Wealth In One Lesson

permalink         categories: politics         originally posted: 2007-01-05 00:06:09

I'm a big fan of the classic 1946 Henry Hazlitt book Economics In One Lesson. It demonstrates time and again how nearly all departures from laissez-faire economics (aka "government intrusion and regulation of the marketplace") results in the impoverishment of the citizenry. The "one lesson" it teaches from, the "broken window fallacy", is an apt metaphor for most forms of government economic policy.

But in terms of being the "one lesson" that you should use to understand capitalism, I think it slightly overshoots the mark. There is an even more fundamental theory underlying lassiez-faire economics: the theory of wealth. And that requires a slightly different lesson.

The Sale Of The Cow

The theory of wealth is best illustrated through the "one lesson" of The Sale Of The Cow. It goes like this:

Adam has $50. Beth has a cow.
Adam would rather have Beth's cow than $50.
Beth would rather have $50 than her cow.
Adam gives Beth the $50 and Beth gives Adam the cow.
Adam and Beth both walk away pleased with their transaction.

You might think that, at the end of that story, Beth is wealthier and Adam is poorer. That harkens back to a more traditional view of economics called "zero-sum". But this is not a zero-sum transaction—at the end of the story, both Adam and Beth are wealthier.

How could that be? Simple: because they both got what they wanted. Adam preferred Beth's cow to his $50, and Beth preferred $50 to her cow. Obviously Beth is now free to spend the $50 on whatever she likes. As for Adam, perhaps he took the cow back to his restaurant, ground it up, and sold the hamburgers for $500. Perhaps he bred the cow on his ranch and sold the babies for $1000. Perhaps he just likes cows, and feels his life will be enriched with his new pet. It doesn't matter; what matters is that he thinks he's better off having bought the cow. So, from how he judges his own life, he is better off. After all, if he didn't think he'd be better off, he wouldn't have gone through with the transaction!

And that's what wealth is: having what you want. A person with a billion dollars isn't wealthy unless they can spend it. The crucial observation here is that wealth is created through voluntary transactions, rather than something that already exists in the natural world waiting to be taken.

Years ago I read one author who claimed this realization is why the British empire overtook the Spanish one. The Spanish believed the zero-sum theory, that wealth was a thing that already existed. The British were more sophisticated and understood this theory of creating wealth. When the New World was discovered, the Spanish came over here and took the gold they could haul away—but the British came over here and traded. The British got wealthier; all the Spanish did was inflate their money supply and drive up prices.

The Non-Sale Of The Cow

Now let's compare our happy story above with one less-happy, The Non-Sale Of The Cow:

Adam has $50. Beth has a cow.
Adam would rather have Beth's cow than $50.
Beth would rather have $50 than her cow.
But Ira S., the town revenuer, reminds Adam "You owe the government $50."
Adam hands over his $50 to Ira.
Ira uses the $50 to buy nice new streetlamps for the town.
Nobody buys Beth's cow.

This is a less happy story. Instead of having a cow, Adam has the use of the new streetlamps in town. Instead of having $50, Beth has her old cow, and the use of the new lamps in town. Sure, the lamps are nice and all, but Adam and Beth didn't get what they really wanted.

That illustrates why government intervention in the market is always a bad idea. Government intervention is a way of forcing people to change their behavior, into making transactions that they wouldn't have made on their own. We already know that when people left to their own devices will buy and sell to maximize their own happiness. Adam and Beth would have been happier if Ira had left them alone.

Now sure, there are some instances when this seems irrelevant. When government forces you to spends the money in the way you wanted to anyway, or takes the money from you and spends it exactly how you would have, it is merely unneccesary—though again it does this through force, which is both unpleasant and of nonzero cost. If a policeman came along and forced Adam to buy the cow, or if Ira took the money, bought the cow, and gave the cow to Adam, the result is basically the same... although the policeman or Ira somehow expect to be paid for this marvelous service.

But if government spends your money in any other way, it is by definition mis-spending the money, and very pointedly not maximizing your wealth. How should Ira know that Adam wanted a cow, rather than new streetlamps? Yes, perhaps he could have asked. But think about how many other people there are in town, all clamoring for "the government" to spend its money on their pet projects. Ira doesn't have the time to ask everybody, much less to figure out how to spend the money to maximize everyone's happiness. So odds are pretty good he's gonna screw it up.

To summarize this idea: money that government takes from you with taxes and spends is almost guaranteed to be mis-spent, and on balance this practice always impoverishes the nation.

Sensible Government Expenditures

Perhaps you're thinking: surely there are many sensible government regulations of the marketplace. We want the food we buy at the market to be safe to eat, we want to be sure our restaurants are genuinely clean. Would I do away with the FDA and the Board Of Health? Why, as a matter of fact, yes.

After all, if you really want it, you're willing to pay for it. In the case of safe food and clean restaurants, enough people would want that that the market and restaurant would voluntarily pay for a privately-run certification service. They'd then pass those costs on to their customers in the form of slightly higher prices. If you wanted to shop at an uncertified market or eat at an uncertified restaurant, you should be free to do so. (After all, "freedom" is just another way of saying "the right to make your own mistakes".)

The corollary of the rule above is just as important: if you're unwilling to pay for it, then you don't really want it. Many people think "the government" should pay for elaborate projects, presumably by taking money from other people. But in a free-market system many of these projects would never get off the ground—which is actually a very good thing. The town doesn't get its new streetlamps, sure, but maybe the old ones were fine, and keeping them was a lot cheaper!

Which is exactly why it's so important to leave these decisions up to the people themselves, rather than doing it through government. How does the government correctly determine which projects are actually important, and which are irrelevant bunk? This is the biggest question in economics, and the simple answer is that government just can't, not accurately, not ever. Centralized planning of the economy has never and will never work. A free market is far better at maximizing the wealth of its citizens. (Unproven assertions, sure. But proving these assertions was the life's work of Ludwig von Mises and Friedrich Hayek; it is infeasible and ill-advised for me to tackle the proof here.)

And consider this: since the FDA and your local Board Of Health currently monopolizes food and restaurant certification, there is no competition. But when when these functions move to private enterprise, there would be competition, and competition naturally drives quality up and prices down. In other words, when food and restaurant certification moves to the private sector, you will be more certain the food is safe and the restaurant is clean, and this will cost less. (Remember, nothing that government does is free; it's always paid for through the labors of its citizens, one way or another. So you're already paying for this certification. I bet you'd be interested in a cheaper, better service!)

There are very few legitimate uses of government force. Taking your money away from you so it can spend it ostensibly on your behalf certainly isn't one of them.

Wealth Itself

Perhaps you still don't agree that "wealth" is the same thing as "having what you want". Here's one more thought experiment.

Let's say I wave my magic wand, and bam!, now you own a rare painting by Van Gogh worth $3m. Are you wealthy? The correct answer is, "it depends." Unless you're already rich, and a Van Gogh fan, it's dead certain you'd rather have the $3m than the painting. Now, if you sold it, and were able to comfortably spend the proceeds, then sure, you're wealthy.

But what if you've lost at sea, stranded on a desert island? Sure, now you've got this painting. But you'd probably rather have a GPS distress beacon, or a satellite phone, or at least some food and fresh water and a sharp knife. Nope, all you got was that stupid painting. It's hard to think of yourself as being "wealthy" in those circumstances.

What if you've got that painting, but you're in prison for life (maybe for art theft, you dirty crook!). You're not allowed to have any possessions except what they give you (the painting goes into storage), and you can't participate in the market except by proxy. Again I would say that you're not "wealthy"; prison deprives one of nearly all the joy in life.

In order to be "wealthy", you have to either already have what you want, or have the money and freedom to buy what you want.

(What if a revenuer came by and told you "if you sell that painting, we'll take 100% of the proceeds in taxes, under the Magic Wand Disbursed Painting Sales Tax Act Of 2007"?)

Further Reading

There are even unhappier versions of the cow story I could tell. But the best way to explore this topic further is to read Economics In One Lesson. After all, The Non-Sale Of The Cow is almost the same story as "the broken window fallacy", and our esteemed Mr. Hazlitt is going to do a far better job of dissecting the topic than I could ever hope to.

But I have a surprise for you! Economics In One Lesson is available online, here. Happy reading!