Wednesday, July 13, 2011

Basic Economics by Thomas Sowell

Well this took forever to read! At 634 pages, it's not a quick, light read for the faint of heart.

But it is an essential book for all Americans. Everyone needs to know the common sense principles contained in this book so that we can make sense of economic policies and not be taken advantage of by power-hungry politicians counting on our economic ignorance to keep voting for them.

First the most basic of all things: a definition. Economics - the allocation of scarce resources that have alternative uses. I wrote that from memory because Sowell repeats it so frequently. (It probably takes up about 200 of the 634 pages!) But that's because he wants this ingrained in our minds! Scarce resources, whether gold, beach-front property, oil, time, talent, money, all must be allocated one way or another and all have alternative uses.

A free-market, capitalist economy like ours uses prices to allocate these scarce resources with alternative uses. Some economies use lotteries, or personal connections, or the spoils system, but all economies allocate scarce resources one way or another. The beauty of the price system is that it is so efficient and much less bloody than other methods. It is a mechanism of instant feedback. Prices rise when a scarce resource is considered more valuable in a particular usage. For example, if I have a dairy, my milk could be bought by milk vendors or ice cream manufacturers. If the ice cream manufacturer believes he can bid up the price of my milk because he knows he can recoup the cost in his sales price for ice cream, my milk will most naturally flow to him. Consequently we will have no shortage of ice cream! Another reason to love the free market.

When the price mechanism is messed with and not allowed to work naturally, shortages and surpluses occur. This is why price controls never work. If prices are kept artificially low (as defined by the price which would have been set by the free market) we will experience shortages as people buy up and over use what appears to be cheap or free - think healthcare or gasoline in the 70's. If prices are kept artificially high, in order to prop up an industry for example, we will suffer sometimes crippling and cruel surpluses. During the Depression, food was destroyed by the ton in order to keep food prices artificially high and prop up farmers. Americans literally starved to death because they couldn't afford the food. The same thing is happening with ethanol subsidies which artificially inflate the price for ethanol and therefore the scarce resource of corn is diverted from food to fuel, resulting in mass starvation around the world. 

A most important point made by Sowell is about the role of profits and LOSSES in regulating our free market to most efficiently allocate scarce resources that have alternative uses. Business have every incentive to provide what the public wants at a price the public is willing to pay. The promise of profits keep businesses working hard to innovate and lower production costs to consistently deliver what their customers want. The threat of losses is just as important, as loses provide very powerful feedback as to what not to do - think Edsel or New Coke. Business can respond very quickly and very efficiently or risk losing it all. While they may do it out of pure greed or an altruistic heart to better provide for their fellow citizens, the result is the same: better products at cheaper costs and a higher standard of living for all.

When the profit and lose mechanism is taken out of the picture, the result is ALWAYS inefficiency and a lower standard of living - think DMV. This is not because those involved in organizations like government bureaucracies are always incompetent and inefficient, it's simply that there is no other result possible. They have no feedback to tell them if what they are doing is working or not. Even if an agency begins with the best possible intentions and product, like the East German car, Tabrant, which was cutting edge when first entering production, but remained the EXACT SAME CAR for 30 years, they will very quickly become inefficient and wasteful simply from a lack of feedback provided by a free market. Ask yourself, would you be excited to buy a 1981 Ford today? They had no reason whatsoever to modernize and update the only car in existence in a government-run economy.

Sowell shines when he takes on economic fallacies and myths. A particular enlightening passage destroys the myth of "trickle-down economics." He states this has never been an economic theory and never will be. Money does not "trickle-down" in a business. It trickles-up. The owner and investors are the last to get paid, not the first. He uses Amazon as an example. Amazon went several years without making a profit at all. But their investors were willing to wait many years for a payout while continuing to pay employees, vendors, and other costs associated with the business. The little guy was paid first! The big guy was paid last, and many never get the payout if they run out of capital before they have a chance to make a profit. Yet you will never hear this told in the media. It's always "Tax cuts for the rich in the hopes of trickle down prosperity."

He also discusses the fallacy of greed controlling the markets. The simple fact is that everyone is greedy. That's human nature. Would you willingly give up 20 - 30% of your salary because you personally are not greedy? Of course not. You are not paid according to your greed or according to your employers stinginess. You are paid because that's what you are worth. Of course, every business would love to pay their employees nothing and charge millions for their products. But they cannot. Why? The beauty of the self-regulating free market. No one would work for free and no one would pay millions for a toothbrush. So the ostensibly greedy business man MUST pay his workers to make toothbrushes and charge only a few dollars each so people will buy them. Too bad for him.

This leads to a discussion of the job-killing minimum wage. It's a simple fact that an employer CANNOT pay you more than you are worth. If the minimum wage is $7.25/hour and you do not produce more than $7.25/hour benefit to your employer, you are unemployable. Read that again. The minimum was has had the effect of making certain members of our society, fit, able-bodied, reasonably smart, people unemployable. This is a crime! It is particularly hard on minority youths, who through no fault of their own, do not yet have the skills to provide economic benefits to an employer. With a high level of entry pay, they may never be able to obtain the skills to make them employable.

Read this book. If you cannot stomach 634 pages, read the "Overviews" at end of every chapter. They provide an excellent summary. The book will change your life and expose you to how stupid politicians think you are.

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