Naked Economics – Charles Wheelan

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated)

A nice introductory approach to economics, and how economics is at the core of many important decisions made in this world.

Markets are consistent with our views of individual liberties. Communist governments interfered with their markets, controlling the prices of commodities and often wrecked themselves in the process as it did not accurately reflect supply/demand. Lots to be learned from the collapse of the Soviet Union. Monopoly stifles people’s needs to be innovative or adjust to market conditions.

Every action has a positive/negative result. Important to balance these when making decisions. Distributing the wealth of a small number of people across many poor people is more challenging than it seems. Higher taxes implies more flight to the ‘underground economy’ to preserve wealth. Everyone is trying to maximize their own utility.

Incentive structures are critical to markets.

Government plays an important role in the regulation of markets. We can and use government to interfere (positively) in our markets and firms often do. Black Rhino example = the more they are hunted, the more valuable the commodity becomes and the prices go up and incentives to hunt go up even higher. Same applies to fishing, one possible solution is to have a quota per fisherman. Overall quotas per state/city/country are not helpful as it creates perverse incentives to fish aggressively and take more of the share of benefits.

Externality = When the private costs of my behavior are different from the social costs. Ex: Buying an SUV instead of a smaller car, also polluting more of the environment in the process. When an externality is large, the gap between private costs and the societal cost of a behavior – people do things that make them better off at the expense of others. Ex: parents taking their bawling kids on airplanes (at no additional cost), creates massive utility for parents but negative utility for everyone else. Creates need for regulation.

Regulation is good, good government matters. At some level, bureaucracy in America is good for the market as it prevents bad actors from doing illegal business. Countries like Somalia where corruption is rampant, leads to bad incentives which leads to bad, inefficient markets and economies.

It seems remarkable that we often take substantial amounts of money to our bank and hand it over to people we have never met before. Or that when we use credit cards to buy a new CD or tennis racquet over the Internet, from a business that is located in some other state of country, we are confident we will get our merchandise, and they are confident they will get paid.

Tax cuts stimulate hard work and risk taking. Higher taxes result in ‘deadweight’ losses, where some people choose not to work to pay 50% of their salary to the government. US is a richer but more unequal place than Europe. “Deadweight” – when both parties do not net out with a gain.

Markets are rarely a zero sum game (unless in the case of perfect competition, which has been studied extensively). Story of America in a nutshell = Farmers producing crops. Person X sells a better tool to harvest crops and moves into town. Farmers buy tool to harvest more crops. Less farmers now making more crops due to better technology. Loss in farming jobs has created other jobs to keep up with the growth in economy. Ultimately, the number of crops sold goes up which is the most important metric.

Economics of Information party who has more information in a transaction is almost always better off. People often resort to this in the lack of information. Applies to everything from going to a McDonalds (predictable) in a foreign country, to hiring someone purely based of which university they went to. People also pay for information, curators who review music/films are filling that role in the market.

Human Capital dictates why some people are richer than others. HC is the sum total of skills embodied within an individual: education, intelligence, charisma, creativity, work experience, entrepreneurial vigor and even the ability to throw a baseball fast. Human capital matters because it is linked to productivity. More productive humans = richer humans = richer economies. Productivity is the measure of efficiency with which we can convert inputs to outputs.

All activity in financial markets fall into four categories –

  • Raising capital
  • Storing, protecting and making profitable use of excessive capital
  • Insuring against risk
  • Speculation

Politics and Economics Small groups with a deep passion for a topic (high utility risk) can have extraordinary influence on the rest of the population. Tail will wag the dog, so to speak. 9 right handed people for every left handed person. If lefties had to pay $900 for every $100 that a right handed person paid as taxes, would result in outrage. Politicians can gain favor by siding with the left handed side even if they are the minority, because their utility/risk is higher. Vocal minorities matter in politics. It’s not just how many people care about an issue one way or another, its how much they care.

Local recessions can become global issues. If the US economy weakens, we buy fewer goods from abroad. Mexico, which sends more than 80% of it’s exports to the US will suffer. In business, competitor’s misfortune is your gain but in global economics, the opposite is true.

Fiscal policy is the government’s ability to tax and spend money as a way to keep the economy progressing forward.

  • Monetary policy involves changing the interest rate and influencing the money supply.
  • Fiscal policy involves the government changing tax rates and levels of government spending to influence aggregate demand in the economy.

Budget deficit/surpluses – neither is good or bad, just depends on policy and what the country needs at the time. If the economy slips into recession, tax revenues will fall and spending on programs like unemployment insurance will rise. This will lead to a deficit, but it is also likely to help the economy recover.

The Fed – the most powerful economic body in the US and likely in the world. Fed controls America’s money supply. It moves interest rates by changing the quantity of funds available to commercial banks like Citi. It manipulates money supply to control interest rates, as it cannot do so directly. It sets a target federal funds rate. If banks are awash with money, interest rates must be relatively low to attract borrowers. And vice versa. Decided in the FOMC meetings. Funds are not given to banks for free, they trade in government bonds. Fed must maintain a rate of economic growth that’s neither too fast nor too slow, combating inflation. If interest rates are too low, results in too much borrowing, results in inflation.

Printing too much money (corrupt governments often do) results in inflation which is horrible for the consumer. People rush to spend their cash before it becomes worthless. On the other hand, deflation results in lower spending (money is worth more tomorrow), which affects economic growth.

International Economics strong/weak currencies are neither good nor bad. A country with a booming economy will typically have a currency that is appreciating. Strong growth presents investment opportunities that attract capital from the rest of the world.

Gold standard sounds good on paper but provides for horrible policy, especially during depression. Crowd frenzy during depression calls for people demanding gold for their paper money (as a safe bet) but the government has to protect its gold reserves (a finite resource), so naturally it has to increase interest rates. But, higher interest rates during a depression is terrible for the economy as it curbs spending and revival.

Trade is good for the world, especially for developing countries. Anti-globalization argument makes no rational sense. People are able to ‘trade’ or buy things that are already made, and that they don’t need to waste their time making. Extreme example = an engineer does not need to milk his own cows, he can buy the milk and focus on what he is good at (engineering). Free trade makes countries prosperous, limitations on trade affects growth.

Optimistic outlook shoe workers in Vietnam, or chinese Apple workers might get paid low, but they are choosing to do it and not being forced to (their alternatives are usually worse). Trade makes goods cheaper for consumers. Trade is voluntary exchange.

Author argues that the path to developing a poor nation includes the following steps –

  • Effective government institutions
  • Property rights
  • No excessive regulation
  • Human capital
  • Geography
  • Openness to trade
  • Responsible fiscal and monetary policy

Natural resources matter less than you think.