Thursday, May 23, 2013 | No comments

Why Economics Should Matter To You, Part Two

By Riley Risto

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For part one in this series, click here.

One useful device to understand basic economic concepts is to first consider the actions of a single market participant in a closed system with limited raw materials, and then expand to two participants with multiple finished goods, then multiple market actors (some belligerent) and so on. This is similar to what was developed in the great novel Robinson Crusoe.  By conducting this mental exercise one can start to intuitively understand the prioritization of factors which influence personal economic decisions—an understanding necessary to ensure that public policy is sound and just.

For instance, when faced by cannibals Crusoe must move personal defense up the value chain ahead of prior preferences.  This hardly seems like an economic decision, but economics at its heart is no more or less than the study of resource allocation (including time and energy). Since so much of what we do hinges on these types of decisions, the broader term praxeology was employed by Ludwig von Mises to describe the study of human action as the parent of more specialized economics (for more on this, see here).

Now imagine making decisions that impact the economic well-being of billions of other people, with limited inputs and uncertain outcomes.  This is what central planners attempt to do every day.  If it seems like an impossible task, that’s because it is.  While the average person understands intuitively the law of unintended consequences, it seems to be nothing more than a mathematical obstacle for today’s modern-day alchemist economists—one that can be supposedly overcome by simply developing a better model.  The whole economics profession is now littered with professional mathematicians trying to do just that.  They receive Nobel Prizes and federal grants for their work, but the fruit of their labor is less than desirable.

Over the last 80 years governments have doubled down multiple times on the idea of economic manipulation, even after repeated failures.  No financial shock or bursting bubble causes them to question their market interventions.  Instead, they blame those partial to classical economics for starving the economy through austerity (their preferred label for fiscal conservatism). They say, “The problem isn’t loose monetary policy, it’s that we haven’t stimulated the economy enough.”  Unfortunately, it is literally impossible to disprove such negative suppositions, so most pundits and politicians just take these experts at their word.

This sort of foolishness can only be countered by a return to individual decision making, i.e. human action.  When individuals act in their own best interest, or in the interest of those they are directly responsible for (such as children or their infirm elders), more predictable decisions are made that can actually be used as templates to understand future actions. These lead to better market signals that can be acted upon with confidence by producers and entrepreneurs. Conversely, the unpredictability of central planners causes entrepreneurs to question their actions, hesitate to innovate, and generally stagnate. Predictability leads to prosperity.

The most common market manipulation—one which has far reaching consequences—is interest rate manipulation through open market operations of central banks.  The founding idea behind central banks (at least from the mainstream, non-conspiratorial perspective) was to give governments the ability to stabilize markets by smoothing out currency shocks. However, by “fixing” the problem of deflation, which many felt was created by a fixed exchange rate between dollars and gold, another was created; inflation.  Given unlimited power for expanding the money supply, expecting a central planner to restrain himself to just smoothing out business cycles has proven too much to ask.  It wasn’t long before this power was being abused to accomplish short-term political and social objectives such as boosting employment, price controls, shifting trade imbalances, economic warfare, etc.  Central planners have shown themselves willing to sacrifice long-term economic stability to keep up with the promises of the politicians who appoint them.

In the 42 years since Nixon cut the cord between gold and the dollar, Americans have been the beneficiaries of world reserve currency status.  Despite massive commodity price inflation and erosion of the dollar’s purchasing power; we enjoy historic prosperity as a result of productivity gains, technological advancement, offshore manufacturing, and wage increases.  Most Americans can now hold in their hands more computing power than the most powerful computer 30 years ago, and, wait for it…it doubles as a phone!  We’ve been on a gravy train for the better part of three decades.  Unfortunately, many structural changes to society had to take place in order to make that happen.  The increasing proportion of two-income families, substandard working conditions in third world production facilities, the domestic shift from a manufacturing to a service-based workforce, and a widening wealth gap between rich and poor are all by-products of our focus on consumption, which puts short-term gratification in front of long-term financial security.

With all of the evidence of severe malinvestment and society’s structural disfigurement, opponents of a fixed currency standard still point to the Great Depression as a reason to bury their heads in the sand.  Whether we’ve crossed the tipping point of massive budget deficits and national debt is irrelevant to this discussion.  It is up to us as a nation to ration the prosperity we have left until the children we have saddled with our burdens have a chance to fix our mess.  That means changing the way we do business.  It’s time to return economic decisions to the individual.  In proposing this I am not blind to our interdependence. Unlike Robinson Crusoe, it is clear that our actions have consequences far beyond our immediate “island”.  However, if we can’t trust an individual to make good decisions for himself, how can we trust a distant bureaucrat, who has no knowledge of your value chain and priorities, to make decisions you can live with?

Economics really boils down to a study of the causes and effects of our actions.  Whether you realize it or not, every decision an individual makes has consequences.  The more we take personal responsibility for our own decisions, the more experiences will hone our decision making.  This will lead, spontaneously, to an optimization of individual and societal outcomes.  That is not to say outcomes will be perfect; market perfection has never been the claim of free market proponents. However, along with an increase in personal liberty and responsibility, we can all expect over time to realize a coincident degree of prosperity which is more accessible to and better balanced across all social strata, making this truly the land of opportunity.

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About the Author

Riley Risto is Director of the Center for Free Enterprise. He holds a masters in business from Brigham Young University and works as a community banker. He is a passionate advocate of Austrian economics, outdoor enthusiast, husband and father of six children. He lives with his family in Midway, Utah.


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