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Friday, July 9, 2010

Applied Economics: Thinking Beyond Stage One

Government Policies Have Long-Term Costs

This book works well on two levels. First, it explains the basic principles of economics in an unusual way—without equations, graphs, and jargon. It could be read easily by an intelligent ninth-grader, but it is neither condescending nor dull. Sowell is a master storyteller. Second, Applied Economics compares how well markets work to how well governments do.

Sowell stresses two fundamental ideas. One is that we desire far more things than we could ever hope to produce. Since we can’t have everything we want, we must, both individually and collectively, make choices. And when we choose one thing, we sacrifice the chance to obtain other things we want. Choices are often difficult to make, but unavoidable.

In chapters on the labor, housing, and medical-care markets, Sowell vividly illustrates that idea. For example, we can punish doctors who we believe have made mistakes, but we will discover that doctors are subsequently less willing to perform risky procedures.

The other fundamental idea is that in making their choices, people will respond to incentives, particularly prices. If the price of doing something rises, people will do less of it. If the price falls, people will do more of it. This simple idea provides powerful insight into individual behavior. Here, too, Sowell illustrates. If the government limits the price per visit doctors may charge, they will schedule more but shorter—and rushed—visits. If laws restrict the height of buildings, more buildings will be created, leading to more traffic and more sprawl. Sowell relates that Mikhail Gorbachev once asked Prime Minister Margaret Thatcher how she arranged for her citizens to get fed. She answered that she didn’t arrange it; individuals responding to prices did.

Sowell shows that a key characteristic of markets is that they confront individuals with the costs of their actions. If I fail to maintain my car, I’ll bear the cost and inconvenience if it breaks down. Even if it doesn’t break down, I’ll suffer the decrease in value when I dispose of it. But when I decide which government policies to support or officials to vote for, I bear little of the cost of my actions. If I am uninformed or apathetic, it matters little because my individual vote has a negligible effect on the outcome. Since the price of supporting unwise public policy seems low, economics predicts that people will often support unwise public policy.

Furthermore, government employees and officials bear little of the cost of their actions. Unlike private firms, few government agencies are eliminated because of bad results. Elected officials can avoid bearing the cost o f their actions if the consequences take time to appear, because it’s difficult to attribute a particular problem to poor government policy implemented years earlier. Sowell concludes, therefore, that politicians tend to choose policies that offer quick benefits, even if large costs come later. This gives Sowell the subtitle of his book, “Thinking Beyond Stage One”: he urges readers to use economics to think past the promise of easy benefits and to understand the full cost of government policies.

He presents many examples of the underappreciated long-term cost of government actions, including price controls on apartments and medical care, mandatory recycling, and laws “guaranteeing” job security. One impressive example is heavy city or state taxation of profitable companies. In the short run—stage one—this can raise lots of money for programs that benefit some citizens. But in the longer run, as companies reduce employment, move away, and refuse to locate in the area, cities and states inevitably incur significant costs. Sowell concludes, “Politics offers attractive solutions but economics can offer only trade-offs.”

For anyone interested in learning some economics, but who is discouraged by its seeming complexity, this is an informative and well-written book. (Readers interested only in fundamental economics can read Sowell’s earlier book, Basic Economics.) For anyone interested in public policy and how to improve it, this is a superb book.