The Economy Constantly Changes, Sound Economics Doesn’t

by Ray Keating

The Keating Files – April 7, 2020

In these hard, uncertain economic times, it must be kept in mind that while the economy constantly changes, sound economics largely doesn’t.

In good times, dynamism and innovation generate rather awesome beneficial changes in an economy. But in bad times, the economy changes via reduced production, bankrupt businesses, and lost income and jobs. However, the fundamentals of sound economic thinking rarely change. 

Indeed, many people miss or don’t grasp the difference between the economy and economics, and therefore, spout off various baseless claims, such as, “This change in the economy has altered how we should think about economy.”

Really? No.

Consider a variety of ways that the U.S. economy has changed in some fundamental aspects in recent times. On the positive side, for example, entrepreneurship has generated innovation (i.e., bringing new products, services and techniques to the economy) and growth, and in turn, has been further fed by innovation and growth. Technological advancements have accelerated the rate of dynamism across most industries. International trade as a share of the U.S. economy vastly expanded over the past six decades, and has generated greater opportunity for entrepreneurs, businesses, workers and consumers. 

As for the negatives, the 2008-09 economic and credit mess – often called the Great Recession – inflicted considerable harm, much of which proved to last or linger throughout the subsequent recovery/expansion period, such as reduced labor force participation and employment as shares of the relevant population, a diminished rate of entrepreneurship, fewer employer firms, a failure of U.S. manufacturing production to fully recover, and an average real economic growth rate languishing well below its historical norm.

And now we face historic changes due to the coronavirus and the shutting down of much of the economy. There have been breathtaking alterations to our lives, including in terms of massive jobs lost, and how many people are working (such as at home). Government’s attempt to alleviate at least some of the economic suffering created by the  pandemic, and the necessary governmental responses to limit illnesses and deaths, has been to pass unprecedented aid measures.

These changes and more have led assorted politicians, TV talking heads, many analysts, and yes, assorted economists to proclaim that we need to think differently about how the economy works. That would not only would be incorrect, but by doing so, it could sentence the U.S. economy to a much longer period of economic losses, including even permanently placing the U.S. on a path of short and long-run decline.

The fundament tenets of economic thinking that I taught MBA students for a decade, for example, have not changed. No matter the course I taught, I took at least one class to briefly teach foundational guideposts or principles of economics (usually as laid out in my favorite textbook Economics: Private and Public Choice by Robert Gwartney, Richard Stroup, Robert Sobel, and David Macpherson). 

Here are 15 key concepts guiding economic thinking that I always brought into the lesson:

• The use of scarce resources is costly and decisions require trade-offs. As the saying goes, there’s no such thing as a free lunch. Whenever there is less of a good or a resource freely available in nature than people would like, there is scarcity and choices are required. And there always is a cost, no matter who pays. 

• Individuals choose with purpose. That is, economizing behavior means choosing the option with the most benefits and least costs. 

• Incentives matter. Choices are affected in a predictable way by incentives, with, again, costs and benefits influencing decisions. 

• Individuals make choices at the margin, that is, considering the difference in the costs and benefits of a decision, and between alternatives. 

• Decisions have secondary effects, i.e.,  unintended or overlooked consequences. These tend to be big sources of economic errors, especially on the public policy front. For example, the most reliable is raising taxes to fund a program without considering the negative effects of increased taxes.

• The value of goods and services are subjective, and entrepreneurs and managers excel when they can determine and provide such value.

• Economic thinking is scientific thinking in that an economic theory is useful based on its ability to predict future consequences, in particular, to predict how incentives affect decision makers. 

• Good intentions do not equal or guarantee desirable outcomes. Politicians often talk about intentions, while ignoring economic realities. 

• Association is not causation. Actual causation must be explained logically.

• Economics is not about dividing up a fixed economic pie. The size of the economy – or the economic pie – actually is not fixed. Economics is not a zero-sum game. Economic growth occurs, and wealth is created. Higher income for one person, for example, does not mean less income for another. 

• Freedom, human knowledge and ingenuity drive economic growth and progress. When individuals are free to create, innovate, invest, work and trade, everyone benefits and prospers, including millions of individuals and entire economies being lifted out of poverty. Study after study confirms that the world’s freest economies overwhelmingly are the wealthiest.

• Trade creates value, whether a transaction takes place across town, across the nation or across an international border. Why? 1) Both parties are better off when making a voluntary exchange. If not, why would they trade? 2) Goods and resources are moved away from products/services valued less to those valued more. 3) Specialization and division of labor mean higher output and increased productivity, as we learned from Adam Smith in 1776 in his Wealth of Nations. 4) The law of comparative advantage – courtesy of early-19^th-century economist David Ricardo – makes clear that total output is greatest when the individual or firm with the lowest opportunity cost (i.e., “opportunity costs” is the highest valued alternative sacrificed in order to choose an option) produces each good or service. Another way to put it: Produce what you are best at, and trade with others, and as a result, everyone is better off. (Please take note President Trump and White House adviser Peter Navarro.)

• Private property rights are essential to economic development, as individuals and businesses have incentives to take care of and properly manage what they own, and to develop resources valued by others. 

• Prices, profits and losses serve as signals in the marketplace, directing resources to activities that increase value and away from activities that diminish value. In comparison, government works under very different incentives, with resources being allocated and decisions guided by political incentives, including power and control, getting votes, sizes of budgets and staff, and serving special interests. Waste in government comes about, in part, due to spending other people’s money; a tendency to subsidize and/or reinforce failure (like providing more dollars and staff for failed programs – think public schools); and a lack of necessary knowledge.

• Key sources of economic growth in a free market economy (see the importance of freedom above) are: 1) Private investment and entrepreneurship mean new and improved technologies, tools, skills, abilities, and productivity in generating goods and services, and enhanced innovation. 2) Essential rules under which the economy operates are critical, including, for example, the rule of law, enforcing contracts, stopping fraud, limited governmental interference or costs (such as in terms of taxes, regulations and government spending), and strong property rights. 3) Working harder – more work and less leisure – will boost growth as well.

So, as much as assorted experts will be spouting off in coming days, weeks and months that this pandemic has changed our economic thinking, don’t buy it.

Economics hasn’t changed. Therefore, we know and should be concerned about certain aspects of government aid packages. 

While there will be plenty of waste in the near term, I will not quarrel with the necessity of emergency government aid given that the current situation is a product of a true public health crisis and government ordering a widespread economic shutdown. 

However, at the same time, we cannot toss aside sound economics in favor of magical political wishes. Therefore, it must be recognized that short-term aid  is not a “stimulus,” as government is draining resources from the economy in order then to reallocate those resources. And there will be real costs to these actions, in addition to the sharp economic downturn we are now experiencing. 

For good measure, given the mindboggling costs of the coronavirus itself, the government-led economic shutdown, and government aid packages, the U.S. economy faces a longer road back to where the economy was than, I think, most people are anticipating – never mind where we should be when economic growth is factored into the equation.

And make no mistake, the longer that government interferes with the workings of the economy, the longer the road to full recovery and expansion. That’s why when this pandemic is brought under control and managed, it’s critical that the government quickly step back, and allow freedom, the private sector and the economy to, once again, flourish and grow. In contrast, if we choose to persist with increased government controls and intervention, the U.S. will surely be sentenced to economic decline, with real and significant costs for all.

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Ray Keating is a columnist, an economist, a novelist (his latest novels are The Traitor: A Pastor Stephen Grant Novel, which is the 12^thbook in the series, and the second edition of Root of All Evil? A Pastor Stephen Grant Novel with a new Author Introduction), a nonfiction author (among his recent works is Free Trade Rocks! 10 Points on International Trade Everyone Should Know), a podcaster, and an entrepreneur. You can also order his forthcoming book Behind Enemy Lines: Conservative Communiques from Left-Wing New York– signed books or for the Kindle. The views expressed here are his own.