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Spending Our Way to Prosperity

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American politicians and bureaucrats continually bombard us with the notion that the road to prosperity lies in increased spending by the citizenry. It is one of the most destructive economic myths promoted by our governmental officials. And unless the American people carefully reason out the processes by which people become prosperous, they and their children are doomed to suffer lower and lower standards of living. Why do wages rise?

Americans are taught in their government-approved schools that labor unions are the reason that people in America earn high wages. Without unions, we are taught, wages would be set at subsistence levels. The idea is that labor unions protect the poor, oppressed worker from the greedy, bourgeois capitalist, who would, if given total freedom, refuse to pay his employees a “living wage.”

Actually, labor unions perform no role in raising wages for people in society in general. While they may succeed in raising wages for their members, the result is lower wages for those in the non-union sectors of the economy. Unions cannot generate wage increases for all workers in society, which is the reason that unions always represent only a small percentage of the overall work force.

We are also taught that the overall wage rate has been raised by minimum-wage laws. Without these laws, we are told, employers would fail to pay a decent wage to their workers.

How easy, then, to cause prosperity in a society! All governments have to do to eliminate poverty and starvation in Third World countries, for example, is to pass a minimum-wage law requiring every person to be paid $3 per hour for his labor — and voila! — poverty and starvation are eliminated through the stroke of the politician’s pen!

The truth is that minimum-wage laws do nothing to increase wealth and prosperity in society. Instead, they cause unemployment and poverty. People whose labor is valued at the minimum will be hired anyway in the absence of the law. But people whose labor is not valued at the minimum are locked out of the labor market by minimum-wage laws. Thus, the best thing that could ever be done for “the homeless” and those who will “work for food” is to repeal minimum-wage laws — for this would enable these people to enter the labor market at a lower wage than the governmentally imposed minimum. Well, if unions and minimum-wage laws are, not the key to prosperity in a society, what is? Our public officials tell us that it lies in spending — if people will just spend their money in retail establishments, this will generate a rippling effect across society which will mew more money for everyone.

On first blush, this seems to be a reasonable way to cause wealth. If I purchase your suits and you purchase my furniture, it would seem that we both are wealthier. And, of course, we are — we both benefit from the exchanges we make; otherwise, we would not enter into them.

But assume that you and your employees are able to produce 100 suits per year. If that number never changes, then how do you and your workers ever materially improve your economic condition? In other words, how can a business — and the workers in a business — significantly improve their income if they, year after year, produce the same quantity of goods and services? The answer is (other things being constant) that they cannot. Thus, the mew fact that people are spending their money on retail goods cannot improve the overall economic well-being of the citizenry.

What is the answer, then, to the nature and causes of the wealth of nations? — as Adam Smith entitled his famous treatise. It lies not with labor unions — not with minimum — wage laws — and not with increased consumer spending. It lies in the production of more goods and services in the society! And what enables the production of more goods and services? An increase in the amount of productive capital in society. Thus, it is capital that is the key to ever-increasing wage rates and standards of living in a society.

Let us consider an example. Suppose a farmer is producing 1,000 bushels of wheat with the assistance of five workers who manually hoe the fields and harvest the wheat. The farmer, let us say, receives $10,000 from the sale of his wheat; out of this amount, he pays his workers $5,000 in wages, and he pays $2,500 for other costs of production, leaving him a profit of $2,500.

Now, suppose the farmer uses his profit to purchase furniture for his house. While he may be more comfortable at home, the following year, his workers will again produce the same 1,000 bushels of wheat, resulting in the same income stream as before.

But suppose, instead, that the farmer uses his profit to invest in capital — that is, he purchases a tractor for his fields rather than furniture for his home. With a tractor, rather than hoes, his workers are now able to plant and harvest a larger quantity of wheat — let us say 3,000 bushels, resulting in overall income of $30,000 rather than $10,000! By sacrificing consumption for capital in the short run, the farmer has significantly improved his economic position. But what about the workers?, it is asked. How do they benefit? From increased wages which the higher income generates! What will ensure that the farmer will use his increased revenues to pay his workers more money? Do we have to depend on his good will and generosity? No! What will came the farmer to pay the higher wages is the threat dial neighboring farmers will “still away” his workers to run their farm equipment and thereby improve their economic condition. The farmer now pays his workers $10,000 in wages, for example, not because he is a nice guy (which he may or may not be) but because the neighboring farmer is willing to do so — not out of the kindness of his heart but simply in order to improve his own position through increased production and more revenue.

But notice that under no circumstances (other things remaining constant) can the workers’ position improve in the absence of the tractor. Without it, production levels stay constant. With production levels constant, there is no increase in revenues. With no increase in revenues, there is no chance for increases in wages.

Thus, the key to increased wage rates and increased standards of living lies in the accumulation of productive capital in a society. As the amount of capital invested per worker goes up, production increases, revenues increase, and wages rise. Thus, workers in society have a vested interest in seeing the amount of capital increase in their society — for without it, wages will remain constant or decline.

What is it, then, that brings capital into existence? Savings! — not spending! The farmer saves his profits — that is, rather than using his money for consumption, he purchases capital equipment which enables his workers to be mom productive — which, again, means higher wages for them. The, workers benefit from their employer’s decision to purchase a tractor for his fields rather than furniture for his home.

What if the farmer desired to purchase two tractors but had the money for only one? He would have to borrow other people’s savings in order to make the purchase. And whose savings could he borrow? That of his workers, who have chosen to save, rather than consumer parts of their income. They deposit their savings in a bank which pays them interest. The bank lends the savings to the farmer, who pays the bank interest. The farmer uses the loan to purchase a second tractor. The second tractor increases production….

Are the farmer and his workers the only ones who benefit from the accumulation of capital? No! Everyone in society benefits, because now there are increased supplies of wheat on ft market — which means lower prices for the consuming public, including the farmhands and their families!

Thus, when governmental officials encourage people to spend, not save, they are, inducing people to travel a road to lower standards of living and, ultimately, impoverishment. The source and cause of wealth and higher standards of living in society lie in savings, not consumption.

Does this mean that governments should alter their income-tax policies to encourage savings rather than consumption? No! There should be no income tax at all — people should be free to keep everything they cam. How then can we be certain that people will do the “right” thing with their money? There can be no such certainty — but that is what freedom is all about: the right of people to do what they want with what belongs to them — save, spend, invest, donate, hoard, or even destroy their own money and property.

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    Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.