The future of economic policy

Henry Hazlitt summed up the guiding principle of economics in one 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.

The reprinting of the Hazlitt classic Economics in One Lesson is timely. As the world responds to the massive economic losses of the COVID-19 crisis, it will be prudent to base policies on sound economic theory.

Describing Hazlitt's book, F.A. Hayek, 1974 Nobel Laureate in Economic Science wrote: "It is a brilliant performance. It says precisely the things which need most saying and says them with rare courage and integrity. I know of no other modern book from which the intelligent layman can learn so much about the basic truths of economics in so short a time."

Nassim Taleb, who wrote The Black Swan, advised that there was likely to be more wisdom in a book written 20 or 50 years ago, that was still in print, than anything your Harvard Professor told you yesterday. The former had been tested in the maelstrom of public opinion and voted a success.

This certainly applies to Henry Hazlitt's, Economics in One Lesson. First written in 1946, it has been continuously in print for nearly 75 years. A new special edition has been published this year with support from the Mises Institute.

Hazlitt builds on the work of Frederic Bastiat, the French economist who wrote over 170 years ago and whose work is also still in print. He expands on Bastiat's famous essay That Which is Seen and That Which is Unseen. His simple lesson is that good economics must account for both the present and the future effects and must examine the consequences not only for a targeted special group but for everybody else too.

Hazlitt begins by restating the Bastiat story of the broken window. A hooligan throws a brick through the baker's window smashing glass all over the loaves of bread. The baker will need to replace the window creating work for the glazier and the manufacturers of glass who in turn will have the funds to buy goods and services from others. The general public misunderstand the consequences. They think that "the smashed window will go on providing money and employment in ever-widening circles. The logical conclusion [is that] the hoodlum who threw the brick, far from being a public menace, was a public benefactor." But what is not seen is that the baker was about to purchase a new suit but now has to spend that money on the window. The tailor is disadvantaged and also all those who would have benefited from his additional purchases. The wealth of the community is reduced. Whereas it might have had a window and a suit, it now only has the window – and diminished economic activity.

A similar fallacy relates to the claimed benefits from war and natural disasters. The rebuilding of destroyed homes and factories requires diversion of resources that could have been used for other purposes. Or as Frank Muir and Dennis Norton famously explained "You can't have your kayak and heat it too."

In 2020, the governments of the world spent a fortune they did not have to ameliorate the unemployment caused by lockdowns designed to protect us from the coronavirus. Central banks have gone on a printing spree to provide the funds to compensate people who have been unable to work. As I have written elsewhere, counterfeit is not the path to prosperity. Presciently, Hazlitt saw the errors of Modern Monetary Theory before it knew its name!

"Everything we get, outside 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 inflation itself is merely a form, and a particularly vicious form, of taxation."

What Hazlitt is telling us is very simple. Common sense if you like. But our responses are so ingrained that it takes considerable intellectual effort to change our thinking. Take public housing for example. Our first response is that it seems like an excellent idea to use public funds to create housing for low income families. We see the houses being built and the families enjoying them. What we don't see is the alternatives that might have been. Other citizens have been taxed and to that extent have been unable to spend on things they would have preferred. The policy does not even necessarily produce more homes. Worse, it makes low income families dependent on the state.

Politicians are given kudos for spending public money on worthwhile schemes. But they receive our condemnation for increasing taxes. It is therefore unsurprising that when new schemes are announced it is implied that they are a gift from a generous government. Our journalists never ask, "Which citizens will be disadvantaged to pay for that?"

For example, if government announces "free childcare" that is a huge benefit for young families and child-care workers. It would make no sense for it to be paid for by taxing the families who will benefit. It follows that some other sector of society will be taxed to pay for it. They will then have fewer resources for other things. They may be unable to afford a granny flat in the back yard so they can look after an aging relative, or spend money on their children's education, or fund a local charity. Lacking resources to pay for things themselves, they may ask government to build an aged-care facility, or a library for their children's school, or to fund the change rooms at their local sporting facility. In this way, communities become dependent on government and on the political process rather than being personally responsible for meeting their wants.

One very popular economic fallacy is the efficacy of tariffs. Theoretically we have known since Adam Smith that everyone benefits if we specialize in what we are good at and trade with strangers to obtain the things we need at the best possible price. Certainly, no-one who ever read Bastiat's witty demolition of protection A Petition on Behalf of the Manufacturers of Candles, Waxlights, Lamps, Candlelights, Street Lamps, Snuffers, Extinguishers, and the Producers of Oil, Tallow, Resin, Alcohol, and, generally, of Everything Connected with Lighting could possibly remain a believer in tariffs. Yet the idea persists. There are many who still mourn the loss of our ability to make shoes and cars in Australia.

Hazlitt patiently explains how the benefits of tariffs to the workers in the protected industry are outweighed by the fact that the higher costs that other workers have to pay for the locally produced goods reduces their capacity to buy other things and effectively lowers their wages.

Because of the COVID-19 crisis, we have become very aware of our dependence on goods from overseas. There is bound to be political pressure to ensure that we can source critical items locally and quickly. There will be pressure to support local industries by introducing tariffs. It is worthwhile thinking through what we actually need. Reliable supply. We might achieve this by manufacturing locally, by diversifying sources of supply, or by holding higher inventories of crucial items. Maybe some combinations of all three. We may even simply want to maintain the capability to manufacture quickly if needed. Whatever we choose we should recognise that we shall be paying a premium to avoid risk.

Perhaps the most contentious of Hazlitt's fallacies is his view on minimum wages. He argues that the minimum wage may enable a select few to be paid more but that if you force employers to pay above market rates then there will be fewer jobs and fewer opportunities for people to learn the job skills that enable them to climb the ladder. There is also the perverse effect that someone who might be employable at slightly below the minimum wage instead must accept unemployment benefits which are typically half that wage. There is no economic output from the unemployed; so society's wealth is diminished.

"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."

Elsewhere, (see How to Bolster Youth Employment), I have shown that the negative effects of the minimum wage have most impact on young people; unemployment rates for them are typically double the overall average.

In the 1978 edition, Hazlitt added a final chapter reviewing what had changed in the intervening 32 years. He was horrified at the extent of inflation. In America, the stock of money had increased from $113 billion in 1947 to $357 billion in 1978. "The effect of this increase in money has been a dramatic increase in prices. The consumer price index in 1946 stood at 58.5. In September 1978 it was 199.3. Prices, in short, more than tripled."

"More than forty years after the publication of John Maynard Keynes' General Theory, and more than twenty years after that book has been thoroughly discredited by analysis and experience, a great number of our politicians are still unceasingly recommending more deficit spending in order to cure or reduce existing unemployment."

Keynes had recommended public works to soak up underutilised resources. The deficit spending in the poor years were to be balanced by surpluses in the good ones. It never happened that way. Politicians throughout the world were seduced by the opportunity to buy votes via policies which provided gifts to special groups. In practice, there were deficits in six years out of every seven. Following COVID-19 we may not get a surplus even one year in every seven.

The impact of inflation is that wealth is transferred to the asset-rich. The house that you bought for $2million is now valued at $3million, but your mortgage does not rise.

All of the inflation is credited to you. Contemplate, if you will, whether that makes for a fair society. Is the Welfare State the source of the inequalities it seeks to remedy?

Pointing out the huge losses in purchasing power in the decade to 1978 of the West German mark (35%), the Swiss Franc (40%), the American dollar (43%), the Swedish krone (47%), the French franc (50%), the Italian lira (56%), the Japanese yen (57%), the British pound (61%), the Brazilian cruzeiro (89%), and the Uruguayan, Chilean, and Argentinian pesos more than 99%, Hazlitt wrote: "I leave it to the reader to picture the chaos that these rates of depreciation of money were producing in the economies of these countries and the suffering in the lives of millions of their inhabitants. As I have pointed out, these inflations, themselves the cause of so much human misery, were in turn in large part the consequence of other policies of government intervention. Practically all these interventions unintentionally illustrate and underline the basic lesson of this book. All were enacted on the assumption that they would confer some immediate benefit on some special group. Those who enacted them failed to take heed of their secondary consequences – failed to consider what their effect would be in the long run on all groups."

Hazlitt concludes:

"The outlook is dark, but it is not entirely without hope. Here and there one can detect a break in the clouds. More and more people are becoming aware that government has nothing to give them without first taking it away from somebody else – or from themselves. Increased handouts to selected groups mean merely increased taxes, or increased deficits and increased inflation. And inflation, in the end, misdirects and disorganizes production. Even a few politicians are beginning to recognize this, and some of them even to state it clearly."