How many lessons do you need in economics? Listening to the impenetrable jargon of commentators in the media, you might think you need a lifetime’s worth of them. Similarly the reams of statistics used in academic articles demonstrate why economists often call it a ‘science’, (with critics adding the modifier ‘dismal’).
However there is an alternative tradition of popularising economics which insists that its core propositions are very simple, indeed ‘common sense’. Condensing economics into single idea from which all others flow is an approach exemplified by Henry Hazlitt’s 1946 bestseller Economics in One Lesson. In his new book, John Quiggin summarises that lesson as ‘leave markets alone, and all will be well’. Quiggin has to summarise it thus, because Hazlitt doesn’t set out the lesson itself very clearly. But the conclusion that flows from the lesson, says Quiggin, is that:
‘Once all the consequences of any act or policy are taken into account, the opportunity costs of government actions to change economic outcomes always exceed the benefits.’
Such popularisations of economics tend towards promoting what you’d broadly call a ‘free market’ view. That is, for practical purposes you don’t really need to ‘know’ much else about the economy beyond the need for government to get out of the way of the market. Indeed much of the economy is fundamentally unknowable, which is why policies that go beyond letting the markets operate unhindered will invariably (for a writer such as Hazlitt) lead to bad outcomes (even if unintended by well meaning policymakers). John Quiggin’s Economics in Two Lessons sets out to confront Hazlitt’s ‘One Lesson’, but does so in an accessible and straightforward style. He treats Hazlitt’s ideas seriously, but demonstrates that ‘One Lesson’ economics is not enough.
Quiggin quotes Hazlitt’s own statement of his One Lesson as:
‘The art of economics consists of looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.’
This seems like a call for more research, however Hazlitt has already provided you with the answer: always leave the market alone. This is the only lesson you need, all else is commentary. Thus those who call for government intervention for whatever reason are invariably wrong, because they cannot see ‘what is unseen’ — namely the opportunity cost.
The ‘opportunity cost’ concept is key to Two Lessons. Quiggin argues that the central question posed by Hazlitt’s ‘micro-economic’ world view is whether the prices of goods and services reflect, and determine, all the costs involved for providing those goods and services. Specifically:
‘The opportunity cost of anything is what you must give up in order to have it.’
Opportunity cost is the road not taken on your journey — by definition you don’t see what was on it. So while you know the benefits of a particular action, you won’t necessarily know the costs. Hazlitt illustrates this by retelling a ‘parable of the broken window’ written by a 19th century economics journalist named Frédéric Bastiat. Bastiat imagines a shopfront with a recently broken window. the crowd who gathers to look at the damage offers the shopkeeper reassurance that at least there will now be work for the local glazier to repair it. Bastiat points out (and Hazlitt agrees) that while the benefit for the glazier’s business may be clearly seen, the costs are unseen — namely that the money spent on repairing a window is money not spent on other businesses — such as a new suit that the shopkeeper was intending to have made by a local tailor. This is opportunity cost, although Bastiat did not use the term. Hazlitt uses this parable to rebut a caricatured version of Keynesian economic policy i.e. the usefulness of stimulating the economy through spending. The benefits of such spending (what is seen) are always outweighed by the costs of what is not seen.
However Quiggin points out that, while the parable is a corrective to the idea that disasters can be economically useful (e.g. that cleaning up an oil spill, or going to war, are good for economic growth), it rests on an unseen (or unwritten) contradiction. Bastiat’s story assumes an economy at full employment, therefore more business for the glazier must mean less business for the tailor. However the crowd that advises the shopkeeper that at least the glazier will have work, clearly assumes there is not enough work in the glazing business.
For the parable to teach the lesson it purports to deliver, something (unseen) must have achieved a full employment economy (except in glazing). ‘One lesson’ economics, with its message that the costs of government actions always exceed the benefits, gives us few insights into how we get to such a state. It is much better at telling us what not to do, than what to do. However this is a feature, not a bug, of the One lesson: the overall political message is that, since we can’t know the cost of ‘interfering’ with markets, we should never try. This is a useful lesson if you want to ensure that those who currently have wealth get to keep it, but it is not so useful if you have a public policy issue such as the restoration of full employment after a slump. This is the point that John Maynard Keynes was making in his much misquoted statement:
‘The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.’
Mass unemployment occurs regularly under capitalism, despite market economics assuming, for the purposes of modelling, that it doesn’t. It represents a market failure, which is where Quiggin’s Second lesson comes in, namely:
‘Market prices don’t reflect all the opportunity costs we face as a society.’
Quiggin is particularly concerned with social opportunity costs. Under recession conditions, he argues, market prices do not work as accurate signals for opportunity costs for the economy as a whole. The ‘microeconomic’ assumptions of One lesson economics fail when there is mass involuntary unemployment, because it offers nothing to address the opportunity costs ‘which are not seen’. Those costs are borne by individuals who lose their standards of living, as well as potentially their mental and physical health, and by society as a whole in terms of lost output by those workers, and an increase in unemployment benefits. In short, ‘One lesson’ economics needs the policies it purports to reject, such as government action to restore full employment, in order for its assumptions about about price signals to operate.
Social opportunity costs, Quiggin explains, are the value of what you ‘AND OTHERS’ give up in order to have something. These have been called ‘externalities’, of which the most famous example is pollution. Because the costs of (say) emitting carbon are not borne by industrialists, they aren’t reflected in the costs of their products. Therefore, in the absence of government action (e.g. setting a price on carbon), market prices will not reflect the costs. This view of opportunity costs is particularly interesting when Quiggin sets out the intellectual history of the idea itself.
The economist who originally coined the term ‘opportunity cost’ was Friedrich von Wieser (1851–1926). He was an Austrian as in he was born in Vienna, but he was also an ‘Austrian’ in that he was an early member of the Austrian school of economics. This school later included more famous members such as Ludwig von Mises, Friedrich Hayek, and Hazlitt himself. Austrians are a heterodox bunch, however they broadly speaking favour an approach of ‘methodological individualism’: that the motivations and actions of individuals are better studied than those of ‘groups’. Nowadays they are more associated with radical free market prescriptions for economic policies, although in the manner of Marxist sects they are often keen to seperate themselves from the ‘neoclassical’ school of free market economics — a distinction without a difference for our purposes.
Von Wieser is particularly heterodox from the contemporary Austrian point of view because he rejected classical liberalism in favour of a ‘Social Economics’. Von Wieser applied the concept of opportunity cost not only to decisions made by markets, but to the wealth and resources of society as a whole. Therefore the original ‘opportunity cost’ came from the highly unequal distribution of wealth in society, in which the luxury consumption of the rich is prioritised over the basic consumption needs of the poor. Quiggin quotes von Wieser thus:
‘It is therefore the distribution of wealth that decides what will be produced, and leads to a consumer of a more anti-economic variety: a consumer wastes on unnecessary, guilty enjoyment that which could have served to heal the wounds of poverty’.
‘Opportunity cost’ in its original form was an argument for a progressive income tax. The ‘wounds of poverty’ are the ‘unseen’ cost in a society that allows conspicuous, unequal consumption flowing from its wealth distribution. This is not a perspective on opportunity cost you are likely to find in most economics textbooks, and for me was one of the most interesting things I learned from Quiggin’s book.
‘Economics in Two Lessons’ ranges over subjects such as: property rights, whether there is a ‘free lunch’, airline policies, and how the minimum wage works. Quiggin frames his book around the Hazlitt’s ‘One Lesson’, but unlike Hazlitt he is not providing his readers with a simple, single answer from which can flow certainty in all things. In that sense the book starts with a disadvantage compared to the ‘just so’ story that Hazlitt provides — particularly with the book’s avalanche of information. ‘Economics in Two Lessons’ will probably for the lack of a business and billionaire funded propaganda infrastructure which assists books such as ‘Economics in One Lesson’. Hazlitt was a foundation member of the ‘Foundation for Economic Education’ — a think tank to promote free market and libertarian ideas most recently funded by the infamous Koch brothers, and ‘Economics in One lesson’ is freely available on the FEE website. In Australia mining billionaire Gina Rinehart supports the Mannkal Economic Education Foundation which ensures Hazlitt’s name and writings are always available to each new generation of libertarians.
However, that Quiggin can demonstrate so many insights flowing from ‘only’ adding a second lesson is a testament to the book’s value. Quiggin leads you through economics effectively and insightfully. You won’t get all the answers, but you will certainly get a better idea about the questions.
Declaration of interest: John Quiggin published early versions of book’s chapters on his own blog, and the Crooked Timber group blog, and invited comments. I did make some comments (not many) and am listed in the Acknowledgements. Make of it what you will.