Monday, May 11, 2009

Leadership and Economics

Going by the expanding nature of global economics and varying national economies, today’s leaders should be compelled to understand that the best, much-applauded, and unanimously accepted form of fundamental economics is the capitalist market economy which contains many buyers and sellers of numerous goods and services where all of them are interested primarily in their own well-being. From the Greek word oikonomos, economy denotes to mean “one who manages a household.” However, according to the great 19th-century economist Alfred Marshall, “economics is a study of mankind in the ordinary business of life.” In essence, economics is the study of how society manages its scarce resources. [1]

Two prominent economists, Adam Smith and David Ricardo inspired the modern economics we cherish today. Adam Smith’s 1776 book titled An Inquiry into the Nature and Causes of the Wealth of Nations, shed light on the subject of trade and economic interdependence. Likewise, inspired by Adam Smith’s writings, David Ricardo, millionaire broker turned economist, in his 1817 book Principles of Political Economy and Taxation, developed the principle of comparative advantage as we know it today. The principle of comparative advantage explains interdependence and the gains from trade. As a member of the British parliament of the day and in his defense of free trade and his opposition to the Corn Laws which restricted the import of grain, Ricardo put his economic beliefs to work by displaying total rejection and repugnance at the British government’s infringement on free trade. Undoubtedly, the legacies left behind by Smith and Ricardo continues to empower the values and ideals of today’s capitalist economies.

Based on decentralized control and delegation, a leader who has the will and commitment to steer a nation to its right course must understand that micromanaging economies, people’s lives or jobs is nothing but a futile enterprise. Likewise, a leader cannot save, motivate, and satisfy everyone. Leaders must understand that when people associate no risk or cost to something, they will abuse it. That is why all social programs like welfare, social security, and Medicare fail to have rigid foundations despite concerted government efforts at their resuscitation. With markets being a good way to organize economic activity, boosting trade makes everyone better-off. Though not always positive, governments can sometimes improve market outcomes. During the Cold War era, the former Soviet Union and her Communist allies in Eastern Europe experienced retarded economies because their economies were based on outdated centralization systems managed by irrational central planners which culminated in their collapse in the 1980s. Because of corruption, insecurity, coup d’états, political obscurantism, dictatorships, and a host of other natural and human calamities, Africa, a continent abundant in natural resources, remains entangled in a protracted economical mess that make it a laughing stork in every sector of the economic scale and a burden to international financial institutions like the IMF and the World Bank. Lack of human capital, grinding poverty and diseases like HIV/AIDS and malaria, and the collective theft of state coffers, has diminished the continent’s prospects for economical prosperity and political maturity. Despite minor modifications, the economic principles left behind by Adam Smith and David Ricardo continue to drive the nerves and fibers of many nations including the United States while resourceful African nations continue to suffer from self-inflicted economic woes without any prospect for recovery.
Some important aspects of managing a capitalist economy include:
(1) A strong national defense-if people do not feel safe, economic growth will be retarded and suffering and destitution will reign.
(2) Property rights-when people own something, they have the tendency to invest and protect it.
(3) Judicial system to handle disputes.
(4) Low taxes and low regulatory environment.
(5) Few entitlement programs like welfare, social security, and Medicare. These programs are inefficient and wasteful (transfer payments-taking money from one citizen and giving it to another is always counterproductive). A program like welfare falls under what economists refer to as “the Law of unintended consequences” which occurs when government actions or policies fail to produce the desired results. Initially, welfare was intended to help the poor but only created more poverty and an underclass that grew reliant on government. We have to be careful what behaviors we reward because if people associate no cost or risk to something they will abuse it.

Said another way, production possibilities curves can be expanded with the following in mind: (1) movement towards capitalism and free trade (India, China), (2) education, (3) technological advances, and (4) discovery of new natural resources. By raising taxes, consumer and producer surplus is destroyed beyond measure and automatically the standard of living of the ordinary citizen is lowered. Leaders need to understand that people get what they earn and that there are no other solutions except trade-offs. Thus, growing economies need energy to safeguard and maintain their demand and supply. A country’s standard of living depends on its ability to produce goods and services.

Consequently, leaders and politicians have caused extensive miscalculations to numerous national economies by thinking that they know more about economics than economists. In broad terms, this is what is referred to as “fatal conceit” by economists. Both golden rule and fatal conceit, malevolent in context, are based on self-interest and are detrimental to the economic well-being of any nation and must be shunned at all cost.

One other form of unwarranted government exploitation or practice that places unnecessary hardships on businesses is price gouging. A firm’s costs are a key determinant of its production and pricing decisions. This practice is outlandish and absolutely authoritarian in nature. Leaders fail to grasp the theory that demand is based on ability and willingness to pay. On the ability notion, one may have the ability to pay but unwilling to pay for the product either because the product is inferior or exorbitant. Apparently, wary consumers understand the implications of buying cheap and inferior Chinese products that flood the markets. Everything, regardless of make or model, has a price attached to it. Unquestionably, above that price, no one is willing to pay. Supply and demand of goods and services determine price. As a result, when the price of a commodity goes up, demand goes down; when price goes up it provides an incentive for suppliers to supply more of the goods or services if they can. One other principle why prices rise is when government prints too much money. Nations experience inflation when there is an increase in the overall level of prices in the economy. An observable fact where prices in the economy rose by similar standards was experienced by Germany in January 1921 when the price of a daily newspaper that cost 0.30 marks rose to 70,000,000 marks in less than two years later. The best tool to defeat inflation is to limit the growth in the quantity of money. The U.S. experienced high inflation in the 1970s and high inflation in the 1980s because of high and slow growth in the quantity of money. Despite the U.S. experiencing “Every time we break down barriers to trade and investment, we open up new markets for American ranchers, farmers, workers, and entrepreneurs. ...” [2]

Economics and leadership are two inseparable and intertwined subjects with significant advantage and contributions to free market economies. To have an effective economy, it is of vital importance for a leader to come up with effective planning and implementation. Economists are of the view that planning is never perfect and that plans are absolutely nothing without action and that at all times the trickiest thing to do is executing a plan.

There is a popular consensus among economists which affirms that in economics demand is easy and there is no limit to the wants and needs of human beings. The most difficult thing is meeting the supply of goods and services. What a country can do to encourage its people and how corporations and businesses can supply the necessary products and services demanded by the people is a pressing issue and a daunting task in the science of economics. As mentioned earlier, the answer of course is capitalism as reflected in the decentralized economy. An important resolution could be the 70 % solution adopted by the US military and corporations which states that if you feel that you have 70% of a problem covered –take action!! Because of the law of diminishing returns, trying to make a plan perfect is futile. The art of economics consists not merely looking at the immediate but at the longer effects of an act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Because people respond to incentives, leaders must remain rational by weighing or comparing benefits and costs just as those they govern perceive it to be so. A situation in which the market price has reached the level at which quantity supplied equals quantity demanded, is called equilibrium. Also called market-clearing price, equilibrium is found where the supply and demand curves meet. At the equilibrium price, the quantity supplied equals the quantity demanded. In free markets, a so pervasive phenomenon that brings into balance the quantity of goods supplied and the quantity of goods demanded is referred to as the law of supply and demand-meaning the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance. In economics, deadweight loss is referred to as the fall in total surplus that results from a market distortion, such as a tax. Because taxes cause deadweight losses, they prevent buyers and sellers from realizing some of the gains from trade. What determine whether the deadweight loss from a tax is large or small are the price elasticities of supply and demand. Henry George, the 19th century American economist and philosopher, in his 1879 book, Progress and Poverty, argued that the government should raise all its revenue from tax on land. To him, this “single tax”, was both equitable and efficient. However, not many economists of our era and age support George’s proposal for a single tax on land. Because governments have no money, the only way they can obtain it is through taxation which carries with it a deadweight loss to society as a whole.

With rigorous debate mounting in the U.S. regarding immigration, opponents and proponents of this contentious issue base their arguments on the supply of labor. Some factors that would cause the labor supply curve to shift include changes in tastes, changes in alternative opportunities, and immigration. For instance, when immigrants come to the United States, the supply of labor in the United States increases and the supply of labor in the immigrants’ home countries contracts. The never-ending policy debate about immigration centers on the effects of immigration and its effect on labor supply-equilibrium in the labor market.

A new field of economics known as behavioral economics has made basic psychological insights into human behavior. Some exclusive studies on human decision-making have come up with the following findings:
 People are overconfident.
 People give too much weight to a small number of vivid observations.
 People are reluctant to change their minds.
Because economists have differing views regarding the imperfections of Homo sapiens, some economists have suggested that humans are “near rational” or that they exhibit “bounded rationality”. It was Herbert Simon, a social scientist who worked at the boundaries of psychology, who suggested that humans should best be viewed as satisficers and not rational maximizers. Thomas Sowell, an African American economist stated that the mark of a good economist is "thinking beyond stage one". In essence, this is part of leadership. Professor Richard Epstein University of Chicago Law School, commenting on Thomas Sowell’s book Applied economics: Thinking beyond Stage One, had this to say, “In Applied Economics, the companion volume to his earlier work, Basic Economics, Thomas Sowell uses rudimentary economic theory to unmask the cant that surrounds too many policy debates.” [3] To further add more weight to Sowell’s book, the Publishers Weekly had a commentary that read: “The great achievement of Sowell's book is its simplicity. His writing is easy and lucid, an admirable trait considering the topic at hand. . .His target audience is the average citizen who has little or no economics background, but would like the tools to think critically about economic issues.” [4]

In broader terms, economics is an appealing subject, informative, and educative to the core. It is part sociology, part philosophical, and undoubtedly a subject meant for every human being seeking to overcome barriers in daily financial and economical handicaps.

N. Gregory Mankiw: Principles of Microeconomics (2007). Thomas Higher Education, 5191 Natorp Boulevard, Mason, OH 45040.

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