ECO 4119 POLITICAL ECONOMY

Chapter 1

Politics, Economics, and Political Economy

Introduction• Political economy is the original name what is now known as

economics.

• Is it a better name?

• Scarce resources / unlimited wants (needs) vs. Production, exchange / distribution, consumption

• It draws attention to the political motivation of economic policies.

• Political economy is branch of social science that studies the relationships between individuals and society and between markets and the state, using a diverse set of tools and methods drawn largely from economics, political science, and sociology.

Introduction

• Political economy was the original social science.

• Theorists such as Adam Smith, John Stuart Mill, and Karl Marx developed broad visions of the social system.

• Not until the latter half of the nineteenth century did political economy splinter into economics, political science, sociology, social history, social psychology, and social philosophy.

Introduction

• Modern economics often acquires skepticism from other social scientists.

• Criticism is directed toward its simplistic assumptions about human behavior, its focus on material and pecuniary interests, its blindness to social relationships, and its arcane jargon, graphs, and mathematics.

Introduction• Economists have been successful in large part because

their simplistic assumptions and narrow focus permit them to borrow mathematical techniques from the physical sciences.

• Historians, political scientists, sociologists, and psychologists have been unable to reach consensus on a single scientific paradigm within their respective disciplines.

• Neoclassical microeconomics• Keynesian macroeconomics

Four Perspectives:

• Classical Liberal

• Radical

• Conservative

• Modern Liberal

Politics, Economics,and Political Economy

Economics Politics Primary Goal Prosperity Justice InstitutionalArena Market Government Primary Actor Individual Community

• Economics might be defined as the individual pursuit of prosperity through the market, while politics is the communal pursuit of justice through government.

• The primary economic goal of prosperity has three dimensions: efficiency, growth, and stability.

• The primary political goal of justice, also includes three dimensions: individual freedom, equity in the distribution of benefits and burdens, and social order.

• Prosperity and justice are inextricably linked.

• Both economics and politics are concerned with promoting human well-being by maintaining prosperity and justice.

• A prosperous society is more likely to be perceived as a just society because the range of individual choice is broadened and order tends to prevail.

• Conversely, a just society fosters prosperity by providing open opportunities, fair rewards, and individual security to motivate production and accumulation of wealth.

• Politics often refers to activities associated with government, while economics deals with activities occurring in the market.

• This method of distinguishing between politics and economics is certainly common, but it also leads to ambiguity.

• Like economic transactions, political activity often consists of mutually beneficial exchanges among self-interested persons or groups.

• Profit maximization vs. Vote maximization

• Government as an economic agent: achieve public goals with min cost. Optimal use of resources.

• Many market activities have public consequences and, therefore, become political issues of concern to the community as a whole.

• The origins of the words “economics” and “politics”.

• Greek words oikos, (household), and nomos, (principle or law).

• Politics, also, derives from the Greek word polis, meaning community or society.

• As the principle of household management, economics deals with efforts to attain private goals with available resources.

• Economizing behavior can be directed toward any goal and practiced in any institutional arena (so the arena can be market or government)

• Politics and economics cannot be clearly distinguished.

• Both are concerned with:• organizing and coordinating human activity • marshaling resources• managing conflict• allocating burdens and benefits• providing for the satisfaction of human wants and needs.

• Prosperity/justice, market/government, and individual/community are interrelated, but not identical.

THE MARKET AS AN ECONOMIC INSTITUTION

• Market• Exchange• Supply & Demand• Price determination

• Dimensions of prosperity: efficiency, growth, and stability.

• Arguments both for and against the market

Efficiency For the market:•A perfectly competitive market •most highly valued use of resources, Pareto optimality (efficient economy in which no person can be made better off without making someone else worse off)

•Prices provide information and incentives to guide individuals and businesses in making rational choices (price system)

•Competition and market efficiency: Firms and individuals are under constant pressure to adopt the most efficient technology, enabling them to produce at the lowest possible cost.

Efficiency

Against the market:•Competition is imperfect due to barriers to entry, immobility of resources, lack of information, product differentiation, and concentrations of power caused by both technical conditions of production and the efforts of individuals to protect themselves from competition. These imperfections cause inefficiency.

•Transaction costs (costs associated with conducting a transaction such as costs of gathering information, specifying contracts, and enforcing the terms of contracts) reduce efficiency.

Efficiency Against the market:•Externalities: When external costs are present, government may be able to improve efficiency by taxing or regulating the industry. On the other hand, when the external benefits of a good are very large, government can increase efficiency by providing the good at public expense.

•The competitive individualism underlying market behavior may also be detrimental to efficiency. Intense competition may weaken social bonds, causing alienation, apathy, or hostility.

•Even if the market achieves economic efficiency, it may fail to attain the broader notion of social efficiency.

GrowthFor the market: •increasing both the availability and productivity of economic resources.

•Market’s incentives (individual gain or loss)•Innovation and risk taking •Technological development

•The market also fosters psychological changes conducive to growth. By minimizing the constraints of moral and cultural norms, the market encourages individuals to create their own identities by transcending the bounds of traditional roles and expectations.

•Formerly dormant talents / energized individuals

GrowthAgainst the market:•Market’s inability to establish adequate social and economic infrastructure (transportation systems, education, and other public goods) •Can individuals provide them?

•Uncertainty due to lack of information

•Conspicuous consumption: Competition for social status may entail excessive consumption in order to display affluence.

•High levels of consumption--- low levels of saving and so investment.

•Formation of interest groups for protection from competition.

Stability

For the market:•Flexibility through the price system•Quick adjustments•Financial markets and stability through market transactions

Against the market:•Business cycles•Speculative bubbles (national and international instability)•Psychological shifts--- self-fulfilling prophecies

THE MARKET AS A POLITICAL INSTITUTION• Although basically an economic institution, market

performs important functions in achieving the political goal of justice.

• Three dimensions of justice: • Freedom• Equity• Order

• Arguments both for and against the market:

Freedom

For the market:•Wide range of freedoms provided by the market: choices concerning employment, place of residence, consumption patterns, and social relationships.

•The market provides citizens with opportunities to engage their resources, including entrepreneurial talent.

•The market potentially protects individuals from abuses of governmental authority by establishing decentralized bases of power from which citizens can express opinions and organize opposition.

Freedom Against the market:•Market also limits choice. It provides only commodities that can be sold at a profit and therefore fails to respond to demands for goods such as national defense, a clean environment, or public transportation.

•It conditions individuals to tailor their interests to suit the capabilities of the market.

•Work relations: dependence of the employee to his/her employer.

•Interests of different groups or individuals are not harmonious. The freedom of one can restrict the freedom of the other.

•Monopolization, pollution, discrimination etc.

Equity

For the market:•Price system, resource prices: the market distributes rewards according to each person’s ability to provide resources.

•Presence of opportunity: In a perfectly competitive market, individual characteristics such as race, gender, religion, or ethnicity should be irrelevant in determining a person's success.

Equity Against the market:•Concentrations of wealth and power: control over technology--- large businesses---no competition: powerful groups are likely to receive income in excess of their productivity, while members of disadvantaged groups are likely to receive lower incomes than they would in a competitive market.

•Ownership of productive resources determines income distribution.

•There is no genuine equality of opportunity (differences in family backgrounds, cultures etc.)

•The market neither recognizes nor allocates resources toward the protection of human rights.

Order For the market:•The market erodes traditional human relations based on arbitrary privilege and hierarchy (ex: feudal system)

•The market fosters order by increasing specialization of labor (formerly diverse and separate groups become mutually dependent).

•The market distributes society’s benefits and burdens without visible political authority, so each person’s success or failure appears to result from impersonal market forces (no resentment, no envy, no social disruption).

Order Against the market:•The dynamism of the market undermines traditional values and social structures (Ex: village life or tribal life or).

•The market functions well only within a social context based on respect for ethical norms and individual rights.

•When self-interested behavior degenerates into unrestrained selfishness, social bonds begin to resolve.

•Class conflict: Conflict between capitalists and workers. Profit maximization and exploitation

GOVERNMENT AS A POLITICAL INSTITUTION• As a political institution, government seems well-suited to

pursue justice by promoting freedom, equity, and order.

• However, government also has significant potential to violate these ideals.

Freedom

For government: •Government contributes to freedom by broadening the range of feasible choices (education).•Government can restrain powerful individuals and groups from restricting the freedom of others. •Government increases the choices available to citizens.•Government allows for the development of a broader range of preferences and values (government as a model and teacher).

Freedom Against government:•Few public policies have unanimous support, so government necessarily violates the freedom of some citizens. •Democratic governments may be coercive to the extent that they enable the will of the majority to be imposed on the minority. •With its monopoly on the legitimate use of force through command over the police and military, government has the potential to severely restrict freedom (arbitrary arrest, seizure of property, and surveillance).•If factions of society hold undue influence over government, it ceases to represent the public interest and becomes a tool with which powerful groups oppress their fellow citizens.

Equity For government:•Whereas the market recognizes only property rights in determining the distribution of income, a broader conception of equity includes the recognition of human rights.

•Government assigns human rights to secure those individual interests deemed worthy of support, even if they are not backed by individual purchasing power.

•If human rights entitle individuals to economic resources, only government can protect these rights and secure equity (right to a decent standard of living).

Equity

Against government:•A competitive market distributes income in accordance with the productivity of resources. When government overrides market distributions, it confronts the problem of formulating an alternative criterion of equity. A democratic government will respond to input from citizens, yet citizens with different conceptions of equity will send conflicting messages to government.

•Competition among interest groups seeking to control government for their own benefit

Order For government:•Government promotes orderly human interaction by defining and enforcing rights and obligations.

•Government fosters order by maintaining society’s culture, traditions, and boundaries (formation of individual identity and a sense of shared purpose and trust among citizens).

•Government contributes to order by promoting equality of opportunity.

•Government secures order by altering incentives to make self-interest more consistent with the public interest (crime and punishment).

Order Against government:•Interest groups: Because government can supersede the market’s distribution of income, citizens may attempt to use governmental authority to benefit themselves.

•The politicization of the economy may contribute to disorder in two ways.

• First, productive resources are diverted to the political struggle for control of government, resulting in slower growth and reduced competitiveness.

• Second, when government becomes a major determinant of individual success in a society lacking consensus about social justice, resentment toward government erodes support for public authority.

•The combination of a sluggish economy and political alienation results in social disorder.

GOVERNMENT AS AN ECONOMIC INSTITUTION• Cooperation and purposeful coordination of human activities to

increase a group’s ability to cope with scarcity and uncertainty.

• Because collective action can often be more effective than individual action, humans have a strong interest in forming organizations with rules and structures of authority.

• These organizations range from labor unions to corporations to government.

• Government is unique in that its laws are applicable to all persons within its jurisdiction and can be enforced through the legitimate use of force.

Efficiency

For government:•Government may improve efficiency by responding to imperfections in the market (ex: asymmetric information).•Externalities•Economic policies (expansionary in depression, contractionary in booms) •Redistributive activities of government, creating the perception of fairness.•In addition to improving economic efficiency, government can contribute to a broader social efficiency by pursuing goals incapable of attainment in the market (safe neighborhoods, clean air, and social justice).

Efficiency Against government:•Government lacks the internal pressure for efficiency created by competitive market forces. •Since public goods are financed through compulsory taxation, government may provide unsatisfactory services without fear of losing customers. •Slow and inflexible bureaucracy, inefficient interventions.•Voters cannot precisely specify which programs they support.•Self-interest of politicians and bureaucrats whose pursuit of higher incomes and increased power may subvert efficiency.•Majority rule: Your taxes can be used for programs that you do not support.

Growth For government:•Growth: the ability of society to produce more than it consumes and to direct this surplus into productive investment. •Government may be able to improve the market’s ability to produce a surplus. When custom and tradition keep resources out of productive use, government has the power to pry these resources loose and place them into active production. •Its control over taxes, spending, and interest rates, government can steer resources toward capital accumulation. •By financing education and research, government can contribute to long-run growth of the economy.•Government reduces uncertainty for private investors by establishing well-defined property rights, a smoothly functioning legal system, and stable market conditions.

Growth Against government:•Government taxation and borrowing, regulations, subsidies can divert money from its most efficient use.

•Government redistribution of income may undermine incentives to engage in productive activity.

•The positive incentive of higher income is diminished by taxes and regulations.

•The disincentives posed by hunger and deprivation are partially removed by welfare programs and social security.

Stability For government: •The very presence of government authority increases stability by minimizing conflict and providing security of property. •Appropriate government policies encourage “business confidence” that is essential to stability. •Even policies opposed by some businesses may be beneficial to the economy. •For example, antitrust policies, minimum-wage laws, and progressive taxation can counterbalance the market’s tendency to foster concentrations of wealth and power that jeopardize stability. •Finally, when recession or inflation occurs, government can respond with appropriate fiscal or monetary policies.

StabilityAgainst government: •Government efforts can reduce profitability and undermine business confidence, so can contribute to instability.

•Political business cycles

•Monetary and fiscal policy tools may increase instability.

•By seeking to perpetuate prosperity, government may suppress the mechanisms, such as rising interest rates, that allow the market to stabilize itself. When prosperity is artificially prolonged, the subsequent recession may be more severe.

POLITICAL ECONOMY• The interdisciplinary approach of political economy offers great

potential for analyzing and responding to the problems confronting modern societies (growth, distribution, stability).

• Neither market nor government is solely capable of organizing society to secure prosperity and justice.

• Both institutions are sufficiently flawed to require a balancing of political and economic processes to sustain a healthy society.

• In a positive sense, each institution serves to complement weaknesses of the other.