Sowell Basic Economics A Citizen's Guide to the Economy
.pdfquietly. Representatives of industries and regions that stand to lose business and jobs because of international competition are almost certain to seek restrictions on imported goods or resources which threaten their particular well-being, however beneficial such international transactions may be to the population as a whole.
International movements of goods and investments also restrict the range of options available to particular governments. As noted in Chapter 16, governments have for centuries transferred wealth from the people to themselves by the simple process of issuing inflationary amounts of money and spending the newly created money for whatever the government wanted to finance. With free international movements of wealth-at instantaneous speeds with computerized financial transactions-money and the resources they represent tend to be transferred out of countries whose governments are conducting such clandestine confiscations.
Other economically counterproductive policies tend likewise to cause domestic wealth to flow out of a country and foreign wealth to stop coming in.
Thus it was a matter of concern to India when the private financial rating agency Standard and Poor's downgraded the rating of the country's currency in August 2001 because of what The Economist magazine called the "shaky finances" of India's government. In California as well, that state's bonds were sharply downgraded by both Moody's and Standard and Poor's, even though the state had a record surplus in its budget, because both these rating agencies recognized that the policies being followed would soon turn that state's huge surplus into a huge deficit-as it did.
Both businessmen and politicians who suffer from the operation of free international trade and wealth transfers have every reason to represent their own problems as disadvantages to the country as a whole. No small part of the confusion surrounding international trade has its origins in their attempts to mobilize political support to stop international trade from causing them problems. Such attempts have been going on for centuries, in countries around the world. Most economists today reject most of their arguments, and the economics profession has rejected most of these arguments since 1776, when Adam Smith rebutted them in The Wealth of Nations.
There are special circumstances in which special interferences with free international trade can in fact be beneficial-national defense being one obvious example-but that is very different from saying that most of interferences that are advocated are likely to be beneficial.
Political leaders have far more control when wealth flows into their countries in the form of "foreign aid"-that is, transfers from national or international agencies to governments-rather than as private investments to private individuals or businesses. But receiving wealth from abroad via the marketplace would require satisfying foreign investors that a project was likely to succeed and that the local legal and political system was one they could rely on when time came to take their earnings out or to take their whole investment out if they wished.
Showy projects with only a political pay-off for the government-a sports stadium, a glitzy plaza, or a national airline in a country without enough passengers to enable it to pay for itself-can all be financed by foreign aid, but are unlikely to be financed by international investors risking their own money. Moreover, government officials can be more generous with themselves and their followers and favorites when it comes to appropriating foreign aid money for personal use, including putting it in Swiss banks. Third World countries often have ruins or remnants of failed projects financed by foreign aid, like these in the African nation of Niger:
The relics of many high-minded, high-tech development projects litter Niger like the dinosaur bones occasionally discovered beneath the shifting sands. Sophisticated irrigation systems that work well with First World maintenance turned into rusted pipes in Niger. The
European cows that were supposed to improve milk production keeled over in the heat.
The availability of foreign aid reduces the necessity for a country to restrict its investments to economically viable projects or to reduce its level of corruption. Far more wealth may be available internationally for the economic development of a poor country through private international investors than through foreign aid, and yet that country's government may prefer to receive a smaller amount through foreign aid, since government officials themselves benefit more from this smaller amount than from a larger amount of wealth that would have preconditions which negatively affect these officials' well-being, even if private investment would enhance the economic well-being of their country as a whole.
In short, countries with inefficient economies and corrupt governments are far more likely to receive foreign aid than to receive investments from people who are risking their own money. Put differently, the availability of foreign aid reduces the necessity for a country to restrict its investments to economically viable projects or to reduce its level of corruption.
An intermediary form of wealth transfer is an investment from private sources that is guaranteed by their own government, which stands ready to reimburse them with taxpayers' money should their overseas investment prove unprofitable or the profits uncollectible. Thus when the Mexican government was on the verge of defaulting on its loans from American banks in 1996, the American government lent them the money to payoff these banks and other investors. Obviously, if these banks had been forced to take huge losses, they would have become more wary of risky investments in the future and in other countries. As we have seen in other contexts, losses play as important a role in the economy as profits, though they are not nearly as popular. Artificially preventing losses is reducing incentives to allocate resources efficiently.
The periodic "forgiveness" of loans to Third World countries likewise reduces incentives for the governments of these countries to use the loans in ways that contribute to the growth of national wealth, from which the loans could be paid off. The only clear beneficiaries of such "forgiveness," aside from Third World political leaders who escape responsibility, are those people in wealthier donor countries who feel a sense of noblesse oblige. But the subsidizing of political irresponsibility has heavy costs that fall ultimately on the peoples of the poorer countries.
The sums of money received in foreign aid are dwarfed by the sums of money available for investment internationally in countries with responsible and dependable governments. Moreover, as noted in Chapter 20, vast sources of untapped capital already exist within Third World countries themselves, in the form of economic assets which cannot be turned into financial assets because of the inaccessibility of property rights for most people in those countries. In short, the internal institutions and policies which inhibit international transfers of private investment to poor countries also inhibit the mobilization of investments based on existing assets within those countries.
These assets also include human capital, which may be as under-utilized as the country's physical assets. Many Third World countries contain entrepreneurial minority groups-Chinese minorities in various Southeast Asian countries, Lebanese in West Africa, Indians in East Africa and Fiji-who have been subjected to discriminatory restrictions on their economic activities or have even been expelled or forced out by hostile public or governmental actions. Painful as the losses suffered by members of these minorities are when forced to leave countries where they were born, the losses suffered by the countries themselves after such groups have left have been a major factor in the continuing poverty of some Third World nations. For example, whole
sectors of the Ugandan economy collapsed after 50,000 Indians and Pakistanis were forced to leave the country in the 1970s.
Indigenous human capital may also leave because the political and institutional climate offers far less opportunity for individuals to advance economically than the opportunities available in some foreign countries. India, for all its poverty, has for centuries been an exporter of entrepreneurs, who have created thriving enterprises from the Caribbean to the South Pacific and from Russia to Africa. Today, computer engineers from India are a major force in America's Silicon Valley and Indians are 10 percent of all anesthesiologists in the United States.
Despite a vision of helpless Third World countries, whose economic rise is possible only through transfers of foreign aid and foreign know-how from more prosperous and more industrially advanced countries, many Third World nations have within themselves both physical assets and human assets far exceeding any that they are likely to receive from other countries. This is not to say that it would be easy politically to reform the policies and institutions which hold back internal economic development in the Third World.
What is easy politically is to accept foreign aid and use it to help keep existing political leaders in power, whether or not the foreign aid has any significant effect on the economic condition of the country as a whole.
Enormous amounts of wealth created in "underground" economies in the Third World provide evidence of the entrepreneur ship already present in these countries, even if the legal systems in these countries impede this wealth from being mobilized for larger corporate development, such as occurs in Western countries or in some Asian nations such as Japan. Often there have been entrepreneurial minorities in Third World countries who have been responsible for much, if not most, of the development of modern economic sectors in those countries. The Chinese have played this role in Malaysia, Indonesia and other Southeast Asian nations, Indians and Pakistanis did the same in East Africa and the Lebanese in West Africa. In past eras, Armenians played this role in parts of the Russian and Ottoman Empires, and the Jews in much of Eastern Europe.
Without exception, the success of these minorities has been resented and this resentment has in many cases led politically to their persecution or expulsion. In addition to the tragedies inflicted on these minorities, the economic impact of their departures has been a loss to the countries in which they have not been allowed to contribute what they could. Very few Third World countries have been devoid of the human capital-indigenous or otherwise-needed for economic development. West Africa, for example, became the world's leading grower and exporter of cocoa as a result of the planting and growing of this crop by innumerable African small farmers, even though cocoa was not indigenous to Africa.
During the twentieth century, many poor countries spent decades keeping out foreign products, foreign investments, and multinational corporations, for fear of being exploited. This meant that they had to produce for themselves many products that were available at lower prices in the world market, as well as products that could have been produced more cheaply within their own borders by foreign companies using more advanced technology and industrial experience. People in poor countries were thus denied not only the benefits of a greater abundance of goods, but also opportunities to become familiar with more advanced technology and modern organizational practices that would enable them to create and manage such enterprises themselves. An analysis of 2,700 firms in East Asia by the National Bureau of Economic Research concluded that "firms in which foreigners have a substantial ownership share have markedly higher productivity than those that are domestically owned." More productivity means
higher standards of living.
The poorer the country, the less could they afford to forgo opportunities for a higher standard of living. Eventually, by the late twentieth century, many Third World governments finally realized their mistake, but whole generations had had their economic well-being needlessly sacrificed in the meantime. Partly this change in policy was made because these governments had observed the dramatic economic improvements in once-poor countries like South Korea and Taiwan, which opted to participate heavily in global markets, as compared to the relative stagnation in countries like India and some Latin American nations which did not. However, the history of Western nations in centuries past could have revealed similar lessons.
While Britain was the nation that led the world into the industrial age, nevertheless in earlier pre-industrial centuries, Britain was much like Third World countries today. It exported raw materials such as wool and imported manufactured products from more advanced nations on the continent of Europe. Britain's financial institutions were run by foreigners and whole British industries, such as watch-making and piano-manufacturing, were created by immigrants and expatriates. It was only after centuries of learning from others that Britain was ready to take its place at the head of technological and organizational advances in the world economy. Japan went through a similar phase in the late nineteenth and early twentieth centuries.
PART VII:
SPECIAL ECONOMIC ISSUES
Chapter 22
Non-Economic Values
While economics offers many insights and makes it easier to see through some popular notions that sound good but will not stand up under scrutiny, economics has also acquired the name "the dismal science" because it pours cold water on many otherwise attractive and exciting-but fallacious-notions about how the world can be arranged. One of the last refuges of someone whose pet project or theory has been exposed as economic nonsense is to say: "Economics is all very well, but there are also noneconomic values to consider." Presumably, these are supposed to be higher and nobler concerns that soar above the level of crass materialism.
Of course there are non-economic values. In fact, there are only non-economic values. Economics is not a value in and of itself. It is only a way of weighing one value against another. Economics does not say that you should make the most money possible. Many professors of economics could themselves make more money in private industry. Anyone with a knowledge of firearms could probably make more money working as a hit man for organized crime. But economics does not urge you toward such choices.
Adam Smith, the father of laissez-faire economics, gave away substantial sums of his own money to less fortunate people, though he did so with such discretion that this fact was discovered only after his death, when his personal records were examined. Henry Thornton, one of the great monetary economists of the nineteenth century and a banker by trade, regularly gave away more than half his annual income before he got married and had a family to support-and he continued to give large donations to humanitarian causes afterwards, including the anti-slavery movement.
The first public libraries in New York City were not established by the government but by industrial entrepreneur Andrew Carnegie, who also established the foundation and the university that bear his name. John D. Rockefeller likewise established the foundation that bears his name and the University of Chicago, as well as creating many other philanthropic enterprises. Halfway around the world, the Tata Institute in Bombay was established by the country's leading industrialist, J. R. Tata. In eighteenth century Britain, canals were built with donations from businessmen.
The United States, which has come to epitomize capitalism in the eyes of any people around the world, is unique in having hundreds of colleges, hospitals, foundations, scholarship funds, libraries, museums and other institutions created by the donations of private individuals, many of these being individuals who earned money in the market place and then devoted much . it-sometimes most of it-to helping others. Businessweek magazine in >02 listed numerous
entrepreneurs who had donated hundreds of millions : dollars each-and some, billions-to philanthropy. The market as a mechanism for the allocation of scarce resources among alternative uses is one ling; what one chooses to do with the resulting wealth is another.l What lofty talk about "non-economic values" usually boils down to is that some people do not want their own particular values weighed against anything. If they are for saving Mono Lake or preserving some historic building, then they do not want that weighed against the cost-which is to say, ultimately, against all the other things that might be done instead with the same :sources. For such people, there is no point considering how many Third World children could be vaccinated against fatal diseases with the money that is spent saving Mono Lake or preserving a historic building. We should vaccinate those children and save Mono Lake and preserve the historic building-as well as doing innumerable other good things, according to this way of looking at the world.
To people who think (or rather, react) in this way, economics is at best a nuisance that stands in the way of doing what they have their hearts set on 'Back in the 1960s, Professor George}. Stigler of the University of Chicago, already one of the leading economists of his day and destined to become a Nobel Prize winner, used to sell :prints of an article by Frank Knight to his graduate students for 25 cents each. It is very unlikely that either Stigler or Knight did this for the money. Rather, it was a way to allocate copies of the reprintsof which there was not an unlimited supplyso that they went to lose students who actually wanted to read them, rather than to all those who would have taken them if they had been handed out free of charge. doing. At worst, economics is seen as a needlessly narrow, if not morally warped, way of looking at the world.
Such condemnations of economics are due to the fundamental fact that economics is the study of the use of scarce resources which have alternative uses. We might all be happier in a world where there were no such constraints to force us into choices and trade-offs that we would rather not face.
But that is not the world that human beings live in-or have ever lived in, during thousands of years of recorded history.
In the world that people live in, and are likely to live in for centuries to come, trade offs are inescapable. Even if we refuse to make a choice, circumstances will make choices for us, as we run out of resources for many important things that we could have had, if only we had taken the trouble to weigh alternatives.
MARKETS AND GREED
"Greed" is seldom defined. Virtually everyone would prefer to get a higher price for what he sells and pay a lower price for what he buys. Would you pay a dollar for a newspaper that was available for fifty cents? Or offer to work for half of what an employer was willing to pay you? Would adding a string of zeros to prices or salaries change the principle or the definition of greed?
It is hard to see why it should. But, if everybody is greedy, then the word is virtually meaningless. If it refers to people who desire far more money than most others would aspire to, then the history of most great American fortunes-Ford, Rockefeller, Carnegie, etc.-suggests that the way to amass vast amounts of wealth is to figure out some way to provide goods and services
at lower prices, not higher prices.
Back in the nineteenth century, Richard Sears was ferociously determined to overtake Montgomery Ward, the world's largest retailer at that time, and worked tirelessly for incredible hours toward that end, sometimes taking risks that bordered on the reckless. Sears sought out every way of cutting costs, so that he could undercut Ward's prices, and every way of attracting Customers away from all his rivals. He did all this, not because he did not have enough money to live on, but because he wanted more-and he wanted his company to be number one. If that is our definition of "greed," then he Was greedy. More important, in this case as in many others, it was precisely such greed that led to lower prices. That was how Sears overtook Montgomery Ward and replaced it as the leading retailer in the country at the beginning of the twentieth century. In later years, that is how WalMart overtook Sears.
Those who condemn greed may espouse "non-economic values." But lofty talk about "non-economic values" too often amounts to very selfish attempts to have one's own values subsidized by others, obviously at the expense of those other people's values. A typical example of this appeared in a letter to Editor & Publisher magazine, written by a newspaper columnist who criticized "the annual profit requirements faced by newspapers" due to "the demands of faceless Wall Street financial analysts who seem, from where I sit, insensitive to the vagaries of newspaper journalism." Despite the rhetorical device of describing some parties to a transaction in less than human terms ("faceless Wall Street analysts"), they are all people and they all have their own interests, which must be mutually reconciled in one way or another, if those who supply the money that enables newspapers to operate are to be willing to continue to do so. Although people who work on Wall Street may control millions of dollars each, this is not all their own personal money by any means. Much of it comes from the savings, or the money paid into pension funds, by millions of other people, many of whom have very modest incomes.
If "the vagaries of newspaper journalism" make it difficult to earn as high a return on investments in newspapers or newspaper chains as might be earned elsewhere in the economy, why should workers whose pension funds will be needed to provide for their old age subsidize newspaper chains by accepting a lower rate of return on money invested in such corporations? Since many editors and columnists earn much more than some of the people whose payments into pension funds supply newspapers with the money to operate, it would seem especially strange to expect people with lower incomes to be subsidizing people with higher incomes-teachers and mechanics, for example, subsidizing editors and reporters.
Why should financial analysts, as the intermediaries handling pension funds and other investments from vast numbers of people, betray those people who have entrusted their savings to them by accepting less of a return from newspapers than what is available from other sectors of the economy?
If good journalism-however defined-results in lower rates of return on the money invested in newspaper chains, whatever special costs of newspaper publishing are responsible for this can be borne by any of a number of people who benefit from newspapers. Readers can pay higher prices, columnists, editors and reporters can accept lower salaries, advertisers can pay higher rates.
Why should the sacrifice be forced onto mechanics, nurses, teachers, etc., around the country whose personal savings and pension funds provide the money that newspaper chains acquire by selling corporate stocks and bonds?
Why should other sectors of the economy that are willing to pay more for the use of these funds be deprived of such resources for the sake of one particular sector?
The point here is not how to solve the problems of the newspaper industry. The point is to show how differently things look when considered from the standpoint of allocating scarce resources which have alternative uses.
This fundamental economic reality is obscured by emotional rhetoric that ignores the interests and values of many people by summarizing them via unsympathetic intermediaries such as "insensitive" financial analysts, while competing interests are expressed in idealistic terms, such as journalistic quality. Financial analysts may be as sensitive to the people they are serving as others are to the very different constituencies they represent.
Both in the private sector and in the government sector, there are always values that some people think worthy enough that other people should have to pay for them-but not that they should have to pay for them themselves. Nowhere is the weighing of some values against other values obscured more often by rhetoric than when discussing government policies. Taxing away what other people have earned, in order to finance one's own moral adventures via social programs, is often depicted as a humanitarian endeavor, while allowing others the same freedom and dignity as oneself, so that they can make their own choices with their own earnings, is considered to be pandering to "greed." Greed for power is no less dangerous than greed for money, and has shed far more blood in the process. Political authorities have often had "non-economic values" that were devastating to the general population.
Does a free market, as a mechanism for mutual accommodation, facilitate greed as it facilitates the fulfillment of people's other desires? It certainly does not prevent greed, though it does exact a quid pro quo-providing others with something that they want, in order to get them to part with their money. A more relevant question, however, is whether other economic systems, including those founded on altruistic and egalitarian principles, actually end up with less greed than an economic system that depends on prices to allocate scarce resources.
Although socialist systems, including the Communist variety, began as attempts to apply egalitarian principles, examples of sacrificing the well-being millions of people for the well-being of those with political power abounded in the Soviet Union and the Communist bloc in general. At the purely economic level, the ruling nomenklatura of the U S.S.R. had separate stores in which only they were eligible to make purchases, as well as other government-supported facilities to which they alone had access. These were of course the best stores, with the most abundant supplies of the commodities most in demand. In addition, the housing, medical care and other facilities open to Communist Party bosses was likewise the best. The rhetoric of equality-egalitarian terms like "comrade" and "people's democracy"-was no match for the reality of greed, especially when that greed could use the power of a totalitarian state, instead of having to supply others' desires in order to earn their money.
Even in a democratic country like India, the era of massive government controls over the economy-lasting for nearly half a century, from independence in 1947 to the beginning of the last decade of the twentieth century was an era of massive corruption of both high officials and innumerable petty bureaucrats, whose permissions were necessary to do virtually all of the ordinary things that people do at will in a free market economy. Pervasive bribery was only part of that cost. The inefficiencies created by intrusive bureaucratic controls have been estimated to have cost the economy vast amounts of lost production that would have made the average Indians' income hundreds of dollars a year higher. In one of the poorest countries in the world, where malnutrition was a serious problem for many, such a loss meant far more than whether the average American's annual income was a few hundred dollars more or less.
Greed can flourish under very different economic systems. The only real question is: What
are its actual consequences under these systems? Where the desire for a fortune can be satisfied by finding ways to lower prices and thereby expand the market for one's output, that is very different from a system where that same desire is more readily fulfilled by imposing political power. In other words, greed is not the product of one particular economic system, but something that all economic, political, and social systems have to cope with in one way or another.
People who deplore greed often show a disdain for wealth. Although a disdain for wealth is often admired, only those who already have a certain amount of wealth can afford to disdain any further pursuit of it. Wealth means options and who would want fewer options? More important, from the standpoint of society as a whole, wealth is the only thing that can prevent poverty. Yet many people who claim to be concerned about poverty show remarkably little interest in how wealth is generated or which policies make it harder or easier to create more.
One of the special variations on the theme of greed is that some businesses are guilty of "charging all that the traffic will bear." Often such statements are made, not simply as a moral condemnation, but as a causal explanation of prices that are considered to be "too high" for one reason or another. If widgets have been selling for five dollars apiece for some time and suddenly the price rises to eight dollars, then the explanation that is offered may be that the widget manufacturers are now charging all that the traffic will bear.
As a causal explanation, this immediately raises a question: Why were they not charging all that the traffic would bear before? Chances are that they were. It is just that the traffic would not bear more than five dollars before and will now bear eight. Therefore what needs to be understood is a causal explanation of what has changed, if widget manufacturers were charging all that the traffic would bear both times.
It is not just businesses that charge all that the traffic will bear. The very people who are making this accusation would seldom agree to work for half of their present salaries-or even three-quarters of their present salaries.
They are charging what the traffic will bear for their work. And if someone else offers to pay them twice what they are currently earning, it is very unlikely that they will continue working for their current employer, unless that employer matches the offer.
Strictly speaking, a business is unlikely to charge literally all that the traffic will bear. If General Motors is selling a certain automobile for $25,000, it could probably still sell some to real devotees of that particular car if they doubled the price to $50,000. But, although the traffic would bear a price of $50,000, sales would probably be so reduced that GM would not make as much money as they would by charging $25,000. However, we can take the expression "charging what the traffic will bear" as meaning simply maximizing total profits. What we really need to understand are the implications of saying that higher prices are due to profit maximizing. We also need to understand the consequences of trying to stop it.
During the California electricity crisis of 2000-2001, for example, as the wholesale price of electricity suddenly shot up far above what they had been, Some electricity generating companies were accused of charging whatever the traffic would bear. Why would the traffic bear higher electricity prices in 2000 and 2001 than before? Not surprisingly, it had to do with supply and demand.
, As the price of the fuels used to generate electricity rose, so did the cost of generating a given amount of electricity. Whereas the price of natural gas delivered to electric utilities in California was only $2.70 per million British thermal units (BTUs) in 1998-1999, by the summer of 2000 the price had nearly doubled to $5.00 per million BTUs. This was part of a nationwide increase in natural gas prices, as a result of a cold winter after several mild winters, thereby
causing more natural gas to be used for heating than in the previous years. In the meantime, the international oil cartel raised the price of petroleum, which is also used to generate electricity. Moreover, this all happened while a west coast drought reduced the amount of water passing over hydroelectric dams, thereby generating less electricity than usual.
Meanwhile, on the demand side, Pacific coast winters were colder than usual and summers were hotter than usual in California and Nevada. This meant that more electricity was being used for heating in the winter and for cooling in the summer. In short, there was a reduction in the quantity of electricity available at a given cost and an increase in the quantity of electricity demanded at existing prices. A price rise under these conditions is hardly surprising.
Unfortunately, most members of the general public were unaware of these factors behind the suddenly rising prices, and so were resentful and became receptive to those who blamed the price increases on power companies' charging what the traffic would bear. If this were just a philosophical issue, it would have no economic implications. But when the political consequences included price "caps" placed on electricity sold to western states, that in turn led to economic consequences.
When there was more electricity demanded than supplied at government controlled prices in the western states, power generators had a choice of where to sell their output, just as a landlord has a choice of which of the surplus applicants to rent his apartments to under rent control. Not surprisingly, they sold their electricity to states not covered by the price controls. In other words, California and other western states received less electricity than they would have received if the electricity-generating companies had been allowed to charge what the traffic would bear.
Had the price controls been nationwide, then California would no doubt have received a larger share of the electricity being generated in other states.
However, it is doubtful whether the total amount of electricity generated nationwide would have remained unchanged. More likely, less electricity would have been produced nationwide when its price was held down artificially nationwide, and more shortages and blackouts would have occurred across the country, instead of only in California and Nevada.
Electricity is only an example. The same principle applies much more widely. To say that the traffic will bear a higher price is to say that the quantity demanded-of electricity, widgets, cameras, or whatever-exceeds the quantity supplied at the current price. Price controls under these conditions virtually guarantee that the shortage will not be corrected. Focusing on the seller's "greed" neither explains what caused the shortage nor offers any way of ending it.
SAVING LIVES
Perhaps the strongest arguments for "non-economic values" are those involving human lives. Many highly costly laws, policies, or devices designed to safeguard the public from lethal hazards are defended on grounds that "if it saves just one human life" it is worth whatever it costs. Powerful as the moral and emotional appeal of such pronouncements may be, they cannot withstand scrutiny in a world where scarce resources have alternative uses.
One of those alternative uses is saving other human lives in other ways.
Few things have saved as many lives as the simple growth of wealth. An earthquake