Henry Hazlitt tried to explain economics in one lesson in his famous book. What lesson? The lesson conveyed by Frédéric Bastiat’s 1850 analogy of the broken window. This is the lesson of the fallacy of the thing not seen. An economist should always consider what the owner of a broken window would have done with the money that he must now spend to replace the window. To consider only the employment-generating effects of the repair money is to commit the fallacy of the thing not seen. This is the error committed by people who praise government taxation used to build public works projects.
I like to put it this way. Bastiat and Hazlitt taught people to follow the money ... backward. Backward to where? To the things the owner of the broken window would have done with his money, had no one broken his window.
This lesson is a very good lesson. But it is not really economics in one lesson. It is merely one lesson in economics.
Hazlitt once told me this. “I should have called the book One Lesson in Economics” In terms of marketing, that would have been a disaster. Hardly anyone would have bought it. After all, what busy American wants to spend time reading a book that will give him only one lesson in economics? Americans want educational books to be short, sweet, and easy. Mainly easy. Hazlitt’s book title fit the bill. Most of its readers have been content with this one lesson.
The book teaches by negation. It shows what was economically wrong in 1946. By “wrong,” Hazlitt meant technically wrong: incapable of increasing most people’s wealth and therefore well-being. He avoided the issue of moral right and wrong.
There is a problem with this strategy. This problem is related to an old American political slogan: “You can’t beat something with nothing.” Hazlitt’s book ignored this slogan. It teaches what works to increase productivity and individual wealth by means of showing what does not work well. Repeal government controls, he argued, and most people will be better off.
His intellectual problem in 1946 was this: the Great Depression had lasted for a decade before the war broke out. In 1946, there was no well-developed body of economic literature that provided a cogent explanation of why the free market did not recover after 1932. It seemed by 1946 that government intervention was responsible for what little recovery there was. No one in 1946 blamed government intervention for causing and then prolonging the depression. There was no well-developed treatise that made the case against intervention. There were a pair of academic monographs that argued that central bank inflation in the 1920’s caused the depression in the 1930’s. They were both published by Macmillan: Lionel Robbins’ The Great Depression (1934) and Banking and the Business Cycle (1936) by three unknown economists. These works had never received attention. They were buried by the publication, also by Macmillan, of Keynes’ General Theory of Employment, Interest, and Money (1936).
Hazlitt was caught in a dilemma. He could not appeal to a body of academic literature that provided a plausible post-depression case for the free market. He therefore adopted another tactic: to show what was wrong with intervention in 1946. He made a case for “nothing” against something. Just abolish the interventions!
This strategy was politically futile. People need to have faith in something. If the economy cannot safely be left to businessmen and bankers, as Franklin Roosevelt announced in his 1933 inauguration address, then voters would have to trust the state. By 1946, they did.
Hazlitt did not persuade anyone in power in 1946. Truman abolished most price controls in November. The head of the Office of Price Administration persuaded him.
Hazlitt also did not persuade anyone in academia. Keynes died in April 1946, just before Hazlitt’s book appeared. He became an instant legend. That inaugurated what can accurately be called the age of Keynes. We still live in it. Never in history has one man’s ideas dominated the thinking of economists and policy-makers to the extent that Keynes’s ideas have ... or at least Paul Samuelson’s interpretations of his ideas in his legendary textbook, Economics, first published in 1948. Almost nobody has read The General Theory. It is unreadable.
The absence of any well-developed body of free market literature in 1946 was an enormous liability. Mises’ Human Action appeared in 1949. It sold better than the senior editor at Yale University Press had expected, but no one in academia knew who Mises was. Neither did financial journalists. Hazlitt knew. He had been reading Mises for years. They were friends. Leonard E. Read knew. Read founded the Foundation for Economic Education in the same year: 1946. This was a decade before FEE started publishing The Freeman.
To understand why Keynesianism has been overwhelmingly successful as an ideology and as a movement, I present this brief survey of economic history, 1911 to today.
A. The Expansion of the State
Great Britain adopted the income tax in 1911. The United States adopted it in 1913. This enabled both governments to finance World War I. In addition, the United States created the Federal Reserve System in December 1913. Great Britain already had the Bank of England, founded in 1694. The income tax and the central banks enabled the West to fight the war.
The war ended a century of peace, small government, and unprecedented economic growth. This economic growth spread across Western Europe after the defeat of Napoleon in 1815. This changed the West. The West of early 1914 would have been unrecognizable to an old man in 1815. Yet the economic world of Christ would have been quite recognizable to him, except for the absence of printed books and materials.
The old order that prevailed from 1815 to 1914 ended in August 1914. It ended, not in the bloody fields of Northwest Europe, but in the national treasuries and the central banks. The gold coin standard was abolished, nation by nation, in late 1914 through 1915. The masses no longer had a way to keep the banks and the governments from inflating. They could no longer demand gold coins from banks.
Wartime income tax rates on the rich went to high double digits across the West. While they were reduced after the war, they never returned to where they were in 1914. Governments began a century of expansion.
The Great Depression brought a new era of government regulation. All national Governments adopted policies of running deficits to fund government economic projects. By 1930, there had been total socialism in the USSR after the 1917 revolution. Italy adopted a form of socialism in the 1920’s. Mussolini had been a senior member of the Italian Socialist Party until 1912, when he was expelled for his militarism. His brand of socialism was nationalistic and militaristic. It did not involve state ownership of the means of production, merely state control. This was the corporate state. Hitler adopted a similar system when he came to power in April 1933. A soft-core version was adopted by Roosevelt.
Keynes intellectually justified policies of government deficits in 1936. He found immediate supporters in Western governments. Younger academic economists came on board as soon as the war ended. Older professors retired, ideologically beaten, never having offered explanations for the depression. They did not understand Keynes. By mid-1950’s, American academia was Keynesian.
World War II centralized economic power as never before. Central governments grew in influence. They did not shrink to pre-war influence after the war. This repeated the experience of World War I.
The Expansion of the Free Market
National economies recovered after 1946. They always do after major wars. They recovered at different rates. Postwar economic conditions by 1950 were far better than wartime conditions. Things got better despite massive government debts and wartime monetary inflation.
A postwar system of stable money was established by a wartime agreement made at Bretton Woods, New Hampshire, in 1944. The agreement began operating in 1946. It placed the U.S. dollar and the British pound at the center of the Western monetary system. The governments and the central banks of Great Britain and the U.S. agreed to exchange their currencies for gold at fixed prices to other governments and central banks. This was an extension of the pseudo-gold standard that came into existence by international agreement in 1922. This became known as the gold exchange standard. Individuals and private corporations did not gain the right to demand gold coins for currencies.
This system functioned until August 15, 1971, when President Nixon unilaterally abolished it during a Sunday evening speech. The Treasury would no longer redeem American currency in gold. In that speech, he also unilaterally imposed price and wage controls. He had begun his career in government in 1942 as an attorney for the Office of Price Administration. But from 1946 until 1971, the Bretton Woods agreement did restrict the expansion of fiat money in the West. This was a great benefit for the world economy. Businessmen and consumers could make long-term plans based on relatively stable prices. American prices as measured by the consumer price index declined in only one year in this era: 1954. That was a decline of less than one-tenth of 1%. They have not declined since.
America’s system of price ceilings was vulnerable in 1946. Truman capitulated in late 1946. This unleashed a new era of productivity in the United States. The old price floors that had predominated in the Great Depression, beginning with Herbert Hoover’s administration, were no longer economically relevant. Wartime monetary expansion had raised the nominal prices of goods, services, and wages. Controls had repressed consumer prices. The results were shortages and rationing. All of this ended in late 1946. Young men returned from the war and went back to work. They married and had large families: four children on average, which peaked in 1957. The war had brought a managerial revolution. New techniques of mass production became common. The economy boomed. Canada’s economy boomed with it.
Great Britain’s Labor Party, elected in 1945, kept much of the wartime price controls and rationing system until its defeat electorally in 1951 by the conservatives. Great Britain’s economy lagged Western Europe’s. The empire was abandoned. India became independent in 1947.
The Allies kept Germany under control. East Germany became a Soviet Satellite. West Germany was under the control of France, Great Britain, and the United States. The USA ran the show. The money system was based on pure fiat paper money issued by the joint command. Price controls and rationing were dominant in the Western zone. Economic recovery was slow.
This changed on June 20, 1948. On that day, a Sunday, the newly appointed director of Bizonal Economic Council, economist Ludwig Erhard, went on the radio and announced a currency reform and the abolition of the controls system. The German economic recovery began the next day. (For details, see the essays by Hans Sennholz and Bruce Bartlett here.) Erhard was a disciple of Wilhelm Röpke, who was a disciple of Mises
The Allies did not allow Germany to re-arm. What they did not recognize in 1945 was this: the Germans’ social tradition of respect for the military and commitment to the arts of war ended with the total destruction of World War II. The postwar humiliation confirmed this rejection. That tradition extended back to the tribes before the Roman Empire. So, the German tax money that would have gone into the military went elsewhere. This was Keynesianism, but it was non-militaristic Keynesianism
In Japan, a similar transformation took place. Its military tradition died in 1945. It had been dominant for over a millennium. America did not allow rearmament. The Japanese therefore concentrated on production. In 1947, the occupation force’s commander, Gen. Douglas MacArthur, authorized a purge of senior managers in Japan’s industries. This was to prevent a resurgence of militarism. Almost 2,000 managers lost their jobs. This opened up senior management to what had been line workers. This broke the pre-war hierarchical system of industry.
A new philosophy of management was then imposed. This system had first been imposed on the broken telecommunications industry. The American occupation forces needed a working system of telephones. Three young American engineers in their late twenties were given the responsibility in 1946 of helping the Japanese to rebuild the system. They had been employees at Bell Labs. They taught what came to be known years later as bottom-up management. In 1949 and 1950, they gave two seminars on this system to young Japanese executives outside of the telecommunications industry. This material was published as a government manual in January 1950. This manual became the basis of the quality production program that has dominated large Japanese industries ever since. (Contrary to widespread opinion, it was not W. Edwards Deming who introduced these management techniques in Japan. He began presenting his seminars the following June.) (This story appears in the book by the Hopper brothers, The Puritan Gift [2007], chapter 10.) So, starting in rubble in late 1945, the Japanese steadily rebuilt their economy, not from the top down, but from the bottom up. The free market made this possible.
In 1953, the Korean War ended in a stalemate. Hostilities ceased. South Korea in 1953 had the per capita income (output) of Europe in 1500. Four decades later, this had increased 18-fold. South Korea’s GDP is ranked around tenth of all nations. This was the result of a free market. Meanwhile, North Korea is a Marxist tyranny that suffers from periodic famines. This satellite image is perhaps a testimony to the economic difference between the two economies.
In 1961, Western Europe adopted a system of low tariffs. This was the result of a treaty: the European Coal and Steel Community. This was replaced by another treaty in 1957: the Treaty on the Functioning of the European Union, better known as the Common Market.
China’s economic growth began in 1979, when Deng Xiaoping freed the agricultural system from state ownership. This has been the fastest growing large nation in history. Mercantilist? Yes. State capitalist? Yes. But intervention was not the primary factor in China’s economic expansion. It was the removal of state ownership of the means of production.
Russia’s story was similar. Economic growth began when the USSR went out of existence: December 25, 1991. Prior to 1991, the government rationed the ownership of cars. The cars were Ladas. The best anyone could say about it was that it was better than a Yugo. Today, Russia is the world’s dashcam leader. Russians use dashcams to prove that they were not responsible for auto accidents. Urban traffic is heavy.
India reduced its bureaucratic controls in 1991. Its economy began to accelerate at a far faster pace.
[https://www.theglobaleconomy.com/India/GDP_constant_dollars]
For all of this economic growth, Keynesians were granted credit . . . by Keynesians. Yet it was achieved mainly by the removal of wartime price controls and rationing. It really was a case of nothing beating something. But most people, including economists, want to believe that Keynesian central planning by taxation and central bank inflation were the causes of this recovery. They do not believe in an unhampered economy. They believe in the net economic productivity of governments that break privately owned windows. They believe that something (Keynesianism), not nothing (the absence of controls), restored world prosperity and continues to maintain it.
C. Academic Economic Theory
Beginning with the publication of Human Action, a handful of scholars and literate writers who sought a defense of the free market that was not based on neo-Keynesianism had intellectual aid. But the 1950’s were generally a wasteland for books defending the free market. In 1959, Hazlitt’s anti-Keynes book, The Failure of the “New Economics” appeared. Almost no one noticed. The next year, his collection of articles against Keynes written by academic economists appeared: The Critics of Keynesian Economics. Almost no one noticed. Both were published by an obscure publisher: Van Nostrand.
In 1962 came Milton Friedman’s short book, Capitalism and Freedom. It was published by the University of Chicago Press. I bought it. Other young economists bought it. He was well-respected as an economist. That was a major breakthrough in academia.
Also in 1962, Murray Rothbard’s Man, Economy, and State appeared. In 1963, his follow-up book appeared: America’s Great Depression. Both were published by Van Nostrand. His second book ended with Hoover. This was not what conservative critics of the New Deal expected or wanted. Both books were ignored by academia. Few people read them. I did: in the summer of 1963. They greatly affected my thinking.
Slowly, the number of academic economic monographs favorable to the free market increased. They gained little traction in the conservative political community until the Reagan revolution that began in 1980. Much of the pre-Reagan interest was generated by the rise of the hard-money (pro-gold investing) newsletter industry after 1965. This interest accelerated in the second half of the 1970’s when gold’s price soared. After 1980, the number of free market books increased rapidly. Hazlitt’s book kept selling.
The rise of interest in free market economics has come from outside academia. There are still few Austrian School economists in academia, and none in Ivy League and top-tier universities. The academic blackout continues. There have been other free market schools of opinion that have gained marginal academic support and employment. They have this in common: the acceptance of central banking.
Conclusion
Hazlitt was a modern John the Baptist: a voice crying in the wilderness. He did not live on locusts and honey. His income came from his superb writing. He was unique.
He never wrote an economic treatise. He is known most for what he opposed: government intervention into the economy. He never tried to overcome this criticism: you cannot beat something with nothing.
[Reprinted from the Remnant Review, January 19, 2019.]
