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Tuesday, 1 February 2011

Thoughts about Economics

First thought: Why has it taken me sixty-four years to think about Economics at all or to read about it? I must be very slow. Perhaps I was frightened by the Maths. I took it for granted that to understand even basic Economics I would have to follow complex formulae. This turns out not to be so. Economics also turns out to be very interesting.

Second thought: Economics is very very important and, as citizens of a democracy, we ought all to be better informed. The huge majority of us are dismally ignorant and thus pitifully inadequate for our roles as members of a democratic society.

Politics and Economics

Politics is 90% Economics. All political action has economic consequences and all economic policy has political consequences.

Economics is not normative. Good economics doesn’t tell us what we ought to do but what the effects of actions will be and why. For example, if prices are increased artificially by tariffs, then some people will seek to avoid high prices by smuggling; the higher the tariff, the more people will be led to break the law. It doesn’t matter in the slightest, from an economic point of view, what motivates actions. Well organised smugglers are likely to be enthusiastic about tariffs, just as the Mafia loved Prohibition and your local drug dealer would be gutted by repeal of the drug laws. The very best motives can lead us to catastrophic results. Thoroughly reprehensible motives can lead to results which suit lots of people. Well intentioned people can and do initiate programmes which have disastrous outcomes.

Politics is normative: people should be equal before the law; despotism is bad. Or, the Aryan race should dominate all other races. Not!

The Default Position [It isn’t fair! Wouldn’t it be nice if...]

You are the child of loving parents, taught that you can’t grab everything you want from your siblings and playmates, that might is not right - it isn’t! You observe that some people have better lives, more toys, more holidays, nicer houses, better suppers than others. This strikes you as somehow unfair. You might visit third world countries, either in the flesh or via the medium of television. You observe that some people have really dreadful lives, that young children have to work long hours in ghastly conditions, that death from disease and starvation is an every day reality for lots of people. Worse still, you come to realise that these dreadful conditions apply not just to lots of people but to a substantial proportion, if not most of the human race. How do you react? Of course, you are outraged. “It’s not fair,” you wail. Of course you believe that it would be much nicer if all these things weren’t so.

Of course you want something to be done. The people in charge must put these evils right because it would be much better if everybody had enough to eat and doctors to look after them when they got poorly. Your outrage is not only laudable but right. It’s not fair. It’s horrible. The question is: what should be done? Before we rush to “do the right thing”, we are morally bound to consider the consequences - in other words, the Economics. If doing what appears to be the right thing has consequences which appall us, we had better hold off.

Given that in the midst of such misery there are people living lives of luxury, it is natural to suppose that the misery of the many may be the result of the behaviour of the few. That may, in fact, be part of the truth. And let us look more closely.

Overwhelmingly, throughout human history, misery has been the norm and a privileged minority has also existed. Overwhelmingly, the privileged are those who make the rules. They make the rules to suit themselves. And they have the resources to enforce the rules. Without democracy, this has been and will always be the case. The rich and powerful will tend to exploit the poor and powerless. They will tend to grab more than their fair share. They still do, and in democracies too. Any rich and powerful group will attempt to manipulate the rules to benefit themselves. This is called Original Sin.

[Any defence of Free Market Economics, which of course this is, has got to distance itself from the idea that the interests of any group (including Business, large or small) should be paramount. It is certainly true that big businesses will tend to favour (and press for) regulations which impose costs on them (which they can afford) when those regulations put smaller competitors out of business. Being for Free Markets does not mean sticking up for Business.]

But we now have Democracy. How and why are not questions we can allow to detain us now.

The melancholy truth is that most benign human beings start from the assumption that the organisation of the economy is so important and so complex that it is best left to experts. Democratic governments should therefore legislate to make life fair. This means taking from people who have more and giving to others who have less. What could be fairer? Because some people are rapacious and unscrupulous, government needs to regulate all economic activity. Some things are too important not to be carefully managed by experts.

[This happens to be at variance with the principal of democracy: non-experts (voters) elect other non-experts (parliamentarians) to ensure that government officials are not oppressive. This is in contrast to the Chinese Imperial system (or totalitarian regimes) which attempted to create bureaucracies of the brightest and best by selecting the bureaucrats by examination (or political orthodoxy). By definition, they would be the most fit to govern.]

The Truth

It is undeniable that for nearly all history nearly all humans have lived lives of intolerable poverty, drudgery and disease. Their children have died young. Life has been “nasty, brutish and short”. Your great grandparents lived lives that by your material standards would be unbearable. Their grandparents’ lives were worse.

What is also undeniable is that, starting in the nineteenth century, in a few places on the Earth, this began to change. In Western Europe and North America the nastiness and brutality began to retreat. Many remained poor. A few became spectacularly rich. And this was invariably when their entrepreneurial skills increased wealth and made products cheaper for all. And, for most people in these societies, the prospect of tolerable lives increased. Largely because the stuff they wanted got cheaper and more opportunities arose for them to exchange their labour with people who valued it. What did these societies have in common? Property Rights, Democracy, Free Markets and the Rule of Law. Also Christianity.

How did we get so lucky? This is not the time or place to go into detail. For what it is worth, in my opinion, the decisive factor was Christianity, which also gave us Science.However, the mechanism was Free Markets. Over time, in Europe and North America, production (ie wealth) soared, prices fell, employment and prosperity increased. Some became fabulously wealthy and in doing so gave their countrymen a standard of living that would have made their ancestors stretch their eyes.

[I have very recently been reading that the philosophical basis of free markets was articulated as early as the 13th Century, by none other than St Thomas Aquinas.]

These improvements have continued in fits and starts ever since in countries where free markets have continued to exist not wholly attenuated by state intervention. In countries where markets have been freest, the results have been outstanding (Singapore, Taiwan, Hong Kong and latterly China). Desperately poor people have risen - by their own efforts, given the opportunity, from grinding poverty to better than subsistence to relative comfort or to affluence.

How dramatic the contrast with countries burdened with a socialist or statist economic system: The USSR, its satellites, Mao’s China and the hell-hole which is North Korea. Not only did the population not become more prosperous but, to maintain the system, the state found it had no recourse but to violence on a scale unprecedented in human history. The death toll was hundreds of millions!

What is a Free Market?

To have free markets we must have two absolutely necessary, though not sufficient, requirements: Property Rights and The Rule of Law. To have these we must have government.

In a truly free market purchasers exchange the fruits of their labour for the fruits of someone else’s (the supplier’s) labour. Money is the mechanism which makes this easy and convenient. Historically, gold and silver have been used as money. However, the purchaser has previously had to exchange his labour with someone who valued it.

Every exchange is win-win. I buy so many apples from you for a pound because I would rather have the apples than the pound. You sell me the apples because you would rather have the pound. If I can find better or more apples for a pound, all things being equal, you don’t get my pound. Our agreeing to exchange pounds for apples and vice-versa creates the price.

Of course, you are not going to kindly sell me apples for a pound if they cost you two pounds in the first place, to purchase, transport and store. You have to charge me more than you paid. Otherwise, why would you bother? The difference is your profit. Why should I resent you getting a profit? I have the choice of doing without apples or planting an apple tree.

Thousands of greengrocers and millions of apple lovers create the market price for apples, which can and does fluctuate over time. Frosts in Kent may mean that you have fewer apples to sell and, if I really love apples, I may be prepared to pay £1.50 for the same number of apples so that you sell them to me not to someone less keen on apples and only prepared to pay £1.25. This is called The Law of Supply and Demand. If lots of people want apples, the price goes up - by mutual agreement. If apples are scarce the price also goes up - by mutual agreement. If the price of apples goes up, then other people will plant apple trees. In time, there will be more apples and price of apples will fall, perhaps to the point where being in apples is just not worth it and people cut down apple trees and plant pear trees. Alternatively, we we might all eat more apples.

[Incidentally, an economic theory which cannot account for prices is holed below the water-line. Marx thought it was all to do with the amount of labour which went into a product that determined the price. Wrong!]

Perfect! What can go wrong? Plenty. You have a cousin on the Fruit Marketing Board who pushes through a regulation giving you a monopoly on apples. I have to come to you for apples or do without. I could be imprisoned for planting an apple tree because you have been granted the monopoly. You decide on the supply of apples and because no-one else can undercut you, your price will be high. This is absolutely unfair, no matter how you look at it. Something like this has occurred over and over in human history. Monopolies are granted openly and unashamedly by kings to their favourites.

What else can go wrong? Plenty. The king’s mistress is the daughter of a Kent fruit farmer. He (the farmer) and his fellow farmers would like to see the price of apples go up. The trouble is that pesky French farmers are also in the market, competing with the Kent farmers and helping to create equilibrium. In spite of their transportation costs, because their climate is more favourable to apple production than that of Kent and they can produce apples for less. Not good for Kentish farmers wanting to raise prices. So the king favours the Kentish farmers by imposing a tariff on foreign apples. This means that the French can’t compete with Kent farmers. The king’s mistress is very happy. She makes the king very happy.

What else can go wrong? Plenty. The Minister of Health decides that people are not eating enough fruit and this is because apples cost too much. “Right,” says the Minister, “We’ll put a cap on the price of apples! 50p max for a quantity of apples that used to cost a quid! Any greengrocer selling apples for more than this is in big trouble!” A host of price checkers is employed to police fruit markets and greengrocer shops. Incidentally, they are not producing anything - not, in other words, increasing the wealth of the county. The immediate effect is that everybody gets out of apples. Who is going sell apples for 50p if they have to pay 75p for those apples? Apple orchards by the acre are turned over to some other crop.

Whoops, an expensive mistake. Sack the checkers, then, who had to be paid, after all, even if all they did was to destroy the apple industry, reducing the country’s wealth. Having learnt from his last mistake - unlikely, but let’s pretend - The M of H proposes to subsidise apples. A huge bureaucracy, which doesn’t produce anything, recruited perhaps from the ranks of temporarily unemployed price checkers, devises a complicated system for rewarding apple growers by paying them a pound for what used to be a pound’s worth of apples on the market stall. The farmers can then sell the the apples to the greengrocers for next to nothing and the apple lovers can have their apples for 50p. Greengrocers - happy! Apple growers - happy! Apple lovers - happy! M of H - happy! At last the government has done something right.

But what about the unintended consequences? For a start, there is huge incentive for corruption, among the apple growers to distort the figures (ie to steal from the taxpayers) and possibly among the bureaucrats. The bureaucrats are being kept from productive jobs. They, and the subsidies, are paid for out of taxes, which the government takes from everybody, which means that taxpayers have less to spend on other real goods and services, which means that an unknown number of people are not benefiting. Add to this the likelihood that that other types of producers will be tempted to lobby for subsidies to their industries and the spiral will continue.

Of course the EU is this last scenario writ large. The EU corrupt? Heaven forfend! Well, how comes it that the EU’s accounts have not been approved for 14 years? Businessmen guilty of this would be in gaol.

What, if Anything, is the State Good for?

The state is necessary to uphold property rights and the rule of law and to adjudicate in disputes between citizens. It enforces contracts. It is necessary to provide internal and external security. Pretty well everything else is better provided by free markets.

We have ample evidence that, at least insofar as the state actually produces goods and services (as opposed to paying for them), it does so wastefully. Corruption is likely. Inefficiency is inevitable.

The collectivisation of agriculture in socialist regimes has meant, at best, shortages and, at worst, mass starvation.

Government run industries (eg British Leyland and East Germany’s Trabant in days gone by) produce poor quality products at high prices and in volumes which do not meet the requirements of consumers.

State run education has a tendency to drive standards down and costs up. Britain and the US are spectacular examples of this. What is more insidious, in the case of education, is that when schools and colleges are part of the state apparatus and the educational establishment is beholden to the state, there is every incentive to brainwash the students about the benefits of the state, or, at best, to withhold from them true lessons about free markets.

As for health care, the merest glance at the NHS is sufficient to reveal that it is fabulously costly, over-managed and inefficient.

This does not mean, of course, that we cannot, in a democracy, choose to use taxation to buy health care for those who need it or education for all who can benefit. All the experiments in which parents are given ‘vouchers’ to spend with whichever provider they choose have demonstrated conclusively that good schools prosper and give good value and that bad schools either pull up their socks or cease to be. Empirical fact and common sense (ie good Economics) agree. If the state pays for the vouchers, the cost will be borne by taxpayers. In a democracy we might agree that we all benefit from better education all round because better educated workers produce more real goods and services and more wealth is created.

It is alleged that communist officials visiting Britain were astounded that nobody (no government agency) was responsible for London’s bread supply. Some supporters of state intervention argue that health and education are too important to be left to the market. More important than food production and distribution, where the market does a good job? Though not as good as it might without the burdens of regulation and control?

Milton Friedman holds up a pencil and asks rhetorically, “Who knows how to make one of these?” The answer, of course, is nobody. The pencil comes into existence through the efforts of and voluntary exchanges between thousands and thousands of individuals: miners, forestry workers, chemists, truck drivers and others too numerous to mention. And yet we do not have pencil shortages on the one hand or warehouses full of unsold pencils on the other. Each pencil is unimaginably cheap, considering how many people’s labour has gone into its production. Manufacturers of over-priced or crappy pencils go out of business. Only manufacturers of good cheap pencils survive. A consummation devoutly to be wished for!

The Soviet Union could not produce toilet paper in the quantities which people required, though you can be sure there were bog paper czars aplenty.

Henry Hazlitt

Hazlitt’s awesome book, Economics in One Lesson, published in 1946 is as valid today as it was more than half a century ago.
The lesson is: The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Milton Friedman

The late lamented Milton Friedman is a Free Market economist of the Chicago School. See videos of his Free to Choose TV programmes here:

Ludwig von Mises and The Austrian School

Von Mises was a great and humane man, one of the founders of the Austrian School. These are terrific people. They were eclipsed by the Keynesian School of statist interferers for many years. I believe, and pray, that their time is coming. They did, after all predict the bust of 2008, when the Keynesian had their heads in the sand.

One of their many contributions is their theory of The Business Cycle. In brief, when interest rates are kept artificially low by central banks (the government again), money will be directed towards inappropriate projects. Using this theory, they predicted the housing boom (bad because low interest rates encouraged ‘malinvestent’, which led to excessive house building). When the inevitable bust occurred, they argued strenuously against bail-outs and stimulus packages. According to their theory, the bust, painful as it is, is the beginning of recovery.

Milton Friedman points out that free markets involve profit and loss. Profit is the reward for prudent and far-sighted investment. Loss is the punishment for reckless investment. If banks and motor companies can take profits when they make them but taxpayers take all the losses, we have a naked invitation to... words fail me.
Tom Woods FDR
Thomas E Woods is brilliant, erudite and funny. He makes an irrefutable case against The New Deal, Roosevelt's colossal programme of government spending and federal agencies after the crash of 1929. He argues that only months after the crash, markets were already recovering and that unemployment was on the way down. The New Deal killed the recovery and the Great Depression went on for the rest of the thirties.
Adam Smith and Greed
Adam Smith, author of The Wealth of Nations, is accused of promoting “greed”, perhaps because he was misunderstood when he said, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

The butcher knows that he cannot satisfy his own needs without satisfying the needs of his customers. If he cannot supply steak and kidney of adequate quality at a price they are prepared to pay, they will go elsewhere and he will have nothing with which to pay his rent and clothe his children. It is almost a statement of The Golden Rule: “Do unto others as you would have them do unto you.” Of course, he may be a greedy man and he may try to pass off minced donkey as minced beef. If he does, he is sinning and committing an offence against the law, for which he may be prosecuted.

Adam Smith, a moral philosopher, is in no way promoting greed. Gordon Gecko in Wall Street does say, “Greed is good!” But these are words put into his mouth by Oliver Stone, who is no apostle for free markets. Anyway, we know that GG cheats, that he sins and breaks the laws against insider trading.

See Jay Richards for a brilliant defence of free markets from a Christian point of view.

Jay Richards

Here is A link to a talk by Jay on his book Money, Greed and God


Jay Richards book is organised around 8 great fallacies about Economics. Hazlitt’s book is also about laying waste economic fallacies. The first is The Broken Window Fallacy.


Prices - Only One Theory Makes Sense



Inflation is wicked. It happens when government prints money to pay its debts. It means that the value of the money in your pocket goes down. It is theft! If you did it, you would go to prison.

Hyperinflation is when the value of money falls extremely rapidly. It has occurred many times in history in Germany between the wars, in China after WWII and now in Zimbabwe. Here follows an illustrative story - true.

A German businessman had his money in a savings account. Sixty-eight thousand marks, enough to retire on. After a period of hyperinflation he got a letter from the bank saying that they were closing his account because the money was simply worthless. They were not able to give him 68,000 marks because the lowest value banknote was then one million marks. So they had decided to round up what they owed him to one million marks. A banknote was enclosed - one million marks. He looked at the envelope and saw that the face value of the stamp was five million.

Samuel Gregg - The Acton Institute

This guy is a completely new discovery for me. He is Australian born with a PhD from Oxford and is the institute’s director of research. He describes, as well as anybody, the concept of “moral hazard” - the catastrophe which is inevitable when governments encourage enterprises, usually large ones, to believe that they will always be rescued from the consequences of recklessness.

It is preposterous to suppose that our current difficulties are the result of a “crisis of capitalism”. They are the result of government interference.

Frederic Bastiat

This is great.

Kel Kelly discusses his book: The Case for Legalising Capitalism

This guy says it all!
The whole book is here - free!

George Reisman