Review: Economics Explained

Economics Explained
Economics Explained
Robert Heilbroner and Lester Thurow
Simon & Schuster Inc., New York, NY 1998

Review Copyright — 1998 Garret Wilson — September 12, 1998, 11:00am

It looks as though I’ll be taking an international economics class soon, which makes me think that the material will build upon concepts pertaining to "normal" domestic economics. Since I’ve never had any economics classes, I decided that Economics Explained by Robert Heilbroner and Lester Thurow might be the place to start learning.

Seeing that I don’t know exactly what I should be learning, it’s hard to judge the content of my first brush with the subject. The style is fitting for a rudimentary easy-reading introduction, and going by instinct, Economics Explained presents the basics of what one should look for in future studies in economics. The information presented is a whirlwind tour that covers, though in a limited way, the highlights of all areas of market systems.

Starting out by knowing nothing about economy (except, of course, a few phrases like, "supply and demand," and a few basic concepts such as how different types of companies are structured and how their stocks work), I did learn some fundamental concepts from Economics Explained that will be invaluable in my future studies. From the information I gathered from Economics Explained, here is the economy as I understand it now:

"Economy" as presented in the book does not refer to any general system of earnings and welfare, as I had understood it to mean before. "Economy" is used to mean any (more or less) free market systems. This is not a term to be taken for granted, because there are other systems besides free market systems.

The market system is a recent invention. In the Middle Ages, for example, we (or at least, I) assumed that people had wages and occupations just as we do now, although, granted, through oppression and economic and class status one’s choice in the matter was extremely limited. Heilbroner and Thurow explain, however, that the feudal system was not a market system for many reasons. First of all, although the workers made "wages" (or more precisely, the landowner supported them), there was no reason for the landowner to pay them more or less.

Why would the landowner pay them more? To get more workers and/or to produce more crops or products, possibly. But why would the landowner need more crops or products? Why would a shoemaker, for example, lower prices to produce more shoes, or raise them to make more money? The same people would buy shoes from the same person, and the shoemaker or the landowner never changed on the class scale, because landowners in their class because they owned land and had riches, and the shoemakers or crop reapers were in their class because the didn’t own land or have riches. There was no equilibrium to maintain; things just were the way they were.

This static state of the population did make certain things less worrisome. The landowners would worry their status with the king, for instance, which might influence their riches or status. It had nothing to do with any product they produced. Likewise, the peasants would simply work and get their sustenance. There was no incentive to be creative or to change your "place" in life.

A market system, on the other hand, plays by a different set of rules. Basically, there are producers which produce items that are bought by others in a population. If lots of people in the population want a certain item, the producers make more of that item. If they cannot supply enough to meet the demand, they will raise the prices. Of course, if they raise the prices too much, less people will buy the items, and they will wind up with a lot of products in their inventory. The same thing will happen if they keep the prices the same, but make more than the population wants — they will wind up with items that cannot be sold, so they will lower prices and/or produce less. Overall, the theory is that the demand from the public and the supply from the suppliers will eventually equalize and settle down to a price and quantity somewhere in the middle that works for everyone.

With those definitions, then, communist countries do not have economies, or at least they do not have free market systems. The price of shoes is not set by how much people are willing (or able) to pay for them, or from how many (or how little) shoes are produced. The government rather has a shoe factory and sets the prices of the shoes, the wages of the employees, and the wages of the population who have other occupations who actually buy the shoes. Since everything is set by the government, all the wages, prices, and people should all work out just right, assuming the government correctly manipulates all these variables. The government in effect rations wages and items to people.

Heilbroner and Thurow therefore bring out a very important concept that was new to me: all of those bills, coins, and checks that we call, "money" are in effect ration cards that determine who will get how much of a certain item. If someone has more ration cards (i.e. more money), they can have more a particular item. If they have less ration cards, they can have less of that item. The entire market system is really just a rationing system that determines who gets how much of what.

This all works out quite nicely: the market system determines who will have how many ration cards, so that the market system effectively rations products so that a government or some other entity does not have to do so. A market system says nothing about the desirability of the outcome, however. The entire system will still work if 50% of the people have more than enough money to buy shoes, but the other 50% doesn’t have anywhere near enough money to buy shoes. Whether this situation is desirable or not is a moral/political observation.

Because of the desirability or undesirability of certain outcomes, most market systems are not completely free market systems. The government, to some extent or another, steps in and controls some aspect of the market to remove certain outcomes which it feels to be undesirable. For example, the price of corn in the United States is not set by market forces, that is, by supply and demand. The government subsidizes corn, artificially keeping corn at high prices by paying farmers to produce corn. This is done because, if the price of corn were allowed to adjust itself in a completely free market system much more corn would be produced than is needed (the supply would be more than the demand), and the price of corn would drop substantially, putting many farmers out of a job.

The market system would still work completely well with farmers out of jobs, and presumably farmers would get other jobs or something, but the government (in this case, probably with the support of the population) has decided that putting farmers out of a job is worse than having the government control part of the economy. Thus, the reasoning behind state-controlled markets seem to rest on two assumptions: 1) the state can decide in most cases which outcomes are more desirable for the population, and 2) the state has the competence to determine what actions to take (e.g. raising/lowering prices/wages, building/destroying factories) to bring about these results. The authors of Economics Explained in most instances take a liberal viewpoint: they promote the free market concept in general but acknowledge that in many instances government intervention is needed to reduce undesired (again, a subjective concept) results.

The output of the domestic economy is called the Gross Domestic Product (GDP) (which used to be called the Gross National Product, or GNP). The GDP is divided up into several sectors, which include the private sector (people working at jobs and getting money and then buying shoes), the business sector (the shoe factories which take the money from sales and buy equipment and pay salaries), the public sector (the government, which pays businesses to build highways and make airplanes for the Air Force), and the foreign sector (people buying Fords and corn outside the US, if I understand it correctly.)

Looking at the economy from this high up (macroeconomics), we see that each of these sectors work together to make up their own economy. That is, each of the sectors have their own balance of supply and demand. The more the private sector buys from the business sector, the more the business sector can buy equipment and hire people from the private sector, for example. The public sector, on the other hand, can influence the business and the private sectors by raising or lowering taxes.

The actual money, the rationing cards of the market system, is a difficult concept to understand, in some aspects. It seems that the entire system of money is built on itself in a never ending loop of circular dependencies. People can only make money making shoes if the shoe factory pays them. The shoe factory can only have money to pay the workers if people buy shoes. People can only buy shoes if they have money, People can only make money making shoes if the shoe factory pays them. And on and on...

It gets more complicated than this, however. Besides money being more or less valuable by what it can buy, the government can print more money that will also change the value of money. The economy is suddenly this gigantic machine that has so many variables that it is seemingly impossible to know what’s going to happen next. But it is also so interconnected that small changes can have far-reaching effects. For example, raising or lowering the rate at which the government borrows money (because, when the government sells bongs, it is really just borrowing money at its own set rate) can also change the amount of money in circulation, which therefore changes the value of money.

One point that Heilbroner and Thurow make is that corporations always run at a deficit. They constantly borrow money by selling stock to make the company grow, and the more company grows the more money they invest and the higher the price of their stock goes up (another example of the system being built on itself). This works quite well for corporations, who want to basically exist and expand forever. The book makes the point that government, which makes up a sector of the economy just like businesses, should have no problem forever borrowing money and growing.

Businesses can be debt-ridden indefinitely, because their expenditures buy equipment and buildings which have values. They are raising their capital. Likewise, government can borrow money to build bridges and roads and to fund education, all of which raises the capital of the public sector. With these thoughts in mind, the authors declare that deficit spending or a rising government debt are not in themselves problems, as long are the spending results in more capital, such as roads and educated citizens, for the nation. My initial problem with this idea (which is, granted, not based on a good knowledge of the subject) is that it seems to me that businesses can pay creditors and lower debts at any time by selling equipment and buildings. How can the government sell highways, or regain education expenditures?

Another point here that I had not realized that, with the exception of money owed to foreign countries and entities, when speaking of the country’s "debt," the debtors are the citizens themselves! When the government borrows money, it usually sells bonds to citizens, which is in effect borrowing money from the population. When we say that "if the government were to pay its debt at this moment, every man, woman, and child would owe XXX amount of money," I had not realized that the people who would be paid to clear the debt are these same men, women, and children.

Alright, it’s not the same men, women, and children, which brings up another illustration of the economy being a vast rationing system: if the government were to pay all its debts right now, it could tax all citizens (which could either be a flat tax or more or less taxes for certain parts of the population) and then pay its debts, the money going to the people who had bought the government bonds. The authors seem to be saying that, in general terms, if the government were to pay its debts at this very moment, it would simply be redistributing money among the population, based upon the method of taxation and who had bought government bonds.

This edition of Economics Explained ends with some updated information about the interaction of the economies of different countries. The authors seem to indicate that a 20's-like crash is very unlikely, given the expansion of the public sector. The book also gives some details on what the authors feel to be a potential problem, which they label the, "specter of inflation." Their point is that, for a variety of reasons, inflation is under control, but government policy is in many instances set in place as if inflation were a potential problem. This fear of inflation is actually holding the economy back. Events in the last couple of weeks appear to have held up this notion, with the stock market dropping considerably and rumors of interest rates being lowered, which had been kept high before to curb inflation.

In all, I found Economics Explained to be a good introduction to many important (I assume) economics concepts. Its conversational approach (there are very few graphs) explains ideas and gives one many things to consider, as is evident by this long review. The discussion of the market system, along with the government, functioning as a redistribution of products and wealth is particularly interesting in light of Jared Diamond’s explanation of the evolution of societies and governments and their related mechanisms and wealth redistributions in Guns, Germs, and Steel. This book doesn’t explain many economics concepts in detail, and it won't teach you to read graphs or solve equations. However, although a liberal bias of the authors is evident (and even plainly explained at points), most if not all of the information in Economics Explained is clearly labeled as fact or opinion and, most importantly, presents an overview of market systems and gives the reader a good starting point to understanding the concept at a deeper level.