Economists and the State: From Enemies to Friends

by
Joseph T. Salerno
My articles My booksMy videos
Follow on:

Economists and the state are natural enemies. The central principle of economics is that the means for improving human well-being—what economists call “goods”—are naturally scarce and must be produced before they can be used to satisfy human wants. The scarcity principle also implies that, once produced, goods cannot be bestowed on one person without depriving some other person or persons of their use. In other words, there is no such thing as a free lunch. The state and its friends reject the scarcity principle and uphold its polar opposite, the Santa Claus principle, which Ludwig von Mises defined as “the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes.”

One hundred years before Mises wrote this, the French liberal and laissez-faire economist Frédéric Bastiat exposed the Santa Claus fable underlying all arguments for state intervention in the economy while emphatically affirming the scarcity principle. It is worth quoting Bastiat’s argument at length: “Here the public, on the one side, the state on the other, are considered as two distinct entities, the latter intent upon pouring down on the former . . . a veritable shower of human felicities. . . . The fact is the state does not and cannot have one hand only. It has two hands, one to take and the other to give. . . . Strictly speaking, the state can take and not give. . . . [because] its hands . . . always retain a part, and sometimes the whole, of what they touch. But what has never been seen, what will never be seen and cannot even be conceived, is the state giving the public more than it has taken from it. . . . It is fundamentally impossible for it to confer a particular advantage on some of the individuals who constitute the community without inflicting a greater damage on the entire community” (emphasis added).

Based on this reasoning, Bastiat formulated his justly famous definition of the state: “The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else.”

Bastiat also foresaw that once the Santa Claus view of the state was widely embraced by the public, the state would be able to grow without limit. The reason, according to Bastiat, is that the state is “composed of cabinet ministers, of bureaucrats, of men, in short, who, like all men, carry in their hearts the desire, and always enthusiastically seize the opportunity, to see their wealth and influence grow. The state understands, then, very quickly the use it can make of the role the public entrusts to it. It will be the arbiter, the master, of all destinies. It will take a great deal; hence a great deal will remain for itself. It will multiply the number of its agents; it will enlarge the scope of its prerogatives; it will end by acquiring overwhelming proportions.”

Prior to World War I, economists as a group were hated and denounced by statists of all stripes—monarchists, socialists, nationalists, theocrats, democrats—because by exploding the Santa Claus myth, economists had exposed the state for what it really is: a predatory organization whose every action benefits itself and its cronies by victimizing those who earn their income by voluntarily producing and exchanging goods. In 1949, Mises emphasized the historical enmity between economists and the state: “It is impossible to understand the history of economic thought if one does not pay attention to the fact that economics as such is a challenge to the conceit of those in power. An economist can never be a favorite of autocrats and demagogues. With them he is always the mischief-maker, and the more they are inwardly convinced that his objections are well founded, the more they hate him.”

Economics Takes a Wrong Turn

Unfortunately, at about the time that Mises wrote this, the relationship between economists and the state was already beginning to undergo a radical change. This change was most clearly manifested in the publication of the first edition of Paul Samuelson’s celebrated textbook, Economics: An Introductory Analysis. In this book, Samuelson concocted what has come to be called the “neoclassical synthesis,” a vain attempt to combine the scarcity principle with the Santa Claus principle.

The movement to incorporate the Santa Claus principle into economics was propelled by theoretical developments during the interwar period, particularly in the 1930s. On the one hand, the publication of Lionel Robbins’s Austrian-influenced monograph on economic method, An Essay on the Nature and Significance of Economic Science, impressed on most of the economics profession in Great Britain and the United States that scarcity and not material wealth is the central theme of economic theory. On the other hand, several developments in other areas of economics at about the same time persuaded Anglo-American economists that markets were “imperfect” and often failed to deliver the goods—at the lowest cost, in the proper combination, and at a level consistent with the full employment of resources.

Let us briefly consider these theories of “market failure.” The monopolistic competition revolution, which began in 1933, promoted the view that most markets in the economy are monopolistic. Brand names, locational differences, trademarks, and variations in product composition and packaging mislead consumers to differentiate between similar products. This gives almost every firm a monopolistic niche and endows it with the market power to raise its price above the perfectly competitive price, which is a price that would exist in a never-never land where all sellers and buyers possess perfect knowledge, all firms are infinitesimally small, and goods in every market are completely identical. The supposed monopolistic competition results in firms’ inefficiently restricting the production of goods to achieve a higher price, while driving up production costs and creating excess capacity.

The 1930s also saw the continued development of welfare economics, which emerged as a formal subdiscipline in 1920 with the publication of The Economics of Welfare by the British economist A.C. Pigou. Pigou emphasized what we today call external benefits and external costs. These concepts still play a central role in welfare economics and refer to the fact that individuals do not always reap all the benefits or bear all the costs of their market activities. In the case of external benefits, this is said to lead to market failure in the form of underinvestment in goods like education, lighthouses, and basic scientific research because the social benefits exceed the private benefits received by those who pay for the goods. An educated voter and a lighthouse yield benefits to third parties who did not pay for the education of the voter or the production of the lighthouse, and thus less of these goods are produced than would be the case if the producers of the goods and their paying customers captured all the goods’ benefits or if all the goods’ beneficiaries were somehow forced to pay.

The market failure argument that was most influential in entrenching the Santa Claus myth in modern economics was contrived by John Maynard Keynes in his book The General Theory, published in 1936. In it Keynes argues that the market economy generally fails to generate sufficient total spending (or “aggregate demand”) to purchase the entire output that the economy can potentially produce when its labor force is fully employed. This implies that resources are, in general, superabundant and that scarcity exists only in what Keynes calls the “special case,” where consumers and entrepreneurs fortuitously spend just enough to purchase the full-employment level of output. If superabundance of resources is the general case, then the Santa Claus principle takes center stage in economics. Government expenditure financed by money creation does not deprive anyone of part of his real income but miraculously conjures into existence extra goodies that can be bestowed on some without taking from others.

Keynes’s Upside-Down Economics

As the Keynesian revolution began to take root among the Anglo-American economics profession, Abba Lerner, a radical Keynesian and the grandfather of so-called modern monetary theory (MMT), strained mightily to cloak the Santa Claus principle in scientific terms. He called the economic theory that applied to a world of excess resources “topsyturvy” economics and contrasted it with “ordinary” economics based on the scarcity principle. Without completely rejecting the latter, he argued: “An economy suffering from unemployment is an upside-down economy for which only a topsy-turvy economic theory is of any use. Ordinary or right-side-up economics is concerned with the economical use of resources. The resources are scarce. . . . It is important to economize—to use less of any resource for the performance of any task. . . . But when there is unemployment this is no longer the case. . . . There is no point . . . in managing to carry out some task with less labor if there are unemployed workers available . . . because the workers set free would merely be added to the unemployed.”

Hence, for Lerner, improving economic efficiency only increases unemployment and makes things worse in Keynes’s upside-down economy. Similarly, Lerner concedes that thrift is “a virtue and a blessing” and “a fundamental condition for . . . rapid growth” in an ordinary economy. “But,” he warns, “in our upside-down economy which suffers from unemployment, thrift merely reduces the demand for products[,] and the resources which might have gone into making them are merely left unused and are wasted.

According to Lerner, “The same considerations apply in reverse too. Just as efficiency and thrift lead to suffering and impoverishment, so do inefficiency and prodigality bring relief and enrichment.” Thus, he contended that anything and everything that causes inefficiency and waste—monopolistic restrictions, union work rules, tariffs—raises employment and income in the upside-down economy. To emphasize his point, Lerner offered a backhanded compliment to Henry Hazlitt’s magnificent exposé of economic fallacies, Economics in One Lesson. Wrote Lerner: “One of the finest attacks on topsy-turvy economics is to be found in Henry Hazlitt’s book Economics in One Lesson. Mr. Hazlitt is able to tear to little pieces a large number of propositions of the kind put forward in this chapter because all his argument is based on the assumption, mostly unconscious, of a state of full employment in which topsy-turvy economics is completely out of place. Perhaps he will one day consider the possibility of an economy suffering from unemployment and write the second lesson” (emphasis added).

The great Hazlitt never took Lerner up on his suggestion—perhaps because he was conscious that, in the real world, the economy is right side up, resources are always scarce, and the state is not the incarnation of the mythical Santa Claus but a descendant of the legendary—and very real—Attila the Hun.

In the same vein, Lerner dedicated his book to “Harold J. Laski and Ludwig von Mises, and the millions of lovers of freedom in between who are addicted to baiting ‘capitalism’ or ‘socialism.’” The only thing that the British socialist Laski and the laissez-faire Austrian economist Mises had in common was their belief in scarcity and their rejection of topsy-turvy economics. Of course, Marxian socialists like Laski believe in a variation of the Santa Claus myth: scarcity is inherent in capitalism and will disappear with its abolition and the emergence of a socialist utopia.

Compared to Lerner, contemporary mainstream economists are much more temperate in their rhetoric. However, their theoretical position does not essentially differ from Lerner’s. Although they pay lip service to scarcity, they still firmly hold to the main principle of topsy-turvy economics—that the state is able to provide something for nothing. All current economics textbooks teach that the state increases the supply of goods and improves human welfare by curing market failures with appropriate policies. The optimal number of educated citizens is ensured by state provision of education at all levels; monopolistic restriction of vital goods is suppressed by antitrust laws and regulation of “public utilities”; and the ever-present tendency toward a deficiency of aggregate demand and toward unemployment is neutralized by monetary and fiscal policy.

The idea that state economic policies can call into being a cornucopia of resources that is impossible for private markets to generate is a gross fallacy. The only resources the state has at its disposal are those that already have been produced on the market and that have been coercively siphoned off from the producers through taxation and inflation. This theft reduces the welfare of productive workers, capitalists, and entrepreneurs for the benefit of parasitic politicians, bureaucrats, government contractors, and financial elites, as well as of the state’s favored victim groups. Aside from the direct seizure of their income by taxation and inflation, productive taxpayers suffer further depredation of their wealth and welfare from a host of additional state interventions in the economy, such as regulations, tariffs, antitrust laws, price controls, and state-granted monopoly privileges.

The theory of market failure is thus a rhetorical device used to conceal the fact that modern welfare economics is based squarely on the Santa Claus principle that the state is an entity existing apart from society and possessing mysterious powers to tap into a fount of resources that it can freely shower on selected individuals and groups without imposing deprivation on other individuals and groups. Austrian economists, particularly Mises and Murray Rothbard, have demolished all market failure arguments, and with them the case for the welfare state. They have demonstrated that monopolistic restriction of production cannot arise in an unhampered market; that external benefits are a blessing to society at large and do not cause an underproduction of vital goods; that any supply of money is sufficient to facilitate the exchange of the entire output of goods produced in an economy; and that all who seek employment are always able to find jobs at freemarket wage rates.

Once it is affirmed that economics is all about— and only about—human action in a world of pervasive and unremitting scarcity, it becomes crystal clear that the proponents of welfare economics, topsy-turvy economics, MMT, and their ilk are not economists at all. They are antieconomists who fail to grasp that capital goods, the indispensable foundation blocks of civilized human existence, are scarce and perishable and must be continually economized, maintained, replaced, and accumulated to preserve and improve living standards for everyone. Confiscatory taxation, chronic inflation, and the many other interventions that they promote discourage saving and cause capital consumption, declining living standards, and an accelerating process of decivilization. The importation of the Santa Claus myth into economics is not only absurd, but also economically and socially destructive.

Mises on the New Breed of Economist Now, since it is evident to all that human labor and natural resources are rigidly limited, the economists who uphold the Santa Claus principle implicitly assume the superabundance of the third great class of productive resources, capital goods. This assumption is attributable to the fact that modern economics still lacks a coherent theory of capital. Mises recognized this and attributed the manifold errors committed by proponents of the welfare principle to their failure to comprehend the nature and function of capital. Quoting Mises: “The Santa Claus fables of the welfare school are characterized by their complete failure to grasp the problems of capital. It is precisely this defect which makes it imperative to deny them the appellation welfare economics with which they describe their doctrines. He who does not take into consideration the scarcity of capital goods available is not an economist but a fabulist. He does not deal with reality but with a fabulous world of plenty. All the effusions of the contemporary welfare school are based . . . on the implicit assumption that there is an abundant supply of capital goods.”

To conclude, it was the smuggling of the Santa Claus principle into economics under the cover of welfare economics and of the topsyturvy economics of Keynes that transformed economists and the state from bitter enemies into the best of friends. Since the start of World War II, this has been a relationship of great mutual benefit. The state receives a scientific imprimatur for every conceivable kind of intervention, and the economics profession receives extravagant government research grants and lucrative positions in the federal bureaucracy to study and administer these destructive interventionist schemes that eat up capital.

As Mises perceptively noted shortly after World War II, “The development of a profession of economists is an offshoot of interventionism. The professional economist is the specialist who is instrumental in designing various measures of government interference with business. He is an expert in the field of economic legislation, which today invariably aims at hindering the operation of the unhampered market economy. . . . It often happens that such experts are called to direct the affairs of big banks and corporations, are elected into the legislature, and are appointed as cabinet ministers. They rival the legal profession in the supreme conduct of political affairs. The eminent role they play is one of the most characteristic features of our age of interventionism.”

Since Mises wrote this in 1949, economists have gone from friends and wartime consiglieri of the state to an integral part of the state apparatus. Economists infest almost every department and agency of the bloated federal bureaucracy, from the Fed and the Treasury Department to the Department of Homeland Security and the CIA. Economists also serve as full-time advisers to both chambers of Congress and as aides to individual senators and representatives. According to the Brookings Institution, the federal government employs 2,200 PhD economists. A few economists have even achieved elected office in the legislative branch. Fortunately, we have thus far been spared from having an economist in the White House. The reason for this is summed up in the old joke: an economist is an accountant without the personality.