Practical Economics: How Things Work, Why There is Room for Morality, Where to Go from Here

There is a great deal of debate over the economy in the current Presidential election. Indeed, the Republican ticket has focused the election on economic issues, and particularly on government spending, by adding Paul Ryan as its Vice Presidential candidate. This enables the Democratic Party to take shots at Republican economic ideas, in the hope that most voters will be wary of losing “entitlements” if the Democrats fail to win the election.

Unfortunately, ignorance concerning economic issues is widespread in the United States, and judging by the current political-economic problems elsewhere in the Western world, the problem is by no means restricted to America. When I say “political-economic” problems, I am referring to the fact that voters everywhere seem to expect their political choices to determine what happens to the economy, as if governments can produce wealth by fiat.

In America, at least, there are two good reasons for this confusion, which I can illustrate here only with very broad strokes. First, the Federal Reserve banking system seeks to manipulate the economy by controlling the money supply, and ever since the early 20th century, American policy has tended to simulate increased wealth by “easing” the supply of money. The problem is that this is inherently inflationary, reducing the value of money. Moreover, Federal Reserve banking tends to mortgage each dollar more than once, making multiple financial commitments against the same real money, to stimulate growth. The problem with this is that it dramatically increases risk for everyone invested in the system. Such a system works only when there is no more than one default for each sum of money being promised as security for debt, yet typically loans outpace real money by a factor of ten.

Second, since the time of the Great Depression, the American government has used a combination of taxation and debt (borrowing) to solve (or attempt to solve) economic problems for American citizens. There is a kind of “rob Peter to pay Paul” aspect to doing this, but the result is that voters frequently think that government can simply decide to make things better or worse, without any fundamental accountability to the way the economy really works—that is, to the real wealth available, and how it is produced (which is not by government). In this sea of confusion, much of politics consists of promising the maximum prosperity to swing voting blocks. So I repeat that the confusion about political-economic questions is understandable. But that doesn’t make it good.

The Left-Right Debate

Conflicts over political-economic issues are significantly exacerbated by the left-right dialectic which plagues the West generally, and which Pope Benedict XVI addressed in his recent social encyclical Caritas in Veritate. There are quite a few significant insights in this encyclical, but surely one of the most important is Benedict’s insistence that a binary view of society—the view that pits the business tycoon as a producer of wealth against the State manager as a distributor of wealth, conceiving nearly everything in these terms—is “corrosive of society” (#39). Yet much of the left-right dialectic is built on a simplistic myth involving “selfish and evil” capitalists, tolerated only grudgingly because they produce wealth, and “good and caring” State authorities who must spend much of their time crafting regulations to make sure the majority of citizens do not get the fuzzy end of the proverbial lollipop.

In our precise moment in history, there are several factors which are stimulating a greater effort to make sense out of the prevailing confusion, and to back away from our mythical dialectic. The most important factor is the massive and debilitating debt amassed by most governments, and especially by our Federal government. The problem is so severe, that bankruptcy has already occurred at some lower governmental levels, and bankruptcy—with its resulting crashing and burning—seems just around the corner even at the Federal level. Unfortunately, a materialistic citizenry used to turning to the government for its economic well-being often falls into one of three traps in dealing with the fundamental economic realities, including the reality that not even government can continue indefinitely to live beyond its means. Citizens (a) do not really understand why government cannot simply keep giving out money; or (b) are content to insist on so-called entitlements here and now no matter what the consequences in a few years, or the consequences for future generations; and/or (c) fail to recognize the connections between declining prosperity and the general failure to produce a numerous and hard-working next generation.

The recent meltdowns of the financial sector have also, I think, contributed something to the erosion of the dialectical myth, at least among students of what has actually happened. It is not that the image of the selfish businessman has been improved—far from it—but only the most mythical interpreters of reality have refused to admit that government regulation played a significant role in this meltdown, that regulation alone cannot dictate financial probity, and—most jarring of all—that there is a very curious and unhealthy relationship between government regulation and big business. Specifically, the regulators come into government from business, make rules, and then move back out into business knowing how to work the system; moreover, this creates and perpetuates a “good old boy” network among politicians, regulators and business leaders. In other words, while the evil capitalist hasn’t come close to getting his halo back, many people are beginning to wonder why politics and business so often appear to be different names for the same thing.

Still, the ideological wars continue, based on a combination of myths and shameless pandering to self-interest. On the one side we have the interests of businessmen who would like to become richer; on the other we have the interests of voters who think certain kinds of politicians will give them a bigger piece of the American pie.

The Realities of Economics

There can be no longer any question, I think, that when it comes to understanding economics and how wealth is created, advocates of the free market have the greater grasp on reality by a country mile. They know several things which it is scarcely possible any longer for a sane person to deny. I would group this knowledge into three categories:

• There are clear relationships among the money supply, wages and prices which are part of the nature of reality, and which enable us to understand the consequences of artificially manipulating any one factor. Thus, if government mandates higher wages, there must in theory be a decline in the number of people who can be employed. If government mandates lower prices for certain goods and services, there must in theory be a decline in the availability of those goods and services. If government increases the money supply, the value of each unit of money must decline. If government shifts money from a high-entrepreneurial group to a low-entrepreneurial group, there are two inevitable results: First, the costs of the transfer are siphoned from the investment pool; second, the transferred wealth will have a smaller impact on long-term economic growth than what otherwise would have been the case. And so on.
• No centralized plan can organize the economy as well as the free market does. This was recognized at least as early as the Catholic scholastic writers of the early modern period, and its truth has been driven home by two critical factors. The first factor is the abject, consistent and inevitable economic failure of all societies based on socialism (that is, any system which relies extensively on government ownership of the means of production and/or government planning of the economy in general). This is not only because socialism eliminates the kind of incentives which naturally drive human creativity and work, but because government has no means apart from the market itself to determine the necessary economic indicators on the basis of which proper decisions can be made. The second factor is the increasingly obvious sheer impossibility of centrally managing a process which (a) has too many variables for effective tracking, analysis and coordination, and (b) depends for its very vitality on the decisions of a great many creative persons who respond, each in his own field of endeavor, to the opportunities and risks they encounter “on the ground.”.
• The standard of living is driven by labor efficiency: Unless one has a source of wealth drawn from outside the economic system in question—bringing ships of bullion in from the New World, for example—which can temporarily skew this economic law, improvements in a society’s living standard always (and only) come through increased efficiencies in the use of labor. When the labor required to produce certain goods and services is reduced, those goods and services become more readily available at a lower cost; as a society gains the ability to work more efficiently to produce the things people desire, there is a corresponding rise in the ability of members of that society to possess the things they desire more easily. For this reason, entrepreneurial activity—the creativity and financial investments of those who can conceive and implement new and more efficient ways of producing things—is the primary and by far most potent driver of increases in the standard of living in society as a whole.

Unfortunately, conservative champions of the free market have not done our collective understanding of economic reality any favors by insisting, in their zeal to stave off government intrusion, that economic theory plays itself out in practice as if there is no leeway for decision-making whatsoever. Wages and prices, they tend to imply, are always exactly what the impersonal market determines; there can be no variable range; and any effort by anybody to tinker, be it ever so small a tinkering, must inexorably lead to disaster. Moreover, driven by an enlightened self-interest (they argue), the businessman will at least generally do things in a way that favors success with both customers and employees over the long term and, if he does not, the market will weed him out quickly enough. In other words, though they deny it vehemently when pressed, free market apologists have an annoying habit of falling into the trap of arguing (against government intervention) that whatever is, is best.

Still Plenty of Room for Judgment: Within the Economy

Now there is a great deal to be said for this view that the market will, at least as a general rule, sort things out far better for our economic well-being across the board than will significant intrusions into the economy by the State. But this general expression, which should certainly give us great pause when considering government intervention in the economy, still leaves a large space for human decisions and in particular for moral decisions. Without a realistic understanding of how economies function, the best moral sentiments are likely to prove economically fruitless. But within a realistic understanding, the most important decisions we can make will often be moral decisions.

There are two main areas in which human judgment, and in particular human moral judgment, can and should be exercised economically. The first is in the space for human creativity that always exists within the operations of broad economic laws, and which these laws actually demand as a condition of success. For example, just because an employer knows that market conditions make it impossible to raise salaries across the board from $20,000 to $100,000 per year in a particular business, this does not mean that market conditions have no room for creatively planning the business to maximize employee welfare within the broader trends, or even to introduce new ways of doing business which creatively improve employee well-being. Free market advocates may argue that eventually, if larger conditions warrant, the condition of labor in a particular industry will improve. If work is becoming more efficient, I have no doubt that this is true, generally and in the long run, all other things being equal. But it is not necessarily true specifically and in the short run and, in any case, all other things are never equal. Thus, a businessman who makes the well-being of his employees a priority may be able to do substantial good.

In fact, observation, personal experience, and our own self-awareness (of how we act when certain possibilities present themselves) leads us to understand that not all businessmen are motivated by a truly enlightened self-interest, that those who are lacking it are not always weeded out, and that whole sectors of the economy sometimes take on a character that is dominated by the very unenlightened self-interest of key players. Economic cultures can form around decidedly unenlightened practices just as easily as human culture as a whole can do so. While competition is a great means of economic improvement, effective competition must think outside the box. Part of thinking outside the box is moral reflection. Within the same old box, there is never any guarantee that competition and other market forces will always, inevitably and quickly shake key economic participants out of their bad habits, including bad moral habits.

Markets are ultimately human creations, which inevitably reflect the multi-dimensionality of the human person. For example, as we are learning in the twenty-first century, through both financial commentators and popes, markets work far better when they are infused with a solidarity which builds trust, than when suspicion dominates. For this and many other reasons, real markets as they develop in real cultural situations are far more than the sum-total of economic laws. And again, those very laws both demand and provide significant room for human creativity, and therefore for the exercise of human prudence and morality.

Still Plenty of Room for Judgment: Transcending Economics

The other area in which human judgment can and must operate with respect to the market is in determining what set of goods we wish to secure with the prosperity we have. There are several aspects of this, of which I’ll simply illustrate two. The market for pornography is very strong, and it generates wealth, but there is no iron law of economics that says we must invest in, or even permit, pornography. This is a relatively straightforward “moral calculation” based on the natural law—that we will, either personally or as a society through government, eliminate the economic advantages of a pornographic culture because the sum total of benefits of a non-pornographic culture outweigh them.

Secondly, let me take a more controversial and far less easily-decided example, in the form of a symbol. Just because there are economic benefits to the ubiquity of Wal-Mart, it does not follow that personally or socially we need to become a Wal-Mart culture. I am referring here to our current tendency toward huge mega-stores and mega-services exemplified by such business as Wal-Mart, Costco, Amazon, eBay and many others. The argument in favor would be that these operations, which require immense initial capital, increase product availability and lower prices, solving a very real problem for those with lower incomes, and generally increasing everyone’s purchasing power. The argument against would be what many see as the cultural banality of the Wal-Mart model of life, in which the world is built out of massive enterprises in which very few people are permitted to play a creative, satisfying or even knowledgeable role; and in which we lack substantial human contact in our financial transactions.

My point is that there is no iron law of economics that says we must subordinate all other values to the values of price and availability of an ever-increasing array of largely incidental goods. In fact, when we do that, it says something profound about our culture. Thus America is frequently described primarily as a “commercial culture”. Yet a culture which prizes other values might organize its affairs differently, even if some economic values are better served by Wal-Mart (again, here used as a symbol). Of course the Wal-Mart concept depends on many other cultural realities, such as high concentrations of people in a given shopping district and an immense and effective transportation infrastructure. Online equivalents rely on a high concentration of online connections around the world, and a truly astonishing shipping infrastructure. But perhaps in an alternative universe, people would be more often spread across small towns, less digitally-connected, and more prone to patronize small shops which are a direct part of their local community life. Or perhaps people would not even consume the sheer volume of eminently discardable things on which the large-store model depends for its low margins. Different cultures and different cultural values (not necessarily moral values) give rise to different models of business.

Moreover, these examples also show that economic realities are never simple. In every case, an economic change will benefit some and hurt others, certainly in the short term, and often in the long term. Seen in a multi-generational perspective, the long-term trend of greater efficiency is likely to help nearly everyone materially, though there may be less obvious social and cultural costs. We humans are not particularly good at assessing the full implications of long-term trends, and in any case a long-term trend does not ease human suffering now, suffering which demands a moral response, including the suffering of families put out of business by big box stores and major online businesses, which only those with access to substantial wealth are capable of establishing. All of these considerations simply suggest that we ought to be wary not only of government intrusion but also of the assumption that whatever is happening “freely” is both inevitable and good.

There is, then, plenty of room for human judgment, and particularly for moral judgment, which at times operates within the confines of the economy and at times transcends the economy altogether. But to give the science of economics, and the market, its due, we would be fools if we attempted to make decisions without some perception of how the economy works and of what the theoretical impact of various changes must be, if all other things are equal—even though, in human affairs, they rarely are. We must not be naïve: We cannot produce either a robust economy or a robust culture by government fiat. Indeed, there is strong evidence that government ought to be a last resort for most things because it tends to weaken culture, which ultimately must be strong and healthy for every kind of human flourishing. There is no substitute for prudent and moral judgment in the effort to secure both our private and our common goods.

A Cautionary Tale

Pope Benedict reiterated in Caritas in Veritate that solidarity must be present in our economic relations as in everything else—the concern of all for all. In one place, he put it this way:

Even if the ethical considerations that currently inform debate on the social responsibility of the corporate world are not all acceptable from the perspective of the Church’s social doctrine, there is nevertheless a growing conviction that business management cannot concern itself only with the interests of the proprietors, but must also assume responsibility for all the other stakeholders who contribute to the life of the business: the workers, the clients, the suppliers of various elements of production, the community of reference. (#40)

The Pope, perhaps, is expressing optimism about the impact of sensible business theory in the hope of making a point. But we can agree, I am sure, that business leaders who possess a truly enlightened awareness of their self-interest ought to find plenty of motivation for operating in this way.

But not all do, and I’ll illustrate this truth with an experience of my own from just last week. I had a blockage in the drain line which runs from our house to the city sewer, and sink water was backing up in several places. My usual plumber was out of town (on vacation with his family, he said when I called, of all the nerve), so I called one of the big outfits which could send someone quickly. They did, both to fix the problem on the first day, and then to put a camera down our drain lines on the second day. Altogether, they spent between five and six hours occupying my attention to do about fifteen minutes of work, they charged a high flat rate (in the end, I understood why they couldn’t charge by the hour), and they spent at least five of the six hours going over things with me in a manner calculated to sell me a total of $20,000 worth of plumbing work, some of it with considerable urgency. These plumber employees spent most of their time being salesmen.

Once the immediate problem was fixed, fortunately, I went back to my trusty local man (he calls himself “Eddie the Plumber”), who staved off any remaining issues for at least another five years—and perhaps far longer—by doing about a half-hour’s work for $175. I won’t go into all the details, but trust me to have done the necessary research. Eddie had his customers’ best interests at heart; and, as he said of the other approach: “All the big companies now are operating on a model of selling the homeowner services and repairs he does not really need.” If you thought that was only a problem for women negotiating with car mechanics, you can think again. Much of modern commerce is manifestly based on this model.

Now, you could argue that the “market” will quickly put an end to this (apparently) industry-wide technique, but I think you’d be wrong. And the reason you’d be wrong is that you would not be taking into account three things: (1) Our constant confusion and indecision about what we really need and what we don’t; (2) Cultural habits of trust and interdependence which can take a long time to break down when abused; and (3) The constant manipulation of our perceptions, by people who do not have our best interest at heart, through advertising and all the other techniques we use in sophisticated cultures to both create economic demand and sway votes (that is, in both private and public venues).

The big plumbing company did not have the well-being of its customers in mind. The business model was built on something else, something widely practiced in this and many other industries, and something quite successful, even over long periods of time, which is sustained by our superb modern ability to manipulate perception through advertising. This plumbing firm may or may not score high marks on treatment of employees, suppliers, shareholders, or its “community of reference”. For all I know, half of all its profits are donated to the poor. But the decisions on which this company prospers, in its own way, are only partly economic. The more important decisions are moral, and the capital and human creativity follow these moral decisions.

Other companies may be very concerned about their customers, while treating their employees as badly as they can get away with; or they may fleece the local government for all kinds of phony support under various stimulus or grant programs; or they may lie about their minority ownership to gain political advantages; or they may pollute the environment incessantly. There is more than one model for business, just as there is more than one way to make a profit. And again, many of the key decisions are moral. Though there is a tendency for any market to punish in its businesses the moral failures which people both recognize and care about, there is nothing in the market which infallibly identifies or corrects moral failures, or effectively ensures that only moral decisions will be made.

Poverty vs. Inequity

Taken as a whole, this is really pretty simple. The dynamics of the market are a lot like the dynamics of religion. There are enormous bodies of evidence regarding human behavior which, if we truly understood and followed an enlightened self-interest, would lead whole societies to God. But there are also an enormous number of wildly-interacting variables in play. Moreover, people are often terribly myopic. They seldom see the whole picture, and they often act for short-term benefits, or for the wrong kinds of benefits. No matter how many are stopped in their tracks by disaster, there will always be many who do not recognize disaster for what it is, and many new people who blithely ignore the evidence. Moreover, the most highly influential cultural leaders will always attempt to condition public perception to favor their own worldview.

Make no mistake: There are certain broad religious and cultural laws which, all other things being equal, will produce predictable results. And in just this way, there are also certain broad economic laws which, all other things being equal, will produce predictable results. It is important to understand these laws and make intelligent decisions in light of them. But all other things are never equal; accurate recognition is in short supply; complex human systems are never reliably self-correcting; and the will to improve is frequently either spotty or non-existent.

So where does that leave us?

Before answering that question, I want to clear up one other small area of confusion. There is an argument that is frequently used by advocates of the free market that the millionaire’s millions, if used instead to raise the incomes of his workers, really won’t solve the problem of worker poverty. After all, one million dollars divided by, say, 10,000 employees will raise pay by only about eight dollars a month. I think everybody gets that, but it is misleading. And it is misleading because it is not poverty itself which occasions moral outrage. It is inequity.

Even if some people expect politicians to be able to guarantee unlimited prosperity, nobody really expects businessmen to do so. But when people see workers or customers or communities suffering while managers and owners enjoy multi-million dollar salaries (and perhaps even bonuses in the tens of millions of dollars for creating profits built on fraud), it is the sheer inequity among the various stakeholders which rankles. We can understand perfectly the relationship of wages to the pool of labor, and to prices, and to standards of living, but this understanding does not eliminate the moral responsibility of pointing out the injustice, not of poverty itself, but of owners who show no disposition to share the common burden, or to use their capital and creativity to do what they can for those who participate in or are affected by their businesses, especially if they are in serious need.

It is precisely a lack of solidarity which prompts outrage. Wherever solidary is lacking, inequity spreads like a cancer. Moral outrage is the correct response.

Conclusion

The point of this essay is twofold:

First, a legitimate moral concern lies at the heart of the economy as a whole, and in the end the economy cannot function nearly as well without it, though this will often go unrecognized. Even with a necessary understanding of how the economy works—an understanding which is surely essential in making prudent judgments—there is enormous room and enormous need both within and outside the economy for moral judgments. It is not possible to embrace the myth that impersonal market forces leave no room for morality (or concern for all stakeholders), or that a mythical reliance on impersonal market forces always works out for the best. Rather the very human creativity and capital which drive the market must be directed morally if business is to contribute to a flourishing human culture.

This is why Pope Benedict has taught that mere commutative justice, especially between parties of unequal power, is never enough. Distributive justice must be taken into account as well:

The market is subject to the principles of so-called commutative justice, which regulates the relations of giving and receiving between parties to a transaction. But the social doctrine of the Church has unceasingly highlighted the importance of distributive justice and social justice for the market economy, not only because it belongs within a broader social and political context, but also because of the wider network of relations within which it operates. (Caritas in Veritate, #35)

It is here that too many advocates of the free market, in their understandable zeal to avoid government intrusion whenever possible, obscure the moral heart of human economic activity, even though they so frequently understand better than their critics how economies actually function. On close questioning, many free market proponents actually believe strongly in the moral dimension of business while failing to articulate or emphasize it, either from a desire to focus more effectively on their abstract economic points, or from a reluctance to let the camel’s moral nose under the tent—that is, the nose of those who so sadly equate morality with State control. Nonetheless, the moral dimension must be inserted fully into discussions of the free market if the promise of the market as a component of positive culture is to be properly grasped.

Second, and precisely because of how economies function (not to mention how a truly vibrant moral culture must be built), looking to the State to adjust the economy is extremely dangerous and very likely to bring about the direct opposite of its intended effects. There is plenty of room for government in the punishing of immoral economic activities—theft, fraud, coercion, or even the abuse of the legal system to gain unfair advantages at the expense of others. We must ask ourselves here how often, between cronyism and the “too big to fail” argument, wealthy market leaders who behave immorally actually get severely punished no matter how many “smaller” people they harm.

These activities of government, like the punishment of all crimes, must derive from the prudent application in positive law of the larger natural law, to which all of us are ultimately accountable on principles of natural justice. Improvement of the governmental record of punishing crimes should be both possible and desirable. But it is quite another thing for government to make sweeping decisions in an effort to increase wealth or “make the economy work better”. Very often this will be attempted through manipulation of the money supply, increased debt, or direct and indirect wage and price controls—all of which tend, by well-known economic laws, to benefit some at the expense of others, and (all other things being equal) to have severe negative consequences for economic growth.

While one cannot rule out government action in extreme cases, especially in tax breaks which tend to free the economy in certain directions, or unusual temporary measures in times of significant peril (wars, natural disasters, and the like), nonetheless an authentic understanding of economics suggests a fundamental principle regarding central planning: In economics even more than many other areas, it is unwise to put our trust in princes.

Indeed, the fundamental problems which plague our economy—stagnation, a failure to reproduce, intense moral erosion and the consequent erosion of trust, and growing inequity—are likely to be solved only through the strengthening of the human culture which gives rise to the economic culture, and in particularly the strengthening of the Catholic Church as a voluntary instrument of spiritual growth and moral conversion. This is because human culture thrives only if its spiritual core is sound. In any case, our best hope, even if it is a long-term hope, is to look to the stronger intermediary institutions and more robust morality of a more wholesome culture—and not to the State which constantly erodes culture—for the reduction of inequity and an increase in prosperity of every kind.

I have made this cultural argument more extensively in Intermediary Institutions Represent, Preserve, and Shape a Robust Culture. With respect to the economy in particular, I make it again here. We must understand economics, clearly grasp its moral dimension, avoid the illusory promise of State solutions, and work hard to build a culture that is capable of handling prosperity well.