Element 1.11: Productivity Is the Key to High Living Standards

“Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer.”⁽¹²⁾

As Adam Smith noted nearly 250 years ago, consumption is the objective of all production. But consumption comes before production only in the dictionary. Income and living standards cannot increase without an increase in the production of goods and services people value.

Elon Musk, Tesla founder and aerospace innovator, recently high-lighted this point artfully when he stated, “If you don’t make stuff, there’s no stuff.” Musk was criticizing the view that government checks could replace lost production during the COVID-19 pandemic. As Musk put it, “This notion that you can just sort of send checks out to everybody and things will be fine are not true.” His point is right on target. The government checks will not buy more if there are not more goods and services available. Instead, they will merely lead to higher prices, which is what happened in 2021 and 2022.

The linkage between more goods and services valued by people and higher living standards is straightforward. Similarly, destruction of goods and services people value will make a society worse off. These propositions are so intuitively obvious, it would seem unnecessary to highlight them. But policies based on the fallacious idea that destroying goods will benefit society have sometimes been adopted. In 1933, the US Congress passed the Agricultural Adjustment Act (AAA) in an effort to reduce the supply of agricultural products and thus prevent their prices from falling. Under this New Deal legislation, the federal government paid farmers to plow under portions of their cotton, corn, wheat, and other crops. Potato farmers were paid to spray their potatoes with dye to make them unfit for human consumption. Healthy cattle, sheep, and pigs were slaughtered and buried in mass graves to keep them off of the market. Six million baby pigs were killed under the AAA in 1933 alone. The Supreme Court declared the act unconstitutional in 1936, but not before it had kept millions of valuable agricultural products from American consumers. Moreover, under modified forms of the act, even today governments continue to pay various farmers to limit their production, increasing the prices to consumers. While the political demands of those benefiting from the policies are understandable, such programs destroy valuable resources and create artificially high prices. These types of policies make the nation poorer and increase the burden on at-risk communities and low-income households.

The United States is not alone in responding to political pressure to “support” farmers at an enormous cost to taxpayers and consumers. The European Union’s Common Agricultural Policy (CAP) is one of the largest and most controversial parts of the EU’s budget (as was discussed in element 9).

The 2009 US “Cash for Clunkers” program provides another example of politicians attempting to promote prosperity by destroying productive assets—used cars, in this case. Under the Cash for Clunkers program, car dealers were paid between $3,500 and $4,500 to destroy older cars traded in for new vehicles. Dealers were required to ruin the car engines with a sodium silicate solution, then smash the cars and send them to the junkyard, assuring that not even the parts could be used in the future. Proponents argued that this policy would stimulate recovery by inducing people to buy new cars even though new cars cost more than used ones. Because of the decline in supply, the price of used vehicles increased. As a result, consumers spent more on both new and used automobiles, meaning that less money was available for saving or spending elsewhere. Thus, the Cash for Clunkers program failed to stimulate total demand. In essence, taxpayers provided $3 billion in subsidies for new-car purchases, while destroying approximately 700,000 used cars valued at about $2 billion. Those who could afford new cars were subsidized, while low and middle-income people who depend on used cars were punished. Not surprisingly, new car sales plunged when the program expired.⁽¹³⁾ Germany also introduced a scrappage program, which has been estimated to cost taxpayers over $7 billion, more than twice as much as in the United States.

Similar programs existed in many East European countries, including Russia and Slovakia. Operating between 2005 and 2015 in Romania under the program called “Rabla” (the wreck) over 525,000 cars, eight years or more in age, were scrapped for vouchers worth up to €1,500. An individual could turn in up to three older cars for vouchers to be applied towards new cars.

If destroying automobiles is a good idea, why not require everyone to destroy their automobiles every year? Think of all the new-car sales this would generate. All of this is unsound economics. You may be able to help specific producers by increasing the scarcity of their products, but you cannot make the general populace better off by destroying marketable goods with consumption value. Policies of this type are counterproductive and harmful to society.

A more subtle form of destruction involves government policies that increase the opportunity cost of obtaining various goods. The World Bank Publication Detox Development 2023 shows that global subsidies for fossil fuels, agriculture, and fisheries are driving degradation of clean air, land, and oceans and harming people, the planet, and economies.⁽¹⁴⁾ According to this publication, worldwide subsidies for fossil fuels, agriculture, and commercial fisheries are over $7 trillion, equivalent to about 8% of the global GDP. Direct government spending in these sectors, known as explicit subsidies, is approximately $1.25 trillion. Beyond these explicit subsidies, the broader impact on people and the planet, referred to as implicit subsidies, amounts to over $6 trillion each year. Moreover, agriculture, the essential sector for feeding the world and employing a billion people, is subsidized in ways that foster inefficiency, inequality, and unsustainability. Subsidies play a role in 14 percent of annual deforestation by incentivizing the cultivation of crops near forested areas. Unfortunately, the burden of these implicit subsidies falls disproportionately on the poor. Countries worldwide spend $35.4 billion a year on commercial fisheries subsidies (2018 data). These transfers leave thousands of fishing-dependent communities struggling to compete with subsidized rivals and threaten the food security of millions of people as industrial fleets from distant lands deplete their oceanic stocks. West Africa, where fishing can be a matter of life and death for the local people, is being particularly hard hit. Since the 1990s, when foreign vessels, primarily from the EU and China, began to fish on an industrial scale off its shores, it has become impossible for many local fishers to make a living or feed their families.

Politicians and proponents of government spending programs generally exaggerate their benefits and boast about the jobs created. This makes economic literacy particularly important. While employment is often described as a means to create wealth, we must remember that it is not simply more jobs that improve our economic well-being, but rather jobs that produce goods and services that people value. When that elementary fact is forgotten, people are often misled into acceptance of programs that reduce wealth rather than create it.

The focus on artificially creating jobs can be extremely misleading. As we have already discussed in Element 1-9, the great early French economist Frédéric Bastiat clearly pointed out the fallacy in his parable of the broken window from his essay “Ce qu’on voit et ce qu’on ne voit pas” (“What is Seen and What is Unseen,” 1850):

Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son has happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—“It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”

Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.⁽¹⁵⁾

Bastiat properly refocuses our attention on wealth rather than production. Creating demand for new production by destroying already existing valuable assets is not an effective way to make a society better off.

It is critical to remember, however, that the argument is not to destroy things in order to replace them. If they are destroyed by accident (say a hail storm) or by someone who seeks personal gain from the destruction (say the window is broken by a robber who gains privately from the jewelry he steals even though society loses) then repairing the window even at the cost of foregone production elsewhere makes sense. Bastiat’s “broken window fallacy” is very different from James Q. Wilson and Thomas Kelling’s equally famous broken window hypothesis⁽¹⁶⁾ which claims that a prevalence of disorder creates fear in the minds of citizens who become convinced that the area is unsafe. This withdrawal from the community weakens social controls that previously kept criminals in check. Once this process begins, it feeds itself. Disorder causes crime, and crime causes further disorder and even more crime. This is a clear example of what economists call a “negative” externality.