The Six Rules
Wednesday, December 2, 2015 at 10:45AM
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Understanding basic economics means understanding how the world works. It allows one to peer through a lot of noise, haze, obfuscation and deliberate misdirects put out there by clever frauds. Nearly a quarter century (sigh) of studying economics has helped me boil things down to 6 economic maxims, which I have very creatively dubbed the Six Rules. I came up with none of these on my own, but have borrowed them from an assortment of giants upon whose shoulders I humbly stand, most notably Adam Smith, Thomas Sowell, David Ricardo, Milton Friedman and Friedrich Hayek. One or more of the Six Rules can be used to explain virtually anything you see happening, including things that don’t at first blush appear even remotely related to economics. Steven Levitt and Stephen Dubner, in their popular Freakonomics books, have done a decent job pointing this out (their premise being sound even if some of their conclusions are dubious). For the Six Rules to be of much use, however, a reasonably firm foundation in the basics, such as the laws of supply and demand, is necessary. As they demonstrate daily, such a foundation is by no means a given even among our most elite politicians and policymakers.
 
The Six Rules are, as follows:

1. RESOURCES ARE SCARCE, AND HAVE ALTERNATIVE USES. A “resource” in this instance means anything that has economic value (e.g., for which there exists at least one person in the world who is willing to give something else of value in exchange for it). “Scarcity” in the economic sense means there is more demand for something than there is supply. This is also the case for anything of value, and price is both the signal and the medium for bringing supply and demand into a state of equilibrium. Something with a price of zero will not be supplied because there’s no demand for it, and the fact that there’s no demand for it is the reason its price is zero. 

The second part of the sentence–that resources have alternative uses–means that every dollar used for X is rendered unavailable to use for Y. It is another way of saying resources need to be allocated or, if you prefer, that their use needs to be prioritized. This rule comes from Thomas Sowell’s indispensable Basic Economics, where it is used in tandem with what should possibly be a separate Rule on this list in itself: There are no "solutions," only trade-offs. Which is to say, in a world where resources are scarce and have alternative uses, there can be no solutions, only trade-offs. We simply can’t do everything, because resource scarcity requires their allocation in one way which necessarily precludes their allocation in an alternative way.

2. PEOPLE RESPOND TO INCENTIVES IN WAYS THAT ARE EXTREMELY PREDICTABLE. You’ll often hear economists refer to “perverse incentives.” When you hear that, it means people are responding to a law, policy or set of circumstances in the exact opposite manner as was hoped for or considered desirable. A commonly used example is a law that drives landowners to kill off an endangered animal the law intended to protect so they can avoid being deprived of the economic value of their timber or some other natural resource they would be able to exploit but for the animal’s presence. Such a law creates a perverse incentive against protecting endangered species. Whenever you hear a politician or pundit gassing about the “unintended consequences” of a law, you should call to mind this Rule. Look not at the intention behind the law–which is perfectly irrelevant–but at the incentives it creates and you’ll quickly conclude that people are responding to those incentives very predictably.

3. PEOPLE ARE NEVER AS CAREFUL WITH OTHER PEOPLES’ RESOURCES AS THEY ARE WITH THEIR OWN. Hopefully no elaboration is required for this one.

4. GOVERNMENT, MONOPOLIES, AND OTHER ENTITIES NOT SUBJECT TO MARKET DISCIPLINE ARE INVARIABLY ILL-MANAGED. When you can’t go out of business, there’s nothing to keep you in line. This is doubly true when you're playing with other people's money. Governments and monopolies routinely violate the other five Rules on this list and get away with it, which is why they tend to behave arbitrarily, capriciously and even irrationally. Other very large businesses–virtual monopolies–behave similarly. The bigger a big business gets, the more it behaves like government.

5. WITH THE EXCEPTION OF THOSE DESCRIBED IN RULE NO. 4, ECONOMICS IS NOT ZERO-SUM. Unless Bob robbed you at gunpoint, or had something you needed so desperately that you’d pay any price for it (the same thing as robbing you at gunpoint), Bob’s being rich is not the cause of you–or anyone else–being poor. People get rich by adding value to the economy, which increases the overall amount of wealth in circulation, not by impoverishing others. No Steve Jobs = no iPhones. No iPhones = You need to carry a camera, a video camera, a phone, a computer, a calculator, a calendar and some dozens of other objects around with you. You can’t have wealth without the rich. Moreover, if Mark Cuban didn’t have a private jet, nobody would be employed flying it, maintaining it and supplying parts and fuel for it. If there were no demand for private jets more generally, thousands of people up and down the supply chain required to build them would be out of the job. Rich people are the reason venture capital exists, which in turn is the only reason anyone is able to start businesses and create employment opportunities. We’d be living in caves subsisting on whatever we could grow or catch without them.

6. PRICE FLOORS CAUSE SURPLUSES AND PRICE CEILINGS CAUSE SHORTAGES. All the time, every time, without exception. It’s important to remember this because politicians in particular are very fond of scoring points by attempting–successfully, more often than not–to convince people that through their peerless and indispensable genius, they’ve found a way to magically carve out an exception to this rule in this or that special case. Hasn’t happened, never will. Price ceilings on oil always–always–lead to oil shortages. Price floors on unskilled labor (the minimum wage) always lead to a surplus of unskilled labor, meaning higher unemployment for the unskilled, particularly if they are younger workers. The political gains to be had from convincing people that this basic economic maxim can be suspended in a particular instance are obvious and irresistible to politicians. Your job, as an informed voter, is to stop falling for this ruse. The laws of supply and demand are no different from the laws of physics: indifferent to our will and utterly immutable. Price is the mechanism by which the two drive each other, and price controls, whether floors or ceilings, are merely lies about fundamental reality. They’re feel-good fairy dust mixed with moonshine.

 

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