Economics

Economics is not as formidable as it may sound: It has to do with voluntary exchange of goods — things people make or wish to buy — and services — help people hire or offer to provide.

An important part of economics is money. In a free society, money would be whatever its members choose it to be, however it may very well be gold in both physical and electronic form.

Gold coins contain a large amount of value and even though smaller ones may well be minted it would be tricky to make and handle any that are worth less than one hundred dollars. So for smaller transactions electronic facilities would be more convenient; there, payments could be made in units of one cent or less.

It may well be that the metric system of measurement would be preferred in the market; thus prices might be expressed not as “point zero zero one gold ounces” but as “point zero three gold grams” or “thirty milligrammes” of gold. Metric measurement always uses multiples of ten, so one need not even think of remembering how many ounces there are in a pound, nor pounds in a ton, tablespoons in a pint, and so on.

Macro or micro

Economics is not an exact science like physics, so opinion and judgement play large parts and there are different and rival “schools” of the subject. For most of the twentieth century and into the twenty–first, most of what gets taught in government schools and government–supported colleges has favoured “macro economics”; that takes a top–down view of what is going on in a country and passes judgement on whether the central bank should raise or lower interest rates, whether more or less money should be supplied, and whether tax rates should be lowered or raised so as to stimulate investment or “consumption” — that is the word they give to what people might buy and use. The underlying assumption of macro economics is that wise people close to government can twiddle knobs and control what the economy does. There are truckloads of textbooks and mathematics to show how right they all are — or would have been, had not Unexpected Factor X intervened.

It is arrogant, and it is ruinous; for nobody is actually smart enough to do it right and the proof of that is that for seventy years the Russians, who include some very smart people indeed, managed the Soviet economy so fully that they drove it in to the ground; so little of value was being produced by 1989 that the people just walked away from the system and the puppeteers in charge gave up the impossible task. So macro economics is not an idea worth entertaining — even though it provides the language for most of what gets reported every day on television, by news readers who do not understand it either but who dare not admit it for fear of looking foolish.

Micro economics in contrast concerns itself with what individuals may or may not do, and then tries to add it up to form a total for the economy; it gives, with due humility, a bottom–up perspective. With scores of millions of individuals to understand it too is imprecise, and for that reason there are several viewpoints or “schools” within this broad grouping; but at least micro economics starts the right way up. The two that favour a free society in varying degrees are the Chicago School, led by Milton Friedman, and the Austrian — or “Vienna” — School, founded by Carl Menger, whose great twentieth century exponent was Ludwig von Mises.

Demand, supply, and price

There are a few key concepts of economics that ought to be understood by everyone; and this first is the strong, real–world relationship between the three parameters of demand, supply and price. They are not mysterious factors set forever by unknown forces, but move daily in a kind of dance, responding to each other, for any product or service in the marketplace.

The higher the price, the lower the demand quantity; and “demand” in economics means the quantity buyers will purchase. Most drivers would like a Porsche or a Mercedes; but most drivers buy a cheaper brand. Why? Because “would like” is not the same as “demand”. Demand is the wish plus the money. So this first reality check is that for real people, price matters. There is no bottomless pit of taxpayer money to be spent.

What manufacturers or suppliers will make or supply also depends on the price they can sell something for! Back in 1979, all suppliers stopped selling oil derivatives in the United States because the Federal Government, starting with a decree by Nixon in 1971, forbade the retailing of petroleum at prices over about 85 cents a gallon — even though actual buyers were quite willing to pay more. Since the suppliers could not sell it that low and still make a profit, they quite naturally quit. The result was kilometre–long lines all over the country. Supply dried up, and stayed that way until Jimmy Carter repealed the prohibition; supplies were back to normal within two weeks and prices rose to about one hundred twenty cents and later moderated. Incidentally, a 1979 price of eighty–five cents is about the same as a 2005 price of two hundred forty cents a gallon; and one hundred twenty then equates to three hundred forty in 2005. The real price may actually be fairly stable over time, at about one hundred fifty gold milligrammes!

So, the higher the price buyers are willing to pay, the higher the supply that will be produced, and vice versa. This holds true for virtually all goods and services.

There is a price at which suppliers and buyers are equally satisfied with the deal. There is great beauty in the balance here; that all players take part on a voluntary basis, and respond to each others’ bids and offers; and that nobody is forced to be a slave to anyone else and the buyers — “consumers” in econ–speak — are just as powerful in the market as the suppliers.

Competition

This is an important component in any market — the one for vegetables, the one for jobs. It is good to have a choice of veggies, of veggie buyers, of employers, and of employees. That gives a better chance that all will be fully satisfied. Competition is one factor that affects both suppliers and buyers, and is very good for everyone because it minimises waste; but it does not alter anything directly.

Visibility

Is it important for all prices being bid and offered to be equally visible to all participants? Some economists say yes it is, and since that is never fully possible, that this picture of economic activity is false or simplistic. Translation: “You need to hire an expert like me to understand what is really going on”.

It is a factor, of course, and the more everyone knows about the market the more likely everyone will end up satisfied — but no, of course it is not essential. If there are four greengrocers in town, do people really have to know the price of lettuce at all of them? Not really. If someone finds out later they were overcharged, they may not patronise that vendor again; and the vendors know that. Partial knowledge is quite good enough in practice, and as the internet becomes more and more of a marketplace, visibility will become closer and closer to perfection.

Jobs

Quite a lot of people get paid today when government steals money from others and hands it to its workers in exchange for work they do. That work may be done well or poorly; it may perform a function — like mending roads — that would get done in a free market with proper ownership and honest accounting, or it may be entirely useless; but always, government hires get paid from loot stolen from taxpayers at gunpoint. Yet when in the future everyone understands what freedom from government really means and walks out on the latter, everyone including former government employees will need to live and work in a free market. So it is worth getting ready, and this offers a little help. First, a reality check. Supposing someone works for an employer, who has the right to the job? Nobody has a right to it, except under the contract the employer and employee signed; a “job” is not something that anyone can possess. An individual will keep their job only for as long as the boss thinks they are getting their money’s worth out of what they are paying — for if they were forced to pay when they do not want to, they would be a slave. This has some consequences!

Sell yourself

Key consequence, of that reality: Anyone wanting to be paid has to “sell themselves;” and that means to offer benefits to someone who might be willing to pay for them.

If someone is job–hunting — or job–holding — they are the supplier, of services, and their salary is the price the employer is to pay. The employer’s demand will be their wish to hire someone — to benefit from the service a potential employee would bring them — plus the money they pay for such services. So if an individual’ services are not bringing them at least as much profit as the money they are handing over every month, it will be perfectly rational for them to let their employee go — subject of course to the terms of the contract between them.

Conversely if one’ services are bringing their employer more profit than the wage is costing them, the employer has a good rationale to keep their employee. In fact, it may be a good time to negotiate a raise . . . though they should be careful, there may be a jobless competitor out there willing and able to work just as well but for less money. So all in all, an employee would do very well repeatedly to make sure they are worth their pay.

Full employment would prevail in a free society. By “full” it is meant: Everyone who wants a job will have a job — except those in the process of changing jobs, which is generally reckoned to be about five percent. How so? Because nothing will stop that.

The main factors that prevent full employment today are:

• Minimum wage laws that prohibit jobs being offered for less than some specified hourly rate, even though both parties would accept one.
• Misallocation of capital or other distortion of the economy, due to government manipulation of resources.

That is not to say that all jobs available would pay well. It just means that nothing would prevent any jobless person obtaining one, at some wage. Many, of course, would have saved up for a rainy day and prefer to ride out a rough situation and wait for a better offer.

What brings prosperity

Countries differ widely, in measures of prosperity such as per–capita income, even though they might have very similar cultural backgrounds. Why?

Two reasons above all: Investment and trade — and both depend on freedom, or in other words, on the extent to which self–ownership is respected.

Investment

Investment means not consuming all that is produced, but taking some of it and buying equipment that will make future production easier. For example, a subsistence farmer might eat half of all they grow and spend eighty percent of what they can sell the rest for on clothes, shelter, and heating — but the remainder they spend on upgrading their plough. Literally, they are “ploughing back” some of what they produced. Next year, the new plough enables them to grow more — to expand their business — without any extra labour. So they can put aside even more, and plough that back by trading their horse for a used tractor, and so the cycle of prosperity has begun, for them. In a decade or two they will prosper and their children will own Porsches.

Tragedy is, governments usually intervene in a variety of ways to monkey–wrench that process; so in most countries of the world, even in the twenty–first century, grinding poverty remains.

Trade

Trade means that members of a society are free to exchange what they produce not only with each other, but with foreigners who wish to do so. Such cross–border exchange is usually called “free trade”. This freedom is critically important because very few countries have all they need for economic growth; land on which to grow all the food they want, minerals to yield all the raw materials required for machinery, fuel to provide power to run those machines, and so on. That does not matter, provided they can freely exchange their surplus of one kind of product to make good their shortage of another.

Thus, the Japanese since about 1850 have had too little agricultural land to feed everyone — but they have been very skilled and hardworking in manufacturing a wide range of things from toys and watches to computers to ships. They export ships and cars, and use the money to bring in food. Problem solved. Hong Kong, similarly, had virtually no space to grow food — yet by free trade has been able to achieve the highest standard of living in the Pacific.

Tragedy is, government often intervenes to prevent or hinder free trade by imposing import tariffs to distort the apparent prices of available foreign goods. Result: Continuing poverty.

Savings, capital, and investment

Consider a small town, one of whose residents has just invented a New and Improved Widget, which holds the promise of making life more pleasant for millions of people; a highly saleable product. Such is the expected demand that a new factory is needed to produce it, which will need to hire fifty people to work at the task. One problem: The inventor does not have the fifteen million dollars it will take to set things up. So where might that money come from?

1. Government could tax everyone in the county and lend fifteen million dollars to the inventor and later receive dividends. Today that would be possible; alternatively government could simply print the money. That is very easy, and no bureaucrat would be risking any of their own savings, so provided the prospect of new jobs seemed likely to attract votes, that might well happen and with very little careful analysis of risk.
2. The inventor might advertise the opportunity and sell shares in a company formed for the purpose. That is called capitalism and every participant shares the risk in the hope of sharing the profits. Scrutiny of that risk could not be more thorough, because nobody cares for their money more than they do.
3. The inventor might borrow the fifteen million dollars from the nearest friendly bank, and later pay it back like a mortgage. The bank would get the money from . . . where? Today banks get such funds from the fractional reserve system, which is to say from thin air, and so are not too worried about security. In an honest free–market society it would get the money only from depositors and so would be very concerned that the investment was sound; so much so that it might pass on the opportunity.

So, all three ways would make the needed fifteen million dollars available, but only one of them would do so with maximum care and with no inherent disruption of the economy such as inflating prices by creating new, paper “money”. In a free society, that is the method that would always apply, and therefore only a free society would provide such “capital” with the least risk of loss and, so ensure that of all possible business ventures considered, the maximum number succeed.

Nobody spends or invests other peoples’ money as carefully as they do their own.

The project may fail anyway — but notice what happens in the three cases. In all of them, of course, the inventor is deeply disappointed; and those people whom the new plant had hired will be let go, perhaps suddenly. They will need to find new jobs, fast.

If the money came from the government, all taxpayers will have to kiss it farewell; but they lost it anyway, the moment it was stolen from them — so it makes little difference. They were never promised any return on their forced investment, and they will not get any. The only consequence is that $15 million was created and, in effect, thrown away. The whole society is the poorer.

If the money came from the bank by the strong magic of fractional reserve, the same will apply; though if it came that way honestly, from depositor money, the bank may well go belly up and depositors will lose fifteen million dollars that they never expressly chose to place at risk. Big trouble.

But if the money came from shareholders, they of course will lose it but they knew they might. They assessed the risk, judged it was worth it when compared with the lucrative returns from the sales of the new Widget, but unhappily lost. They will be worse off but — apart from those laid off — nobody else. The risk is carried exactly where it ought to be carried.

If the project succeeds on the other hand, those shareholders will become very wealthy — as will the inventor who made it all possible, presuming they wrote a good contract when offering the shares for sale. And so they all should; those are the rewards of taking carefully considered risks. That is capitalism, freedom, and responsibility.

The “business cycle”

The business cycle theory from the Austrian School of economics explains why some times are good and some, hard.

The natural, free–market way that capital is generated for business expansion is that ordinary people save some of what they earn, and directly or indirectly invest the savings where they think it will yield a high but safe return. They have a “preference” balance between spending it now or keeping and increasing it for later use.

In the first phase of the business cycle, government artificially lowers interest rates and increases the supply of paper “money” so as to create a “boom” that makes voters feel rich — and grateful. This bonanza of cheap money is borrowed by businesses and others who suppose it really reflects that preference of real people to save and invest — and if that were truly the source, the borrowing and investing would be a very rational response.

In its second phase, the cycle sees an increase in the proportion of investment projects that fail — partly because the loans were so cheap that insufficient care was taken in using them, partly because the reasonable expectation that, having saved up, ordinary people would then spend some of the savings on what manufacturers produced with the money they borrowed. That expectation is false, because the loans never came from individual savers in the first place. So there are collapses and layoffs.

The third phase is one of liquidation; items bought in the first — often capital equipment, by businesses — which are found not to be needed are sold off for what they can fetch, to those who can use them; some companies go under, and provided no new money is “created” to slow down the process of correction, the “bust” completes the cycle quite rapidly. It is nasty while it lasts, but historically — before 1931 — two years proved ample. The problem in 1931 was that then and for fifteen more miserable years the government intervened to block the necessary falls in wages and prices and to continue to manipulate money supply. Thus did the Feds prolong the Great Depression until 1946, distracting attention from its disastrous failure by needlessly involving America in a terrible four–year war.

When a free market replaces government, the disruption and discomfort of boom–bust business cycles will end; for their cause will have been removed. Money for borrowing and investing will be exactly as plentiful as individual owner–savers choose to make it, neither more nor less. There will of course still be investment errors as well as successes, with consequent losses falling on those who erred; but there is no reason for the error rate to vary over time.

Review

Make use of the following questions and the associated feedback to check knowledge and understanding of the topic covered in this unit.