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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
Primary Goal
InstitutionalArena
Primary Actor
Economics
Prosperity
Market
Individual
Politics
Justice
Government
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.
Growth
For 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
Growth
Against 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
transactions
through
market
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.
Stability
Against 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.