Economics in One Lesson

Hazlitt believes the power of unions in raising workers’ wages has been exaggerated, because the rise and fall of wage rates is mainly based on labor productivity rather than union demands. Hazlitt points out that wages in the US were exponentially higher than those in England and Germany, even in the decades where the latter two countries had great labor movements.

The utility of labor movements, then, is to help workers negotiate so that their wages match the true market value. This is because employers want to maximize profit and tend not to want to pay their workers anything more than the very minimum necessary. However, they do not have all information on the labor market and can underestimate it; unions and their members can share their side of the story and help make a strong case when negotiating wages. By banding together, workers are also less likely to underestimate their real worth.

However, Hazlitt also believes that unions are in danger of extending their power beyond their legitimate functions when they try to fix wages above the market rate. This has the consequence of increasing unemployment, for the same reasons as explored in the previous chapter. Unions may also practice discriminatory policies in an attempt to maintain these higher-than-market-rate wages: They may restrict membership and organize violent strikes to enforce their demands. Hazlitt warns that both of these actions, though directed at the employer, actually hurt fellow laborers most by forcing those not within the union circles to find worse alternative jobs.

The author also warns of the dangers of falling for “emotional economics,” a term that designates nice-sounding but what he regards as economically unsound theories. For example, some people believe labor to be underpaid generally, as if market rates are chronically too low. Others believe that a union’s win in raising wages above market rates in one industry is beneficial to all workers everywhere. Hazlitt argues that both of these ideas are flawed, with Hazlitt attempting to illustrate this with an analogy.

Consider 6 groups of workers A, B, C, D, E, and F, all of whom are unionized. Some of these unions are successful in demanding a wage increase above market rates based on their political power and strategic position. Group A’s union is weakest and is unable to secure wage increases, but Group B is successful in demanding a 10% increase; Group C a 20% increase; Group D a 30% increase, Group E a 40% increase, and Group F a 50% increase. The average overall increase in wages across all groups is 25%. However, with this increase in wages also comes an increase in price of the goods that they produced by 25% (this number is selected for simplicity’s sake; in real-world situations, it is likely going to be less, as wages do not represent all costs of production). With this increase in prices also comes a 25% increase in the cost of living.

As a result, workers in Group A are significantly worse off; workers in Groups B and C are less heavily impacted but still worse off than when they started; workers in Group D enjoy a slight gain; and only workers in Groups E and F will have made gains, though only for half as much as their wage increase. This paints a very unequal distribution of wealth, in which only a small specialized group gained anything at all. Additionally, if some unemployment is factored in for all groups involved, then averaging the wages of those laid off with those whose wages increased will lower the gains of workers even in the most advanced Group F. Offering unemployment relief only exacerbates the problem by wasting taxpayers’ money.

Hazlitt concludes that unions have not in fact significantly impacted wage rates. People only believe they did because they only look at the short-term gains of specific groups without seeing the big picture. They see the correlation between the rise of the labor movement with the rise of wages in the recent half century, without ever realizing that, according to Hazlitt, the actual direct cause of the wage increase is the growth in capital investment and technology.

Unions do benefit workers for helping raise their skills and competence; increase their welfare and workplace health standards; and negotiate for wages that match the market value. However, when they overextend their powers and insist on rigid subdivisions of labor that exponentially increase production costs; oppose the adoption of technology; and insist on promotion based on seniority rather than merit, they cause great harm to the economy overall.

As a Classical economist, Hazlitt believes that prices and wages should be functional, rather than fair or just. In other words, prices of items should be fixed at a point that allows for maximum production and sales, while workers’ wages should encourage the highest employment rates and largest payrolls.

Marxists and other economic schools that insist on purchasing-power, however, believe that prices and wages should be “fair.” Most importantly, they argue that, in order for wages to be “fair,” workers should make enough to buy back the product they create. Hazlitt finds this puzzling, because workers earn different wages based on the price of what they produce. A maker of cheap dresses will need a significantly lower wage to buy back the cheap dress compared to an automobile engineer. This hardly seems “fair” to him.

Another possible explanation for the “buy back the product” line of reasoning is to assume it means raising workers’ purchasing power to an arbitrary “reasonable” level. This, however, raises a fundamental issue: “In an exchange economy, everybody’s income is somebody else’s cost” (135). Hazlitt believes that raising all wages to a “reasonable” level also causes an equivalent increase in the cost of production, which in turn could force a price increase, unemployment, and/or an overall decrease in production (this argument was explored in the previous two chapters). Thus, Hazlitt argues that, when considering the industry as a whole, raising wages in an attempt to increase purchasing power actually results in the opposite effect of lowering standards of living.

Hazlitt supports this position using a statistic. According to a big data study by American Economist Paul H. Douglas and English Economist A.C. Pigou, an increase in wages above the level of marginal productivity will result in a decrease in employment three to four times as great as the increase in hourly rates. Thus, even if an increase in wage gives a specialized group a temporary advantage, it is unlikely that this will become an absolute gain overall.

Hazlitt concludes that, instead of attempting to define a “just” wage, economists should be looking to reach an “equilibrium” between wages and prices and prices that equalize supply and demand. The best prices and wages are not the highest prices and wages, but rather those who encourage full production, full employment, and the largest sustained payrolls.

This chapter explores in more depth the price system introduced in Chapter 14. It primarily argues that, though the word “profit” has become morally vilified in recent years to stigmatize the rich, this is merely emotional speech. Hazlitt argues that any sound economic endeavor has as its fundamental goal to turn a profit.

Hazlitt points out that making a return on investments is actually harder than it sounds. The net income of American businesses between 1929 and 1943 averaged less than 5% of the total national income. Between 1930 and 1938, more corporations showed a loss than a profit. Some economists such as Frank H. Knight even argue that, in the long run, businesses who invest in riskless ventures and pay reasonable wage values are most likely not to turn a net profit at all.

The goal of profit in a free economy is to guide production to reach an equilibrium with demand, so as to maximize production and minimize costs. It also serves the purpose of encouraging business owners to find more efficient ways to produce, so that they can increase their profits in good times, beat competitors in normal times, and stay afloat in bad times. Profit is thus the guiding force that tells businesses what goods to produce and how to most economically make them.

This chapter explores what Hazlitt regards as common beliefs and misunderstandings concerning inflation, which have been omitted in the discussion on public works and credit in Chapters 4 and 6.

The greatest belief related to inflation is to believe it will kickstart an economy that has been stagnating or declining. This has been the proposition of the US government in Hazlitt’s time. Hazlitt argues that economists who advocate for inflation are disingenuous; they deceive themselves and others by conflating money with wealth. They think the more money someone possesses, the wealthier they are. Therefore, they will decry the need for printing more money to prevent businesses from shrinking their operations and to increase the prices of goods, which will raise profits and incentivize firms not to lay off workers.

However, Hazlitt believes that money is not wealth. Real wealth is more closely related to purchasing power, which in turn relates to standards of living: It consists of what is being produced and consumed. People who have the ability to eat healthier foods, wear better quality clothes, enjoy better social services, such as railroads and cars, are wealthier. Money is but a medium and its value must be tied to how much it can be exchanged for those products.

The more money is being printed and injected into the economy, the more prices of goods will rise. Hazlitt illustrates this relationship with a simple analogy: If the government hands out freshly printed bills to Group A, then Group A has a temporary increase in purchasing power. They will buy more products from Group B, who, in turn, will make a greater profit and buy more products from Group C. This cycle will continue, causing an overall increase in demand without a corresponding increase in supply. Since doubling the amount of money in circulation will not double the amount of fridges or cars produced, printing money will only devalue its worth relative to the products it can purchase, without generating more wealth.

Hazlitt argues that this analogy shows that money increases will slowly spread out from Group A to Group B to Group C, etc. However, this time discrepancy will cause Group D and later, those who have yet to enjoy an increase in money, to be worse off from the start, since greater demand from the earlier groups means less to buy or higher prices to pay. Here, once again, the belief stems from only looking at the short-term gains of specialized groups, rather than at the net economic gain of everyone in the long run. By overlooking money, economists will realize that the world operates on an exchange economy, where fundamentally A produces products in exchange for those made by B; inflation therefore merely disrupts these exchange rates.

Hazlitt believes the true cause of economic depressions is the maladjustment of the wage-cost-price structure: Wages might be too high for the price of products, or vice-versa; raw materials might cost too much compared to the price of finished goods; or wages and prices do not balance out across industries. This ultimately leads to firms unable or unwilling to produce, shrinking their operations and increasing unemployment. Rather than printing money and causing an inflation then, he argues that it would be better to decrease wage rates, which he says encourages production, increases supply, and reduces the price of goods across industries. However, this is politically impossible to achieve.

Hazlitt believes that using inflation to attempt to correct economic downturns can at times work to realign specific price structures that were skewed. However, he argues that it is effective not because it is theoretically sound, honest, and open, but because it creates a temporary illusion of satisfaction by increasing people’s access to money, without truly increasing people’s buying power. In the long run, inflation is in itself a form of taxation, one that disproportionately affects the poor, as its worse effects are most strongly felt over time. It taxes not people’s current expenditures, but their savings and life insurance for the future. Even worse, the possibility of buying things cheap now to sell them at an inflated price later encourages risky speculation rather than effective production. Hazlitt concludes that inflation can plant the seeds of fascism and communism by forcing people to increasingly rely on the government to rectify everything.

Hazlitt notes recent attacks on the concept of saving and questions their validity. Experts have been touting the importance of spending to immediately boost the economy and encourage greater production. He claims that they vilify people for saving their money for later use, since these hoarded funds serve no immediate purpose and can intensify or prolong economic depressions. As a result, these experts posit that too much saving is what causes economic depressions.

Hazlitt argues that this line of reasoning is unsound, since modern-day saving is vastly different from earlier periods in history: Rather than stockpile their gold or cash under their beds, people deposit their money in banks, or reinvest it. Even depositing money into banks is useful, as modern banks will reinvest part of this capital by lending it to businesses on the short term for working capital. In other words, money saved is not idle or lost: Most of it is recirculated into the economy immediately and people can often earn back on interest. Although less consumption can prolong economic depressions, the practice of saving money in the modern world is hardly the cause of them.

Hazlitt argues that modern-day saving is another form of spending, with the only difference between saving and direct spending being the middle man of the bank, who is in charge of reinvesting it to support production. When people refuse to spend immediately, it might be because they foresee the potential for greater gains in the future. If they are not confident investing now, it is likely because they do not foresee an upturn and are withholding their funds for later. Saving is therefore not the cause, but the consequence, of depressions.

Hazlitt asserts that the real cause of depressions is uncertainty, which are mostly brought about by irresponsible government policies. People fear investing or producing at times where laws can drastically shift the balance between costs of production and price. Even if interest rates on borrowing money are artificially kept low, if the risks remain high, people will not be willing to invest. Insofar as savings constitute the “supply” of new capital and investments are the “demand,” it has been shown in previous chapters that keeping supply costs below market rates increases demand and reduces production. People are encouraged to invest in highly speculative ventures that are unsound in regular times and save less, which causes even greater oscillations in business and a shortage of real capital.

Hazlitt argues that the belief that an economy can only absorb so much new capital, and that this limit has already been reached, is flawed. This reasoning suggests that the economy can only expand so much before it has excess and useless capital. Hazlitt finds this proposition ridiculous: He argues that never has there been enough durable goods, such as automobiles, furniture, schools, libraries, and hospitals in human history. This is because, even if there is a quantitative limit to these, there is no limit to improving their quality. With any excess capital, businesses will find ways to improve their product or service; sometimes, with technological development, they may even create goods that have previously been impossible to produce. Improvements can always be made to improve the quantity and quality of a product, as well as reduce its production costs. Hazlitt therefore concludes it is erroneous to believe there can be a limit to capital absorption in any economy.