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60 Second Adventures in Economics (combined) - YouTube
Channel: OpenLearn from The Open University
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60-second Adventures in Economics.
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Number one: the invisible hand.
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An economy is a tricky thing to control and governments are always trying to figure out how to
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do it. Back in 1776, economist Adam Smith shocked everyone by saying that what
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governments should actually do, is just
leave people alone to buy and sell
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freely among themselves. He suggested
that if they just leave self-interested
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traders to compete with one another,
markets are guided for positive outcomes
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as if by an invisible hand. If someone
charges less than you, customers will buy
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from them instead, so you have to lower the price or offer something better.
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Whenever enough people demand something, they will be supplied by the market, like
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spoiled children, only in this case
everyone's happy. Later free marketeers
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like Austrian economist, Friedrich Hayek,
argued that this hands-off approach
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actually works better than any kind of
central plan. But the problem is
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economies can take a long time to reach
their equilibrium and may even stall
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along the way, and in the meantime
people can get a little frustrated. Which
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is why governments usually end up taking
things into their own more visible hands instead.
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Number two: the paradox of thrift.
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Much like a child getting his pocket
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money, one of the biggest economic
questions is still whether it's better
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to save or spend. Free marketeers like
Hayek and Milton Friedman say that even
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in difficult times, it's best to be
thrifty and save. Banks then channel the
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savings into investment, in new plant
skills and techniques that let us
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produce more. And even if this new
technology destroys jobs, wages will drop
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and businesses hire more people,
so unemployment falls again, simple. At
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least in the long run. But then a 'live
fast die' young kind of chap called John
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Maynard Keynes, cheerfully pointed out
that in the long run we're all dead, so
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to avoid the misery of unemployment, the
government should instead spend money to
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create jobs. Whereas if the government
tightens its belt when people and
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businesses are doing the same, less is
spent, so unemployment gets even worse.
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That is the paradox of thrift. So instead
they should spend now and tax later when
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everyone's happy to pay. Though making
people happy to pay tax for something
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even Keynes didn't solve.
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Number three: The Phillips Curve.
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Bill Phillips was a crocodile hunter and
economist from New Zealand, who spotted
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that when employment levels are high,
wages rise faster. People have more money
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to spend so prices go up and so does
inflation, and likewise, when unemployment
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is high, the lack of money to spend means
that inflation goes down. This became
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known as The Phillips Curve. Governments even set policy by the curve, tolerating
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the inflation when they spent extra
money creating jobs. But they forgot that
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the workers could also see the effects
of the curve, so when unemployment went
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down, they expected inflation and
demanded higher wages causing
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unemployment to go back up, while
inflation remained high. Which is what
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happened in the 1970's, when both
inflation and unemployment rose. Then in
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the 90's, unemployment dropped, while
inflation stayed low, which all rather
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took the bend out of Phillips's Curve.
But at least part of Phillips's troublesome
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trade-off lives on. When faster growth and full employment
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return, you can bet inflation will be
along to spoil the party.
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Number 4: The Principle of Comparative Advantage.
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Whether you think economies work best if
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they're left alone, or the government's
need to do something to get them working
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the one thing that can't be controlled
is the rest of the world. Fear of foreign
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competition once led countries to try
and produce everything they needed and
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impose heavy taxes to keep out foreign
goods.
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However, economist David Ricardo showed that international trade could actually
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make everyone better off bringing in one
of the first great economic models. He
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pointed out that even if a country can
produce pretty much everything at the
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lowest possible cost, with what
economists call an absolute advantage,
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it's still better to focus on the
products it can make most efficiently
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that sacrifice the least amount of other
goods and let the rest of the world do
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the same. By specialising, they can then
export these surpluses to each other and
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both end up better off. This is the
principle of comparative advantage and
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it has persuaded many countries to sign
up to free-trade agreements, but
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unfortunately it can take a long time
for countries to trade their way to
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prosperity. And because it's now much
easier to move to where money is, it's
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increasingly not only goods that cross
borders but people, which has somewhat
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uprooted Ricardo's theory.
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Number Five: The Impossible Trinity.
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Most countries trade with one another,
which is usually pretty good for all
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involved. But it does mean it's a bit
harder for each to keep control of its
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own finances. There are three things that
governments are particularly keen on.
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They like to keep the exchange rate
stable so that import and export prices
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don't suddenly jump around. They also
like to control interest rates so they
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can keep borrowers happy without
upsetting savers. And they like to let
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money flow in and out of their country,
without causing too much disruption.
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But there's a problem when you try to do all of these at once. Say, for example, the
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euro-zone tries to lower its interest
rate and reduce unemployment.
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Money flows out to earn higher interest rates elsewhere. Exchange rates drop,
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which causes inflation, so the Euro interest rate is forced back up again. You can
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either fix your exchange rate and let
money float freely across national
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borders, but have no control over your
interest rates, or control your interest
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and exchange rates, but then you can't
stop the capital flowing in and out. But
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like an overzealous triathlete, you can't
do all three at once.
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Number Six: Rational Choice Theory.
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Of all the things to factor in when running an
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economy, the most troublesome is people. Now, by and large, humans are a rational
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lot, when the price of something rises
people will supply more of it and buy
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less of it. If they expect inflation to
go up, people will usually ask for higher
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wages, though they might not get them. And if they can see interest or exchange
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rates falling in one country, people with
lots of money there will try to move it
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out faster than you can say double-dip.
And governments often decide their
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economic policies, assuming such rational actions. Which would be great, if it
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weren't for the fact that those pesky
humans don't always do what's best for
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them. Sometimes they mistakenly think
they know all the facts, or maybe the
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facts are just too complicated. And
sometimes, people just decide to follow
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the crowd, relying on others to know what
they're doing. When too many cheap
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mortgages were being sold in 2007, a lot
of people didn't know what was going on.
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And a lot of others just followed the
crowd. Some lenders may have rationally
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believed that when the crunch came the
scale of the problem would force
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governments to rescue them. Which was
true for the banks, if not for all their customers.
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