Basic Economics: A Citizen’s Guide to the Economy

Edited and written by David Gordon, senior fellow of the Mises Institute and author of four books and thousands of essays.

0001_basic_economics_by_thomas_sowellI am jealous of Thomas Sowell. He has a genius for the striking fact and the apt analogy. These enable him to present his points in a way that readers will not soon forget. He aims in Basic Economics to present elementary economic principles that he thinks most people ignore at their cost. He manages to achieve his goal without a single diagram and with few technical terms.

But it is out of character for me to bring unalloyed good news. He adopts without adequate argument an “efficiency” standard to judge the economy, and this leads him to some questionable remarks. Also, a problem that has plagued him in an earlier book here makes a brief appearance: he makes a radically mistaken statement about socialism.

One of his best examples, though, occurs in a discussion of that system. Readers of The Mises Reviewwill no doubt be familiar with the socialist calculation argument. Our author offers a good discussion of it, stressing, as one might expect from an authority on Hayek, the knowledge aspects of the argument. So far, so good, but similar treatments can be found in many other works. But Sowell, characteristically, finds an unusual detail.

He has discovered a passage from none other than Friedrich Engels that acknowledges the force of a version of the calculation argument: “Engels pointed out that price fluctuations have `forcibly brought home to the commodity producers what things and what quantity of them society requires or does not require.’ Without such a mechanism, he demanded to know `what guarantee we have that [the] necessary quantity and not more of each product will be produced, . . . that we shall not lack trousers to cover our nakedness while trouser buttons flood us in millions. ‘ Marx and Engels apparently understood economics much better than their latter-day followers” (p. 15).

Sowell’s appreciation for the price system is at least as great as Engels’s, and he insightfully counters a common objection to it. Opponents of the free market will sometimes acknowledge that capitalism allocates resources to their most efficient use. But what happens to those who lose out through efficient transfers of resources? Suppose that someone loses his job in an automobile plant because a competing Japanese firm forces his company out of business. No doubt, an economist could explain to the newly unemployed worker that the tariff that would have enabled him to retain his job is inefficient. But why should the worker care about that? And, if he does not, why should the rest of us invariably hold that efficiency considerations are overriding?

As will be apparent later, I do not think Sowell fully responds to this question, but he does make an excellent point about it. The problem of dealing with those who suffer from transfers of resources is not exclusive to capitalism. Every society confronts it, and the main alternative to reliance on the market is governmental coercion. “Scarcity implies that resources must be taken from some places, in order to go to other places.

Few individuals or businesses are going to be willing to give up what they have been doing, especially if they have been successful at it, for the greater good of society as a whole. . . . The financial pressures of the free market are just one of the ways this [transfer] can be done. Kings or commissars could simply order individuals to change from doing A to doing B. . . . What is crucial . . . is that it must be done” (p. 123).

If choice in allocating resources cannot be avoided, what ought to govern decisions about such matters? Our author sets forward a principle that is obviously true but frequently neglected: We should not ignore the fact that we are choosing between alternatives.

At first glance, saying this appears silly: Who could possibly doubt it? But a common mode of argument ignores the principle. Often, social reformers think that to point out a need suffices to show that something must be done about it. But this is precisely to ignore the fact that all expenditures to meet a need involve a choice in the use of resources. “So long as we respond gullibly to political rhetoric about unmet needs, we will arbitrarily choose to shift resources to whatever the featured unmet need of the day happens to be and away from other things. Then, when another politician . . . discovers that robbing Peter to pay Paul has left Paul worse off . . . we will start shifting resources in another direction” (p. 310).

Though Sowell’s claim is of vital importance, he does not always defend it with conceptual precision. To provide people with the food and water they require to survive involves a choice in the use of scarce resources; but to note that “beyond some point . . . both [food and water] become unnecessary and dangerous” (p. 310) does not support this contention. The question at issue involves the necessary quantity of these goods. Further, the fact that all use of resources involves choice does not show that the “very word `needs’ arbitrarily puts some desires on a higher plane than others” (p. 310). One can with perfect consistency delimit a class of needs and claim that these outrank desires, while acknowledging that any use of a resource involves choice.

But I come to praise Sowell, not to bury him-at least at this point in the review. Many have pointed out that the market can allocate resources even during emergencies, but Sowell finds a brilliant illustration: “When the San Francisco Chronicle resumed publication a month after the [1906] earthquake, its first issue contained 64 advertisements of apartments or homes for rent, compared to only 5 ads for people seeking apartments to live in . . . neither the newspapers nor any documents of that time mention any housing shortage” (p. 31).

Supporters of a Rothbardian view of fractional reserve banking will take great delight in another historical point our author raises: “Under this system of fractional reserve banking, anything that could set off a run on the banks could cause these banks to collapse. . . . This is what happened during the Great Depression of the 1930s, when literally hundreds of banks collapsed in one year and the total monetary supply of the country contracted by one-third” (p. 234).

But, defenders of fractional reserves will say, doesn’t the Federal Reserve System make such panics impossible? Sowell displays in response a healthy skepticism: “The Federal Reserve System was established in 1914 as a result of fears of such economic consequences as deflation and bank failures. Yet the worst deflation and the worst bank failures in the country’s history occurred after the Federal Reserve was established” (p. 235).

One more illustration of Sowell’s genius for the telling detail must here suffice. A few economists, denying the elementary principles of their science, claim that empirical evidence falsifies the theory that minimum wage laws produce unemployment. Sowell quickly sees to the heart of the matter: “[S]urveys of employers before and after a minimum wage increase can survey only those businesses which survive in both periods. Given the high rates of business failures in many fields, the results for the survivors may be completely different from the results for the industry as a whole. . . . George Stigler once said about such surveys of survivors, using such methods you can prove that no soldier was killed in World War II” (pp. 154-55).

Unfortunately, Sowell is not always in top form. When he compares the relative efficiency of socialism and capitalism, he wrongly maintains that socialism trades eliminating profit for efficiency in allocating resources. (From the context, he means by “profit” the excess of returns over costs.) He writes: “[W]hile capitalism has a visible cost-profit-that does not exist under socialism, socialism has an invisible cost-inefficiency-that gets weeded out by losses and bankruptcy under capitalism” (p. 75).

But socialism does not eliminate profit; if all goods sold at cost, no funds would exist for future investment. Of course, a socialist system usually does not let the managers of its firms keep the excess of returns over costs, but this simply transfers profit to the planning authorities.

Sowell’s devotion to economic efficiency, however admirable, is a shade too uncritical. In his discussion of monopoly, he takes for granted that it is desirable for an economy to maximize total wealth: “From the standpoint of the economy as a whole . . . consumers of the monopolist’s product are foregoing the use of resources which would have a higher value to them than in alternative uses. That is the inefficiency which causes the economy as a whole to have less wealth under monopoly than it would have under free competition” (p. 92). In similar fashion, he allows, on grounds of promoting efficiency, governmental intervention in the economy to cope with external costs and benefits.

Sowell offers no defense of wealth maximization as a criterion for policy. True enough, to show that an economic policy leads to chaos conclusively refutes it. It would be perverse to respond to the calculation argument, “All right, socialism leads to economic disaster; so what? I’m still a socialist.” But it does not follow from the fact that efficiency must be given some weight that it has supreme importance. What if people wish to put up with certain efficiencies? Sowell has failed to show that they should not. (His excellent point that all societies face problems of resource allocation does not gainsay this.)1

1The context makes clear that Sowell does adopt efficiency as a criterion. He is not just making the purely factual claim that monopolies and external costs generate inefficiencies.

Basic Economics: A Citizen’s Guide to the Economy .pdf file

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