Professors James Gwartney (Florida State University), Richard Stroup (Montana State University) and Dwight Lee (Georgia University), three longtime colleagues of mine, have recently published "Common Sense Economics." It's a small book, less than 200 pages, that addresses a serious economist dereliction of duty: making our subject understandable to the ordinary person.
Public misunderstanding of basic economic principles leaves us easy prey to political quacks, charlatans and assorted hustlers. Part I of "Common Sense" focuses on 10 key elements of economics that I'll only briefly describe.
The first is incentives matter. During the 1970s, gasoline prices rose dramatically. Immediately, people did more carpooling and eliminated unimportant trips. Gradually, they shifted to more fuel-efficient cars. During the 1980s and 1990s, gasoline prices fell. Again, people altered their behavior by buying more SUVs and more powerful cars.
Incentives matter under socialism, too. In the former USSR, managers and employees were compensated by the number of tons of glass they produced. Factories produced glass so thick one could hardly see through it. The rules were changed so that compensation was made according to square meters of glass produced. Factories produced glass so thin that it broke easily.
The second element is there's nothing that's free. Politicians talk about "free education," "free medicine" or "free housing," but that's nonsense. Resources are required to produce each of them. Of course, some people received these goods at a zero price, but that doesn't mean they didn't cost someone, usually a taxpayer, something.
Their third element is we don't make all-or-nothing decisions such as choosing between eating or wearing clothes, that is, dining in the nude so we can afford food. Instead, we choose between having a little more food at the cost of a little less clothing.
Their fourth element is that trade promotes economic progress through encouraging specialization. That's true whether the trade is between individuals, regions or countries. Specialization and trade make us dependent upon one another, but not to worry. The world's poorest people are far more independent than we. Check out Darfur. You might see families building their own shelter, gathering their own food and heating supplies, and making their own clothing. The flip side of the idea that trade promotes progress, and their fifth element, is the idea that obstacles to trade stymie progress. Among these political obstacles are taxes, licenses, regulations, price controls, tariffs and quotas.
Elements six and seven are related. Profits direct resources to their highest value uses. Losses free misused resources for higher value uses. People earn income by serving their fellow man. This link between serving others and income gives us incentive to develop talents and skills and become highly valued.
Elements eight and nine address the other keys to progress: Investment, better ways of doing things, sound economic institutions, and Adam Smith's idea that market prices direct buyers and sellers toward activities that promote the general welfare.
Their tenth element is crucial. We shouldn't ignore the secondary and long-term effects of an action. For example, trade restrictions on foreign sugar that result in higher prices for domestically produced sugar save jobs in our sugar industry. Because of those higher prices, major candy manufacturers such as Wrigley and Brach's moved to Canada and Mexico to take advantage of lower sugar prices. That resulted in more U.S. jobs lost than were saved by the sugar trade restrictions.
"Common Sense," subtitled "What Everyone Should Know About Wealth and Prosperity," contains a wealth of information about the major sources of economic progress, economic progress and the role of government, and important elements of practical personal finance. The latter contains finance principles on how to invest your money, using the principles of compound interest and how to get more out of your money. There's nothing in the book that goes beyond common sense, something rare these days.
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