Some readers of THE FREEMAN may deem this article a bit elementary for their taste. It was especially written for the forthcoming Jefferson Encyclopedia and is reprinted here by permission of the World Publishing Company of Cleveland, Ohio. Obviously, it is intended for high school students and laymen rather than for specialists in economics. Henry Hazlitt is no layman in his field.
The Failure of the "New Economics," his analysis of the Keynesian fallacies, is the work of a master. Yet, he is not one of the overspecialized specialists of our time. The ever popular Economics in One Lesson reveals his capacity to handle his subject in terms anyone can grasp.
Those of us who presume to specialize do well from time to time to back off and view our field broadly, as in this article, that we may better play our individual roles in the general scheme of things.
Economics is the science that studies how men make their living—how they provide for their material wants.
A Robinson Crusoe, alone on an island, would face a tremendous problem. He would have to find enough fresh water to slack his immediate thirst and then find enough to eat before, say, he could try to build himself some crude shelter. He would have to work to fill his most urgent need up to a certain point before he could try to fill his next most urgent need, and so on.
In a great society this problem, of each man trying to fill a hundred different needs and wants of different urgency, is solved by the division of labor. Each man devotes himself to making a single thing, or even to a single process in making that thing, and then exchanges the product of his labor for the products of other people’s labor.
In a primitive society this exchange is made directly, by barter. In a modern community goods and services are first exchanged for money, and then the money in turn is exchanged for the particular quantities of other things that each man wants.
In origin, money was some commodity that was found to be more generally acceptable than any other, and later came to be wanted mainly as a medium of exchange for other things.
Historically, cattle, tobacco, copper, silver, and gold have served as money. Of these, gold came to be much the most widely used. Except for final payments between nations, however, even gold has now been largely displaced by currency notes, and by bank deposits that can be transferred by checks.
The division of labor, made possible by voluntary exchange, enormously increases the total of goods and services that a community can produce. Each man tends to devote himself to the thing that he can do best. He acquires a special skill, and uses special tools. Generally speaking, the more labor is divided the more productive it is.
In a free enterprise economy people also are constantly seeking to produce the things that yield the highest profit above their cost of production. These are usually the things that are in shortest supply in comparison with the demand for them. But as the supply of these particular things is increased, and the need for more of them becomes less and less urgent, their price tends to fall, and there is less profit in producing them. By this process profits and wages in different lines tend to be more equalized, and the thousands of different goods and services tend to be produced in the proportions in which they are most wanted—in other words, in proportion to the comparative demand for them.
Parts of a Continuous Process
Men must work and produce goods and services in order to be able to enjoy and consume them. Yet they must have their health and strength and enough to eat in order to be able to produce. Production, distribution, and consumption are not, as is often supposed, three separate and independent processes, but inseparable parts of one continuous process.
Men early discovered that they could produce most of the things they wanted only with the help of tools. This meant that they first had to divert part of their time and energies to making such tools—axes, hammers, saws, scissors, needles, hoes, spades, wheels, and thousands of more complicated implements. Then, still further, they had to divert part of their time and energies to making tools to make tools, and then to building the factories and developing the mines and smelters and other processes to obtain the metals to make the machines that make the tools to make tools.
The Importance of Capital
Economists divide goods into two main classes—consumption goods, which are those that directly meet the needs of the people, and capital goods, which are necessary to produce the consumption goods.
A solitary individual would have to divert part of his time to producing capital goods. But with the division of labor in a modern society some people devote themselves wholly to making consumption goods and others wholly to making production goods.
This is made possible, in turn, only by the process of saving and investment. Instead of spending all they earn on immediate consumption or current enjoyment, some people save part of their earnings to invest them, directly or indirectly, in the production of capital goods to increase production in the future. The money they save is lent at interest to producers who use it to pay the workers who make the capital goods during the period required to make these goods and before they can be sold.
The greater the amount of saving and investment in a nation, the more and better the tools and other means of production that can be placed in the hands of workers. Therefore, the more productive the workers can be, the more they can be paid, and the better off the whole society can be.
Individuals are constantly deciding, by the amount of their saving and investment, how much of their income they will devote to immediate consumption and enjoyment, and how much they are willing to sacrifice of their present consumption and enjoyment in order to increase their future income and future consumption and enjoyment.
In recent years a great deal of emphasis has been placed on the need to increase the rate of "economic growth" of a nation—by which is meant the rate of increase of income and production. This rate of economic growth is directly dependent on the rate of saving and capital investment.
In recent times, also, there has been a constant increase in the number of processes of production, formerly performed by hand, that are taken over by machines. This is known as "automation." Ever since this replacement of hand labor by machinery became widely noticeable (beginning as far back as the Industrial Revolution in the middle of the eighteenth century) there have been fears that machines destroy jobs. It is true that machines often destroy old jobs, and may render valueless skills that some workers may have taken a lifetime to acquire. But experience has shown that on net balance machines not only create as many jobs as they destroy, but that they usually create far more productive and better paid jobs than the ones they destroyed. In addition, by reducing costs of production, they enable the masses to afford goods and luxuries previously beyond their reach.
The Conditions of Freedom Versus Coercive Collectivism
A system by which everybody, subject to the competition of others, and guided by the conditions of supply and demand, is free to choose his line of work, or to produce and sell what he wishes, is variously known as a capitalist system, a profit-and-loss system, or a free-enterprise system. Such a system, of course, can be "free" only within limits. It can operate only within a framework of laws which forbid violence, force, theft, and fraud, oblige men to live up to their agreements, and protect the right of private property.
The opposite of a free enterprise system is socialism. Under socialism it is not private individuals or companies but the government that owns the means of production and operates industry. In practically no country of the world today do we find capitalism or socialism in a pure form. In many "capitalist" countries the government operates some industries—the postal service, telegraph and telephones, railroads and electric power, gas and water supply. In nearly all countries where private companies supply such "public utility" services they are subject to strict government regulation of their charges.
Today most governments attempt much more directly than in the past to relieve poverty and prevent widespread unemployment. And all governments now deeply influence the economy of their own country, for good or ill, by their spending, taxation, and monetary policies.