Economics in One Lesson

by Henry Hazlitt

  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 in aggregate 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 forgoing 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 are, we shall examine in succeeding chapters.

  Chapter XVI

  “STABILIZING” COMMODITIES

  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 becau
se 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 nonperishable crops remains the same all year round except for an allowance for storage, interest 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 overoptimism 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 value of the 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 carryovers 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 a field to describe in detail what actually happened when this program was applied, for example, to American cotton.1 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.

  2

  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 overpriced 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 bravely to “stabilize” prices and conditions brings incomparably greater instability than the free forces of the market could possibly have brought.

  Yet new international commodity controls are constantly being proposed. This time, we are told, they are going to avoid all the old 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 allocation
s 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 world of superinternational 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.

  1The cotton program has been, however, an especially instructive one. As of August 1, 1956, the cotton carryover mounted to the record figure of 14,529,000 bales, more than a full year’s normal production or consumption. To cope with this, the government changed its program. It decided to buy most of the crop from the growers and immediately offer it for resale at a discount. In order to sell American cotton again in the world market, it made a subsidy payment on cotton exports first of 6 cents a pound, and, in 1961, of 8.5 cents a pound. This policy did succeed in reducing the raw-cotton carryover. But in addition to the losses it imposed on the taxpayers, it put American textiles at a serious competitive disadvantage with foreign textiles in both the domestic and foreign markets. The American government was subsidizing the foreign industry at the expense of the American industry. It is typical of government price-fixing schemes that they escape one undesired consequence only by plunging into another and usually worse one.