Applied Economics

Recommendation
This excellent, short, clear book should be part of everyones reference library,
particularly those who wish to understand standard conservative economic thought.
The distinctions author Thomas Sowell draws between political and economic logic
should become a valuable part of each voters mental apparatus. Writing to educate
the general reader, not to further instruct the sophisticated economist, the author
advocates minimal government interference. He calls for as little regulation as
possible, mainly because regulations have unintended and usually undesirable
economic consequences when seen with a long-range perspective. Sowells concise,
easy-to-read style cuts through the jargon of most economic discussions to lay bare the
underlying, plain heartwood. It is easy to quibble here and there. Sowell doesnt offer
lots of statistics and back-up material. And, he seems to argue against individual
economic decision making when he tilts a drug pricing discussion into a sermon
against Americans buying medicine at low Canadian prices.
However, getAbstract.com finds that his book stands on its merits nonetheless, as
long as you understand that the author has a political - as well as an economic - point
of view.

In this summary, you will learn

How to distinguish economic issues from political issues; and
How to think through economic issues logically.

Take-Aways
Economic thinking is long term and logical. Political thinking is short term and
emotional.
To understand the effect of policies, think through all of the consequences.
Economic consequences may take years to happen but it is usually possible to predict
them.
Free individuals making their own decisions and allowing prices to determine and
reflect supply and demand will collectively build the most efficient, just and
reasonable economic systems.
The price system is extremely effective at allocating scarce resources.
Regulatory distortions of the price system usually have undesirable, unintended
consequences.
Rent control laws lead to housing shortages and more expensive rents.
Drug price restrictions lead to less research and the discovery of fewer new drugs.
Minimum wage laws result in fewer jobs and more unemployment.
It is folly to establish economic rights - socialism means shared poverty.
Economic Thinking about Real World Issues

Knowing about economics is one thing, but applying economic thinking to real-world
issues is something else again. Many people know the basic facts of economic life - for
example, that when supply is low and demand is great, prices rise, and that when
prices rise to a certain level, more supply enters the market and prices fall. Its clear to
most people that there is a wage for which they wont work, a wage at which they will
work, a wage at which it makes sense for them to hire help and a wage at which it
doesnt make sense. But even though people may know that refusing to let prices rise
will prevent new supply from coming into the market, and that keeping wages
artificially high will result in fewer people getting hired, they often advocate policies
that make little or no sense in the face of economic reality.

Families, gangs, feudal warlords, insurance companies, partnerships, commodity

speculators, and issuers of stocks and bonds are all in the business of reducing and
transferring risk.
Well, perhaps its not quite fair to say that these policies make no sense. They do make
some sense, but only for a few people over the short term. For most people, they make
no sense over the long term. For example, you may not be willing to make the sacrifices
necessary to pay a doctor with your own money. But you may very well vote for state
subsidized medical care that will pay your medical bills with someone elses money. If
you have to pay a doctor out of pocket, you may try to stay in good physical shape and
avoid going to the clinic except in an emergency. But if someone else is paying the bill,
you might take life a little easier, think less about exercise and diet, and go to the doctor
whenever you feel a twinge. The predictable result of subsidized medical care is that
more people use more medical care and, perhaps, more people keep themselves in a
poorer state of health because they have no economic incentive to stay healthy. Thus,
what looks good for you in stage one - the state paying your medical bills - becomes
bad for you down the line.

Political thinking tends to conceive of policies, institutions or programs in terms of

their hoped-for results - drug prevention programs, profit-making enterprise,
public-interest law firms, gun control laws, and so forth.
The reason that people - not only politicians but also the public - advocate nonsensical
policies is simple. Economic logic and political logic have two different frames of
reference. Political logic operates in the realm of things people wish were true or hope
will be true. Thus, political logic looks at a program to lower the cost and risk of drug
use as a desirable step toward easing the drug problem. Economic logic, by contrast,
looks at the real facts of life. Thus, a program lowering the risk of drug use, in effect,
makes drug use more economically desirable and will probably result in more, not
fewer, drug addicts. Politics is about emotion and to some extent about fantasy.
Economics is about the cold, hard facts of life. Thats why they call it the dismal
science.

For purposes of economic analysis, what matters is not what goals are being sought
but what incentives and constraints are being created in pursuit of those goals.
Economics does not ask what you hope will happen. It asks what will actually happen.
And what will happen next, and next. Economics understands that every political
decision has consequences. Every policy establishes some set of incentives and
disincentives. People will respond positively to the incentives and negatively to the
disincentives. A policy to control the price of drugs will result in fewer new drugs -
companies will invest less in researching new drugs because their return on
investment is lower than it might be in a free market.

As markets replaced politically managed economic decision-making, China

experienced one of the highest economic growth rates in the world.
Why do politicians advocate policies that will undermine their constituents in the long
run? The answer is simple. Economic consequences take years to work through the
system. Suppose a state decides to raise education funds by taxing corporations. Most
companies do not leave and the state raises more money. Thats stage one. Within a
year or two, businesses at the edge of profitability go bust because they cant afford
their taxes. As taxes go up, more firms fail. Thats stage two. Meanwhile, as other
businesses consider alternatives to operating in a high-tax region, some move away.
Other businesses that might have come to the state decide not to, because of high taxes.
Thats stage three. At that point, the state suffers an employment problem and a
revenue shortfall because too few companies are hiring. By now, the politicians who
voted on the first tax increase are long gone. With the state facing an employment and
budgetary problem, what do their successors propose? Experience shows that in such
circumstances, politicians often propose a tax increase to balance the budget.

The advantages of a free labor market benefit not only the worker but also the
economy.

Solutions That Hurt

Politicians often offer solutions that make economic problems worse. In India and
other developing countries, politicians have offered subsidized grain and other
relatively costly services and goods to gain votes. The result almost invariably is a fiscal
crisis, unemployment and consequent economic difficulties for the entire population.

Given the low educational levels of many who become career criminals, crime may
well be their best-paying option.
The problem isnt limited to developing countries. In the early years of the new
millennium, Californias politicians decided that electric bills were getting too high and
decided to solve the problem by regulating electricity prices. In fact, prices were getting
high, but for sound economic reasons. Reduced rainfall meant less water flowed
through the hydropower plants and, consequently, less power came out - but the cost
of operating the plant remained the same. Hydrocarbon prices were also rising, which
meant it cost more to generate power in coal and oil-fueled power plants. Californias
politicians trolled for votes by regulating the prices that electric utilities could charge
for power, but did nothing to ease cost pressures on the utilities. As a result, utilities
paid 15 cents a kilowatt-hour for electricity they could only sell for a maximum of seven
cents a kilowatt-hour. Within a relatively short period of time, California experienced
blackouts, bankrupt public utilities and a power shortage. The state stepped in to buy
electricity from the power generators because the public utilities had such bad credit
ratings that the generators would not sell to them. Californians ended up paying much
more for electricity than they would have if politicians had not meddled with the price
mechanism. They paid on their utility bills, on their tax bills and in the form of lost
economic opportunity because of the businesses that relocated or failed because
Californias electric grid became so unreliable.

A given individuals value as a free worker was likely to be greater than that same
persons value as a slave, because of the constraints inherent in keeping someone in
bondage.

Some Burning Issues

That is, roughly speaking, how economic logic works. It goes well beyond stage one -
the stage at which politicians congratulate each other about a new piece of legislation
that fixes an alleged problem. Politicians are usually wrong about the existence and
severity of a problem. In a free market system, people can make up their own minds
about whether or not a problem exists, and they can pay for the solution that makes
the most sense to them, given the price of the solution and the severity of the problem.
Maybe the solution to Californias energy crisis was to leave the price system alone.
Eventually prices might have risen to a point at which Californians would have adopted
conservation measures. Maybe someone would have built a new power plant or two.
Maybe voters would have considered new energy sources - even nuclear power - in
economic rather than emotional terms. But economic logic never had a chance to work.
The political distortion of the price system turned a relatively minor inconvenience,
rising electricity prices, into a statewide disaster. This sort of thing happens over and
over. By thinking in relentlessly economic terms, you can foretell the future of almost
any policy. The following sections offer a few examples.

Paying less and getting less - whether less is defined quantitatively or qualitatively
- is no bargain, least of all in the case of medical care.

Free Labor

Aside from the moral issues, slavery sounds like a good deal for slave-owners. Own a
slave and get free labor. So why is it that the regions where slavery was most
widespread are even now relatively poor compared to regions where slavery was scarce
in recent history? Under slavery, people are not free to choose the jobs they can fill
best or to demand the wages the market will pay. As a result, human capital remains
undeveloped. Slave owners have little or no incentive to engage in more productive or
efficient forms of economic enterprise, because their economic eyes dazzle at the
mirage of free labor. Slavery is a very inefficient foundation for an economic system,
and most slave-owning regimes were self-destructive.

As far as the practical effect on patients is concerned, advertising is as much of an

ingredient in the drugs benefits as any of the pharmaceutical components
themselves.
The free movement of labor benefits workers and, thus, benefits the whole economy.
Nowadays, slavery is dead, except in a few backward regions. But labor is no longer
free to move. Minimum wage laws require employers to pay every worker a certain
amount. The flip side of the minimum wage law is that it prohibits unskilled workers
from taking sub-minimum wage jobs even if they might get valuable training. Some of
the greatest fortunes in the U.S. were earned by people who started working for
pennies or even for free, including Andrew Carnegie, Henry Ford and F.W. Woolworth.
If minimum wage laws had been in force when these entrepreneurs began their
careers, they might never have gotten a start.

Although rent control is often thought of as a way to protect the poor from
unaffordable housing, only the poor who initially occupied the rent-controlled
housing benefit.

Socialized Medicine

Does everyone have a "right" to good medical care? Think past stage one before you
answer. Worldwide, governments have established such a "right" by subsidizing
medical care. The result is predictable. Price controls or subsidies on medical care
mean that people demand more of it, because the price is artificially low. Because
theres not much money in providing care, less supply enters the market. High demand
and low supply means that somehow or other the price has to rise - and it does, several
ways. Because providers have many patients and patients have no alternatives, quality
falls and health care consumers get less for their money. Often a parallel health
services market develops in countries with nationalized health care. In such systems,
consumers may choose to patronize doctors outside the system and pay out of their
own pockets. In other cases, consumers may pay quite a bit extra to get a truly
competent, qualified doctor to provide high quality care within the system. The pricing
of medical care can be distorted many ways. In the U.S., one of the most egregious is
the tort system. Juries award hefty malpractice verdicts to plaintiffs, often based on
very unsound logic. The result is to increase the cost of medical care. In some
jurisdictions, the cost has risen so high that providers have withdrawn, leading to news
reports of pregnant women who are unable to find local obstetricians.

More pedestrians and motorists are likely to suffer injuries or death because more
high-risk drivers can afford to be on the roads and highways than could do so if auto
insurance rates were allowed to rise to the very high rates required to compensate
for the damage done by reckless drivers.

Housing

Politicians have distorted the housing market many ways, almost always with
deleterious results. One early effort was slum clearance in big cities. Appalled to see so
many Jewish and Italian immigrants crowded into slums, reformers demanded that
the slums be cleared. As a result, immigrants had to pay more for housing and could
not afford to send money back to their kin or to help relatives escape famine, disease
and persecution and come to America.

The reformers may have made their cities more attractive, but they did no favors for
the immigrants and their relatives. More recent political initiatives in housing,
especially in big cities, have included rent control. Rent control limits what landlords
can charge. Thus, it artificially lowers the price of apartments, with predictable results,
including housing shortages, homelessness and exorbitant rents once the landlords
find loopholes or ways around the regulations. Of course, such loopholes and work-
arounds always exist. Other such political meddling includes land use restrictions.
Limiting the height of apartment buildings means fewer units of housing can occupy a
given amount of land, resulting in relatively higher prices for the units that get built.
Zoning restrictions that prevent housing construction have a similar result.

Risks and Benefits

One often hears charges of discrimination leveled against financial institutions that
refuse to lend in certain areas or stores that charge higher prices in particular
neighborhoods. Almost always, the decision is not a consequence of racial
discrimination, but a rational economic response to the risks of doing business in those
areas. Measures that force prices down or force financial institutions to lend distort
the pricing system and make it impossible for businesses to act on a true assessment
of risks and rewards. Distortion of risk also underlies the growth of so-called "public
interest" law. Public interest lawyers raise money to advance their causes by suing and
winning cases. Often, they win by distorting the truth about risks and benefits.
Whether the issue is nuclear power or auto safety, the question of risk should always
be "Risk to whom, and what was the alternative?"

No matter what the issue may be, a ruthless economic logic that goes beyond political
rhetoric to examine actual consequences is the only reasonable test of any policy.
Policies have a way of generating unintended, though not unforeseeable,
consequences.