Economics in Our Times

Economics in Our Times
by Roger A. Arnold
(St. Paul, West Publishing Co., 1995), 539 pp.

Rating: A-

General Comments: This is an attractive hardbound book. It is colorful, but does not devote an excessive amount of space to photographs and other fillers. The focus of Arnold’s book is clear—teaching students to "think like an economist," and it succeeds very well in that task. It is peppered with "Thinking Like an Economist" boxes and question-answer segments that show how economists think. As the author writes, "What is different about economics is not so much what is studied, but how it is studied. Through your study of economics, you will acquire new tools, concepts, and ways of thinking" (p. 4). The writing is good, the explanations clear, and the illustrations engaging. The only major disappointment is that in most chapters, the book wastes space on merely descriptive material that could instead have been used for more wide-ranging and through economic analysis.

Criterion 1: Costs and Prices—How Production is Determined

Arnold’s book is excellent on the fundamentals of economic analysis. His definition of economics is broad: "Economics is the science that studies the choices of people trying to satisfy their wants in a world of scarcity" (p. 16). Almost immediately, he starts to encourage the economic way of thinking with good discussions of opportunity costs and unintended results, two of the most important components of the economist’s mental toolkit.

The book’s presentation and its chief implication (the need to make choices) is very clear. Arnold shows very nicely the connection between scarcity, choice, and opportunity cost.

Similarly, the book’s treatment of supply, demand, and the price system is excellent. He capably explains the dynamics of the free market and the crucial point that prices serve as the means for allocating scarce goods and resources. For the benefit of those who might be inclined to question the morality of price, Arnold analyzes possible alternative rationing mechanisms, including "need," and notes the serious drawbacks each would entail. In the accompanying "Thinking Like an Economist" box, he writes, "An economist is not content to sit and listen to a person say that he or she dislikes price as a rationing device. The economist quickly thinks, ‘If not price as a rationing device, then what?’" (p. 100).

The price system coordinates consumer and producer behavior, Arnold notes, and profits are essential for guiding production to the most highly desired uses. The profile of Adam Smith is good not only for its introduction of Smith’s views on free trade and limited government, but also for making the point that to be pro-free enterprise is not the same thing as being pro-business.

Criterion 2: Competition and Monopoly

Arnold clearly explains the four models of market structure, but unfortunately does not spend enough time in the analysis of the decision-making implications of doing business under each. For example, how would a monopolist decide upon the profit-maximizing price? More analysis here would have been useful.

A point that the author makes strongly is that monopolies rarely thrive in the absence of governmental protection against new entrants. In an "Analyzing Primary Sources" feature, he quotes from a work on Robert Fulton, saying "it is very difficult to establish or sustain a monopoly without government patents, licensing, tariffs, or regulations to keep out competition" (p. 156). Fulton’s story makes the point nicely, but more analysis would have strengthened it. Except for Fulton’s efforts to secure government protection against competition, the book lacks references to Standard Oil, Alcoa, IBM, and other key historical cases.

A weakness in the book is its brief, descriptive treatment of antitrust law and enforcement. Arnold describes the Sherman Act, but spends little time analyzing its effects. The student does read that "Many economists believe that, rather than preserving and strengthening competition, the Robinson-Patman Act limited it" (p. 202). Quite true, but many scholars have made the same point about antitrust law generally. The book would have been improved by incorporating a discussion of the way that antitrust laws (and many other laws) have unintended consequences that run contrary to their stated objectives.

Criterion 3: Comparative Economic Systems

Arnold provides an excellent analysis of the consequences of adopting different economic systems. Besides covering the customary points on key differences in the ways an economy can be organized to answer the basic economic needs, he includes an analysis of how different mindsets incline a person toward a preference for capitalism or socialism, following Thomas Sowell’s work.

As to the production of wealth and innovation, Arnold observes that most of the material goods that make life easier and more enjoyable are products of free-enterprise economies. The student who reads between the lines will see the reasons why command economies necessarily stifle innovation, but this point ought to have been made very explicit.

The book is exceptionally good at explaining the inherent inefficiency in central economic planning that arises from the absence of a price system and profit motive—one of the great consensus truths of our time and one that fully illuminates the vast disparities in living standards between free and unfree economies. Arnold also explores the difficulties involved in making the transition from socialism to capitalism.

Another valuable section of the book is the debate over "industrial policy." Arnold takes the student through an economist’s questioning of the popular notion that some government planning (as in the case of Japan’s MITI) can lead to increased prosperity. Among other reasons for skepticism, Arnold states that we should doubt that government officials are "smart enough to know which industries will be the industries of the future. They shouldn’t try to impose their uninformed guesses about the future on society" (p. 459). The recent collapse of Asia’s state-managed markets and industrial policy provides ample evidence that Arnold’s perspective is correct.

Criterion 4: The Distribution of Income and Poverty

Arnold takes an analytical approach to income distribution and poverty. He explains that poverty has several causes, including governmental impediments to self-improvement. Here, the book strongly encourages the student to focus not on the stated intentions of laws and programs, but rather on their effects.

The book’s discussion of the unintended effects of welfare programs is very good. For example, Arnold shows the impact of high implicit marginal tax rates on the incentive for welfare recipients for work. He describes at length two alternatives to welfare, the negative income tax and the free-market policy of eliminating obstacles to self-improvement. Finally, Arnold explores the unintended consequences of Medicare and Medicaid in driving up the cost of medical care.

Criterion 5: The Role of Government

The author begins his discussion of the role of government with a rarely considered but important point: that a free-market economy requires a mechanism for the enforcement of contracts: "Without government to enforce contracts, the risk of going into business would be too great for many people" (p. 48). He then continues with the public goods argument. His definition and explanation are clear, but he fails to make the point that many of the goods government now provides are not public goods at all (such as corporate welfare).

The book also has a good treatment of "negative externalities"—spillover effects from a transaction that affect third parties. Arnold examines pollution as a problem of trade-offs, and asks pertinent questions, such as, "Why is there air and water pollution, but not front-yard pollution?" Here, the author does an excellent job of showing that government action to deal with negative externalities may impose costs far in excess of benefits and have adverse, unintended consequences.

On the other side of the coin, the author chooses a dubious example of positive externalities, education. It is true that education may create positive externalities (free benefits for others), but it does not follow that individuals will systematically underinvest in education simply because some benefits may spill over to others. Furthermore, the proposed "solution" of government-provided education deserves much more discussion than just asking the student, "What do you think?"

Criterion 6: Public Choice

Given that Arnold was a student of Nobel Prize-winning economist James Buchanan, acknowledged as a founder of the public choice school, the absence of a concentrated presentation of public choice theory is surprising. To be sure, there are hints of public choice analysis scattered throughout the book, but only that. On p. 406, for example, Arnold includes a "Case Study" on economic growth and special interest groups, but this would have had more impact if he had explained why special interest groups so often triumph in the political arena. Likewise, a "Thinking Like an Economist" box on p. 387 states, "There is sometimes tension between economics and politics. The economist knows that politics may often be a stronger force than economics." True, but a section on public choice theory would have helped the student to better understand why.

Criterion 7: The Role of the Entrepreneur

Arnold tells the reader that an entrepreneur is someone who has a special talent for searching out and taking advantage of new business opportunities and developing new products and ways of doing things. He explains further that the entrepreneur is interested in his own gain, but if he is to be successful, he has to please large numbers of people. The book provides several examples, giving the student both a theoretical and a "real world" understanding of this important topic.

The treatment of entrepreneurship would have been stronger, however, if the author had stressed the high risks involved. Most new products and businesses fail the test of the market. Investors know that, and will risk their capital only because of the high profits that accrue from those ventures that succeed. Arnold should have stressed the risk-reward connection. He also should have let the student know that entrepreneurship is not something that can be taken for granted; burdensome taxes and regulations can easily stifle it.

Criterion 8: Taxation

Arnold describes the various types of taxes, but he should have done more analysis of the economic effects of taxation. For one thing, there is no discussion of the problem of tax incidence, i.e. how different groups are affected by particular taxes. Neither with regard to the corporate income tax nor Social Security is there any suggestion that the party writing the check to the government may not be the party that actually bears the burden of the tax. This is an important omission. Thinking about the problem of tax incidence is good practice for the student. Also, the section on taxation would have been better with an analysis of the ways taxation can change incentives and divert resources from other uses.

Criterion 9: The Business Cycle

Perhaps the most serious weakness in the book is the absence of a focused discussion aimed at answering the question: "What causes economic fluctuations?" The closest the book comes is an "Analyzing Primary Sources" feature containing a number of short quotations relating to the subject of the business cycle (pp. 316-17). Unfortunately, this does not give the student much guidance. There are a few glimpses into what different schools of thought have to say—for example that Keynesians blame economic downturns on "stickiness" in wages and prices (p.357) and Monetarists point to erratic monetary policy (p.366)—but there is no cohesive, well-developed treatment of this important issue.

Arnold should have had a few pages on the famous controversy between Keynes—who believed that during a depression, government was needed to intervene to create jobs—and the classical economists over Say’s Law, which said that supply created its own demand without government involvement. Arnold’s text would also have benefited from a description of the major non-Keynesian theories on the business cycle. However, the book is solid in describing how hard it is to manage the economy through fiscal and monetary policy.

Criterion 10: Wages, Unions, and Unemployment

Supply and demand, the author shows, explains the price of labor (wages), just as it explains the price of other resources. Missing, however, is a discussion of the connection between a worker’s wages and his productivity.

Arnold does well explaining the effects of minimum wage laws, but he gives no economic analysis of anti-discrimination laws. The latter are mentioned, but Arnold does not delve into the subjects of discrimination in labor markets and the consequences of trying to solve this perceived problem through "affirmative action."

On the subject of labor unions, the book is more descriptive than analytical. Several pages are devoted to a history of labor unions and the laws affecting labor-management relations. Eventually the book turns to an analysis of the economics of unions and the author demonstrates that there are secondary effects of union strikes and wage gains. The analysis is correct, but the student would have been better served with a more wide-ranging investigation.

The book discusses unemployment by dividing it into the traditional categories (frictional, structural, and cyclical) and Arnold does a good job of explaining why there must always be some unemployment in a free economy. Unfortunately, he says nothing about government programs to deal with unemployment.

Criterion 11: Trade and Tariffs

Arnold’s discussion of trade is excellent, beginning with his reminder to students that "international trade" is really no different from other trade: It is one individual or firm trading with another who happens to be on the other side of a national border. His explanation of comparative advantage and the economic benefits of specialization is very clear, but he needs a discussion of trade imbalances.

Arnold does a fine job of analyzing the effects of and arguments for trade restraints: national defense, infant industry, dumping, low foreign wages and tit-for-tat arguments. He shows the weakness in each, particularly in getting the student to penetrate through simple slogans and emotional appeals. Given the importance of the debate over trade policy in the U.S., Arnold should perhaps have provided a deeper analysis. Single paragraphs are not enough to get very far into these arguments.

Criterion 12: Money and Banking

The book’s discussion of the fundamentals of money is outstanding. Arnold shows how money developed because it suited the needs of traders in the market. Money, Arnold explains, like other market phenomena, was an unintended consequence of self-interested actions. In addition to covering the functions of money, the book goes into related matters, such as Gresham’s Law. What is missing is a discussion of the reasons for and consequences of the nation’s abandonment of the gold standard.

The book says very little on the origins of the Federal Reserve System except to quote a passage from the Federal Reserve Act. How the Fed operates and its fallibility is brought out in a "case study" on its role in the Great Depression. Unfortunately, Arnold fails to bring out the key point that poor Fed policy during the 1920s and early 1930s helped trigger the Great Depression. There is also a case study (pp. 290-91) on the S&L bailout that argues against the popular notion that the great losses were caused by dishonest people running S&Ls, arguing instead that federal regulation had created a situation rife with bad incentives.

On the subject of inflation, the book fails to mention the view of Milton Friedman and many other economists that inflation is always a monetary phenomenon. In one of the very few questionable assertions in the book, Arnold states that inflation can have either demand-side or supply-side causes, citing the possibility of a drought that lowers agricultural output as an example of the latter. But many economists would counter that rising prices in one sector of the economy does not, and in the absence of an increase in the supply of money, cannot lead to rising prices generally.