Whatever Happened to Econ-101?

Once upon a time, our economy seemed to obey some rules, passed down from Adam Smith, taught in all universities, assumed by everyone who thought about the economy. We called these laws Economics-101, and we ignored them at our peril.

But lately, the economy is behaving in such strange ways that we wonder whether the laws of economics have been repealed. Is Econ-101 out of date? The answer probably is no. Some laws still stand. But the economy itself has changed, from an industrial economy to a global one, and that changes everything, including the way these laws work, especially here in the Midwest.  

Most of these laws started with Adam Smith, and have been augmented, refined, twisted, corrected, amplified and otherwise enshrined over the years, a process that is still going on. Here, very simply stated, are a few:

1. The invisible hand works. People left to pursue their own self-interest will end up not only bettering themselves for all society.
2. The law of supply and demand works. If there’s both a high demand for a certain good and a shortage of its supply, its price will rise, encouraging more production, until supply and demand are in synch. From this follows:
3. Incentives work. People respond to incentives, mostly monetary ones. If you want people to work harder and better, you pay them more or tax them less.
4. Free trade is good. It enables each country to do what it does best and most cheaply, and to sell the result to other countries doing what they do best. The result is better quality and cheaper products on all sides. 
5. Mechanization works. A machine that lets one worker do the work of many increases productivity. In the short term, a buggy-maker may suffer. But in the long run, he’ll get a better job on an auto assembly line, producing more goods that benefit the economy. From this follows: 
6. Increased productivity is good. It expands the economy, which expands the number of jobs, which expands demand for jobs, which raises wages.

There are more laws where these came from, but this is a good start. But this blog, plus many other writers, have been struggling with the evidence that they just aren’t working, at least in the traditional industrial areas. Since these areas include not only the industrial Midwest but much of the United States and Europe, where the laws were written in the first place, this is a puzzlement and a problem.

Let’s list a few:

1. The invisible hand is doing more taking away than giving. People and their corporations, pursuing their own self-interest, are leaving behind many of the other people who once shared their economy.
2. The law of supply and demand still works for goods but not for people. There’s a widely-reported demand for skilled workers: every manufacturer complains he can’t get good welders, for instance. So wages should go up, to increase the supply. But instead, they’re stagnant, even falling. How come? The same manufacturers are in global competition and say they just can’t pay more and stay in business.
3.  The law of incentives has gone off the rails. Fabulously-paid workers at the top, the notorious one percent, work hard but, as the mortgage crisis showed, not well. The evidence is zero that tax cuts for this clan do any good at all. Members of the troubled middle class work longer hours and more jobs for less money. The only incentive that employers give them is a negative one – to work even longer for less or see their jobs disappear to outsourcing or automation. How come? Once again, global competition.
4. The glories of free trade escape the millions of workers who have lost their jobs to imports, or to global pressures. Economics-101 has always argued that trade may cause short-term pain, as a job is lost, but this is outweighed by long-term gain, as trade strengthens the economy and creates better jobs. Increasingly, the pain is long-term and the gain is nowhere in sight. Cheap imported goods at Wal-Mart or Dollar General aren’t much consolation.  
5. For the first time, the Luddites may be right. Automation is raising productivity, even luring outsourcers back to American shores, but is producing fewer jobs than it destroys. From this follows:
6. The old links between rising productivity, a growing economy, more jobs and rising living standards have been broken. Productivity is growing, largely through automation. So is the economy (and so are corporate profits). But job growth lags far behind, as do wages. For the first time since World War II, a rising tide is not lifting all boats, only the yachts.

So again, is Econ-101 out of date? Is everything we thought we knew wrong? Not at all. It’s not much comfort for the industrialized West, but the economy is working pretty much the way it’s supposed to work.

Econ-101 argues that markets are generally efficient. Not perfect, as University of Chicago fundamentalists say, but pretty efficient. Responding to supply and demand and reacting to market prices, the economy is going to places where costs are lowest and profits higher – in other words, where resources can be used most efficiently.  

Around the world, the traditional economy – the one we learned about in school – is delivering the goods. Rising productivity, freer trade, incentives – all are increasing not only productivity but the living standards of hundreds of millions of persons.

But it’s not happening here, and Americans and Europeans haven’t begun to figure out what to do about it. The global economy is growing, just as the national economy grew here for most of the 20^th century, and workers around the world are benefitting, just as workers here once benefitted.

But market economics, like free trade, produces losers as well as winners. Once the losers were localized – miners stranded when their mine played out, or buggy-makers sidelined by the horseless carriage. In a sense, they’re still localized – except that the locale now embraces much of America.

So keep Econ-101 in the syllabus, if only to help us understand what’s happening to our lives.