Economics in One Lesson Part 3

 Chapter XX Do Unions Really Raise Wages?

"Wages are basically determined by labor productivity." In other words, wages are simply another manifestation of the law of supply and demand. Employers demand productive employees. The supply can fluctuate, but employers must either pay competitive wages or put up with sub par employees while their competitors get better, more efficient employees. 

"Emotional economics has given birth to theories that calm examination cannot justify. One of these is the idea that labor is being "underpaid" generally. This would be analogous to the notion that in a free market prices in general are chronically too low." I loved this quote for the phrase, 'emotional economics' which I do recognize as a problem all too often. 

Hazlitt offers an example as to why unions don't raise real wages. He gives several groups, and assumes they all unions, to different levels of effectiveness. One group succeeds in raising their wages 50%, one group 40%, one 30%, one 20%, one 10%, and one group gains no extra wages. So the last group is no better off and no worse off, while many get more money. Not bad, right? Except that, as discussed in earlier chapters, that money, or better thought of as value, must come from somewhere, which eventually will be manifest in cost of living. With an average raise in wages of 25%, cost of living will catch up to an equal 25% increase. Not too bad for the group that got a 50% increase in wages. Pretty terrible for the group that got none. 

Some like to dream of a utopia where a raise in wages comes exclusively out of the profits of the higher ups in the company. This fantasy doesn't work for a couple of reasons. I recently saw an example where someone took the total yearly income of the CEO of Starbucks, millions of dollars. What excess, how unfair! But if you took every penny of it and distributed it to all Starbucks employees equally, they'd all get a $0.42/week raise. Not exactly life changing. And suppose we do something like that, shrink CEO profits down to what we think is "fair", not so high above workers. Then the incentive to invest in that company tanks. Employees don't get new equipment, remodels, new uniforms, and eventually it becomes a terrible place to work. 

Many union policies operate "under the assumption that there is just a fixed amount of work to be done, a definite "job fund" which has to be spread over as many people and hours as possible so as not to use it up to soon." This is untrue. "Work creates work". Timely and efficient completion of a project invites further projects and further investors. These types of policies reduce productivity, and as explained at the beginning of the chapter, "wages are basically determined by labor productivity." 

Chapter XXI Enough to Buy Back the Product

Some people, ("amateur economist") seek a world of "just" (meaning fair) wages. But as Thomas Sowell explains so well in his book The Quest for Cosmic Justice, finding what is "fair" is not an easy task for mere mortals. And Hazlitt argues that "functional" wages are a much better goal. Functional wages are "those that tend to bring about the highest volume of employment and the largest real payrolls." This idea has been corrupted by Marxists to mean that workers should make enough money to buy back the thing they produce. However, as they are paid more in order to have the purchasing power to buy what they produce, "In an exchange economy, everybody's money income is somebody else's cost." We have already covered in an earlier chapter the effects of artificially raising minimum wage, and similar effects apply here. When you mess with the equilibrium of the economy, it ripples out and corrects itself. 

"The best prices are not the highest prices, but eh prices that encourage the largest volume of production and the largest volume of sales. The best wage rates for labor are not the highest wage rates, but the wage rates that permit full production, full employment and the largest sustained payrolls. The best profits, from the standpoint not only of industry but of labor, are not the lowest profits, but the profits that encourage most people to become employers or to provide more employment that before. 

If we try to run the economy for the benefit of a single group or class, we shall injure or destroy all groups, including the members of the very class for whose benefit we have been trying to run it. We must run the economy for everybody." 

Chapter XXII The Function of Profits

"The indignation shown by many people today at the mention of the very word profits indicates how little understanding there is of the vital function that profits play in our economy."

Much of what is important in this chapter has already been discussed. The above example of the CEO of Starbucks applies. Profit incentives determine where investments go. Where investments go, labor and production go. Profits encourage efficiency in production which means more product available to more people. The promise of profits must outweigh the risk of loss, which is why government price fixing is so terrible, another point that has already been discussed. Profits are good for consumers because investors compete to make consumers happy in order to get profits. No profits, no one competing to make you happy. 

Chapter XXIII The Mirage of Inflation

Inflation is tantalizing because people often confuse money with wealth. If you won a million dollars, you would certainly feel more wealthy. Even if your cost of living rose so much that you couldn't really buy anything that wouldn't have been able to afford before, you'd feel rich. But you wouldn't be materially any better off, you might have a higher number in you bank account, but you wouldn't be any wealthier. This distinction is vital. If we doubled the money supply, but doubling everyone's bank account, they wouldn't actually be able to buy twice as much stuff unless suddenly twice as much stuff is produced. 

Inflation is often associated with war, when governments increase the money supply rather than raising taxes in order not to decrease support for the war. DOD contractors are first to get this extra money, and their purchasing power is increased. The people of receive the increase spending of these first beneficiaries can raise prices and become the second beneficiaries, and so on and so on. But by the time this extra money spreads out to reach more people, the cost of living as risen too, as the law of supply and demand reaches a new equilibrium. The people at the bottom receive the same raise in cost of living, while receiving a smaller amount of the extra money. It's trickle down economics of the worst kind. When their wages have finally risen by the same amount as the higher levels, it is too late for them. "It will never compensate for its losses during the period when its income and prices had not risen at all, though it had to pay up to 30 percent more for the good and services it bought from the other producing groups in the community." 

We discussed how the price system is how we communicate the intricacies of price and demand. Inflation messes with this communication and things get lost in translation, leading to misallocation of investment funds and waste of capital. However, it is sometimes this very confusion of all economic processes that makes inflation appealing to those in charge, as it can obscure the negative impacts of their planned economy policies. 

Politicians sometimes try to control the inflation, but it can't be done. The value of money isn't inherent in the paper, especially since we left the gold standard. The value of your money depends on your faith in the money, it's soundness and salability (see The Bitcoin Standard). How much money is valued in the present depends on how much you think it will be worth in the future. "All this explains why, when hyperinflation has once set in, the value of the monetary unit drops at a far faster rate than the quantity of money either is or can be increased." Once you see the dollar tanking, no one wants dollars anymore. Inflation is a tax not on your expenditures, it is a tax on your savings. It is "a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man." 

"It discourages all prudence and thrift. It encourages squandering, gambling, and reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusionment and collapse."

Chapter XXIV The Assault on Saving

Keynesians take Hazlitt's above point about the best wages, the best profits, etc., and correctly see that this requires circulation. It's like when we did economic shutdowns in 2020 and just gave people a bunch of money. But they had fewer places to spend it and couldn't work to produce things for people to buy. It was like a circulatory system that we kept adding blood to, but it wasn't pumping. Keynesians mistakenly apply this to say that saving money is bad, because it takes money out of circulation. The discourage saving with inflation and low interest rates. An example from Bastiat to refute this uses two brothers, each inheriting an estate that provides an income of $50,000 a year. Brother A spends and spreads around the wealth. He tips well, parties, people love him for it. He diminishes his capital to increase his spending, but that's good, right? Saving bad, spending good? Then there's Brother B. He is thrifty. He has income left over at the end of each year, which he reinvests into his capital, resulting in more income and more savings. Bad Benjamin, that money could have been put to use! Except that it was! Assuming Brother B didn't amas his fortune under his mattress or in buried coffee cans, the bank put that money to good use. It was used to start new businesses and build new houses. It was used to improve people's situation in a way that they couldn't have done without help and then paid back so Brother B or his progeny could spend it again. There is also the hedge against disaster, as we learn well from Joseph in Egypt convincing Pharaoh to save food. It might have seemed awfully wasteful at the time, but when it was available when needed it was obviously a prudent blessing.

I mentioned keeping interest rates low to encourage spending and discourage savings. This has a similar effect as when any prices are kept artificially low. Increased demand and reduced supply of loans. By discouraging savings, there is less to loan, which is fixed by new injections of money (inflation) which creates an illusion of more capital and leads to mismanaged investments, as the resulting inflation obscures the communication of supply and demand via prices.

This all parallels what Saifedean Ammous talks about in The Bitcoin Standard when he discusses Time Preference and how, contrary to Keynesian interpretation, savings (low time preference) benefits individuals and society as a whole. 

Chapter XXV The Lesson Restated

The economy is a complex system. There is often a small part of the system that seems unfair or even dangerous, but to reach forth a hand to fix it is to inadvertently affect all other areas of the system, often in disastrous ways. The summary in the chapter reminded me of the little part of Bastiat that I started reading about two years ago. We are all producers (we earn) and we are all consumers (we spend). In our role as producers we want high prices and in our role as consumer we want low prices. It depends on what hat we are wearing at the time. When we view the entire system we can see that a plus on one side equals a minus on the other. Hazlitt quotes from William Graham Sumner about the Forgotten Man. A sees a problem that is bothering X and talks it over with B. A and B propose a law to help X. Poor C never enters into the equation, even though he will finance this law in one way or another. "It is C, the Forgotten Man, who is always called upon to stanch the politician's bleeding heart by paying for his vicarious generosity." 

Part III The Lesson After Thirty Years

Although the book was originally written in 1946, it was revised in 1978, as is evidenced by the inclusion throughout the book of real life examples after 1946. Hazlitt bemoans the fact that the one lesson does not appear to have had much affect, and talks about the US deficit "soaring" to $49 billion. If only he could see that we've reached $30 trillion in debt, I'm sure he'd have some things to say. He touches on a proposal in the 1970s for a UBI, although that wasn't what it was called at the time. "It would be hard to imagine a plan more clearly calculated to discourage work and production and eventually to impoverish everybody." He also criticizes the ending of the gold standard and Social Security. He explains how, whatever good intentions it began with, SS because a beast of it's own mind that could not be controlled. It grew so far out of hand that in 1977 the unfunded liabilities reached $4.1 trillion. I laughed at the way he put 'trillion' in italics, again imagining what he'd think of the current state of things. He basically describes how SS is a ponzi scheme without using that word. Maybe that word didn't exist yet, IDK. And yet it is political suicide to cut back SS, as so many people depend on it. A final quote to sum up the spirit of the book. "Practically all government attempts to redistribute wealth and income tend to smother productive incentives and lead toward general impoverishment. It is the proper sphere of government to create and enforce a framework of law that prohibits force and fraud. But it must refrain from specific economic interventions. Government's main economic function is to encourage and preserve a free market."