Special Problems in the National Economy | Basic Economics by Thomas Sowell | Ch. 20

This week, in the 20th chapter of Thomas Sowell’s Basic Economics, we finish looking at the national economy by exploring special miscellaneous issues not yet touched.

If you want to see my previous summaries and thoughts on this excellent book, please click here. Otherwise, here we go!

Chapter Summary

The Scope of Government

In many general areas of society, there is an overlap in the abilities of government and economics to overlap. Things like housing, transportation, and education can be decided by either government or the market, and the need to understand the effectivity of each helps us answer which is better in each circumstance.

Political choices are binding until future elections. Furthermore, rather than taking things piecemeal, they are package deals, since politicians stand on multiple platforms. On the other hand, consumers make choices day-by-day, and change them based on their own desires. So the choice is between voting categorically (despite perhaps not agreeing with everything in that platform) and trusting that the policies will do well over time, or being able create change in the national economy little by little.

However, politics incentivize governments to create change, even when change isn’t necessary, or could destabilize the national economy. For example, in recessions and depressions, the public often pressures and expects governments to do something at scale, even if it would be in the best interest of the economy in the long term to do nothing.

This happened in the United States during the Great Depression, where government spent large amounts of tax revenues to intervene in the economy, resulting in massive and counterproductive unemployment and furthering recession. During the years of the Reagan administration, on the other hand, when the stock market crashed once again, the media noted the President’s failure to react, but also 20 year expanse of “steady growth and low inflation”.

The problem, of course, in any kind of monetary and financial policies is the complexities of a national economy, along with the lack of predictable outcomes for such policies. Theorizing what could happen economically is different from what does actually happen. It is more likely that monetary policy negatively effects business viability and employment, since a trial and error process is effective because of correction of errors.

Government Obligations

The public also often has various expectations and obligations for government. Of course, such obligations vary with different individuals and groups, and are impossible to estimate. Should the government compensate for unemployment? Should they loan money and not expect repayment in times of crisis? How should governments provide pension plans? The varied answers depending on who you ask these questions illustrate the difficulty of understanding the role of government.

But in the national economy, the difference between government and market forces can show us which is better. For example, government funded pension programs are paid for by using current tax dollars to pay for current pensions. This is simply money transference (i.e. spending money), and no real wealth builds up over time. On the other hand, private insurance companies which provide pensions and annuities invest customer premiums, and pay pensions through the overflow of those investments. This creates real wealth.

The problem of government pensions is clearly seen in the Social Security system of the United States. The flow of tax payer dollars to retirees works as long as the birthrate consistently increases. But when it declines, resulting in a retiring class larger than the working class, as in most modern nations such as the United States and western European nations, the slow roll of impending crises becomes inevitable. In fact, most people in these and other nations do not expect to receive their pensions when they retire.

Market Failure and Government Failure

As we talked about before, though both markets and government have failures successes, the way they fail and succeed are incentivized and constrained differently. We can see how this plays out when private businesses, like banks, are nationalized or controlled politically. Because politicians are not beholden to economic incentives (their pay is based on what they themselves vote for, as well as what is politically popular), the banks they take over often become less efficient, and collect more risky debt.

For example, in the United States, laws encouraged banks to give ‘subprime’ loans, which led to the disaster of the 2007-2008 mortgage crisis. Similarly, in India in the late ’60s, nationalizing banks led to loans being made only to the rich, though they were called the “deserving poor”. A great quote from Sowell here gives us some perspective:

As an entrepreneur in India put it: “Indians have learned from painful experience that the state does not work on behalf of the people. More often than not, it works on behalf of itself.”

As an aside, the history of using political means to rectify economics is very old. The market alternative, in view of history, is actually quite young, and the combination of the market and democratic societies is even newer, especially if you count the United States as the first one.

Elected officials are not incentivized by failure in their policies. If policies fail, politicians are more likely to blame other factors than themselves and their platform. Thus, if they are able to successfully pass the blame (and in many cases they do), they can stay in office never having truly learned a thing (except how to attack the opposition to stay elected).

On the other hand, the incentive of markets is to admit failure and reverse quickly. If you don’t, your business will very quickly become uncompetitive and bankrupt. And so, the two processes often produce very different results, even in similar situations (like the banking example above).

My Thoughts

I had an interesting conversation on Ruqqus the other day with a netizen who believed that aspects of socialism (centralized control of the economy) and capitalism (market control of the economy) could work together. During our conversation, it became apparent to me that a misunderstanding of the two may have caused him or her to attempt to propose such a thing.

The idea that socialism is simply just government involvement in economics is false. Socialism means centralized control over an economy, meaning that government (which is supposedly the will of the public) determines and pre-plans all or some aspects of an economy. It is not (as the fellow I had a conversation with thought) simply the government providing the market with leases on property with which to build on. Depending on how the latter is done, it could be either capitalist or socialist.

The reason why socialism doesn’t work is not because “governments are evil”, but rather because governments have no incentive to make good, long term economic decisions. I’m not even saying that government officials and politicians won’t try to make good economic decisions. After all, they will at the very least try to appear to do so, so as to make sure they stay in office. But because markets and economies are infinitely more complex than any single entity can hope to understand, any centralized authority will always be less efficient and wasteful, and thus economically deficient, in its decisions.

That, I believe, is the main argument Sowell has against government control in the national economy.

There is also the problem in misunderstanding voting. Or rather, believing that voting as a tool is only available in the political process. The truth is that the electoral process also happens in economics. It’s actually how the market works. In the modern day, we call it “voting with our dollar”.

A win by a candidate usually has lasting effects in the political process. In the United States, once a political candidate is voted into the Executive or a Legislative office, they are there for 4 years at minimum. This means that these political officials have 4 years to do whatever they want. Because most people are interested in keeping their job, the vast majority of what political officials do is prepare for their elections in 4 years. They may try to do what their platform was about (although these days it’s more of what their political party is about), but such things can take much longer than their never-ending desire to get re-elected in 4 years.

And, again, this isn’t exactly an evil thing. Instead, it’s the rational thing. If you truly believe that you (as a political candidate) have the best and most moral ideas to be executed on a public platform, you should do your hardest to make sure that you stay in that office.

The problem, of course, is that markets and economies shift far faster, and in far more unpredictable ways than politics. The idiom “politics is downstream from culture” is pretty true. And culture, as an ever-shifting entity, will also drive markets. When markets are allowed to be free, they willingly adapt extraordinarily fast to changing ideas and opinions, because there is no government or political authority forcing something to stay longer than the market desires, or preventing something from rising that the market wants. And thus, in the tides of change, markets definitively become a better mechanism for the national economy than centralized entities.

This is a very simply argument that anyone can understand. Oftentimes however, people don’t believe they have the capital to participate in the market system. And when they believe such things, they are incentivized to shift to gain political capital instead. Thus, in a rationalistic sense, politics becomes a large focus for the impoverished and working class, because it’s easy to convince them (who are the masses) that they can get their way through politics rather than participating through the market. And politicians take advantage of this fact regularly.

So what is the solution to all this? While I certainly believe technologies like blockchain and cryptocurrency will help toward this direction, we need a more basic and universally applicable understanding here. Namely, that each individual human being is powerful and able to make his or her own decisions to the betterment of their own lives.

When we truly believe and understand this simple thing, everything changes. We don’t need to be celebrities to make a difference, nor to be powerful. We are powerful in ourselves. No longer will we want to rely on politics or government for the betterment of our own lives, because we understand that our individual selves are the greatest and most reliable empowerment. No longer can we be tricked by the emotion of compassion to let politicians take care of the poor and impoverished. We ourselves will go out of our way to help the poor and needy as we see best. Will there be people that don’t help? Certainly. But that doesn’t give us the right to snatch the money from other powerful people to do what we want.

More than any crypto or other technology, this understanding can shift the world.