For the last two articles, we have been discussing non-stop about QE (Quantitative Easing, i.e. printing money) and inflation. You should get used to this term, QE, because you might see it a lot on the news. So just to spice things up, we should take a rest from QE and inflation for a while and further expand our knowledge about Economics in general.
I guess what this blog missed, what I overlooked from the starting point is explaining to you the role, the importance of Economics. I have mentioned again and again of how understanding economics is a boon at both national and individual levels. However, I have yet to provide any reason or explanation as to how and why it is beneficial.
Well, you see, in an ideal world, where humans perfectly understand their role and responsibility in addition to having the ability to see far beyond their own personal comfort zone, then running an economy could not get any easier. It would be a piece of cake! Sadly, that is not the case. In reality, whether it is a top-down (favoring central planning and regulations) or a bottom-up (favoring free movement of economic elements adapting to the market force with little or no interference from the government) approach, humanity lacks the requisites to fully maneuver their kinds through the vast economic ocean.
That is why having abundant human and physical capital and natural resources does not make a country the greatest or the most prosperous nation in the world, and that is why we need Economics. Economics is an art used to govern resource allocation so to meet maximum efficiency and greatest return considering the alternative uses of each resource. Misuse of Economics will result in stagnation within the whole nation ranging from small hot-dog stands along the street to something as gigantic and powerful as NASA.
I will give you an example of how having adequate resources does not suffice when it comes to running an economy. Russia, back in the day when it adopted a socialist planned economic system, the country went through a painful ordeal. Russia, as one of the global powers, is one of the most, if not the most naturally endowed nation on earth. Neither did she lack manpower, nor did she lack human capital (i.e. intelligent and capable people), technical know-how or great research facilities to fulfill her hunger and need for growth and prosperity. However, with the economic decision imposed, Russia was locked inside a period of insufficiency, inefficiency, and decline. Looking at Japan, we all know that it is currently one of the global largest economies with every aspect of its economy and society only second to a few. Japan, unlike Russia, did not possess great wealth of natural resources, and at the same time, she occasionally suffered from natural disaster, a harsh punishment by our mother earth. Still, despite going through war and pain, with little at hand, Japan has positioned itself among the top few. China, though not lacking in the gross amount of natural resources, the per capita (per person) amount was diminishing bit by bit, eating away its growth. With over a billion population at hands, its daily concern is nothing but trying to figure out how to feed its people. Of course, despite all that, China’s economy is expanding to an unexpected level. All the aforementioned countries’ social and physical infrastructure was, at one point, extensively damaged by war, but what did they do differently? What caused unbelievable growth in one country and decline in another? One of the major factors, if not the most decisive, is nothing but the economic system adopted.
Economics is much more interesting than that. For instance, in Economics, we distinguish between physical scarcity and shortage. Do not mix them up. With the right economic system, we can have physical scarcity but still no shortage. With the wrong economic system, however, we can end up with resource abundance but also shortage. Just how can this be possible?
To illustrate, I’ll pass on to you one of my favorite examples. In the 1970s, the US was struck by a severe shortage of gasoline. The amount of gasoline available, however, did not vary that much from the previous years. The number of population, the number of vehicles in need of gasoline did not increase that much either. What caused the shortage despite not having actual physical shortage? That is an economic question. Remember that people are mostly driven by their own self-interest. Yes, that is not entirely true, but I believe it still applies to a majority. With the economic miscalculation by the government, it can create a false incentive. The US government back then set a price ceiling (i.e. set a maximum so that the price does not exceed a certain level). That is to say, regardless of the increase demand, price cannot rise above the limited level. Remember our article about “Individual rationality and Collective irrationality”? As each profit-oriented individual made a rational decision, sometimes they ended up with collective irrationality leading to a bad outcome, which is exactly what happened when the US did not allow the gasoline price to fluctuate freely in sync with the market force of supply and demand. With low and constant price despite being in high demand, people can consume much more gasoline without having to be thrifty. The consumption gets higher and higher, and since price did not rise, there was no signal given to the public, no incentive to cut back on the consumption. In the end, they ended up with a long line of vehicles waiting to fill up their tanks, and as getting gasoline becomes a tedious time-consuming task, another problem occurred, which was hoarding. People started to fill up their tanks to the fullest every single time they could. They hoarded gasoline because gasoline was then (after the implementation of the price ceiling policy) becoming harder and harder to acquire. You would either have to drive around all day to find a gas station with available gasoline or waiting with many others in a long line of cars with no guarantee of having your tank filled. The gas stations could not amass enough supply for the whole day, so they only operated for a few hours and they closed way too early. That worsened the shortage, and people hoarded more. With gasoline in individual gas tank instead of in the general inventory of the gas station, it was impossible to reallocate the excess amount to the other locations with greater economic, social, and scientific activities (where most goods, services, innovations, and knowledge materials are produced). This is how much damage economically and socially an error in economic decision can harm you and your country. That is why studying Economics is of great importance for the growth of a country.
As we progress, the economy becomes more difficult to monitor and harder to conquer. In fact, we have never (not even once) had a full control or understanding of our economy, not to mention the world economy. Don’t be confused. I said we cannot control it, but it is more like “we should not try too hard to control it”. When it comes to Economics, sometimes, it is a mystery, and sometimes, we are a fool. Economics is not a hard science. Thus, there is no clear-cut answer to an economic question or problem. This is why it requires you to think, most of the time, from every angle exhausting all the knowledge you have, not limited to economics. If you are trying to set a policy, then not only do you have to consider it from an economic point of view, but you have to understand its constraints, the limitation imposed by Economics itself.
What we have discussed so far mainly concerns with macroeconomics, but the information and knowledge provided here are merely pieces at the atomic level of the enormous economic discipline. Still, I hope it at least gives you an idea of how and why Economics is indispensable at both micro and macro levels in governing a nation. It is dubbed as a dismal science because of its seemingly gloomy and negative attitude towards the world and its future. However, that is nothing other than a misconception because economics sometimes act as a warning signal telling us when to prepare for the big wave and when to ready our ship and sail onward. Economics never fails, it is our understanding of it that fails us.