All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

 An Introduction to Economics: Alternative Systems and Perspectives

1. "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.  Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." John Maynard Keynes

2. "the twentieth century is unique in that its wars, purges, massacres, and executions have been largely the result of economic ideologies. ... it is hard to see World War II in the absence of Adolf Hitler's insane idee fixe that the Germans needed a better land-labor ratio—more “living space”—if they were to be a strong nation." Brad DeLong

3. "'Wealth of Nations' shows how self interest, tamed by sympathy and constrained by economic rivalry, leads to a widespread prosperity known as 'universal opulence."  Introducing big government, Economist 12/31/99

4. "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages."  Adam Smith, The Wealth of Nations, Book I Chapter II p16

5. “Whereas the liberal mistake is to think that there is a program or policy to alleviate every problem in the world, the conservative flaw is to be vigilant against concentrations of power in government only – not in the private sector.”

6. "There are three kinds of economics: Greek-letter, up-and-down, and airport." Paul Krugman

We live in extraordinary times, what Peter Drucker once referred to as "The Age of Social Transformation," a time where the world is moving Beyond the Information Revolution.  When you are talking about transformations or revolutions, you know we are into something BIG, and we are right in the midst of it. As Drucker says, you belong to the "first society in which ordinary people - and that means most people - do not earn their daily bread by the sweat of their brow.  It is the first society in which ''honest work' does not mean a callused hand. ...Knowledge workers...may not be the ruling class of the knowledge society, but they are already its leading class. ...And in their characteristics, social position, values, and expectations, they differ fundamentally from any group in history that has ever occupied the leading position."  It is a society where education takes on increasing importance as a gateway to the "promised land," a world in which flexibility and mobility are seen as the keys to success.  The elite in this new society will be, what former Secretary of Labor Robert Reich called, "symbolic analysts," those individuals who, at the nation's best universities, are encouraged to be "skeptical, curious, and creative" and "become problem solvers par excellence, equal to any challenge.  Unlike those who engage in mind-numbing routines, they love their work, which engages them in lifelong learning and endless experimentation." (The Revolt of the Elites)

As you make your move into the "real world" you will benefit from studying economics because it will help you create order out of what often looks like chaos.  While most of you are here because you were "forced" into the course and few of you are excited about beginning a semester studying the "dismal science," many of you may leave the experience excited about it and about what you have learned.  The experience will help you on two levels.  On a personal level, economics will provide you some insight into an array of critical choices you will be making, and a framework for approaching those choices.  What occupation will provide me with a sense of satisfaction and accomplishment?  In what industry should I look for a job?  Should I go to graduate school?  Should I take Spanish as a language, or Chinese?  Should I move to Florida or Arizona after graduation?  Is this a good time to invest in Google?  The list could go on, but you get the point.  You have many important personal and professional choices and the things we talk about here will help with those choices.  

Economics will also provide you with a way of looking at the world that will allow you to better understand many of the important - and I mean very important - public policy issue you can be expected to voting on in upcoming years.  Keynes was right when years ago he wrote: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.  Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." When you hear politicians talking about policy decisions - a tax cut, a new environmental law, or reform of Social Security - you can be assured there are some academics who have studied the issue and provided the theory upon which the decision was made.  As we head into the 21st century, the centrality of economics is accepted almost without question as the " understanding of markets – not as artifacts of human civilization but as phenomena of nature – now serve as the unquestionable foundation of nearly all political and social debate.” Bigelow

It turns out that in your lifetime you will be called upon to help make many important policy changes because we live in a world of too many unsustainable policies.  At this time in your life you have probably heard many people make comments similar to "we've always done it this way," as justifications for the status quo, and maybe it has made some sense to you when you have heard it, but be aware that in your lifetime this line of reasoning will be wrongheaded and dangerous.  The forces that molded the lives of the generation who designed today's policies are no longer the forces shaping the world.  There are a number of technological and demographic forces that exist today that were never envisioned by those designing today's policies, and in this course we will look at some of those forces and some of these policy choices you will be confronted with in the not so distant future.  And there is a sense of urgency since the later we wait the tougher the decisions will be, but politicians who live and die by the election cycle are not likely to make the decisions that protect future workers and their families.  It will be you and me and others who raise the call for better policies.  For example, to prompt governments to begin to think in terms of sustainability, the International Monetary Fund in 2003 published "Who Will Pay? Coping with Aging Societies, Climate Change, and Other Long-Term Fiscal Challenges, and you might check it out for some ideas on the magnitude of the situation and some possible "solutions."

While there are far too many issues to list them all here, we'll mention just a few that will be in the news because there is no better time than now to get some practice reading and thinking about public policies.  A good place to start would be with war.  According to economist Brad DeLong, "the twentieth century is unique in that its wars, purges, massacres, and executions have been largely the result of economic ideologies. ... it is hard to see World War II in the absence of Adolf Hitler's insane idee fixe that the Germans needed a better land-labor ratio—more “living space”—if they were to be a strong nation,"  but it may turn out not to remain unique.  The war in Iraq and the efforts to spread capitalism and democracy to those who have yet to embrace those systems, may mark the beginning of a period of sustained conflict.  In my generation there were many millions who died in battles between two economic systems - communism and capitalism - and in your generation, in the post 9/11 Afghanistan and Iraq world, there is every reason to believe that the potential for conflict between opposing world views will remain great, although the fault line will be different. For those who tend to learn visually, you might check out the movie 13 Days to see how close the Cold War conflict came to blowing up our world, and to see what we never saw at that time.  In the early 2000s the US invaded Iraq on the pretense of WMD, but this was not the real reason.  The war was a battle in an ideological war to spread freedom - read that democracy and capitalism - to the Middle East.  For some background on this you might check out Dick Cheney's Song of America (TO DO, This link should be local NOW), (link no longer available) that describes the long-standing views of the neocons who pushed for the war since the early 1990s, or you might check out the UN's 2002 Human Development Report, Deepening Democracy in a Fragmented World where you will find the theme for the report to be "For politics and political institutions to promote human development and safeguard the freedom and dignity of all people, democracy must widen and deepen.  You can see the US policies as leading the way toward a world where people have freedom, but if you read on there is the cautionary statement that "democracy that empowers people must be built - it cannot be imported." 

Another key issue would be energy policy since energy is at the heart of the economies of modern wealthy nations and there are billions of desperately poor people around the world who aspire to have what these wealthy countries have, and as they jump on the economic growth bandwagon energy demand will skyrocket and conflicts over oil may become a permanent fixture of modern life.  Make no mistake, the war in Iraq was about oil, an absolutely crucial input in the modern industrialized world, a fact highlighted in a 1941 National Geographic article "Today's World Turns on Oil" that opens with the statement "Rob us of oil, with its grease and gasoline, and our life rhythm would freeze." Little has changed since then. The same could be said of water, and you can be assured you will hear more about water wars.  Maybe Kevin Costner was too early when he produced Waterworld, but the concept is very real.  Closely related to energy policies would be environmental policies, and here it is not difficult to see the nature of the problem.  At the turn of the millennium, India and China contained 40% of the world's population, but consumed slightly more than 10% of its energy, a clearly unsustainable allocation of energy given the rapid growth in the two countries.  When we read articles such as "Welcome to the Asian Century" in magazines like Fortune, then its time to begin to contemplate life in a world where the Chinese do turn in their bicycles for cars and the Indians do manage to industrialize the world's largest democracy.  In this world, energy consumption in these three countries in twenty five years will be about four times the world's entire energy consumption in 2000 and the images in the movie The Day After will look all too familiar. 

Domestically, there are questions of who should pay taxes, what should be taxed, and what the taxes should pay for.  Should we move toward replacement of the income tax with a consumption tax and toward a reallocation of taxes from capital to labor?  Should the tax system be used to increase or decrease the inequity in the US?  These are important questions as tax cuts are being passed that overwhelmingly favor the nation's wealthiest individuals at a time when increasing inequality in the US created a situation in 2000 such that "the share of income received by the top one percent exceeded that of the bottom 40 percent.  As a result, the 2.8 million people who made up the top one percent of the population received more after-tax income in 2000 than did the 110 million Americans in the bottom 40 percent of the population."  This prompted Paul Krugman to write in "The End of Middle-Class America:" “The first point you learn from these estimates is that the middle class America of my youth is best thought of as not as the normal state of our society, but as the interregnum between Gilded Ages.”  Bill Moyers, in a 2003 speech This is your story - The progressive story of America - Pass it on, sees strong parallels in the growing inequality in the US at the turn of the 20th and 21st centuries, which should surprise no one since they have both been described as revolutionary periods - the industrial and information revolutions.  We will follow Moyer's lead in this course and examine today's pressing economic and social problems, as well as proposed solutions, in an historical context. 

Closely associated with the accumulation of these massive fortunes has been the increased concentration of market power in the hands of a few multinational companies.  In this course we will spend time looking at the economic dimension of the concentration of economic power, but you should not lose sight of the political dimension pointed out by Moyers.

All these leaders were on record in favor of small government – but their opposition wasn't simply to government as such. It was to government's power to confer privilege on insiders; on the rich who were democracy's equivalent of the royal favorites of monarchist days. (It's what the FCC does today.) The Populists knew it was the government that granted millions of acres of public land to the railroad builders. It was the government that gave the manufacturers of farm machinery a monopoly of the domestic market by a protective tariff that was no longer necessary to shelter "infant industries." It was the government that contracted the national currency and sparked a deflationary cycle that crushed debtors and fattened the wallets of creditors. And those who made the great fortunes used them to buy the legislative and judicial favors that kept them on top. So the Populists recognized one great principle: the job of preserving equality of opportunity and democracy demanded the end of any unholy alliance between government and wealth. It was, to quote that platform again, "from the same womb of governmental injustice" that tramps and millionaires were bred.

And as powerful as the partnership between BIG business and BIG government that comes with the rise of the mega corporations can be, beware of increasing concentration in the media. This is a point raised by Robert Hormats in his op-ed article "Technologies of Freedom" that appeared in the Wall Street Journal.  According to Hormats, "the lesson of the last five centuries is that information confers political, economic, and social power on those who have access to it," which suggests the control of that information will also confer power.  

A little closer to home, the current system for the public financing of college education is unsustainable and you will need to join in the debate over the financing of higher education to determine whether in the future the solution will be more funds or less education.  For those looking for issues with the potential to set one generation against another, try retirement and health care since today's policies cannot persist too far into the future.  Who will pay for the new extended drug benefits?  Who will pay for my retirement?  Do workers have a right to retire after 20 or 30 years of work or once they reach age 65, and should the elderly be guaranteed life-extending medical treatments and drugs?  Many think they do, and it will be your generation that will pay for these "rights," so you can expect a heated debate / battle over these and related issues.  What we are talking about here is intergenerational equity, a concept you will be hearing much about in the future because the numbers are HUGE - maybe $45 trillion.  This is what Nathan Littlefield, in "The $45 Trillion Problem," explains it this way: "if the US government were a company its owners would pay a rational investor $45.5 trillion to take it off his hands."  Putting this number in perspective, "each American's share of the government's long-term unfunded liabilities - meaning tomorrow's debt as well as today's -- comes to about $156,000," and the BIG question is which generation will pay off that debt.

What is it about Economics that will prove so valuable as you grapple with all of these choices?  Economics fills a general education requirement in the Social Science division and economists, like the other social scientists (Psychologists, Sociologists, and Political Scientists), are concerned with uncovering the secrets of human society - the "real" world in which we all live and work.  If you want to see this first hand you can check out a wonderful publication, Foreign Affairs, where you will find ample evidence of the overlap between political science and economics.  In fact, it would be safe to conclude that the division between these disciplines is often blurred, that economics cuts across topics normally considered within the realm of the other social sciences while other social scientists are increasingly using economic frameworks and researching topics once thought to be within the domain of economics. Economists, like psychologists, are very much concerned with the study of human behavior, human judgment, and human well-being. Economists also share with sociologists an interest in the history and structure of human society - in issues of poverty, crime, and discrimination.  As one student put it, "Economics is the study of how the world works."  Psychologists, meanwhile, have contributed much to the understanding of human behavior that is at the center of modern microeconomics.  In fact the 2002 Nobel Prize in Economics was awarded to a psychologist, DANIEL KAHNEMAN, "for having integrated insights from psychological research into economic science."   

What separates economics from the other social sciences is therefore not the subject matter.  It is also not the method of analysis since in each of the social sciences there has been an effort to employ the scientific method - the development and testing of theories and hypotheses.  We are all professional observers of the "real" world whose job it is to make order out of what may appears to many as chaos, to explain why things happen by developing and testing of hypotheses.  This is why some think of Economics as a "bunch of theories." There is one minor difference in terms of the method of analysis.  Economics tends to be a bit more mathematical than the other social sciences as economists tend to tell their stories with more often with graphs and equations, although researchers in all of the disciplines have increasingly utilized sophisticated quantitative techniques in their work.  This explains why many think of economics as "lots of graphs." Because we will rely on some graphs during the semester we will take a little time at the beginning of the course in the second unit to review some of the basics of graphical analysis, but there will certainly be fewer graphs and possibly more tables here than you will find in most of the other introductory economics sections. 

If it is not the method or subject that sets economics apart, what then is it that is unique about economics? We will call it perspective.  Economists tend to begin with the premise that scarcity exists - it has always existed and it will always exist - and individuals and society must therefore devise systems to deal with it.  At the individual level scarcity means people must make choices - precisely the subject matter of much of microeconomics.  Success at University as well as in the "real world" will be dependent upon your decision-making skills.  The same is true at a larger, societal level.  There is not enough "stuff" so everyone can have a 'hot' car, a fancy house, a good education and first-class health care, so each society has had to develop an economic system to allocate scarce resources.  Even though economic systems vary across space and time, each system must provide the answers to a set of very basic questions scarcity has imposed on each society - What will be produced? How will it be produced? and Who will get it?  Economics is the study of the systems devised to solve these three basic questions - what we will call an economic system - and we will begin this course by taking some time to examine alternative economic systems.  As we look back over time there have been many "solutions" to the basic economic questions, but they can be classified into three broad types - Tradition, Command, and Market.  

The focus in this course will be on the economic system you are living in, the market system.  If you talk to your friends who are taking other economics courses and compare notes from these courses that are also focused on the same subject, you will find in many cases there are important differences between the courses. One of the significant differences is the ideological bias of the instructor - the way the instructor tends to see the world.  It will not take you long to realize that economists have a well earned reputation for disagreement, and one thing they disagree on is the relative merits of these economic systems.  These competing views on economic systems will be discussed in the alternative perspectives section where you see why economists disagree so often and why what you read about in the financial section of the New York Times is likely to be so different from what you read about in the Wall Street Journal.  Another significant difference between the courses is the amount of math used by the instructor to tell their stories.  Because these factors have such an influence on the course, we will examine these three topics in this unit - alternative economic systems, alternative ideologies, and how much math is required.  The unit will close with a brief description of important ideas to take beyond the course.

The evolution of economic systems - or the very brief history of the world

It should not surprise you that over the centuries many solutions to the basic economic problems have been tried, and each solution is unique. The economic system in ancient Greece was different from the systems in ancient Egypt and Rome as well as being different from the current system in the US, which is also different from the systems in Germany, Japan, China ... . Rather than focusing on the differences in the myriad of economic systems that have existed, we will focus our attention on similarities and discuss three major types - Traditional, Command, and Market Systems.  The differences between these three systems is readily apparent when you look at your career - how you found yourself in business (or TMD or engineering), how you ended up in an economics course, and how others decided not to enter college. One approach to allocating the limited number of "university slots" would be to allocate them the way they had always been allocated.  If your parents went to college, then you would go to college: if your father was an engineer, then you would be an engineer; if your mother liked her economics course or thought it was valuable, then you would enroll in an economics course.  Scarce resources would be allocated as they had always been - by Tradition. 

An alternative approach would have been to have some "BIG BOSS" make the decisions on who would go to college and who would major in engineering.  For this system to run smoothly we would need a modern-day Pharaoh or Czar with the power to decide how many engineers are needed, who they should be, and where they should work.  You would also need someone to determine who needed to take economics courses.  In this world scarce resources would be allocated by Command.  A wonderful example of life in a command society could be found in the article "This is Monika. I'm Over the Wall" that appeared in the Wall Street Journal.  In that article a young East German girl who comes in contact with a Westerner describes her career "choice" as follows. "It doesn't matter what we will become when we grow up.  We will still always be treated like children."  As Monika saw life in the East, she would always be told what to do so she would never get the chance to "grow up" and make her own choices.  

And then there is the system in which you choose to be an engineering student.  For some the choice may have been made because a parent enjoys life as an engineer; for others it may be the higher-than-average starting salaries for college graduates with an engineering degree; and for others it may be the love of applied mathematics that was the deciding factor in the choice.  As for enrollment in economics courses, students were there because they thought it was in their best interest to be there.  If we had a world where the allocation of resources was determined by people pursuing their own interest, we would have a world in which the Market determined resource allocation.  

Which of these three systems is best?  This is a tough question since each system has advantages as well as disadvantages, which you can see that in your career and course choices.  There is a great comfort in following in your parents' footsteps because they can act as mentors and contacts.  This is especially good for those who are risk averse, who do not like change.  We may very well find a young woman who is quite satisfied becoming a lawyer because her mother was one - it was easy, and there seemed to be little risk.   It can also be nice to have someone tell you what to do so you will not be forced to make too many difficult choices.  Think about choosing courses or careers.  These are not easy choices, so a young man may be happy to be taking courses he is required to take and never asks who was responsible for these requirements.  It should not be surprising that societies organized by tradition or command are rather static, that the pace of change is slow and the concept of economic growth is virtually nonexistent. It should also not be surprising that since the beginning of time, most societies have adopted one of these approaches.

An indication of the situation in a world dominated by tradition and command can be seen in the graph of GDP per person (a measure of the standard of living) that appeared in The Economist magazine a few years ago.  When you look at GDP per person you should think standard of living, or income the "average" person has access to.  It is very clear in the graph that for many centuries there was little increase in income - Western Europe was characterized as a zero-sum game where the gains of any individual were offset by the losses of others.  For the "common person" there was little difference between life in 1000 BC in Greece, the countless feudal estates of 1000 AD, and the emerging nation-states of 1500 AD - the overwhelming number of people lived off the land, were illiterate, never ventured more than a few miles beyond their home, and died young.  By the 1500s, mercantilism was the dominant economic philosophy, one in which a nation's well-being would be improved by the accumulation of precious metals.  You know from your history books that the timing was perfect since this was the era in which the Americas were discovered and it provided a foundation for the plundering of the New World.

It is also clear that something BIG happened around 1700-1800 in Western Europe, a period of time known as the Enlightenment.  It was a period of time where scientists such as Newton were looking for natural laws that explained the working of the natural  world, which opened the door for philosophers looking for natural laws to the social order.  In your political science or philosophy courses you will certainly talk about the ideas of John Locke, who wrote about the "inalienable and indestructible rights of the individual," and Rousseau, who wrote of the "inalienable rights of life, liberty, and the pursuit of happiness" that you will find in the US Declaration of Independence.  It was also the time of Adam Smith who described the outlines of a new economic system providing a foundation for the industrial revolution responsible for the sudden change in income trajectory.₂  It was just around this turning point, in 1776, when Adam Smith wrote his book, The Wealth of Nations, in which he demonstrated how "self interest, tamed by sympathy and constrained by economic rivalry, leads to a widespread prosperity known as 'universal opulence."  Smith was laying out the framework for the market system he believed would unleash economic growth on the world, replacing the zero-sum world with a positive-sum world, and improving the standard of living for the common person.  At the center of Smith's view was this system of voluntary exchanges where both parties benefited, a dramatic change from the zero-sum world it replaced. 

Make no mistake though, it was a very painful and difficult transition from the ordered agricultural world of feudalism in the Middle Ages, where everyone knew their position in life, to the chaotic industrial world where markets determined what one would do and how much one would be paid for that work.  For a glimpse of the hardships associated with this transition all you need to do is read any of Charles Dickens' work such as The Christmas Carole or David Copperfield where the human misery is readily apparent. And for those with a true taste for travel, you could travel to South America, Asia, or Africa where you would see many nations currently in the midst of much faster transition to a market-driven industrial society.  Or you might rent the video, Battle of the Titans, where you will see unsettling scenes of industrialization and urbanization in developing Asia and Africa. 

Not surprisingly, the ideas of Smith came to America with the thousands of immigrants from Europe, and one of the benefits of going to school in New England is that you can get an idea of how life and society was transformed by the industrial revolution and the emergence of the market system by taking a brief road trip.  For those less adventurous, you might take a virtual trip through time by checking out A Digital Archive of Architecture and Digital Archive of American Architecture.  On your road trip start with a visit to Plimouth Plantation where you can see first-hand a recreation of a community in the early 17th century (1627), and then head to Slater Mill in Pawtucket where you can see one of the nation's first factories of the industrial revolution from the late 18th century (1790s).  These places give you an insider's view on life in the pre industrial revolution world, the world before the turning point in the graph. And before leaving these places make sure you look for the closets in the early homes.  They are there but you'll need to look carefully because there weren't many.  It turns out this was pre "universal opulence" and it was unlikely there would be those extra clothes and shoes that fill modern walk-in closets.  And forget about looking for indoor plumbing and central heating. 

Then head off to Sturbridge Village where you can get a 'feel" of rural, agricultural life, and then drive and to Lowell National Park where you get a "feel" of urban, industrial life in the mid 19th century (1830-1860).  This was the early stages of the industrial revolution in the US, and you can see it in the massive size of the mills with their boarding houses for young women workers and in the appearance of some of the trappings of universal opulence in the dining room of a home in Sturbridge Village that most certainly had closets, but you wouldn't find running water or a modern toilet.

Now get back on the road and head to Fall River where the massive granite and brick mills give you a glimpse at what a "world-class" textile city looked like in the early 20th century as the US found itself in the midst of the second industrial revolution that forever changed the lives of Americans.  It was this era when there was a surge in innovation that brought us electricity, the telephone, radio, and the car. To give you some idea of the situation in the US at the turn of the 19th century, check out the images created by Gordon who wrote "Does the New Economy Measure up to the Great Inventions of the Past?." 

• "The steadily increasing production of animal waste caused the more pessimistic observers to fear that American cities would disappear like Pompeii - but not under ashes.  Added to that was acrid industrial smog, sidewalks piled high with kitchen slops, coal dust, and dumped merchandise, which became stirred together in slime after a rain. ... imagine unrefrigerated meat and poultry hung unrefrigerated for days, spoiled fruit, bacteria-infected milk, ... Epidemics included yellow fever, scarlet fever, and smallpox."
• "...urban streets were a chaotic jungle of horse trolleys, and horse-drawn conveyances of all types ... Travel between cities on railroads was surprisingly dangerous; in 1890 railroad-connected accidents caused 10,000 deaths."
• "In 1882 only two percent of New York City's houses had water connections."
• "Coal miners, steel workers, and many others worked 60-hour weeks in dirty, dangerous conditions, exposed to suffocating gas and smoke. Danger was not confined to mines or mills; in 1890 one railroad employee was killed for every 300 employed."  

And to finish your journey you should head to Boston where you can see a world-class city of the early 21st century with its glistening skyscrapers and McDonalds and Starbucks shops.  What should be clear from your trip would be the massive changes that took place during this period, and you can easily imagine the rapid pace of change was often unsettling as people continually changed jobs and locations. 

The "beauty" and potential that Smith saw in the market system was not seen by everyone, which should not be a surprise since not everyone benefited from the system.  There were certainly a number of characters in Dickens' work who would have had a hard time seeing the good in capitalism.  One group who questioned the merits of capitalism were the French Utopians of the 17th century who included Jeremy Bentham who proposed an economy that provided the "greatest good to the greatest numbers" and Louis Blanc who introduced the phrase "from each according to his ability, to each according to his needs."  Karl Marx, who authored The Communist Manifesto in 1848, also had a very different view of capitalism, one more in line with what you would have expected of Dickens' characters and the French Utopians.  Where Adam Smith saw capitalism as possessing a potential for unprecedented economic growth that could improve the lives of all, Marx saw it as a system based upon the owners of capital exploiting labor.  More importantly, Marx saw capitalism as possessing a fatal flaw that would eventually bring about its collapse. Over time the number of exploited laborers would increase and their earnings would decrease, while the number of capitalists would decrease and their earnings would increase.  This ever widening gap between the wealthy few and the numerous poor would eventually cause a collapse in the capitalist system, so Marx viewed capitalism as an intermediate stage in the evolution of economic systems. The first such revolution occurred in Russia in the early 1900s as the Russian peasants overthrew the Czar in 1917 in the midst of WW I and after a long civil war, Lenin established the Union of Soviet Socialist Republics (USSR) in 1921.  As of 1921 there was now an alternative to capitalism, and people around the world would eventually have to "choose" sides - between capitalism and communism.  Joseph Stalin, who ruled the USSR from 1924 to 1953, transformed the USSR from a backward agricultural nation into an industrial giant challenging the world's new superpower - the US - based upon a three part system - collectivism in the agricultural sector,  massive industrialization, and central planning. 

If there were any doubts about the ability of communism to appeal to others, the doubts were ended in the 1920s with the beginning of a second "communist" revolution - this one in China.  Following the lead of the Russians, a communist revolution began in the South of China that by the 1930s, after possibly a million deaths, "forced" people from their land and began the "long march" into the mountains of northern China where they 'regrouped" under the leadership of Mao Ze Dong.  With the defeat of Japan in WW II the communists renewed their attacks on the government and by 1949 the communists under Mao were victorious.  What followed was the Great Leap Forward in the late 1950s, that included the establishment of People's Communes, and the Cultural Revolution led by the Red Guard in the 1960s that attempted to rid the nation of the old ideology, thought, habits, and customs. 

The rest, as they say, was history.  It did not take long before the world was divided into three groups - the capitalist countries lead by the United States (US), the communist countries led by the Soviet Union (USSR), and the "undecided" countries that the US and the USSR spent a good deal of time and money trying to bring into their sphere of influence.   In fact, much of the post WW II Cold War era can be viewed as a battle between two economic / political systems - capitalism (market control) in the West vs. communism (command control) in the East.  The US and the USSR spent many billions of $s on building up military capabilities to "protect" their territory and the wars in Vietnam and Korea are just two examples of where the Cold War heated up.  

The nature of the conflict, however, changed dramatically in the late 1980s.  In China, Deng Xiaoping rose to power in the early 1980s and worked to open up the country to foreign investment and reform the nation's economy, at least until the Tiananmen Square crackdown of 1989 that was dramatically captured with the image of a student standing in front of an army tank.  In the Soviet Union, Mikhail Gorbachev assumed power in 1985 and quickly introduced the policies of glasnost (openness allowing public expression of dissent) and perestroika (economic restructuring that reintroduced private ownership of businesses) and by 1989 elections were being held for Parliament , Soviet troops were being pulled out of Afghanistan, and countries in the Warsaw Pact were allowed to decide on their future.  It was also the year in which Hungary, where an anticommunist revolt had been crushed in 1956, opened its borders to the West, the Berlin Wall collapses, and Czechoslovakia, where a revolt had been squashed in 1968, broke free in the Velvet Revolution, and the year closed with images of the execution of Romania's ruler, Nicolae Ceauşescu,  Within the Soviet Union there was a relentlessly rising three-way battle between Gorbachev, Communist hardliners, and the leaders of the independence movements in the member republics.  By 1991 the hard liners attempted a coup against Gorbachev that opened the door for the breakup of the Soviet Union and Boris Yeltsin's emergence as the ruler of Russia, and the days of the Cold War were numbered.  What followed were decisions regarding the speed of transition to a market economy, with Poland gaining notoriety for its "Big Bang" attempt to quickly make the transition and Russia gaining notoriety for the corruption surrounding the privatization of its industries and the emergence of the powerful oligarchs, and in virtually all of the countries the transition ushered in a period of hyperinflation and economic depression.

When the wall between Eastern and Western Germany came down and the Soviet Union was dismantled, the consensus was that capitalism had proved itself superior to communism and the ideological debate had been settled.  In fact in 1989 Francis Fukuyama wrote an essay entitled "The End of History" in which he noted that "a remarkable consensus concerning the legitimacy of liberal democracy as a system of government had emerged throughout the world over the past few years, as it conquered rival ideologies like hereditary monarchy, fascism, and most recently communism. More than that, however, I argued that liberal democracy may constitute the 'end point of mankind's ideological evolution and the 'final form of human government,' and as such constituted the 'end of history.' That is, while earlier forms of government were characterized by grave defects and irrationalities that led to their eventual collapse, liberal democracy was arguably free from such fundamental internal contradictions."  Although his focus was on political systems, the same could have been said about economic systems and the superiority of capitalism.  Capitalism had shown itself to be a superior system and it would only be a matter of time before it spread across the remainder of the world sweeping aside the last remnants of tradition and communism.₂ 

Not everyone agreed that history had ended, and in fact Samuel Huntington gained some notoriety for a very different view of the future, one in which the Cold War that pitted two economic systems against each other would be replaced by a new conflict, The Clash of Civilization?.  In the 'new world" you will see Western civilization competing with other civilizations - Confucian, Japanese, Islamic, Hindu, Slavic-Orthodox, Latin American, and African - and there was no reason to believe in 1993 when Huntington was writing that the other civilizations would openly adopt the Western view.  Robert Kaplan, in "Was democracy just a moment?," goes a step further and suggests that maybe democracy is not always the ideal system, and that as the process of globalization continues and corporations gain increasing power you may see democracy as we know it today disappear.  You would not be too far off the mark if you looked at the US invasion of Iraq as one such clash, one that would hardly be described as peaceful.  The belief expressed by the Bush administration that American soldiers would be treated as liberators suggests their acceptance of the end of history over the clash or civilizations view, but as I write and you read we would have to say it is "too early to call."

Regardless of whether history is over or just beginning, we can be certain that the world is smaller - and if Thomas Friedman is right - a little flatter.  What Friedman is suggesting, and I think he is right on target, is that for much of its history the US has been protected from the rest of the world by limited transportation and communications technology, two large oceans that separated it from potential competitors, and a number of political decisions such as those in the Soviet Union and China to insulate themselves from competition with the west and the governments of the former colonies in Latin American and Indian to cut themselves off from the world after WWII.  As we head into the 21st century, those walls and barriers that once protected the US are gone, however, and Americans no longer have the high ground that is easy to protect.  The world is getting flatter as the playing field gets leveled, and this has dramatic implications for the future of the US - and your future - and in this course we will talk often about those implications. 

What is it about the market system that helped unleash the powers creating unimaginable growth and the flattening world?  How is it that an entire system in which scarce resources would be allocated by the choices of individuals doing exactly what they want to do would actually work?  For this system to be effective, decision makers need both the information necessary to make informed choices as well as the incentive to make those choices.  You need to have some incentive to get out of bed in the morning as well as some idea of what to do with your time once you are out of bed.  In the market system, prices provide the necessary information while property rights, which enable the owners of property to use their property and to sell it, provide the incentives. Getting back to the career choice problem, you have decided to be an engineer because the price (income) was right and with your new wealth, which you have the rights to control, you would be able to obtain those things that matter to you.  Furthermore, you are much more likely to work diligently if you are studying to be a lawyer because you want to be a lawyer, if you are taking a course in history because you want to know more about history, or if you are working on development of a web site because you own stock options that could make you rich if the product ever hits BIG.  

But how do we avoid chaos when all decision makers are pursuing their self interest? The "secret" is in the interaction between the individual decision makers. The nature of the interaction can be seen below in a very simple version of the Circular Flow Diagram identifying the three major aggregate markets (output, capital, and labor) that tend to bind the major decision makers (households, firms, and government) together.  Households / individuals buy goods and services in the output market, sell labor in the labor market, and borrow money (mortgages, car loan) and lend money (savings account, mutual fund) in the capital market. [We have ignored the rest of the world here, but we will expand this model later to include it.]

Diagram 1
Circular Flow Diagram

In the case of your career choice, the logic of the system would go something like this.  In the output market we could find evidence that people want computers.  The output market would send a signal (high profits) to firms prompting them to raise the production of computers.  This generates a need (demand) for more electrical engineers prompting the labor market to send out a signal (higher wages for engineers).  People respond in a predictable fashion to this signal.  Because they can keep the money earned from selling their skills, more people will decide to become engineers as the wages of engineers increase. As more people decide to become engineers there will be more people needing to borrow money to finance their schooling and the capital market will send out the appropriate signal (higher price). The higher interest rates (price of money) should increase savings, which should result in an inflow of money into the capital market providing adequate financing for the new students ... .  We can stop now because you can see the pattern  of interaction that defines the market system. 

Before we move on, however, it is important to know that there are many versions of capitalism.  A very abbreviated overview of the versions can be found in "The good (and bad) model guide," an article that appeared in The Economist magazine where reference is made to a number of models including the American, Japanese, German, and East Asian models.  In the Japanese model, loyalty and longevity were highly prized so workers - at least some - had guaranteed lifetime employment and pay was largely determined by length of employment.  Corporations, meanwhile, because of their strong relationships with banks, were able to avoid the focus on short-term stock prices and focus their efforts on loner term investments.  And the system worked BIG TIME.  Japan's economy had been obliterated during WW II, but by the end of the 1980s Japan economy had risen to the point where people were beginning to talk about the 21st century as the Japanese century. The US was slowly losing its economic leadership role as we began to buy Japanese products - think cars and electronics - and the Japanese began buying the US with the $s - think Pebble Beach in CA and Rockefeller Center in NY.  The belief in the superiority of the Japanese model can be seen in James Fallows' 1993 article in The Atlantic Monthly, "How the World Works." Fallows identifies significant differences in the  "Anglo-American" economic theories and policies and those in other capitalist countries such as Germany and Japan.  If you look carefully at Fallows work you will find he believed the Anglo- Americans were being beaten in the world economy by a country that was better managed by agencies such as Japan's MITI (Ministry of International Trade and Industry), by countries that "managed" markets rather than let them run freely.  As Fallows saw it, "violating the rules of Anglo-American economics - may be indispensable for nations that are trying to get ahead' and that the US would eventually lose out to those countries that "rigged" the system of markets.  The problem for Fallows was that the US had lost its way, had given up on its "managing" of its economy, and that the slide of the 1970-1980 period could be expected to continue unabated as the managed economies continued their rise. 

As it turns out Japan did not take over the world and in fact they had to sell back Pebble Beach and Rockefeller Center at a substantial loss.  Confidence in the Japanese model was shattered as Japan's economy suffered through a decade long recession, and for those looking for an interesting perspective on why the Japanese model ground to a halt you might want to check out The Social Contradictions of Japanese Capitalism where you see the uglier side of a well-developed case of crony capitalism.  The US economy, meanwhile, boomed as it became the center of the Internet revolution that amazingly began in the early 1990s.  This should be no surprise given that the American model of capitalism is one where resources can move quite freely between sectors of the economy, where markets are quite flexible, taxes are low, and corporations tend to focus on stock market value - a perfect setting for the Internet revolution.  To better understand the American model, consider the situation in Megacorp, a hypothetical world leader in the production of high tech widgets.  This is an organization with a well developed management hierarchy, a structure that has made it the world leader, a structure filled with individuals who have learned the secrets of success in the industry.  Now imagine yourself as a young hot shot who has to tell the boss, who has been there for years, that there is a need to change strategies, that all the boss has been responsible for creating in his or her professional life will need to be destroyed to enable the creation of a newer, better, faster, cheaper way of doing things.  It will not be an easy meeting for you, and as the company gets bigger, it will be even more unpleasant and difficult to elicit change.  Unfortunately Japan's economy, dominated by large companies that rewarded loyalty and longevity, was not the right environment to foster a revolution.  A wonderful example of this could be found in John Markoff's article "A Rebel in Japan, an Inventor is Hailed as an Innovator in US," that appeared in the New York Times in 2002.   Markoff relates the story about a scientist in Japan who had to hide his patents from his bosses.  Another example can be found in the 2001 Foreign Affairs article by Clayton Christensen, Thomas Craig, and Stuart Hart, "The Great Disruption" where we see how the structure of Japan's corporate management was responsible for Japan's missing the Internet revolution.  Success in the New Economy requires individuals willing to take risks, individuals willing to look relentlessly for a better way to build that mousetrap - and the US had more than its share of these change agents while Japan had less than their share. The downside is that inequality is a problem with the gulf between the well-to-do and the poor being wider in the US than any other rich country.₄  The prevalence of inequality is also a growing problem in China as they move from a command to a market economy - the theme in the article "To each according to his abilities."  Another place to look for some insight into the important differences between versions of market economies and the significance of these differences would be the OECD's publication, The New Economy: Beyond the Hype in which explanations for the growth differentials - the ability of the US to pull away from most of the wealthy countries in the 1990s - are sought.  The contrast between the European and American models can also be found in Gordon Brown's article "Old Europe's Choices" that appeared in the Wall Street Journal in 2003 and "Europe's Scrap-heap" that appeared in The Economist in 2001.₅   The short answer is the dynamism of the US version of capitalism where markets are more powerful and freer to adjust to shocks and government interferences are smaller.

Before we begin our detailed discussion of what you can expect in this particular course, we will take a moment to discuss some of the alternative perspectives on economic systems.   Economists are notorious for their ability to disagree and we will briefly examine one source of disagreement - what some would call an ideological perspective. 

Alternative perspectives (ideologies)

Anyone who listened to even a little of the committee hearings on Bill Clinton's impeachment in December of 1998 or the debate on George Bush's tax cut in 2003 knows the power of political parties.  Regardless of one's views on the validity of the charges against Clinton or the value of Bush's tax cuts, there was no question they were partisan affairs where you could identify a person's party from his / her comments.  There is a difference between the way Republicans and Democrats see the world, and this is reflected in nearly all that they say and do, although sometimes it is not so obvious in their campaign statements.  The same is true to some extent in economics because economists have very different views of the world - what we will call ideology.  Whereas in politics we have Democrats and Republicans, in economics we have Conservatives and Liberals.₆  It is conservatives and liberals whose opinions and theories you might expect to see in print on the pages of The Wall Street Journal and The New York Times.  

Conservatives tend to possess a general distrust of the state (government) and an unending faith in the supremacy of "free choice" as a mechanism for allocating resources and promoting growth. The Father of Conservative economists would be Adam Smith who wrote The Wealth of Nations in 1775 and first outlined the capitalist economic system that allocates resources in a decentralized fashion by individuals pursuing their own self interest.  According to Smith, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest," and it is the pursuit of this self interest that society will produce what individuals want in the most efficient manner.  For conservatives, a good government is a small government simply setting the "rules" to govern the competition among businesses and individuals.  In his book Smith describes the situation as follows: 

All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of society. 

Not only is the sovereign freed from managing the economy, officials are freed from responsibilities for the less fortunate.  Gordon Bigelow, in "Let there be markets: The evangelical roots of economics," ( Harpers May 2005) suggested officials accepted the free market as " a perfectly designed instrument to reward good Christian behavior and to punish and humiliate the unrepentant. … while evangelicals believed salvation was ultimately possible only through conversion and faith, they saw the pain of earthly life as a means of atonement for original sin.”  An early manifestation of this was in England where the “The Poor Law nationalized and monopolized poverty administration.  It forbade cash payments to any poor citizen and mandated that he’s only recourse be the local workouts….Trevelyan [asst. secretary of the treasury] viewed the potato-dependent economy as the result of Irish backwardness and self indulgence.  This crisis seemed to offer the opportunity for the Irish to atone…. Trevelyan stopped the supply of food.  He argued that the fear of starvation would ultimately a useful in modernizing Irish agriculture: it would force the poor off the land that could no longer support them.”  If you fast forward to the 1920s in the US, you find a similar logic in response of the Secretary of the Treasury, Andrew Mellon, to the Great Depression.   "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. … It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."  And I suspect if you move to today you will find that you were often hearing about how the poor were poor because they were lazy or stupid, or the rich were rich because they were smart, hard-working,  and creative. 

Liberals, meanwhile, share with the Conservatives a strong faith in the market, but believe there are advantages to be gained by moving to a "compromise" position where the government is able to devise policies to offset some of the "structural flaws" of the system.  Liberal theorists believe there are instances where the capitalist system behaves less than optimally, including a tendency to produce unacceptable and avoidable levels of economic instability. One of the more influential liberals, and the father of modern macroeconomics, is who wrote The General Theory John Maynard Keynes of Employment Interest and Money. In his critique of the prevailing conservative theory, Keynes wrote:

"Now 'in the long run' this is probably true.... But this **long run** is a misleading guide to current affairs. In the long run we are all dead.  Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again." 

As Keynes saw it, the conservative view emphasizing the power of markets to allocate resources may be an adequate explanation of what would happen in the long-run, but we may not have the will to wait that long.  For a more extended overview of the alternative perspectives you should check out the History of Economics web site.  

The truth, as so often happens, probably falls somewhere in the middle. For those with an open mind I trust you will find truth in the statement: “the liberal mistake is to think that there is a program or policy to alleviate every problem in the world, the conservative flaw is to be vigilant against concentrations of power in government only – not in the private sector.” Keep this in mind as you read the op-ed pieces in The Wall Street Journal pushing the conservative agenda and The New York Times where you will find the liberal perspective.  A great example of the differences could be found in the 2003 discussions of Bush's tax cut proposal.  The Wall Street Journal continually supported the tax cuts designed to "starve" the government of funds and force it to get smaller while The New York Times relentlessly focused on the cuts in government services that were associated with the tax cuts. A good example of a liberal bias can be found in Paul Krugman's article, "Bums and Rushes" that appeared in the New York Times. 

A reoccurring theme in the two introductory courses will be the parallels between economic theory, economic policy, and economic performance.  Economic policies will be grounded in the prevailing economic theories and there will be little pressure to unseat those theories or policies as long as the economy is performing adequately.  It is only in times of economic crises where there is any real movement in public policies and any shift in the balance of power among theorists - a reversal of the ideological pendulum.₅  

Diagram 2
Ideological Pendulum

When we look at the history of the US there have been only two turning points, two time where the ideological pendulum reversed itself.  The first such crisis was the economic collapse of the Great Depression in the 1930s that was so complete that it is difficult to comprehend its magnitude today - but we'll try.  First, take a moment to read a passage from John Steinbeck's book, The Grapes of Wrath, and then look at the unemployment rate graph.

"And then the dispossessed were drawn west - from Kansas, Oklahoma, Texas, New Mexico: from Nevada and Arkansas families, tribes, dusted out, tractored out. Carloads, caravans, homeless and hungry; twenty thousand and fifty thousand and two hundred thousand. They streamed over the mountains, hungry and restless... The kids are hungry. We got no place to live. Like ants scurrying for work, for food, and most of all for land... and the dispossessed, the migrants, flowed into California, two hundred and fifty thousand, and three hundred thousand. Behind them ... [other] tenants were being forced off [their lands]. And new waves were on the way, new waves of the dispossessed and the homeless, hardened, intent, and dangerous."

With nearly 25 percent of the nation's workers unemployed and countless thousands migrating out of the cities and farms and heading westward, it was time for the nation's leaders to reconsider the status quo, which is precisely what Roosevelt did.  Following the advice of economic theorists such as John Maynard Keynes, Roosevelt moved the country to the ideological left with adoption of the liberal policies known as the New Deal.  The philosophy of the liberals is captured in a 1960s Supreme Court decision: "We have come to recognize that forces not within the control of the poor contribute to their poverty. .... Public assistance, then, is not mere charity, but a means to "promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity." ("Evident truths," Harpers July 2004)  It was the responsibility of the government to protect its people, and Roosevelt, having seen the ravages of the Great Depression and WWII, recognized that all of the enemies of the American people were not foreign countries.  Roosevelt committed the nation to a second Bill of Rights in his 1944 state of the union address in which he set out the guidelines for the nation once the war was over. These rights were to complement the first set of rights, free speech, free press, free worship, trial by jury, freedom from unreasonable searches and seizures that appeared in the US Constitution.  According to Roosevelt, Americans had the:

the right to a useful and remunerative job in the industries or shops or farms or mines of the nation;
the right to earn enough to provide adequate food and clothing and recreation;
the right of every farmer to raise and sell his products at a return which will give him and his family a decent living;
the right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home and abroad;
the right of every family to a decent home;
the right to adequate medical care and the opportunity to achieve and enjoy good health;
the right to adequate protection from economic fears of old age, sickness, accident, and unemployment;
the right to a good education. 

In fact you can see this philosophy in the interim Iraqi constitution "ghost written" by the US: "The individual has the right to security, education, health care, and social security." ("Evident Truths," Harpers July 2004). 

This is not, however, the prevailing mood in the early 21st century in the US.  There was a second economic crisis significant enough to shift the ideological balance, this one in the 1970s when the US suffered through the Great Stagflation - the simultaneous appearance of both high levels of inflation and unemployment - what a policy official might consider the worst of all possible worlds.  The liberal economists found themselves unable to adequately explain the rising unemployment and inflation rates, the loss of 100,000s of American jobs to foreign competition, and home mortgage rates nearing 20 percent, which opened the door for conservative economists who provided the theoretical basis for Ronald Reagan's movement of the country back to the ideological right with his supply-side policies.  It is this conservative ideology that continued to dominate economic theory and policy at the turn of the millennium, where you might characterize the situation as: "the United States seems to have embraced a form...of individualism, which endorses rights of private property and freedom of contract but claims to distrust 'government intervention' and insists that people must fend for themselves." ("Evident truths," Harpers July 2004)  You can also see the significance of ideology in the following excerpt that appeared in Harpers magazine.  A journalist documented changes in the US Fish and Wildlife Service website in the week following Bush's inauguration.  The words with the strikethrough were dropped from the wording under the Clinton administration. ("Dept. of Corrections" Harpers 6/2001). 

<s>The Arctic National Wildlife Refuge is the most pristine unit in the National Wildlife Refuge System. Oil and gas exploration and development in the Refuge would permanently and irreversibly.

Destroy the unique wildland values of a world class natural area;

Disrupt ecological and evolutionary processes in one of the most pristine conservation areas in the North American Arctic;

Diminish the Refuge's scientific value as a benchmark for understanding these processes;

Damage the biological and ecological integrity of the entire Refuge.</s>

One hundred thirty-five species of birds are known to use the area, including numerous shorebirds, waterfowl, loons, songbirds, and raptors. <s>Oil development in the Arctic Refuge would result in habitat loss, disturbance, and displacement or abandonment of important nesting, feeding, molting, and staging areas.</s>

One <s>species of bird that could be greatly impacted by oil development</s> notable example is the snow goose. Large numbers of snow geese, varying each year from 15,000 to more than 300,000 birds, feed on the Arctic Refuge coastal tundra for three to four weeks each fall. They feed on cottongrass and other plants to build up fat reserves in preparation for their journey south, eating as much as a third of their body weight every day. The rich vegetation of the coastal tundra enables them to increase fat reserves by 400 percent in only two to three weeks.

Snow geese feed on small patches of vegetation that are widely distributed across the Refuge's coastal tundra, so a large area is necessary to meet their needs. They are extremely sensitive to disturbance, often flying away from their feeding sites when human activities occur several miles distant. <s>Oil exploration and development would displace snow geese from areas that are critically important to them.</s>

If you take out the deleted words the "picture" looks very different, and this is the power of ideology.  In this course the discussions will be focused on the ideological spectrum spanned by conservatives and liberals, although there are important ideas about economics that do not fall in that range and we will also touch on some of them during the semester.  You should also realize that the introduction to economics is generally divided into two separate courses. The first would be Microeconomics.  The analysis of a career choice, as well as the choice of someone to teach you economics, would be the subject matter of microeconomics where the emphasis is on the choices made by individuals and firms - how many hours to work, how many children to have, how much output to produce, and how many workers to employ?  As you will hear me say many times, we look at decision makers as calculators continuously weighing the costs against the benefits associated with any decision/choice, and we'll look closely at how those calculators work.  

In Macroeconomics the emphasis is on how well these aggregate markets function.  Can we expect the labor market to function effectively so all people looking for work can find it?  Will there be a job waiting for you when you graduate? Can we expect the output market to function properly?  Will there be inflation eroding the buying power of your earnings, and will there be economic growth so we can enjoy a future in which the standard of living continues to rise? And will the capital market provide enough funds so people can borrow money to finance their education and buy their cars and homes on credit, or will there be a return to 18 percent mortgage rates and credit crunches.  These are important issues, but they are beyond the scope of the micro course.  

How Much Math?

Now for the question so many of you have been waiting for: How much math will you need? As you saw earlier, economics involves story telling and the teller of the story has a considerable say in how much math will be used in the story.  While my college degree was in mathematics and I believe very strongly that adequate quantitative skills would be on the short-list of skills all students should posses upon graduation from college, there is no need to rely on sophisticated mathematical / statistical techniques to tell the stories that told in this course.  

There are actually four ways in which to tell our stories, and during this semester you will run into examples of all of these. The four forms for story telling are:

• Verbal
• Tabular
• Graphical
• Algebraic

To give you an idea of the differences in the "presentation" of the story, consider the following rather simple story about population growth.  In the past few years we have heard much about the rapid growth of the world's population and the havoc it is wreaking on the environment, but how important are the proposals which would reduce the growth rate of the world's population.

As a first step toward answering this question, let's look at the situation in twenty years. At the present time the world's population is approximately 5.8 billion and it is growing at a rate of 1.4 percent per year. If it continues to grow at that rate, then the world's population in ten years would be 6.67 billion, and at the end of twenty years it would be nearly 7.7 billion people.  So much for the verbal approach.

In addition to the verbal representation, the story of population growth could also have been told using a table such as the one below. The advantage of this is that more information can be seen quickly - we can see what the population would have been at six different points in time in the future.

Or you could present the relationship between time and population with a graph comparable to the one below. The advantage of the graph is we see the continuous growth of the population for the twenty years.  The disadvantage is we cannot read off what the population would be in any one year.

Finally, for those who have a good command of mathematics, we could use the algebraic version. The solution for the world's population in twenty years [Pop (20)] using the equation would be:

Pop(20) = 5.8*(1.014)²⁰ = 7.66

Ideas for beyond the exam

A number of years ago the text I used for this course began with a short list of ideas for the students to take beyond the course, and more recently I read Building Wealth in which Lester Thurow identified ten rules for success in the new knowledge economy.  They both have that Letterman "Top Ten" feel to them, but I liked the idea of some guiding principle to keep in mind as you work your way through the course because once the course is done you will not remember the details, but you should be able to remember a few overarching principles.  I have included the lists plus the list of concepts identified in Thinking Like an Economist: A workshop on economic principles, which gives you an idea of how economists tend to view the world, a view that is embedded in the other two lists.  Most of these concepts are pretty straightforward, but you should check out these sources for more details about the concepts/ideas.

Here's my list of ideas that have guided me in developing the introductory courses in economics.  Keep them in mind as you work your way through the course.

1. Self interest is a force to be reckoned with:  When you are trying to explain or forecast the behavior of some decision maker - a government policy official, a corporate executive, or a neighbor - think about them as "calculators" constantly weighing costs and benefits of their decisions.
2. There is no free lunch: Economists know you can't have it all, so be sure you know what you are giving up when you choose a course of action. If you are looking for efficiency, you will probably sacrifice equity, while if you are looking for lower inflation rates, it will probably cost you some additional unemployment.
3. Getting to yes - or maybe there is a free lunch: There is no free lunch, but we can expect that two people (or countries) could enter into a transaction where both would benefit.  This is the basis for the economists' belief that trade is a positive force in the world and a key to increases in the standard of living.
4. What you see depends upon where you sit: Ideology matters because it affects the way you look at the world.  It turns out that we see what we want to see and hear what we want to hear. 
5. All is not as it seems to be: Be careful of numbers since they can be very misleading and keep in mind the fact that "all that matters can't be measured and all that is measured doesn't matter."
6. Markets matter - and so does the government: Scarcity must be dealt with, and markets are one powerful way of dealing with it, but they have well-known limitations that provide the basis for government actions.  The debate over the size and scope of the government will not be solved in your lifetime, but what all will agree on is that it needs to play a BIG role.
7. Demographics and technology matter. The two forces that will exert the most influence on the future are demographics and technology.
8. And so does productivity: If you are to consume more we will need to produce more - and the key to that is productivity.
9. Beware of unintended side effects: When you do something always think about how those "calculators" are likely to respond, not how you would like them to respond to it. 

1. As you now know, this was not the end of history in the sense that the collapse of communism ushered in a peaceful world.  In fact after the events of 9/11 president George Bush announced the US was engaged in a "War on Terrorism" that sounded very much like the Cold War when he said it could cost many 100s of billions of $s to fight it and that it could go on for 40 years.  The War in Iraq is viewed by some as an opportunity to bring capitalism and democracy to the Middle East, and once it establishes itself in Iraq it will spread to the surrounding countries.  While it may be costly in the short run, the view of the neoconservatives pushing this plan is that the replacement of the stagnant traditional society in the Middle East with a prosperous capitalist society will reduce the likelihood of disgruntled Middle Easterners to strike out at the West.

2. Another interesting question is: why was the change centered in Europe and not China, which during the Middle Ages was at least as advanced as Europe?  Jared Diamond in The Ideal Form of Organization provides a clue to the widening gap between Europe and China.  The short answer was competition and lack of central control.  In China the decision was made to eliminate international travel and trade, to close down China to external influences.  In Europe where there were a number of competing monarchies, there was no single ruler who could eliminate international trade since each made their own decision.  A good example of this was Christopher Columbus who shopped around his idea of a journey to India to many rulers before he found Ferdinand and Isabella wiling to provide the funds. And when the other rulers saw the wealth coming from the New World, they bought into the idea and began their own colonization and exploitation.  

3. Debates on how the economy operates and on appropriate government policies generally that you follow in the mainstream press are generally between the two ideological groups falling within the midrange of the ideological spectrum.   There are also Marxists and Institutionalists who also posses differing views on these issues, but they tend to not be represented in the mainstream press. 

4. Another article that describes the limitations of the Japanese model is Edmund Phelps' "The Global Crisis of Corporatism," that appeared in the Wall Street Journal in 1999.

5. The German model is centered on a generous welfare state and worker-management cooperation, while the dominant characteristics of the East Asian models are an openness to international trade  - they tend to export vast numbers of goods to the US, and their people tend to have high savings rates.  You should look at the article to see the characteristics of the other models not discussed here.  

6. Bruno and Easterly (1996) suggest that economic crises, in this case crises triggered by bouts of hyperinflation, can speed the process of economic reform in lower income countries and the return of growth will be faster in those countries that experienced the hyperinflation.  If we follow the logic a bit further we end up where Albert Hirschman (1987) did and conclude that "inflation has acted as the equivalent of war in eliciting change" or Alesina and Drazen (1991) who "model delayed stabilization as a war of attrition." 

7. Here are the two lists, and it is not a surprise that behind them are common ideas. 

Version 2

Introduction to Economics: Alternative Systems and Perspectives

In this Unit we will look at three issues:

• Alternative Economic Systems
• Alternative Ideologies
• How Much Math

Alternative Economic Systems

It should not surprise that over the centuries many solutions to the basic economic problems have been tried, and each solution is unique. The economic system in ancient Greece was different from the current system in the US, which is substantially different from the system in China. Rather than focusing on the differences in the myriad of economic systems that have existed, we will focus our attention on similarities and discuss three major types - Traditional, Command, and Market Systems.

The differences between the systems is readily apparent when you look at your career - how you found yourself in engineering or business or TMD and others did not. One approach to allocating the limited number of "university slots" would be to allocate them the way they had always been allocated. If your parents went to college, then you would go to college: if your father was an engineer, then you would be an engineer.  Scarce resources would be allocated as they had always been - by Tradition.

A alternative approach would have been to have some "BIG BOSS" make the decisions on who would go to college and who would major in engineering.  For this system to run we would need a modern day Pharaoh or Czar with the power to decide how many engineers are needed, who they should be, and where they should work.  In this world scarce resources would be allocated by Command.

And then there is the system in which you chose to be an engineering student.  For some the choice may have been made because a parent enjoys life as an engineer; for others it may be the higher than average starting salaries for college graduates with an engineering degree; and for others it may be the love of applied mathematics that was the deciding factor in the choice.  Regardless of the reason, in each case you have chosen the engineering route.

Now imagine an entire system in which scarce resources would be allocated by the choices of individuals. This is a Market system which is pictured below in Diagram 1.  For this system to be effective, decision makers such as you need both the information necessary to make informed choices and the incentive to make those choices.  In the market system, prices provide the necessary information while property rights that enable the owners of property to use the property and to sell it, provide the incentives. Getting back to the career choice problem, you have decided to be an engineer because the price (income) was right and with your new wealth you would be able to obtain those things which mattered most to you.

Diagram 1
Structure of Market System

The analysis of this choice of career, as well as the choice of someone to teach you economics, would be the subject matter of Microeconomics where the emphasis is on individual choice.  Here the focus is on the explanation of choices made by individuals and firms - how many hours to work, how many children to have, how much output to produce, and how many workers to employ. The basic premise in microeconomics is that firms are pursuing profit while individuals / households are pursuing their self interest.   As you will hear me say many times, we look at decision makers as calculators continuously weighing the costs against the benefits associated with any decision/choice.  

But how do we avoid chaos when all decision makers are pursuing their self interest? The "secret" is in the interaction between the individual decision makers. The nature of the interaction can be seen below in a very simple version of the Circular Flow Diagram that identifies three major aggregate markets (output, capital, and labor) that tend to bind the decision makers (households, firms, and government) together.  Households / individuals buy goods and services in the output market, sell labor in the labor market, and borrow money (mortgages, car loan) and lend money (savings account, mutual fund) in the capital market.

Diagram 2
Circular Flow Diagram

In the case of your career choice, the logic of the system would go something like this.  In the output market we would find evidence that people want computers.  The output market would send a signal (profits) to firms that would prompt them to raise the production level of computers.  This generates a need (demand) for more electrical engineers and the labor market would send out a signal (higher wages for engineers).  We would expect people to respond in a predictable fashion to the signal.  Because people can keep the money earned from selling their skills, more people will decide to become engineers as the wages of engineers increases.   As more people decide to become engineers there will be more people needing to borrow money to finance their schooling and the capital market will send out the appropriate signal (higher price). The higher interest rates (price of money) should increase savings which should result in an inflow of money into the capital market that will mean adequate financing is available for the new students.

The analysis of what goes on in these markets, because it is at the center of the market system, will be the discussed at the outset of both courses as we examine the supply - demand model of prices.

In Macroeconomics the emphasis is on how well these aggregate markets function.   Can we expect the labor market to function effectively so all people looking for work can find it?  Will there be a job waiting for you when you graduate? Can we expect the output market to function properly?  Will there be inflation that will erode the buying power of your earnings, and will there be growth so we can enjoy a future in which the standard of living continues to rise? And will the capital market provide enough funds so people can borrow money to finance their education and buy their cars and homes on credit, or will there be a return to 18 percent mortgage rates and credit crunches.

Before we begin our detailed discussion of either micro or macro, we will take a moment to discuss some of the alternative perspectives on economic systems.   Economists are notorious for their ability to disagree and we will briefly examine one source of disagreement - what some would call an ideological perspective.

Overview of Alternative Perspectives (Ideologies)

Anyone who listened to even a little of the committee hearings on Bill Clinton's impeachment in December of 1998 knows of the power of political parties.  Regardless of one's views on the validity of the charges, there was no question this was a partisan effort where you could identify a person's party from his / her comments.  There is a difference between the way Republicans and Democrats see the world and this is reflected in nearly all that they say and do. 

The same is true to some extent in economics. When you ask an economist the question, which economic system is the "Best," the answer you get will depend very much upon the economist's view the world - on what would be called ideology.  Whereas in politics we have the Democrats and Republicans, in contemporary economic thought, the debate on which is the best economic system is generally between the two ideological groups that would fall within the midrange of the ideological spectrum - Conservatives and Liberals - whose opinions and theories you might expect to see in print on the pages of The Wall Street Journal and The New York Times.  For a brief overview of the alternative perspectives you should check out the History of Economics web site.

Conservatives tend to possess a general distrust of the state and an unending faith in the supremacy of "free enterprise" as a mechanism for allocating resources and promoting growth. The Father of Conservative economists would be Adam Smith who wrote The Wealth of Nations in 1775. The capitalist economic system allows allocation decisions to be made in a decentralized fashion by individuals pursuing their own self interest.  According to Smith, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."  More importantly, this system based on individual choice will tend to operate optimally.  Again in Smith's words: "...by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this...led by an invisible hand to promote an end which was no part of his intention."  For conservatives, a good government is a small government that simply sets the "rules" to govern the competition.  In his book Smith describes the situation as follow: 

All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of society. (Book 4, Chapter 9):

Liberals, meanwhile, share with the Conservatives a strong faith in the market, but believe there are advantages to be gained by moving to a "compromise" position where the government is able to devise policies to offset some of the "structural flaws" of the system.  Liberal theorists believed they had proven the existence of instances where the capitalist system would behave less than optimally, including a tendency to produce unacceptable and avoidable levels of economic instability. One of the more influential liberals, and the father of modern macroeconomics, is John Maynard Keynes who wrote The General Theory of Employment Interest and Money. In his critique of the prevailing conservative theory, Keynes wrote:

"Now 'in the long run' this is probably true.... But this **long run** is a misleading guide to current affairs. In the long run we are all dead.  Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again." 

As Keynes saw it, the conservative view that emphasized the power of markets to allocate resources may be an adequate explanation of what would happen in the long-run, but we may not have the will to wait that long.

The differences between these two views will be a reoccurring theme in both macroeconomics and microeconomics. In microeconomics one of the issues you would be likely to talk about would be the education industry.  Liberals tend to believe education is too important to be left to the private sector because we can expect the private sector will provide less education than would be best for our society. Their solution is the public provision of education - institutions such as University where the cost of education is subsidized by the general public. Conservatives, meanwhile, tend to believe the market system will provide adequate levels of education and the secret to improving our educational system is privatization. 

In macroeconomics, some of the most heated debates are likely to be about the ability of the government to alter macroeconomic performance with the use of monetary and fiscal policies - printing more money or raising government spending.  The questions you will look into here are: How much money should be in the system and who should control it? How big should the level of government spending be and should we view the level of government spending as a tool to reduce the level of unemployment? Should Japan's government increase government spending to move the country out of a long-running recession? Should the Fed raise interest rates to head off future inflation?  Conservatives tend to push for limited discretionary policies on the part of both monetary and fiscal authorities while liberals tend to believe that discretionary monetary and fiscal policies should be employed to improve the performance of the macro economy. 

This story will be told, to the extent that it is possible, in the third person. Less effort will be spent taking sides and more on describing how economic theory and policy have swung back and forth between these two views over the past sixty years. We will focus our attention on how new ideas develop as the economy changes in ways that old theories find hard to explain - how the new theories become an orthodoxy that eventually becomes incapable of explaining new facts, leading to the rise of yet another set of new ideas. 

As we move forward we will see there is clearly a parallel between economic theory, economic policy, and economic performance.  Economic policies will be grounded in the prevailing economic theories and there will be little pressure to unseat these theories or policies as long as the economy is performing adequately.  It is only in times of economic crises that there is any real movement in public policies and any shift in the balance of power among theorists - a reversal of the ideological pendulum.  Bruno and Easterly (1996) suggest that economic crises, in this case crises triggered by bouts of hyperinflation, can speed the process of economic reform in lower income countries and the return of growth will be faster in those countries that experienced the hyperinflation.  If we follow the logic a bit further we end up where Albert Hirschman (1987) did and conclude that "inflation has acted as the equivalent of war in eliciting change" or Alesina and Drazen (1991) who "model delayed stabilization as a war of attrition." 

Diagram1
Ideological Pendulum

As we work our way through the story you will find there are two dominant themes. One theme is the proper scope of government - a theme that actually pervades all economics courses and discussions.  It is the flip side of the discussion of how well the economy operates on its own - on the adequacy of the economy's self-adjustment mechanisms to deal with the inevitable external shocks such as the Asian financial crises of 1997-98. 

Although our discussions of microeconomics and macroeconomics will be focused on the ideological spectrum spanned by conservatives and liberals, there are important ideas about economics that do not fall in that range.  One would be Marxism, the economic theory attributed to Karl Marx who wrote during the second half of the 19th century.  Where Adam Smith saw Capitalism as possessing a potential for unprecedented economic growth, Marx saw it as possessing a fatal flaw that would eventually bring about its collapse.  Capitalism was simply an intermediate stage in the evolution of economic systems and it would eventually fall under its own weight.  [You might want to check out the Karl Marxweb site for more information and some of his original writings].  In fact, much ofthe post WW II era can be viewed as a battle between two economic / political systems - capitalism (market control) in the West vs. communism (command control) in the East.  When the wall between Eastern and Western Europe came down at the beginning of the 1990s, the consensus was that capitalism had proved itself superior to communism and that the ideological debate had been settled.  This is undoubtedly an optimistic view and you can expect that Marxism / communism will be around for quite some time.

Now for the question so many of you have been waiting for: How much math will you need? As you saw earlier, economics involves story telling and the teller of the story has a considerable say in how much math will be used in the story.  While my college degree was in mathematics and I believe very strongly that adequate quantitative skills would be on the short-list of skills which all students should posses upon graduation from college, there is no need to rely on sophisticated mathematical / statistical techniques to tell the stories which will be told in this course. 

There are actually four ways in which to tell our stories, and during this semester you will run into examples of all of these. The four forms for story telling are:

• Verbal
• Tabular
• Graphical
• Algebraic

To give you an idea of the differences in the "presentation" of the story, consider the following rather simple story about population growth.  In the past few years we have heard much about the rapid growth of the world's population and the havoc it is wreaking on the environment, but how important are the proposals which would reduce the growth rate of the world's population.

As a first step toward answering this question, let's look at the situation in twenty years if the current situation remains unchanged. At the present time the world's population is approximately 5.8 billion and it is growing at a rate of 1.4 percent per year. If it continues to grow at that rate, then the world's population in ten years would be 6.67 billion, and at the end of twenty years it would be nearly 7.7 billion people.  So much for the verbal approach.

In addition to the verbal representation, the story of population growth could also have been told using a table such as the one below. The advantage of this is that more information can be seen quickly - we can see what the population would have been at six different points in time in the future.

Or you could present the relationship between time and population with a graph comparable to the one below. The advantage of the graph is we see the continuous growth of the population for the twenty years.  The disadvantage is we cannot read off what the population would be in any one year.

Finally, for those who have a good command of mathematics, we could use the algebraic version. The solution for the world's population in twenty years [Pop (20)] using the equation would be:

Pop(20) = 5.8*(1.014)²⁰ = 7.66

Each approach has its advantages and disadvantages, each appeals to a different audience. The equation approach is likely to be a favorite among engineering students, while the verbal approach would be the favorite among humanities students. In this course mathematics will not get in the way of the story. You can expect the weighting to be heavy on the verbal with some graphical and tabular work and almost no algebra.

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