After years of internalizing invalid economic concepts because of the huge number of fallacies incessantly issued by the media and on-call commentators, it is easy to forget which are the truest and most fundamental laws of the economy. The purpose of this article is to undo this smokescreen for the public and help them solidify their economic knowledge base through the ten fundamental commandments of economics that must always be repeated and are never to be forgotten.
1. Before consuming, produce
Production necessarily comes before consumption. To consume something, that something must first exist, being impossible to consume something that has not yet been created.
Such a logical finding is obvious, yet recurrently ignored. The idea that the government should stimulate population consumption so that it will then boost production and the entire economy is prevalent in the media and academia. It is a perfect reversal of cause and consequence.
Consumer goods does not come out of nowhere, they are the end result of a long chain, called “production structure”, which involves several interconnected production processes. Even the production of a seemingly simple item, such as a pencil or a sandwich, requires an intricate web of production processes that take time to complete and span multiple countries and continents.
Stimulating consumption, by definition, does not generate economic growth.
2. Consumption is the purpose of production
People produce what others want to consume. It makes no economic sense to produce something that no one will consume. Therefore, consumption is the goal of all economic activity. And production is your medium.
Often advocates for “job creation” government policies violate this idea. Programs geared to artificial job creation make production the ultimate goal, not the consumption of it. This means stimulating the production of something that is not being voluntarily demanded by consumers.
It is the consumers who value the final consumer goods. By attributing value to consumer goods, they are indirectly attributing value to the factors of production used in the production process of these consumer goods. Therefore, the consumers determine the value of labor, raw material, machinery and equipment used in all production processes.
Ignoring real consumer demands and creating artificial jobs with production processes that are not in line with consumer desires is a destructive measure that attempts to repeal this whole reality. As a result, this tends to immobilize labor and scarce resources in activities that are not being demanded by the population, causing destruction of capital and wealth.
3. There is no free lunch, everything has costs
Getting something free just means there is someone else paying for everything. Behind every public university, “free” health care, student scholarships, and any form of welfare is the tax money of working and producing people.
Although taxpayers know that it is the government that confiscates part of their income, they do not know to whom or where this money goes. And while the recipients of this money and the services funded by this money know that it is the government behind it, they do not know from whom the government took the money.
4. The value of things is subjective
The manner in which each individual attaches value to a good is subjective, and varies according to the individual’s situation and tastes. The same physical good has different values for different people.
The usefulness of each good is subjective, individual, situational and marginal. Therefore, there can be no such thing as “collective consumption”. Even the temperature of a room brings distinct sensations to every person there. The same football match has different subjective values for the spectator, as is easily apparent the moment one of the teams scores a goal.
5. It is productivity that determines wages
An individual’s output over a certain period determines how much he can earn during that period. The more this individual produces a good or service voluntarily demanded by consumers in a given period of time, the higher their compensation might be.
In a genuinely free labor market, companies will hire additional labor whenever the marginal productivity of each of these workers is greater than their salary. In other words, whenever an additional worker is able to generate more income than expenses, he will be hired. Competition between firms will raise wages to the point where it equals productivity.
Trade union power can alter the distribution of wages among different groups of workers, but it cannot increase the total wage value of all these workers. These depend entirely on productivity.
And what increases labor productivity? Savings, investments and capital accumulation. Without savings there is no investment. Without investment there is no accumulation of capital. Without capital accumulation there is no higher productivity. And without more productivity there is no increase in income.
6. Spending is income for some and cost for others
Some economists say that all spending generates income. While true, they seem to forget that all spending is also a cost. The spend is a cost to the buyer and an income to the seller. The income equals the cost.
The income multiplier mechanism says that the more you spend, the more you get rich. The more everyone spends, the richer everyone gets. Such logic obviously ignores the costs. The fiscal multiplier, by definition, implies that costs increase along with income. If income multiplies, costs also multiply. The model of this multiplier mechanism ignores this cost effect and generates serious economic policy errors.
Spending, therefore, are costs. The income multiplier implies the cost multiplier.
7. Money is not wealth
The value of money is its purchasing power. Money serves as an instrument for making exchanges. The greater the purchasing power of money, the greater its ability to trade.
But money by itself is not wealth. It is just a means of exchange. Wealth is abundance of goods, services and welfare. An individual’s wealth therefore lies in his ability to access the goods and services he desires.
Government creating more money does not mean creating more wealth. A nation cannot increase its wealth by increasing the amount of money it has. Robinson Crusoe would not be a penny richer if he found a gold mine or a briefcase full of 100 dollar bills on his isolated island.
8. Work, by itself, creates no value
Work, when combined with other factors of production (raw material, tools and infrastructure), creates products. But the value of these products depends on how useful it is to the consumer.
The usefulness of this product depends on the subjective valuation made by each individual, as we made clear in item 4. Therefore, creating jobs just for more jobs is economically foolish, as we made clear in item 2.
What really matters is value creation, not how hard an individual works. To be useful, a product or service must generate consumer benefits. The value of a good or service is not directly linked to the effort required to produce it.
9. Profit is the prize of the successful entrepreneur
In free-competition capitalism, economic profit is the extra bonus a company earns from knowing how to properly allocate scarce resources and knowing how to satisfy the demands of consumers.
In a stationary economy in which no change occurs, there would be neither profit nor loss, and all companies would have the same rate of return. Already in a dynamic and growing economy, changes occur daily in the wishes of consumers. And those who are better able to anticipate these changes in consumer desires and who know how to direct scarce resources — labor, raw materials and capital goods — to satisfy these consumers will reap the economic profits.
Entrepreneurs able to anticipate future consumer demands will earn the highest profit rates and will grow. Entrepreneurs who do not have the ability to anticipate consumer wishes will shrink until finally driven out of the market.
10. All true economic laws are purely logical.
Economic laws are apriorists, meaning that they do not have to be previously verified and cannot be empirically falsified.
No one can falsify such commandments empirically because they are true in themselves. As such, the fundamental commandments of economics do not require empirical verification. References to empirical facts serve merely as illustrative examples and do not represent a statement of principles.
It is possible to ignore and violate these fundamental laws of economics, but it is not possible to change them. Individuals, and consequently societies, who understand and respect these 10 economic commandments will prosper.