It
can seem to work well for a while, particularly in wartime, when it is
supported by patriotism and a sense of crisis. But the longer it is in
effect the more its difficulties increase. When prices are arbitrarily
held down by government compulsion, demand is chronically in excess of
supply. We have seen that if the government attempts to prevent a
shortage of a commodity by reducing also the prices of the labor, raw
materials and other factors that go into its cost of production, it
creates a shortage of these in turn. But not only will the government,
if it pursues this course, find it necessary to extend price control
more and more downwards, or “vertically”; it will find it no less
necessary to extend price control “horizontally.” If we ration one
commodity, and the public cannot get enough of it, though it still has
excess purchasing power, it will turn to some substitute. The rationing
of each commodity as it grows scarce, in other words, must put more and
more pressure on the unrationed commodities that remain. If we assume
that the government is successful in its efforts to prevent black
markets (or at least prevents them from developing on a sufficient scale
to nullify its legal prices), continued price control must drive it to
the rationing of more and more commodities. This rationing cannot stop
with consumers. In war it did not stop with consumers. It was applied
first of all, in fact, in the allocation of raw materials to producers.
The natural consequence of a thoroughgoing 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 be lifted without lifting prices. When
it becomes obvious that wages can be raised only at the expense of
profits, the bureaucrats begin to argue that profits were already too
high anyway, and that lifting wages and holding prices will still permit
“a fair profit.” As there is no such thing as a uniform rate of profit,
as profits differ with each concern, the result of this policy is to
drive the least profitable concerns out of business altogether, and to
discourage or stop the production of certain items. This means
unemployment, a shrinkage in production and a decline in living
standards.
What lies at the base of the whole effort to fix maximum prices? There
is first of all a misunderstanding of what it is that has been causing
prices to rise. The real cause is either a scarcity of goods or a
surplus of money. Legal price ceilings cannot cure either. In fact, as
we have just seen, they merely intensify the shortage of goods. What to
do about the surplus of money will be discussed in a later chapter. But
one of the errors that 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 rooked.
The only exception is the item he makes himself: here he understands and
appreciates the reason for the rise. But he is always likely to regard
his own business as in some way an exception. “Now my own business,” he
will say, “is peculiar, and the public does not understand it. Labor
costs have gone up; raw material prices have gone up; this or that raw
material is no longer being imported, and must be made at a higher cost
at home. Moreover, the demand for the product has increased, and the
business should be allowed to charge the prices necessary to encourage
its expansion to supply this demand.” And so on. Everyone as consumer
buys a hundred different products; as producer he makes, usually, only
one. He can see the inequity in holding down the price of that. And just
as each manufacturer wants a higher price for his particular product, so
each worker wants a higher wage or salary. Each can see as producer that
price control is restricting production in his line. But nearly everyone
refuses to generalize this observation, for it means that he will have
to pay more for the products of others.
Each one of us, in brief, has a multiple economic personality. Each one
of us is producer, taxpayer, consumer. The policies he advocates depend
upon the particular aspect under which he thinks of himself at the
moment. For he is sometimes Dr. Jekyll and sometimes Mr. Hyde. As a
producer he wants inflation (thinking chiefly of his own services or
product); as a consumer he wants price ceilings (thinking chiefly of
what he has to pay for the products of others). As a consumer he may
advocate or acquiesce in subsidies; as a taxpayer he will resent paying
them. Each person is likely to think that he can so manage the political
forces that he can benefit from the subsidy more than he loses from the
tax, or benefit from a rise for his own product (while his raw material
costs are legally held down) and at the same time benefit as a consumer
from price control. But the overwhelming majority will be deceiving
themselves. For not only must there be at least as much loss as gain
from this political manipulation of prices; there must be a great deal
more loss than gain, because price-fixing discourages and disrupts
employment and production.
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 combatting the evil of low wages, and that the possible good
to be achieved by such a law can exceed the possible harm only in
proportion as its aims are modest. The more ambitious such a law is, the
larger the number of workers it attempts to cover, and the more it
attempts to raise their wages, the more likely are its harmful effects
to exceed its good effects.
The first thing that happens, for example, when a law is passed that no
one shall be paid less than $30 for a forty-hour week is that no one who
is not worth $30 a week to an employer will be employed at all. You
cannot make a man worth a given amount by making it illegal for anyone
to offer him anything less. You merely deprive him of the right to earn
the amount that his abilities and situation would permit him to earn,
while you deprive the community even of the moderate services that he is
capable of rendering. In brief, for a low wage you substitute
unemployment. You do harm all around, with no comparable compensation.
The only exception to this occurs when a group of workers is receiving a
wage actually below its market worth. This is likely to happen only in
special circumstances or localities where competitive forces do not
operate freely or adequately; but nearly all these special cases could
be remedied just as effectively, more flexibly and with far less
potential harm, by unionization.
It may be thought that if the law forces the payment of a higher wage in
a given industry, that industry can then charge higher prices for its
product, so that the burden of paying the higher wage is merely shifted
to consumers. Such shifts, however, are not easily made, nor are the
consequences of artificial wage-raising so easily escaped. A higher
price for the product may not be possible: it may merely drive consumers
to some substitute. Or, if consumers continue to buy the product of the
industry in which wages have been raised, the higher price will cause
them to buy less of it. While some workers in the industry will be
benefited from the higher wage, therefore, others will be thrown out of
employment altogether. On the other hand, if the price of the product is
not raised, marginal producers in the industry will be driven out of
business; so that reduced production and consequent unemployment will
merely be brought about in another way.
When such consequences are pointed out, there 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”; but we merely change the nature
of the consequences. “Work relief” means that we are paying the
beneficiaries more than the open market would pay them for their
efforts. Only part of their relief-wage is for their efforts, therefore
(in work often of doubtful utility), while the rest is a disguised dole.
It would probably have been better all around if the government in the
first place had frankly subsidized their wages on the private work they
were already doing. We need not pursue this point further, as it would
carry us into problems not immediately relevant. But the difficulties
and consequences of relief must be kept in mind when we consider the
adoption of minimum wage laws or an increase in minimums already fixed.
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 be taken for
granted. The real question concerns the proper means of achieving it.
And in trying to answer this we must never lose sight of a few
elementary truisms. We cannot distribute more wealth than is created. We
cannot in the long run pay labor as a whole more than it produces.
The best way to raise wages, therefore, is to raise labor productivity.
This can be done by many methods: by an increase in capital
accumulation—i.e., by an increase in the machines with which the workers
are aided; by new inventions and improvements; by more efficient
management on the part of employers; by more industriousness and
efficiency on the part of workers; by better education and training. The
more the individual worker produces, the more he increases the wealth of
the whole community. The more he produces, the more his services are
worth to consumers, and hence to employers. And the more he is worth to
employers, the more he will be paid. Real wages come out of production,
not out of government decrees.
The power of labor unions to raise wages over the long run and for the
whole working population has been enormously exaggerated. This
exaggeration is mainly the result of failure to recognize that wages are
basically determined by labor productivity. It is for this reason, for
example, that wages in the United States were incomparably higher than
wages in England and Germany all during the decades when the “labor
movement” in the latter two countries was far more advanced.
In spite of the overwhelming evidence that labor productivity is the
fundamental determinant of wages, the conclusion is usually forgotten or
derided by labor union leaders and by that large group of economic
writers who seek a reputation as “liberals” by parroting them. But this
conclusion does not rest on the assumption, as they suppose, that
employers are uniformly kind and generous men eager to do what is right.
It rests on the very different assumption that the individual employer
is eager to increase his own profits to the maximum. If people are
willing to work for less than they are really worth to him, why should
he not take the fullest advantage of this? Why should he not prefer, for
example, to make $1 a week out of a workman rather than see some other
employer make $2 a week out of him? And as long as this situation
exists, there will be a tendency for employers to bid workers up to
their full economic worth.
All this does not mean that unions can serve no useful or legitimate
function. The central function they can serve is to assure that all of
their members get the true market value of their services.
For the competition of workers for jobs, and of employers for workers,
does not work perfectly. Neither individual workers nor individual
employers are likely to be fully informed concerning the conditions of
the labor market. An individual worker, without the help of a union or a
knowledge of “union rates,” may not know the true market value of his
services to an employer. And he is, individually, in a much weaker
bargaining position. Mistakes of judgment are far more costly to him
than to an employer. If an employer mistakenly refuses to hire a man
from whose services he might have profited, he merely loses the net
profit he might have made from employing that one man; and he may employ
a hundred or a thousand men. But if a worker mistakenly refuses a job in
the belief that he can easily get another that will pay him more, the
error may cost him 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-sided 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, but
of the products even of affiliated unions in other states or cities.
The most obvious case in which intimidation and force are used to put or
keep the wages of a particular union above the real market worth of its
members’ services is that of a strike. A peaceful strike is possible. To
the extent that it remains peaceful, it is a legitimate labor weapon,
even though it is one that should be used rarely and as a last resort.
If his workers as a body withhold their labor, they may bring a stubborn
employer, who has been underpaying them, to his senses. He may find that
he is unable to replace these workers by workers equally good who are
willing to accept the wage that the former have now rejected. But the
moment workers have to use intimidation or violence to enforce their
demands—the moment they use pickets to prevent any of the old workers
from continuing at their jobs, or to prevent the employer from hiring
new permanent workers to take their places—their case becomes
questionable. For the pickets are really being used, not primarily
against the employer, but against other workers. These other workers are
willing to take the jobs that the old employees have vacated, and at the
wages that the old employees now reject. The fact proves that the other
alternatives open to the new workers are not as good as those that the
old employees have refused. If, therefore, the old employees succeed by
force in preventing new workers from taking their place, they prevent
these new workers from choosing the best alternative open to them, and
force them to take something worse. The strikers are therefore insisting
on a position of privilege, and are using force to maintain this
privileged position against other workers.
If the foregoing analysis is correct, the indiscriminate hatred of the
“strikebreaker” is not justified. If the strikebreakers consist merely
of professional thugs who themselves threaten violence, or who cannot in
fact do the work, or if they are being paid a temporarily higher rate
solely for the purpose of making a pretense of carrying on until the old
workers are frightened back to work at the old rates, the hatred may be
warranted. But if they are in fact merely men and women who are looking
for permanent jobs and willing to accept them at the old rate, then they
are workers who would be shoved into worse jobs than these in order to
enable the striking workers to enjoy better ones. And this superior
position for the old employees could continue to be maintained, in fact,
only by the ever-present threat of force.
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 be found, when their unemployed are
averaged with their employed members, to be worse off than before. And
in terms of welfare, of course, the loss suffered will be much greater
than the loss in merely arithmetical terms, because the psychological
losses of those who are unemployed will greatly outweigh the
psychological gains of those with a slightly higher income in terms of
purchasing power.
Nor can the situation be rectified by providing unemployment relief.
Such relief, in the first place, is paid for in large part, directly or
indirectly, out of the wages of those who work. It therefore reduces
these wages. “Adequate” relief payments, moreover, as we have already
seen, create unemployment. They do so in several ways. When strong labor
unions in the past made it their function to provide for their own
unemployed members, they thought twice before demanding a wage that
would cause heavy unemployment. But where there is a relief system under
which the general taxpayer is forced to provide for the unemployment
caused by excessive wage rates, this restraint on excessive union
demands is removed. Moreover, as we have already noted, “adequate”
relief will cause some men not to seek work at all, and will cause
others to consider that they are in effect being asked to work not for
the wage offered, but only for the difference between that wage and the
relief payment. And heavy unemployment means that fewer goods are
produced, that the nation is poorer, and that there is less for
everybody.
The apostles of salvation by unionism sometimes attempt another answer
to the problem I have just presented. It may be true, they will admit,
that the members of strong unions today exploit, among others, the
non-unionized workers; but the remedy is simple: unionize everybody. The
remedy, however, is not quite that simple. In the first place, in spite
of the enormous political encouragements (one might in some cases say
compulsions) to unionization under the Wagner Act and other laws, it is
not an accident that only about a fourth of this nation’s gainfully
employed workers are unionized. The conditions propitious to
unionization are much more special than generally recognized. But even
if universal unionization could be achieved, the unions could not
possibly be equally powerful, any more than they are today. Some groups
of workers are in a far better strategic position than others, either
because of greater numbers, of the more essential nature of the product
they make, of the greater dependence on their industry of other
industries, or of their greater ability to use coercive methods. But
suppose this were not so? Suppose, in spite of the
self-contradictoriness of the assumption, that all workers by coercive
methods could raise their wages by an equal percentage? Nobody would be
any better off, in the long run, than if wages had not been raised at
all.
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 on their investment.
But there is an inevitable corollary of this. If the money that they
have invested in railroads now yields less than money they can invest in
other lines, the investors will not put a cent more into railroads. They
may replace a few of the things that wear out first, to protect the
small yield on their remaining capital; but in the long run they will
not even bother to replace items that fall into obsolescence or decay.
If capital invested at home pays them less than that invested abroad,
they will invest abroad. If they cannot find sufficient return anywhere
to compensate them for their risk, they will cease to invest at all.
Thus the exploitation of capital by labor can at best be merely
temporary. It will quickly come to an end. It will come to an end,
actually, not so much in the way indicated in our hypothetical
illustration, as by the forcing of marginal firms out of business
entirely, the growth of unemployment, and the forced readjustment of
wages and profits to the point where the prospect of normal (or
abnormal) profits leads to a resumption of employment and production.
But in the meanwhile, as a result of the exploitation, unemployment and
reduced production will have made everybody poorer. Even though labor
for a time will have a greater relative share of the national income,
the national income will fall absolutely; so that labor’s relative gains
in these short periods may mean a Pyrrhic victory: they may mean that
labor, too, is getting a lower total amount in terms of real purchasing
power.
Thus we are driven to the conclusion that unions, though they may for a
time be able to secure an increase in money wages for their members,
partly at the expense of employers and more at the expense of
non-unionized workers, do not, in the long run and for the whole body of
workers, increase real wages 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 have certainly been a force working to
hold down or to reduce wages if their effect, on net balance, has been
to reduce labor productivity; and we may ask whether it has not been so.
With regard to productivity there is something to be said for union
policies, it is true, on the credit side. In some trades they have
insisted on standards to increase the level of skill and competence. And
in their early history they did much to protect the health of their
members. Where labor was plentiful, individual employers often stood to
gain by speeding up workers and working them long hours in spite of
ultimate ill effects upon their health, because they could easily be
replaced with others. And sometimes ignorant or shortsighted employers
would even reduce their own profits by overworking their employees. In
all these cases the unions, by demanding decent standards, often
increased the health and broader welfare of their members at the same
time as they increased their real wages.
But in recent years, as their power has grown, and as much misdirected
public sympathy has led to a tolerance or endorsement of anti-social
practices, unions have gone beyond their legitimate goals. It was a
gain, not only to health and welfare, but even in the long run to
production, to reduce a seventy-hour week to a sixty-hour week. It was a
gain to health and leisure to reduce a sixty-hour week to a
forty-eight-hour week. It was a gain to leisure, but not necessarily to
production and income, to reduce a forty-eight-hour week to a
forty-four-hour week. The value to health and leisure of reducing the
working week to forty hours is much less, the reduction in output and
income more clear. But the unions now talk, and often enforce,
thirty-five and thirty-hour weeks, and deny that these can or should
reduce output or income.
But it is not only in reducing scheduled working hours that union policy
has worked against productivity. That, in fact, is one of the least
harmful ways in which it has done so; for the compensating gain, at
least, has been clear. But many unions have insisted on rigid
subdivisions of labor which have raised production costs and led to
expensive and ridiculous “jurisdictional” disputes. They have opposed
payment on the basis of output or efficiency, and insisted on the same
hourly rates for all their members regardless of differences in
productivity. They have insisted on promotion for seniority rather than
for merit. They have initiated deliberate slowdowns under the pretense
of fighting “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 be spread over as many people and hours as possible so as
not to use it up too soon. This assumption is utterly false. There is
actually no limit to the amount of work to be done. Work creates work.
What A produces constitutes the demand for what B produces.
But because this false assumption exists, and because the policies of
unions are based on it, their net effect has been to reduce productivity
below what it would otherwise have been. Their net effect, therefore, in
the long run and for all groups of workers, has been to reduce real
wages—that is, wages in terms of the goods they will buy—below the level
to which they would otherwise have risen. The real cause for the
tremendous increase in real wages in the last half century (especially
in America) has been, to repeat, the accumulation of capital and the
enormous technological advance made possible by it.
Reduction of the rate of increase in real wages is not, of course, a
consequence inherent in the nature of unions. It has been the result of
shortsighted policies. There is still time to change them.
Amateur writers on economics are always asking for “just” prices and
“just” wages. These nebulous conceptions of economic justice come down
to us from medieval times. The classical economists worked out, instead,
a different concept—the concept of functional prices and functional
wages. Functional prices are those that encourage the largest volume of
production and the largest volume of sales. Functional wages are those
that tend to bring about the highest volume of employment and the
largest payrolls.
The concept of functional wages has been taken over, in a perverted
form, by the Marxists and their unconscious disciples, the
purchasing-power school. Both of these groups leave to cruder minds the
question whether existing wages are “fair.” The real question, they
insist, is whether or not they will work. And the only wages that will
work, they tell us, the only wages that will prevent an imminent
economic crash, are wages that will enable labor “to buy back the
product it creates.” The Marxist and purchasing-power schools attribute
every depression of the past to a preceding failure to pay such wages.
And at no matter what moment they speak, they are sure that wages are
still not high enough to buy back the product.
The doctrine has proved particularly effective in the hands of union
leaders. Despairing of their ability to arouse the altruistic interest
of the public or to persuade employers (wicked by definition) ever to be
“fair,” they have seized upon an argument calculated to appeal to the
public’s selfish motives, and frighten it into forcing employers to
grant their demands.
How are we to know, however, precisely when labor does have “enough to
buy back the product”? Or when it has more than enough? How are we to
determine just what the right sum is? As the champions of the doctrine
do not seem to have made any clear effort to answer such questions, we
are obliged to try to find the answers for ourselves.
Some sponsors of the theory seem to imply that the workers in each
industry should receive enough to buy back the particular product they
make. But they surely cannot mean that the makers of cheap dresses
should have enough to buy back cheap dresses and the makers of mink
coats enough to buy back mink coats; or that the men in the Ford plant
should receive enough to buy Fords and the men in the Cadillac plant
enough to buy Cadillacs.
It is instructive to recall, however, that the unions in the automobile
industry, at a time when most of their members were already in the upper
third of the country’s income receivers, and when their weekly wage,
according to government figures, was already 20 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.”[3] 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”[4] 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 in wage rates will ultimately lead to an
increase in prices of approximately the same percentage.
The belief that the price increase would be substantially less than that
rests on two main fallacies. The first is that of looking only at the
direct labor costs of a particular firm or industry and assuming these
to represent all the labor costs involved. But this is the elementary
error of mistaking a part for the whole. Each “industry” represents not
only just one section of the productive process considered
“horizontally,” but just one section of that process considered
“vertically.” Thus the direct labor cost of making automobiles in the
automobile factories themselves may be less than a third, say, of the
total costs; and this may lead the incautious to conclude that a 30 per
cent increase in wages would lead to only a 10 per cent increase, or
less, in automobile prices. But this would be to overlook the indirect
wage costs in the raw materials and purchased parts, in transportation
charges, in new factories or new machine tools, or in the dealers’
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
be paid out of the national product. While there would have to be both
deductions from this figure and additions to it to provide a fair
estimate of “labor’s” income, we can assume on this basis that labor
costs cannot be less than about two-thirds of total production costs and
may run above three-quarters (depending upon our definition of “labor”).
If we take the lower of these two estimates, and assume also that dollar
profit margins would be unchanged, it is clear that an increase of 30
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 be
doubted whether this would be greater in absolute size (and it might
easily be less) than the previous narrower slice of a larger pie.
This brings us to the general meaning and effect of economic
equilibrium. Equilibrium wages and prices are the wages and prices that
equalize supply and demand. If, either through government or private
coercion, an attempt is made to lift prices above their equilibrium
level, demand is reduced and therefore production is reduced. If an
attempt is made to push prices below their equilibrium level, the
consequent reduction or wiping out of profits will mean a falling off of
supply or new production. Therefore an attempt to force prices either
above or below their equilibrium levels (which are the levels toward
which a free market constantly tends to bring them) will act to reduce
the volume of employment and production below what it would otherwise
have been.
To return, then, to the doctrine that labor must get “enough to buy back
the product,” The national product, it should be obvious, is neither
created nor bought by manufacturing labor alone. It is bought by
everyone—by white collar workers, professional men, farmers, employers,
big and little, by investors, grocers, butchers, owners of small drug
stores and gasoline stations—by everybody, in short, who contributes
toward making the product.
As to the prices, wages and profits that should determine the
distribution of that product, the best prices are not the highest
prices, but the prices that encourage the largest volume of production
and the largest volume of sales. The best wage rates for labor are not
the highest wage rates, but the wage rates that permit full production,
full employment and the largest sustained payrolls. The best profits,
from the standpoint not only of industry but of labor, are not the
lowest profits, but the profits that encourage most people to become
employers or to provide more employment than before.
If we try to run the economy for the benefit of a single group or class,
we shall injure or destroy all groups, including the members of the very
class for whose benefit we have been trying to run it. We must run the
economy for everybody.
The indignation shown by many people today at the mention of the very
word “profits” indicates how little understanding there is of the vital
function that profits play in our economy. To increase our
understanding, we shall go over again some of the ground already covered
in Chapter 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 incorporated business, and a sufficient number
of good and bad years. But some eminent economists believe that over a
long period of years, after allowance is made for all losses, for a
minimum “riskless” interest on invested capital, and for an imputed
“reasonable” wage value of the services of people who run their own
business, no net profit at all may be left over, and that there may even
be a net loss. This is not at all because entrepreneurs (people who go
into business for themselves) are intentional philanthropists, but
because their optimism and self-confidence too often lead them into
ventures that do not or cannot succeed.[5]
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 be the effect on the profit incentive, and hence on
employment and production? The wartime excess-profits tax has already
shown us what such a limit can do, even for a short period, in
undermining efficiency.
Yet governmental policy almost everywhere today tends to assume that
production will go on automatically, no matter what is done to
discourage it. One of the greatest dangers to production today comes
from government price-fixing policies. Not only do these policies put
one item after another out of production by leaving no incentive to make
it, but their long-run effect is to prevent a balance of production in
accordance with the actual demands of consumers. If the economy were
free, demand would 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
reinvest its profits in more machinery and more employment; it would
also attract new investors and producers from everywhere, until
production in that line was great enough to meet demand, and the profits
in it again fell to the general average level.
In a free economy, in which wages, costs and prices are left to the free
play of the competitive market, the prospect of profits decides what
articles will be made, and in what quantities—and what articles will not
be made at all. If there is no profit in making an article, it is a sign
that the labor and capital devoted to its production are misdirected:
the value of the resources that must be used up in making the article is
greater than the value of the article itself.
One function of profits, in brief, is to guide and channel the factors
of production so as to apportion the relative output of thousands of
different commodities in accordance with demand. No bureaucrat, no
matter how brilliant, can solve this problem arbitrarily. Free prices
and free profits will maximize production and relieve shortages quicker
than any other system. Arbitrarily-fixed prices and arbitrarily-limited
profits can only prolong shortages and reduce production and employment.
The function of profits, finally, is to put constant and unremitting
pressure on the head of every competitive business to introduce further
economies and efficiencies, no matter to what stage these may already
have been brought. In good times he does this to increase his profits
further; in normal times he does it to keep ahead of his competitors; in
bad times he may have to do it to survive at all. For profits may not
only go to zero; they may quickly turn into losses; and a man will put
forth greater efforts to save himself from ruin than he will merely to
improve his position.
Profits, in short, resulting from the relationships of costs to prices,
not only tell us which goods it is most economical to make, but which
are the most economical ways to make them. These questions must be
answered by a socialist system no less than by a capitalist one; they
must be answered by any conceivable economic system; and for the
overwhelming bulk of the commodities and services that are produced, the
answers supplied by profit and loss under competitive free enterprise
are incomparably superior to those that could be obtained by any other
method.
I have found it necessary to warn the reader from time to time that a
certain result would necessarily follow from a certain policy “provided
there is no inflation.” In the chapters on public works and on credit I
said that a study of the complications introduced by inflation would
have to be deferred. But money and monetary policy form so intimate and
sometimes so inextricable a part of every economic process that this
separation, even for expository purposes, was very difficult; and in the
chapters on the effect of various government or union wage policies on
employment, profits and production, some of the effects of differing
monetary policies had to be considered immediately.
Before we consider what the consequences of inflation are in specific
cases, we should consider what its consequences are in general. Even
prior to that, it seems desirable to ask why inflation has been
constantly resorted to, why it has had an immemorial popular appeal, and
why its siren music has tempted one nation after another down the path
to economic disaster.
The most obvious and yet the oldest and most stubborn error on which the
appeal of inflation rests is that of confusing “money” with wealth.
“That wealth consists in money, or in gold and silver,” wrote Adam Smith
nearly two centuries ago, “is a popular notion which naturally arises
from the double function of money, as the instrument of commerce, and as
the measure of value.... To grow rich is to get money; and wealth and
money, in short, are, in common language, considered as in every respect
synonymous.”
Real wealth, of course, consists in what is produced and consumed: the
food we eat, the clothes we wear, the houses we live in. It is railways
and roads and motor cars; ships and planes and factories; schools and
churches and theaters; pianos, paintings and books. Yet so powerful is
the verbal ambiguity that confuses money with wealth, that even those
who at times recognize the confusion will slide back into it in the
course of their reasoning. Each man sees that if he personally had more
money he could buy more things from others. If he had twice as much
money he could buy twice as many things; if he had three times as much
money he would be “worth” three times as much. And to many the
conclusion seems obvious that if the government merely issued more money
and distributed it to everybody, we should all be that much richer.
These are the most naive inflationists. There is a second group, less
naive, who see that if the whole thing were as easy as that the
government could solve all our problems merely by printing money. They
sense that there must be a catch somewhere; so they would limit in some
way the amount of additional money they would have the government issue.
They would have it print just enough to make up some alleged
“deficiency” or “gap.”
Purchasing power is chronically deficient, they think, because industry
somehow does not distribute enough money to producers to enable them to
buy back, as consumers, the product that is made. There is a mysterious
“leak” somewhere. One group “proves” it by equations. On one side of
their equations they count an item only once; on the other side they
unknowingly count the same item several times over. This produces an
alarming gap between what they call “A payments” and what they call “A+B
payments.” So they found a movement, put on green uniforms, and insist
that the government issue money or “credits” to make good the missing B
payments.
The cruder apostles of “social credit” may seem ridiculous; but there
are an indefinite number of schools of only slightly more sophisticated
inflationists who have “scientific” plans to issue just enough
additional money or credit to fill some alleged chronic or periodic
“deficiency” or “gap” which they calculate in some other way.
The more knowing inflationists recognize that any substantial increase
in the quantity of money will reduce the purchasing power of each
individual monetary unit—in other words, that it will lead to an
increase in commodity prices. But this does not disturb them. On the
contrary, it is precisely why they want the inflation. Some of them
argue that this result will improve the position of poor debtors as
compared with rich creditors. Others think it will stimulate exports and
discourage imports. Still others think it is an essential measure to
cure a depression, to “start industry going again,” and to achieve “full
employment.”
There are innumerable theories concerning the way in which increased
quantities of money (including bank credit) affect prices. On the one
hand, as we have just seen, are those who imagine that the quantity of
money could be increased by almost any amount without affecting prices.
They merely see this increased money as a means of increasing everyone’s
“purchasing power,” in the sense of enabling everybody to buy more goods
than before. Either they never stop to remind themselves that people
collectively cannot buy twice as much goods as before unless twice as
much goods are produced, or they imagine that the only thing that holds
down an indefinite increase in production is not a shortage of manpower,
working hours or productive capacity, but merely a shortage of monetary
demand: if people want the goods, they assume, and have the money to pay
for them, the goods will almost automatically be produced.
On the other hand is the group—and it has included some eminent
economists—that holds a rigid mechanical theory of the effect of the
supply of money on commodity prices. All the money in a nation, as these
theorists picture the matter, will be offered against all the goods.
Therefore the value of the total quantity of money multiplied by its
“velocity of circulation” must always be equal to the value of the total
quantity of goods bought. Therefore, further (assuming no change in
“velocity of circulation”), the value of the monetary unit must vary
exactly and inversely with the amount put into circulation. Double the
quantity of money and bank credit and you exactly double the “price
level”; triple it and you exactly triple the price level. Multiply the
quantity of money n times, in short, and you must multiply the prices of
goods n times.
There is not space here to explain all the fallacies in this plausible
picture.[6] Instead we shall try to see just why and how an increase in
the quantity of money raises prices.
An increased quantity of money comes into existence in a specific way.
Let us say that it comes into existence because the government makes
larger expenditures than it can or wishes to meet out of the proceeds of
taxes (or from the sale of bonds paid for by the people out of real
savings). Suppose, for example, that the government prints money to pay
war contractors. Then the first effect of these expenditures will be to
raise the prices of supplies used in war and to put additional money
into the hands of the war contractors and their employees. (As, in our
chapter on price-fixing, we deferred for the sake of simplicity some
complications introduced by an inflation, so, in now considering
inflation, we may pass over the complications introduced by an attempt
at government price-fixing. When these are considered it will be found
that they do not change the essential analysis. They lead merely to a
sort of backed-up inflation that reduces or conceals some of the earlier
consequences at the expense of aggravating the later ones.)
The war contractors and their employees, then, will have higher money
incomes. They will spend them for the particular goods and services they
want. The sellers of these goods and services will be able to raise
their prices because of this increased demand. Those who have the
increased money income will be willing to pay these higher prices rather
than do without the goods; for they will have more money, and a dollar
will have a smaller subjective value in the eyes of each of them.
Let us call the war contractors and their employees group A, and those
from whom they directly buy their added goods and services group B.
Group B, as a result of higher sales and prices, will now in turn buy
more goods and services from a still further group, C. Group C in turn
will be able to raise its prices and will have more income to spend on
group D, and so on, until the rise in prices and money incomes has
covered virtually the whole nation. When the process has been completed,
nearly everybody will have a higher income measured in terms of money.
But (assuming that production of goods and services has not increased)
prices of goods and services will have increased correspondingly; and
the nation will be no richer than before.
This does not mean, however, that everyone’s relative or absolute wealth
and income will remain the same as before. On the contrary, the process
of inflation is certain to affect the fortunes of one group differently
from those of another. The first groups to receive the additional money
will benefit most. The money incomes of group A, for example, will have
increased before prices have increased, so that they will be able to buy
almost a proportionate increase in goods. The money incomes of group B
will advance later, when prices have already increased somewhat; but
group B will also be better off in terms of goods. Meanwhile, however,
the groups that have still had no advance whatever in their money
incomes will find themselves compelled to pay higher prices for the
things they buy, which means that they will be obliged to get along on a
lower standard of living than before.
We may clarify the process further by a hypothetical set of figures.
Suppose we divide the community arbitrarily into four main groups of
producers, A, B, C and D, who get the money-income benefit of the
inflation in that order. Then when money incomes of group A have already
increased 30 per cent, the prices of the things 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 be merely one more example of our central
lesson. It may indeed bring benefits for a short time to favored groups,
but only at the expense of others. And in the long run it brings
disastrous consequences to the whole community. Even a relatively mild
inflation distorts the structure of production. It leads to the
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 be increased. When this stage is reached, the
disaster is nearly complete; and the scheme is bankrupt.
Yet the ardor for inflation never dies. It would almost seem as if no
country is capable of profiting from the experience of another and no
generation of learning from the sufferings of its forbears. Each
generation and country follows the same mirage. Each grasps for the same
Dead Sea fruit that turns to dust and ashes in its mouth. For it is the
nature of inflation to give birth to a thousand illusions.
In our own day the most persistent argument put forward for inflation is
that it will “get the wheels of industry turning,” that it will save us
from the irretrievable losses of stagnation and idleness and bring “full
employment.” This argument in its cruder form rests on the immemorial
confusion between money and real wealth. It assumes that new “purchasing
power” is being brought into existence, and that the effects of this new
purchasing power multiply themselves in ever-widening circles, like the
ripples caused by a stone thrown into a pond. The real purchasing power
for goods, however, as we have seen, consists of other goods. It cannot
be wondrously increased merely by printing more pieces of paper called
dollars. Fundamentally what happens in an exchange economy is that the
things that A produces are exchanged for the things that B produces.[7]
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.
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 resorted 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.
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.”[8] 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.[9] The less he
withdraws from the existing stock of wealth for his own use, the more he
leaves for others. Prudence in consumptive spending, he feels, mitigates
the problems raised by the inequalities of wealth and income. He
realizes that this consumptive restraint can be carried too far; but
there ought to be some of it, he feels, in everyone whose income is
substantially above the average.
Now let us see, apart from Benjamin’s ideas, what happens to the $20,000
that he neither spends nor gives away. He does not let it pile up in his
pocketbook, his bureau drawers, or in his safe. He either deposits it in
a hank 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 be
extended over a longer period if they do lose their jobs.
But consumers reduce their buying for another reason. Prices of goods
have probably fallen, and they fear a further fall. If they defer
spending, they believe they will get more for their money. They do not
wish to have their resources in goods that are falling in value, but in
money which they expect (relatively) to rise in value.
The same expectation prevents them from investing. They have lost their
confidence in the profitability of business; or at least they believe
that if they wait a few months they can buy stocks or bonds cheaper. We
may think of them either as refusing to hold goods that may fall in
value on their hands, or as holding money itself for a rise.
It is a misnomer to call this temporary refusal to buy “saving.” It does
not spring from the same motives as normal saving. And it is a still
more serious error to say that this sort of “saving” is the cause of
depressions. It is, on the contrary, the consequence of depressions.
It is true that this refusal to buy may intensify and prolong a
depression once begun. But it does not itself originate the depression.
At times when there is capricious government intervention in business,
and when business does not know what the government is going to do next,
uncertainty is created. Profits are not reinvested. Firms and
individuals allow cash balances to accumulate in their banks. They keep
larger reserves against contingencies. This hoarding of cash may seem
like the cause of a subsequent slowdown in business activity. The real
cause, however, is the uncertainty brought about by the government
policies. The larger cash balances of firms and individuals are merely
one link in the chain of consequences from that uncertainty. To blame
“excessive saving” for the business decline would be like blaming a fall
in the price of apples not on a bumper crop but on the people who refuse
to pay more for apples.
But 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 be even more unsettling
if former savers suddenly switched their demand from capital goods to
consumers’ goods.
Still another objection is made against saving. It is said to be just
downright silly. The Nineteenth Century is derided for its supposed
inculcation of the doctrine that mankind through saving should go on
making itself a larger and larger cake without ever eating the cake.
This picture of the process is itself naive and childish. It can best be
disposed of, perhaps, by putting before ourselves a somewhat more
realistic picture of what actually takes place.
Let us picture to ourselves, then, a nation that collectively saves
every year about 20 per cent of all it produces in that year. This
figure greatly overstates the amount of net saving that has occurred
historically in the United States,[10] 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 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:
YearTotal ProductionConsumers’ Goods ProducedCapital Goods
ProducedFirst1008020*Second102.58220.5Third1058421Fourth107.58621.5Fifth1108822Sixth112.59022.5Seventh1159223Eighth117.59423.5Ninth1209624Tenth122.59824.5Eleventh12510025
been already under way at the same rate.
The first thing to be noticed about this table is that total production
increases each year because of the saving, and would not have increased
without it. (It is possible no doubt to imagine that improvements and
new inventions merely in replaced machinery and other capital goods of a
value no greater than the old would increase the national productivity;
but this increase would amount to very little, and the argument in any
case assumes enough prior investment to have made the existing machinery
possible.) The saving has been used year after year to increase the
quantity or improve the quality of existing machinery, and so to
increase the nation’s output of goods. There is, it is true (if that for
some strange reason is considered an objection), a larger and larger
“cake” each year. Each year, it is true, not all of the currently
produced “cake” is consumed. But there is no irrational or cumulative
consumer restraint. For each year a larger and larger cake is in fact
consumed; until, at the end of eleven years (in our illustration), the
annual consumers’ cake alone is equal to the combined consumers’ and
producers’ cakes of the first year. Moreover, the capital equipment, the
ability to produce goods, is itself 25 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. The consumers’ goods industries, in other
words, are already geared to the assumption that the past situation in
regard to the rate of savings will continue. Only an unexpected sudden
and substantial increase in savings would unsettle them and leave them
with unsold goods.
But the same unsettlement, as we have already observed, would be caused
in the capital goods industries by a sudden and substantial decrease in
savings. If money that would previously have been used for savings were
thrown into the purchase of consumers’ goods, it would not increase
employment but merely lead to an increase in the price of consumption
goods and to a decrease in the price of capital goods. Its first effect
on net balance would be to force shifts in employment and temporarily to
decrease employment by its effect on the capital goods industries. And
its long-run effect would be to reduce production below the level that
would otherwise have been achieved.
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.[11]
Few people nowadays, in a modern industrial community like the United
States, hoard coins and bills in stockings or under mattresses. To the
small extent that this may occur, it has already been reflected in the
production plans of business and in the price level. It is not
ordinarily even cumulative: dishoarding, as eccentric recluses die and
their hoards are discovered and dissipated, probably offsets new
hoarding. In fact, the whole amount involved is probably insignificant
in its effect on business activity.
If money is kept either in savings banks or commercial banks, as we have
already seen, the banks are eager to lend and invest it. They cannot
afford to have idle funds. The only thing that will cause people
generally to increase their holdings of cash, or that will cause banks
to hold funds idle and lose the interest on them, is, as we have seen,
either fear that prices of goods are going to fall or the fear of banks
that they will be taking too great a risk with their principal. But this
means that signs of a depression have already appeared, and have caused
the hoarding, rather than that the hoarding has started the depression.
Apart from this negligible hoarding of cash, then (and even this
exception might be thought of as a direct “investment” in money itself)
“savings” and “investment” are brought into equilibrium with each other
in the same way that the supply of and demand for any commodity are
brought into equilibrium. For we may define “savings” and “investment”
as constituting respectively the supply of and demand for new capital.
And just as the supply of and demand for any other commodity are
equalized by price, so the supply of and demand for capital are
equalized by interest rates. The interest rate is merely the special
name for the price of loaned capital. It is a price like any other.
This whole subject has been so appallingly confused in recent years by
complicated sophistries and disastrous governmental policies based upon
them that one almost despairs of getting back to common sense and sanity
about it. There is a psychopathic fear of “excessive” interest rates. It
is argued that if interest rates are too high it will not be profitable
for industry to borrow and invest in new plants and machines. This
argument has been so effective that governments everywhere in recent
decades have pursued artificial “cheap money” policies. But the
argument, in its concern with increasing the demand for capital,
overlooks the effect of these policies on the supply of capital. It is
one more example of the fallacy of looking at the effects of a policy
only on one group and forgetting the effects on another.
If interest rates are artificially kept too low in relation to risks,
funds will neither be saved nor lent. The cheap-money proponents believe
that saving goes on automatically, regardless of the interest rate,
because the sated rich have nothing else that they can do with their
money. They do not stop to tell us at precisely what personal income
level a man saves a fixed minimum amount regardless of the rate of
interest or the risk at which he can lend it.
The fact is that, though the volume of saving of the very rich is
doubtless affected much less proportionately than that of the moderately
well-off by changes in the interest rate, practically everyone’s saving
is affected in some degree. To argue, on the basis of an extreme
example, that the volume of real savings would not be reduced by a
substantial reduction in the interest rate, is like arguing that the
total production of sugar would not be reduced by a substantial fall of
its price because the efficient, low-cost producers would still raise as
much as before. The argument overlooks the marginal saver, and even,
indeed, the great majority of savers.
The effect of keeping interest rates artificially low, in fact, is
eventually the same as that of keeping any other price below the natural
market. It increases demand and reduces supply. It increases the demand
for capital and reduces the supply of real capital. It brings about a
scarcity. It creates economic distortions. It is true, no doubt, that an
artificial reduction in the interest rate encourages increased
borrowing. It tends, in fact, to encourage highly speculative ventures
that cannot continue except under the artificial conditions that gave
them birth. On the supply side, the artificial reduction of interest
rates discourages normal thrift and saving. It brings about a
comparative shortage of real capital.
The money rate can, indeed, be kept artificially low only by continuous
new injections of currency or bank credit in place of real savings. This
can create the illusion of more capital just as the addition of water
can create the illusion of more milk. But it is a policy of continuous
inflation. It is obviously a process involving cumulative danger. The
money rate will rise and a crisis will develop if the inflation is
reversed, or merely brought to a halt, or even continued at a diminished
rate. Cheap money policies, in short, eventually bring about far more
violent oscillations in business than those they are designed to remedy
or prevent.
If no effort is made to tamper with money rates through inflationary
governmental policies, increased savings create their own demand by
lowering interest rates in a natural manner. The greater supply of
savings seeking investment forces savers to accept lower rates. But
lower rates also mean that more enterprises can afford to borrow because
their prospective profit on the new machines or plants they buy with the
proceeds seems likely to exceed what they have to pay for the borrowed
funds.
We come now to the last fallacy about saving with which I intend to
deal. This is the frequent assumption that there is a fixed limit to the
amount of new capital that can be absorbed, or even that the limit of
capital expansion has already been reached. It is incredible that such a
view could prevail even among the ignorant, let alone that it could be
held by any trained economist. Almost the whole wealth of the modern
world, nearly everything that distinguishes it from the 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,[12] 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.
Economics, as we have now seen again and again, is a science of
recognizing secondary consequences. It is also a science of seeing
general consequences. It is the science of tracing the effects of some
proposed or existing policy not only on some special interest in the
short run, but on the general interest in the long run.
This is the lesson that has been the special concern of this book. We
stated it first in skeleton form, and then put flesh and skin on it
through more than a score of practical applications.
But in the course of specific illustration we have found hints of other
general lessons; and we should do well to state these lessons to
ourselves more clearly.
In seeing that economics is a science of tracing consequences, we must
have become aware that, like logic and mathematics, it is a science of
recognizing inevitable implications.
We may illustrate this by an elementary equation in algebra. Suppose we
say that if x=5 then x + y = 12. The “solution” to this equation is that
y equals 7; but this is so precisely because the equation tells us in
effect that y equals 7. It does not make that assertion directly, but it
inevitably implies it.
What is true of this elementary equation is true of the most complicated
and abstruse equations encountered in mathematics. The answer already
lies in the statement of the problem. It must, it is true, be “worked
out.” The result, it is true, may sometimes come to the man who works
out the equation as a stunning surprise. He may even have a sense of
discovering something entirely new—a thrill like that of “some watcher
of the skies, when a new planet swims into his ken.” His sense of
discovery may be justified by the theoretical or practical consequences
of his answer. Yet his answer was already contained in the formulation
of the problem. It was merely not recognized at once. For mathematics
reminds us that inevitable implications are not necessarily obvious
implications.
All this is equally true of economics. In this respect economics might
be compared also to engineering. When an engineer has a problem, he must
first determine all the facts bearing on that problem. If he designs a
bridge to span two points, he must first know the exact distance between
those two points, their precise topographical nature, the maximum load
his bridge will be designed to carry, the tensile and compressive
strength of the steel or other material of which the bridge is to be
built, and the stresses and strains to which it may be subjected. Much
of this factual research has already been done for him by others. His
predecessors, also, have already evolved elaborate mathematical
equations by which, knowing the strength of his materials and the
stresses to which they will be subjected, he can determine the necessary
diameter, shape, number and structure of his towers, cables and girders.
In the same way the economist, assigned a practical problem, must know
both the essential facts of that problem and the valid deductions to be
drawn from those facts. The deductive side of economics is no less
important than the factual. One can say of it what Santayana says of
logic (and what could be equally well said of mathematics), that it
“traces the radiation of truth,” so that “when one term of a logical
system is known to describe a fact, the whole system attaching to that
term becomes, as it were, incandescent.”[13]
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 inclineth man’s mind to atheism, but depth in
philosophy bringeth men’s minds about to religion.” It is certainly
true, however, that a little economics can easily lead to the
paradoxical and preposterous conclusions we have just rehearsed, but
that depth in economics brings men back to common sense. For depth in
economics consists in looking for all the consequences of a policy
instead of merely resting one’s gaze on those immediately visible.
In the course of our study, also, we have rediscovered an old friend. He
is the Forgotten Man of William Graham Sumner. The reader will remember
that in Sumner’s essay, which appeared in 1883:
As soon as A observes something which seems to him to be wrong, from
which X is suffering, A talks it over with B, and A and B then propose
to get a law passed to remedy the evil and help X. Their law always
proposes to determine what C shall do for X or, in the better case, what
A, B and C shall do for X.... What I want to do is to look up C.... I
call him the Forgotten Man.... He is the man who never is thought of. He
is the victim of the reformer, social speculator and philanthropist, and
I hope to show you before I get through that he deserves your notice
both for his character and for the many burdens which are laid upon him.
It is 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 I wish to see abundance in
everything else, it is in my interest for scarcity to exist in the very
thing that it is my business to supply. The greater the scarcity,
compared to everything else, in this one thing that I supply, the higher
will be the reward that I can get for my efforts.
This does not necessarily mean that I will restrict my own efforts or my
own output. In fact, if I am only one of a substantial number of people
supplying that commodity or service, and if free competition exists in
my line, this individual restriction will not pay me. On the contrary,
if I am a grower of wheat, say, I want my particular crop to be as large
as possible. But if I am concerned only with my own material welfare,
and have no humanitarian scruples, I want the output of all other wheat
growers to be as low as possible; for I want scarcity in wheat (and in
any foodstuff that can be substituted for it) so that my particular crop
may command the highest possible price.
Ordinarily these selfish feelings would have no effect on the total
production of wheat. Wherever competition exists, in fact, each producer
is compelled to put forth his utmost efforts to raise the highest
possible crop on his own land. In this way the forces of self-interest
(which, for good or evil, are more persistently powerful than those of
altruism) are harnessed to maximum output.
But if it is possible for wheat growers or any other group of producers
to combine to eliminate competition, and if the government permits or
encourages such a course, the situation changes. The wheat growers may
be able to persuade the national government—or, better, a world
organization—to force all of them to reduce pro rata the acreage planted
to wheat. In this way they will bring about a shortage and raise the
price of wheat; and if the rise in the price per bushel is
proportionately greater, as it well may be, than the reduction in
output, then the wheat growers as a whole will be better off. They will
get more money; they will be able to buy more of everything else.
Everybody else, it is true, will be worse off; because, other things
equal, everyone else will have to give more of what he produces to get
less of what the wheat grower produces. So the nation as a whole will be
just that much poorer. It will be poorer by the amount of wheat that has
not been grown. But those who look only at the wheat farmers will see a
gain, and miss the more than offsetting loss.
And this applies in every other line. If because of unusual weather
conditions there is a sudden increase in the crop of oranges, all the
consumers will benefit. The world will be richer by that many more
oranges. Oranges will be cheaper. But that very fact may make the orange
growers as a group poorer than before, unless the greater supply of
oranges compensates or more than compensates for the lower price.
Certainly if under such conditions my particular crop of oranges is no
larger than usual, then I am certain to lose by the lower price brought
about by general plenty.
And what applies to changes in supply applies to changes in demand,
whether brought about by new inventions and discoveries or by changes in
taste. A new cotton-picking machine, though it may reduce the cost of
cotton underwear and shirts to everyone, and increase the general
wealth, will throw thousands of cotton pickers out of work. A new
textile machine, weaving a better cloth at a faster rate, will make
thousands of old machines obsolete, and wipe out part of the capital
value invested in them, so making poorer the owners of those machines.
The development of atomic power, though it could confer unimaginable
blessings on mankind, is something that is dreaded by the owners of coal
mines and oil wells.
Just as there is no technical improvement that would not hurt someone,
so there is no change in public taste or morals, even for the better,
that would not hurt someone. An increase in sobriety would put thousands
of bartenders out of business. A decline in gambling would force
croupiers and racing touts to seek more productive occupations. A growth
of male chastity would ruin the oldest profession in the world.
But it is not merely those who deliberately pander to men’s vices who
would be hurt by a sudden improvement in public morals. Among those who
would be hurt most are precisely those whose business it is to improve
those morals. Preachers would have less to complain about; reformers
would lose their causes: the demand for their services and contributions
for their support would decline. If there were no criminals we should
need fewer lawyers, judges and firemen, and no jailers, no locksmiths,
and (except for such services as untangling traffic snarls) even no
policemen.
Under a system of division of labor, in short, it is difficult to think
of a greater fulfillment of any human need which would not, at least
temporarily, hurt some of the people who have made investments or
painfully acquired skill to meet that precise need. If progress were
completely even all around the circle, this antagonism between the
interests of the whole community and of the specialized group would not,
if it were noticed at all, present any serious problem. If in the same
year as the world wheat crop increased, my own crop increased in the
same proportion; if the crop of oranges and all other agricultural
products increased correspondingly, and if the output of all industrial
goods also rose and their unit cost of production fell to correspond,
then I as a wheat grower would not suffer because the output of wheat
had increased. The price that I got for a bushel of wheat might decline.
The total sum that I realized from my larger output might decline. But
if I could also because of increased supplies buy the output of everyone
else cheaper, then I should have no real cause to complain. If the price
of everything else dropped in exactly the same ratio as the decline in
the price of my wheat, I should be better off, in fact, exactly in
proportion to my increased total crop; and everyone else, likewise,
would benefit proportionately from the increased supplies of all goods
and services.
But economic progress never has taken place and probably never will take
place in this completely uniform way. Advance occurs now in this branch
of production and now in that. And if there is a sudden increase in the
supply of the thing I help to produce, or if a new invention or
discovery makes what I produce no longer necessary, then the gain to the
world is a tragedy to me and to the productive group to which I belong.
Now it is often not the diffused gain of the increased supply or new
discovery that most forcibly strikes even the disinterested observer,
but the concentrated loss. The fact that there is more and cheaper
coffee for everyone is lost sight of; what is seen is merely that some
coffee growers cannot make a living at the lower price. The increased
output of shoes at lower cost by the new machine is forgotten; what is
seen is a group of men and women thrown out of work. It is altogether
proper—it is, in fact, essential to a full understanding of the
problem—that the plight of these groups be recognized, that they be
dealt with sympathetically, and that we try to see whether some of the
gains from this specialized progress cannot be used to help the victims
find a productive role elsewhere.
But the solution is never to reduce supplies arbitrarily, to prevent
further inventions or discoveries, or to support people for continuing
to perform a service that has lost its value. Yet this is what the world
has repeatedly sought to do by protective tariffs, by the destruction of
machinery, by the burning of coffee, by a thousand restriction schemes.
This is the insane doctrine of wealth through scarcity.
It is a doctrine that may always be privately true, unfortunately, for
any particular group of producers considered in isolation—if they can
make scarce the one thing they have to sell while keeping abundant all
the things they have to buy. But it is a doctrine that is always
publicly false. It can never be applied all around the circle. For its
application would mean economic suicide.
And this is our lesson in its most generalized form. For many things
that seem to be true when we concentrate on a single economic group are
seen to be illusions when the interests of everyone, as consumer no less
than as producer, are considered.
To see the problem as a whole, and not in fragments: that is the goal of
economic science.
[1] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[2] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[3] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[4] Cf. Hartley Withers, Poverty and Waste (1914).
[5] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[6] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[7] Cf. Hartley Withers, Poverty and Waste (1914).
[8] Karl Rodbertus, Overproduction and Crises (1850), p. 51.
[9] Cf. Hartley Withers, Poverty and Waste (1914).
[10] Historically 20 per cent would represent approximately the gross
amount of the gross national product devoted each year to capital
formation (excluding consumers’ equipment). When allowance is made for
capital consumption, however, net annual savings have been closer to 12
per cent. Cf. George Terborgh, The Bogey of Economic Maturity (1945).
[11] 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.
[12] For a statistical refutation of this fallacy consult George
Terborgh, The Bogey of Economic Maturity (1945).
[13] Karl Rodbertus, Overproduction and Crises (1850), p. 51.