Economics: Institutions and Analysis

Economics: Institutions and Analysis
by Gerson Antell and Walter Harris
(New York: Amsco School Publications, 1997), third edition, 649 pp.

Rating: D

General comments: This book (EIA) is a hefty paperback, printed in black and white with few pictures. It is sober both in tone and appearance. The writing is generally clear and neither too advanced nor too simple for most students. On some topics, the book is very good, concentrating on teaching the economic way of thinking. Unfortunately, on many controversial policy issues, the authors stop being even-handed and provide their own conclusions as unchallenged truth. On some issues, such as antitrust laws, the authors seem confused and unaware how history affects their argument.

Criterion 1: Costs and Prices—How Production is Determined

In its treatment of "the basics," EIA is very good. The authors take the student carefully through scarcity, choice, opportunity cost, the price system, allocation of resources, consumer sovereignty, marginal analysis, and other foundational matters. The early chapters are solid and get the student off to an excellent start.

Criterion 2: Competition and Monopoly

On the subjects of competition and monopoly, the book begins to falter. While the authors do not themselves disparage market structures that are not purely competitive, they present a feature on Joan Robinson [xx—who?] that does. Readers are told that "many economists disagree with her conclusions"(which call for government intervention to correct markets that are not perfectly competitive). After reading Robinson’s call for vigorous national regulation to prevent the "abuses" of the free market, students ought to read some counter-arguments, but sadly none are provided here.

EIA properly analyzes the economic effects of monopoly, explaining that monopolists rationally find their profit-maximizing price (a point the authors later forget when discussing inflation). The weakness in the book’s treatment of monopolies and cartels is that it fails to consider how hard it is to establish a monopoly or cartel in a genuinely free market. The authors repeat the conventional wisdom that Standard Oil secured a virtual monopoly by driving competitors out of business through predatory pricing, but this charge was thoroughly disproven in a celebrated October 1958 article in the Journal of Law and Economics by John McGee. More recent scholarship (e.g., the 1996 book by Robert Bradley, Oil, Gas, & Government) has confirmed McGee’s conclusions. Even socialist historian Gabriel Kolko in the 1985 reissue of his classic, The Triumph of Conservatism, paints a very different picture of Rockefeller and Standard Oil from EIA.

The authors also charge Standard Oil with securing low railroad rates. Here, they could have encouraged the economic way of thinking by asking students to think about the economic reasons for and consequences of Standard’s ability to negotiate low freight rates. Several noted scholars, including D. T. Armentano in his 1996 book, Antitrust Policy: Anatomy of a Policy Failure, have written extensively on these points, but the book shows no awareness of their work. Nor do the authors note that Standard Oil (which always had dozens of competitors in the U.S. and abroad) steadily lowered its prices and improved the quality of its product over a span of decades.

The book’s treatment of antitrust is, overall, quite poor. The student reads the familiar arguments for antitrust action by the government (e. g. monopolies are wasteful, insensitive to consumers, and they threaten our political institutions). The authors portray antitrust laws as an easy, effective remedy. The benefits of antitrust are simply assumed, and the costs—useless litigation, the deterring of competitive behavior—are ignored. The economics of antitrust is a hotly debated field, but one would scarcely know it from this book.

The authors say nothing about the role of the government in creating and protecting monopolies and stifling competition, which is where many economists think the real problem lies.

On the subject of mergers, however, the book is sound, and even makes the important point that much of the corporate downsizing of recent years has occurred because of previous mergers that had produced inefficient economic combinations.

Criterion 3: Comparative Economic Systems

EIA’s section on comparative economic systems begins with several pages on the theories of Karl Marx, presented without criticism. For instance, are there reasons to disbelieve his contention that profits are really value stolen from the workers? Yes, and discussing them would sharpen the student’s economic thinking ability. When the authors finally get around to asking, "Why was Marx wrong?" the answer they give is that governments passed laws to help consumers and workers. That answer says nothing about the internal logic of Marxism and greatly overstates the role of the state in quelling revolutionary fervor. Contrary to Marx, real wages rose steadily long before the passage of any "pro-labor" legislation in nations with free economies. One reason Marx was wrong was that he did not understand that the benefits of rising productivity cannot be confined just to the owners of capital.

In discussing the failure of the Soviet economic system, the authors point out that the absence of a price system made it impossible for economic planners to allocate resources efficiently, leading to shortages and surpluses. That is a vital point. They should also have discussed the problems of poor quality goods when competition and profits are not allowed. The student learns that people living under socialist regimes had to wait in long queues to make purchases, but does not get a full idea of the privation suffered by ordinary people and the low standard of living they had compared with ordinary people living in market economies.

The Swedish "middle way" is given a very favorable presentation ("highly successful from the 1930s to the 1990s," they write), but this conveys the misleading impression that Sweden has enjoyed a prosperous economy because of its welfare system. Sweden’s stagnating economy, its high level of unemployment, its alcoholism and suicide, and its highly authoritarian state contrast sharply with the book’s glowing picture of that country. Students would have been better served by a serious analysis of the economic effects of welfare and government economic control.

Criterion 4: The Distribution of Income and Poverty

The book’s section on income inequality and poverty is weak because it focuses on polemics, not economic analysis.

The discussion of poverty begins with the Census Bureau data on the percentage of the population living below the poverty line. The authors do not mention that these figures are not adjusted for in-kind transfers [xx—such as food stamps?]. Nor do they mention that there is a high degree of income mobility in the U.S. Those who are in the lowest quintile while young often advance by the time they have reached middle age. Failing to bring out these points makes the "poverty problem" seem much greater than it is. An accompanying "mini-reading" entitled "The Growing Problem of Homelessness" on p. 469 reinforces the impression that the authors are interested more in proselytizing than in instilling an economic way of thinking. Despite the title, nothing in the reading says that homelessness is, in fact, growing. The book’s discussion of public assistance programs fails to go into the effects of those programs; nor is there any analysis of the costs and benefits of government job training and public works programs.

Worse still is the book’s assertion that "discrimination has been a major cause of poverty" (p. 476). This gives the authors a springboard for a brief discussion of affirmative action programs that considers intentions rather than results. Both the premise that labor market discrimination is "a major cause of poverty" and the conclusion that affirmative action is the solution are highly contested points in the economics literature. But the student only hears one side of the issue.

The treatment of minimum wage laws is only slightly better. The student at least learns that there is debate over the impact of minimum wage laws, but the arguments are threadbare.

The book proceeds to a lengthy discussion of health care reform. The analysis is not bad, pointing out that health insurance encourages unnecessary spending on health care. Unfortunately, the possible reforms that are then discussed are all interventionist. One is to mandate that insurance companies cover everyone who applies. The authors say, "Insurance companies warn that forcing them to insure poor-risk individuals will cause insurance premiums in general to increase dramatically. Supporters reply that insurance companies overestimate the added costs. Moreover, they say, the moral issue (the belief that it is unfair to deny any individual insurance protection) overrides economics of costs: Consumers should be willing to pay higher premiums so that more people are covered" (p. 489). Such polemical discussion does little to improve the student’s ability to analyze.

The section continues on through "Play-or-Pay," compulsory health insurance and nationalization. Tellingly, there is no discussion at all of reforms that move toward the market and individual choice, such as medical savings accounts. Even though government intervention in medical care is already substantial and has been shown to have fostered many costly distortions in the market for health care, the authors would have the student believe that problems that exist must be due to free markets. The message to students in this book is that improvements in our vastly complicated health care system can only come through more government intervention.

Criterion 5: The Role of Government

Antell and Harris explain the "public goods" problem very briefly, giving police services and street lamps as examples. They correctly state that many things that government provides are not public goods, but fail to explore the well-known inefficiencies associated with government-provided goods and services, except to note that "some people argue that the government already provides too much." This does not help the student understand the economics of government-provided goods and services.

The authors give more space to the problem of externalities, but still do not engage the student in any economic analysis. They deal with the issue of pollution without examining the economic trade-offs that are always involved in such issues. Economic thinking is largely a matter of analyzing competing options, but here the authors fail to encourage the student to look at the problem this way.

In similar fashion, EIA argues that government should redistribute income and maintain economic stability. The authors devote several pages to a section discussing "changing attitudes toward the role of government" (p. 257), which posits that the vast expansion of government since the 1930s has been due to public demand. The authors fail to note that interest group politics is almost always behind new laws and programs. The authors then present a list of programs created during President Lyndon Johnson’s "Great Society" of the 1960s. Again, the student reads only about the good intentions of these programs, and nothing about their actual results. Failure to acknowledge the mountain of scholarly criticism of these programs suggests that the authors are more interested in advancing their personal ideology than sound economics.

Finally, the discussion of Social Security is weak and outdated. The student does not learn about the incidence of Social Security taxes; that the Social Security Trust Fund contains no actual wealth, but only government debt obligations; that Social Security has any adverse impact on capital formation; or that it deters many older people who might otherwise choose to work from doing so. The discussion of reform proposals is limited to those that would raise Social Security taxes or lower the level of benefits it bestows. There is nothing on the widespread debate over privatization through individual investment accounts. The student, in short, will learn almost nothing from this book’s treatment of Social Security that will equip him to deal with one of the most important policy debates of our day.

Criterion 6: Public Choice

In yet another glaring omission, the concepts of public choice theory never appear in this book. The closest the authors come to mentioning the incentives of political decision-makers is to say that "political considerations" may make it difficult to implement fiscal policy in an ideal way. Students learn nothing about the impact of voter ignorance, interest group pressures, or the self-interest of politicians and bureaucrats. This omission leads to a persistent bias toward government action.

Criterion 7: Entrepreneurship

EIA includes a brief discussion of entrepreneurship, defining the term and explaining that the motivation for entrepreneurial activity is profit. There is also a short case study on one successful entrepreneur. What is missing is any sense that entrepreneurs are important in promoting prosperity, or how government policy can deter it.

Criterion 8: Taxation

The authors provide an extensive discussion of the various reasons why taxes are levied and the different types of taxes. Their treatment of the economics of taxation, however, is weak.

Readers are reminded that, like all other activities, there is an opportunity cost to taxation—the funds collected by the government cannot then be used by individuals and firms for their purposes. However, the book leaves the impression, especially in its discussion of estate and gift taxes, that money that isn’t taxed is somehow lost to society. Yet, this is the money that starts businesses, builds buildings and homes and pays for education. The correct point to emphasize is that the government uses money in certain ways, and the general economy puts money to use in other ways.

The book’s treatment of the personal income tax only lightly criticizes the current system. "Some critics of the personal income tax say that it is harmful to the economy because it lacks enough deductions, exemptions, and credits that would promote individual investments in private enterprise" (p. 283). The major criticism of the income tax, however, is not that it needs more deductions, exemptions and credits, but that its enormous compliance costs and high rates waste resources and deter saving and investment at the margin.

The discussion of the corporate income tax is also weak. The authors do note as a "criticism" of this tax that "Money taken by government might have been used by corporations to expand their production" (p. 283). This, however, is not merely a "criticism." It is an economic fact, one whose implications the authors fail to explore. They also call attention to the incidence problem [xx], saying that some or all of the corporate income tax is passed on to consumers. But this oversimplifies the problem. Economists have been arguing for decades over the distribution of the corporate income tax and the extent to which it is passed on to consumers. A key point the authors fail to make is that businesses cannot be taxed—that all taxes on business ultimately are borne by workers and consumers. A very dubious point they make instead is that corporate taxes are linked to inflation, though inflation is a monetary not a taxation phenomenon.

When it comes to discussion of the Social Security tax, the authors are silent on the incidence problem [??xx]. They repeat the often-criticized view that "Wage earners and their employers both pay the same percentage of the worker’s salary into the Social Security system" (p. 285). Economists who have studied the matter argue that employers factor the cost of payroll taxes into the gross compensation paid to workers. Workers do not see the full impact of the Social Security tax, but it is one that they bear entirely. Unfortunately, readers of this book do not learn this, nor do they learn the more general point that businesses make marginal adjustments to offset costs mandated by government.

Finally, the issue box on the underground economy misses the vital point that much of the economic activity conducted "underground" would not take place but for the impact of taxation on prices. The authors mention the possibility of "much lower" taxes for the populace if only the underground economy could be taxed. Instead of engaging in real economic analysis of the costs and benefits of attempting to tax "off the books" transactions, the authors merely say to the student, "What do you think should be done?"

Criterion 9: The Business Cycle

Perhaps the worst of all the major sections of the book is its treatment of the business cycle. The students are presented with the discredited Keynesian view with almost no hint of skepticism. They never learn any of the devastating criticism to which it has been subjected for more than fifty years.

First, on the causes of economic fluctuations, the authors squander space on the long-refuted notion that innovation can cause business cycles. They ignore the Austrian and Monetarist arguments that erratic management of the money supply leads to economic maladjustments that must later be rectified in a period of recession. In analyzing the reasons for cycles, the authors have tunnel vision. Their ignorance of more reliable and modern scholarship is appalling.

The Great Depression is given a brief discussion that asks many questions, but fails to describe the government blunders that helped create and perpetuate the crisis. Furthermore, the authors present the Keynesian aggregate demand analysis [xx?] in an uncritical way. Many economists have ridiculed the components of this analysis (the "multiplier," the "accelerator," the "paradox of thrift," and the idea that spending determines national income), but the reader is led to believe that the Keynesian theory is just as true as the law of demand. The debate over Say’s Law is breezily dismissed in a single sentence: "In the 1930s, however, many people concluded that Say’s Law simply did not work" (p. 405). But was that conclusion correct? Many economists have argued that it was not—see, for example, Thomas Sowell’s The Rehabilitation of Say’s Law.

Supply-side theory is presented as a form of economic stabilization policy, but supply-siders have argued that their policies will increase economic growth over the long-run. What’s worse is that the authors repeat some of the emotional attacks against supply-side theory ("would only enrich the wealthy," "indifferent to the needs of millions sorely in need of government assistance") without any rebuttal or analysis for the students. Some students may wonder if the authors’ attachment to warfare slogans has blinded them from seeing evidence that doesn’t fit their particular point of view.

Criterion 10: Wages, Unions, and Unemployment

Much of the material on the labor market in the book is descriptive rather than analytical, with several pages devoted to labor force trends. When the authors finally get to wages and the market for labor, they competently explain that worker compensation is determined by supply and demand.

Unfortunately, EIA says nothing on the effects of minimum wage laws or labor market restrictions. It correctly explains the different kinds of unemployment, but does not go into the effects of government programs on unemployment.

Regarding labor unions, the book correctly notes that unions cannot repeal the laws of economics. Unions, therefore, can affect worker compensation only marginally. Many pages are spent in describing the goals of unions, but there is little economic analysis of the effects of unions. Moreover, the union objectives are presented as if the welfare of workers was their sole concern. The authors never raise the possibility that union officials have interests that differ from the interests of all the workers they represent; nor do they analyze the adverse effects that the realization of union aims can have on other workers and on productivity.

Criterion 11: Trade and Tariffs

The authors accurately explain the fundamentals of international trade. Missing, however, is a discussion of the erroneous belief that dire economic consequences arise from trade deficits. The arguments for and against trade restrictions are presented, but not critically examined. It would be better to consider each protectionist argument, and show the student how a good economist thinks through the problem.

Criterion 12: Money and Banking

EIA provides a good explanation of the function of money and implies that money is a creation of the market, not the state. The chapter, however, assumes that government provision and regulation of money is the only imaginable state of affairs. Nothing encourages the student to think about the possibility that problems can arise as a result of government officials being in charge of the monetary system.

The book does include a section on the gold standard, but the authors make the dubious statement that it failed because of the "inability of nations to manage their money supply" (p. 543). However, a major virtue of the gold standard was that it imposed an automatic discipline on national monetary policy. Students ought to learn that the gold standard facilitated price stability and international trade. Since a strict gold standard was largely abandoned with the creation of the Federal Reserve System in 1913, the U. S. has fallen victim to a great depression, at least nine recessions, and an uninterrupted erosion of the value of the dollar—hardly a compelling case for government’s monetary management.

In discussing the causes of inflation, EIA covers both demand-pull and cost-push as if they were equally valid theories [xx]. Many economists maintain that cost-push inflation is an impossibility because there cannot be a sustained, general increase in prices in the absence of an increase in the money supply. As Milton Friedman says, inflation is always and everywhere a monetary phenomenon. The cost-push inflation idea is rooted in one of the most widespread of economic misconceptions, namely that costs determine prices.

The book’s treatment of banks correctly explains their purposes and operations, but is weak on the effects of government regulation of capital markets and financial institutions. The reader hears nothing on the tendency of federal deposit insurance to encourage unsound lending. The discussion of the S&L crisis is similarly deficient because the authors never make the link between the vast losses and federal policy.

The functions of the Federal Reserve are accurately described, but the authors do not delve into such interesting questions as the responsibility of the Fed for the Great Depression and subsequent economic downturns, and whether a fixed rule or discretionary monetary policy is preferable.