Dollars and Sense: An Introduction to Economics

Dollars and Sense: An Introduction to Economics
by Marilu H. McCarty
(New York: Harper Collins 1994), seventh edition, 372 pp.

Rating: D

General Comments: This paperback text is written at a fairly sophisticated level and some students will probably struggle with it. The amount of space devoted to photographs and filler is low, which leaves a lot of space for teaching economics. Unfortunately, that space is not used well. Too often, the book labors to inculcate government solutions rather than instruct the student in the economic way of thinking. She also has errors and confused analysis on key economic issues.

Criterion 1: Costs and Prices—How Production is Determined

McCarty’s treatment of the economic fundamentals is generally good. She clearly explains the concepts of scarcity, specialization, opportunity cost, and profit and loss. One omission, however, is a definition of economics itself. Students ought to understand that the study of economics encompasses the whole range of purposeful human action and has applications not just to business and consumer decisions, but to all rational choices.

The author’s explanation of the "invisible hand" is much too limited. It fails to give the student a true understanding of the market’s ability to coordinate economic activity. Moreover, she accepts the outdated idea that if the free market is to work, "there must be perfect competition in the marketplace" (p. 32). That idea was popular 50 years ago, but few economists accept it today.

McCarty’s discussion of the price system is capable, but does not impress strongly on the student that economic efficiency begins with the market’s spontaneous adjustments to price changes. "So what if the market gets rid of surpluses quickly?" the students may wonder. They should learn that price is the key to helping us get the maximum benefit from limited resources.

The discussion of price controls is weak. McCarty writes that price controls "can prevent markets from movng to equilibrium." Sooner or later, price controls must interfere with market equilibrium and when that happens, there must be economically wasteful shortages or surpluses. Furthermore, she writes of natural gas price controls that they were occasioned by "voters’ preferences for fairness." This is economically naïve. Natural gas price controls were a means by which non-gas state politicians tried to curry favor with voters who naturally preferred cheaper fuel.

Criterion 2: Competition and Monopoly

McCarthy sets up perfect competition as the ideal market structure and criticizes "imperfectly competitive" markets as inefficient. She writes, "Resources allocated to packaging, advertising, and designing . . . might better be allocated to real production." This attack is nowhere balanced by any discussion of how consumers benefit from product variety, packaging and advertising. Everyone could choose to buy generic cereal, for example, and save money; since most consumers don’t, they must see some value in variety, advertising, and colorful packaging.

She also asserts that "gentleman’s agreements" often lead to "shared monopolies." That belief is common, but overlooks how hard it is to make such agreements last. Often these agreements are broken as soon as one of the "gentlemen" reaches a phone. The book also implies that it is easy to drive rivals out of business and form a monopoly. Many economists argue that it is competition that is durable and easy to maintain, and monopoly that is fragile, not the other way around.

The book’s antitrust section is poor. To say that the Sherman Act "has been primarily used against labor unions" (p. 102) is wildly untrue. A few, very early cases involved unions, but there have been none since 1914 when the Clayton Act exempted unions from antitrust actions. Worse is McCarty’s failure to consider the costs of antitrust. Scholars have long noted how the government’s Antitrust Division sees competition under constant threat and brings many suits that merely waste resources. Many economists now argue that both government and private antitrust suits often inhibit rather than protect competition. Unfortunately, the book conveys the impression that antitrust is all benefit and no cost. Finally, McCarty describes Standard Oil as a case of monopoly, even though the company always had many competitors.

Criterion 3: Comparative Economic Systems

McCarty almost ignores the subject of comparative systems. Only in the introduction, briefly, does the reader find any discussion of the economic problems with central planning. She writes, "You can imagine how difficult a command economic system would be in a modern, complex economy. It would be particularly difficult without computers for planning production and without rapid communication and transportation facilities for carrying out the production plan" (p. 10). This is very misleading. The Soviet Union had computers and fairly modern communication and transportation facilities, but suffered from massive inefficiency. Students never read a serious explanation of why central planning fails whenever and wherever it is tried.

Criterion 4: The Distribution of Income and Poverty

The book’s discussion of poverty and income distribution issues is marred by overblown rhetoric. For example, McCarty writes, "If a nation guarantees absolute freedom to pursue individual gain, it will ensure misery for those who are least able to succeed" (p. 292). This implies that the only way to assist people who cannot provide for themselves is through restrictions on the economic freedom of others, an idea that many economists would find debateable, if not absurd. The nearly absolute economic freedom of early America did not "ensure misery" for anyone. Statements like that, redolent of political campaign oratory, should be left out of teaching materials. They smack of propaganda, not honest presentation of fact.

McCarty makes much of the fact that income is very unequally distributed, but students cannot know what to think about that unless they learn that many people who begin life poor advance far up the income ladder, and that many other people fall in income. The rich don’t necessarily stay rich and the poor don’t necessarily stay poor. On the subject of poverty, McCarty seeks to pin the blame on discrimination: "A major cause of poverty is discrimination" (p. 295). This is a controversial theory that many economists reject. In competitive markets, employers, landlords, or other business decision-makers who decide to discriminate put themselves at a disadvantage with non-discriminators. Instead of a penetrating analysis of the economics of discrimination, the student gets only a blanket conclusion of doubtful accuracy.

The book discusses the Social Security system in conjunction with the distribution of income. McCarty’s presentation of the financial problems confronting Social Security is clear and correct, but when it comes to solutions, she looks only at adjustments to the status quo. She does not consider the possibility of phasing out Social Security and relying on individual savings—a major element of the current discussion about the possibility of following the lead of more than a dozen countries and privatizing government-sponsored retirement programs. Nor does she bring out any of the important economic consequences of Social Security.

Finally, the discussion of urban poverty is incomplete. She never explains that many cities have created climates that are very hostile to enterprise through high taxes, zoning, burdensome regulations, occupational licenses, and poor services.

Criterion 5: The Role of Government

McCarty’s book does not have a section specifically devoted to the role of government in the economy, but discussions of the major issues are included throughout the text. The subject of public goods is hardly raised at all. The closest the book comes to it is a box entitled "Letting Government Do It." She asserts: "We ask government to do for us what we cannot do for ourselves" (p. 210). Unfortunately, there is no discussion of what public goods are, why they pose a problem for the market, and what are the costs and trade-offs in government intervention.

Negative externalities are discussed under the section on economic growth, although this problem is certainly not confined to growing economies. This section is badly flawed with dubious pronouncements on the environment such as, "The world as a whole is threatened by the greenhouse effect. . . ." (p. 325). There is much dispute among scientists over the existence of the greenhouse effect, and what its impact is if it exists.

The book treats the problem of economic instability in Keynesian fashion: The reason for economic cycles is that spending is sometimes inadequate to maintain full employment. McCarty presents Keynesian theory in much detail, but with no critical analysis. She also gives no alternative explanations for the business cycle. There is a brief discussion of supply-side theory, but not so much as an alternative theory of the business cycle as a critique of the exclusive focus on demand management policies. Even here, she gives the false impression that supply-side tax cuts were harmful, and that the nation’s economic recovery was the result of later tax increases. Many economists dispute this notion, but you wouldn’t know it from the text.

The book leaves the student with the belief that market economies are inherently unstable and that government must solve that problem in some way. Students never learn that many economists regard this conclusion as erroneous and contend that the government itself is the source of economic instability. Not only does McCarty fail to teach economic analysis, she propounds as truth ideas that have been vigorously attacked for decades.

Criterion 6: Public Choice

"Public Choice" does not appear in the index, nor do the basic public choice concepts appear much in the book. The problem of special interest groups is adverted to when the author says, "What is politically desirable for a particular group may be undesirable for the economy as a whole" (p. 208). This statement, however, doesn’t help the student see why interest groups are so successful in their quest for special favors from government. Generally, the book presents "government" as an abstraction that pursues "the public interest" rather than as a collection of individuals who are as self-interested as people in the private sector.

Criterion 7: The Role of the Entrepreneur

Entrepreneurship is barely touched upon. McCarty only briefly mentions in the introduction the role of the entrepreneur and the need and reward for risk-taking. Nowhere does she describe how important entrepreneurs are to economic progress. Nor does the student learn how entrepreneurship can be stifled by taxes and regulations.

Criterion 8: Taxation

McCarty begins by pointing out that taxation necessarily means transferring resources from the private to the public sector. "Through taxes, government takes purchasing power away from spending for private purposes and spends it instead for public purposes—for producing goods and services to be used by the community as a whole" (p. 192). This is misleading: Taxes are often spent for things that benefit only small segments of the community, and spending for "private purposes" often creates benefits for many people.

The book identifies the various kinds of taxes collected, but never gives a serious discussion of the economics of taxation, particularly its costs and impact on incentives. The author’s comments on the Reagan tax cuts are very biased. She writes, "Income tax cuts favored high-income taxpayers, whose work incentives were already high at the expense of low-income taxpayers, who had to reduce their savings to maintain their former standard of living" (p. 207). This sounds more like campaign rhetoric than serious economics. Good economists do not ask whom a tax change "favored," but the positive question of what the consequences were. In any case, when the marginal income tax rates for high-income taxpayers were reduced from 70 to 28 percent, that did not increase taxes for low-income tax payers. In fact, the Reagan tax cuts dropped many low-income taxpayers from having to pay income taxes at all. Also, the revenue to the government after the Reagan tax cuts sharply increased because entrepreneurs had new incentives to invest in industry instead of hiding their savings in tax-exempt bonds.

Criterion 9: The Business Cycle

McCarty’s one-sided treatment of the business cycle is covered in Criterion 5. Instead of wasting space on a box on the "sunspot theory" of the business cycle, she could have presented to the student the Austrian and Monetarist theories of the business cycle and criticisms of the Keynesian approach.

Criterion 10: Wages, Unions, and Unemployment

The book’s explanation of wage rates as a standard supply and demand price phenomenon is good, and the important implication that worker compensation is directly related to productivity is clearly made. Also good is the discussion of minimum wage laws; McCarty explains why they reduce employment opportunities for low-skilled workers.

The treatment of labor unions is also reasonably good. McCarty notes that while collective bargaining may raise wages for union workers, it also prevents many willing workers from being able to find ways to enter the labor market. That has led to job losses in unionized industries. She also encourages students toward skepticism about the claim that wage and benefit increases are necessarily due to union action: Market conditions often compel firms to raise wages to attract and retain good employees. She should also have said that capital investment raises productivity, and that is the ultimate source of rising wages.

On the subject of unemployment, McCarty correctly notes the various types of unemployment and that some amount of unemployment is natural and unavoidable. However, there are two weaknesses in this section. First, government programs to deal with unemployment are mentioned, but not analyzed. What are the effects of unemployment insurance; of government job training programs? They are not discussed. Second, the book advances the "Phillips Curve" notion that there is an inevitable trade-off between inflation and unemployment. Many economists reject this view and its policy implication, that we can have low unemployment only at the cost of inflation. That idea should not be presented to students as truth.

Criterion 11: Trade and Tariffs

McCarty’s discussion of trade is sound, but it would have been better if she had explained that "international" trade is not "trade between nations" but trade between individuals or firms located in different nations. She also fails to confront the popular misconception that a "negative trade balance" is something to worry about. The book’s treatment of the effects of trade restraints is also good, including non-tariff barriers and export subsidies. The weakest spot in the analysis of trade is the overly charitable view of the "infant industry" argument. Many trade scholars have cast doubt upon the assumptions underlying this argument, but the student is led to believe that planners can use tariffs to cultivate new industries.

Criterion 12: Money and Banking

The book’s handling of money and banking is mixed—some very good points, but some significant errors and omissions, too.

On the functions and characteristics of money, the reasons for the use of money, and the development of banking, the book is good, if somewhat brief. That money is a creation of the market, however, is an important insight that is not brought to the student’s attention. McCarty discusses the problem of inflation from overissuing bank notes and from "wildcat" banking, but never mentions either the role of government policy in encouraging unsound banking, or the ways market institutions (such as banknote reporters) have minimized the harm.

On the establishment of the Federal Reserve system, McCarty writes that, after the Panic of 1907, "voters finally began to support the idea of a strong national banking system." The push for a central banking system, however, did not come from "voters," but from a few large bankers who saw advantages in having a central bank to regulate the banking system and act as a lender of last resort. This is another manifestation of the book’s lack of public choice analysis.

The book’s treatment of the S&L bailout is misleading. McCarty portrays the deregulation of S&Ls as the cause of the debacle, but many economists have argued strongly that S&Ls were doomed in any event; their very existence was due to unwise regulation in the first place. Moreover, the author fails to discuss the role of government deposit insurance. She writes that S&Ls are "important to the health of the nation’s housing industry" (p. 221), but this argument is hard to defend. There has never been a need for government to encourage lending institutions specifically geared toward the housing industry, any more than there is a need for lending institutions that might concentrate on auto loans. The capital market allocates capital wherever it does the most good, but McCarty does not encourage the student to think through the way the market works.