By Henry Hazlitt The Freeman. February 1971. (Irvington-on-Hudson, NY: The Foundation for Economic Education). Edited by Hilton Ratcliffe.

From the beginning of history sincere reformers as well as demagogues have sought to abolish or at least to alleviate poverty through state action. In most cases their proposed remedies have only served to make the problem worse. The most frequent and popular of these proposed remedies has been the simple one of seizing from the rich to give to the poor. This remedy has taken a thousand different forms, but they all come down to this. The wealth is to be “shared,” to be “redistributed,” to be “equalized.” In fact, in the minds of many reformers it is not poverty that is the chief evil but inequality.

These direct redistribution schemes (including “land reform” and “the guaranteed income”) are so immediately relevant to the problem of poverty that they warrant separate treatment. Here I must content myself with reminding the reader that all schemes for redistributing or equalizing incomes or wealth must undermine or destroy incentives at both ends of the economic scale. They must reduce or abolish the incentives of the unskilled and shiftless to improve their condition by their own efforts, and even the able and industrious will see little point in earning anything beyond what they are allowed to keep. These redistribution schemes must inevitably reduce the size of the pie to be redistributed. They can only level down. Their long-run effect must be to reduce production and lead toward national impoverishment.

The problem we face here is that the false remedies for poverty are almost infinite in number. An attempt at a thorough refutation of any single one of them would run to disproportionate length. But some of these false remedies are so widely regarded as real cures or mitigations of poverty that if I do not refer to them, I may be accused of having undertaken a comprehensive analysis of the remedies for poverty while ignoring some of the most obvious. What I shall do, as a compromise, is to take up some of the more popular of the alleged remedies for poverty and indicate briefly in each case the nature of their shortcomings or the chief fallacies involved in them.[11]

Unions and Strikes

The most widely practiced “remedy” for low incomes in the last two centuries has been the formation of monopolistic labor unions and the use of the strike threat. In nearly every country today this has been made possible to its present extent by government policies that permit and encourage coercive union tactics and inhibit or restrict counteractions by employers. As a result of union exclusiveness, of deliberate inefficiency, of featherbedding, of disruptive strikes and strike-threats, the long-run effect of customary union policies has been to discourage capital investment and to make the average real wage of the whole body of workers lower, and not higher, than it would otherwise have been.

Nearly all of these customary union policies have been dishearteningly shortsighted. When unions insist on the employment of men that are not necessary to do a job (requiring unneeded firemen on Diesel locomotives; forbidding the gang size of dock workers to be reduced below, say, 20 men no matter what the size of the task; demanding that a newspaper’s own printers must duplicate advertising copy that comes in already set in type, etc.) the result may be to preserve or create a few more jobs for specific men in the short run, but only at the cost of making impossible the creation of an equivalent or greater number of more productive jobs for others.

The same criticism applies to the age-old union policy of opposing the use of labor-saving machinery. Labour-saving machinery is only installed when it promises to reduce production costs. When it does that, it either reduces prices and leads to increased production and sales of the commodity being produced, or it makes more profits available for increased reinvestment in other production. In either case its long-run effect is to substitute more productive jobs for the less productive jobs it eliminates. Yet as late as 1970, a book appeared by a writer who enjoys an exalted reputation as an economist in some quarters, opposing the introduction of labour-saving machines in the underdeveloped countries on the ground that they “decrease the demand for labour”![12]

The natural conclusion from this would be that the way to maximize jobs is to make all labour as inefficient and unproductive as possible.

Overtime Rates

A similar judgment must be passed on all “spread-the-work” schemes. The existing Federal Wage-Hour Law has been on the books for many years. It provides that the employer must pay a 50 per cent penalty overtime rate for all hours that an employee works in excess of 40 a week, no matter how high the employee’s regular hourly rate of pay.

This provision was inserted at the insistence of the unions. Its purpose was to make it so costly for the employer to work men overtime that he would be obliged to take on additional workers. Experience shows that the provision has in fact had the effect of narrowly restricting the length of the working week. In the ten-year period, 1960 to 1969 inclusive, the average annual workweek in manufacturing varied only between a low of 39.7 hours in 1960 and a high of 41.3 hours in 1966.

Even monthly changes do not show much variation. The lowest average working week in manufacturing in the fourteen months from June, 1969 to July, 1970 was 39.7 hours and the highest was 41 hours. But it does not follow that the hour-restriction either created more long-term jobs or yielded higher total payrolls than would have existed without the compulsory 50 per cent overtime rate. No doubt in isolated cases more men have been employed than would otherwise have been. But the chief effect of the overtime law has been to raise production costs. Firms already working full standard time often have to refuse new orders because they cannot afford to pay the penalty overtime necessary to fill those orders. They cannot afford to take on new employees to meet what may be only a temporarily higher demand because they may also have to install an equivalent number of additional machines.

Higher production costs mean higher prices. They must therefore mean narrowed markets and smaller sales. They mean that fewer goods and services are produced. In the long run the interests of the whole body of workers must be adversely affected by compulsory overtime penalties. All this is not to argue that there ought to be a longer workweek, but rather that the length of the work week, and the scale of overtime rates, ought to be left to voluntary agreement between individual workers or unions and their employers. In any case, legal restrictions on the length of the working week cannot in the long run increase the number of jobs. To the extent that they can do that in the short run, it must necessarily be at the expense of production and of the real income of the whole body of workers.

Minimum Wage Laws

 

This brings us to the subject of minimum-wage laws. It is profoundly discouraging that in the second half of the twentieth century, in what is supposed to be an age of great economic sophistication, the United States should have such laws on its books, and that it should still be necessary to protest against a nostrum so futile and mischievous. It hurts most the very marginal workers it is designed to help.

I can only repeat what I have written in another place.[13] When a law exists that no one is to be paid less than $64 for a 40-hour week, then no one whose services are not worth $64 a week to an employer will be employed at all. We cannot make a man worth a given amount by making it illegal for anyone to offer him less. We merely deprive him of the right to earn the amount that his abilities and opportunities would permit him to earn, while we deprive the community of the moderate services he is capable of rendering. In brief, for a low wage we substitute unemployment.

But I cannot devote more space to this subject here. I refer the reader to the careful reasoning and statistical studies of such eminent economists as Professors Yale Brozen, Arthur Burns, Milton Friedman, Gottfried Haberler, and James Tobin, who have emphasized, for example, how much our continually rising legal minimum wage requirements have increased unemployment in recent years, especially among teen-aged Negroes.

The Mounting Burden of Welfare Plans and Taxes

 

In the last generation there has been enacted in almost every major country of the world a whole sackful of “social” measures, most of them having the ostensible purpose of “helping the poor” in one respect or another. These include not only direct relief, but unemployment benefits, old-age benefits, sickness benefits, food subsidies, rent subsidies, farm subsidies, veterans’ subsidies—in seemingly endless profusion. Many people receive not only one but many of these subsidies. The programs often overlap and duplicate each other.

What is their net effect? All of them must be paid for by that chronically forgotten man, the taxpayer. In perhaps half the cases, Paul is in effect taxed to pay for his own benefits, and gains nothing on net balance (except that he is forced to spend his earned money in other directions than he himself would have chosen). In the remaining cases, Peter is forced to pay for Paul’s benefits. When any one of these schemes, or a further expansion of it, is being proposed, its political sponsors always dwell on what a generous and compassionate government should pay to Paul; they neglect to mention that this additional money must be seized from Peter. In order that Paul may receive the equivalent of more than he earns, Peter must be allowed to keep less than he earns.

The mounting burden of taxation not only undermines individual incentives to increased work and earnings, but in a score of ways discourages capital accumulation and distorts, un-balances, and shrinks production. Total real wealth and income is made smaller than it would otherwise be. On net balance there is more poverty rather than less.

But increased taxation is so unpopular that most of these “social” handout schemes are originally enacted without enough increased taxation to pay for them. The result is chronic government deficits, paid for by the issuance of additional paper money. And this has led in the last quarter-century to the constant depreciation of the purchasing power of practically every currency in the world. All creditors, including the buyers of government bonds, insurance policy holders, and the depositors in savings banks, are systematically cheated. Once more the chief victims are the working and saving families with moderate incomes. Yet everywhere this monetary inflation, eventually so disruptive and ruinous to orderly balanced production, is rationalized by politicians and even by putative economists as necessary for “full employment” and “economic growth.” The truth is that if this monetary inflation is persisted in, it can only lead to economic disaster.

Price and Wage Controls

 

Many of the very people who originally advocate inflation (or the policies which inevitably lead to it), when they see its consequences of raising prices and money wages, propose to cure the situation, not by halting the inflation, but by having the government impose price and wage controls. But all such attempts to suppress the symptoms enormously increase the harm done. Price and wage controls, to precisely the extent that they can be made temporarily effective, only distort, disrupt, and reduce production—again leading toward impoverishment.

Yet here again, as with the other false remedies for poverty, it would be an unjustifiable digression to spell out in detail all the fallacies and evil consequences of special subsidies, improvident government spending, deficit financing, monetary inflation, and price-and-wage controls. I have myself dealt with these subjects in two previous books: The Failure of the New Economics[14] and What You Should Know About Inflation;[15] and there is, of course, an extensive literature on the subject. The chief point to be reiterated here is that these policies do not help to cure poverty.

Another false remedy for poverty is the progressive income tax, as well as a very heavy burden of capital-gains taxes, inheritance taxes, and corporate income taxes. All of these have the effect of discouraging production, investment, and capital accumulation. To that extent they must prolong rather than cure poverty.

Outright Socialism

 

We come now to the final false remedy for poverty to be considered in this article—outright socialism. Now the word “socialism” is loosely used to refer to at least two distinct proposals, usually but not necessarily tied together in the minds of the proposers. One of these is the redistribution of wealth or income—if not to make incomes equal, at least to make them much more nearly equal than they are in a market economy. But the majority of those who propose this objective today think that it can be achieved by retaining the mechanisms of private enterprise and then taxing the bigger incomes to subsidize the smaller incomes.

By “outright socialism” I refer to the Marxist proposal for “the public ownership and control of the means of production.”

Now one of the most striking differences between the 1970’s and the 1950’s, or even the 1920’s, is the rise in the political popularity of Socialism Two—the redistribution of income—and the decline in the political popularity of Socialism One—government ownership and management. The reason is that the latter, in the last half-century, has been so widely tried. Particularly in Europe there is now a long history of government ownership and management of such “public utilities” as the railroads, the electric light and power industries, the telegraph and telephone. And everywhere the history has been much the same—deficits practically always, and in the main poor service compared with what private enterprise supplied. The mail service, a government monopoly nearly everywhere, is also nearly everywhere notorious for its deficits, inefficiency, and inertia. (The contrast with the performance of “private” industry is often blurred, however, in the United States, for example, by the slow strangulation of the railroads, telephone, and power companies by government regulation and harassment.)

As a result of this history, most of the socialist parties in Europe find that they can no longer attract votes by promising to nationalize even more industries. But what is still not recognized by the socialists, by the public, or even by more than a small minority of economists, is that present government ownership and management of industries, not only in “capitalist” Europe but even in Soviet Russia, works only as well as it does because it is parasitic for accounting on the world market prices established by private enterprise.

Too Much Taken for Granted

 

We are so accustomed to the miracle of private enterprise that we habitually take it for granted. But how does private industry solve the incredibly complex problem of turning out tens of thousands of different goods and services in the proportions in which they are wanted by the public? How does it decide how many loaves of bread to produce and how many overcoats, how many hammers and how many houses, how many pins and how many Pontiacs, how many teaspoons and how many telephones? And how does it decide the no less difficult problem of which are the most economical and efficient methods of producing these goods? It solves these problems through the institutions of private property, the free market, and the existence of money—through the interrelations of supply and demand, costs and prices, profits and losses. When shoes are in deficient supply compared with the marginal cost of producing them, their price, and therefore the margin of profit in producing them, will increase in relation to the price and margin of profit in producing other things. Therefore, the existing producers will turn out more shoes, and perhaps new producers will order machinery to make them. When the new supply catches up with existing demand, the price of shoes, and the profit of making them, will fall; the supply will no longer be increased. When hats go out of fashion and fewer are worn, the price will decline, and some may remain unsalable. Fewer hats will be made. Some producers will go out of business, and the previous labor and salvageable capital devoted to producing hats will be forced into other lines. Thus, there will be a constant tendency toward equalization of profit margins (comparative risks considered) in all lines. These yearly, seasonal, or daily changes in supply and demand, cost and price, and comparative profit margins, will tend to maintain a delicate but constantly changing balance in the production of the tens of thousands of different services and commodities in the proportions in which consumers demand them.

The Competitive Role

 

The same guide of comparative money prices and profits will also decide the kinds and proportions of capital goods that are turned out, as well as which one of hundreds of different possible methods of production is adopted in each case.

In addition, within each industry as well as between industries, competition will be taking place. Each producer will not only be trying to turn out a better product than his competitors, a product more likely to appeal to buyers, but he will also be trying to reduce his cost of production as low as he possibly can in order to increase his margin of profit—or perhaps even, if his costs are already higher than average, to meet his competition and stay in business. This means that competition always tends to bring about the least-cost method of production—in other words, the most economical and efficient method of production.

Those who are most successful in this competition will acquire more capital to increase their production still further; those who are least successful will be forced out of the field. So capitalist production tends constantly to be drawn into the hands of the most efficient.

But how can this appallingly complex problem of supplying goods in the proportions in which consumers want them, and with the most economical production methods, be solved if the institutions of capitalism—private ownership, competition, free markets, money, prices, profits and losses—do not exist?

The Baffling Problem of Economic Calculation

 

Suppose that all property—at least in the means of production—is taken over by the state, and that banks and money and credit are abolished as vicious capitalist institutions; how is the government to solve the problem of what goods and services to produce, of what qualities, in what proportions, in what localities, and by what technological methods?

There cannot, let us keep in mind, be a hundred or a thousand different decisions by as many different bureaucrats, with each allowed to decide independently how much of one given product must be made. The available amount of land, capital, and labor is always limited. The factors of production needed to make A are therefore not available for B or C; and so on. So there must be a single unified overall decision, with the relative amounts and proportions to be made of each commodity all planned in advance in relation to all the others, and with the factors of production all allocated in the corresponding proportions.

So there must be only one Master Production Plan. This could conceivably be adopted by a series of majority votes in a parliament, but in practice, to stop interminable debate and to get anything done, the broad decisions would be made by a small handful of men, and the detailed execution would probably be turned over to one Master Director who had the final word. How would he go about solving his problem?

We must keep in mind that without free competitive markets, money, and money-prices, he would be helpless. He would know, of course (if the seizure of the means of production has only recently occurred), that people under a capitalist system lived in a certain number of houses of various qualities, wore a certain amount of clothing consisting of such and such items and qualities, ate a certain amount of food consisting of such and such meats, dairy products, grains, vegetables, nuts, fruits, and beverages. The director could simply try to continue this pre-existing mix indefinitely. But then his decisions would be completely parasitic on the previous capitalism, and he would produce and perpetuate a completely stationary or stagnant economy. If such an imitative socialism had been put into effect in, say, the France of 1870, or even of 1770, or 1670, and France had been cut off from foreign contacts, the economy of France would still be producing the same type and per capita quantity of goods and services, and by the same antiquated methods, as those that had existed in 1870, or even in 1770, or 1670, or whatever the initial year of socialization. It is altogether probable that even if such a slavishly imitative production schedule were deliberately adopted it would overlook thousands of miscellaneous small items, many of them essential, because some bureaucrat had neglected to put them into the schedule. This has happened time and again in Soviet Russia.

What Shall Be Produced?

 

But let us assume that all these problems are somehow solved. How would the socialist Planners go about trying to improve on capitalist production? Suppose they decided to increase the quantity and quality of family housing. As total production is necessarily limited by existing technological knowledge and capital equipment, they could transfer land, capital, and labor to the production of more such housing only at the cost of producing less food, or less clothing, or fewer hospitals, or schools, or cars, or roads, or less of something else. How could they decide what was to be sacrificed? How would they fix the new commodity proportions?

But putting aside even this formidable problem, how would the Planners decide what machines to design, what capital goods to make, what technological methods to use, and at what localities, to produce the consumers’ goods they wanted and in the proportions they wanted them?

This is not primarily a technological question, but an economic one. The purpose of economic life, the purpose of producing anything, is to increase human satisfactions, to increase human wellbeing. In a capitalist system, if people are not willing to pay at least as much for the consumer goods that have been produced as was paid for the labour, land, capital equipment, and raw materials that were used to produce them, it is a sign that production has been misdirected and that some of these productive factors have been wasted. There has been a net decrease in economic well-being instead of an increase.

There are many feasible methods—crucible, Bessemer, open hearth, electric furnace, basic oxygen process—of making steel from iron. In fact, there are today a thousand technically feasible ways of making almost anything out of almost anything. In a private enterprise system, what decides which method will be used at a given place and time is a comparison of prospective costs.

And this necessarily means costs in terms of money. In order to compare the economic efficiency of one productive method with another the methods must be reduced to some common denominator. Otherwise numerical comparison and calculation are impossible. In a market system this common denominator is achieved by comparisons in terms of money and of prices stated in money. It is only by this means that society can determine whether a given commodity is being produced at a profit or a loss, or at what comparative profits or losses any number of different commodities are being produced.

“Playing” Capitalism

 

In recent years even the most doctrinaire communist countries have become aware of this. They are going to be guided hereafter, they say, by profit and loss. An industry must be profitable to justify itself. So they fix money-prices for everything and measure profit and loss in monetary terms. But this is merely “playing” free markets. This is “playing” capitalism. This imitation is the unintended flattery that the communists now pay to the system they still ostensibly reject and denounce.

But the reason why this mock-market system has so far proved so disappointing is that the communist governments do not know how to fix prices. They have achieved whatever success they have had when they have simply used the quotations they found already existing for international commodities in the speculative markets—i.e., in the capitalist markets—in the Western world. But there are a limited number of such grains and raw materials with international markets. In any case, their prices change daily, and are always for specific grades at specific locations.

In trying to fix prices for commodities and the multitudinous objects not quoted on these international markets the communist countries are at sea. The Marxist labor theory of value is false and therefore useless to them. We cannot measure the value of anything by the number of hours of “labour-time” put into it. There are enormous differences in the skill, quality, and productivity of different people’s labour. Nor can we, as suggested by some Soviet economists, base prices on “actual costs of production.” Costs of production are themselves prices—the prices of raw materials, of factories and machinery, rent, interest, the wages of labour, and so on.

Our Differences Guide Us

 

And nowhere, in a free market, are prices for long exactly equal to costs of production. It is precisely the differences between prices and costs of production that are constantly, in a free market economy, redirecting and changing the balance of production as among thousands of different commodities and services. In industries where prices are well above marginal costs of production, there will be a great incentive to increase output, as well as increased means to do it. In industries where prices fall below marginal costs of production, output must shrink. Everywhere supply will keep adjusting itself to demand.

Where prices have been set arbitrarily, real profits and losses cannot be determined. If I am a commissar in charge of an automobile factory, and do not own the money I pay out, and you are a commissar in charge of a steel plant, and do not own the steel you sell or retain the money you sell it for, and we are each ordered to show a profit, the first thing each of us will do is to appeal to the Central Planning Board to set an advantageous price (to him) for steel and for automobiles. As an automobile commissar, I will want the price of the cars I sell to be set as high as possible, and the price of the steel I buy to be set as low as possible, so that my own “profit” record will look good or my bonus will be fixed high. But as a steel commissar, you will want the selling price of your steel to be fixed as high as possible, and your own cost prices to be fixed low, for the same reason. But when prices are thus fixed blindly, politically, and arbitrarily, who will know what any industry’s real profits or losses (as distinguished from its nominal bookkeeping profits or losses) have been?

Decentralized Chaos

 

The problems of centralized direction of an economy are so insuperable that in socialist countries there are periodically experiments in decentralization. But in an economy only half free—that is, in an economy in which every factory is free to decide how much to produce of what, but in which the basic prices, wages, rents, and interest rates are blindly fixed or guessed at by the sole ultimate owner of the means of production, the state—a decentralized system could quickly become even more chaotic than a centralized one. If finished products m, n, o, p, and so on are made from raw materials a, b, c, d, and so on in various combinations and proportions, how can the individual producers of the raw materials know how much of each to produce, and at what rate, unless they know how much the producers of the finished products plan to produce of the latter, how much raw materials they are going to need, and just when they are going to need them? And how can the individual producer of raw material a or of finished product m know how much of it to produce unless he knows how much of that raw material or finished product others in his line are planning to produce, as well as relatively how much ultimate consumers are going to want or demand?

An economic system without private property and free-market price guides must be chaotic. In a communistic system, centralized or decentralized, there will always be unbalanced and unmatched production, shortages of this and unusable surpluses of that, duplications, bottlenecks, time lags, inefficiency, and appalling waste.

In brief, socialism is incapable of solving the incredibly complicated problem of economic calculation. That problem can be solved only by capitalism.[16]

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[11] I have examined most of these schemes in more detail elsewhere (chiefly in my Economics in One Lesson and in Man vs. the Welfare State) and must refer the interested reader to these and other sources for more extended discussion.

[12] Gunnar Myrdal, The Challenge of World Poverty (Pantheon Books, 1970), pp. 400–401 and passim.

[13] Man vs. the Welfare State (Arlington House, 1969), pp. 23–25.

[14] (Princeton: D. Van Nostrand, 1959.)

[15] (Princeton: D. Van Nostrand, 1960, 1965.)

[16] For a fuller discussion of the problem of economic calculation, see my novel, Time Will Run Back (originally published by Appleton-Century-Crofts in 1951 as The Great Idea, and republished under the new title by Arlington House in 1966). And see especially the discussion by the great seminal thinker who has done more than any other to make other economists aware of the existence, nature, and extent of the problem, Ludwig von Mises, in his Socialism: An Analysis (London: Jonathan Cape, 1936, 1951, 1953, 1969), and in his Human Action (Chicago: Henry Regnery, third revised edition, 1963), pp. 200–231 and 698–715. See also Collectivist Economic Planning, edited by F. A. Hayek (London: George Routledge, 1935), and Economic Calculation in the Socialist Society, by T. J. B. Hoff (London: William Hodge, 1949).

 

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