Thanks to everyone who commented on Chapter 1 my book, Economics in Two Lessons. I’ve benefited a lot from the comments and implemented quite a few changes.
The book so far is available
Table of Contents
Feel free to make further comments on these chapters if you wish.
Moving along, here’s the draft of Chapter 2. Again, I welcome comments, criticism and encouragement.
11 thoughts on “Economics in Two Lessons: Chapter 2”
David Ricardo discovered a flaw in his Principle of Comparative Advantage. Unfortunately, just like Einstein, he could not solve the complicated mathematical dilemma that presented itself. This flaw exists today in the application software we call free trade. In Ricardo’s Portugal-England bilateral two good analysis he encountered no mathematical difficulties with opportunity cost comparisons. But as any high school student can tell you that is not so extraordinary. It’s only when you get to university and look at Offer Curve Analysis that the difficulties come into focus. International trade exposes the ugly side of market power. As President Trump is demonstrating, when you have market power free trade becomes unfair trade. Adam Smith saw international trade under mercantilism. He was not impressed. His Principle of Absolute Advantage was meant to address trade monopolies. But Ricardo was more interested in the supply side. Supply side economics gets empowered by free trade deals.
Here’s an economic question for “Economics in Two Lessons”. It takes a little exposition. It questions the notion of competition in our modern global and oligopolistic economy.
With large markets and especially global markets, I believe it is possible for certain levels and types of businesses to remain in business for at least the mid-term haul by offering, at a mid-range price, very poor quality products which fail to perform as promised. The global market and the internet market assist this business model. Customers who buy such products are very disappointed and vow never to buy a product from company X again. However, the global market is big enough (many hundreds of millions of consumers) that new customers can always be found, especially by aggressive advertising. It very likely would take a decade or maybe two decades for the company to “burn” their reputation and their customer base. By that time, the principles have made many millions, off-shored it, paid no tax and invested in the financial market (maybe). They can simply close the company down and either live off the proceeds or start another if they wish.
Competition is not what it is claimed to be in a global economy of trans-nationally operating companies. Companies which make (or assemble) items up to about the size and cost of white-goods and electronic goods can operate as I detailed above. Companies which make bigger things cannot. I mean from car makers and heavy machinery makers up to construction and infrastructure companies. In this case, reputation and longevity in business do matter. However, these companies follow an oligopolistic model which is tacitly adhered to by their “competitors”. In some cases, some might even be true monopolists. Tacit cartels of the oligopolistic model compete not so much on price but on advertising spend and product differentiation. But prices themselves are tacitly fixed high (within bounds) to a significant extent.
The whole classical notion of competition (many small firms, no single one of which can do anything but fully compete on price and quality in the market) does not apply to our economy in the main. Competition is very imperfect in the real world conditions of the contemporary, extant economy. I wonder if “Economics in Two Lessons” will deal with this problem?
I am concerned with the projected outline of the book. Starting with markets really starts in the middle of the story. The forms of markets in our economy (commodity market, stock market, labor market etc.) are creations of political authority and accumulated institutional foundations. Interacting with these, with feed-backs going both ways, are custom and enculturation.
Your starting point, J.Q., takes the market as an un-examined given (perhaps handed down to humans by the gods in the machinery?). I think it would be better to start with the historical story of the creation of modern markets. No need for mythologizing, of course, about Crusoe and Friday. Stick to the history and point out the different ways market (and even non-market) societies have been constructed.
Starting from about 1600 might be the way to go with any quick earlier references as necessary. “In the early 1600s the Dutch East India Company (VOC) became the first company in history to issue bonds and shares of stock to the general public.” – Wikipedia. Perhaps the rough general starting point is where the nascent modern commodity markets, stock markets and labour markets began. It doesn’t need more than a chapter. So long as it points out that humans made these institutions and can make, unmake, re-form and re-regulate these institutions to a very great degree based on political will. Without that perspective, I believe that markets, in their current form, implicitly get canonized as something eternal and immutable, whether this effect in the reader’s mind is intentional or not. You have to get people to question the basics and their own basic a priori assumptions. I am not sure your current approach will do that.
Hedges interviewing John Ralston Saul:
h t t p s://www.youtube.com/watch?v=kXUJEWNHweE
I found the discussion here rather intricate mainly because of the extensive use of the ambiguous “no free lunch” idea. I think there are more direct ways of discussing the “gains-from-trade” and the important “comparative advantage” idea. One difficulty is that you seem to use the “no free lunch” concept in different ways. A key issue: What is the intended audience for this book? If it is the well-educated non-economist I think they will struggle a bit.
This is one of the most difficult chapters in the book. Maybe I should flag that.
There is a concept in Economics that is learnt early by most economists. It is called the Pareto Optimum. As with most of the basic principles that underlie economic thinking this comes from a nineteenth century writer analyzing on an earlier form of capitalism. Pure capitalism never existed except in the minds of its inventors the French school of moral philosophers called Physiocrats. This school gave Adam Smith his ideas for that pivotal book WEALTH OF NATIONS.
In those days wealth was more important than income. World economies were dominated by wealthy individuals whose wealth was mainly from land ownership.
This difficult are is better read in bits not bytes. So here goes. In today’s world we live under the regime of free trade deals. The World Trade Organization was set up to promote free trade. The whole idea of free trade has moved away from its theoretical origins after David Ricardo first correct Adam Smith on capitalist trade theory. Simply put, Free trade implies that all nations can benefit from concentrating their resources on exporting only those things that they can efficiently produce. Of course it must be a surplus to domestic needs. But finding those goods or services to export is not an easy task. Vested interest will always try to distort the reality of production cost and benefits for any exportable item. This is why Professor Quiggin mentions the need to study this question as a political economy issue and not a pure economic theory issue.
Now I will try to directly address your concerns. But you realize that I am going to simplify complex theory and empirical data. This is only a “boot” device to allow you to understand what Professor Quiggin has written in his second chapter. The “free lunch” concept warns about the Pareto Optimum difficulty when trade deals are signed by politicians. This suggests that a so called ‘WIN-WIN’ trade deal does not exist. Some nation must lose in some way from the trade deal. Why then do they sign the trade pact? Usually its because they have a high level of unemployment in their economy. A lot of other reasons like national security requirements, the need for hard currencies and some form of political hidden agenda may also be there somewhere in the trade negotiations process. So “gains from trade” are not confined to monetary gains. In economics there are social benefits and costs as well as non-social benefits and costs. Trade may increase the wealth of a nation as implied by Adam Smith’s book. But it may also strengthen military ties, support a national currency and win political power at elections.
As Professor Quiggin has already said the principle of comparative advantage is a very difficult theoretical theory. It relies on the idea that all trade deals come down to some sort of compromise. The best first grasp of this principle is to consider the situation of two nations and two goods at any one point in time. So the discussion is about which country is best at producing which good for the lowest resource allocation. This means that all production uses up a certain amount of land, labour, capital and enterprise. No country has an unlimited amount of these four pillars of economic wealth. So if a nation can save any of these resources for other things like defence, education and health social goods production then this is another gain from trade. If both nations can see some money and/or social benefits from this two good free trade deal they may sign up to cover those two goods. This is clearly an oversimplification but it is the ‘boot’ you need to get up to understanding the multi goods / multi nations trade deals we see today. One good current example of a two nations free trade deals is the one between New Zealand and Australia. This is long established multi goods trade deal that has successfully navigated some bumpy periods.
Economics is riddled with jargon and a special adaption of mathematics. Economic analysis uses mathematical concepts but in an unusual way. this confuses many non economists. I did three years of mathematics at university but remain s8spicious of some econometrical models. For opportunity cost analysis, central to the application of the principle of comparative advantage, the maths is deceptively simple. Usually though it is too simple. The ‘no free lunch’ idea also rests on the economist’s view of opportunity cost. To over simply for one moment. If you go to lunch and someone else pays the lunch has still cost you lost opportunities. Whilst you sit in that restaurant you cannot do productive work. Thus you cannot increase your income. This view suggests that all lunchtimes are part of an opportunity cost trade off because you cannot be in two places at one time. The temptation to accept an invitation to a free lunch comes at some opportunity cost. For nations who trade the opportunity cost is assessed in terms of economic resources. Economists concentrate on the four main resources. The more these are being wasted on inefficient production of goods and/or services the higher is the opportunity cost.