Why Does Economics Matter?

0:00Okay, it's a pleasure to be with you here today and to have you visit the Mises Institute. I want to welcome you from my perspective. I'm going to be addressing the question, why does Austrian economics matter? And if there's one thing I'd like everybody to get across here today, is the difference between economists on the one hand and Austrian economists on the other. because there's a great deal of difference between the two groups, some of which I'm going to try to explain today. Mainstream economists, all the other economists other than the Austrians have a different perspective on what economics is in your particular part in it. They devise mechanical type models of how the economy operates or how it should operate.

0:58They used advanced statistical software. They employed mountains and mountains of data in order to validate their models, in order to make predictions about the economy. And every time the economy doesn't fit their particular models, they call on the government to somehow change us so that we fit into their models. Austrians have a different perspective. We don't rely on computer software or computers or mathematical models. We rely on basic economic theorizing about using logic and deductive reasoning to determine what people are all about.

1:44What common traits do we see in humanity that we can distill down into particular theories that help us understand how the economy operates. And this is critical. Austrians want to understand how an economy can be successful, as well as why do economies fail? And so that's our total emphasis is in coming to grips with those two particular questions, Success and Failure. This is obviously going to tell us a great deal about the world we live in and that world which we ourselves are going to try to succeed or at least avoid lots of big failures. When we look at our own country, the United States of America, what we see is a very successful economy that was built literally from nothing to become The world's largest economy with one of the highest standards of living, basically over a few hundred years.

2:58Now what's the reason for that success? That's something that's very, very important to know how the United States has succeeded up until this point. It's something you really haven't been taught throughout all your school years. That's something that doesn't get raised very often, and it's something that, frankly, the mainstream economists also tend to ignore. So that's one of the things we're going to be looking at here today. We also see countries like India and China, which when you were born, basically their entire populations were poverty stricken. And yet now, over the last couple of decades, with economic reforms, they've become the growth engines of the world economy.

3:53Where did that success come from? Why did that just pop up? We need to know the reason why. And similarly, we look at Africa, where most of the population is poverty-stricted. Why is that the case? Why is that continual economic failure on that particular continent? We can look at even smaller problems, but just as perplexing, like if we took the city of Atlanta. Millions of people all over the place, all sorts of different jobs, daily schedules, likes and dislikes, and yet somehow, someway, the people of Atlanta are fed on a daily basis.

4:42They basically get to eat what they want, when they want, and all of that takes place in a rather smooth, well-functioning process. But if you have to actually sit down and think about how can we get Atlanta fed, the problem would be so complex that it would be on anybody's ability or all of our abilities together in order to come to grips with that particular question. And then we've got the economic crisis here in the United States, 10% unemployment. If we add in discouraged workers who are no longer looking for work, if we add in people who are working part-time who would prefer to be working full-time, we have something We're losing like 17 or 18% of our labor force that is unemployed, and that's a big problem.

5:34We've got people losing their houses to foreclosure. We've got people losing their houses to bankruptcy. It's a big problem. It's a huge problem, and it's one that Americans have never faced during our particular lifetime. The problem is so big that the government is spending trillions of dollars to try to address that problem. Stimulus money, bailouts, and so forth, and what's a trillion dollars? Well, a trillion dollars is enough money to give everyone in this room a million dollars every day for two years. So each and every one of us would end up with six or seven hundred million dollars. It's also enough money that if we put a trillion dollars into the bank at five and a half percent interest, each one of us could earn a million dollars of interest every day for our entire lives and then your family thereafter forever would would get a million dollars every day for the rest of their lives in perpetuity and we'd never have to touch the principle on that money.

7:01So it's a lot of money. So the next time your parents point out what a big mess you've made, just tell them that government has made a much bigger mess in Washington D.C. Now in terms of the differences between Austrians and mainstream economists, there was a video that came out last year featuring characters named F.A. Hayek and John Maynard Keynes. Keynes is sort of the leading light of mainstream economists and Friedrich von Hayek was an Austrian and Economist, and they're basically debating what we should do about the economic crisis and the business cycle, with Hayek saying we need to let markets be free, and Cain saying no, we need to regulate those markets.

7:57And I'd like to show you that particular video, but there's drinking and dancing and carrying on and all sorts of stuff, and so it's really not appropriate for me to recommend this video. So I'm not going to recommend this video to you as a way of seeing the differences between the Austrians and the Keynesians or mainstream economists. And then just recently, another animated video came out within the last couple of weeks which which explained quantitative easing and it's a YouTube video called quantitative easing explained but there's some bad language in it so I'm not going to recommend, I'm not I'm not going to show you that video here today, or recommend that you see it.

9:05So economics, Austrian economics in particular, is going to be a way of theorizing that's is going to provide an understanding for people to understand success in the economy and failure in the economy.

9:31In economics, things can be complicated and they can be simple. Simple things can be quite complicated, complicated things can be made quite simple. Take for example the pencil. Some of you have pencils in your hand. You can pick it up and take a look at it. And what do you see? Well, there's not much there to meet the eye. There's some wood, there's some paint, there's some graphite, a little metal band around it, an eraser on one end. This is pretty simple stuff. And yet, not a single person on earth knows how to make a modern pencil. I know that must sound unbelievable given that millions of pencils are produced every year, but think about it.

10:24Each component of the pencil, the wood, the graphite, the eraser, the paint, and so on, is made out of material that has been individually harvested using lots of different tools and heavy machinery. These materials had to be processed and transported to a factory. The materials were then cut into exact size pieces and finally all the pieces have to be assembled at the factory. Each stage of a unit's input production requires all sorts of specialized labor as well as Specialized Tools, the people who harvested the trees for the pencil and the people who harvested the rubber for the eraser are probably working on different continents, probably don't know what their harvesting is going to be used for, don't know one another, probably couldn't do each other's job and yet everything does get put together and those pencils ultimately And so it goes along a chain of production, when we get to the factory floor, we find specialized labor at each stage of production using highly specialized tools and pencils are actually made with multi-million dollar machinery.

11:58All these tools are in turn made by people using different sets of tools in other locations, possibly in other countries, and this process goes on and on, backward into the chain of production. So no one person actually knows the entire process involved in all of the raw materials and all the machines and all the tools and all the different specialized labor that goes into the production of a single pencil so that simple product you're holding in your hand is actually the result of a process that is so complex that no one fully knows all the knowledge necessary for the process to be successful. The economic question then becomes how do all of these people cooperate in such a Such a way is to produce pencils that are so cheap, in this case the pencil in your hand was probably cost less than 10 cents.

13:02What brings about a smooth production process and the coordination of all these people, all of their duties and all of their resources? What brings about cooperation both within firms and between companies across continents along the chain of production that turns raw materials into finished consumer goods. The answer to this question is the price system. The price of the consumer goods, such as a pencil, is established by competition amongst all the various pencil suppliers, as well as the consumer of pencils. You first choose amongst the various brands, just as you do other goods, and between alternatives, such as pens, markers, computers, whatever.

13:56The revenue from selling the pencils is then used in turn to pay the workers, the materials, the machines, and all the other expenses of producing pencils. Money left over, the owners of the firm profit. If money is not left over, they suffer a loss. Initially, of course, all of the companies had to invest large amounts of money in order to establish their firms. And so those entrepreneurs that established those companies have a tremendous So again, system of profit and loss guides the entrepreneur in the direction of the wishes of the consumer.

14:50When there are profits, owners may reinvest that money into their companies, expanding production and increasing the workforce. When a company suffers losses over time and is not able to compete in satisfying the consumer's demands, it's going to go out of business. It is this system of profits and losses that ties the whole system together and keeps the system targeted towards satisfying consumers' desires. All these people, including the labor force, are actually all working in their own self-interest. The company owner is trying to increase profits, the workers are trying to get the best jobs in terms of wages and working conditions, and through this system, the consumer interests are ultimately satisfied.

15:44This is what is making places like China and India much more successful, because instead Instead of the state running the production, telling people what to do, entrepreneurs are now in charge of resources and they're goaded along by the lure of profits. As a result, they're hiring more people, they're raising wages, they're making tons of money for themselves. So the system ultimately depends on prices. So how are prices determined? That's pretty important. The answer is that no one gets to set prices. In a free market economy, no one person gets to determine prices.

16:34For example, as a professor of economics, if I wanted to determine my own price, then I would think that maybe a million dollars a year would be the appropriate wage for myself because after all, I do a lot of good, much more than like a baseball player or a rock star, so a million dollars is really not too unreasonable to ask. My employer, on the other hand, if they were just to sit down and come up with a figure, they might say, well, how about the minimum wage? $7.25 an hour, that sounds like a good wage for them and they leave extra money available for other things that the firm wants to do.

17:26So if I set my wage, it would be very high. If the employer set the wage, they would want it very low. Therefore, there's a wide gap between what I want and what my potential employer would like to pay. The resolution of my salary comes about by the competitive forces of supply and demand. Here the supply is all the people who wanna work in a particular job and offer their services in a particular career that they're qualified for. While the demand side in this market is all the people who are interested in hiring an economics professor. Every hiring decision contributes to the process of establishing a market determined wage rate, so that every time somebody looks for a job or somebody wants to hire somebody, it's not like we have to start from scratch.

18:25We can look at what people were paying in the recent past to start the negotiations. And of course there's always certain differences in wages based on the quality of a worker, the particular area of expertise and so on so that an economics professor who specialized in the history of economic thought might not make as much as somebody who specialized in macroeconomics because for example macroeconomics is a hotter topic right now and the History of Economic Thought. So there's always gonna be individual variances in particular wages and prices based on quality, location, working conditions, so forth.

19:17Suppose economic professors at the University of Alabama were making twice what economic professors at Auburn were making. What would go on that would somehow create more market-determined wages in a situation like that where there was a wide disparity between one group and another. What we typically see is that if the wages were that much higher at the University of Alabama an Auburn economics professor would even be willing to go to Alabama to work for that higher wages and so Alabama could offer maybe slightly lower wages and still be able to hire everybody they wanted while Auburn would have to start to increase its wage offers in order to retain professors in order to get new professors and in this way of professors moving from one university to another tends to reduce the wages at one university and raise wages at another.

20:23The same competitive forces work on all aspects of the production of those pencils, from the value of the trees standing in the forest, to the wages of the lumberjack, to the cost of transporting the lumber to the factory, to the workers in the factory, to the machine operators in the factory, and even the commissions of the pencil salesmen are all going to be Influenced and guided by the forces of supply and demand depends vitally on the existence of property rights in order to properly function.

21:28So property rights are something that the Austrians stress. What kind of property rights do we have? Well, first of all, you have the right to your body, and no one has the right to make a slave out of you, except, of course, your parents. You have the right to the fruits of your labor and to all the materials that you own, rightfully own. You have the right to sell your labor, to exchange with others, to make contracts. You also have the right to any unclaimed natural resources. As a matter of fact, the very first pencil, use of a pencil, occurred about 500 years ago when this guy in Scotland discovered a solid graphite rock formation sticking out of the ground near his property that no one else had claimed, and he found that he could use chunks of this graphite to mark his sheep as his property.

22:34So you know with sheep you can't use a branding iron like you can on cattle or you ruin the wool and the wool sort of grows over the brand anyways so you can't use branding with sheep the same way you could with cattle. But this guy found out he could draw a particular design on his sheep and that would mark those sheep as his property and he also found that he could sell chunks of this graphite to other and other sheep farmers, so that ironically, the simple pencil played an important role in establishing concrete property rights in sheep in Scotland. It took people over 200 years to figure out a way of getting wood around that graphite to come up with sort of the modern pencil.

23:27Okay, violations of property rights are the things that make people poor. The existence of property rights is what allows us to have economic success, prosperity and growth. Where people, you can produce something and it's not just going to be taken away from you. But when we have violations of property rights, that's when the economic problem starts. If someone enslaves you, then you are obviously poor. If somebody steals your stuff, then you're going to be poor. If someone taxes your income, then you are going to be poor. If theft and taxation occur on a regular basis, then we lose our incentive to produce, and everyone is poor, including the thieves and governments themselves. There's less to go around.

24:25Now, the most common fallacy in economics is that you can make everyone better off by violating property rights. Consider what happens when government tries to direct the economy in any particular way. The problem is that the government must first take money away from people because it has no money or resources itself. Mistaking or taxing is really just a sophisticated form of theft. The taxpayer now has less income with which to solve their own problems, their own day-to-day problems and they have less incentive to work hard, earn money and save for the future.

25:10Even if government actually solve some problems, which it almost never does, it has created A whole bunch of unseen problems for each individual taxpayer. French economist Frederic Bastiat tells us a story of a young boy who was throwing rocks and broke the window of Felix's shoe store. A crowd gathers around the broken glass and someone remarks that this would be good news for Oscar the Glazier, the Glazier is the person who reinstalls windows, because he will probably earn more than a thousand dollars installing a new window for Felix. And then Thelma in the crowd says, well that's good news for me because Oscar and his family are overdue to buy new clothes and they shop at my store.

26:04Then Louise then says, and this is also good news for me because Thelma can now finally purchase the necklace that she has been wanting to buy at my jewelry store. Then George exclaims that this here broken window is the greatest thing that's ever happened to our town. And then Barack remarks that, quote, this was just the change we were looking for. Now, the fallacy, of course, of the broken window is that it doesn't stimulate the economy. The fallacy is that Felix would still have that $1,000 as well as an unbroken window, And that thousand dollars could then start this chain of spending throughout the economy with no loss of the window.

27:03With the broken window, there is no silver lining. It's a loss, plain and simple. This however does not prevent some of our friends in mainstream economics from violating in this fallacy on a regular basis. It seems like every time there's a natural disaster, there's a reporter putting a microphone in front of an economist who says, well, their silver lining is that this will, this is gonna stimulate the local economy. So that for example, when an earthquake hits, the headlines will be, the earthquake destroys hundreds of homes, but economist says that it will stimulate the economy. Or, quote, the hurricane destroyed buildings, homes This, of course, is nonsense. Destruction does not stimulate an economy. It forces people to rebuild, who would rather spend their time and money on other things.

28:09If we had a choice to push a button that would prevent any future earthquakes or hurricanes, Questions. Is there anyone possibly in favor of not pushing that button? This nonsense also applies to government efforts to stimulate the economy. When government spends a trillion dollars on a stimulus package, they must take that money away from taxpayers or borrow money from the future, which means higher taxes and more inflation in the future. Now, what does that mean? Well, you basically get four results. First, this means that taxpayers are going to have fewer resources with which to address or to deal with their own day to day problems. Everybody's got problems throughout the economy. And if you take money systematically away from taxpayers, that leaves them less able to deal with their day to day problems about health care, about education, and so forth.

29:17Two, higher tax rates means that people have less incentive to work hard. If the tax rate goes from 25 to 45 percent, people lose their desire to work because the return that you get for all of your efforts is likewise reduced, and as a result, the The entire economic pie shrinks. Third, higher taxes and inflation also discourage investment in our future, and this diminishes economic growth. That's one of the problems we're having right now with the economic crisis, is that people are very reluctant to invest money in the American economy, which would mean hiring more people in the American economy because of the prospects of higher taxes and higher inflation and therefore lower returns on all of those investments.

30:26Fourth, government spending rarely creates any kind of stimulus for the economy whatsoever. and in many ways that same government spending can actually retard economic progress and economic growth by taking resources out of the economy and out of the prospects of the hands of entrepreneurs. So if government is busy taking resources out of the economy in order to build bridges to nowhere or whatever it happens to be, that means they're not available for entrepreneurs In Austrian economics, everything is measured by opportunity cost.

31:14Opportunity cost is what actually determines the choices people make. For example, you can buy a gallon of milk in the grocery store for, say, $3. You can buy the same gallon of milk at the gas station for $4. So the price is different by a significant amount. And yet it's not the case that everybody buys milk at the grocery store and nobody buys it at the gas station. And the reason for the difference there is opportunity cost. The opportunity cost of going all the way to the grocery store just to make a purchase of one gallon of milk is a lot of time to give up if the gas station is just right down the street or on your way home from work or on your way home from school.

32:15So that's the opportunity cost and the opportunity cost of course the government, stimulus spending and so forth is a tremendous burden on the U.S. economy in terms of protracting the economic crisis. So there is also an important opportunity cost of government stimulus packages. What we give up to finance these stimulus packages are all the taxes we pay in our current and future tax bills to finance the stimulus. This really means all the things we could have done with our money but will never actually get to see to fruition. And I must say that government stimulus spending is often not much better than breaking windows.

33:06What are they actually spending the money on? When the spending is used simply to keep high-paid government bureaucrats in their jobs and building bridges to nowhere, this type of spending is every bit or more destructive than the little boy with his rocks. Thank you very much.