Applying Economic Principles

Applying Economic Principles
by Sanford D. Gordon and Alan Stafford,
(New York: Glencoe, 1994), 480 pp.

Rating: F

General comments: This is an attractive book with many color photos and diagrams. In its 480 pages, however, it teaches little about economics. The book devotes so much space to photos, "personal narratives" that seldom have much instructive value, and to current issue "boxes" that are too sketchy to help the student understand the issue, that what is left is a very threadbare treatment of economic principles. At many important points, the authors provide the student with nothing but government solutions to policy issues. Its conclusions have sometimes been outdated for over two generations, and in one case for over two centuries. The book fails to teach the student how to think like an economist.

Criterion 1: Costs and Prices—How Production is Determined

The book begins with a limited definition of economics as "the study of the decisions involved in producing, distributing, and consuming goods and services" (p. 5). The authors then explain the role of prices and profits in the allocation of resources, but not always clearly. Consider, for example, this sentence: "The allocation of resources in capitalism is efficient because resources tend to be attracted to the most profitable firms." Unfortunately, the student is not told just what "efficient" means here, nor do the authors explain the process by which the price system channels resources away from the production of goods that don’t pass the test of the market. Students need a deeper investigation of the market process.

The treatment of consumer sovereignty and "the invisible hand" is satisfactory, as is the connection between profit and satisfying the wants of consumers. The problem of dangerous or defective products is raised in conjunction with consumer sovereignty. The authors make the important point that there is a trade-off between consumer protection laws and regulations on one hand, and the availability of products on the other. The book leaves the student with the impression that the only possibilities are government action or no protection at all. The authors never describe the ways in which the market provides consumers with information and tends to deter poor quality.

Criterion 2: Competition and Monopoly.

The authors’ treatment of competition and monopoly is weak. On the plus side, they do manage to dispel the idea that big businesses are always highly profitable; and they explain that "monopolistic competition" is not a wasteful, inefficient market structure.

However, they use some ill-chosen language that conveys the idea that it is dangerous to allow businesses to get "too big." They write, for example, "Government tries to prevent firms from getting so large and powerful that they can take advantage of the consumer." It is misleading to use the word "power" in conjunction with business. Businesses have no power to do anything but make offers to potential suppliers and consumers. The unfortunate implication of the term "market power" is that consumer sovereignty somehow vanishes once a business has reached a certain size.

To make matters worse, the book’s discussion of antitrust is lopsided. It gives the student no hint of the possibility that antitrust enforcement can actually be used to stifle vigorous competition. Instead of an economic analysis on the costs and benefits of antitrust, the student reads only the discredited opinion that antitrust laws protect competition. Are the authors utterly unaware of the solid critiques of antitrust?

Nor does the book consider the tendency for government itself to create monopolies and cartels. Although the breakup of AT&T is covered at some length, the student learns nothing about the early role government played in eliminating AT&T’s rivals in the telephone industry. Similarly, the authors discuss airline deregulation, but ignore the role of the federal government in cartelizing the airline industry—and the effect of this action on consumers.

Criterion 3: Comparative Economic Systems

The book’s coverage of comparative economic systems is threadbare. The authors write that "Communism seems to have failed as a political and economic system" (p. 424), but fail to give any analysis. Students should understand that central economic planning suffers from several inherent problems (among them, the limited knowledge of the planners, the lack of incentives for efficiency and good quality, and the tendency to put the interests of the state far above the interests of ordinary consumers). These problems occur in all government directed economic activity, not just under "communism." Instead of giving students a look at the process of central planning, the book gives them platitudes like this: "In exchange for security, the people have given up a degree of individual economic freedom."

Although the extreme backwardness and inefficiency of the Soviet-style economic system is well documented, the student reads that Lenin’s economic system, "worked reasonably well." Here again, dubious conclusions take the place of serious analysis. Another example: "As societies become more complex, the need for government power tends to increase" (p. 419). The book fails to explain what it means by "more complex," or why complexity necessarily calls for greater government power. Many economists would argue that although the products of our modern economy are far more complex than in the past, society—the network of human relationships—remains fundamentally the same.

Elsewhere in their discussion of comparative systems, the authors stumble into another cliché—that population growth is a major reason reason why many poor nations remain poor. Gordon and Stafford write that "population growth has made economic growth almost impossible in many developing nations" (p. 406). Nowhere do they acknowledge contrary views of population and economic development experts. In trying to account for persistent poverty, the authors point to government favoritism, militarism, and insufficient spending on education, but fail to mention government economic controls and taxes that hinder the growth of free enterprise.

Finally, the book’s treatment of foreign aid is vague, couched in muddy language. For example: "Because of the apparent lack of progress in many developing nations, people in developed nations questioned whether aid could ever solve the world’s economic problems" (pp. 400-01). This gives the book’s only hint that economic analysis has shown harmful effects of foreign aid.

Criterion 4: The Distribution of Income and Poverty

The section on income inequality is superficial. Rather than providing any real analysis of the effects of welfare programs, the student reads that "many people doubt there can be a solution to the problem of hunger without more government support" (p. 348). This simply pushes students toward a belief, rather than helping to develop their ability to think economically.

Furthermore, the book fails to mention the high degree of income mobility and is silent on the key role government policies play in hindering people from prospering on their own. Many economists advocate free markets and private charities to alleviate poverty, but that view is dismissed without any analysis.

Criterion 5: The Role of Government

The authors’ discussion of the role of government in the book is more opinion than economic analysis. Students are told, for example, that it is "necessary for our government to play a greater role in our economic system because consumers are no longer able to protect themselves from economic abuse" (p. 320). This statement reinforces the popular image of government in white hats, business people in black hats, and consumers as defenseless pawns. Here, as elsewhere, the writing is more like political rhetoric than serious economics.

On the subject of public goods, the authors substitute vague generalities and personal conclusions for economic analysis. Public education—which is not a "public good" as most economists use the term—is purportedly essential; without it, "only the children of the rich could become educated" (p. 329). Both theory and history strongly suggest that this conclusion is false; in the 1840s, before the rise of public education, the literacy rates in many Northern states were higher than they are today with universal public education. Students, however, read nothing of this evidence. Nor do the authors bother with an investigation of how an education marketplace might work without government sponsorship. They also write as if it were self-evident that the medical marketplace needs increased governmental interventiont: "Modern medicine has become so expensive that many people could not afford medical care unless the government helped them pay for it" (p. 239). There are Nobel Prize-winning economists who argue that the very reason many people cannot afford medical care is because government interference has distorted the market for this service.

The problem of negative externalities is also poorly treated. Instead of focusing on the different ways in which we might deal with the problem of pollution, the book devotes several pages to the Times Beach, Mo. fiasco, in which a federal overreaction caused the town to be abandoned and destroyed. But the authors draw no sensible conclusion from this event. After noting the financial loss to residents, they say that it was "corrected by government action" (p. 241). The loss was not "corrected," but paid by the taxpayers. The economics of environmental protection is an important subject, but receives feeble treatment here.

Criterion 6: Public Choice

Nowhere in this book do you find the term "public choice." Virtually nowhere do you find any references to public choice concepts. A fleeting mention that politicians desire to be re-elected is all there is on the key subject of the economics of government decision-making.

Rent seeking by special interest groups, political incentives for waste, the rational ignorance of voters—the book omits any discussion of such topics. Rather than painting government "warts and all," the authors almost invariably depict it as a wise and kindly uncle who can be counted on to do the right thing. History and economics show this to be far from true.

Criterion 7: The Role of the Entrepreneur

Entrepreneurship is barely mentioned. The authors never try to explain its importance to the economy, or how it can be stifled by taxes and regulations.

Criterion 8: Taxation

The authors devote several pages to describing the different kinds of taxes that are collected, and also to the normative "principles" of taxation. But on the economic effects of taxation, where the student would get some practice in thinking about costs and benefits, incentive changes, misallocation of resources, and other elements of economic analysis, the book is silent. Also, the question of tax incidence is never raised.

Criterion 9: The Business Cycle

Gordon and Stafford leave the student with the impression that the Depression was a natural phenomenon of the free market that discredited clasical economics. "Classical economists believed there was no need for government intervention in the economy. But when the Great Depression did not automatically come to an end, it became clear that other theories would have to be found to explain how economies worked" (p. 324). The reader finds no hint, even in the page-long profile of Milton Friedman, that many economists blame bad government policy for causing and prolonging the Depression. The book focuses entirely on the Keynesian aggregate demand theory to the exclusion of all others. The authors ignore the destructive policies of the Federal Reserve in the 1920s and 1930s, the dramatic boost in tariff rates in 1930, the doubling of income tax rates in 1932, and most of the New Deal interventions from 1933 until World War II.

There is nothing here on the important debate between economists who see a market economy as being a stable, self-correcting mechanism and those who see it as inherently unstable, in need of frequent government adjustment. The book does include some discussion of the difficulties with federal "fine tuning" policies, but does not tell the student that many economists argue against the need for such policies at all.

Criterion 10: Wages, Unions, and Unemployment

The authors correctly explain that wages, like other prices, are established by the interplay of supply and demand in the market. They also needed to make the important point that in a competitive market, wages and productivity are necessarily linked. Their discussion of the effects of minimum wage laws is accurate, but not very deep.

The book’s treatment of unions is not good. Again, the student is given very dubious conclusions, not serious analysis. For example: "It is clear that unions have helped to improve working conditions, wages and benefits for many Americans" (p. 183). To some economists who study labor economics, the above conclusion is not at all "clear." The book lacks economic analysis of the effects of unions on efficiency, employment, and wages (both for unionized workers and non-unionized workers). It also implicitly assumes that union leaders have interests identical to the interests of the workers they represent, even though this is not always the case.

Last, the authors correctly identify the different types of unemployment, but are weak on analysis of the impact of policies crafted to deal with it.

Criterion 11: Trade and Tariffs

Gordon and Stafford start by failing to make it clear to the student that all trade is an individual phenomenon. People, wherever located, seek to improve themselves by purchasing from or selling to others. Instead, the book employs language that casts trade as a group phenomenon: "countries trade because they want to" (p. 370). Writing like this perpetuates the erroneous notion that "international" trade is fundamentally different from "ordinary" trade.

To make matters worse, the book argues in favor of trade restrictions—using the infant industry argument, the protection of wages argument, and others. Margin notes to the instructor suggest that he or she question these arguments, but the student reads (and will probably hear) nothing to cast doubt on the virtues of trade restrictions.

Finally, the authors include a preposterous discussion of the balance of trade. They say that having a "negative balance of trade" reduces employment, decreases profitability and slows economic growth. A repetition of mercantilist fallacies refuted over two centuries ago is not what you want in a book designed to teach young people how to think economically.

Criterion 12: Money and Banking

The book provides a good explanation of the functions and characteristics of money. It also explains correctly that inflation is caused by excessive money creation. Nothing, however, leads the student to understand that money is a market phenomenon, how and why the gold standard arose, or the drawbacks to having a fiat money system under government control.

The explanation of the Federal Reserve System and its operations is reasonably good, but the chapter does not say anything about the Fed’s track record. Nor does it go into the debate over the right target for Fed action (interest rates, money supply, or something else).

The book’s discussion of banks is superficial; it fails to give the student an appreciation for their importance. Also, the authors never discuss the impact of government regulations (such as deposit insurance). The coverage of the S&L bailout is minimal, and the student does not learn of the government’s role in that problem.