Monday, August 31, 2015

Hazlitt in One Lesson: Or, How I Learned to Stop Worrying and Love the Market

Although this book may be a little dated (first published in 1946), let me first say that in terms of brevity and clarity, it is a wonderful introduction to Economics. You can purchase it here. For the casual reader, or the die-hard Econometrician that's gotten so far into proofs about the consistency of esoteric estimators under never-to-be-satisfied conditions, it's a nice reminder of why carefully reasoned economic analyses are important.

The book examines and unravels common economic fallacies by showing them to be violations of a common lesson, which is: "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 group." (pp. 17). Some of these fallacies include the following:

  1. The Broken Window Fallacy: This is the belief that destructive activities are necessarily beneficial to society, because they create business. Hazlitt uses the case of a child who breaks a window, which then must be replaced by the window-maker, who may use the proceeds to buy shoes from the shoemaker etc. etc. While this may seem like destruction creates business, what is ignored is what the window owner might have done if he hadn't been forced to replace the window. We could create the same chain of transactions, only these would be voluntary, and in all likelihood represent a more efficient chain of production. Thus, from burning crops to destroyed homes in the aftermath of WWII, he argues that those who see this as a boon for new business are mistaken, because they ignore what might have happened instead.

  2. Forgetting that Public Works Require Taxes: This might fall under ignore the "There's no such thing as a free lunch," dictum. Government spending is usually thought of as being financed through two channels:
    • Taxes: money taken directly from the public by adding on to the price of goods, charging fees, taxing income, etc. 
    • Bonds: borrowing money through financial institutions.

    Hazlitt points out that taxes must come directly from the public (reducing their choices of consumption). Furthermore, the bonds must eventually be repaid, and the only way to repay them is...some form of tax on the public. So we must remember, under normal circumstances, an increase in government spending comes at the cost of a decrease in private spending. It's easy to see the jobs, roads, bridges, etc. that this can create, but we also shouldn't forget those things other people might have chosen to build or buy if those resources had never been diverted. 

  3. The Limited Work Fallacy: This fallacy shows up mostly on the employment side. In short, workers throughout the ages have been afraid of technology and machines, because they are afraid that as their jobs are automated or production becomes easier, that they themselves become less valuable or necessary. This had led to laws that can severely limit work hours, make the production of some goods purposefully cumbersome, or has led to outright violence where machines are destroyed. Hazlitt, however, reminds us that the purpose of economics is the study of scarcity, the simple fact that humans seem to have unlimited wants but limited means with which to meet them. It seems absurd then to think that there's some limited amount of work. If machines make work easier, then it seems more logical that workers would move on to other occupations where this isn't the case. There are also cases, as we commonly saw in the industrial revolution, where the machines required armies of workers to service them, and increased the demand for labor. Thus, while painful adjustments sometimes occur when new machines or technologies are implemented, there are no signs yet that production is so great as to satisfy mankind's unquenchable thirst for more stuff!

  4. Forgetting that Prices and Profits are Signals: If you've kept up this long, I promise I'm going to wrap it up. This last point is my personal summary of a lot of his case studies. There is a knee jerk reaction in many circles to see "high" prices and "high" profits as somehow immoral. By "high" we often mean above what they have been in the recent past. Hazlitt makes an often overlooked and valuable point that before we judge a price or profit margin, we should attempt first to understand why it came to be this way. Rising prices usually indicate an increase in demand for a product, or an increase in the cost to produce it (limes may get more expensive if there's a bad crop harvest, for example). Rising profits can indicate the same thing, or that a firm or industry has found a more cost effective way of producing goods at the same price. While companies can use things like market power, government fiat, or asymmetric information to achieve high prices and/or profits in the short-term (and these are mostly bad), it is usually not a long-term phenomenon. So before we attempt to "fix" a price or levy a tax on "windfall profits", we should first try to understand why they currently exist. What are the prices and profits telling us?
There's a lot more in the book, so I would encourage you read it for yourself. Also, at the end, I'll insert my personal take which may explain my tongue-in-cheek title. While I enjoyed the book and think the arguments are important and meaningful, I think the author is often guilty of whitewashing some of the real world complications that occur while we fight our way towards the "long run".

  • Maybe breaking windows and burning crops doesn't create prosperity, but what about that piece of property with the old gas station and ruptured gas tank under the ground? Who wants to buy it and convert it into its next best use? Should we charge the current owner for the cleanup, who only remembered that his father closed it 20 years ago? What if he/she can't pay?
  • All government spending must eventually be paid by business. But when millions of people are temporarily unemployed and banks are unwilling to finance many business ventures because they're unsure how long the downturn will last, is leaving millions of hours of manpower and billions of dollars in capital idle while the private sector sorts its prices the best our public officials can do?
  • For the time being, our projections may indicate that moving manufacturing to another nation will increase profits for shareholders and lower costs for consumers, while only a segment of the population will be unemployed and require retraining in another line of work. But what if the wages were kept low by pressure from a corrupt and undemocratic government? What if the manufacturing base were moved to a nation that later seized it and used it to make war on the nation that financed that very venture? Can we ask our own displaced workers to quietly accept the loss of their own earning power so their neighbor can buy what they used to make for a lower price? 
These situations are not hypothetical. They have occurred in the past, occur today, and will occur in the future. So, my takeaway is to return to Hazlitt's point of focusing on the long-term consequences of all involved parties, and to know when we can count on the time-tested rules of commerce to apply, and when we should be skeptical.