Economics in One Lesson
The driving theme of this book was around one particular economic fallacy, hence the name Economics in One Lesson, and that theme is simply to consider more than just the immediate consequences of a decision. Whether at the hands of politicians, economists, business owners, or anyone in power, people have a tendency to focus on short-term effects for the benefit of a small group of people rather than focusing on the long-term effects to the aggregate. Short-term gains are more tangible and politically popular because they’re immediate and easily traced back to one’s decisions, which can make that person look really good in the moment. Yet it’s the long-term consequences that end up being far more important, it’s just harder to measure all those consequences, and it’s especially hard for people to connect those long-term consequences back to the original decisions that led to them, which is why they are often overlooked and why short-sighted economic actors tend to ignore them.
But the ripples following economic decisions can be incredibly far reaching—there’s often a domino effect extending way beyond the first order goals of those decisions. Politicians or entrepreneurs may successfully accomplish one thing, but there can be 100 other things that resulted from that decision that they didn’t predict and that negate any positive consequences they intended. Quite often, the second order externalities of economic actions actually go entirely unnoticed because the first order consequences prevented them from ever occurring. For example, if you had plans to buy a suit but came home to find your window was broken, that may generate economic activity for the window maker, but it will draw away activity from the tailor as that money was used to repair the window. The same can be true of government decisions to build bridges or start new welfare programs; there could have been plans or opportunity to spend that money somewhere else, but a decision is made—a decision usually focused on immediate and self-serving gains—and that economic activity was directed elsewhere, perhaps at great cost to the economy, but nobody would know because it never happened.
The government often touts economic projects like bridge construction, new programs, or what have you as positive as they create jobs, but every dollar spent on that bridge or new program is a dollar taken from taxpayers. This means those dollars being used must (or at least should) offer a better value proposition than whatever else that money could have been spent doing. The government doesn’t consider the second order externalities, they only focus on what these singular events resulting from their decisions are accomplishing in the short run. Though their decisions may create jobs and generate economic activity, the question is, is the money being spent creating the most jobs or generating the most economic activity it can? Is spending this money just to create jobs actually creating less jobs because the tax dollars aren’t being spent to their full potential? So much of government spending is poorly allocated and actually generates fewer jobs and less value than it could if properly
allocated. They take money from taxpayers, which leaves less money to be spent in the economy, which leads to less business, which leads to job destruction, so whatever jobs the government creates must be more than the jobs it destroys by taking money from taxpayers. However, people in government don’t view spending this rationally—they only want to create jobs now for political points instead of creating more jobs later when they might not get all the credit.
Another important point raised in this book is on some of the problems with taxation, namely, how it discourages risk taking in the citizens and encourages risk taking in the public sector.
As it pertains to the average individual, taxation is problematic because they lose 100% of what they lose in business, but only gain a portion of what they make because 30-50% of that is taken through taxes. If you lose 100 cents for every dollar you lose and gain 60 cents for every dollar you earn, your risk to reward is unfairly skewed and you are discouraged from taking the risks necessary to create a successful business, which is obviously what we need people to do if we want innovation and business to thrive. Without risk taking, we don’t get the Amazons and Teslas of the world—we don’t get entrepreneurs putting themselves out on a limb to risk it all for this idea they have because even if everything goes perfectly right, they only make 60% of their earnings. For those familiar with trading, this would be like taking a trade with .6R or .6 risk to reward. Even if you are right or successful most of the time, you could still lose more than you make. If taxes are too high to make these risky endeavors worth undertaking in the first place, more and more people will choose the safer path of finding a job rather than creating one, which will lead to a dramatic drop in productivity and spell disaster for the economy.
As for governments and their use of taxes, they themselves bear no risk for bad loans or malinvestment. Taking risks is generally a good thing for entrepreneurs insofar as it’s necessary to build great businesses, but that’s because they have a healthy fear of those risks. They only want to take calculated risks and will do whatever possible not to fail or lose their hard earned money. Governments, however, aren’t spending their money, they’re spending taxpayer’s money, so there is no risk of failure or really any serious negative consequences if they spend that money poorly or even if they outright lose it. The government employees making spending decisions are getting a safe and predictable salary no matter what—they aren’t worried an investment may go south the way someone with their own money on the line would be. Governments, thus, are more likely to issue bad loans and misallocate funds because they don’t have the same incentives or real risks that drive entrepreneurs to allocate money as effectively as possible. Every dollar earned through taxation is spent by the government and taken from the entrepreneur, business owner, or individual. So you have to ask yourself, who is the better capital allocator? The individuals who bear all the risk and have all the incentives to spend that dollar well or the government who bears none of the risk and whose primary incentive is generally short-term political gain?
And this offers a nice segue into another great point raised in the book, which is the shortsighted pursuit of job growth at the expense of overall productivity. Adding jobs at the expense of productivity by employing more people to do the job fewer could do leads to less overall money in the economy to go around. An excess of employees means consumers are paying more than they need to for a service, which then prevents them from using that money on other goods or services. If a job only takes two people but that business hires three, that additional expense has to come from somewhere. Either the business itself is making less money by eating those extra costs, or those costs are extended to the consumer, or each employee is earning less than they could be because they are subsidizing the pay for the third unnecessary worker. Though employing more people sounds good on its face and is often the government’s prime directive, adding more jobs to do the same amount of work just steals value from somewhere else. The goal is to create more value and become more productive and hiring two people to do the job of one doesn’t magically create more money or value to go around—it deprives someone else of that value whether it be the business owner, the consumer, or the fellow employee now getting half the pay. Jobs are good, but only if they are productive.
Shifting gears to my next takeaway, Hazlitt mentions the economics around managing post-wartime labor and demand, which I found very interesting. After wartime, there are concerns of how the labor market will support the returning and now unemployed soldiers, but if the war and funding thereof is over, that extra money can now be returned to taxpayers either by directly cutting the taxes that were needed for the war or by reallocating the deficit spending used to support the war to then cut taxes, increase demand and, in turn, jobs, which would help absorb the soldiers into the workforce. This point may not be the most relevant, but I found it very telling about the simplicity of balancing supply and demand sometimes. It isn’t always as complicated as people make it out to be and really can be as simple as shifting things from one side of the scale to the other.
The next point raised in this book I found noteworthy was on tariffs. Hazlitt argues tariffs can hurt economies because by taxing cheaper imported goods nations drive money toward a more expensive domestic good, which leaves less money available to chase other domestic goods. This is getting back to the second order consequences we often overlook when it comes to economic policy. We create tariffs to help a particular industry stay competitive, but consumers now spend more than they were spending and that leaves less money to be spent elsewhere, which hurts all other industries. Tariffs also promote a producer that is less efficient at making a good, which is selecting for lower productivity overall. If another nation is better at making a good or can make it cheaper, creating a tariff is telling the domestic producer they don’t have to compete to make their good as affordable as the oversea competitor.
Another great point brought up in the book is on price controls. Price controls are usually used to curb inflation by fixing prices at a specified price lower than the market value. By fixing the price below the market value, they increase demand because the product is enticingly cheap and more people can afford it, but that also reduces the supply because more people are buying while production is discouraged due to the artificially low price. If a price of a good doesn’t reflect the costs associated with producing it, supply will slowly vanish. Fixing prices for consumers doesn’t change how much the parts, labor, transportation, or whatever else needed to create that good costs the producer. Price controls can work if they are accompanied by rationing or artificially limiting demand, but they can’t work in any practical sense. Prices are a reflection of free market circumstances that can’t be resolved by arbitrarily writing a different number on the price tag. This is why price controls always end in disaster. The low consumer cost relative to the productive costs means producers can’t afford to keep making it and eventually the consumers buy up all of the available supply. By preventing a good from selling at its real market price, you create massive shortages— shortages that can only be resolved by paying producers what they need to produce that good for more than what it actually costs them to make.
On a related note, an interesting manifestation of price controls mentioned later in the book and not often considered is wage control, including a minimum wage. Forcing wages to be higher or lower than their market value can lead to much of the same problems as traditional price controls. If a minimum wage is too high, employers can’t afford to employ enough workers to meet demand unless they raise all their prices, which is paid by the consumer. A minimum wage also means nobody whose work is worth less than that minimum will be employed meaning you force someone who could’ve generated a small amount of value into unemployment, which actually takes value from the system rather than contributing value (however small that value would have been). The best way to raise wages is to raise productivity. You can’t pay workers more value than the value created by industry so arbitrarily moving up the minimum wage only takes money from somewhere else in the economy. It might give more money to certain workers, but it leaves less money for consumers to spend on other goods and services, which could actually lead to a net loss of jobs. It’s important for workers to ensure they are getting the fair market wage for their work, but minimum wages (or price controls) don’t accomplish this effectively. Unions can be important in ensuring supply and demand are keeping wages around their fair price, but unions should be focused on improving productivity rather than raising the minimum wage if they want any lasting changes in wages without negative second order consequences like job cuts to support those higher wages. Ironically, unions often fight against the displacement of workers due to increased efficiency, but, in doing so, they are stifling overall productivity and long-term wage growth. Their short-sighted goal of immediate help to workers leads to long-term wage suppression from a lack of increased productivity. Controlling wages one way or the other doesn’t change the fundamentals driving the value or economic activity that supports those wages. It may seem like a good idea to create a high minimum wage to support low-level workers in the short term, but it will lower overall productivity by taking money that would have been spent elsewhere and likely lead to second order consequences like fewer jobs and higher unemployment.
In fact, Hazlitt argues depressions are the result of these kinds of maladjustments in prices, whether on the goods side or the wages side. When materials needed to produce goods and wages needed to purchase those goods don’t properly align, the production or purchase of goods becomes difficult or even impossible. If goods cost too little because of price controls, producers suffer, no more goods are created, and then consumers suffer. If goods cost too much, consumers suffer, can no longer afford to buy, and then producers suffer. Both of these outcomes are terrible for economies. Conversely, if wages are too high because of a minimum wage, businesses can’t afford to employ as many workers, unemployment rises, productivity slows, and the whole economy suffers. And if wages are too low, workers can’t afford to buy, businesses struggle, unemployment rises, and the economy, once again, suffers. Now, there are a lot of factors that can lead to misaligned prices and wages, like price controls or a minimum wage, but a major contributor is inflation because it affects prices, industries, and people in different ways at different times. Prices for producers may inflate much sooner than wages do and the lag between those changes can lead to a lot of wealth destruction for workers and consumers. Inflation can first hit wages in just a handful of industries, which makes them spend more and drive up prices in the economy, while other wages are still flat amid these ubiquitously rising prices. Because inflation doesn’t move prices and wages equally or simultaneously, it leaves many to suffer from the maladjusted prices. Even if all wages eventually catch up to inflation, you will never get back the money lost during that time it took those wages to catch up to prices. When prices and wages don’t align, economies suffer and recessions or depressions can follow.
The final point from this book I want to mention is regarding interest rates. As Hazlitt explains, if interest rates are kept artificially low, there will be a reduction in both saving and lending. Earning a near 0% interest on your savings, especially with inflation, makes saving seem nonsensical and lenders, too, will want to allocate their money to something that pays them a higher return, like equities. Manipulating interest rates is actually quite similar to price controls in that it increases demand (borrowing) and reduces supply (lending). Normally, low interest rates are used to stimulate the economy with cheap debt, which eventually leads to increased economic activity and, in turn, inflation, which then prompts rates to rise to curb that inflation. But when governments force rates to remain low, they are preventing this natural economic force from occurring. Rather, to continue meeting the excessive demand for borrowing, the government creates liquidity through quantitative easing, but QE can be inflationary, which would prompt the already artificially low rates to move even higher to compensate for the new inflation. By suppressing rates, governments are creating the same problems found when price controls are implemented, they are just able to keep this imbalance going on for much longer because they can keep printing more and more supply whereas producers can’t just print more goods, and they especially can’t do so for free the way the government can make money for free. But while the government can postpone the negative consequences of interest rate controls longer than a producer could weather price controls because of their unique ability to print money, eventually the outcome will be the same: worse than if they never did it.
So, just to summarize, the main themes of this book are, one, to consider all the second order and long-term consequences of economic actions, including those that never occur because of the first order consequences, and, two, controlling elements of the market like prices, wages, or interest rates only leads to more problems. Imbalances are the market’s way of telling us something needs to be fixed and suppressing that or attempting to temporarily mask it with an arbitrary fixed price, wage, or rate will only delay and exacerbate the problem.