A Treatise on Economics and Market-Based Economy - Term Paper Example

19 April A Treatise on Economics How “fair” is a market-based economy? A market-based economy is largely self-regulating. This type of economy leverages human behavior. In his book, Naked Economics: Undressing the Dismal Science, Charles Wheelan states that “when the cost of something falls, it becomes more attractive to us” (10). The converse is also true. The price of a product settles where the supply meets the demand (15). If an item falls out of demand, businesses will no longer produce it. Wheelan indicates that “the market rewards scarcity” and “does not provide goods that we need; it provides goods that we want to buy” (18). While not perfect, a market-based ecomony operates on familiar rules because those rules mimic the choices people are likely to make. In Wheelan’s words, “a market economy is to economics what democracy is to government: a decent, if flawed, choice among many bad alternatives” (21). Do market incentives always lead us in the right direction? Market incentives are subject to interpretation and application by individuals, groups, and other entities. Incentives exist to encourage desired behavior, and can be successful to the extent that incented people embrace the incentives. Wheelen asserts that “when we are paid on commission, we work harder; if the price of gasoline goes up, we drive less” (26). People’s responses to incentives allow the market to adjust. If an economy is not reliant on the market, government does not reward good or poor work practices and behaviors; the result is often inefficiency, poor quality, and high cost (27). Alternatively, incentives can present problems. One of these is the “principal-agent problem” that presents itself when a business, the principal, hires an employee, the agent, who may be incented not to act in the best interest of the company (31). In these cases, the agent may see personal gain as a greater incentive than the incentives provided by the company and steal or take advantage of the work situation in other ways. The success of incentives in a market-based economy is subject to the decisions of the people who respond to them. Incentives may not always lead us in the right direction. Can government help to guide our incentives? Government can help guide our incentives, but too much of this guidance could spell disaster. Wheelan states that “the communist governments of the twentieth century controlled their economies by controlling their citizen’s lives” and “often wrecked both in the process” (21). Other ways the government could guide incentives include taxes and regulations. Incentives tied to taxation add complexity to “public policy” in an effort to transfer wealth to the poor (38). Businesses and individuals respond by “avoiding or reducing the activity that is taxed” (38). The result is often that the economy does not realize the anticipated boost to the expected extent, if at all. Regulations, on the other hand, may be unavoidable. Wheelan suggests that “good government makes a market economy possible” (51). One role the government plays is to “define and protect property rights” so that individuals and businesses can develop and produce unique products without fear of those products being stolen or misused (52-4). The government can also support business and individuals by “providing uniform rules and regulations, such as contract law; by rooting out fraud; by circulating a sound currency” (54-5). While government involvement in economics may not be popular, if present at an acceptable level, the government can provide a framework in which a market economy can thrive. In Wheelan’s words, “government is like a surgeon’s scalpel: It is an intrusive tool that can be used for good or for ill” (80). What is “human capital” and how does it relate to a country’s economic well-being? Wheelan defines “human capital” as “the sum total of skills embodied within an individual: education, intelligence, charisma, creativity, work experience, entrepreneurial vigor, even the ability to throw a baseball fast” (99). Possessions and finances do not define human capital; it is the worth of a person when he or she has nothing but intrinsic human value and the talents and skills he or she was born with or obtained through education or experience. Society can enhance and expand human capital through education and opportunity. Investments in this area can have exponential impact on the society that participates by increasing productivity through application of improvements and innovation (107). Production and productivity correlate directly to the economy. Consequently, human capital and a country’s economic well-being are co-dependent. How do financial markets support economic growth? Financial markets support economic growth in a number of ways. In example, financial markets are a means by which one can raise capital (120). Businesses, individuals, and governments buy and sell shares of companies through financial markets. This practice, along with credit extended through the financial markets, allows business growth and expansion to occur that would not otherwise be possible. Additionally, financial markets provide a way to store, protect, and make profitable use of excess capital (121). “Individuals, companies, and institutions” deposit excess funds into the financial markets, essentially so “others who can make more productive use” of the funds can rent them (121). Wheelan states that, “the financial markets do for capital what other markets do for everything else: allocate it in a highly productive, albeit imperfect, way” (126). What are the “tools” for measuring the performance of the economy? One can use several tools to measure economic performance. The primary tool is the gross domestic product, or GDP. Wheelan defines the GDP as “the value of all the goods and services produced in an economy” (150). To provide an accurate comparison between countries, one should calculate the GDP “per capita”, or divided by the nation’s population (151). Other measures of economic performance include unemployment, poverty, income inequality, the size of the government, budget deficits and surpluses, current account surpluses or deficits, national savings, and demographics (160-165). All of these tools provide a glimpse into the economic health of a nation on an individual basis, but the best assessments should include a blending of many, if not all of them, to understand a nation’s economic state. How does the Federal Reserve support economic stability? One way the Federal Reserve supports economic stability is by using “monetary policy to counteract economic downturns (or prevent them in the first place)” (168). Additionally, the Federal Reserve can loosen or tighten the monetary supply, and raise interest rates to discourage spending (169). According to Wheelan, “the Federal Reserve must strike a delicate balance” to allow the country to grow at a sustainable pace, without crippling its growth capability (171). Though the techniques to achieve this appear very simple, the Federal Reserve maintains economic balance through constant monitoring and adjustment. Wheelan asserts that “a paper currency has value only because it is scarce” and the link between the Federal Reserve and economic growth is the control it exercises over the scarcity of the nation’s currency (179). Overcorrection is always a concern, because economic conditions like inflation are unpredictable, forcing people and businesses to “guess about future prices when they make economic decisions (181). Does our economy benefit from international trade? Our economy benefits from international trade in a number of ways. International trade creates wealth by allowing countries to specialize in areas where they are able to achieve high production and trade those products with countries that excel in other areas (190). International trade is mutually beneficial; one need not assume that “if trade is mostly good for America, then it must be mostly bad for somewhere else” (196). International trade provides opportunities for growth by opening markets that allow poor countries to export goods (196). For countries that engage in international trade, this is a win-win situation. Another way our economy benefits from international trade is by lowering “the cost of goods for consumers, which is the same as raising their incomes” because salaries stretch further and people “can afford to buy more” (195). International trade is “based on voluntary exchange”, and gives people more options of where and how to spend their money (199). Additionally, it opens up more voluntary options for the workers in poor nations. These workers can choose to work in what developed countries would consider harsh conditions for little pay. However, when asked how they feel about the jobs, they share that the pay is generous and the conditions are as good as or better than other available options (201). The cheap labor available in developing countries allows companies to manufacture products less expensively and to pass that savings along to the consumers. The positions offered to residents of these low-income countries are voluntary and no one forces the workers to stay in them. Furthermore, the extra income, a wage often “twice the average domestic manufacturing wage”, boosts the local economy and benefits the country as well (201). What are some reasons for why poorer nations are poor? Wheelan asserts that poorer nations are poor because “their economies have failed them” (207). Through a variety of contributing factors, poor nations lack the organization to take inputs like raw materials and human capital, and use them to produce something of value that others will want to purchase (207). Despite the potential that is inherent in all people, without a supportive infrastructure to encourage production and growth, the poor nations do not equip their people for success and they will not realize the potential of which they are capable. The infrastructure starts with “effective government institutions (208). As noted earlier in the paper, the laws, rules, and regulations that comprise a good government, if well managed, can support economic growth (51). A study conducted on the current state of former colonies indicated that “as much as three-quarters of the difference in their current wealth can be explained by differences in the quality of their government institutions” (209). Though government institutions can present frustration for citizens in developed countries, a lack of government institutions can spell economic disaster. Conversely, an overabundance, or excessive regulation is also problematic (210). Wheelan suggests that “excessive regulation goes hand in glove with corruption” (211). In these situations, businesses and individuals must resort to bribery to accomplish simple tasks, and the cost of doing business can sky-rocket. Governments are also responsible for fiscal and monetary policy; they need to maintain a reasonable budget to protect the interests of their nations (216). Poorer countries may engage in heavy borrowing that could lead to higher taxation on the people, inflation, and default on the loans that funded their deficit spending (216). Loans to countries often rely on the confidence of foreign investors; if those investors lose confidence they may decide to cease funding and leave the country in peril of default (217). Another factor that contributes to poorer nations being poor is a deficit of human capital (212). The investments in improving human capital in these countries are minimal, and the educational infrastructure to support programs that enhance skills and knowledge is weak or non-existent. Wheelan asserts that “we have strong reasons to believe that education causes growth, not the other way around” (212). However, raising human capital is not as easy as starting to train people because “skilled workers usually need other skilled workers in order to succeed” (212). Skill often equates to specialization and completion of complex tasks can require teams of people skilled in different areas. Consequently, skilled workers in undeveloped nations have limited opportunities to practice their skills and there is little incentive to make an investment in human capital (213). Other factors contributing to poorer nations being poor are an unfavorable geography, a lack of openness to trade, poor exchange rates, overvalued currencies, and a type of government that does not support economic growth, specifically one that is not democratic (213-224). While the future for these countries seems bleak, Wheelan suggests that “much of the world is poor because the rich countries have not tried very hard to make it otherwise” (227). His assertion that developed nations should play a greater role in influencing the economic health of poor nations is compelling and bears consideration. Can our economic growth be sustained? One idea Wheelan discusses suggests that the economic growth in America is sustainable, but there are trade-offs. He projects that “if productivity grows at 1 percent over the next half century, our standard of living will be some 60 percent higher by 2050” (230). Americans can continue to work at the same pace and produce more, work less and produce the same amount, or strike some other agreeable balance (230). These options support the theory of the “backward-bending labor supply curve” which suggests that at some point, time will become more important than money and Americans will decide to work less (230). However, to sustain an affluent society, America may need to become more compassionate. As the growth continues, the dichotomy between the wealthy and impoverished of the country may become broader than it is today. Wheelan compares the American system to the European system and notes that “the American system is a richer, more dynamic, more entrepreneurial economy—and harsher and more unequal. It is conducive to creating a big pie in which the winners get huge slices” (231). In the end, people have to make decisions on how to live, what to purchase, and to determine the policies and tenets that will govern their lives. If the framework for success is present, people are likely to succeed. In Naked Economics, Charles Wheelan presents compelling information, data, and facts to suggest that the governmental, financial, and educational systems in place in America today are stable and flexible enough to sustain economic growth into the future. Works Cited Wheelan, C. J. Naked economics, undressing the dismal science. W. W. Norton & Company, 2002. Print. Read More