In a cold and snowy land there lived the people of the North Country.  Some of them made a living by plowing and disposing of the snow that seemed to fall endlessly from the skies between November and March.  Though the work was hard, and often took place in the dark hours of the early morning, they frequently prospered, since the snowfalls came each year and the people of the North Country needed their driveways and parking lots free of the beautiful white flakes.  The Snow Plowers were happy.

But in the winter of 2011-12 the snows seemed to stop.  Oh there was a little ice and some snow, but not really enough to plow: Warmer temperatures quickly melted the little that fell.  The Snow Plowers were not happy.  They gathered the people of the town and complained that the lack of snowfall was devastating the economy of the North Country.  Without the income they earned from plowing, they told their fellow citizens, they would have no money to spend at the local grocery store or bars or restaurants.  And their fellow citizens who owned those fine establishments (and worked there too) would see their income fall, leading quickly to an economic disaster.

Saving the Economy

At first the people of the town nodded along in agreement.  “Yes,” they said, “we must save our economy. But how?”  The Snow Plowers suggested a petition to the Clouds, begging them to bring the snow that would save their business and, through the Magic Multiplier, save their town’s economy.  And so a petition was created.

But then a wise old man stepped forward and declared this was foolishness.  When asked by the townspeople to explain, here is what he said:

It is true that the lack of snow hurts our friends the Snow Plowers, and that is truly unfortunate.  However, just because they have lost income and therefore cannot spend it in the town and beyond, that does not mean the town as a whole is suffering.  Consider your own situation.  Most winters you spend perhaps $300 to pay the Snow Plowers to clear your driveways.  This winter you have spent but $50.  What has happened to that other $250?  You have presumably spent it (or perhaps put it in the bank to be lent to others who have spent it).  And where did you spend it?  On the exact same things the Snow Plowers would have spent it on.  You have been able to eat out a few more times, buy some extra beers, or a nicer steak at the grocery store, or even some candles.  The economy hasn’t been harmed; the flow of spending has just been altered.  You must, in the words of a wise man, “see the unseen.”  And what is unseen is what you have done instead of pay the Snow Plowers.

The Difference It Makes

One young man raised his hand and asked, “If this is true, then what you are saying is that it doesn’t make a difference whether it snows or not to our local economy.  So why should we not ask for more snow and help out our friends the Snow Plowers?”

The wise man responded:

Ah, but it does make a difference.  The rest of us are better off when it doesn’t snow.  Think of it this way: Each time it snows we must spend $25 to get the thing back we value: a usable driveway.  So in snowy winters we give up $300 and have a clean driveway — and that is all.

This winter, by contrast, we have both the clean driveway and the $300.  And we are free to spend that $300 on other things we might want, such as a new flat-screen TV.  This winter we are able to have both a new TV and a clean driveway, while in past years we’ve  had only the clean driveway.  Are we not all better off as a result?   It is unfortunate that our Snow Plower friends are worse off, but would we really prefer a world where we spend $300 to get us right back where we were before the snow?

The people pondered his wisdom, and they understood.  Some of them suggested that if their Snow Plower friends were truly suffering, the rest might use some of the money they saved by not plowing to help them through winter, perhaps by asking them to do some other sort of much-needed work around their homes or around the town.  After all, painting a room or installing new thermal windows would make them better off in a way that unnecessary snow plowing would not.

So the Snow Plowers’ petition to the Clouds was ripped up, and the people of the town rejoiced in the windfall created by the absence of snowfall.

(Thanks to Sarah Skwire for some stylistic suggestions.)

In a world of uncertainty, waste—the destruction of value—is inevitable. Human action, which aims to replace inferior circumstances with superior circumstances, often involves laboring to transform scarce resources from a less useful form to a more useful form. For example, I transform money earned by my labor into raw beef (by using time and gasoline to drive to the supermarket and engaging in exchange), then I transform the raw beef into a medium-well hamburger through the time-consuming process of cooking. If after I eat the hamburger I wish I had done something else with the money and time (say, bought a chicken), I will regret my course of action and feel I’d wasted both.

We have all devoted time and resources to some project that we later realized was the wrong project. That’s the price of imperfect knowledge, which plagues all human beings. If we’re lucky some of the resources we used might be salvageable and put to other purposes, but the time, effort, and other resources are gone.

The same thing of course occurs in commercial production. An entrepreneur buys inputs and hires labor, thinking the finished product will bring a price that covers costs and yields a competitive return—only to find that people don’t want the product, or not badly enough to pay the anticipated price. The loss represents the destruction of value: The value of the inputs before the transformation took place turned out to be greater than the value of the finished product.

As I say, this happens because our knowledge is imperfect. It’s too bad, but perhaps not a tragedy—just a fact of life we learn to live with and minimize. The tragedy occurs when government intervention distorts price signals and induces people en masse unwittingly to make value-destroying plans. That’s part of the story told by the Austrian theory of the business cycle. In the present economic case the Federal Reserve’s low-interest-rate policy in the early 2000s and several federal agencies’ decade-long easy-housing policies induced builders to produce too many houses relative to what the demand would have been without those unsustainable policies. The result was the infamous housing boom and inevitable bust. With housing prices apparently on an unstoppable upward trajectory, and government-backed Fannie Mae and Freddie Mac—not to mention too-big-to-be-allowed-to-fail banks—willing to buy lenders’ mortgages no matter how shaky, builders and buyers were found in great abundance. Buying more house than one could afford seemed smart when one could get a low teaser rate on an adjustable-rate mortgage for a low-to-no-down-payment home and expect its price to rise significantly in six months. When the higher rate kicked in, one could refinance or sell and walk off with the equity.

But when interest rates rose, the bubble burst, and demand plummeted, this smart scheme turned sour. Houses stood unsold, and many people couldn’t pay their mortgages, refinance, or sell at a profit. Foreclosures skyrocketed and the multitude with underwater homes simply disappeared, leaving banks holding a slew of vacant houses that cost money in taxes, code violations, and so on.

As a result, banks now would rather donate the properties to government-created nonprofit land banks and pay for the demolition than hold them and hope for future sales. This is happening in Cleveland, and the Washington Post reported that similar programs were being discussed elsewhere.

How does this relate to the waste identified by the Austrian business-cycle theory? To the extent the homes were vacated and allowed to deteriorate because of the process described above, the demolitions represent destruction of value attributable to government. In the absence of the unsustainable bubble-inflating policies, some of those houses wouldn’t have been built.

In the case of older homes, fewer newly built houses would have competed with them in the real estate market. They would still be occupied and therefore would have been maintained. (There would have been no Great Recession and high unemployment.) Demolition would not have been an attractive alternative.

The tragedy is that because of government policy, demolition is the most attractive alternative. Think of the resources and labor—now seen to have been squandered—that went into making each house. Imagine what products might have been created instead. It’s worse than that: Products always summon complementary products. A housing boom stimulates the production of related shopping centers, office parks, and myriad smaller facilities and products. The resources required to make those things also would have gone elsewhere. Now all those resources, along with much labor and time, are gone because people in government thought they knew how to plan the housing market.

* * *

Georgia and Alabama have joined Arizona in enacting a tough law directed at undocumented immigrants. As Scott Beaulier, Darrick Luke, and Daniel Smith demonstrate, this is already damaging their economies.

Andrew Morriss has been to Graceland, where he found that the lap of luxury in which its fabulously wealthy late resident lived doesn’t look so luxurious today.

Conventional wisdom holds that without the welfare state, the poor would be in dire straits. But what if, as Gary Chartier suggests, government is responsible for the poor’s condition in the first place?

If public policy created the housing bubble, the bursting of which has caused so much misery, can it really be a good idea to reinflate the bubble? Richard Fulmer says that according to political logic, the answer is yes.

The more government controls the curriculum, the more inimical schooling becomes to education. Peter McAllister explains.

The eurozone is in trouble, leading Robert Murphy to explore the possibility that it was a colossal mistake in the first place.

Regulation at the national level gets the lion’s share of attention from market advocates. But let’s not overlook the planning mentality more locally. Sam Staley surveys the taxicab industry.

Here’s what our columnists have whipped up: Donald Boudreaux audits the economics textbook writers. Robert Higgs explains why there’s so little investment. John Stossel brands government a job destroyer. Charles Baird looks at the latest outrage against free speech. And Tyler Watts, bombarded with claims that we couldn’t live without FEMA, responds, “It Just Ain’t So!”

Books on libertarianism, the economy, socialism, and the threat to freedom occupy our reviewers.

—Sheldon Richman

srichman@fee.org

As described in William J. Bernstein’s book The Birth of Plenty: How the Prosperity of the Modern World Was Created, France’s minister of finances under Louis XIV from 1665 to 1683, Jean-Baptiste Colbert, worked tirelessly to expand commerce by improving his country’s roads and canals. Unfortunately, trade was hindered by more than potholes—a complex system of internal tariffs was throttling commerce. Colbert tried to dismantle the tariffs but was only partially successful. After his death, “all fiscal restraint was lost. By the end of Louis XIV’s reign three decades later, the State had doubled the tolls on the roads and rivers it controlled, and the nation that had once been Europe’s breadbasket . . . was bled white. . . .” Bad regulations trumped good roads.

During the Great Depression Franklin Roosevelt initiated massive public-works programs to improve the nation’s infrastructure in hopes of putting people back to work and jump-starting the economy. The construction efforts were staggering. According to Conrad Black:

The government hired about 60 percent of the unemployed in public-works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York City’s Lincoln Tunnel and Triborough Bridge, the Tennessee Valley Authority, and the heroic aircraft carriers Enterprise and Yorktown. They also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields.

Yet these extraordinary accomplishments were not enough to pull the nation out of the Depression. Neither were the millions of jobs generated by this monumental work.

At the same time as he was directing resources away from the private sector, Roosevelt also unleashed upon it a regulatory blizzard that significantly increased the risk of doing business. Higher personal, corporate, excise, and estate taxes; wage and price controls; production restrictions; antitrust lawsuits; and constant experimentation provided few incentives for companies to expand. As in Louis XIV’s France, an improved infrastructure could not revive commerce in the face of stifling government regulations.

Enough Roads; Too Many Roadblocks

Today President Barack Obama is touting high-speed rail and other infrastructure improvements as keys to economic renewal. But if massive infrastructure investments were not enough to turn the economy around in the 1930s, they are far less likely to do so today. Because Roosevelt was starting from a lower base his improvements would have had a far greater impact on the economy of his day than would similar work done now. Also, the lighter regulatory burden in the 1930s meant there were projects then that truly were “shovel-ready.” Today environmental impact studies, possible archeological finds, and nuisance lawsuits may stall construction for years or halt it completely.

The real roadblock to economic growth is the burgeoning regulatory burden that President Obama, like Roosevelt before him, has placed on business. According to a study by James Gattuso and Diane Katz, “[T]he Obama Administration imposed 75 new major regulations from January 2009 to mid-FY 2011, with annual costs of $38 billion.” Hundreds of additional regulations will pour forth from Obamacare, Dodd-Frank, and proposed EPA greenhouse gas restrictions. All this on top of an already monumental regulatory burden imposed by government. A Small Business Administration report estimates the cost of regulatory compliance at over $1.75 trillion in 2008 alone.

Briefly, our current economic woes were triggered by the collapse of a housing bubble, produced by loose monetary policy together with federal pressure on mortgage companies to lend to bad credit risks. When the bubble burst, housing prices fell, causing many homeowners to default on their mortgages. Investment vehicles based on those mortgages lost much of their value, leading to huge investor losses and the failure of some major financial institutions.

Lost in Transition

Absent government interference industry would retool, shifting capital and labor out of home construction and into other areas. Because neither capital nor labor is homogeneous, this shift takes time. Equipment that can be put to other uses may have to be sold or physically moved. Other equipment may have to be modified or scrapped altogether. Workers may need to increase their market value by relocating or by gaining new knowledge and skills. In a recession consumers typically reduce spending and increase savings, thus freeing up the resources needed to complete the shift.

Keynesian economists, however, see both labor and capital as homogeneous, aggregated lumps. Where Austrians see capital in transition Keynesians see “idle capital.” Keynesian programs to put that capital back to work only hinder or halt the needed transition, either leaving capital in its malinvested state or forcing it into the very idleness they seek to remedy. For example, expanding credit may re-inflate the collapsed bubble for a time, leading industry to continue producing unneeded goods. Stimulus spending—whether for infrastructure or other things on the government’s wish list—transfers scarce resources from industry to government, further impeding the transition. New laws, enacted to prevent future recessions, make businesses reluctant to invest until the associated regulatory structures are defined—a process that can take years. Once in place the regulations may inhibit capital flow, locking inefficiencies and malinvestment in place and propping up companies that should be allowed to fail. Unemployment insurance and other such programs eliminate or at least reduce workers’ incentives to move or reeducate themselves.

The country’s problems are not the fault of inadequate highways. They are the result of government intervention: loose monetary policies, programs that encourage unsustainable debt, explicit and implicit guarantees to financial institutions, massive spending that crowds out private investment, oppressive regulations, higher taxes with constant threats of more to come, and political payoffs to “friendly” companies and unions. Building high-speed railroads will not stop the malign effects of these policies; the solution is to stop the policies.

Goods, people, and information will not flow freely across a nation, regardless of the quality and extent of its infrastructure, if taxes and regulations block their flow. Trade perished in France as Colbert’s improved roads and canals were made all but useless by high internal tariffs. Hundreds of thousands of miles of new and rebuilt roads were not enough to move commerce past the regulatory roadblocks that Roosevelt erected. President Obama’s proposed high-speed trains—indeed, his latest nearly half-trillion-dollar jobs program—will not pull the country over the mountain of regulations that has been created in the decades since the Great Depression and that Obama has raised to new heights.

So how could O’Donnell permit himself to say this in a promo that ran on his network: “We can afford anything in this country. It’s just a matter of deciding what our priorities are. . . . There isn’t anything we can’t afford, if we prioritize.”

This clearly is nonsense. He seems to be saying that if we prioritize—ignore who “we” are for the moment—we have the resources to satisfy everyone’s wants. He also might mean that if we prioritize, there isn’t any particular thing we can’t afford. I doubt that’s what he has in mind because it would be far less sweeping a statement. Even so, it would still be nonsense.

We live in a world of scarcity. Individually and collectively we want more than available resources can yield. That will remain true even as the supply of resources expands. That’s how people are. Ends exceed means. Demand exceeds supply. That’s why we economize and always will. That is why human action is choosing. That is why we face tradeoffs all the time. Indeed it is why the discipline of economics exists.

And it is why we prioritize, that is: “arrange or deal with in order of importance.” Since resources and time are limited, we have to rank our ends so 1) we don’t expend resources achieving a less important end at the expense of more important ends, and 2) we don’t achieve a less urgent end at the expense of a more urgent end.

If we literally could afford everything in terms of resources and time, we would have no need to prioritize. But prioritizing doesn’t prevent us from running out of resources.

I assume that Lawrence O’Donnell knows all this. To be fair, tucked in between the two sentences I quoted is this: “If we want [fair and decent health care] we can afford that. It may mean that we have to cut back on something else somewhere else. But we can do it.” But then he immediately forgot he had said this.

I’d guess it was just a demagogic strike at those who think we can’t afford a government that spends close to $4 trillion a year. He apparently wants to say that anyone who believes this is just a stingy bastard, especially when it comes to the poor, the elderly, and the sick.

As a subscriber to the principle of charity, I tried hard to make sense of O’Donnell’s statement. Maybe he really means we can afford everything he thinks is worthwhile. I doubt that’s true, but it takes us into another area of discussion.

Who is “we”? Of course O’Donnell means the taxpayers. It’s quite remarkable how some people sit around casually spending other people’s money. You’d think our incomes were public property. By that logic the government budget isn’t $3.8 trillion. It’s something over $14 trillion—the entire GDP. The 73 percent of our income not taxed is actually a form of government spending because some government could have spent the money some other way but chose not to.

People who think like that (or whose premises logically commit them to think like that) no doubt assure themselves that it’s all for the good of the country. But they can’t escape the fact that their schemes merely empower an elite whose real priority is keeping the corporate state intact. The benefits handed to people outside the governing clique are intended at best to consolidate and maintain power.

* * *

We take the conveniences of modern life for granted, so it is worthwhile reminding ourselves what they are and what makes them possible. Warren Gibson has a go at it.

One grievance of the American revolutionaries was that King George III “erected a multitude of New Offices, and sent hither swarms of Officers to harass our people and eat out their substance.” Paul Schwennesen offers two vignettes to illustrate the continuing relevance of the complaint.

For many years most Africans have suffered oppression and poverty under centrally run economies. But deeper in Africa’s history—before Western colonization and modern independence—one finds decentralization, markets, and trade. George Ayittey has the story of Africa’s original liberalism.

This month marks the 130th anniversary of the birth of Ludwig von Mises, the great Austrian economist, political philosopher, and prophet. We commemorate this occasion with a selection of his Freeman writings.

If the Progressive Era stood for anything, it was the proposition that experts know best about everything. What is unappreciated is how widely this principle was applied. Kevin Carson has the details.

To hear most politicians and pundits tell it, the way to solve a problem is to manipulate its indicators. Why worry about the real cause? Richard Fulmer tells why.

Freeing the market will take more than just scraping off a thin layer of government intervention. It will require going down to the roots of government economic distortion and exploitation. Charles Johnson elaborates.

Provocative insights pour from our columnists’ word processors. Lawrence Reed says government should not subsidize the arts. Donald Boudreaux discusses the causes of the Industrial Revolution. Burton Folsom assesses competing strategies for ending the Great Depression. John Stossel indicts occupational licensing. Walter Williams examines the concepts monopoly and collusion. And David Boaz, confronting the claim that drug decriminalization has failed, responds, “It Just Ain’t So!”

Books on the ruling class, neoconservatism, Lysander Spooner, and limited government have kept our reviewers occupied.

‎So how could O’Donnell permit himself to say this in a promo currently running on his network?

We can afford anything in this country. It’s just a matter of deciding what our priorities are. . . . There isn’t anything we can’t afford, if we prioritize.

This clearly is nonsense. He seems to be saying that if we prioritize – ignore who “we” are for the moment – we have the resources to satisfy everyone’s wants. He also might mean that if we prioritize, there isn’t any particular thing we can’t afford. I doubt that’s what he has in mind because it would be far less sweeping a statement. Even so, it would still be nonsense.

A World of Scarcity

We live in a world of scarcity. Individually and collectively we want more than available resources can yield. That will remain true even as the supply of resources expands. That’s how people are. Ends exceed means. Demand exceeds supply. That’s why we economize and  always will. That is why human action is choosing. That is why we face tradeoffs all the time. Indeed it is why the discipline of economics exists.

And it is why we prioritize, that is: “arrange or deal with in order of importance.” Since resources and time are limited, we have to rank our ends so 1) we don’t expend resources achieving a less-important end at the expense of more-important ends, and 2) we don’t achieve a less-urgent end at the expense of a more-urgent end.

If we literally could afford everything in terms of resources and time, we would have no need to prioritize. Prioritizing doesn’t prevent us from running out of resources. It merely aims at achieving the more important and more urgent before the less important and less urgent.

I assume that Lawrence O’Donnell knows all this. To be fair, tucked in between the two sentences I quote is this:

If we want [fair and decent health care] we can afford that. It may mean that we have to cut back on something else somewhere else. But we can do it.

But then he immediately forgets this and says we can have it all if only we prioritize.

So why does he say that? I’d guess it’s a just demagogic strike at anyone who thinks we can’t afford a government that spends close to $4 trillion a year. He apparently wants to say that anyone who believes that is just a stingy bastard, especially when it comes to the poor, the elderly, and the sick. He and his friends, on the other hand, are compassionate.

Making Sense of It

As a subscriber to the principle of charity, I’ve tried hard to make sense of O’Donnell’s statement. Maybe he really means we can afford everything he thinks is worthwhile. That may or not be true – I doubt it — but it takes us into another area of discussion.

Who does “we” refer to and why does O’Donnell feel entitled to spend “our” money? Of course he means the taxpayers. It’s quite remarkable how some people sit around casually spending other people’s money, whether it’s for medical care, pensions, global policing, or nation-building. You’d think our income was public property. By that logic the federal budget isn’t $3.8 trillion. It’s something over $14 trillion – the entire GDP. The 73 percent of our income not taxed at some level is actually a form of government spending because some government could have spent the money some other way but chose not to.

People who think like that (or whose premises logically commit them to think like that) no doubt assure themselves that it’s all for the good of the country. But they can’t escape the fact that their schemes merely empower an elite whose real priority is keeping the corporate state intact. The benefits handed to people outside the governing clique are intended at best to consolidate and maintain power.

I’ve always taken this simple and valuable statement for granted and hadn’t thought about it very much. Lately though I’ve been puzzling over it because I’ve come to realize that there are free lunches – it is possible to create something from nothing.  In fact, I think for economic growth to take place there have to be free lunches, lots of them. Let me explain.

The Truth Behind TANSTAAFL

In a world of scarcity you can’t have everything you want. For one thing, time is scarce. I can spend the next hour sleeping in bed or working out at the gym, but if I do one I can’t do the other. Same thing with any other scarce resource. My labor is scarce — I can’t be in two places at once, for example — so I have to decide whether to take a full-time job in New York or one in London. My money is certainly scarce, so I can either spend a given $20 on a good lunch or a good book.

So scarcity makes it necessary to choose between two or more valuable alternatives. The more scarce something is, the more valuable it becomes and, other things equal, the more likely I will choose it over the next best alternative. The value of that next-best alternative, what I don’t choose, becomes the (opportunity) cost of the thing that I do choose.  If I choose to sleep, then the cost is the value I attached to going to the gym.  If I decide to work in London, the cost is what I think the value of working in New York would have been.  And if I decide to spend $20 on a book, the cost is the expected value of a good lunch.

How to Make a Free Lunch

Suppose I’m in the business of making lunches. Let’s say that with my current know-how I can make a maximum of 20 lunches a day by using two units of labor and four units of capital. One day I discover a way to make two lunches of the exact same kind, at least from the perspective of my customers, with the same amount of inputs that it previously took to make one.  In other words, before that fateful day I was selling lunches inefficiently; I was producing only half the lunches that I could have been.  Discovering that inefficiency means I can create 20 additional lunches.

Alternatively, I could produce 20 lunches a day as before and use the one unit of labor and two units of capital that my increased efficiency saves to produce some other valuable good, say, ten dinners or 30 breakfasts or some other thing that no one had ever thought of making before. Those would all be “free lunches” in the same sense.

Now, it’s true that all those extra things that I could now make still use labor and capital, so they’re not costless to produce, and in that sense TANSTAAFL is true.  But it’s also true that creative discovery, what Israel Kirzner calls “entrepreneurship,” creates value where none existed before.

The Production Possibilities Frontier

It might help to clarify things to introduce the concept of “production possibilities frontier,” or PPF.  The PPF tells us the maximum amount of all kinds of goods, say, lunches and books, that can be produced with the best-available technology from a given set of labor and capital.  So with two units of labor and four units of capital, let’s say you can produce either 40 lunches and no books or no lunches and ten books, or any combinations of the two –  for example, 36 lunches and one book, 32 lunches and two books, and so on. Think of the PPF as a downward-sloping curve with lunches measured on the horizontal axis and books on the vertical axis. So, as I indicated, producing more books means making fewer lunches as we travel up that curve.

We’ve already seen through my first example — where at first I don’t know I can make more than 20 lunches a day — that I would not be on the curve itself but rather somewhere inside the frontier – that is, I’m not producing efficiently.  Producing more (free) lunches or more (free) books means moving onto the curve. That’s one way that entrepreneurship can create free lunches.  And there are at least two more kinds of free lunches that entrepreneurship can create in this way.

Even More Free Lunches

Entrepreneurship can to shift the PPF outward.  Even if you’re presently on the frontier and are producing efficiently, discovering a new source of labor and capital or inventing a new way of making lunches or books means that you can stretch that curve out farther, producing more lunches or more books or more of both than was possible before, without using any more inputs.

The third way is for entrepreneurship to add a completely new dimension to the curve by introducing a new kind of good or service. Edison’s incandescent light bulb, Ford’s Model T, and Jobs’s iPad are examples. So if you were on the frontier of the curve before, you may find yourself off of it again once its dimensions expand.

There are ways to create free lunches — a net increase in value without any increase in cost — that don’t involve production at all.  Suppose I’m eating a nice sandwich but about halfway through I realize that I don’t really want to finish it, that it would actually be best if I stopped eating it and throw the rest away.  The free lunch here isn’t the sandwich I didn’t eat, but the realization that I didn’t have to finish it.  That may sound strange, even wasteful, but in the economic sense it’s not.  Any discovery that makes me better off, whether it’s producing and consuming more or producing and consuming less is a free lunch.  Economists call this “consumption efficiency.”

In other words, discovering a production inefficiency is a free lunch. Discovering a consumption inefficiency is also a free lunch.

So even if Thomas Edison was right that “genius is 1 percent inspiration, 99 percent perspiration,” that 1% is free.

Sowell stresses two fundamental ideas. One is that we desire far more things than we could ever hope to produce. Since we can’t have everything we want, we must, both individually and collectively, make choices. And when we choose one thing, we sacrifice the chance to obtain other things we want. Choices are often difficult to make, but unavoidable.

In chapters on the labor, housing, and medical-care markets, Sowell vividly illustrates that idea. For example, we can punish doctors who we believe have made mistakes, but we will discover that doctors are subsequently less willing to perform risky procedures.

The other fundamental idea is that in making their choices, people will respond to incentives, particularly prices. If the price of doing something rises, people will do less of it. If the price falls, people will do more of it. This simple idea provides powerful insight into individual behavior. Here, too, Sowell illustrates. If the government limits the price per visit doctors may charge, they will schedule more but shorter—and rushed—visits. If laws restrict the height of buildings, more buildings will be created, leading to more traffic and more sprawl. Sowell relates that Mikhail Gorbachev once asked Prime Minister Margaret Thatcher how she arranged for her citizens to get fed. She answered that she didn’t arrange it; individuals responding to prices did.

Sowell shows that a key characteristic of markets is that they confront individuals with the costs of their actions. If I fail to maintain my car, I’ll bear the cost and inconvenience if it breaks down. Even if it doesn’t break down, I’ll suffer the decrease in value when I dispose of it. But when I decide which government policies to support or officials to vote for, I bear little of the cost of my actions. If I am uninformed or apathetic, it matters little because my individual vote has a negligible effect on the outcome. Since the price of supporting unwise public policy seems low, economics predicts that people will often support unwise public policy.

Furthermore, government employees and officials bear little of the cost of their actions. Unlike private firms, few government agencies are eliminated because of bad results. Elected officials can avoid bearing the cost o f their actions if the consequences take time to appear, because it’s difficult to attribute a particular problem to poor government policy implemented years earlier. Sowell concludes, therefore, that politicians tend to choose policies that offer quick benefits, even if large costs come later. This gives Sowell the subtitle of his book, “Thinking Beyond Stage One”: he urges readers to use economics to think past the promise of easy benefits and to understand the full cost of government policies.

He presents many examples of the underappreciated long-term cost of government actions, including price controls on apartments and medical care, mandatory recycling, and laws “guaranteeing” job security. One impressive example is heavy city or state taxation of profitable companies. In the short run—stage one—this can raise lots of money for programs that benefit some citizens. But in the longer run, as companies reduce employment, move away, and refuse to locate in the area, cities and states inevitably incur significant costs. Sowell concludes, “Politics offers attractive solutions but economics can offer only trade-offs.”

For anyone interested in learning some economics, but who is discouraged by its seeming complexity, this is an informative and well-written book. (Readers interested only in fundamental economics can read Sowell’s earlier book, Basic Economics.) For anyone interested in public policy and how to improve it, this is a superb book.

In the eyes of some people, to question the virtue of ObamaCare is racist and indicative of a wish to see people get sick and die. Think I exaggerate? Read Paul Krugman:

…[T]he emotional core of opposition to reform was blatant fear-mongering, unconstrained either by the facts or by any sense of decency. It wasn’t just the death panel smear.

It was racial hate-mongering, like a piece in Investor’s Business Daily declaring that health reform is “affirmative action on steroids, deciding everything from who becomes a doctor to who gets treatment on the basis of skin color.” It was wild claims about abortion funding. It was the insistence that there is something tyrannical about giving young working Americans the assurance that health care will be available when they need it, an assurance that older Americans have enjoyed ever since Lyndon Johnson — whom Mr. [Newt] Gingrich considers a failed president — pushed Medicare through over the howls of conservatives.

And what are these “facts”? The Congressional Budget Office declares this new legislation will “control” health care costs and reduce the federal deficit. So if you question the “nonpartisan” CBO you must be a racist who hates sick people. Yet when we step back at look at this legislation, the reality is different from what was presented on the House floor or on the New York Times editorial page.

Let us start from the beginning. Medical care is a scarce good. That truth is fundamental to understanding everything else about its production and distribution. Someone must produce this good, and what is produced and who receives it (at least in a free market) are determined by the laws of supply and demand. We can rail all we want against the alleged unfairness of reality, but the fact remains that producing and obtaining units of medical care entail opportunity costs. Something of value must be given up.

Yet in a single vote we heard members of Congress declare that they were going to “provide world-class health care” to needy Americans and save money! They will provide nothing. All they can do is to coerce someone to provide medical care for someone else. In his classic piece that I often quote, “7 Fallacies of Economics,” FEE President Lawrence Reed lists his seventh fallacy as The Fallacy of Economics by Coercion. Indeed, at the heart of this bill, with its mandates, fines, and arbitrary dates, is the attempt to impose a specific medical regime by force. Reed says this about such coercion:

There’s an old adage which is enjoying new publicity of late. It reads, “If you encourage something, you get more of it; if you discourage something, you get less of it.” The good economist realizes that if you want the baker to bake a bigger pie, you don’t beat him up and steal his flour.

Medical care will be no less scarce with the passage of this law. Insurance companies could find price ceilings on their premiums while, at the same time, they are expected to pay unlimited amounts on care for whomever wants it. This is not sustainable under any circumstances, and the framers of this law know it. In the end the government will turn insurers into “public utilities” while raising taxes to finance subsidies. The result will be long lines and less medical care than many people receive now. Thus the law of scarcity will impose itself even though Congress officially has repealed it.

The economics of John Maynard Keynes as taught to university sophomores for the last several decades is now nearly defunct in theory but not in practice. Keynes’s 1936 book, The General Theory of Employment, Interest, and Money, portrayed the market as fundamentally unstable and touted government as the stabilizer. The stability that allegedly lay beyond the market’s reach was to be supplied by the federal government’s macroeconomic policymakers—the president (with guidance from his Council of Economic Advisers), the Congress, and the Federal Reserve.

The acceptance in the economics profession of fundamentalist Keynesianism peaked in the 1960s. In recent decades, enthusiasm for Keynes has waxed and waned as proponents have tried to get new ideas from the General Theory or to read their own ideas into it. And although the federal government has long since become a net supplier of macroeconomic instability, the institutions and policy tools that were fashioned to conform to the Keynesian vision have become an integral part of our economic and political environment.

A national income accounting system, devised with an eye to Keynesian theory, allowed statisticians to chart the changes in the macroeconomy. Dealing in terms of an economy-wide total, or aggregate, policy advisers tracked the production of goods and services bought by consumers, investors, and the government. Fiscal and monetary authorities were to spring into action whenever the economy’s actual, or measured, total output, which was taken to reflect the demand side of markets, fell short of its potential output, which was estimated on the basis of the supply side. Cutting taxes would allow consumers and investors to spend more; government spending would add directly to the total; printing money or borrowing it would facilitate the opposing movements in the government’s revenues and its expenditures.

A chronic insufficiency of aggregate demand, which implies that prices and wages are somehow stuck above their market-clearing levels, was believed to be the normal state of affairs. Why might there be such pricing problems on an economy-wide scale? What legislation and government institutions might be standing in the way of needed market adjustments? These questions were eclipsed by the more politically pressing question of how to augment demand so as to clear markets at existing prices. The New Economics of Keynes shifted the focus of attention from the market to the government, from economically justified changes in market pricing to politically justified changes in government spending.

Politicians still appeal to basic Keynesian notions to justify their interventionist schemes. The continued use of demand-management policies aimed at stimulating economic activity—spending newly printed or borrowed money during recessions and before elections—requires that we understand what Keynesian economics is all about and how it is flawed. Also, identifying the flaws at the sophomore level helps students to evaluate in their upper-level and graduate courses such modern modifications as Post-, Neo-, and New Keynesianism as well as some strands of Monetarism.

The extreme level of aggregation in Keynesian economics leaves the full range of choices and actions of individual buyers and sellers hopelessly obscured. Keynesian economics simply does not deal with supply and demand in the conventional sense of those terms. Instead, the entire private sector is analyzed in terms of only two categories of goods: consumption goods and investment goods. The patterns of prices within these two mammoth categories are simply dropped out of the picture. To make matters worse, the one relative price that is retained in this formulation—the relative value of consumer goods to investment goods as expressed by the interest rate—is assumed either not to function at all or to function perversely.

Keynes’s Neglect of Scarcity

Pre-Keynesian economics, such as that of John Stuart Mill, as well as most contemporaneous theorizing, such as that by Ludwig von Mises and F. A. Hayek, emphasized the notion of scarcity, which implies a fundamental trade-off between producing consumption goods and producing investment goods. We can have more of one but only at the expense of the other. The construction of additional plant and equipment must be facilitated by increased savings—that is, by a decrease in current consumption. Such investment, of course, makes it possible for future consumption to increase. Identifying the market mechanisms that allocate resources over time is fundamental to our understanding of the market process in its capacity to tailor production decisions to consumption preferences. But as Hayek noted early on, the Keynesian aggregates serve to conceal these very mechanisms so essential to the intertemporal allocation of resources and hence to macroeconomic stability.

In Keynesian theory the long-established notion of a trade-off between consuming and investing is simply swept aside. Consistent with the assumed perversity of the price mechanism, the levels of consumption and investment activities are believed always to move in the same direction. More investment generates more income, which finances more consumption; more consumption stimulates more investment. This feature of Keynesian theory implies an inherent instability in market economies. Thus the theory cannot possibly explain how a healthy market economy functions—how the market process allows one kind of activity to be traded off against the other.

The “Multiplier-Accelerator” Theory

The inherent instability makes its textbook appearance as the interaction between the “multiplier,” through which investment affects consumption, and the “accelerator,” through which consumption affects investment. The multiplier effect is derived from the simple fact that one person’s spending becomes another person’s earnings, which, in turn, allows for further spending. Any increase in spending, then, whether originating from the private or public sector, gets multiplied through successive rounds of income earning and consumption spending.

The accelerator mechanism is a consequence of the durability of capital goods, such as plant and equipment. For instance, a stock of ten machines, each of which lasts ten years, can be maintained by purchasing one new machine each year. A slight but permanent increase in consumer demand for the output of the machines of, say, 10 percent, will justify maintaining a capital stock of eleven machines. The immediate result, then, will be an acceleration of current demand for new machines from one to two, an increase of 100 percent.

The multiplier-accelerator theory explains why consumption is increasing, given that investment is increasing, and why investment is increasing, given that consumption is increasing. But it is incapable of explaining what determines the actual levels of consumption and investment (except in terms of one another), why either should be increasing or decreasing, or how both can increase at the same time. Students are left with the general notion that the two magnitudes, investment and consumption, can feed on one another, in which case the economy is experiencing an economic expansion, or they can starve one another, in which case the economy is experiencing an economic contraction. That is, Keynesian theory explains how the multiplier-accelerator mechanism makes a good situation better or a bad situation worse, but it never explains why the situation should be good or bad in the first place.

Only at the two extremities in the level of economic activity is a change in direction of both consumption and investment sure to occur. After a long contraction, unemployment is pervasive and capital depreciation reaches critical levels. As production essential for capital replacement stimulates further economic activity, the macroeconomy begins to spiral upward. After a long expansion, the economy is bulging at the seams. Markets are glutted with both consumers’ and producers’ goods. As unsold inventories trigger production cutbacks and worker layoffs, the macroeconomy begins to spiral downward. Keynes held that the economy normally fluctuates well within these two extremes experiencing a general insufficiency—and an occasional supersufficiency—of aggregate demand.

Textbook Keynesianism

In the simplistic formulations of macroeconomic textbooks, investment is simply “given”; in Keynes’s own formulation, the inclination of the business community to invest is governed by psychological factors as summarized by the colorful term “animal spirits.” Keynes recognized that there are some “external factors” at work, such as foreign affairs, population growth, and technological discoveries. The market is envisioned, in effect, to be some sort of economic amplifier which converts relatively small changes in these external factors into wide swings of employment and output. This is the basic Keynesian vision.

Wage rates and prices are assumed either to be inflexible or to change in direct proportion to one another. In either case the real wage (W/P) is forever constant. The actual level of wages and prices is believed to be determined (again) by external factors—this time, trade unions and large corporations. If the real wage is too high, there will be unemployment on an economy-wide basis. There will be idle labor and idle resources of every kind. The opportunity cost of putting these resources back to work is nothing but forgone idleness, which is no cost at all. The assumed normalcy of massive resource idleness assures that the perennial problem of scarcity never comes into play. William H. Hutt and F. A. Hayek were justified in referring to Keynesian economics as the “theory of idle resources” and the “economics of abundance.”

Textbook Keynesianism has a certain internal consistency or mathematical integrity about it. Given the assumptions that prices and wages do not properly adjust to market conditions—that is, the assumption that the price system does not work—then the Keynesian relationships among the macroeconomic aggregates come into play. Even the policy prescriptions seem to follow: If wages and prices do not adjust to the existing market conditions, then market conditions must be adjusted (by the fiscal and monetary authorities) to the externally determined prices and wages.

In the final analysis, however, Keynesian theory is a set of mutually reinforcing but jointly unsupportable propositions about how certain macroeconomic aggregates are related to one another. Keynesian policy is a set of self-justifying policy prescriptions. For instance, if the government is convinced that wages will not fall and is prepared to hire the unemployed, then unemployed workers will not be willing to accept a lower market wage, ensuring that wages, in fact, will not fall. Thus, while the intention of Keynesian policy is to stabilize the economy, the actual effect is to “Keynesianize” the economy. It causes the economy to behave in exactly the same perverse manner that is implied by the Keynesian assumptions. This convoluted interrelationship between theory and policy has long obscured the fundamental flaws in the theory itself.

Students often ask the obvious question: Why is government policy grounded in such a flawed theory? From a political point of view, advocating and implementing Keynesian policy is the surest way to election and reelection. The gains from printing and spending money are immediate, highly visible, and can be concentrated on individuals who make up powerful voting blocs. The costs of this policy are incurred at a later date and can be spread thinly across the entire population, making the link between policy and long-run consequences difficult for the voting public to perceive.

The fading in recent years of old-line Keynesianism in academic circles provides little comfort. Even as the number of demand-managers continues to decline, it is from this shrinking group of economists that government officials seek advice and reconciliation. And opportunities to lecture to the seats of power rather than in the halls of learning have a way of changing some economists’ minds about the advisability (political if not economic) of managing aggregate demand. Printing and spending money in pursuit of short-run stimulation if not long-run stability remain the order of the day.

There is good reason, then, to study Keynesian theory: It helps us understand what the policymakers in government are likely to do in any given circumstance. But to understand the actual effects of their demand-management policies in the long run as well as the short, we need a more enlightening theory—one that recognizes what market forces can do on their own to maintain macroeconomic stability and how those forces are foiled by government-supplied stabilization.

The Energy Independence and Security Act of 2007 mandated that oil companies increase the amount of ethanol mixed with gasoline. The argued benefits were that it would decrease our dependence on foreign oil and provide a more environmentally friendly fuel. Anyone with an ounce of brains would have realized that diverting crops from food to fuel would raise the prices of a host of corn-related foods, such as corn-fed meat and dairy products. A Purdue University study found that the ethanol program has cost U.S. consumers $15 billion in higher food costs in 2007, and it will be considerably higher in 2008. Higher food prices, as a result of the biofuels industry, have had international consequences as seen in the food riots that have broken out in Egypt, Haiti, Yemen, Bangladesh, Mexico, and other nations.

Anti-Terrorism Spending

The victims of benefits-oriented policies, such as those of the Energy Independence and Security Act of 2007, are visible, but for many other policies the victims and the costs are invisible. That is the case with anti-terrorism expenditures. Take Wyoming with its two major cities: Cheyenne (population 53,000) and Casper (50,000). Federal and state homeland security anti-terrorism expenditures there in 2007 totaled $6,673,910. The benefits of such expenditures are that they might prevent Wyoming from being attacked and if attacked, ameliorate some of the consequences.

There’s no precise way to determine Wyoming’s risk of a terrorist attack and its cost, but simple reasoning suggests that too little or too much can be spent. The costs of spending too little might result in a devastating terrorist attack that could have been prevented. The costs of spending too much are less obvious because the victims are invisible. For example, the price for dump trucks for snow and ice removal ranges between $140,000 and $160,000. How many Wyoming lives could have been saved had some of the anti-terrorism expenditures been spent on additional dump trucks to clear streets and roads of snow and ice? Those victims are invisible.

Environmentalism

Environmentalists have been very active and successful in California in getting huge tracts of land set aside as “open space,” on which nothing can be built, and enacting “smart growth” policies severely restricting residential and business construction. Open space and smart growth are seen as benefits. The cost is skyrocketing housing prices at some multiple of housing prices nationwide, whereas before the 1970s they were similar. Dr. Thomas Sowell wrote, “One of the ways of coping with high housing costs is with ‘creative’—and risky—financing. Roughly two-thirds of the home mortgages in the San Francisco Bay area are interest-only mortgages. Theoretically, you could make mortgage payments forever without acquiring a cent of equity in your home. . . . In reality, the interest-only mortgage payments apply for only a limited number of years—three to five years in most cases—after which the payments rise, so as to contribute something toward the payment of the principal. People who expect their incomes to rise significantly in a few years assume that they will be able to handle the higher payments then. Of course that assumption can turn out to be wrong and the house can be lost” (“Froth in Frisco?” Wall Street Journal, May 26, 2005). Such practices have contributed to the subprime crisis we now face.

There’s another cost. According to Census estimates, the number of black residents in San Francisco has shrunk from 13.4 percent of the population in 1970 to just 6.5 percent in 2005—the steepest decline in any major American city. Guess what. San Francisco Mayor Gavin Newsom appointed a task force to study how to reverse decades of policies that black leaders say have fueled the flight. He made no mention of environmentalist policies that have driven the cost of housing beyond the reach of many blacks.

FDA

The Food and Drug Administration’s (FDA) beneficent mission is to ensure the safety and effectiveness of pharmaceuticals. FDA officials can make two types of errors: approving a drug that has unanticipated dangerous side effects, or disapproving and delaying a drug that is both safe and effective. An FDA official has unequal incentives to avoid these two types of errors. Making the first error, erring on the side of under-caution, the victims are visible and he is directly accountable. Erring on the side of over-caution, the cost and the victims are invisible and there is no accountability. Victims die never knowing why.

In an article in Regulation magazine, Robert M. Goldberg examined some examples of the costs of FDA delay:

Beta Blockers: Beta blockers regulate hypertension and heart problems. The FDA held up approval of beta blockers for eight years because it believed they caused cancer. In the meantime, according to Dr. Louis Lasagna of the Tufts University Center for the Study of Drug Development, 119,000 people died who might have been helped by that medication.

Clozaril: First approved and used in 1970 in Europe, Clozaril’s ability to treat schizophrenics who did not respond to other medicines became known in 1979. Yet the drug was not approved in the United States until 1990 because companies believed the FDA would reject it on the grounds that 1 percent of all patients who take the drug contract a blood disease. As an article in the New England Journal of Medicine marveled . . . : “What is remarkable is that [Clozaril] has a beneficial effect on a substantial proportion [30 to 50 percent] of patients who have an inadequate response to other. . . drugs.” FDA delay therefore meant that nearly 250,000 people with schizophrenia suffered needlessly, when relief was at hand.

Mevacor: Mevacor is a cholesterol-lowering drug that has been linked to reduction in death due to heart attacks. It was available in Europe in 1989 but did not become available in the United States until 1992. Studies confirm what doctors saw to be the case: taking the drug reduced death due to heart disease by about 55 percent. During that three-year period as many as a thousand people a year died from heart disease because of the FDA delay.

The economist’s bottom-line message is that for the sake of human compassion and efficiency, any discussion of benefits from this or that public policy should entail an explicit acknowledgment of costs.