(Editor’s Note: This is the first installment of Professor Lee’s new monthly column.)
Although each of my Freeman columns will stand alone, let me emphasize at the outset that economics is far more than a series of unrelated concepts. Economics provides a coherent and powerful framework for seeing order in the seemingly unrelated actions of hundreds of millions of individuals as they struggle to improve their lot in life.
Improving our circumstances is always a struggle because of the fundamental problem of scarcity. All economic concepts are rooted in the problem of scarcity. No matter how productive we become, there always will be limits on what we can accomplish. Each individual confronts the fact that he must choose among many different ways to use his time and talents, and he makes those choices to achieve his particular purposes. No one else can know as much about another person’s purposes as that person himself. So while we may not understand the actions of others, we can be confident that they are doing the best they can to realize their objectives; from their own perspectives, they are acting rationally.
The Power of Economics
But economics is more than just a consideration of how individuals improve their well-being. The power of economics comes from the fact that the implications of scarcity and rational decision-making allow us to understand how certain social institutions make productive cooperation possible among large numbers of people, each of whom is concerned primarily with achieving a better life. This explanatory power goes back to Adam Smith, who elaborated on the connections between “the invisible hand” and the “Wealth of Nations.” It was Smith who first explained systematically how the social institutions of the free market encourage the creation of wealth by motivating people concerned with their own interests to behave in ways that best serve the interests of others.
In some respects, the economics profession has made little progress since Adam Smith. Economists have been ineffective at communicating to the public the tremendous benefits we all realize from the cooperation promoted by the free market, or the threat to that cooperation from the political influence of organized interest groups. In part, this failure can be explained by the difficulty of the task. The benefits of the market are spread so wide in the form of lower prices, improved products, and better opportunities that they tend to go unnoticed or be taken for granted. Because the benefits are primarily the indirect and unintended consequences of the actions of millions of individuals, people fail to connect those benefits to their source.
In contrast, political benefits tend to be concentrated in visible ways and are easily connected to the intentional actions of particular people, while the damage done is spread over the entire economy and difficult to trace back to its cause. But economists could have done more to promote a widespread understanding and appreciation of economic fundamentals. Even in their teaching, professional economists tend to focus on the trees of technical details while overlooking the impressive forest of market cooperation and coordination.
But in other ways, economists have made much progress since Adam Smith. While technical economic concepts can divert economists into analytical minutia, when appropriately used, these concepts improve our economic understanding in important ways. For example, the concept of comparative advantage extends Adam Smith’s insight into the benefits of free trade. The concept of marginalism (which, among other things, drained the “labor theory of value” swamp in which Smith and Karl Marx became mired—Marx more so than Smith) explains a wide range of economic activity that most people find puzzling. Those, and many other economic concepts can help economists better explain the power of the market to promote a pattern of social cooperation impossible under any other arrangement. Communicating this power as widely as possible is one of the most important contributions economists can make. I shall connect the discussion in each column back to the goal of social cooperation.
The Problem of Achieving Cooperation
Despite the common belief that economists are interested only in narrow material concerns, they are primarily concerned with explaining how the spontaneous market process expands the opportunity for people to achieve their objectives, no matter what they are, through cooperation with one another. Whether your goal is accumulating personal wealth, protecting the environment, or assisting the needy, you will be more successful if you can enlist the cooperation of others.
But how do you enlist this cooperation, given the variety of conflicting goals people are intent on pursuing? Reformers usually believe that social cooperation depends on appealing to people to put aside their narrow personal ambitions (such as amassing personal wealth) and concentrate on promoting broad social goals (such as protecting the environment or helping the needy). Achieving more social cooperation requires more virtuous people. The great economist Ludwig von Mises explained in Human Action (page 2):
If social conditions did not fulfill the wishes of the reformers, if their utopias proved unrealizable, the fault was seen in the moral failure of man. Social problems were considered ethical problems. What was needed in order to construct the ideal society, they thought, were good princes and virtuous citizens. With righteous men any utopia might be realized.
In contrast, good economists realize that, regardless of one’s idea of “virtue,” cooperation through the division of labor and exchange—the kind that people engaged in long before there were economists and moral philosophers—is what creates a better society.
Good Intentions Are Not Enough
Without denying the desirability of people behaving “virtuously,” economists see it as largely unrelated to social cooperation on a broad scale. Attempts to change behavior with conventional moral appeals are sometimes frustrated, and even if people were persuaded to put the “interests of the larger community” ahead of their own, the problem of knowing how best to do so would remain.
Economists recognize that people will behave consistently in ways that are simultaneously self-interested and socially cooperative only when market incentives are permitted to reward that behavior. But this means that not just any incentives will do; they have to be incentives that embody information on the best course of action. Next month I will examine the effect of incentives on human action.