CHAPTER ONE: INTRODUCTION

Political economy (PE) is one of three means or mechanisms for allocating resources.

As the term suggests, political economy brings together both political and economic considerations in allocating resources.

Synonyms for politics: the state, the collective, and government or power or control or authority.

Synonyms for economics: the market or the exchange system, (and less accurately) capitalism or the private enterprise system.

The common idea linking politics, economics, and political economy is that they are all decision making mechanisms for allocating scarce resources and/or conflicting values.

Economic decision making is about production, consumption, distribution and wealth accumulation, the four functions that govern our daily economic life.

In studying political economy, we will be dealing only with the peculiar reason or logic behind the need to combine political and economic considerations in allocating certain scarce resources, but not with the determination of the quantities transferred, nor with the analysis of the consequences of economic choice.

Much of our daily living resolves around decision making, the making of hard choices.

All the choices we make in the short-, medium-, and long-term can be broken down into three categories, depending on whose decision making is competent or efficacious, that is, provides the most desirable solution in the particular case

Economic choices over which individual decision making is competent belong to economics.

Economic choices over which only group decision making is competent belong to politics.

Politics also deals with conflict over group values.

Economic choices over which only a combination of individual and group decision making is competent belong to political economy.

The need to combine politics and economics in allocating certain resources comes from the reality that not all allocative problems can be categorized neatly into the two camps of politics and economics.

Political economy is the social science concerned with economic choices that have both individualistic as well as collective characteristics.

There are two basic approaches to political economy.

The first approach to political economy is cross-pollination between politics and economics.

Most economic decisions have political consequences, just as political choices have economic implications.

The second approach to political economy is market failure analysis.

Critics of the market system point out its many shortcomings as justification why government intervention in markets is appropriate.

But pro-market analysts such as from the prominent Chicago School of Economics, and the Austrian Economic School, while admitting to the failings of the market, do not believe government intervention provides a better solution than the market.

The above basic definition of political economy is restated and further explained under five propositions on which its theory and practice rest.

That at all times, and for all human beings, individuals or groups, there is the perennial challenge of human needs–also called economic wants--exceeding the human resources or means for providing them.

Unlike distribution which presumes abundance, allocation presumes a situation of scarcity.

The scarcity problem is part of our human condition as people who want to do more than we have resources to accomplish.

Resources refer to scarce human utilities or the scarce goods and services we need in order to carry out all of our human economic activities of production, distribution, consumption, and wealth and prestige accumulation.

These four areas of economic activity sum up the human, that is, both individual and collective needs or the purpose for which resources are allocated.

Any utility that is abandon relative to need cannot be considered as a resource.

Resource allocation is the calculated assignment of goods and services in order to provide the best solution to our scarcity problems.

Because capital plays such an important role in economic production, the private market system is often called capitalism.

We can identify several categories of the scarcity problem; see whether you can find other matching examples of these categories, especially the dual individualistic and collective aspects of the examples of political economy problems listed on pages 5-6 of your handbook.

Physical scarcity is a direct and simple question of a lesser amount of resources than is needed by an individual person or corporate unit or by the individual units within a group; thus physical scarcity can be a problem in both economics and politics.

1Physical scarcity facing single individuals (shortfall in your weekend budget) or corporate entities acting as a single unit, e.g., the University of Auburn buying computers from IBM— falls within the realm of economics;

In a purely economic system, an economic agent will respond, all other things being equal, to only one set of incentives (or logic, or reason) that are economic, e.g., paying someone to manicure your lawn.

2.Physical scarcity facing groups, e.g., shortfall in family budget, Auburn University allocating funds to its various competing departments falls within the realm of economics.

The scarcity, or better still, the conflict between abstract values is an exclusive political problem because it occurs only among groups.

In a purely political system, an agent will respond, all other things being equal, to only one set of incentives that are political; e.g. voting for one candidate and not the other.

3. Conflict between groups holding opposite abstract values like law and order versus personal freedom, pro-life versus pro-choice belong to the realm of politics.

In a political economy system, a political economic agent will respond simultaneously to two sets of incentives, one political, the other economic, e.g., locating an auto plant to meet environmental requirements while ensuring maximum profit.

Allocation is the calculated response to demand and supply under conditions of resource scarcity.

Allocation presumes rationality.

To be rational, three conditions must be satisfied.

a. One must have a choice, that is, there must be more than one item to choose.

c. One must choose a higher ranked value over a lower ranked one.

Scarcity also requires the most judicious utilization of resources.

To be efficient one must have a means of comparing possible courses of action.

Allocation cannot be based on charity, love, nor compassion that may not treat all applicants as equally deserving, but on a price system.

Prices reduce the different values of commodities into a common measurable denominator that allows rational comparison.

Scarcity and having to choose means we have to give up several other things we could have devoted our scarce resources to get.

The best alternative use or value of our scarce resource is called opportunity cost.

What is an opportunity cost?

There are three methods of solving the scarcity problem because there are three distinct aspects to the same scarcity problem, those that are individualist, those that are collective and those that involve both individualistic as well as collective characteristics.

Economics is the system for solving scarcity problems which are exclusively individualistic and over which individual decision making is, therefore, competent or efficacious–that is, gets the job done; e.g., what hairstyle should I cut, what courses to pursue this semester, and what should I do with a $25 shortfall in my Christmas shopping budget?

Capitalism is distinguished by private ownership of assets and by private decision making.

Economists assume individuals are free to choose as they see fit and are most competent to address their individual problems.

But in the real world, individuals are not always competent, nor totally free.

But these assumptions are useful for two reasons:

Two reasons why individualized decisions are said to be competent:

The logic behind economics or its method of resolving individual scarcity is market exchange.

Economic exchange can happen only if four conditions are met:

Pareto optimality: Given these conditions, economists claim that exchange would yield nothing but pure gain (gain net of cost).

A lot of everyday scarcity problems are collective or social in nature.

As a concept, politics connotes both social conflict and conflict resolution.

Politics is the system for resolving scarcity problems that affect groups and require collective decision making for solutions.

The social content acts as both opportunity as well as constraint.

There are certain needs the individual can fulfill only when he joins up with others.

Individuation is the process of maximizing our individual potential only through society.

But group membership means the individual is not free to do as he pleases.

Politics is concerned only about those social values that pitch the individual or one group against another.

The logic of politics, or its method of resolving social conflict is power, or the exercise of lawful authority.

Power is only legitimate if voluntarily endorsed by the majority of the group over which it is exercised, which in the case of political economy is the state or the people of a country.

Power is legitimate only when freely endorsed by the majority of the people over whom it is exercised.

We submit to legitimate power because the parties to a political conflict are deadlocked in a stalemate only third party intervention can resolve.

Legitimate power is competent because it is backed by an enforcement capacity: the police, the courts, prison and other forms of punishment.

The scope of jurisdiction of the relevant legitimate power or authority making allocative laws that are binding is what defines the proper allocative authority.

While individuals and households do make allocative decision pertaining to them, generally the basic unit of analysis for political economy is society at the sovereign state level.

Only at the sovereign state level does final authority – called absolute sovereignty – exists for making effective decisions, that is, decisions that are backed by undeniable punitive capacity.

To be useful for nation-wide allocation, an allocative system must possess four properties: It must be systematic, reliable, legitimate, and efficacious.

Only politics and economics have all the requirements for solving the scarcity problem on a large scale, that is, nationally.

Other means of transferring resources from one hand to another such as coercion, mutual reciprocity, persuasion, love and charity, communalism, and communism lack some or all of these prerequisites.

Systematic or ability to operate according to clear logical (cause and effect) reasons why resources should exchange hands.

Political allocation is based on the logic of authority or legitimate use of force.

Economic logic is based on the mutual gains from market exchange.

Reliability or the ability to deliver same effects under same conditions. In economics, $2 will get you the same bigmac no matter where the Macdonald outlet is located across the U.S. In politics, the exercise of power will always produce some arbitrariness (injustice).

Legitimacy or voluntary systems that are approved as lawful by all involved, and therefore backed by a system of laws.

Power is made lawful as authority if willingly approved by those over whom it is exercised.

Coercive systems such as mercantilism, communism, fascism, and dictatorships do not enjoy such legitimacy.

To be efficacious, authority must be backed by lawful and undeniable ability to punish wrong doers.

While possessing the pre-requisites for efficacy in allocating resources, the allocative task does not break neatly into two sets of allocative problems, one political and the other economic.

The efficacious allocation of certain resources requires the merger of politics and economics.

PE is situated (can be found) where politics and economics merge, or must be combined for the efficacious allocation of certain resources.

By merger, we mean where allocation process responds to (takes into account) both political as well as market considerations at the same time.

Politics and economics must merge because (a) the effects of political and economic choices are not insulated from each others or (b) because by themselves neither provides a perfect solution to all of society’s scarcity problems.

Political economy can be defined as a system that combines both political and economic login and concerns to provide solutions to scarcity problems that involve both individualist and collective elements. E.g. Atlanta city authorities prohibiting an individual from building on his private land in order to limit city sprawl.

7^th Proposition:

So how is political economy as a decision making mechanism different from a purely economic or purely political decision?

A system runs on its own unique logic; a mechanism could use a combination of different elements drawn from different systems.

Political economy does not posses an independent logic of its own.

Political economy is a third dimension offering a third mechanism to the allocation process, but not an independent system, because it does not follow a logic of problem solving that is independent of its two originating components, politics and economics.

In political economy, politics and economics are dialectically related–their interaction does not constitute a third and separate entity as in a synthetical relationship.

All the abstract definitions used in political economy are taken from Political Science and Economics.

That gives us two basic approaches to political economy analysis.

Cross-pollination between politics and economics assumes that most political decisions have economic consequences just as most economic choice have political or social effects.

Politics to economics: Voting for candidate A over B may mean accepting the liberal policies, including higher taxes, preferred by A. Other examples include the effects of government regulation.

Economics to Politics: Buying an SUV means encouraging US oil dependency and increased pollution that have negative effects for all.

Analysts point to a special case of intensive cross-pollination between democracy and capitalism such that democracy tend to thrive only in countries with a market economy (or capitalism), and vice versa.

Because of this strong link between democracy and capitalism, there is considerable debate as to which of these two systems is responsible for our modern civilization?

The best answer is that both democracy and capitalism emerged simultaneously, and that neither could have survived without the other.

Cross-pollination is never unidirectional:

Examples of positive effects of politics on economics include, property rights protection, money as government debt, and collective bargaining strategies adopted in the marketplace.

Examples of positive effects of economics on politics include, government revenue to ran a stable democracy comes from the market’s technology, investment, and jobs.

But positive cross-pollination aside, there are also negative cross-effects between politics and economic generally, and between democracy and capitalism in particular.

Legal democratic laws protect the unequal reward for work under capitalism, a restricted franchise which links ability to vote to property ownership, and slavery.

The market systems with its emphasis on the accumulation of wealth, has polluted our democracy such that only the very wealthy get elected to state, and federal legislatures.

In addition, much of contemporary legislation is made to favor the interest of the wealthy who fund the election campaigns of elected officials.

But most political economy phenomenon is analyzed in terms of the second methodology, namely, market failures.

The areas where individual marketplace decision making would fail to yield optimal results are referred to as "market failures."

The market may fail when it either used improperly or used for things for which it is not designed.

The traditional areas of market failures that justify government intervention are:

The production of public goods

The more modern areas of market failures that justify government intervention are:

The coordination of national development.

The stabilization of the macro-economy.

The promotion of industrial policy.

But except in the areas of public goods, market failures never appeared in classical economics.

Classical economics assumes the market is perfect, not that it may never falter, but that whenever it does, it is capable of correcting itself.

Which, by implication, means it does not need government as a corrective intervention.

But not all are convinced.

Quantitatively, the efficiency debate seeks to know just how much of economic waste the market actually eliminates.

Classical economists, have for the longest time, assumed the market eliminates all waste.

Qualitatively, the efficiency debate asks which social group(s) do market outcomes favor?

According to V. Pareto, the market eliminates all waste.

This is achieved whenever supply is equal to demand and all resources assigned to production are accounted for.

This assumption does not reflect the practical everyday market experience, but is held on still for purposes of comparison, and for teaching.

The admission that the market in equilibrium may not always be guaranteed to eliminate all waste first appeared in neoclassical economics.

The market in equilibrium may still be inefficient under two conditions: when externalities are present, and when transaction costs – the cost of doing business – are significant.

An externality is an unintended effect of production and consumption for third parties.

Positive externalities discourage their producers from producing in quantities sufficient for social needs. E.g., Government pays for the retraining of old workers because companies are afraid they might lose them the moment they acquire new skills through company retraining programs.

Negative externalities encourage their producers to produce in quantities that are inordinate for social needs. E.g., Car producing plants would not produce as many cars if they are forced to control all the pollution they generate.

Given the social effects of externalities, only government, the representative of the collective interest of all the people, is sufficiently positioned to produce public goods.

Contrary to liberals’ claim that only government can represent the common interest of all the people, pro-market economists and conservative politicians believe the market can do a better job of representing the common interest.

The latter takes their cue from Adam Smith, who crafted the first principles of capitalism as a replacement for the corrupt mercantile system of his time.

According to Adam Smith’s invisible hand imagery, the market is capable of transforming selfish choices into the best outcome society could ever achieve.

Highlights of the mercantile era:

By contrast, under capitalism:

(d) Market exchange is free and purely voluntary.

Critics of the market system think it over concentrates on wealth creation to the neglect of other things such as fairness and equality that are important to human beings.

Besides, state laws protect the very unequal reward system under capitalism.

The solution as prescribed by liberals is a welfare state in which government may tax the wealthy to aid the poor.

But pro-market advocates believe the market produces many positive things whose collective effect far outweigh the effects of its negative outcomes.

(c) Even minorities do better under capitalism than without.

Government regulates the market because the effects of the poor stewardship of the market, left unchecked, would reduce the overall efficiency of the market.

Our poor stewardship of the market is evident through monopolies, cheating, and transaction costs.

Monopoly exists when an industry-a distinctive production area – is dominated by a single firm, enabling such a firm to set its own prices.

The Sherman Antitrust Act of 1890 was the first ever government regulation of the market.

Since then, the marketplace has seen waves upon waves of regulation ranging from food, and workplace safety regulations, product standard regulations, and to environmental regulations.

Transaction costs are the costs of getting a business partner: tipping, bribery, and monitoring contractual performance.

Transaction costs are externalities: Those benefitting from transaction costs end up paying less than the full amount for an exchange, while those paying transaction costs, pay more than the face value for an exchange.

Therefore, transaction costs tend to encourage free riding – the tendency to consume or impose costs without paying for it.

A stable economy is not one that does not fluctuate but one that is healthy enough to avoid frequent fluctuations, and to recover quickly from recessions and inflation.

Recession in the economy sets in if the gross domestic product (GDP)-- a measure of the overall productivity of the economy -- is negative for two consecutive quarters, that is, eight months in a row.

Inflation is a rapid and often uncontrolable increases in the prices of goods and services.

Prior to the Great Depression, the prevailing neoclassical economic though assumed that the market as a whole could not fail.

So there was no need for government intervention to stabilize the economy.

But the market failed to reverse course once the Great Depression was underway. It lasted for nearly 12 years from August 1929 until the US entry into World War II in 1941.

It took the huge US government expenditure of World War II to establish new investment, to find enough jobs for the unemployed, and so pull the economy out of the Great Depression.

Since then, government intervention to stabilize the market has become part of the western market economy and is known as macroeconomics.

The revolutionary idea that only with government intervention can the market be made stable was first proposed by the English political economists, John Maynard Keynes, a reason macroeconomics is often called Keynesianism.

The revolutionary explosion of Keynesianism following World War II led to the establishment of the economic subpresidency, a major economic role for US presidents that has increased the power and prestige of the executive government at the expense of the legislature, Congress.

The main concern of the developmental state is the uneven regional development pattern of the world, the division of the economic functions of nations into "developed" or "industrial" and "nondeveloped""third world" or "developing" countries and how to close that gap.

The competing theories on development can be grouped into two: Those propositions on the free flow of market forces to bring development to the developing world and those who so much distrust the market, the call for government intervention to spur development in developing countries.

Both schools of thought do agree that the domestic market size for most developing countries is too small for the efficient utilization of technologies they can borrow from developed countries.

Two probable solutions: either integration of the small markets of developing countries or expansion of the domestic market through coordinated government investment (some form of socialism).

State-led development is favored by the radical and structuralist perspectives on development.

The notion that government would successfully initiate development rest on three false assumptions:

Industrial policy is the use of public funds to promote private industries and firms to protect them against external competition.

Industrial policy programming is now very sophisticated, even in the US economy, the most capitalistic of all market economies.

Critics doubt whether it would be any more effective in guiding the macro-economy now that macroeconomics, its predecessor, has run into trouble.

But the most important message of industrial policy for students of political economy is that it shows once again, the readiness of government to fashion new ways of helping the market whenever it gets into trouble.

A lot of pro-market economists furs about the wastefulness of government programs.

But most forms of waste in public projects, while certainly not meeting the rigorous demands of zero waste, should instead be viewed as reflecting the uncompromising nature of politics.

That means, whenever market failures forces us to introduce government into the marketplace, we should expect the results not to produce zero waste.