Economics in Two Lessons: Draft Preface

Over the page, the draft preface for my book-in-progress, Economics in Two Lessons

I got some great comments first time round, but I can see it would be easier if I presented my drafts in a more orderly fashion, though not necessarily sequential. So, I’ll begin at the beginning. Comments, both critical and favorable, much appreciated.

As the name implies, this book is a response to Henry Hazlitt’s Economics in One Lesson, a defence of free-market economics first published in 1946. But why respond to a 70-year old book when new books on economics are published every day? And why two lessons instead of one?

The first question was one that naturally occurred to me when Seth Ditchik, my publisher at Princeton University Press suggested this project. It turns out that Economics in One Lesson has been in print continuously since its first publication and has now sold more than a million copies.

Both where he was right, and where he was wrong, Hazlitt’s arguments remain relevant today, and have not been substantially improved on by today’s advocates of the free market. Indeed, precisely because he was writing at a time when support for free markets was at a particularly low ebb, Hazlitt gave a simpler and sharper presentation of the case then many of his successors.

Hazlitt, as he makes clear, was simply reworking the classic defence of free markets by the French writer Frédéric Bastiat, whose 1850 pamphlets ‘The Law’ and ‘What is Seen and What is Unseen’ form the basis of much of Economics in One Lesson. However, Hazlitt extends Bastiat by including a critique of the Keynesian economic model developed in response to the Great Depression of the 1930s.

Hazlitt presented the core of the free-market case in simple terms that have not been improved upon by any subsequent writer. And despite impressive advances in mathematical sophistication and the advent of powerful computer models, the basic questions in economics have not changed much since Hazlitt wrote, nor have the key debates been resolved. So, he may be read just if he was writing today.

Some of the key questions addressed by Hazlitt are:

* Will Keynesian fiscal policies secure full employment?
* Should the government invest more in infrastructure ?
* Do minimum wages benefit workers?
* Can price controls stop inflation ?

Hazlitt answers ’No’ to all these questions. His One Lesson is:

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.

As Hazlitt develops the argument, his meaning becomes clear. The direct benefits of more jobs and public works, higher wages and lower prices are obvious. But these benefits do not come without costs, often borne by groups far removed from the beneficiaries. The true measure of cost is not a money value, but the alternative use to which resources could have been put. In Hazlitt’s words:

Everything … is produced at the expense of foregoing something else.

Economists call this foregone value ‘opportunity cost’. The decision to provide some particular good or service makes us better off if, and only if, its value to us is greater than the opportunity cost involved in its production.
But how does Hazlitt get from the idea of opportunity cost, accepted by nearly all economists, to the conclusion that government intervention in the economy is hardly ever justified? The answer is simple.

Hazlitt assumes that the opportunity cost of any good or service is its market price. So, he infers, any government interference with markets , such as the provision of ‘free’ services, must involve hidden costs that outweigh the immediate benefits.

So we can restate Hazlitt’s Lesson as:

Assuming that market prices are equal to opportunity costs, government interventions that change the market allocation must have opportunity costs that exceed their benefits.

The simplicity of Hazlitt’s argument is his great strength. By tying many complex issues to a single principle, Hazlitt is able to ignore secondary details and go straight to the heart of the free market case against government action. His answer in every case flows from his ‘One Lesson’.

But Hazlitt’s strength is also his weakness. He never spells out the relationship between prices and opportunity costs. As a result, he implicitly assumes that there is a unique market allocation, in which prices equal opportunity costs, and that the two can only differ as a result of government interference. Although he does not say so explicitly, he implies that the existing distribution of income (or rather, the one that would emerge after the policies he dislikes are scrapped) is the only one that is consistent with his One Lesson.

While markets are exceptionally powerful social institutions, they cannot work unless governments establish the necessary framework in which they can operate. The core of the economic framework in a market economy, and a central role of government, is the allocation and legal enforcement of property rights.

The market outcome depends on the system of property rights from which it is derived. In fact (as we will see later) when markets work in the way Hazlitt assumes, any distribution of goods and resources where prices equal opportunity costs can be derived from some system of property rights. So Hazlitt’s Lesson tells us nothing useful about the distribution of income or about government policies that may change that distribution.

An equally important problem is that, despite the then-recent experience of the Great Depression, Hazlitt implicitly assumed that the economy is always at full employment, or would be if not for government and trade union interference. Experience shows that the economy frequently remains in a depression or recession state for years on end. In such a situation, markets don’t properly match supply and demand. This means that prices, and particularly wages, do not, in general, determine opportunity costs.

Finally, there is what economists call ‘market failure’. Even within a market system, and accepting the initial allocation of property rights, a variety of possible problems, such as monopoly, may result in market prices that do not reflect all the relevant opportunity costs for society as a whole.

To understand the central issues in economic policy debates, we need not one lesson, but two. The first lesson, implicit in Hazlitt’s One Lesson is:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.

The second lesson is the product of more than two centuries of study of the way markets work, and the reasons that they often fail to work as they should:

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

Two lessons are harder than one. And thinking in terms of two lessons comes at a cost: we can sustain neither the dogmatic certainty of Hazlitt’s free-market policies nor the reflexive assumption that any economic problem can be solved by government action. In many cases, the right answer will remain elusive, involving a complex mixture of market forces and government policy.

The problem of how markets work and why they fail is at the core of most of the economic policy issues that drive political and social debate. I hope this book, and the two lessons it contains will help to clarify these issues.

38 thoughts on “Economics in Two Lessons: Draft Preface

  1. @Megan

    I think it’s relevant, in the sense that it can be analysed in terms of opportunity cost, although I’m not sure that doing so tells us anything that we couldn’t figure out anyway.

    From the point of view of the individual worker, if there’s a choice in how to spend money, but not enough money to buy both enough food to avoid starvation and adequately safe transport, then the opportunity cost of buying enough food to avoid starvation is the forgoing of adequately safe transport, or, conversely, the opportunity cost of paying for adequately safe transport would be the forgoing of the consumption of sufficient food to avoid starvation.

    From the point of view of the allocation of the resources available in the system as a whole, the opportunity cost of providing adequately safe transport for the employees would be — most likely, I think — the forgoing of the provision of whatever luxuries it may be that the employers are purchasing out of their higher profits. This last part is not entirely clear, because that information hasn’t been provided, but it does suggest the question: what profits are the employers making, and what are they doing with them?

  2. According to the industry association website (GMAC) the sector is Cambodia’s largest and also its primary export.

    They say it employs 700,000 and it’s revenue is $5 Billion.

    I get an average of about $7,100 revenue per worker and a minimum wage of about $1,500 annually.

    It appears than a lot of further profit is gained after export by the corporations owning the labels.

    The ILO is up to its armpits in cahoots with the industry and the government.

  3. @Ed Penington

    I grasp that the allocation of resources to the provision of a haircut for me (for which I paid $20) means those same resources are not allocated to the provision of any of the other things they might have been allocated to, but I am not persuaded that you have sufficient basis for attributing to those resources a value of $20 (independently of their use to provide my $20 haircut).

  4. About 200 global brands and retailers use Cambodian factories.

    They include:

    GAP (2015 sales $16.4B)
    Armani (2014 revenue 2.2B euros)
    Adidas (2014 sales $14.5B)
    H&M (2013 turnover 14.6B euros)

    Many of them also use Bangladeshi factories, and other countries too.

    As I said, I don’t pretend to understand the opportunity cost concept, but is it possible that there simply wouldn’t be an opportunity cost of paying the workers a tiny percentage more of those huge earnings?

  5. Of course, this draft still needs proof reading for typos (e.g. “then” for “than”) and for faulty usages (e.g. “… he may be read just if he was [emphasis added – should be ‘were’] writing today”).

    “As the name implies” is too strong; I would suggest “As the name suggests” (or a synonym, to avoid it occurring too near another instance of the word).

    “In Hazlitt’s words: Everything … is produced at the expense of foregoing something else” should have something to mark off the quotation; without that, it is unclear where the authorial voice resumes.

    “The decision to provide some particular good or service makes us better off if, and only if, its value to us is greater than the opportunity cost involved in its production”; unless “us” is defined appropriately – and consistently – that may not actually be true. That is, some externalities may fall on yet others (e.g., stipulating global warming for the sake of argument, “our [in Australia]” fossil fuel use does that, which is why “we [in Australia]” rationally need not worry much about reducing that). That in turn means that “restat[ing] Hazlitt’s Lesson” really ought also to address Lenin’s celebrated who/whom question.

    “… he implicitly assumes that there is a unique market allocation, in which prices equal opportunity costs, and that the two can only differ as a result of government interference”. I don’t think that is quite correct. It appears to me – though it has been some while since I read it – that he does indeed make implicit assumptions, just not those but rather ones from which those do indeed follow logically, as conclusions; as he does not state that reasoning either, it is easy to suppose that he is assuming the result of his reasoning without realising how he got there. Now, untangling that sort of second order thing is much harder, but I can tentatively suggest that:-

    – he was unaware of externalities and other naturally occurring market imperfections;

    – he knew that individual transactions tend to settle in a micro sort of way;

    – he intuited that such things would aggregate to a macro stabilisation (without benefit of formal frameworks that show that that actually does apply under certain conditions, so he assumed it necessarily followed);

    – he correctly inferred from those (not realising the “ifs” involved) that it would be inconsistent for prices not then to equal opportunity costs, as there would be gains to be made from changes, which would make the situation not an equilibrium; and

    – not knowing any other possible culprits, he blamed any discrepancies from all that on the only culprit he saw in action, government intervention (and he supposed any intervention wrong from his earlier reasoning).

    “While markets are exceptionally powerful social institutions, they cannot work unless governments establish the necessary framework in which they can operate” is not true in general, not unless you so enlarge the concept of government as to make it virtually meaningless for other purposes. For instance, monasteries sponsored fairs in the Middle Ages, with fair authorities operating “piepowder courts” for them. If you rejoin, “well, I meant these days”, that is not a statement about markets but about these days, and the very fact that non-government approaches are not currently viable is not an essential feature but rather a consequence of governmental action itself. As anarchists would put it, these things don’t need governments but governance (and no, I and they would deny that the latter implies and involves the former; I, unlike they, suspect that in due course it would lead to the former given the nature of mankind – unless we come up with something to stop it).

    The same applies to “… despite the then-recent experience of the Great Depression, Hazlitt implicitly assumed that the economy is always at full employment, or would be if not for government and trade union interference”; again, that is not an assumption but a conclusion by unstated reasoning from more fundamental unstated assumptions – pretty much the same set as I covered above, only now with trade unions as well as governments as culprits.

    “… the opportunity costs we [emphasis added] face as a society [emphasis added]” brings in its own assumptions. As Mad magazine famously put it, “what’s this ‘we’, white man?” (Tonto’s reply to the Lone Ranger’s remark about the Indians being about to over-run them); the same applies to “society”. That really must be spelled out somewhere in the book, whether as your personal position held as a credo or as a reasoned conclusion, and the foreword and/or preface must at least foreshadow that that will be provided even if space or other constraints rule it out just there.

  6. The impact of a minimum wage interests me. Of course a min wage that is exorbitant would have to have some impact on overall employment but I would think that employers woukld respond to “modest” minimum wage by flattening the wage structure of their employees. I would also think that a decent minimum wage should have following beneficial impacts:

    – reduce staff turnover
    – improve the social status of the low paid and
    – make employers more interested in training their workforce.

    From what I gather, the social status of blue collar workers in the US, with its extremely low min wages, is much lower than it is in Oz, which last time I checked the figs has one of the highest min wages in the OECD. I imagine that has various significant social ramifications but this is just intuition and I have no evidence to support it.

  7. According to Fairfax the “Shoppies” have done yet another deal with a corporate giant to screw workers (Coles in this case).

    These fascist unions are – deliberately? – becoming the best argument for abolishing collective bargaining.

  8. While this system keeps delivering the goods people will believe in it. Words and arguments against the status quo, or even questioning aspects of it, will continue to be useless under these conditions.

    The questions to be determined in material reality are these. Can this system keep delivering the goods? Can all planetary boundaries (biosphere limits) be ignored indefinitely with impunity?

    The questions to be determined in socioeconomic reality are these. Can income continue to be shifted indefinitely from wages to profits? What are the limits to this process? When will they be reached? What happens then?

  9. @J-D

    Particularly with specialization of labour. For instance, one of those potentially unemployed resources is the skill of the barber. Some of it might transfer to trimming hedges instead of heads, or cutting flowers instead of hairs — but at the same rate of pay?

  10. I think you should be careful about making an entire book on a strawman argument. Rephrasing the argument Hazlett makes as “Assuming that market prices are equal to opportunity costs, government interventions that change the market allocation must have opportunity costs that exceed their benefits.” is a strawman.

    I think you have some things fundamentally wrong and maybe that is specifically to serve your narrative but if you intend on making a serious effort here I’d suggest you stick with discussing what he actually said rather than jumping to what you think are his implicit claims.

    I’m interested in what you may have to say about “market failures” though again I’d caution you stick with reality rather than the hypothetical or strawmen. In particular the hypothetical of a free market monopoly (“…variety of possible problems, such as monopoly, may result in market prices…) and what harm this could do. The reality is there never has been a free market monopoly and in case you want to stretch the definition of monopoly certainly there has not been one that has been harmful to the public. We have monopolies all over and they are all government created and often quite harmful and they go back to steam ships which was a government enforced monopoly which Vanderbilt helped break up despite him commonly being called a monopolist.

    I think the points made by Hazlett are less like absolutes and more like general tendencies within the market. Meaning it is not impossible for a government incentive to be effective but the general tendency is that they are harmful rather than helpful. It seems clear if you study the market crashes there is very often a government hand at work and this certainly seems to exasperate problems in the markets rather than help reduce the consequences of them.

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