Understanding economics needs a solid base


Emile Woolf, Going Postal
Image by klimkin from Pixabay

Economics is a set of principles that explain how our various needs and wants may be satisfied. The Greek origin of the word “economics” can be roughly, but aptly, translated as “good housekeeping”, and any reliable household accounts will record the expenses incurred on satisfying those needs and wants, as well as the income that provides the means of doing so.

Skill in domestic economics therefore lies in judicious balancing of the two sides of this biblical equation: savings in one period must be available to meet shortages in another.

When this homespun understanding of good housekeeping is elevated to its counterpart at the level of the community and, inevitably, the nation, the simplicity of its truth, although still present, can easily become engulfed in the political morass and lose its clarity and objectivity – and hence its reliability as a record of economic activity.

Notwithstanding this danger, certain fundamentals stand out beyond any political argument. For example, one of the most basic observations in economics is that, as individuals, none of us is completely self-sufficient: we can’t, and don’t, do absolutely everything for ourselves. Yet, on the reasonable assumption that we are of sound body and mind, we must pay for what others do for us – which means that we must work.

So what work should we do?

[As it happens, I personally fell into that category of teenager whose vocation, or future career path, was never obvious to my teachers, my parents or, still less, to me. So, in despair, my parents sent me to an industrial psychologist for “aptitude testing”. Unfortunately, his report left my parents none the wiser: no particular aptitude or avenue of work stood out. Although I was academically “above average”, I was classified as an all-rounder with no easily discernible direction. The only positive recommendation was a negative: “Keep him away from architecture; any structure he designs is likely to collapse in record time!]

Fortunately, my case was the exception. Most people, either due to innate aptitude, predilection or circumstance, are able, not necessarily at first, to optimize the fruits of their labour by working within their range of talents and thereby produce decent goods or provide worthwhile services.

Ricardo’s comparative advantage

Furthermore, their commercial success implies that they must have competed successfully against rival products in terms of quality or price, or both. This principle, initially formulated by 18th Century economist David Ricardo, tells us that “comparative advantage” is what you do best, while giving up the least. It is a principle that operates at all levels, from individual abilities to communal and national attributes, distinguishing economies suited to agrarian, industrial and commercial proclivities respectively.

At the individual level, you may be a great electrician and also an excellent dog-walker. But, commercially, your comparative advantage is your electrical skill because that is the area in which you will make most money. You can hire an hour of dog-walking services for less than you will make from doing an hour of electrical repairs for a customer. Another way of putting this is that your opportunity cost of dog-walking is high – every hour you spend doing it is an hour’s worth of lost revenue from undertaking electric repairs.

Division of labour follows naturally

This is the principle on which the whole of society functions. We can therefore observe that it is also the principle that gives rise to division of labour: any particular industry will attract employees who are most competent to serve its needs. Conversely, in the absence of gulag-style coercion, people with particular qualifications and skills will quite naturally gravitate towards industries and businesses that require those skills.

Another way of understanding these principles is to see them as the cause of trade: since we are not self-sufficient, we must rely on others to provide what we otherwise would lack. But for that service, or for those goods, we must be able and willing to pay compensation.

The cause of trade and the law of markets

Hence we arrive at the law expressed by the 18th/19th Century French economist Jean-Baptiste Say (a law that, understandably, is often referred to as “the law of markets”). It declares that we produce in order to consume, or production must precede consumption. Until we produce, we lack the wherewithal to pay for the satisfaction of our needs and wants. (So far, so obvious – despite which JM Keynes attempted to turn it on its head with his algebraic “proof” that the best way to revive a sluggish economy is to stimulate what he called “aggregate demand”.)

J-B Say, a keen follower of Adam Smith, was an economist and businessman whose liberal writings identified the virtues of entrepreneurship, free trade, competition and the removal of any impediment to the natural process of business. If only 20th Century economists had adopted his, rather than Keynes’, lead!

Keynes and government interventionism

Unfortunately, Keynes’ notion that demand needs to be stimulated to keep the economy going served as an “open sesame” for government intervention. You and I know that “demand” is an innate feature of the human condition. It is visible from the infant’s first intake of mother’s milk; with age its demands will change but, because we are not self-sufficient, they are ever-present. (What a shame no one pointed out “demand requires satisfaction, not stimulation, you idiot!”)

But Keynes saw demand stimulation as the central role of all agencies of government, from Treasury to Central Bank and, with that, all the machinations of a “managed economy”. Keynes provided the proverbial answer to a maiden’s prayer; how they lapped it up, and are still doing so.

You and I know that few politicians understand how the world might actually work if they resisted the urge to “do something about improving it”. Whichever brilliant ideas they dream up, the odds are they will make matters slightly worse. That’s why you can see Keynes’ fateful influence in every instance of demand stimulation over almost 80 years, from successive waves of money-printing, to paying workers not to work, to suppressing interest rates – indeed, doing anything to destroy savings, which Keynes saw as the very antithesis of demand stimulation. His preference was to spend, spend, and spend. [Absolutely nuts? Quite.]

The purpose of trade

Reverting, finally, to a sane principle: the purpose of trade is to benefit consumers – not producers. In defiance of this incontrovertible truism we find perfect examples of twisted governmental thinking. In a centrally “planned” Keynesian economy we experience the horrors of highly regulated protectionism in which specially favoured industrial sectors are shielded from the operation of natural law, causing distortions in price, production, land use, supply chains, and many others – all to the detriment of fellow citizens.

To sum up

In this article I have attempted to show that economics need not appear to be an arcane branch of social mysticism. It is rather a collection of unarguable and mutually supportive principles that, although simple, are sometimes subtle and by no means obvious. Principles identified in this essay, such as comparative advantage, division of labour, Say’s law of markets, and the benefits of free trade (barely touched on), must be properly understood before we embark on my next foray into idiocy masquerading as wisdom.

© Emile Woolf October 2019 (website)

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