CommonSenseEconomics.com1 Seven Major Sources of Economic Progress Common Sense Economics James Gwartney, Richard L. Stroup, and Dwight R. Lee CommonSenseEconomics.com

CommonSenseEconomics.com1

Seven Major Sources of Seven Major Sources of Economic ProgressEconomic Progress

Common Sense Economics

James Gwartney, Richard L. Stroup, and Dwight R. Lee

CommonSenseEconomics.com


Questions to Consider

• Capital investments and new technology clearly contribute to economic growth and prosperity. What else is needed and what can governments add?

• Why are sound institutions, governmental policies and money of stable value important? How can they advance economic progress? How can they stifle it?

• Why do economic growth patterns and rates differ across countries and time?


Source #1

Legal SystemThe foundation for economic progress is

a legal system that protects the private use of land, natural resources, labor, capital, and entrepreneurial talent in

an even-handed manner.


The Foundation for Economic Progress

1. Private property rights• Private property rights grant the

owner of property the right to buy, sell, or derive income from their land, natural resources, capital and entrepreneurial talent.

• Even-handed enforcement protects these rights to exclusive use, protection against abuse, and transfer rights, thus allowing property owners to focus on resource allocation, efficient production, investment, and technological advancement.


Property Rights

1. Encourage people to use their property productively.

2. Promote wise stewardship.3. Encourage people to develop their

property in ways beneficial to others for possible exchange, transfer or sale.

4. Promote the wise development and conservation of resources for the future.


The U.S. Will Run Out of Oil! Or Will It?

1. In which year(s) did experts predict that the U.S. would run out of oil in the near future?a. 1914

b. 1926

c. 1970s

d. 2008

e. All of the above


Why Have Doomsday Forecasts Been Wrong?

• When the scarcity of a privately owned resource increases, the invisible hand of the market takes over and prices rise.

• Buyers and sellers seek substitutes, discover ways to conserve, and innovate!

• Historically, competitive markets and flexible prices spur conservation, substitution, and technological advancement.

• And the “sky” never falls!


Source #2

Competitive MarketsCompetition promotes the efficient use of resources and provides a continuous

stimulus for innovative improvements.


Consumers Rule!

• Competition places pressure on producers to operate efficiently.• Competition forces businesses to cater to their customers’ preferences

and provide goods and services for which they are willing to pay prices sufficient to cover their costs.

• Consumers vote with dollars on which businesses stay and which must go. (e.g. Target vs. Wal-mart vs. Sears vs. K-Mart)

• They make sure that sole proprietors, partnerships and large corporations charge low prices, produce quality products and provide services of value relative to costs!


Source #3

Limits on Government Regulation

Regulatory policies that reduce trade also retard

economic progress.


Governments Limit Trade and Retard Progress By

1. Limiting entry into some businesses and occupations• Licensing requirements, completing

bureaucratic forms, etc.2. Substituting political authority for rule

of law and freedom of contract• Imprecise, ambiguous and discriminatory

laws invite people to spend resources on bribery and lobbying efforts rather than production.

3. Imposing price controls• Price floors and ceilings interfere with

trades between buyers and sellers, distort prices, and lead to inefficient levels of production and employment.


Source #4

An Efficient Capital MarketTo realize its potential, a nation

must have a mechanism that channels capital into wealth-

creating projects.


Capital Investment and Its Role in Growth

• Capital is anything used to produce something else and helps us produce more goods and services in the future.– Machines, buildings, computers, tools

• Capital investment requires consumption sacrifices today. It requires savings. The payoff is increased production and consumption in the future.

• A mechanism is needed to channel savings into productive investments. Capital markets perform this function.


Capital Markets

• Capital markets, broadly defined, include markets for:– Loanable funds, real estate, stock markets

& financial markets• Institutions like banks, credit unions and

investment firms bring savers and investors together.

• Interest rates provide people with incentive to save. Productive investments will yield a return sufficient to cover all costs, including borrowing.

• Not all investment projects are productive. In a world of uncertainty, investments can and do fail. But failures hold investors accountable and provide them the incentive to discover and undertake productive projects.


Capital Markets and Government Intervention

• Governments can and do intervene in capital markets by restricting capital movements, setting interest rates, and using taxes and budgets to allocate capital.

• These actions:– Distort market incentives.– Increase the importance of political

rather than economic considerations.– Make unproductive investments more

likely.


Source #5

Monetary Stability

Inflationary monetary policies distort price signals,

undermining a market economy.


Money, Money, Money!

• “Money is to an economy what language is to communication.”

• Money serves three functions– Medium of exchange – Unit of account– Store of value

• When the value of money is stable,– Many potentially beneficial exchanges

will take place.– Borrowers and lenders will face less

uncertainty.– Gains from trade will be maximized.


Money and Who Controls It

• The nation’s money consists of its currency held by the public, checking accounts, and traveler’s checks.

• A nation’s central bank controls its money by buying and selling assets, usually government bonds.


The Value of Money

• The value of money is determined by supply and demand.

• The value of money is steady when the supply of money grows slowly (e.g. at approximately the same rate as goods and services).

• When a central bank expands the money supply rapidly relative to the production of goods and services, inflation results and the purchasing power of money is eroded.


Inflation’s Uncertainty

• How does inflation undermine prosperity by making investment projects riskier and thwarting savings?– Difficult to forge long-range plans

when you cannot predict the value of money

• How does inflation undermine the credibility of government?– Confidence in government declines

when citizens lack confidence in the value of their nation’s currency.


The Keys to Sound Money and Price Stability

1. Central banks and their officials should be held accountable for following a sound money policy and keeping the nation’s rate of inflation within a narrow range; or be dismissed.

2. A currency board in one nation could establish a fixed rate of exchange between its domestic currency and a selected foreign counterpart with a sound money policy. This is often attractive for small countries.

3. A country could adopt another nation’s currency

to provide stability. For example, the euro or dollar are often used.


Source #6

Low Tax RatesPeople will produce more when they are permitted to keep more

of what they earn.


High Marginal Tax Rates

1. Discourage work effort and reduce the productivity of labor.

2. Reduce both the level and efficiency of capital formation.

3. Encourage individuals to consume tax-deductible goods when nondeductible goods may actually be more desirable.


Source #7

Free Trade

A nation progresses by selling goods and services that it can produce at a relatively low cost and buying those that would be

costly to produce.


Increased Production and Consumption Among All Trading Partners

• International trade makes it possible for each country to acquire goods and services more cheaply.

• It allows domestic producers and consumers to benefit from the economies of scale.

• It promotes competition in domestic markets and allows consumers to purchase a wider variety of goods at lower prices.


Free Trade Allows:

• Consumers to find the lowest prices, the best value from their expenditures, and the greatest variety of goods and services.

• Domestic producers to sell their goods and services where they can get the highest price for the value of what they offer in the marketplace.


Government Barriers to Trade

• Include tariffs, domestic

subsidies, quotas, etc.• Do not create or destroy domestic

jobs; they just shuffle them around.

• Create inefficiencies in the protected industries, forcing domestic consumers to pay higher prices.


International Trade: Imports and Exports

• Trade restrictions that reduce imports will also reduce the ability of foreigners to buy our exports.

• Quotas and tariffs decrease the number of dollars earned by foreigners through the sale of imports to us.

• Therefore, reductions in imports simultaneously reduce exports.


Explain why you agree or disagree.

“More than any other single action, unilateral removal of our trade restrictions would establish the environment for a more peaceful and prosperous world.” CSE


Concluding Thoughts

1. How important are the following institutions/policies for a country’s prosperity?

a. Secure protection of privately owned property

b. Even-handed enforcement of contracts

c. Stable monetary environment

d. Low marginal tax rates

e. Minimal barriers to trade

f. Market versus government allocation of capital


The Evidence Indicates

• The countries with the highest levels of economic freedom have the highest per capita GDP and growth rates.

• The institutions and policies outlined in Part III of CSE produce results. Free economies spur savings and investment resulting in economic growth and prosperity.

• Differing institutions and policies explain why growth rates vary across countries and time.

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CommonSenseEconomics.com1 Seven Major Sources of Economic Progress Common Sense Economics James Gwartney, Richard L. Stroup, and Dwight R. Lee CommonSenseEconomics.com