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Economic Fallacies


In On Liberty John Stuart Mill wrote, “He who knows only his own side of the case, knows little of that.” This is an especially important principle for libertarians. We rely on persuasion to win adherents to the freedom philosophy. To persuade, one must use effective techniques of rhetoric. Just as important, one must know what one is arguing against. Nothing gives a debater a bigger edge than to know his opponent’s case better than the opponent himself does. It pays to familiarize oneself with the views of the other side.

That’s not enough. One should also be able to restate those views with impeccable accuracy. Failing at that can cause one to fail to win others to libertarianism. Nothing is more discrediting than to mischaracterize the other side. (MSNBC’s Chris Matthews does it routinely.)

Libertarians are as guilty as anyone in displaying a lack of care in this regard. I’ve selected three common examples.

The first is the labor theory of value. Libertarians who embrace the theory of subjective marginal utility often find themselves arguing against proponents of the labor theory of value, particularly Marxists, who use the theory as the basis of their view that in a market, employers exploit workers. Marx inherited the labor theory from the fathers of classical economics, Adam Smith and David Ricardo. Judging by how libertarians have argued, the theory is apparently widely misunderstood, or at least often misstated. The Austrian economist Walter Block, for example, writes that according to the Marxian labor theory of value,

goods and services have value in accordance with how much labor has been inputted into them. But this is entirely erroneous, as can be seen by the fact that a mud pie, and a cherry pie, may take an identical amount of labor to create, but one is worthless, the other valuable.

That would indeed be a silly view. How could a mud pie, no matter how much “labor” went into it, have the same value as a cherry pie? But who holds that view? Not Marx or his classical forebears. It is important to bear in mind that when the classical economists (and Marx) spoke of “value,” they had two different things in mind: use-value (utility) and exchange-value (price). For them labor did not determine use-value. But it did provide a measure of use-value and thus determined exchange-value. Smith wrote in The Wealth of Nations,

The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything is really worth to the man who has acquired it, and who wants to dispose of it, or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people.

Smith’s famous example was about beavers and deer. He wrote, “If among a nation of hunters … it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.” Why? Because in Smith’s view, “the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another.” Remember, I’m not saying Smith is right; I’m just putting his actual views on the record. Though it does seem reasonable to assume that in this simple economic model, with one presumed homogeneous input and only two outputs, free competition would tend toward a two-deer to one-beaver ratio. If someone tried to charge more, buyers could always hunt the desired animal themselves at lower labor cost.

Note that Smith assumes that beavers and deer are valuable to the huntsmen. The game have value not because it took labor to capture them. On the contrary, the huntsmen were willing to work to capture them because they had value to someone, either themselves or others. As Ricardo wrote, “Corn is not high because a rent is paid, [but rather] a rent is paid because corn is high.” And corn is high because people find it useful and are therefore willing to pay some price for it.

Thus the classical economists understood, at least to some extent, what the Austrians would later develop into an elaborate theory: that utility is at the base of economics.

For the classical economist, labor did not create value in the simple sense that Block had in mind. Marx — of all people — was emphatic inthis regard. Look at this sentence from Capital, which Austrian Eugen von Böhm-Bawerk, Marx’s intellectual nemesis, quoted: “A thing cannot have value, if it is not a useful article. If it is not useful, then the labor it contains is also useless, does not count as labor and hence does not create value.” (Emphasis added.)

Here is the staunch advocate of the labor theory of value declaring that if labor’s product is not useful to someone, the effort does not qualify as labor at all. Any Austrian would agree. Labor is an economic category. It does not entail any physical or mental exertion. It must be exertion that yields a product somebody wants — that is, something that will command a price on the market.

In closing this section, I should point out that there is a sense in which labor does indeed create, or add, value. Production never creates something out of nothing, but rather transforms matter (inputs) through labor from less-useful to more-useful forms. That is what labor means in economic terms.

Keynes and the long run

The second example comes from John Maynard Keynes. Keynes famously said, “In the long run we are all dead.” His critics enjoy hauling out this quotation to demonstrate that he did not care that his policy prescriptions for ending recessions had bad consequences in the long run because he was concerned only with the present. (Some will take another step and attribute this peculiarity to Keynes’s homosexuality, the argument being that since he did not have children, he was unconcerned about the future beyond his lifetime — as though that’s the only reason people have to care about the future.)

But that is not what Keynes had in mind when he wrote those words. He was not defending his own policies but rather was attacking his opponents’ laissez-faire policies.

Keynes wrote that sentence in his Tract on Monetary Reform, published in 1923, not his 1936 General Theory of Employment, Interest, and Money. To understand what he meant, it helps to see what comes before and after the well-known sentence:

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.

As one sees, Keynes was lecturing the economists who believed that if government kept hands off, economies would recover from monetary disturbances on their own in the long run — that is, through the application of the laissez-faire principle. That won’t do, he said, because in the meantime hardship persists. He was not saying that people should not be concerned with the long run. Rather, he was saying that waiting for the economy to fix itself is an unsatisfactory prescription.

Again, the point here is not that Keynes is right, but that the damning sentence is yanked out of its context, giving a misleading impression about Keynes. Of course he got it wrong. As the economist Mario Rizzo explained, “When economists talk about ‘the long run’ they do not mean calendar time…. The long run happens when all of the variable elements in a model are fully adjusted. It is an intellectual experiment.” He adds, “I believe that Keynes knew this but used the everyday meaning of the term to sow confusion about the ideas of his predecessors and to use that to his advantage.”

The Road to Serfdom

My third example of a common mischaracterization does not involve the views of an ideological adversary but rather of an ally: F.A. Hayek. Hayek’s classic Road to Serfdom is frequently summed up thus: The welfare state must lead to slavery and totalitarianism. It is not only libertarians who interpret the book that way. Advocates of the welfare state do the same, which enables them to proclaim triumphantly that Hayek was wrong: he predicted, so his critics say, that if England and the United States pursued welfare-state policies, their citizens would become serfs in a totalitarian state. But even with elaborate social safety nets, they have democracy and a large amount of freedom.

If that interpretation of The Road to Serfdom were correct, Hayek’s critics would be right to say that his prediction has proven to be wrong. The welfare state has certainly imposed burdens and impeded economic growth, but to call the people’s condition “serfdom in a totalitarian regime” would be a gross exaggeration.

Hayek in fact never said the welfare state was the road to serfdom. Indeed, in his book he unfortunately embraced aspects of the social safety net (though he backed off some decades later). What then for Hayek amounted to a road to serfdom?

It was the movement toward central economic planning, the substitution of government direction of the economy for competition and private property. He wrote in chapter 1:

According to the views now dominant, the question is no longer how we can make the best use of the spontaneous forces found in a free society. We have in effect undertaken to dispense with the forces which produced unforeseen results and to replace the impersonal and anonymous mechanism of the market by collective and “conscious” direction of all social forces to deliberately chosen goals….

The system in which the spontaneous forces of the free society are shut down in favor of conscious and central planning Hayek called “socialism.” He, like Ludwig von Mises, saw a sharp distinction between state socialism and the welfare state. Where socialism abolished the market because it is inconsistent with central planning, the welfare state sought “only” to modify the outcome of the market process through income policies, labor regulations, social insurance, and the like. While the welfare state does not need to stamp out all freedom, the same cannot be said for central planning, because individual liberty would upset the government’s plan at every turn. It is Hayek’s great achievement in The Road to Serfdom to have exhaustively made that case.

This article originally appeared in the January 2012 edition of Freedom Daily. Subscribe to the print or email version of The Future of Freedom Foundation’s monthly journal, Future of Freedom (previously called Freedom Daily).

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.