What is Economics About?

What is Economics About?

August 5, 2006

Textbooks are interesting because they are a distillation of conventional wisdom. They represent “what we know,” which is, of course, “what we all agree on today.” Thus, from my point of view, textbooks are a handy encyclopedia of contemporary economic fallacy and error, which begins at the most basic level.

What is economics, anyway?

I would say: economics is the study of how people make a living.

In other words, economics is the study of how people create the things that they need and want for survival and enjoyment. Look around you. There is some sort of shelter, food, furniture, clothing, et cetera. How was this created? How did you come to acquire it? In the simplest man-on-a-deserted-island economy, the answer is: I made it myself. However, in today’s complex economy, the answer is: it was made by a multitude of humans engaging in specialization, organization and trade. The way you personally came to acquire it is, typically, that you provided some useful service to others, and received a counter of value (money), which you then traded for whatever you wanted.

Thus, economics is the study of production, in the first instance, and how this production is accomplished via specialization, organization and trade. Specialization, organization and trade are now accomplished via a monetary system, involve markets for goods and capital/asset markets, and a government framework of regulation and taxation.

This focus on production is Classical in nature, and is the reason why some people apply the term “supply-side economics” to modern Classical economics.

Now let’s see what the textbook says. From Economics: Private and Public Choice, 10th edition. James Gwartney et. al, South-Western, 2003.

“What is Economics About?

Economics is about people and the choices they make. The unit of analysis in economics is the individual. Of course, individuals group together to form collective organizations, such as corporations, labor unions, and governments. Individual choices, however, still underlie and direct these organizations. Thus, even when we study collective organizations, we will focus on the ways in which their operation is affected by the choices of individuals.”

This is pure poofery. The authors have no idea what economics is about!

They then spend several pages, as is typical, nattering on about “scarcity and choice.” We will just list the headings:

Scarcity and Choice

Scarcity and Poverty

Scarcity Necessitates Rationing

Competition Results from Scarcity

Then, under a heading “The Economic Way of Thinking” lies the “Eight Guideposts to Economic Thinking:”

The use of scarce resources is costly; trade-offs must always be made.
Individuals choose purposefullyãthey try to get the most from their limited resources
Incentives matterãchoice in influenced in a predictable way by changes in incentives
Individuals must make decisions at the margin
Although information can help us make better choices, its acquisition is costly.
Economic actions often generate secondary effects in addition to their immediate effects.
The value of a good or service is subjective.
The test of a theory is its ability to predict.

Thus, we conclude the first chapter with nary a mention of the idea that economics is the study of a process of creation, and that this process of creation involves specialization, organization and trade. Goods and services simply appear out of nowhere, to be “rationed” via a process of “choice.” Modern economics is mostly about shopping! This makes some sense, as the typical professorial mindset is diametrically opposed to the capitalist/entrepreneur. The typical professor gets a fixed salary, which magically appears in his bank account ,and goes shopping. This shopping-centered outlook is known as “demand-side economics,” and, historically, emerged in the Great Depression.

Much of 20th century economics is focused on the Great Depression, because that was the only event in which, it seemed, “professional economists” were actually needed! Before then, the economy more-or-less took care of itself, or seemed to, although that is never quite the case. The Great Depression seemed to have been caused by a sudden scarcity of shopping, or that was the common interpretation for many decades. The Great Depression is better understood as a dramatic change in the conditions of production, specifically the most dramatic changes in tariffs, taxes, regulations, and monetary conditions, which severely impaired the existing processes of specialization, organization and trade.

Of course the textbook mentions Adam Smith, an economist people like to refer to but don’t like to read. Smith became famous for a book, published in 1776, called An Inquiry Into the Nature and Causes of the Wealth of Nations. Notice that he did not title it: An Inquiry Into the Nature and Causes of the Shopping Habits of Nations, or Scarcity Necessitates Rationing. The early economists focused on production, not consumption. Adam Smith starts his book:

“Chapter I

Of the Division of Labor

The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labor.”

In the following page, Smith uses his well-known pin manufacturing example to show how the division of labor allowed vast increases in pin production per labor applied.

Needless to say, I am much more in Smith’s camp than the lost souls populating economics departments today.

John Stuart Mill published his wonderful Principles of Political Economy in 1848. In the Preliminary Remarks, the very first words of the book, Mill lays out what he intends to talk about:

“In every department of human affairs, Practice long precedes Science: systematic inquiry into the modes of action of the powers of nature, is the tardy product of a long course of efforts to use those powers for practical ends. The conception, accordingly, of Political Economy as a branch of science, is extremely modern; but the subject with which its inquiries are conversant has in all ages necessarily constituted one of the chief practical interests of mankind, and, in some, a most unduly engrossing one.

That subject is Wealth. Writers on Political Economy profess to teach, or investigate, the nature of Wealth, and the laws of its production and distribution: including, directly or remotely, the operation of all the causes by which the condition of mankind, or of any society of human beings, in respect to this universal object of human desire, is made prosperous or the reverse. Not that any treatise on Political Economy can discuss or even enumerate all these causes; but it undertakes to set forth as much as is known of the laws and principles according to which they operate.”

After these preliminary remarks, Mill starts on Book I of his opus, which is entitled “Production.” The Chapters of Book I, Production, are:

Chapter 1: Of the Requisites of Production

Chapter 2: Of Labor as an Agent of Production

Chapter 3: Of Unproductive Labor

Chapter 4: Of Capital

Chapter 5: Fundamental Propositions Regarding Capital

Chapter 6: Of Circulating and Fixed Capital

Chapter 7: On what depends the degree of Productiveness of Productive Agents

Chapter 8: Of Co-operation, or the Combination of Labor

Chapter 9: Of Production on a Large, and Production on a Small Scale

Chapter 10: Of the Law of the Increase of Labor

Chapter 11: Of the Law of the Increase of Capital

Chapter 12: Of the Law of the Increase of Production from Land

Chapter 13: Consequence of the foregoing Laws

If you can understand the difference between the Classical approach, which is production-focused (“supply-side”), and the Mercantilist approach, which is demand-focused (“demand-side”), then you are well on your way to understanding the true state-of-the-art in economics today, which you will never find in a university.

Whoops, did I say Mercantilist? Do I mean to imply that economics as taught in universities is clouded by heavily Mercantilist thinking? Do I suggest that this influence comes from the Great Depression via John Maynard Keynes? Did JM Keynes himself devote a whole chapter of his influential General Theory (Chapter 23) to describing how his ideas correspond to those of the 17th and 18th century (and 19th century) Mercantilists?

Yes!