Basic Economics - critical summary review

Reviewing Thomas Sowell’s highly acclaimed “Knowledge and Decisions” back in 1981, Nobel Prize-winning economist Friedrich Hayek – coincidentally, one of the author’s most noteworthy influences – commended him for his ability to translate “abstract and theoretical argument into concrete and realistic discussion of the central problems of contemporary economic policy.”

Well, pretty much the same can be said about “Basic Economics,” Sowell’s mammoth 750-page, 1000-footnote, and  2000-introduction to arguably the most important – and the most misunderstood – of all social sciences. Lacking graphs, equations and even economic jargon – “so that it can be readily understood by people with no previous knowledge of economics” – the book is imagined, as originally subtitled, as “a citizen’s guide to the economy.”

So, get ready to revise – or learn a bit more – about some of the basic concepts of economics, everything from what it actually studies through the supply-and-demand mechanisms that regulate prices to the detrimental aspects of government regulations.

What is economics

Economics is usually defined as the social science that studies the production, distribution, and consumption of goods and services. Thomas Sowell, however, believes that this definition doesn’t go far enough. Because even the Garden of Eden was a system for the production and distribution of goods and services, but it was not an economy – that is to say, it wasn't something that should be an object of study of economics. 

Why does he think that? Well, because everything was available in unlimited abundance in the Garden of Eden (at least according to the Bible). Sowell reinforces that without scarcity, there is no need to economize and, consequently, economics isn't a thing. So, he prefers a definition of economics first formulated by British economist Lionel Robbins. According to Robbins, economics is the study of how society chooses to use and allocate its scarce resources, which have alternative uses, to provide services and goods for present and future consumption.

The keyword here is “scarce,” one of the most grossly misunderstood words by people, even highly educated ones. Scarcity means that “what everybody wants adds up to more than there is.” It is, in other words, a relationship between people’s desires and reality. Since reality always is responsible for adjusting what people desire,  scarcity means different things to different people, and, in one form or another, it has always – and inevitably – been part of the history of the human race. Prehistoric people dreamt of food and shelters, and middle-class Americans believe that not owning a swimming pool is a valid “unmet need.” Both are examples of scarcities, but obviously, there are palpable degrees between them.

Sowell leaves a warning – “Regardless of our policies, practices, or institutions, there is simply not enough to go around to satisfy all our desires to the fullest. ‘Unmet needs’ are inherent in these circumstances.” The problem is how to differentiate between the needs that make sense to be met and those that are senseless – and allow the former’s gratification. And that’s basically the subject-matter of economics.

Unlike what most people believe, economics is not something that tells people how to make money or something capable of predicting the ups and downs of the stock market; it is, as said above, an all-important and continuously perfected tool for distribution of scarce resources, “a systematic study of cause and effect, showing what happens when you do specific things in specific ways.” The basic principles of economics, in other words, aren’t a matter of opinion – but a body of tested knowledge.

Prices

Scarcity is not merely the prerequisite for the existence of an actual economic system – it is also the engine that naturally drives the allocation of certain resources and their prices in a certain direction that’s mostly preferable. If there’s too little of something and many people who need it, then the price of that something goes up; conversely, if there’s too much of something that only a few people desire, then its price drops.

Many people see prices as obstacles to their getting the things they want; in reality, they are nothing more but bearers of news. In the case of beach-front property, for example, they convey bad news: the high prices of these homes basically relay the message that beach-front property is desired by far more people than can live at the beach. Even if the government comes up with a plan for “universal access” to beach-front homes and even if it put “caps” on their price, the ratio of people to beach-front land would not change: the latter would still be a scarcity. 

However, sometimes it happens that a certain discovery or improvement of production processes turns scarcity into abundance; in that case, prices start conveying good news. For example, computers have been getting both better and cheaper at a very rapid rate during the past few decades, due to numerous technological advances. Most of us don’t really know what these technological advances actually are – and yet we are a beneficiary from them. That’s because prices are their automatic end-result: they bear the news that something has happened in the information technology world that’s made a scarcity much more attainable. 

This way, prices also work as financial incentives that affect people’s behavior in the use of resources and their resulting products. You wouldn’t have bought a computer in the 1970s (unless you were really rich), but now you own a laptop, a tablet, and a smartphone. Prices guide producers as well: if nobody buys a certain model of a car, producers will start lowering the price even if that means taking a loss to avert the bigger loss of not selling the produced cars at all.

Markets

Because of this self-regulating mechanism, prices have always played a crucial role in determining how much of each resource gets used where, and how the resulting products get transferred to millions of people.” It’s strange to think that they can do that all by themselves, so many people can’t take it at face value. For example, Mikhail Gorbachev, the last president of the Soviet Union, is said to have asked once British Prime Minister Margaret Thatcher how she was able to feed all of her subjects. The answer, of course, was that she wasn’t: prices did that for her. Or, better yet, the supply-and-demand market that regulates their fluctuations.

Adam Smith was the first to realize this and to elucidate it at some length in the first modern economic classic, “The Wealth of Nations.” There, he marveled at the fact that even though, in a free market society, everyone seems to work for their own interest, the end result is beneficial for the whole society. The intentions of the individual don’t even matter: in the long run, by merely trying to earn a living,they are helping everybody live a better life. Of course, it is in every producer’s best interest to sell goods at the highest possible prices; but because it is in every consumer’s interest to buy more of any good at the lowest available price, sooner or later, things even out for the best of the most.

Adam Smith mainly had the national economy in mind, but three centuries later, we can see how this mechanism works pretty well in international terms as well. It’s not wrong to say that “prices have formed a worldwide web of communication long before the Internet’s creation.” And that’s because price-coordinated markets “enable people to signal to other people how much they want and how much they are willing to offer for it, while other people signal what they are willing to supply in exchange for what compensation.” So, if something is a scarcity in Japan and is commonly found in abundance in Australia, it makes sense that Australians would pay less for it, and Japanese more. Consequently, it would make sense for Australians to export this good, because, even with the shipping fees, they’d earn more than what they would if they sold it locally. That way, the free market allows Australian exporters to make an extra profit while restoring the supply in Japan. 

In the global world of today, the market solves many problems similarly, despite nobody being aware of the underlying mechanisms. For example, the disastrous failure of the wheat crop in Argentina could raise the incomes of farmers in Ukraine, and the discovery of large bauxite deposits in India could reduce the cost of aluminum baseball bats in America.

Government regulations

Now, Gorbachev had a reason to wrongly admire Thatcher’s peculiar capabilities to feed her nation on her own: he came from a country where markets were, by definition, not free. As you might know, after the Russian Revolution, the Soviet Union became the first country in modern history to institute a government-controlled economy. In the USSR, Gorbachev was indeed the man at the top of a pyramid of politicians, bureaucrats and economists tasked with controlling the supply and demand of goods, determining their prices and making sure that the needs of everybody were met. 

Of course, this experiment (accepted by numerous countries during the 20th century) eventually proved a failure: no top-to-down system of economic control has so far produced better results than price-controlled markets. Even in free-market societies, when governments try to impose price-directing controls, the results tend to be disastrous. Take, for example, rent controls. Whether in Cairo, Hong Kong, Stockholm, Melbourne, or New York – they have led to the same undesirable consequences, harming the very people they initially intended to help.

It all starts well, of course, with many poor people otherwise unable to afford a roof over their heads now finding a reasonably priced home for themselves in, say, Cairo. However, because of the price ceiling, investors are disincentivized to build new houses in Egypt’s capital and start building them elsewhere. This unforeseen housing shortage reduces the number of low-income people that can rent a flat in Cairo; even worse, apartments not covered by the laws sharply rise in price, and only the richest people can afford them. With their arrival, the prices of other goods go up as well.

So now, many low-income people want to move out of Cairo because of reasons other than rent, leading to an increase in both the demand for housing and the price of rents outside Cairo. Now, the poor are not only unable to find a house in Cairo, but they are also unable to afford a place outside of the city. In short, a simple, well-intended government regulation ultimately resulted in an utter mess of adverse effects. They all do, claims Sowell.

Final Notes

Plainspoken and straightforward – and rich with real-life examples from countries all over the world – “Basic Economics” might be one of the best introductions to the “dismal science” for the general reader to appear in the 21st century. 

However, that doesn’t mean that it is the only book on economics one should read. On the contrary, because Sowell’s “Basic Economics” is more a shoddy apology of the free market than it is an objective overview of how the economy actually works. One might even argue that the book is too commonsense for its benefit: as behavioral economics soundly demonstrated in the past few decades, many economic problems – just like, say, quantum physics – are beyond the intuitive capabilities of our mind, for the simple reason that our brain was never pressed to evolve to grasp them. 

So, bear in mind that there might be more to the economy than what’s in this book. Unlike Sowell, most modern economists don’t believe in such a self-regulating market, or so detrimental government regulations.  The author might have nothing but good intentions when he says that “learning economics should be as uncomplicated as it is eye-opening,” but, as in the case with almost any science, it’s actually the ability to grasp the complications that makes all the difference between a layperson and an expert. Sowell is certainly the latter; but sometimes it feels as if he is writing from the position of the former.

12min Tip

Even though it is not as exact as math or physics, economics is still a science. It is your duty as a citizen to be familiar at least with its basic laws before you cast your vote. Sowell’s “Basic Economics” is a good place to start as any.