The Problem with Economics 2

Oliver Hoy

If you ask any budding young economist what the problem is they’ll quickly give you a short and sweet definition; ‘how to allocate scarce resources among alternative uses’. Some people would argue that a definition means nothing without understanding; nevertheless I put it to you that the youngest child faced with the simplest choice has some grasp of the gravity of the situation. Imagine a child in a sweetshop, money in hand, meticulously analysing each option. They have the ability to purchase a combination of sweets but clearly not all that they desire. Consequently many factors will be considered, often subconsciously, by the child in order to make the decision; the taste, the appeal of the packaging, the desire to test the unknown, the total length of consumption and many more. Having been in this situation myself and having observed others suffer the same ordeal I would confidently state that this particular decision causes no less turmoil than when a government under pressure has to carefully allocate their resources among the public sector. Clearly it’s not just governments and children who have these experiences; manufacturers have to consider many trade-offs, including when they’re deciding whether to produce a cheaper product at a lower price or a higher quality product at a higher price, in fact every household in the world has to make decisions based on the income available to them. The problem exists in all societies, no matter the size, and affects everybody in some way. Even animals have to choose how they spend their time; eating, resting, interacting with each other. In fact I would suggest the concept has existed in some basic form ever since life itself began, even single-celled organisms are not so simple that they only have one function and no option around whether to perform it or not. So far we’ve established that the issue is simple to define, is experienced by everyone and has done so for as long as we’ve existed. In the film Philadelphia Tom Hanks said ‘every problem has a solution’, if this is true then what’s the solution to this problem? Unlike the problem, the solution cannot simply be defined or explained in a few sentences, however over many years it has been studied, discussed and refined by people from all walks of life with a varying amount of experience, yet there are still a frighteningly large collection of viewpoints, some completely contradictory. For these reasons I believe this study is the most important in the world, even though I’m sure we’ll never come to a definite conclusion. Over time the study itself has been given a name; it’s called Economics.

Many people, including myself, would say that the study of Economics really began in 1776 when Adam Smith published his book, The Wealth of Nations. This doesn’t go against my previous statement that the economic problem has always existed; if we once again consider the child in the sweetshop, just because they realise that there is an issue and they try to resolve it for their situation, it doesn’t mean that they are a student of Economics. Economics is searching for the general answer, trying to find the best way to allocate finite resources to unlimited wants, the resources and wants are not specific. Adam Smith went about explaining how money originated in order to increase businesses’ and consumers’ ability to trade, how labour was first divided to increase the efficiency of production, essentially how economies had minimised the economic problem, without even properly understanding what it was. He put this down to the propensity in human nature to exchange, this exchanging of goods and services is in mans’ best interests in order to maximise their own wealth. Smith was the first person to give an accurate description of how a market economy could function; he explained that governments should not intervene and that the market forces that arose due to human nature and self-interest would control the market better than any government ever could. It’s worth noting that the common misconception that he believed the government had no role to play in running the economy is not true, he supported the government in protecting new businesses and inventions through patents and copyrights, as in market economies business competition is vital. The point of all this is that Smith gave an answer to the economic problem, theoretically a market economy was and still is a valid solution. The answer was never going to involve satisfying all wants, that’s an impossibility that even the child in the sweetshop quickly dismisses. The question was how to allocate finite resources in the most effective way and this is Adam Smith’s answer. The market economy includes a pricing system which allows the demand for the product and cost involved with producing it to determine its price, which gives an accurate representation of the quantity of resources it is worth. In a market economy businesses will also have the ability to function without being impeded by the government, therefore their goal of maximising profits can be prioritised; hence they will do their best to improve efficiency of production. This will in turn bring the lowest possible prices to consumers who will now be able to purchase the greatest possible quantity with the resources available to them. Summing up a market economy is no easy feat; I may not have done it as clearly or as thoroughly as others would have, but I don’t want to spend very long explaining a concept that has already been expanded on, in much more depth than I’m capable of, in many books and essays. Instead I’d like to make the assumption that the market economy is, in theory, perfect, an ideal; I plan to make the same assumption later on about a command economy. My next question is; if this flawless answer was published in 1776, then why haven’t all economies adopted it by now? The UK government for example still have a national minimum wage in place, even though the market economy states that the market forces will produce a base wage, they still tax certain products and subsidise others to manipulate the prices and the Bank of England Monetary Policy Committee still has complete control over the base interest rate. Although the pricing system is allowed to operate freely some of the time, the government still intervenes as and when it sees fit. So why only partially follow a theory that is perfect? Why undermine a flawless concept? The answer is the only logical one; because the theory relies on rationality, it relies on people, businesses and governments acting in their best interests, even though in real life this is often not the case. In an economy there can be any number of people, all with different opinions subject to changing conditions, with different experiences and commitments. There can be any number of businesses in every industry, each business governed by a variety of intelligent (or not) characters who have their own developed opinion on every circumstance. There will be a government or a controlling body with a vast quantity of objectives and aims, some conflicting to the point where one cannot be achieved with the other. Any economy, no matter what size, is so complicated, so diverse and dynamic that control cannot just be handed over to the market because circumstances will always arise where bodies behave irrationally and not necessarily in their best interests. A market economy has the potential to flourish instantaneously but then a moment later everything can change, with changes a market economy may still operate reasonably well, however the controlling body, often a government or monarchy, can’t leave this down to chance, they have to intervene in order to ensure that the changing circumstances won’t tear apart an economy, they have to be ready to react.

So far the path I have taken has been logical; I introduced and explained the existence of the problem, I assessed its severity and nature, I described how it has been studied over the years and I briefly analysed the first solution put forward. At the end of the last paragraph I concluded that that particular solution is never fully implemented because controlling bodies need to intervene to help the economy function efficiently. I suggest therefore that you can likely see where the next step is heading: if controlling bodies know what’s best for the economy, why don’t they take complete control? This concept has been dubbed the command economy; in AS Economics the textbook tells us that a command economy is an economy where resources are state owned and also allocated centrally. Essentially it is the opposite of the market economy where the government has little to no control. It’s not uncommon for economies, in which the government has a very dominant position over the market, to be given bad press throughout history; for instance there are so many negative connotations associated with Stalin’s USSR (the closest example to a pure command economy on that scale that we’ve ever seen). Unlike the market economy there is no individual in particular who I would say developed the idea of a command economy, I understand that in Soviet Russia’s case it came about because Stalin needed to control the exact quantity and type of resources produced due to the upcoming war which he predicted. On the other hand I think one figure deserves reference whenever this topic is being discussed simply due to the fact that his name crops up wherever socialism is concerned, this is Milton Friedman. Milton Friedman founded the school of economic thought called Monetarism; he believed that the government can influence the performance of an economy by manipulating money supply; they have the potential to increase aggregate demand in an economy at the risk of stimulating inflation. Linking this to modern day Economics, I’m sure most people are aware of the Bank of England’s Monetary Policy Committee, they are responsible for setting the base interest rate and money supply in the UK, this is called monetary policy. Again considering the best example we’ve got of this economic system, another feature of the command economy in Soviet Russia was that goals could be set by the government for certain manufacturing firms, if these goals were not met the foremen may have to have paid with his life, many considered this dreadful from a human rights perspective but from a purely economic perspective it made way for rapid expansion of aggregate supply. Again Monetarism is a theory that many others have expanded on in a greater detail than I am possibly capable of, but I would like to make the assumption that the theory itself, the idea that governments can influence aggregate demand by controlling money supply in an economy, is completely accurate. So concluding this paragraph we have to discuss why there has never been a pure command economy (in Soviet Russia some of the smaller scale consumer goods industries operated without complete government control). Well there’s many reasons, for instance reducing consumer choice by deciding exactly what was going to be available to them could be seen as an infringement of human rights. Also there will always be some sort of time lag between when governments make a change in monetary policy and when the change itself actually has an effect, consequently the government have the predict the economic climate ahead into the future, predictions are full of uncertainty and so mistakes will be made, inconceivable events can occur and the economy can be thrown into crisis. The Bank of England MPC is constantly analysing trends and patterns in order to help them set the interest rate. After all this we come to the conclusion that an economy cannot be run solely by a government and it cannot be left completely to the market forces. Due to these facts all economies have to strike a balance between the two ultimatums and that is why every economy in the world can be given the same label (although their policies can vary drastically), we call them mixed economies and as the name suggests they try to take the best of both theories.

Now we finally arrive at the core of the AS level Economics syllabus; the whole course is taught about the workings of a mixed economy, with only brief reference to the command and market economies, because in practice the mixed economy is the only economy present in the real world. With fear of regurgitating all I have learnt in Economics over the past year I will try to briefly summarise the contents of the textbook; economists have a theoretical toolkit, there are a multitude of possible occurrences that can arise and economists have to be ready for all of them, the ‘budding young economists’ who I referenced in the first paragraph are taught all the responses they need, such as how to increase aggregate demand or supply, how governments deal with market failure and much more. John Maynard Keynes was arguably the second most influential economist of all time after Adam Smith; the ideas he produced and developed have been bundled into the term Keynesianism, one of his most famous works, The General Theory of Employment, Interest and Money is used as the basis for a lot of what we’re taught at A level Economics. The controlling body of a country will have a list of economic aims, there is a possibility that these can vary but they will often be quite similar, for example in the UK we have macroeconomic policy objectives; these objectives include low and stable inflation, sustainable and steady economic growth, low unemployment, satisfactory balance of payments, economic stability and a reasonable distribution of income. The governing body is made up of people, amongst these people will be economists and these economists will know the various strategies of fulfilling these objectives. After all this analysis of the history of the study of Economics we can finally come to some sort of conclusion; this is how the battle against the economic problem is being fought to this very day, there has never been an economy that hasn’t needed to be monitored and encouraged, we have to be constantly ready for whatever the world may throw at us and to do this we need to have our toolkit in hand, there is no single just a collection of responses.

I finally feel like I’m ready to come to a conclusion and unlike all the other logical steps I have taken, I would not suggest for a moment that this is the obvious option. In Economics there is a problem and because we have a lot of businesses and consumers in the same area who have this problem we get an economy. An economy is an unpredictable and remarkable phenomenon, it’s ever changing and methods of controlling it have been devised by some of the greatest minds throughout history. Economists today have to go into the world ready to tackle the problems their economy will inevitably place before them, they are therefore trained to a standard specification and they’ll be taught exactly how to respond to any given situation. I don’t believe I’m capable of trying to suggest a perfect system in which an economy could function with consistent economic efficiency, in the real world, without any deviation from a single theory, nor do I believe such a system will ever be devised. However at this point I’d like to go back to my original question; ‘What is the problem with Economics?’ At the beginning of this essay I stated that I believe Economics is the most important study in the world. I’m sure many people will disagree with me although I can justify this opinion; it directly affects the lives of current and future generations and it is at the heart of all consumer decisions, considering we are all consumers it must be beneficial to have at least some knowledge of it. Only now do I believe I can conclude what the problem with Economics really is; at A level we are only taught its applications and as useful as they are they’re not the fascinating component of the study. Many sixth form or college students don’t appreciate the subject because they don’t fully grasp its complexity, they are only aware of precisely what they need to know to pass their exams. My burning passion for the subject doesn’t stem from the textbook but from masterpieces such as Alfred Marshall’s Principles of Economics, or investigating Schumpeter’s Creative Destruction theory. I understand that it is more important that the adolescents, who will one day be in charge, learn how to run the country effectively, but on the other hand it is a terrible shame that many of them take their tests without little more than a glancing interest in Economics. If all they know is how to apply the theory given to them and they don’t have any idea of how to think for themselves, will we ever see the next Adam Smith? Over the course of this essay I have tried to explain how the subject has developed through history yet I put it to you that the vast majority of A level students would have little to no awareness or interest of the some of the names and concepts mentioned. This is the problem with Economics.

2 thoughts on “The Problem with Economics

  1. Reply M Singh Feb 6, 2014 3:44 pm

    An excellent piece! Oliver, I would like to know if you approve of the current A level Economics course or not? Also, could there be a better way of introducing a new subject to youngsters, what suggestions would you like to make if you had the option to alter the course?

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