Key Points from Books: The Economist’s View of The World

As the year goes to an end and my book list is getting shorter, I thought I’d share another eye-opening book, for both economist and non-economist alike, written by Steven E. Rhoads. The version I’m reading was published in the middle of 2021, thirty five years after its first edition. In the book, the author discuss many topics that political and economic policy pundits often argue with one another, and the economic perspective of both camp’s argument. One important takeaway from the book is this: the market works, and harnessing the power of market could increase the overall public welfare. In a world that is increasingly felt being more divided, this book provides a light to what rational economic decision making should looks like.

I think it is a must read for both professionals and students. For someone educated in the field and actively read numerous books on the issue, there are many lessons I could pick from this book.

Markets can seem chaotic. Imagine a 12-year-old prodigy being asked to choose between two economic systems: one in which everyone works as much as they want, at whatever they want, while living wherever they want; whereas, in the second, the best minds in the country work together to decide what should be made, who should make it, and where they should make it. The 12-year-old might say, “Hey, that first system sounds neat.” But if he was then asked which system would produce the most economic growth, I think he would choose the second one. He would be badly mistaken. For one thing, in the second system, political sorts would decide who get to be the planners, and they would be more likely to choose those who will keep them in power than the best economic minds in the country. And, besides, most people could not earn a large income, or even a decent one, if the planners ignored market forces.

The economically correct response to steadily declining demand is to continue to operate with existing equipment as long as the firm can cover its variable costs of production. That is, if a company can cover its variable costs, any additional revenue it generates can be used to pay off fixed costs, such as paying off loans, which must be paid whether the firm is operating or not. It should rarely replace old equipment. To modernize equipment with high capital costs would make the firm’s plight worse, because costs would rise in the face of declining demand and prices.

In 1994 a group of economists compared the cost-effectiveness of various lifesaving interventions. Overall, they found that the median medical intervention cost $19,000 per year of life saved; the median injury prevention cost $48,000 per life-year saved; and the median toxin control intervention cost $2.8 million per year of life.38 It seems obvious that shifting funds from some toxic control interventions to injury prevention ones would save lives. Yet, when economists delve into quantifying the lifesaving effects of particular projects, their work often draws controversy. One study tried to put radiation-induced deaths at Chernobyl in the Soviet Union in context by expressing them as a small fraction of the cancers that probably would have occurred in the affected region even without the disastrous 1986 accident. Likewise, the coal-fired plants that nuclear energy would replace cost more lives per year than Chernobyl cost one time only.

polls have shown that 92 percent of Americans support requiring police officers to wear body cameras, but only 55 percent say they would be willing to pay higher taxes in order to outfit their local police department with body cameras.55 Similarly, 48 percent of Americans support a universal basic income program, but, among those who support it, 54 percent would not be willing to pay higher personal taxes to fund the program.56 Even when considering questions of basic health care, the same pattern holds. For example, 77 percent favor a provision of the Affordable Care Act (ACA) that requires insurance companies to cover anyone who applies for insurance, even if they have pre-existing medical conditions, but only 40 percent favor the measure if it means their taxes will increase.57 Politicians are also inclined to neglect opportunity costs, because unusually strong support for particular programs brings them many benefits. Programs important to a politician’s district will, of course, get special emphasis. But, beyond this, politicians will want the electoral support and psychological pleasures that come from standing for something. They want to be introduced amid applause as, say, “Mr. Solar Energy,” “Someone veterans can always count on,” or “A dependable friend of occupational safety.” The legislator who keeps opportunity cost in mind may have to forsake much of that.

Despite the schoolmarmish tone, Charles Schultze (former head of President Jimmy Carter’s Council of Economic Advisers) and Allen Kneese get opportunity costs exactly right when asking their readers to consider the costs of overambitious antipollution goals: These costs are not simply numbers for accountants or economists to ponder. They represent the value of the resources that must be channeled into controlling pollution and that will not be available for meeting the other wants of society. In the long run their principal source will not be the profits of industrial firms, but the higher prices and higher taxes that all of us will have to pay. Environmental goals therefore are not the simple consequence of decisions about how clean we want the air and water to be or how “tough” the government should be with particular industries. Establishing them confronts us, especially at the highest levels of control, with a set of hard choices between environmental quality and other aspects of living standards, in which the more we want of one, the less we can have of the other.

Writing in the eighteenth century, Adam Smith struggled with what came to be called the paradox of value-in-use versus value-in-exchange. To illustrate this paradox, let’s compare water and diamonds. Water is necessary for existence and is of enormous value in use. Diamonds are frivolous and clearly not essential. But the price of diamonds per ounce, their value in exchange, is far higher than that of water. Smith wondered: what accounts for this discrepancy? What troubled Smith is now explained in the first chapters of every college freshman’s introductory economics text; Smith had failed to distinguish between total and marginal utility. The elaboration of this insight transformed economics in the late nineteenth century, and the fruits of the marginalist revolution continue to set the basic framework for microeconomics. Most choices in life, economists argue, are made “at the margin.” You can live without diamonds, but you can’t live without water. Economists would therefore say that the total utility or satisfaction of water exceeds that of diamonds. But rarely do we face such all-or-nothing decisions. All of us, unless we’re dying of thirst, would prefer to win a prize of a one-ounce diamond rather than an ounce of water. In other words, marginal utility depends on how much of each we already have. Although the first units of water we consume are of enormous value to us, the last units are not. The utility of each additional unit – “at the margin” – decreases as we consume more and more.

In some cases, a comparison of the marginal utility and marginal cost of different alternatives may lead us to give priority to a relatively small “total utility” need rather than a relatively large and powerful one even though the latter is not close to being fully satisfied. And, if the costs of meeting needs change sufficiently, choices and behavior can change substantially while basic needs and preferences remain the same.

Indeed, from the patient’s point of view, the potential for entry into the category of need is enormous. Large numbers of people do not feel entirely well. An English study found that 95 percent of the people in one community considered themselves unwell during the 14 days prior to questioning. A survey in Rochester, New York, found that adults suffered from at least one disorder on 20 percent of the 28 days covered.11 In the absence of money costs, queues, or other allocative devices, many of those who are not now seeing doctors would do so. Doctors know that their science is uncertain, and, if there is no cost to them or their patient, many will do something. After all, further tests might find something, and extra days of hospitalization might prevent complications.

According to the economist Robin Hanson, “We see at best only weak aggregate relations between health and medicine, in contrast to apparently strong aggregate relations between health and many other factors, such as exercise, diet, sleep, smoking, pollution, climate, and social status. Cutting half of medical spending would seem to cost little in health, and yet would free up vast resources for other health and utility gains.”13 In an article published in the Journal of the American Medical Association in 2012, the midpoint estimate for waste in the US health system is 34 percent of total spending and the high end is 47 percent.14 The Institute of Medicine puts the level of waste in context by comparing it to total expenditures in other areas: “Unnecessary health care costs and waste exceed the 2009 budget for the Department of Defense by more than $100 billion” and “could pay the salaries of all of the nation’s first response personnel, including firefighters, police officers, and emergency medical technicians, for more than 12 years.”15 In 2008 Oregon decided to expand Medicaid but received far more applications than it could accept. It randomly chose some of the applicants to receive Medicaid coverage. This made possible a powerful natural experiment in which the Medicaid “winners’” medical care usage and health outcomes could be compared to those who were not selected. A leading article in the New England Journal of Medicine found that the “winners” used about 35 percent more medical service than the “losers,” who did not receive Medicaid. Financial strain was reduced for the winners, but there was a very modest difference in health. For example, the study found “no significant effect of Medicaid coverage on the prevalence or diagnosis of hypertension or high cholesterol levels or on the use of medication for these conditions.”

Schultze notes that we have largely ignored an alternative method of collective intervention: market-like incentives, such as taxes and subsidies, that make private interests more congruent with public goals. We acknowledge the power of markets and economic incentives to foster steadily improving private-sector efficiency and a higher standard of living. And “we would laugh if someone suggested that the best way to reduce labor input per unit of production was to set up a government agency to specify labor input in detail for each industry. But that is precisely how we go about trying to reduce environmental damage and industrial accidents.”1

Just as a business looks for ways to minimize what it must pay for electricity or raw materials, so it will look for ways to minimize expenses from dealing with the pollution problem. If it blithely pays the tax and passes the expense on to consumers even though it would be cheaper to clean up, it risks losing business to competitors whose prices can be lower because they behave more efficiently. Furthermore, investors are increasingly considering environmental sustainability when making investment decisions.

In his book What Price Incentives?, Steven Kelman argues that the environmentalists’ “license-to-pollute” retort reflects incompletely developed intuitive concerns that the economists’ responses cannot so quickly dispose of. Kelman notes that environmentalists are quite concerned with developing an environmental ethic. They want to heighten the public’s environmental consciousness. For these reasons, they want to stigmatize polluting behavior and avoid doing anything that might lower the value the public places on clean air and water. But a price for pollution may end the stigma by saying, in effect, “It’s okay to pollute as long as you pay a fee.” And the price itself may make it impossible for us to see unspoiled nature as priceless. 27 Kelman convincingly shows that an extremely strong environmentalist has reasons to have reservations about pollution taxes. Kelman may be wrong, however, to suggest that a pollution tax would remove the stigma from pollution. Although we tax and license many things about which we have positive or neutral feelings (driving, marriage), we do the same for others of which we do not wholly approve (gambling, liquor, cigarettes). It is not likely that people will stop having negative attitudes toward pollution merely because it is taxed. Some environmentalists, however, argue that we do not just tax murder or “rape, pillage and burning,” and some say that they feel the same way about polluting behavior (“crimes against nature”) as they do about these (“one day a courageous district attorney will prosecute these people for murder”).

three separate functions of government in the economy: allocation, distribution, and stabilization. Allocation questions ask whether particular government tax, expenditure, or regulatory programs improve the mix of goods and services produced by the economy. Distribution questions ask who benefits and who is harmed by such policies. Stabilization questions ask what effect all taxes and expenditures, together with monetary policy, have on aggregate employment, output, and prices.

Pareto improvements are those in which a change in resource allocation is preferred by one or more members of society and opposed by no one. It is an extremely strict criterion for improvement, and is almost never met; obviously, such changes are very hard to find. If any single person objects to changing the status quo, then the Pareto improvement criterion gives no unambiguous public policy guidance. The existing situation may be Pareto-optimal. But there are a nearly infinite number of other non-comparable Pareto optimums, and the concept is of little policy use. Economically efficient allocations are always Pareto-optimal allocations. But, if the initial allocation is inefficient, the achievement of economic efficiency does not require that no one be made worse off before a change can be recommended. Economic efficiency requires only that recommended changes use resources in such a way that it would be theoretically possible – assuming costless transfers of income between gainers and losers – to make some better off and no one worse off. Suppose that most people would gain from some change, but some would lose. If the gainers gain enough so that they could fully compensate the losers with money or goods and still have an improved situation themselves, the change meets what some economists call the “potential Pareto” criterion and would improve economic efficiency even if the transfer to the losers does not actually take place.

Free markets, with their flexible prices, provide more than the right information. They also give people an incentive to act on it. Economists find that the desire for wealth is a sufficiently common goal to ensure that resources will shift when financial incentives do. When consumers start to demand more pencils, the price of pencils goes up to ration the limited supply. The higher price induces the least eager (or the poorer) buyers to drop out of the market, or induces pencil buyers to use them less. The higher price also makes retailers quick to want to increase their supply of pencils so they can take advantage of the new demand and high price. They put pressure on their wholesalers, the wholesalers on their manufacturers, their manufacturers on the producers of wood. Each offers to pay more if necessary; they can do so and still increase profits given the higher price for pencils. The wood companies may, in turn, pay overtime to their employees to get an increase in production or cut back sales to other manufacturers whose consumers are less eager to buy and who therefore cannot afford to pay as much. When consumers are especially eager and drive up the price further and faster, businesses are more eager to meet their demand, and they respond more quickly. Firms that thrive do not often respond clumsily to consumers’ demands. Those that waste scarce resources when making their product have difficulty matching the price and quality of firms that do not. Firms with an inefficient scale of operation come under pressure from those of more optimal size. And firms that guess wrongly about whether consumers would prefer a higher pencil price or a smaller eraser lose business to competitors.

government will be needed to correct for market imperfections that prevent the allocation of resources in accord with consumer valuations. These imperfections may include concentrations of market power (monopolies and powerful labor unions), externalities, and public goods.

Assuming that people in political organizations are moved by narrowly selfish motives just as they are in markets, public choice scholars predict that a government bureaucracy will have little interest in efficiency or in satisfying citizen preferences. A federal administrator who spends more money on his program will find this has almost no effect on his tax bill. But it may help him in other ways. His salary, his power, his public reputation, and his perquisites of office (free parking, cheap lunches, etc.) are all likely to be greater if his budget is large and he has a lot of people working for him. What incentive is there then to run a lean and efficient bureau?

Public choice theory would predict greater private-sector efficiency because of competitive pressures and the greater ability of private firms’ managers to reap the rewards of efficient behavior. One of the most systematic of the comparative studies looked at residential refuse collection. The study found that, on average, US cities with over 50,000 residents get roughly 30 percent cheaper service when they hire firms to pick up refuse than when a city agency performs the work. Reasons suggested for the differences included higher municipal employee absentee rates (12 percent versus 6.5 percent); larger municipal crews (3.26 workers versus 2.15); and the longer time it took the municipal crews to service each household (4.35 work-hours per year versus 2.37).

This survey is sufficient to show that industrial policies in the United States have not had significant achievements. Similarly, economists think that the European experience has been “terrible” and “conspicuously unsuccessful.”53 Targeted industries, such as aircraft in the United Kingdom, computers in France, and the nuclear industry in Germany, have done poorly. For a time Japan’s growth rate was clearly superior to ours. But studies by economists found that government investment was not the secret to their success; in any case, Japan’s economic performance over recent decades is clearly inferior to ours.54

For economists, the biggest problem with the “Jobs, jobs, jobs” chorus is that the politicians usually emphasize preserving existing jobs because it is job holders in existing industries who are the voters. Thus, President Trump put a lot of emphasis on coal miners and steelworkers. Economists want us to understand that, if we want to continue to be one of the richest countries in the world, we have to be willing to work at new jobs at cutting-edge companies. Many of the jobs in older industries will inevitably be lost to labor-saving technologies and countries with significantly lower wages. Economists thus worry when they see evidence that workers are less willing to move for better job opportunities than they used to be.

For economists, profits are not an arbitrary decision to give business owners and managers more money – money that might instead have been transferred to workers. Good management emphasizes cost-cutting, creating and improving products, and accurately predicting consumer demand.85 Managers who are lousy at these tasks will not just have lower profits; they are likely to go out of business. Competing firms keep the pressure on for good performance.

We saw above that economists emphasize economic growth. Increased regulation is offered as one of the main factors reducing growth and new business expansion. Since small and large companies alike require staff to document compliance with regulations, regulatory costs, as a percentage of all costs, are higher for small than for large businesses.

Currently some planes have more legroom than others. If airlines think they can get more passengers with still cheaper tickets and still smaller seats, the market will tell them if they are right. And if they are wrong customers will desert them for other airlines. No one complains when restaurant prices are higher for large steaks than for smaller ones. Economists wonder why it should be outrageous if larger seats are priced higher than smaller ones.

Consumers would like products to be well made and cheaper. To accomplish this, businesses must reduce costs. Labor is an important cost. One way to reduce labor costs is to improve business procedures or equipment so as to be able to make the same product with less labor. This may mean firing people, but it need not. For example, some companies that need less labor give large bonuses to longtime employees who agree to take early retirement. And employers can’t completely ignore their workers’ morale, because there is a market for labor, and businesses that do not offer a competitive wage, fringe benefits, and a pleasant working environment will have a hard time attracting and keeping good workers. For example, when a new restaurant opens in Washington, DC, its managers are seen to frequent area restaurants and pass out their business cards to good waitresses and busboys. (It is important that such competition exist; some states have investigated restaurants that may have agreed to a “no poaching” pact.)

The Dodd–Frank law requires many companies to publish their CEO-to-labor salary ratio. In the 2020 campaign, Senator Bernie Sanders proposed a substantial increase in corporate taxes for businesses in which the ratio of CEO pay to median worker pay was very high.4 There may be excellent reasons, however, why company A’s CEO earns 50 times as much as its average worker whereas company B’s CEO earns only ten times as much. Company B may have 100 workers, most of whom are skilled. Company A may have 2000 workers, most of whom are unskilled. Company A’s CEO may be responsible for managing much more capital as well as more workers. His greater responsibility would justify a much larger salary in comparison to his workers than company B’s CEO receives. Moreover, if one thinks the top 1 percent have too much income, why focus on docking hardworking CEOs rather than others in the top 1 percent who don’t work at all? In any case, it would be easy for many CEOs to reduce their pay ratio by outsourcing low-income labor.

the broader forces that produced inequality will not go away: robots will replace labor and “there is the basic truth that technology and globalization give greater scope to those with extraordinary entrepreneurial ability, luck, or managerial skill.

Taxes will likely reduce innovation and investment, and higher taxes will reduce them more. Some potential entrepreneurs will decide the risks are not worth the rewards; they may instead seek a management position in an existing firm. Some engineers contemplating an advanced degree may decide that the high marginal tax on the added income made possible by their higher productivity makes it not worth the cost.29 More important still, with higher marginal tax rates the well off have greater incentives to think of ways to avoid taxes. Liberal and conservative economists agree that high marginal tax rates have a greater effect on the demand for fringe benefits and other untaxed income than on the supply of labor. As the economist Arthur Okun noted, “High tax rates are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys with sleds.”30 One result is more bartering and “pay me in cash” transactions in the underground economy. Another result is businesses providing top executives with expensive tax-deductible cars and conferences in the Caribbean. Still another result is high incomes for lawyers who help the wealthy find tax loopholes.

percent growth rate over ten years raises real (inflation-adjusted) incomes 22 percent; a 4 percent growth rate raises incomes 49 percent. Both liberal and conservative economists think that, historically, economic growth is far more important in explaining the material progress of ordinary people than labor unions or political reform. From the conservative side, Thomas Sowell says: If you read many histories and hear many discussions of social issues, you get the idea that people are no longer in rags or hungry today because various noble reformers refused to accept such conditions and worked to alleviate them. Meanwhile, it was merely coincidental that the gross national product rose by 5 or 6 times over that same span. But if you really want to know why it is that the poor of the nineteenth century were in rags and those of the twentieth century typically are not, it is because a man named Singer perfected the sewing machine, putting factory-made clothing within the reach of great masses of people for the first time in history

survey of top economists found that most thought CEOs were paid more than their marginal contribution to firms’ value. But most mainstream economists think that executives do not have the free rein to boost their pay that economists on the left believe. They point out that, in privately held companies, CEOs are paid even more than they are in public companies. But the owners, usually private equity investors, hire the CEOs and determine their pay themselves.

political liberals usually place a strong emphasis on equality combined with a strong sense of empathy. This leads them to believe that fairness means embracing and championing groups “that seem to be oppressed, victimized, or otherwise dominated by the strong.” In contrast, conservatives think that equality and compassion can be unfair because they often break the link between hard work, self-control, and personal

responsibility, on the one hand, and money, respect, and other rewards, on the other. Conservative notions of fairness focus on proportionality, not equality. “People should reap what they sow. People who work hard should get to keep the fruits of their labor. People who are lazy and irresponsible should suffer the consequences.” Influenced by the anthropologist Christopher Boehm, Haidt believes that the origins of morality were in a “gossipy, punitive, moralistic community…that emerged when language and weaponry made it possible for early humans to take down bullies and replace them with a shared moral matrix.” He also believes that the propensity to punish is the “key to large-scale cooperation.” In experiments people “pay to punish selfish people even though they gain nothing from the punishment.” People pay to punish because it feels good. “We want to see cheaters and slackers ‘get what’s coming to them.’ We want the law of karma to run its course, and we’re willing to help enforce it.”

The reasons we give for policies matter. A welfare state – yes. A redistributive state – no. As Marc Plattner argues, Having government determine the level of people’s income by redistribution can be morally justified only if those who originally earn income have no legitimate right to it. By making the political process rather than the “honest industry” of private individuals the arbiter of each person’s income, redistribution undermines the notion of genuinely private property. […] By making everyone’s income directly dependent on government largesse, a policy of explicit redistribution must necessarily polarize society. In effect, each citizen would become the equivalent of a government grantee or a welfare recipient.75 Explicit redistributive goals would intensify the conflict between rich and poor that the framers sought to minimize. And, as Okun’s thinking shows, the conflict would not just be between rich and poor but between the upper middle class and the lower middle class.

I would guess that the free tuition policy sounds good to many if not most of the public. They probably believe that subsidies that encourage more people to further their education are obviously good for the country. But I doubt that most of the public understand why most economists on the left and the right would oppose free tuition for everyone. Economists, when looking at who benefits and who loses, oppose the policy. Economists are likely to be even more opposed to a proposal by Elizabeth Warren to wipe out up to $50,000 of student debt for those with household incomes under $250,000. The Brookings economist Adam Looney calculates that the Warren proposal would give the top 40 percent of households about 66 percent of the loan forgiveness, whereas the bottom 20 percent of borrowers would get 4 percent of the savings. No one would get additional education, but more well-off borrowers would get most of the money.

many of the distributional consequences of government policies are not what they appear to be on the surface. Often this is because the policies shift incentives in subtle ways. For example, businesses required to pay certain benefits or taxes will adjust so as to shift the real burden elsewhere. Although those in Congress spend much time deciding what proportion of social security and Medicare contributions should be paid by employers and what proportion by employees, their decisions probably have few significant economic effects. As a Brookings Institution study noted, “Economists generally believe that a payroll tax nominally paid by the employer is ultimately borne by the worker in the form of lower wages than he would otherwise receive or in higher prices for what he buys.”99 The shifting of burdens may also occur with the corporate income tax. Although there are economists who dissent, Columbia University’s Glenn Hubbard says “recent studies find that labor bears much of the burden of the corporate income tax.”

There has been a decades-long debate about whether raising minimum wages leads to a reduction in employment of low-skilled workers. All economists agree that there are more workers who gain from minimum wage increases than who lose, but the losers are often losing all their income. The city of Seattle, which began phasing in a $15 minimum in 2015, hired economists at the University of Washington to assess the results of the new policy. The authors of the resulting report introduced methodological improvements over earlier studies by getting data on individual employees. The report found that, on average, low-wage employees lost $125 a month. (A second paper by the authors found the loss to employees was $74 a month, not $125.)105 The losses occurred because employers cut workers’ jobs or hours and put off new hiring.106 Other studies, however, show that jobs lost because of the rise in the minimum wage are fully offset by increases in jobs paying just above the minimum wage

Just as landlords adjust when forced to keep rents low, employers adjust when required to pay low-skilled workers more than a market wage. If they have previously offered workers inexpensive insurance or partial daycare coverage, they can discontinue these nonwage benefits. Perhaps more important, they can discontinue on-the-job training. Jacob Vigdor, one of the University of Washington economists who conducted the Seattle study, worries that, by harming employment opportunities for junior workers, we may be removing the bottom rung of the ladder to future, better-paid jobs.110 Evidence for this process comes from the US construction industry. Many employers there have found it less expensive to hire unskilled workers at low wages and train them on the job. By accepting lower wages in return for training, unskilled workers increase their expected future income

Externalities are the most pervasive kind of market imperfection that may justify government intervention. When economists discuss “the desirable scope of government,” the externality concept is at the center of their analysis.

when a manufacturer harms his competitors by expanding output and thus forcing down prices, the effect on competitors is not inefficient and is thus not an externality. The effect is transmitted through the price system, in the form of lower prices, not outside the price system. If the manufacturer who had expanded production was forced to cut back and raise prices again to take account of the adverse effect his actions had had on rival businesses, customers would lose at least a dollar for every one the rival businesses gained.3 When Henry Ford put buggy whip manufacturers out of business, the effect on them was quite serious, but there was no inefficiency because Ford and his customers gained more than the buggy whip manufacturers lost. Changes in tastes and technology constantly exert both beneficial and harmful effects on employers, employees, stockholders, and even consumers (e.g., when a big, popular chain restaurant with many potential customers buys out a small, struggling eatery with a loyal clientele). Most of these effects are captured by the price system and are not externalities as economists define them.

The owners of chemical firms and their employees do not have precisely the same interests as the rest of us. Many of the chemicals dumped in “our rivers” will end up in other people’s neighborhoods, far from the homes of chemical industry employees. But, even if all the pollution caused by the chemicals remained in the communities surrounding the chemical plants, the plants’ owners and employees would still have different interests from their neighbors. As Ken Ficek notes, everyone would share in the benefits of cleaner water. But the costs of cleaning up would be far higher for owners and employees than for their neighbors. If chemical firms devote major efforts to reducing the pollution resulting from their manufacturing processes, their costs will increase significantly. They will thus have to raise the price of their products, causing demand for those products to fall. Profits in the industry will then fall as well. Some employees will lose their jobs as business declines, and others may lose their raises. If allowed to decide for themselves, the chemical companies may conclude that the costs of certain pollution control efforts – costs borne mainly by their management, stockholders, employees, and customers – exceed the benefits. But the overall benefits of cleaning up would far exceed those enjoyed by chemical industry folks. And these members of the relevant communities would not have cleanup costs to balance against the benefits of the cleaner rivers.

Donald Trump’s first EPA administrator, Scott Pruitt, said that he hoped Congress would end the tax breaks for wind and solar energy. As suggested in Chapter 4, I think most economists would agree with Pruitt that we should do away with production subsidies for first-generation green energy. (They would also strongly support ending tax subsidies for fossil fuels, which totaled $41 billion over ten years.42) Economists are, however, likely to support “green-energy initiatives focused on innovations, making new generations of technology work better and cost less.”43 Setting aside the notable failures of the subsidies discussed in Chapter 4, economists would remind us that the general public does not receive external benefits when, for example, energy is produced by wind power. In fact, it experiences external costs: the huge blades used to capture wind power create unsightly shorelines and dead birds. We don’t want more and more wind power any more than we want lots of interstate travel via railroad; what we want is less power from fossil fuels, which produce pollution. Many ways to accomplish this goal don’t require power of any kind. We could, for example, have more use of GPSs (thus lessening the frequency of wrong turns) and less traveling by cars. The problem with Pruitt’s stewardship of the Environmental Protection Agency was that he seemed uninterested in forcing polluting industries to clean up. He would sometimes suggest that he wanted to be evenhanded: he wanted wind and solar, coal and oil, to compete in the market. But a fair competition would occur only if subsidies for coal and oil disappeared and if polluting industries were forced to pay for the external costs of their pollution.

There are policy areas where the appropriate framework for analysis is not local, state, or national but international. I am thinking of global warming in particular. International organizations have no ability to enforce, whether by regulation or taxes, policies that force reductions in carbon. The free rider problem is pervasive. If we Americans cut carbon substantially, we pay the cost of the reduction, but other nations share in the benefits whether or not they implement carbon reduction policies of their own. Getting other nations to follow through on commitments is an enormous problem.

The real victims of aggressive regulations may be workers (who lose benefits or even jobs), consumers (who pay more for goods, or who may lose access to some goods altogether), or small enterprises (for whom regulation may serve as a stiff tax or even a barrier to entry).

As we have seen, Americans do not agree that people in other countries have as much claim to US taxpayers’ money as they do. They also would not agree that consumers are incapable of making reasonable decisions about which appliances to buy, once having been presented with good information on energy costs.

Despite the many available sources of information, consumers are never perfectly informed. But economists argue that they should not want to be. There are costs in time and money of both producing and consuming information. Imperfectly informed consumers thus seek more information only if they judge that the expected value of the information will exceed the costs of acquiring it. Although competitive pressures induce firms to provide much relevant information, they do not always yield important kinds of safety information.

Much consumer information about products comes from businesses’ advertising. Contemporary economists are qualified supporters of advertising. They find that, although advertising can help create monopoly power, it can also help break down such power. Moreover, heavy advertising for new products can make possible economies of scale in production and distribution, and thus lead to lower prices. Even for mature products, advertising can help medium-sized firms achieve scale economies. There are cases in which advertising seems to raise costs to consumers, such as aspirin, detergents, and breakfast cereals. But many empirical studies have found cases in which it has reduced prices. By “preselling” customers, advertising makes low-service, low-price discount stores possible. When heavy advertising of toys began in the 1970s, retailer prices and profit margins went down as sales increased. A study of eyeglass providers found lower prices where more advertising prevailed.

This section has argued that a man’s behavior does not necessarily indicate his preferences if “preferences” means what he thinks is best for himself or will maximize his well-being. Behavior seen in the market may be even further removed from what the man believes is best for the community.

William Breit points out that malevolence toward the rich could explain desires for redistribution as easily as does pity for the poor. But, although he discusses this and other possible explanations, he seems most attracted to the theory that the middle class want to take from the rich to give to the poor out of a self-interested desire to avoid “rioting, looting, burning and other crimes.”37 Bruce Bolnick points out that philanthropic activity enables one to avoid costs such as social pressures, psychological unpleasantness, and religious pangs of conscience. He thinks the “apparent irrationality” of philanthropy can be seen as an attempt to avoid these sorts of costs.38

In his book The Costs of Economic Growth, Ezra Mishan argues that commercial advertising teases our senses and taps repeatedly at our greed, vanity, and lusts; because business propaganda emphasizes the “mundane and the material,” it should be balanced by noncommercial attempts to influence tastes “for the better.”

Why are economists so defensive when someone suggests that commercial advertising may leave many consumers with an exaggerated opinion of the importance of goods and services to human happiness? There are a number of reasons for this. First, potential professional recruits very quickly learn that, in evaluative economics, the best thing that can be said about a policy is that consumers want it. Most of those who find this worldview uncongenial are likely to choose other professions. Thus, economics has a disproportionately large number of people who subscribe to a consumer sovereignty standard for public policy. Second, those in the profession also learn that, if consumer tastes can be assumed to be stable and real, economists can show themselves to be quite useful to policy makers. On the other hand, if an economist abandons this assumption, he calls into question the value of the competitive market and of many of his own professional tools. If we trust consumer sovereignty, we should be very concerned when economists locate inefficiencies, but, if consumers’ tastes are distorted and unbalanced because of one-sided propaganda, economic efficiency becomes much less important. Indeed, its very meaning becomes ambiguous. Two thoughtful mainstream economists have called the treatment of consumer tastes “the Achilles heel of neoclassical economics.”62 It is thus not surprising that economists protect this weak spot with such vigor. Third, as seen in the chapter on incentives, assuming self-interested behavior can point the way to good public policy. In his book offering sensible ways to reduce pollution, Charles Schultze is right to focus on redirecting economic incentives. In the middle of the book, however, he waxes philosophical, praising economic incentives because they “reduce the need for compassion, patriotism, brotherly love, and cultural solidarity as motivating forces behind social improvement.” Schultze goes on to say, “Harnessing the ‘base’ motive of material self-interest to promote the common good is perhaps the most important social invention mankind has yet achieved.”63 He suggests what Kenneth Arrow has argued, namely that altruism is a scarce resource that society should avoid depleting recklessly.

There are probably very few cultures that don’t have admirable aspects. We can do justice to diversity by calling attention to those aspects. But we don’t have to make believe that “no one culture is intrinsically superior to another.” High school students in my community and all over the country are now being told that “understanding” this “truth” is a measure of successful educational achievement.71 Tell it to the swimmers trying to get here from Cuba or Haiti or the boat people who set out from Vietnam. United States flags were visible in Tiananmen Square in 1989 and in Hong Kong in 2019. A desire for life, liberty, and the pursuit of happiness is not only a Western value.

Robert Frank leads a group of economists who think they can explain the weak association between income and happiness gains. Frank believes that, although Adam Smith was worthy of his reputation, Charles Darwin was worthier still. Indeed, Frank thinks Darwin was the real founder of economics, because he saw that it is relative income and status that bring the good things in life, not absolute income. Frank argues that what’s good for the individual may not be good for the group. Holding a child’s entry into kindergarten until a later age should help him excel in sports. But, if all parents with athletic children do the same, there will be no gain. If one job applicant buys an expensive suit to get a leg-up on competition, the money will be wasted if his top competitors also buy an expensive suit. When we buy a more expensive car to gain the admiration of neighbors, little will be gained if, a year later, our purchase leads our neighbors to trade in their perfectly good cars to buy a later model of our car. If we spend more money on cosmetic surgery so as to look better than our rivals, we will not gain an advantage if they also do the same.

In almost every happiness study done by psychologists, what is central is connection – to friends, spouses, religious institutions, charitable and recreational groups. Harvard’s Dan Gilbert, sometimes called Professor Happiness, says We know that the best predictor of human happiness is human relationships and the amount of time that people spend with family and friends. We know that it’s significantly more important than money and somewhat more important than health. That’s what the data shows.89

Arthur Brooks is one economist who objects more broadly to the idea of a work–leisure trade-off. He provides evidence showing that 89 percent of Americans say they are very satisfied or somewhat satisfied with their jobs. Even 87 percent of people who self-identify as working class say they are very or somewhat satisfied. When asked if they would continue working even if they had enough money to live as comfortably as they would like, 69 percent of Americans say “Yes.” Brooks says: Imagine two workers who are identical in every way – same income, education, age, sex, family situation, religion and politics – but the first is satisfied with his or her job and the second is not. The first person will be 28 percentage points more likely to say that he or she is very happy in life.99 So what makes for a good job? The European Social Survey finds people in well-paying jobs are happier but “a number of other aspects of jobs are strongly predictive of happiness.” When summarizing, the work–life balance was listed first; but the factors that came next were job variety and learning new things.

Learning also enables the pleasures of a job well done. It makes bakers good bakers and air-conditioning repair people good at their job as well. Both occupations yield big smiles from customers, which demonstrate appreciation and admiration. “Earned success” has been found to bring happiness in a host of occupations that don’t pay particularly well. “Americans who feel they are successful at work are twice as likely to say they are very happy overall as people who don’t feel that way.”

Bronfenbrenner recoils from Mill’s argument for favoring higher tastes, accusing Mill of “priggish condescension” and “intellectual snobbery.”115 Mill can be better understood, however, as anticipating today’s happiness researchers. He wanted people to lead more satisfactory lives and believed the main impediments are selfishness and lack of mental cultivation. No wonder so many of today’s economists would side with Bronfenbrenner! They take it as given that selfishness moves humans, and that encouraging higher tastes (learning) would violate their prized stance of scientific neutrality. Economists are wrong on both counts. We have seen that mitigating selfishness and continued learning are both important steps toward happiness. One major indicator that selfish motives do not dominate us is the growing number of investors who give up some economic returns so as to further their political ends. And economic success is by no means the surest route to happiness. Good friends and loving families are.116 Selfishness loses friends and destroys loving families. Acting on altruism and compassion stimulates these virtues further rather than using them up. Aristotle and Smith recommend practicing the virtues so that they become habitual and argue that being praiseworthy is more important than garnering praise.

Marshall’s great contemporary, P. H. Wicksteed, distinguished tastes further by noting that certain kinds of pleasures increased the capacity for future enjoyment. Intellectual, literary, artistic, and scientific enjoyment demand at some point “painful effort and discipline.” But, with greater study, one’s pursuit of these activities increases “hedonistic capacity,” which is not true of most other activities.

Among the important adverse effects of salesmanship and economic rivalry is their tendency to work against the appreciation of the “free goods.” They thus tend to undermine the “fairly established consensus that happiness depends more on spiritual resourcefulness, and a joyous appreciation of the costless things of life, especially affection for one’s fellow creatures, than it does on material satisfaction.”

Previously, some public choice economists suggested that the rational ignorance of voters would be randomly distributed across the policy spectrum, with mistakes canceling each other out until the well-informed voter’s policy preferences were adopted. Caplan claims that ignorance is not random but, instead, biased in certain directions. Because a single vote is almost never decisive, voters suspend their rational analysis – so crucial in consumer markets – and succumb to the charms of their preferred worldview, regardless of its practical implications. In economic terms, the political arena is unique, in that irrational behavior carries a low cost, allowing citizens to entertain, with apparent abandon, delusions and presumptions they would otherwise mute.15 Caplan uses the 1996 Survey of Americans and Economists on the Economy (SAEE) to identify several areas – such as free trade, the inefficiency of price controls, and labor-saving technologies – in which the public routinely rejects the consensus of economists.

James Madison and Alexander Hamilton believed that the true friend of democracy would support representative institutions that could preserve democracy by guarding against its excesses.20 Lincoln, who saw and condemned “wild and furious passions” and “worse than savage mobs,” agreed completely.21 Even Jefferson, though defending the right of the people to instruct their representatives and emphasizing popular control of government, supported nonetheless a government wherein the “natural aristocracy” held office. The people were “competent judges of human character,” capable of electing the “good and wise.” But the representatives’ independent judgment would be essential, for “the mass of individuals composing the society” are “unqualified for the management of affairs requiring intelligence above the common level.”

Widespread participation was not meant to provide an outlet for narrow self-interest but was, rather, a means of tempering it. Municipal government in America provided a way of “interesting the greatest possible number of persons in the Common weal.” It gave people a taste for liberty at the same time as it taught them the art of self-government.

As mentioned earlier, the founders expected elected representatives to be wiser and more virtuous than the average voter. In addition, the powerful offices created by the Constitution, with their fixed and fairly lengthy terms, would appeal to able men, those who “possess most wisdom to discern, and most virtue to pursue the common good of the society.”38 The founders knew, of course, that “enlightened statesmen will not always be at the helm.”39 But they thought that the large commercial republic they established would encourage quite ordinary representatives to behave in a more statesmanlike manner. In small republics there are few factions and interests, and it is easy for a single faction to compose a majority and proceed to oppress the minority. In a large commercial republic, however, even within an individual congressional district, there are a large variety of limited and specific interests. To win an election, candidates must appeal to diverse interests and win wide popular support. The ability to win such an election inclines the successful candidate toward the decent and moderate quality of representation which the system requires. Moreover, representatives from such districts need not be the captive of any one group but rather can find some elbowroom for statesmanship in the very confusion of factions.40 Even a representative from a district dominated by a single faction soon finds that he must cooperate with representatives with different constituencies if he is to obtain even a portion of what he wants. Thus, the large republic’s legislative process encourages temperaments predisposed to consider the needs of others and the “permanent and aggregate interests of the Community.”

Lincoln noted that the principles of the Declaration of Independence required not only government by consent of the governed but also respect for individuals’ unalienable rights to life, liberty, and the pursuit of happiness.51 He said that people outside the territories could not justly remain indifferent about whether citizens in the territories voted for or against slavery. To adopt a stand of moral indifference would be to enshrine in the body politic the pernicious doctrine that “there is no right principle of action but self-interest.”

Sometimes people vote on the basis of a candidate’s (or a party’s) stance on a policy issue important to them, but more often they vote on the basis of their assessment of a candidate’s experience, integrity, judgment, or capacity for leadership.

About Journeyman

A global macro analyst with over four years experience in the financial market, the author began his career as an equity analyst before transitioning to macro research focusing on Emerging Markets at a well-known independent research firm. He read voraciously, spending most of his free time following The Economist magazine and reading topics on finance and self-improvement. When off duty, he works part-time for Getty Images, taking pictures from all over the globe. To date, he has over 1200 pictures over 35 countries being sold through the company.
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