New Ideas from Dead Economists

1. Economics is About Choice, Not Just Money

Economics is the study of choice. It does not tell us what to choose. It only helps us understand the consequences of our choices.

Beyond the Dismal Science. Economics is not merely about money or cold calculations, but about the fundamental human activity of making choices under conditions of scarcity. It provides a framework for understanding the trade-offs inherent in every decision, from individual consumption to government policy. Economists act as messengers, not causes, of difficult choices.

Choice and Consequences. Every decision, whether it's choosing between cleaner air and faster cars or bigger houses and bigger parks, involves opportunity costs. Economics helps us understand these costs, allowing for more informed decision-making. The great economists sought to improve the world by blending science with a devotion to people.

Politics and Economics. The strongest link between economics and the real world has always been politics. Indeed, until this century economics was called “political economy.” Almost all of the stellar economists served at some level of government. The interplay between government and economists is crucial, as policies are shaped by economic ideas, and economists must understand the political context in which their advice is implemented.

2. Adam Smith's Invisible Hand: Self-Interest and the Free Market

He . . . neither intends to promote the publick interest, nor knows how much he is promoting it . . . he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

The Power of Self-Interest. Adam Smith argued that individuals pursuing their own self-interest unintentionally benefit society as a whole. This "invisible hand" guides resources to their most productive uses, fostering innovation and economic growth. The butcher, the brewer, and the baker provide our dinner not out of benevolence, but out of their own self-interest.

Free Market Principles. The free market, driven by competition and the pursuit of profit, acts as a powerful regulator. It encourages producers to offer goods and services that consumers want at prices they are willing to pay. High prices and profits signal demand, while low profits or losses signal inefficiency.

Limitations and Warnings. Smith was not a naive advocate of unbridled capitalism. He warned against the potential for businesses to collude against consumers and emphasized the importance of ethical behavior and government oversight to ensure fair competition. He also recognized the potential for division of labor to lead to worker alienation, advocating for public education as a remedy.

3. Division of Labor: The Engine of Economic Growth

Division of labor is the great cause of the increase of public opulence, which is always proportioned to the industry of the people, and not to the quantity of gold and silver, as is foolishly imagined.

Specialization and Productivity. Adam Smith identified division of labor as a key driver of economic growth. By specializing in specific tasks, workers become more skilled and efficient, leading to a dramatic increase in overall productivity. Smith's famous example of the pin factory illustrates this point, where dividing the production process into eighteen distinct operations resulted in a massive increase in output.

Benefits of Division of Labor:

• Increased skill and dexterity
• Reduced time wasted switching tasks
• Greater likelihood of invention and innovation

Free Trade and Market Expansion. Division of labor is most effective when markets are large and trade is free. By allowing towns, cities, and countries to specialize in what they do best, free trade expands the overall wealth of nations. Smith argued that England would gain from trade if it could buy a good from another country for less than the cost of producing that good in England.

4. Malthus's Population Trap: A Cautionary Tale

Famine seems to be the last, the most dreadful resource of nature.

Population Growth vs. Food Supply. Thomas Robert Malthus argued that population tends to grow geometrically, while food production increases arithmetically. This imbalance, he warned, would lead to widespread poverty, famine, and disease, keeping living standards at a subsistence level. Malthus identified "positive checks" (war, famine, plagues) and "preventative checks" (moral restraint) as the forces that limit population growth.

Malthus's Errors. Malthus's predictions proved largely inaccurate due to technological advancements in agriculture, medicine, and sanitation. He failed to anticipate the Industrial Revolution and the demographic transition, which saw birth rates decline as societies became wealthier.

Relevance Today. While Malthus's specific predictions did not come to pass, his concerns about resource scarcity and population growth remain relevant today. Modern Malthusians point to issues such as climate change, resource depletion, and environmental degradation as potential threats to human well-being.

5. Ricardo's Comparative Advantage: Trade Benefits All

[W]ithout foreign commerce, the means of production would be far more limited, and, consequently, so would be the real and efficient power of all classes to purchase commodities.

Beyond Absolute Advantage. David Ricardo refined Adam Smith's theory of trade by introducing the concept of comparative advantage. Even if one country is more efficient at producing everything, both countries can still benefit from trade by specializing in the goods they produce relatively more efficiently. This principle applies to individuals, businesses, and nations.

Opportunity Cost. Comparative advantage is determined by comparing the opportunity costs of producing different goods. A country should specialize in the goods for which it has the lowest opportunity cost, even if it is not the most efficient producer overall.

The Gains from Trade. By specializing and trading, countries can consume beyond their own production possibilities. This leads to higher living standards and greater overall wealth. Ricardo's theory provides a powerful argument against protectionism and in favor of free trade.

6. Mill's Blend: Balancing Freedom and Social Welfare

A person may cause evil to others not only by his actions, but by his inaction, and in either case he is justly accountable to them for the injury.

Individual Liberty and Social Responsibility. John Stuart Mill sought to reconcile individual liberty with the need for social welfare. He believed that individuals should be free to pursue their own interests, as long as they do not harm others. However, he also recognized the importance of government intervention to protect the vulnerable and promote the common good.

The Harm Principle. Mill's "harm principle" states that the only justification for limiting individual liberty is to prevent harm to others. This principle provides a framework for balancing individual rights with the needs of society.

Government Intervention. Mill supported government intervention in areas such as education, environmental protection, and poverty reduction. However, he cautioned against excessive government control and emphasized the importance of individual initiative and self-reliance.

7. Marx's Critique: Capitalism's Internal Contradictions

The knell of capitalist private property sounds. The expropriators are expropriated.

Historical Materialism. Karl Marx argued that history is driven by material forces, particularly the mode of production. Each economic system, from slavery to feudalism to capitalism, contains internal contradictions that eventually lead to its downfall.

Exploitation of Labor. Marx believed that capitalism is inherently exploitative, as capitalists extract surplus value from workers by paying them less than the value they produce. This exploitation, he argued, leads to class struggle and ultimately revolution.

The Inevitable Collapse. Marx predicted that capitalism would eventually collapse due to falling profit rates, increasing concentration of economic power, and the growing misery of the proletariat. This collapse would pave the way for a communist society based on equality and cooperation.

8. Marshall's Marginalism: Incremental Decisions Matter

The price of anything will be found to be determined at the margin.

Focus on Incremental Changes. Alfred Marshall emphasized the importance of marginal analysis, which focuses on the incremental changes in costs and benefits that drive economic decisions. Consumers and producers make decisions by comparing the marginal utility of an additional unit of consumption with its marginal cost.

Supply and Demand. Marshall famously compared supply and demand to the blades of a pair of scissors, arguing that both are essential for determining prices. He developed the concepts of short-run and long-run equilibrium to analyze how markets adjust over time.

The Importance of Time. Marshall recognized that time plays a crucial role in economic analysis. He distinguished between the short run, where some factors are fixed, and the long run, where all factors are variable. This distinction allows for a more nuanced understanding of how markets respond to changes in supply and demand.

9. Veblen's Critique: Conspicuous Consumption and the Leisure Class

The motive that lies at the root of ownership is emulation.

Beyond Basic Needs. Thorstein Veblen challenged the neoclassical assumption that consumers are rational and self-interested. He argued that much of consumption is driven by social status and the desire to impress others.

Conspicuous Consumption and Leisure. Veblen coined the terms "conspicuous consumption" and "conspicuous leisure" to describe the ways in which the wealthy display their status through extravagant spending and non-productive activities. These behaviors, he argued, are driven by the "emulatory instinct," the desire to keep up with or surpass one's peers.

The Instinct of Workmanship. Veblen also emphasized the importance of the "instinct of workmanship," the innate human desire to create and improve things. However, he argued that this instinct is often suppressed by the capitalist system, which prioritizes profit over quality and usefulness.

10. Public Choice: Politicians as Self-Interested Actors

The great advantage of democracy . . . is that it makes it possible for the people to get rid of a government they dislike without bloodshed.

Applying Economics to Politics. The Public Choice school applies economic principles to the study of political behavior. It assumes that politicians, bureaucrats, and voters are all self-interested actors who seek to maximize their own utility.

Special Interest Groups. Public Choice economists argue that special interest groups exert undue influence on government policy. These groups, often representing narrow economic interests, are able to lobby for policies that benefit them at the expense of the broader public.

Rational Ignorance. Voters often remain rationally ignorant of complex policy issues, as the costs of becoming informed outweigh the potential benefits. This allows special interest groups to manipulate public opinion and influence policy decisions.

11. Rational Expectations: The Limits of Government Intervention

The only relevant test of the validity of a hypothesis is comparison of its predictions with experience.

Markets Clear and People are Rational. Rational Expectations theory assumes that markets clear quickly and that people use all available information to form rational expectations about the future. This implies that government policies, if anticipated, will have little or no effect on the economy.

The Lucas Critique. A key implication of Rational Expectations is the Lucas Critique, which states that econometric models based on past data are unreliable for predicting the effects of new government policies. This is because people will change their behavior in response to the new policies, rendering the old models obsolete.

Limited Government Power. Rational Expectations theorists argue that government intervention is often ineffective or even counterproductive. They advocate for stable, predictable policies and a limited role for government in the economy.

12. The Enduring Relevance of Economic Thought

The world is ruled by little else [than the ideas of economists and political philosophers].

Lessons from the Past. The history of economic thought provides valuable insights into the challenges and opportunities facing modern economies. By studying the ideas of past economists, we can better understand the forces that shape our world and make more informed decisions about economic policy.

The Importance of Humility. Economics is a complex and ever-evolving field. Economists should be wary of overconfidence and recognize the limitations of their models. The best economists are those who combine rigorous analysis with a healthy dose of humility.

A Continuous Debate. The debate over economic ideas is ongoing. New challenges and new perspectives constantly emerge, forcing economists to re-evaluate their assumptions and refine their theories. This continuous process of intellectual inquiry is essential for advancing our understanding of the economy and improving the lives of people around the world.

Last updated: February 21, 2025