September 14 to 21     Don't forget to come to class this Friday (9.24.05) for the Double Oral Auction!

Q1: We talked about the Smithian Efficiency for the last few classes. Adam Smith is somewhat of a marketing genius, with having the ability to maximize dependence on the price mechanism. With this said, how does Adam Smith rise above Schumpeterian and Keynesian Efficiencies?

R: Adam Smith was not a business professor, so he did not spend much time on advising anyone on how to sell. He was not the first to see the beauty of the price mechanism in a free market society, but he synthesized the market process in his book more completely than any before him. His genius was in describing the self-equilibrating character of the market process -- a shortage causes prices to rise and resources to flow to that line of production (thereby consumers got what they wanted) while surpluses in some other line of production caused producers to pull resources from that activity -- resource allocation is thus automatically determined. All of this operated on the basis of people looking to their own self-interest while society's interests were simultaneously promoted as well (profit-seeking capitalists had to conserve scarce resources to keep costs low and had to give consumers what they wanted at the lowest prices to compete against their rivals -- all as if by an invisible hand).

Q2: For once you can reason that war fulfilled a positive purpose. Not only did it jump start our economy but allowed the jump start and renewal in France and Germany.

R: That was true of World War II. Notice, however, that since the Vietnam War, defense spending has not had the rejuvenating effect on the economy that it did then. Why not? That is an important question that has no easy answer. We can argue that when we fought WW II, most of the production had to come from the U.S. and hence we benefited tremendously in an increase in jobs, income and wealth. Now, the U.S. economy is just one among numerous economies capable of producing commodities to satisfy increased demand world-wide. So, for example, when Americans working in defense industries in the U.S. (and increasingly, many defense contracts are being let to companies in other countries) enjoy higher wages and hours of work they spend a greater share for products produced in China, Europe, Asia and Latin America. This explains our huge trade deficit (exports - imports --> they are negative).

Q3: I think that oligopolies seem to make the most sense to me with an economy that we have. If there are only a few organizations out there, people can trust and invest in them knowing what they will get. When you trust someone you are willing to give your money to it.

R: If our only concern is what we want as consumers or as investors (a return off an investment) then I suppose you have a point. Of course, even then we cannot know for sure that we haven't put our money in Enron or World Com  (prime examples of oligopolies). But if as Mark Sagoff claims we also act as citizens who have values, then we're just as concerned about whether our firms behave well -- we might have made a killing off our stock in Exxon when they spilled millions of gallons of crude oil in  Prince Edwards Sound because they successfully prevented a crippling lawsuit. Or we might have done very well, thank you, as stockholders in Union Carbide even though they were responsible for the Bhopol, India cyanide emissions that killed 6,000 people because they prevented the lawsuits from being filed in American courts where they would have faced triple damages and a higher standard to prove their innocence. As citizens we would have acted on behalf of society's interests, not just our own.

Q4: For modern day monopoly ... how do phone companies (MCI, Verizon) get away with their prices and lies in our economy? For example, hidden costs for no reason because they have all the American market. How is it legal? Thank goodness for Working Assets (http://www.workingassets.com/form.cfm?formid=IE-319-OLA-1).

R: The history of anti-trust enforcement has been a checkered one. The definition of monopoly has changed to that of a) large size relative to the market to a new standard now -- b) size isn't important, it's how you behave, so if you behave like a monopoly then you're breaking the law. AT&T (now Verizon), like other big corporations,  once went into court and convinced the judge that they were not in the telephone industry but the telecommunications industry, meaning that they were competing against television networks, radio networks, cable companies and even the internet. The idea of a natural monopoly has also saved big companies from prosecution -- although they haven't quite used the term, Microsoft has implied that their size alone has allowed them to develop so many leading technologies and as a result they should be left alone. A natural monopoly is one in which economies of scale are so large (when companies invest in very expensive equipment they must have a larger share of the market in order to spread that cost over many units of output; so if average costs fall over a long range, it benefits the customer to have just one firm supplying them with the commodity). To prevent monopoly practices (charging whatever the market will bear) it usually means government must regulate natural monopolies as in the public utility industries, i.e., government sets the electric rates we pay. Both the telephone company and Microsoft, however, have used the defense of size being a benefit to the consumer without admitting therefore that they should be regulated like utilities. Some trick, eh?

Q4: The higher the market rises, is the depression that follows going to hit harder (Is there a recession after an economic boom -- can it be avoided?). Is there a point where it can't get any lower? Any higher?

R: This question of macroeconomic stability or instability doesn't have a definitive answer (much like all of economics). It is likely that the longer we go without a downturn in economic activity, the more we are likely to face a serious re-adjustment -- whether it is deeper and longer is another question. As we press on our capacity limits, producers will encounter more and more shortages (labor, materials etc) and wages and salaries will start to rise faster than prices; capital equipment will wear out and not be replaced due to a shortage of finance capital. As I mentioned in a previous comment, we have cycles within cycles -- inventory cycles, capital replacement cycles and long waves (sometimes called Kondratief cycles which seem to occur every 50 years or so). Again, preventing these cycles has become increasingly difficult because the impact of economic activity abroad has effects here in the United States that are more powerful than 30 years ago.

Q5: If the U.S. economy is not the driving force in the world any more, which countries' economies are?

R: The U.S. is not as powerful in dictating economic transactions, world trade, exchange rates, favorable terms of trade and markets as it once was. This is, as discussed in class, a result of the end of the Bretton Woods system of a modified gold standard based on the dollar, the reconstruction of the world's economies after WW II that began to have deleterious effects on the share of world markets controlled by American corporations, the decline in the value of the U.S. dollar relative to other currencies because the world bought fewer American goods (hence did not need as many dollars) and while the so-called "gold window" was closed to foreign central banks other nations' financial institutions began to buy U.S. debt instead (the share of government bonds and securities owned by foreigners is at an all time high). Increasingly (this is my own thesis), our corporations find that the only way they can force their way into foreign markets is to use the military might of the U.S. government to empower private business interests. It is one thing for Exxon-Mobil to knock on your door, it's quite another if a missile cruiser is floating off shore at the same time. The irony of all this is that the money to pay the huge open account debt (net capital flows -- money coming in relative to money going out)  we have with the rest of the world, which allows us to have the largest military budget in the world (we spend more than the next 20 countries or so -- combined) is increasingly coming from outside the U.S.

Q6: I don't know much at all about economics (this is a 9.3.04 card -- sorry), but one thing really struck me today. The amount of debt our country is in when just last week my grandmother  tried to tell me other countries owe us and we have no debt. I don't understand how some can be so ignorant to the situation our country has put us in.

R: Let's not be too hard on your grandmother. The government doesn't make a point of advertising these facts, our schools don't inform our students and the media are genetically programmed to accept government press releases as hard news. The fact is our current account deficit was $518 billion last year. That means we owed $518 billion more to the rest of the world than they owed us. I would imagine it will be considerably larger this year. Although these are not the latest figures, here is a web page from the 2004 Economic Report of the President to confirm this figure ( http://www.gpoaccess.gov/usbudget/fy05/sheets/b24.xls). Read the column on the far right. Some economists argue that this figure is a smaller share of our GDP (gross domestic product -- the value of all we produce) than it used to be and hence it is less of a concern. The point is that we still need to be taxed to pay the interest on this debt and so a rising share of the average American family's income is being used to support this debt load. Nonetheless, the U.S. is hardly going to become a banana republic (this cultural reference doesn't pack the punch it once did) anytime soon.

Q7: I was very shocked to find that only 10% of the population actually achieve upward mobility. Because my grandfather had assumed it was more common than that,  though now that I think about it , I understand why so few do; the odds are really not in their favor.

R: It is shocking to me too. The opinion of most American's is that we are a land of opportunity and certainly we have an abundance of famous Horatio Alger stories to provide anecdotal support for that view. The way this question is answered has to be carefully examined. The authors make a clear distinction between income and social class. I have not looked at the study that they used to support their contention, so I'm in no position to affirm or deny it. Last night (9.14.04) we went to the Howard Zinn talk at Castleton State College. He wrote the famous book, The People's History of the United States. He made the remark that what struck him at an early age was that we were a country of very rich and very poor with a middle class that was "very nervous". In other words, many didn't know which direction they would be moving in. So, one thing to consider is that the median movement is the net change calculated as the difference between those moving up an income class or two and those moving down.

Q8: The depression was the worst point in America's economy, when was the best? And how long did it last? How many years will it take to get out of all this debt that the "war on terror" has caused? How soon might it be possible to achieve a smooth-flowing economy?

R: The longest sustained growth period without a serious economic downturn (skipping the war years of 1941 - 1945) was from 1946 to 1974 approximately. When you look at the data for per capita gross domestic product or per capita disposable income it looks like it marched right along from 1959 (they have cut off the figures before that in the Economic Report of the President) on, but we have to remember that a better measure would be per fulltime worker. In the early 1970s more women entered the labor force and so a higher percent of the population now are members of the labor force. The data for per capita income and per capita GDP can be found at http://www.gpoaccess.gov/usbudget/fy05/sheets/b31.xls. Read Juliet Shor's book, The Over-worked American. The second and third questions are more problematic. The debt load the U.S. government has taken on cannot be sustained unless we have serious cutbacks in entitlement programs (social security, medicare, medicaid, housing subsidies and so on) or increases in taxes (most likely the payroll tax, which what is referred to as FICA on your paycheck). That tax hits the middle class and working class hardest and it has been rising at a faster rate than any other tax. It is said by some that the Bush administration is talking about a federal sales tax (the states are almost the exclusive  users of that form of tax). Either/or both cutting taxes or lowering benefits will mean a lower standard of living for many Americans. This is why they call economics the dismal science. 

Q9: Is Marx's theory trying to say that in the future the struggle between workers and capitalists will keep growing bigger and worse? What is Marx's theory in short?

R: There is no such thing as Marx's theory in short, unfortunately. But your first question warrants a qualified yes. Capitalists, according to Marx, would become fewer in number and more powerful as a class. Small business owners would be swept up into the proletariat (working class) as large businesses drove them into bankruptcy -- think of Wal-Mart coming to town and forcing the local hardware store, grocery store, pharmacy and clothing store to all close. Those small business owners might now find themselves wearing the blue apron of Wal-Mart and making $7 an hour. The consolidation of business into a few very large corporations creates increased conflict between the workers and the capitalists. Wal-Mart is the most active anti-union employer in the country.

Q10: What is the main difference between free market banks and regular banks? What are their benefits and [shortcomings]? What was Smith's theory in short?

R: Again, I cannot give you a short-hand version of Adam Smith. I can answer a specific question about Smith, but otherwise I wouldn't know where to begin or end -- and you don't want that. I honestly don't know what you mean by "free market" banks. At some point we will talk about the anecdotal history of banking and money. Let's wait for that. 

Q11: What's more important to a company, health (?) issues and quality or price and demand? Why? What does the phrase "allocative efficiency" actually mean?

R: By health issues I'm guessing you're referring to the effects of the product or production process on the workers and community (pollution, shop floor safety, harmful products etc). The answer is that it depends. Robert Heilbroner (another one of those famous economists) once wrote that a market economy is not inherently moral. There is no market pressure on firms to "be good". There may very well be a net tendency to deceive, cheat and ignore the negative spillover effects of commodities and production onto the community at large. Hence, we need a watchdog to oversee the activities of private business. This is why we have the FLSB, OSHA, the EPA, the FDA and the FTC, to name a few. These are government agencies which make it their business to oversee private business. Without them it could be a kind of buccaneer capitalism that we see today in Russia. It would be caveat emptor (buyer beware)  with a vengeance. Allocative efficiency occurs when the right resources in the right quantities are directed to producing the right products at the lowest possible costs. The free market system accomplishes this task more smoothly than any system known, however, whether we're producing heroin or a cure for AIDS is of no concern to free-market capitalism. The criterion is "will it make a profit?"

Q12: Would it be possible for you to explain in more detail the Harberger triangle and the Okun Gap?

R: I discussed this in class after you wrote the card, but I'll add to the explanation here. Monopolies tend to charge higher prices and produce less than firms that are in a perfectly competitive market (many small firms). This means consumers suffer what is called "consumer surplus losses" or efficiency losses. The Harberger Triangle drawn on the board represents that loss. The Okun Gap (named after Arthur Okun) is the lost production that occurs as a result of high levels of unemployment in the national economy. The quote "It takes a lot of Harberger triangles to fill an Okun Gap" is a play on words that was meant to convey the idea that monopolies are less a concern than an economy suffering from a recession or depression. In other words, who cares if there are monopolies charging high prices if everyone has a job? 

Q13: Surplus happens: Workers get laid off, consumers don't buy, the business cycle ends and starts up. Don't you believe that old Russia (Soviet Union?) would have rebuilt and that it would have done better than it is now in a democratic state.

R: A lot of assumptions therein. Some would disagree with the notion that Russia is currently a democracy but, that aside, the Soviet Union's economy was horribly inefficient. It was driven by committees headed by Commissars who determined the kind and quantities of commodities produced. It was a mess. On the one hand, workers always had a job, never starved and had basic health care and education provided free. On the other hand, none of these provided much of a life and freedom was extremely constrained with gulags (political prisons) galore. Consumers had money but no products to spend it on. They would wait in long lines only to find out that there was nothing at the end of the line. Free market ideologists contend that the absence of private ownership of the means of production (factories, businesses, farms) and the incentive of profit-making and income maximization was a serious handicap to the Soviet economy. There is a lot of truth to that. An only joke goes, workers in the Soviet Union said that "we pretend to work and our bosses pretend to pay us." Not much incentive to work hard there, eh?

Q14: Do you think the war in Iraq was a preemptive action to prevent [economic] depression? Perhaps if World War II had happened earlier, there would not have been a Great Depression.

R: No, I do not think that was the reason for entering into war with Iraq (or whomever it is we're at war with -- that's not exactly clear). This war is an economic burden, not an economic boon. A different economic motive may have been behind the decision to invade Iraq. There are very few countries in the world in which the U.S. has an economic interest that do not have an American military presence. There is now one less. Your last point is important. Again citing Heilbroner (and I believe John Galbraith made this same point), it is important to remember that what the government spends our collective money on has little bearing on the impact of that expenditure on economic activity. A dollar spent on weaponry employs about as many as a dollar spent on health care or environmental protection. The Great Depression might have been avoided by the federal government deciding to build roads, dams, highways, bridges or sinking vast amounts of money into finding cures for tuberculosis, diphtheria, cancer and other worthwhile purposes. Eventually it did all that anyway. There is no good economic reason for starting wars (and there are even fewer good reasons of other kinds).

Q15: I believe that eventually technology will increase so much that we will have machines/robots to do most of this "Mcdonaldized" and factory labor, which will leave thousands unemployed (due to many jobs lost). Then, what are these workers, who have been forced to be alienated from society, going to do? Where will they find work? Who will hire them?

R: The fastest growing employment in the nation is in the service sector. There are a lot of low-wage jobs that have replaced the old high-paying blue collar jobs. We have an increasingly two-tiered income structure as income inequality has grown. There is considerable dispute between mainstream economics and progressive economics about the causes of this phenomenon. Some economists argue that everyone benefits if commodities and services are produced more efficiently (by automated processes or cheap foreign labor), while others believe it simply represents the lost economic power of workers in a society of non-union, contingent and part-time labor.

Q16: Could a government provide incentives to prevent companies from sending jobs overseas?

R: It would help if government simply eliminated the subsidies to firms who do business overseas. It is also important to recognize that corporations are creatures of the public sector. Stockholders benefit from laws that allow them to be protected from liability in case their firms commit criminal or civil violations. It's called limited liability. They also have the same right of citizens to sue and be sued and are often accorded other rights originally enacted to protect human citizens. A corporate charter can be revoked if a company is accused of wrong doing. This has never been done. So, for example, plant-closing legislation which forces firms to give workers advance notice before laying off workers and subsidizing the retraining and job search of their workforce has often been defeated on the basis that it is an unlawful taking of property. Many on the left believe it is time to end corporate welfare.

Q17: Don't people more often than not buy what they feel propelled [compelled] to buy rather than what they want to buy? It seems to me that the act of buying something is more of a motion to increase one's own prestige and power, not always just to fulfill ones basic needs.

R: This is what Thorsten Veblin thought and what others, like Juliet Shor, author of The Over-spent American, believe. Shor argues that Americans are working longer hours and sending more family members into the workforce to support lifestyles that mostly contribute to wasteful spending.

Q18: What are the private and public sectors?

R: The private sector is everything but government. So, businesses are part of the private sector while the federal, state and local governments are part of the public sector.