Hazlitt’s economic lesson is simple: The art of economics consists in looking not merely at the immediate but also 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. Hazlitt’s lesson applied to the federal stimulus package reveals the fundamental fallacies of job-creationists on both the left and the right.

Everything we get must in some way be paid for. Government can’t do anything for anyone until it acquires the funds to do so, and ultimately government acquires funds through taxation. Borrowed money plus interest must be paid out of taxes collected. When government simply prints paper money not backed by productivity, the result is inflation, which reduces people’s purchasing power and lowers the quality of life as viciously as any tax.

Cutting to the chase: Every dollar of government spending must be raised through a dollar of taxation.

“So, what?” argue the disciples of government spending. State Sen. Larry Pogemiller preached to a town meeting at the Brian Coyle Center in South Minneapolis, “It’s simplistic and naïve to say people can spend their money better than the government.” Pogemiller justified his faith in almighty government by arguing that an individual can’t build a freeway system, and “that’s why we have taxes” — a half-truth that confuses, not clarifies, the role of government in the economy.

A road is built. Were the road built to meet public demand, if it were more desired by taxpayers collectively than the things they would have purchased individually had their money not been taxed away, no one could object. But stimulus advocates aren’t proposing infrastructure projects based on a cost/benefit priority list. Their stated purpose is “creating jobs.” The criterion for project consideration is “shovel readiness,” not increased mobility.

Thus sayeth the congressman: The economic stimulus package will create jobs that otherwise would not come into existence. It will create employment for “unemployed” Minnesotans. Again, that is a half-truth that fails to look beyond immediate effects to secondary consequences.

Twelve thousand jobs may be immediately visible, as Oberstar says. But the wise policymaker looks beyond those who directly benefit from the stimulus package to those who indirectly suffer because of it. A particular group of highway construction workers will be given jobs — salaries paid from taxes on the productive labor of someone else. Every dollar paid to stimulus-blessed construction workers is taken from stimulus-damned taxpayers.

The stimulus package is $819 billion; taxpayers lose $819 billion. Taxpayers have $819 billion less to spend on things they need and want. But the negative effect of stimulus spending is far greater than simply reducing the purchasing power of taxpayers.

Visible construction jobs created on the “shovel-ready” criterion ultimately result in unseen jobs destroyed someplace else. We can see workers building a road. We can see pictures of Oberstar and Pogemiller making speeches on a new bridge. What we can’t see are the jobs that never had a chance to be because $819 billion was taken from the people who earned it and diverted elsewhere.

The stimulus package gives us more construction workers, but fewer waitresses, home remodelers, retail employees and jobs that entrepreneurs would have eagerly created and consumers would have willingly supported had government not diverted spending elsewhere. We can drive on a new road or cross a new bridge that would not exist without the stimulus package. We cannot, however, taste the food not produced by the restaurant that doesn’t open, make use of the new widget that is not invented, nor enjoy the room addition we cannot afford to build.

Visualizing the unseen damage of excessive government spending on nonetheless living, breathing people requires an imagination and intellectual honesty lacking in politically motivated policymakers. The hell of it is that Oberstar and the chosen few prosper on half-truths while the unseen many silently suffer the whole economic reality.

This commentary originally appeared in the St. Paul Pioneer Press, Friday, Feb. 5, 2009.

Second, Mr. Mindeman agues that government creates wealth when it makes payments to corporations. Among the corporate examples he cites is Halliburton. 

“How would such massive corporations as Lockheed, Boeing, Halliburton, and KBR have fared without government contracts? Did that not create wealth within those companies?” he asks.

In each case, Mr. Mindeman fails to observe Henry Hazlitt’s one lesson in economics cited in my column: The art of economics consists in looking not merely at the immediate but also 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. Mr. Mindeman sees only what he wants to see.

Government “creating” military jobs is a classic example of the seen versus the unseen and failure to heed Hazlitt’s lesson. 

First, it should be noted that without a tax base to support it, a military could not exist. The taxes paid to provide for “necessary and sufficient” national defense is money taxpayers collectively would willingly spend on their own for security, but nonetheless, the military has no productive value to create wealth. In fact, in time of war (whether the war is warranted or not) military activity consists of killing people and breaking things. Money used to support the military must be had at the expense of other sectors of the economy.

The evidence of this is ample. During WWII, American’s manufacturing sector was dedicated to the war effort at the expense of consumer goods. Following the war, the Soviet Union ramped up its military spending at the expense of consumer goods. Guns or butter is as old a debate as, well, the advent of guns and butter.

The constitutional obligation of government to protect its citizens, and what size military that requires, are political questions. How the political questions are answered does not negate the fact that every solider hired is done so at the expense of a job in the private sector. Every tank is built at the expense of a consumer good. That such expenditures provide for the security of the country, they are legitimate, and as I noted in my column, I do not object to good faith government spending intended to meet a constitutional obligation.

However, Mr. Mindeman is supporting the argument that “creating jobs” is such a legitimate function. Yet every solider hired beyond what is necessary and sufficient for national defense is a net loss to the economy. While one can argue for the “necessity” of the military, the “necessity” for a preemptive war, the “necessity” for enhanced security measures, none of those “necessities” change the fundamental economic principle that they are employed at the cost of more economically productive use.

Case in point is the effort of both our DFL and GOP senators, Amy Klobachar and Norm Coleman respectively, to prevent the Pentagon from closing the National Guard air base in Duluth. Neither argued for the defense merits of the base. They fought the closure because the base has a positive annual economic impact on norther Minnesota of $85.1 million, including $41.4 million in wages.

If the base were unnecessary to national defense, as the Pentagon claimed, then the “soldiers” staffing it consumed $41.4 million that would have more effectively flowed to other sectors of the economy if left in private hands. True, Duluth and northern Minnesota would have suffered had the base closed, but the aggregate economy would have been better off with the capital and labor put to more productive use.

Military spending beyond what is needed to provide for national defense is as wasted as salaries paid to construction workers to build “shovel ready” projects whose costs exceed their benefits.

That brings us to Mr. Mindeman’s second contention that the government created wealth by spending huge sums of money with corporations like Halliburton.

This argument of Mr. Mindeman is deliciously ironic. Progressives were critical of the billions of dollars “wasted” on the Iraq war — billions of dollars spent killing people and breaking things. Therefore, it can only be economic ignorance that leads Mr. Mindeman to conclude that paying Halliburton to replace what was broken somehow creates wealth.

Mr. Mindeman makes the classic error behind the “Broken Window Theory,” which assumes that when a window is broken that is a good thing because it creates a job for a glazier that otherwise would not exist. The glazier at work is what is seen. What is not seen is the job that is lost because the owner of the broken window must replace his window rather than buy something he wants. In aggregate, society is poorer by the value of one window, not richer by the money paid to the glazier. 

When government destroys things, whether in a war on terror or a war on global warming by forcing industries to retool plants that still have value it does not create wealth by paying corporations to carry out its programs. Some people get rich — usually those with connections and influence — but in aggregate, society is poorer. 

Money and wealth are not the same things. Government can print money; government cannot create wealth.

Mr. Mindeman’s blog deposits other notions spawned by the same fallacies and failure to look beyond the immediate consequences of government policy to the secondary effects that must necessarily follow. The same analysis can be applied to each. Horse, water, drink and all that.

Although I used some defense contractors as an example of government “wealth” creation…. that, by no means, should be concluded as some kind of endorsement of that process. This type of corporation is just a prime example of Fortune 500 status being attained via the government. I would most assuredly have preferred that all of the government contracts that created the financial well being of these defense giants have gone to solar, wind, and other green companies that would have reduced our dependence on foreign oil rather than contributing to the wealthy retirement of Dick Cheney.

A couple of lessons here. First, principles are principles because they apply in all situations irrespective of whether one might personally approve of the outcome. Gravity is my friend when it keeps my feet firmly on the ground, but it is less than friendly when I trip and fall. The principle of gravity, however, does not change because of my clumsiness. Economic principles apply whether the government is subsidizing Dick Cheney’s retirement or green companies. They don’t change because of the consequences or in forgiveness of intellectual clumsiness.

The discussion we are having is not the political discussion of whether the Iraq war was politically necessary or (now) whether “green companies” should get government subsidies. We are having an economic discussion as to whether or not government stimulus creates jobs – whether in defense or the green industries.  

The fact is that before government can subsidize any corporation, it must take the money out of the private sector in taxes. That necessarily means an opportunity cost. At the theoretical best it means that the increase in green jobs is offset by the loss of jobs in other industries. In reality the loss is greater because the end result is that the community pays a higher price for energy with all the consequent implications. If society were not incuring higher cost, no subsidy would be necessary.

Mr. Mindeman may value green energy more than war in Iraq. That’s okay, but that is a political opinion. The question on the table is whether stimulating either the defense industry or the green energy industry creates a net increase in jobs. Mr. Mindeman sees only the visible effects; he continues to ignore opportunity cost and secondary effects.

Mr. Mindeman further complains that I only dealt with his example of “soldiers” in refuting his notion that government creates jobs.

Now, Mr. Westover goes on, at length, about soldiers and defense contractors as a “poor” example of government created jobs, since the government is solely responsible for national defense. He ignored all the other positions that I listed….

Air Traffic Controllers….Food Inspectors….Park Service….Forest Rangers….Law Enforcement….Soldiers….Disease Research and Control…Regulators….Public Health…etc.,etc.

To the contrary of being a “poor” example, I chose the example of soldiers because soldiers and another category Mr. Mindeman listed, “law enforcement,” are the examples that might best support his position – they represent employment in support of constitutional obligations of government, which might lead one to conclude that government “created” these jobs. As support for his opinion that government creates jobs, the other categories are far less convincing evidence.

My argument briefly is that as long as government contains military spending to that which is necessary and sufficient for national defense, taxing and spending is legitimate. But when the government uses military expenditures as job creation (my example is the Duluth air base) it is wasting resources and creating a net job loss for society.

Mr. Mindeman does not address my argument vis-à-vis employment of soldiers, however, but simply comes back with this laundry list of government jobs to prove government creates jobs. Unfortunately for his position, each job he lists suffers from the same fallacy as the case for soldiers and law enforcement officers. I will be happy to deal with any or all of these categories individually, if Mr. Mindeman can explain to me how government employing these people is categorically different than the argument I made for over-employment of soldiers. I fail to find any discussion of that argument in his post. Of far more importance is clarifying Mr. Mindeman’s failure to comprehend the “Broken Window Theory.” He writes:

“But, there is another curious conclusion in Westover’s critique:

“Mr. Mindeman makes the classic error behind the “Broken Window Theory,” which assumes that when a window is broken that is a good thing because it creates a job for a glazier that otherwise would not exist. The glazier at work is what is seen. What is not seen is the job that is lost because the owner of the broken window must replace his window rather than buy something he wants. In aggregate, society is poorer by the value of one window, not wealthier by the money paid to the glazier.”

Are we making some kind of assumption that society, as a whole, has limited resources? That because a window is broken, it can’t just be fixed while purchasing what he wants at the same time? Are we to assume that their is some kind of economic balance sheet with finite resources in which every single transaction takes away from something else?”

Answering Mr. Mindeman’s questions in order:

Yes, society’s resources are not unlimited. Economics is all about the distribution of scarce resources to their most productive use.

No, a person can’t fix a broken window AND purchase what he wants. Admittedly that is simplistic for purposes of illustration. Certainly a broken window is not going to prevent you from taking a planned vacation to Disney World. But the economic principle is valid – the money spent to fix a broken window is money that cannot be spent more productively on something else.

Yes, every economic transaction has an opportunity cost. Before the window is broken, you have $250 (for example) and a $250 window. After the window is broken and you have it replaced, you no longer have the money, but you still have a $250 window. You can’t invest the $250 spent on the window and earn a return. You can’t spend it at Disney World. Likewise, before the window was broken, society’s wealth consisted of $250 and a window worth $250. After the window is broken, society still has $250 (only now the glazier has it, not you), but society is poorer by the replacement cost of one window, not to mention the productive value had you been able to spend or invest your $250.

Albeit based on his misunderstanding of the role played by opportunity cost, Mr. Mindeman draws an apt conclusion.

“If that is the case, then trickle down economics is the worst of all possible scenarios, because invariably we will run out of resources before we get to the bottom of the economic ladder.”

Indeed we will run out of resources if the predominate form of economic activity is government spending precisely because government produces no new wealth. As Mr. Mindeman stated earlier, he would prefer to see corporate subsides go to green energy companies irrespective of the economic consequences that such subsidies produce less energy at higher cost.

Capitalism is powered by the flow of capital and labor to its most effective use as determined by the price system. Wealth is created when a tailor takes $100 worth of cloth and labor and makes a coat people are willing to pay $200 to own. Society is wealthier by one coat and the quality of life is enhanced. When a Wal-Mart comes along and uses technology to cut its cost of sales so that it can sell the same coat for $180, the quality of life is again enhanced because now a person can own the same coat and still have $20 to purchase something else. Jobs are created to meet the increased demand for coats at a lower price point and to work in industries competing for the additional $20 in purchasing power.

Wealth increases when we pay less for the same or greater value. However, when government imposes taxes to redistribute wealth to a less effective purpose, the additional productivity, additional wealth in the community, is lost — and the jobs dependent on it.

Mr. Mindeman’s justification for the stimulus package boils down to this:

When a bridge is built, we have something tangible. We have an improved transportation conduit. We hopefully have updated and improved transportation. All of which contributes to more efficient commutes to work and transportation of goods. That is a positive on economic growth and stimulus in the truest sense of the word.

My question would be this: Why was the “Bridge to Nowhere” bad? It would have created jobs. It was tangible. It would have improved transportation; very little, but there would have been a net improvement. It was “shovel ready.”

As I note now for the third time, infrastructure projects that have benefits that exceed their costs, that taxpayers would collectively rather have than whatever their tax dollars might individually have purchased, are legitimate projects. But cost/benefit is not the stated criterion of the stimulus package. The stated criterion for projects is “shovel readiness.” The stated purpose is “creating jobs.” There is simply no way any group, however brilliant, can effectively allocate over a trillion dollars to its most effective use – especially when government has no criterion of benefit (like prices) other than “shovel readiness” and no purpose other than to “create jobs.”

David Boaz of the Cato Institute makes this point with an allegorical tale of a businessman on a trip to China.

While touring China, he came upon a team of nearly 100 workers building an earthen dam with shovels. The businessman commented to a local official that, with an earth-moving machine, a single worker could create the dam in an afternoon. The official’s curious response was, “Yes, but think of all the unemployment that would create.” “Oh,” said the businessman, “I thought you were building a dam. If it’s jobs you want to create, then take away their shovels and give them spoons!”

Earth-moving equipment improves productivity and frees up the capital and labor tied up in 100 men with shovels (or 10,000 men with spoons) to flow to other more productive uses. It is rather obvious that one does not stimulate the economy by taking tax money that might be used to build and buy earth-moving equipment to create jobs for shovel and spoon operators. It is less obvious but equally true one does not stimulate the economy by taking tax money from consumers and producers that might be used to produce products people will pay to consume to create jobs whose primary value is that they are metaphorically “shovel ready.”

That is the economic argument against the stimulus package. It may very well be refutable, but it is not refutable simply because Mr. Mindeman doesn’t like the consequences of the logic. Nor is it refutable by the blind faith in government spending that motivates Mr. Mindeman to claim, “We are at a crucial crossroads where only government can bring us back from the brink.” It is generous to call the failure to adequately deal with the secondary consequences of the stimulus package “bad economics”; it is hardly economics at all.

UPDATE: Minnesota Free Market Institute Senior Policy Fellow King Banaian provides an excellent lesson on “shovel ready.”

Mr. Westover, I’m Looking at Secondary Effects

Posted: Tuesday, 10 February 2009 15:23, Edited: Tuesday, 10 February 2009 15:30

by Dave Mindeman

Craig Westover at the Minnesota Free Market Institute seems to be intent on wasting valuable blogging space on their site with refuting blog postings over here.

As you wish…but his latest lecture has a couple of things that I just can’t accept. I don’t pretend to be an expert in economics but there are some things that “Professor” Westover discusses that just don’t make a lot of sense.

Here is one example:

The question on the table is whether stimulating either the defense industry or the green energy industry creates a net increase in jobs. Mr. Mindeman sees only the visible effects; he continues to ignore opportunity cost and secondary effects. 

Westover emphasizes “secondary effects” on economic incursions. Defense industry jobs meet a level of acceptibility for Mr. Westover because they meet a Constitutional obligation of the government. But as to cost and secondary effects, Green industry jobs are a windfall (so to speak). Solar, wind and other alternative energies would replace fossil fuel sources. This would reduce energy costs (a secondary benefit). It would reduce imports of foreign oil and probably help reduce gasoline prices (another secondary benefit for business). It would create secondary industries in replacement parts and jobs for managing the system. (another secondary benefit).

Yet, with all these secondary cost benefits, the current economy has been slow to embrace this change. Why? Maybe because initial outlays for the change are very expensive and require long term planning…or maybe oil companies have lobbied against the changes by putting obstacles in the path of any transition.

But with Government stimulus (sorry, I have to use that word again), the initial changeover can be accelerated by a large government investment now. The economy as a whole would get those secondary benefits more quickly and costs would be recouped. And in addition, new industries would be created to meet new energy needs.

I’m sure that in Westover’s economic vaccum, a change of that magnitude would cause too much havoc with “opportunity costs” and “secondary effects” that are not created from within his closed system. 

Westover seems to imply that Government is an intrusion on the economy and not intricately woven as it seems to be.

But there is one more thing he brings up:

Capitalism is powered by the flow of capital and labor to its most effective use as determined by the price system. Wealth is created when a tailor takes $100 worth of cloth and labor and makes a coat people are willing to pay $200 to own. Society is wealthier by one coat and the quality of life is enhanced. When a Wal-Mart comes along and uses technology to cut its cost of sales so that it can sell the same coat for $180, the quality of life is again enhanced because now a person can own the same coat and still have $20 to purchase something else. Jobs are created to meet the increased demand for coats at a lower price point and to work in industries competing for the additional $20 in purchasing power.

I am going to try to apply Westover’s theory to this same situation. I will surely get it wrong, but this example begs to be examined.

This tailor who makes a coat for $200 via his own labor and $100 of materials, is by definition a small business. In theory, his business would grow if he does a good job and people recommend him to their friends. But along comes Wal-Mart. They decide to make the coat for $180 by the following:

– reduced wages for employees (loss of wealth)
– demanding cost reductions from suppliers (loss of wealth)
– which in turns causes the supplier to lay people off(loss of wealth)
– which in turns causes that supplier to look for cheaper raw materials outside the country — more job loss (loss of wealth)
– in addition, Wal-Mart maintains low cost by moving its employees into government sponsored health programs (societal burden)
– and, Wal-mart drives wages furthur down by fighting off unions which keeps out more livable wages (more loss of wealth)
– and in the end, Wal-Mart drives the tailor out of business because he cannot compete on price (more loss of wealth)

Maybe the purchaser of the Wal-Mart coat gets an increase of $20 in purchasing power…..but what’s the real cost?

Mr. Westover on Wal-Mart and A Scrooge Type Economic Outlook

Posted: Thursday, 12 February 2009 03:21, Edited: Thursday, 12 February 2009 03:34

by Dave Mindeman

According to Mr. Westover, I apparently erred when I evaluated potential stimulus actions by looking at potential secondary “benefits” of any program or project. Apparently, we must stick to “the unseen negative effects of an economic policy”.

I guess that must be the theory that banks who received the TARP money must be working on….why lend the money out to the risky general public when it can be held back for bonuses given to the people who really “understand” how to utilize capital.

Today’s lecture centered on another apparent misunderstanding of mine regarding Westover’s “Wal-Mart” story…..

But then he has to go a spoil it all by saying something stupid and predictably partisan in response to my example of Wal-Mart increasing wealth and purchasing power by using technology to reduce the cost of sales……In my example, Wal-Mart is not buying cheaper coats (which it could do were there a market for cheaper coats). Wal-Mart, is purchasing coats from the tailor (at a wholesale price) and because of its more efficient operation, is able to increase its profits by retailing the same coat at $180. Wal-Mart makes more money, and consumers can buy the same quality coat for $20 less, which gives them an additional $20 in purchasing power. 

Unfortunately, I made some “stupid” assumptions. First of all, I never realized that Wal-Mart would use a simple tailor as a supplier. After all, custom making suits for individuals in a small tailor shop is foolishly inefficient. But, you see, if the tailor was going to furnish “wholesale” goods for Wal-Mart, then he would no longer be a tailor but a mass producer of suits. He would also have to meet the Wal-Mart criteria for that production. Keep the cost of materials and labor down to Wal-Mart standards.

I forget that technology and efficiency is always superior to meticulous individuality and careful custom design. The reality which is lost here is that the $180 coat from Wal-Mart is NOT the same as the $200 coat from the tailor. There is not just an increase of $20 in purchasing power….there is also a loss of quality. But there I go again, looking at those micro secondary benefits instead of the macro economic big picture.

Then Westover goes into some kind of backhand endorsement of labor unions….

However, if an individual employee overvalues or undervalues his worth in the market, it can have significant impact on that individual person. Therein lies the value of unions. A standard union wage for what can be considered commodity jobs provides employees with information about their relative value in the market. Doing so, unions serve a valuable and productive purpose.

OK, I followed him on that part, unfortunately he goes on…

However, when unions, backed by government intervention, push wages above market value, they actually work against job and wealth creation. The visible direct benefits are higher wages for those employed. The unseen secondary effects are willing workers unemployed at a lower wage, higher consumer prices, and lower returns for capital providers to the business.

I missed that one. “unions, backed by government intervention”?? What does that mean? And why the assumption that union wages are by definition “above market value”? Maybe unions arenecessary to determine true market value…. not just the lowest cost value. There might be a palpable difference.

And these “unseen secondary effects….. what are “willing workers unemployed at a lower wage, higher consumer prices, and lower returns for capital providers”…. If you are unemployed, your lower wage would seem to be $0. Don’t blame that on the union. A union is as much a part of “market forces” as availability (or lack therof) of raw materials or larger corporations attempts to drive out smaller competitors. And all of those things factor into prices and returns.

But secondary “benefits” of the union might be more satisfied and productive workers. More efficient wage negotiation. Oh, but I forgot secondary effects are always negative.

Here’ another one….

If that new technology prompts the tailor to lay off people, those people will suffer. But in net aggregate, far more jobs are created by the productive use of capital than are lost. New wealth is created.

The problem with that is that corporate giants like Wal-Mart don’t just eliminate or revamp the tailor shop — entire main streets get decimated. The local hardware store, the electronics dealer, the jewelry shop, and the little toy store on the corner. Jobs get concentrated in the corporate behemoths at wages they determine. Local entrepeneurs are discouraged from start-ups. Competition is stifled. I disagree that more jobs are created… and as for new wealth? It may be created but it gets funneled into the hands of the few.

I also like this concept regarding Wal-Mart emphasis on lower cost foreign imports:

Ultimately, dollars spent on foreign goods must come back to the United States through the purchase of our products or as investment in our economy.

Truth? Dollars come back to the US in the form of debt and trade deficits.

But let’s get back to the stimulus bill. Westover starts out with some realistic talk.

I’ll end this discussion acknowledging the valid moral point that Mr. Mindeman attempts to disguise as economic principle – the creative destruction inherent in a free market system does cause real pain to real people (this severe recesion, however, has more to do with government policy than creative destruction).

You bet there is pain out there and I am encouraged that Mr. Westover admits that recent government policy (which we can only assume refers to the Bush administration) has been a factor in causing that pain.

But then we get to the crux of the matter….

Instead of trying to manage our way out of painful economic situation caused by government mismanagement of the economy, better to accept the pain and deal with it directly. Instead of trying to tweak a trillion dollars worth of stimulus, let the market work. Let the economy sort itself out. Let the foreclosures happen, the companies close and the jobs be lost. Let capital and labor flow to its most effective use. AND let us practice what we preach and consider the secondary effects — the negative consequences of that policy.

Are there no prisons? Are there no workhouses?

“Let the market work.” But then that’s the problem…the market is NOT working. The normal functioning of the economy has been usurped by greedy bankers and lax government oversight. Letting the market “sort itself out” could go on for years, maybe decades. The depth of this recession was caused by an artificial force — greed. Bankers and predatory lenders caused an economic bubble that they knew had to burst — they just counted on it happening on somebody else’s watch.

That is why we need the stimulus. An intervening force to re-ignite the NORMAL economic forces and get us moving again. We will still feel that pain for a time but a damaged and weakened economy needs help to recover more quickly.

There is only one entity that can meet that need — government stimulus. And like it or not, it looks like some version of that stimulus will get passed this week. 

Maybe Mr. Westover hopes it fails…..I don’t.