We have now arrived at Part V of Thomas Sowell's Basic Economics, where we will be talking in depth about “the national economy”, which is really simply applying economic principles on a larger scale rather than specific markets. In this chapter, we look at the problem of national output.

If you want to look at my previous summaries of this book, click here. Otherwise, let's get into chapter 15!

Chapter Summary

When we look at the national economy, many of the same principles of economics, such as supply and demand, can be applied. However, because we are looking at a greater whole, these applications may take more time before the results reveal reality. This is because we are dealing with a lot of different cogs in the economic machine, which are each affected by others. Thus, when we look at the national economy, we need to understand the fallacy of composition.

The Fallacy of Composition

The fallacy of composition is mistakenly assuming that what applies to something small always automatically applies to the whole. For example, in the 1990s, there was a reported loss of jobs in specific American firms and industries. However, at the same time, there was a record low amount of unemployment, and the overall number of jobs rose around the nation.

The fallacy of composition is wrong because it ignores interactions within an ecosystem. On a more negative side, we can see that when a government entity attempts to save an industry by pumping money in, it may not actually be doing good, since perhaps more jobs would be lost elsewhere in the economy. The fallacy in this example is believing that saving any jobs in one sector means saving more jobs overall.

Output and Demand

To understand a national economy, we need to understand the sum of its total output, the role of money in the economy, and how the government factors into it.

There is sometimes this idea that a national economy can produce more than people will buy. During the Great Depression in the 1930's, many prominent people (including the then President, Franklin D. Roosevelt) espoused this idea. Today, with the national output many times that amount in the 1930's, there isn't the same fear as there was during the early 20th century. Why is this?

The national output is practically the same as real income, since national output is the goods and services that money can buy. Thus, it's impossible to produce more than sold by definition. Of course, the question then becomes, what if people (for whatever reason) don't spend money to purchase real goods and services? Such a situation can certainly turn an economy for the worse, as people no longer spend or invest at full capacity. But the effect is that production and employment will slowly cope with this lack of spending. Thus, output and real income are the same.

Measuring National Output

A country's total wealth is different from the national output, since total wealth includes past accumulation, while output is simply what is current. The most typical way to measure output is Gross Domestic Product, or GDP, which is the total of everything produced inside of a nation. GNP, or Gross National Product, on the other hand, is the total of goods and services produced by a nation's people (even if they aren't inside the country). These two measure aren't typically very different from one another.

The reason it's important to understand wealth versus national output is that a country can go beyond its national output by using its wealth accumulated from the past. This happened in the United States during World War 2, when production for things like cars and refrigerators was halted to produce tanks and other military paraphernalia. Then, after the war, there was an uptick in return to producing civilian needs. This set a massive rate of growth in the economy, thus helped by past accumulated wealth.

In order to measure national wealth, serious studies are long-term and take into account changes in prices over time. It's not just about money and paper assets, but real goods and services that have real costs, depending on many circumstances.

The Changing Composition of Output

Of course, prices are just one of the things that change about goods and services over time. In reality, everything changes, including the very existence of products. This makes it difficult to measure national output, since not all changes are comparable. How do you compare GDP of a nation from the year 2000 to 1900 when that same nation probably sold completely different things during those two years?

Thus, a lot of political claims become moot. It's often in the news that the real wages of Americans have been on the decline. But oftentimes, higher prices reflect an increase in quality. This makes the consumer price index bias upward, which makes wages bias downward, thus not really reflecting a decline in wages, but rather in product quality. In reality, while declining real wages is advertised, the average consumption for Americans and net worth actually doubled. And this doesn't even factor in the real effects of inflation.

International Comparisons

A similar problem happens when comparing nations. As Sowell says,

This is not just comparing apples and oranges, it may be comparing cars and sugar.

This is, of course, a literal problem, as different countries have vastly different outputs. But there's other differences as well. For example, it may be that the very people within these nations are statistically different. For example, the median ages in countries such as Nigeria and Tanzania are below twenty, while the same for Japan and Italy are over forty. Or geographically, countries have a difference in climate, with some in tropical climates not needing to run up as much heating bills as those who are not.

There's also the problem of countries having different denominated currencies with which they measure their output. For example, statistical based on official exchange rates of the dollar and the Japanese yen have shown that Japan has a higher per capita income than the United States. But in reality, “the average American's annual income could buy everything the average Japanese annual income buys and still have thousands of dollars left over”. And this doesn't even touch the problem that some countries are more market-based, while others rely on government-provided goods and services.

All these problems show that, while GDP and GNP are our best measures of an economy, they are not meant to be exact or precise in what they say about a certain country. For example, in 2009, the GDP of China was second in the world (behind the United States), but if we were to measure per capita, it would fall incredibly far behind, since it had the world's largest population at that point. In fact, none of the top 5 GDP countries would still be there if measured per capita. But no one would say Bermuda, which has a higher per capita GDP than the United States, has a higher standard of living than the US.

Statistical Trends

Much of current news, no matter which side of the aisle you're on, uses statistical trends to back up their claims. The problem, of course, is in the choosing of which start date or time span to begin from. And thus, how great or horrible a current administration is doing depends often on which year is selected to look at. This doesn't only apply to GDP measures, but crime rates, income inequality, and even things like the S&P 500 rates of return.

In some countries, especially Third World ones, a lot of economic activity is not recorded as part of the national output. Things like cooking food for a family, cleaning a home, and raising children are all uncounted. In more modern societies, where women tend to be in the workforce more, some of this is taken up by daycare centers or home cleaning services. While one can say that the modern societies are better at economically counting such things, it still doesn't account for those countries in which many of these 'jobs' are economically invisible.

It's even possible that some of the poorer countries may be statistically stagnant, but in reality be beginning to prosper. For example, generally, when a Third World country begins to rise economically, its child mortality rate generally decreases. This often means that the impoverished of that country are beginning to survive more, but it also means that the number of poor people in such a country is increasing, thereby averaging the country's real income lower.

Such is the problem of statistics.

My Thoughts

This chapter was a fascinating look at why the statistics often quoted to us or used to push us in a certain direction politically are regularly either wrong or strongly biased. In fact, an appropriate “tl;dr” for this chapter would probably be: statistical analyses must always be taken with a grain of salt. And of course, that statistical analyses are only part of the picture of what's going on.

I think it's appropriate that Sowell has such a disdain for the idea of being able to see economies on a macro scale. After all, the majority of the book so far looks at economics as millions of cogs in an organism rather than a uniform machine. It goes well with the understanding that socialist or authoritarian governments, which seek to control economies from the top down, because they are unable to see the little cogs necessary to make an economy work, will ultimately fail.

In fact, this understanding of how unable GDP and GNP and other measures are in understanding an economy gives us a firm grasp on why such socialist governments don't work. If even the numbers can't give us an accurate representation of what's going on, how on earth can any human government or entity?

If anything, this book is one of the greatest arguments there is against any form of top-down government. And along with a few others that I have read and reviewed so far, it gives us a pretty good glimpse at the necessity of decentralization as humanity grows into the future.