Broken Capitalism, Lecture 2

David Gordon

Mises Academy

June 24, 2013

Production Under Capitalism

• In capitalism, the consumers control what is produced.

• Why is this? Business owners are trying to make money. In order to do this, they have to produce what consumers want.

• Mises speaks of the “dollar votes” of consumers and calls the system one of “consumer sovereignty”

Objections

• Don’t rich people have more votes? Yes, but the masses of the people outweigh them. Capitalism is “mass production for the masses.”

• Also, unlike political democracy, products that only a small number of consumers will be produced, if it’s profitable to do so. It isn’t winner-take-all.

More Objections

• Rothbard objected to the phrase “consumer sovereignty.” If the owner of a business doesn’t want to satisfy consumers, he won’t be forced to do so.

• This is true, and Mises was aware of this. The point of the phrase is that business owners who don’t satisfy consumers will lose money. Others will replace them.

Extension of Rule by Consumers

• We can understand how those who produce consumer goods will respond to consumer demand. But what about those who make producers' goods?

• Those who produce consumer goods will demand first-level production goods. They will try to get these at the least cost.

Extension Continued

• The producers of the first level production goods will be trying to meet the demands of those who produce consumer goods.

• The producers of second-level production goods will try to meet the demands of those who produce first level production goods.

• Consumer demand thus determines all production.

A Problem

• Some critics of the free market say that people shouldn’t be motivated exclusively by trying to make money.

• Instead, they should act according to moral standards. E.g., they should always pay workers a living wage, avoid charging high prices for necessities, etc.

Problem Continued

• If businesses act in this way, production will not be responding to consumer demands.

• People who say that businesses shouldn’t seek profit don’t have an alternative criterion.

• Failure to charge market prices will cause surpluses or shortages.

• When Mises points this out, he is not making a value judgment. He is just pointing out what is required for economic calculation.

Consumers and Producers

• Note the difference between consumers and producers. Consumers demand any products they want.

• Producers aim at maximizing monetary income.

• To the extent that producers don’t do this, they are consumers.

Efficiency

• Under capitalism, economic calculation can take place.

• Producers are trying to use production goods in the least costly way.

• When they do this, they settle the question of how production goods with alternative possible uses should be used.

No Other System

• Socialism can’t solve the problem of economic calculation. To solve the problem, you need capitalist market prices.

• There are two kinds of socialism.

• The Russian kind—the government owns everything

• The German kind—the government controls everything, even though private ownership is maintained in form.

No Other System Continued

• Interventionism isn’t a third system.

• The governments regulates certain transactions within a generally free market arrangement.

• The effects of government measures like taxes are determined by the market, not by the government.

Source of Economic Fallacies

• Why do people fail to realize the benefits of the free market?

• Hazlitt gives two reasons: First, some people and groups benefit from interventions.

• These groups hire people to support and publicize their views.

One Lesson

• The second reason is the main theme of Economics in One Lesson.

• People consider only the immediate consequences of a policy or the effects on only some of the people affected by the policy.

One Lesson Continued

• People need to consider the long run consequences of a policy and also the effects on everybody concerned.

• One reason people don’t do this is that it requires “long chains of deductive reasoning.”

• This doesn’t imply that economists are concerned only with the long run. Allconsequences should be considered.

Hülsmann’s Addition

• Guido Hülsmann has added that many economics fallacies result from failing to take account of what would have happened without the policy being considered.

• That is, he is talking about a counterfactual—what would have happened---rather than the long run.

Broken Window

• The broken window fallacy, presented by Bastiat , is well-known.

• A little boy breaks a window. Someone suggests he has really benefited the economy. The shop owner will have to pay for a new window. The glazier will take the money he receives and spend it on something else. Spending will spread through the economy.

More Broken Window

• What is wrong with this? It ignores the fact that if the window hadn’t been broken, the shop owner would have spent the money on something else.

• There is no gain from the broken window, just a different series of transactions.

• In fact, there is a loss because there has been unwanted destruction of resources—the window.

What Kind of Fallacy?

• The broken window is an example of Guido Hülsmann’s counterfactual case, rather ignoring long run consequences.

• It meets the pattern of failing to take account the effect on all groups.

• Guido’s case is a sub-class of this.

Popularity of the Fallacy

• You might think that the fallacy is so obvious no one would commit it, but people do.

• Hazlitt gives the example of people who thought that repairing the destruction of WWII would revive the American economy.

• These people talked about “backed-up demand.” Money had been spent on the military during the war. This money could now be spent on goods that civilians wanted.

The Source of Demand

• This spending did not increase demand. It diverted it from one thing to another.

• Destruction is not a source of prosperity.

• An increase in money does not help the economy grow. Only an increase in goods can do this. The supply of one good is the demand for another (Say’s Law).

Krugman

• People still commit the broken-window fallacy.

• Paul Krugman thought that repairing the destruction of 9-11 would help the economy.