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Seven Major Sources of Economic Progress

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  1. Seven Major Sources of Economic Progress Common Sense Economics JamesGwartney, Richard L. Stroup, and Dwight R. Lee CommonSenseEconomics.com CommonSenseEconomics.com

  2. Questions to Consider • Capital investments and new technology clearly contribute to economic growth and prosperity. What else is needed and what can governments add? • Why are sound institutions, governmental policies and money of stable value important? How can they advance economic progress? How can they stifle it? • Why do economic growth patterns and rates differ across countries and time? CommonSenseEconomics.com

  3. Source #1 Legal System The foundation for economic progress is a legal system that protects the private use of land, natural resources, labor, capital, and entrepreneurial talent in an even-handed manner. CommonSenseEconomics.com

  4. The Foundation for Economic Progress • Private property rights • Private property rights grant the owner of property the right to buy, sell, or derive income from their land, natural resources, capital and entrepreneurial talent. • Even-handed enforcement protects these rights to exclusive use, protection against abuse, and transfer rights, thus allowing property owners to focus on resource allocation, efficient production, investment, and technological advancement. CommonSenseEconomics.com

  5. Property Rights • Encourage people to use their property productively. • Promote wise stewardship. • Encourage people to develop their property in ways beneficial to others for possible exchange, transfer or sale. • Promote the wise development and conservation of resources for the future. CommonSenseEconomics.com

  6. The U.S. Will Run Out of Oil! Or Will It? • In which year(s) did experts predict that the U.S. would run out of oil in the near future? • 1914 • 1926 • 1970s • 2008 • All of the above CommonSenseEconomics.com

  7. Why Have Doomsday Forecasts Been Wrong? • When the scarcity of a privately owned resource increases, the invisible hand of the market takes over and prices rise. • Buyers and sellers seek substitutes, discover ways to conserve, and innovate! • Historically, competitive markets and flexible prices spur conservation, substitution, and technological advancement. • And the “sky” never falls! CommonSenseEconomics.com

  8. Source #2 Competitive Markets Competition promotes the efficient use of resources and provides a continuous stimulus for innovative improvements. CommonSenseEconomics.com

  9. Consumers Rule! • Competition places pressure on producers to operate efficiently. • Competition forces businesses to cater to their customers’ preferences and provide goods and services for which they are willing to pay prices sufficient to cover their costs. • Consumers vote with dollars on which businesses stay and which must go. (e.g. Target vs. Wal-mart vs. Sears vs. K-Mart) • They make sure that sole proprietors, partnerships and large corporations charge low prices, produce quality products and provide services of value relative to costs! CommonSenseEconomics.com

  10. Source #3 Limits on Government Regulation Regulatory policies that reduce trade also retard economic progress. CommonSenseEconomics.com

  11. Governments Limit Trade and Retard Progress By • Limiting entry into some businesses and occupations • Licensing requirements, completing bureaucratic forms, etc. • Substituting political authority for rule of law and freedom of contract • Imprecise, ambiguous and discriminatory laws invite people to spend resources on bribery and lobbying efforts rather than production. • Imposing price controls • Price floors and ceilings interfere with trades between buyers and sellers, distort prices, and lead to inefficient levels of production and employment. CommonSenseEconomics.com

  12. Source #4 An Efficient Capital Market To realize its potential, a nation must have a mechanism that channels capital into wealth-creating projects. CommonSenseEconomics.com

  13. Capital Investment and Its Role in Growth • Capital is anything used to produce something else and helps us produce more goods and services in the future. • Machines, buildings, computers, tools • Capital investment requires consumption sacrifices today. It requires savings. The payoff is increased production and consumption in the future. • A mechanism is needed to channel savings into productive investments. Capital markets perform this function. CommonSenseEconomics.com

  14. Capital Markets • Capital markets, broadly defined, include markets for: • Loanable funds, real estate, stock markets & financial markets • Institutions like banks, credit unions and investment firms bring savers and investors together. • Interest rates provide people with incentive to save. Productive investments will yield a return sufficient to cover all costs, including borrowing. • Not all investment projects are productive. In a world of uncertainty, investments can and do fail. But failures hold investors accountable and provide them the incentive to discover and undertake productive projects. CommonSenseEconomics.com

  15. Capital Markets and Government Intervention • Governments can and do intervene in capital markets by restricting capital movements, setting interest rates, and using taxes and budgets to allocate capital. • These actions: • Distort market incentives. • Increase the importance of political rather than economic considerations. • Make unproductive investments more likely. CommonSenseEconomics.com

  16. Source #5 Monetary Stability Inflationary monetary policies distort price signals, undermining a market economy. CommonSenseEconomics.com

  17. Money, Money, Money! • “Money is to an economy what language is to communication.” • Money serves three functions • Medium of exchange • Unit of account • Store of value • When the value of money is stable, • Many potentially beneficial exchanges will take place. • Borrowers and lenders will face less uncertainty. • Gains from trade will be maximized. CommonSenseEconomics.com

  18. Money and Who Controls It • The nation’s money consists of its currency held by the public, checking accounts, and traveler’s checks. • A nation’s central bank controls its money by buying and selling assets, usually government bonds. CommonSenseEconomics.com

  19. The Value of Money • The value of money is determined by supply and demand. • The value of money is steady when the supply of money grows slowly (e.g. at approximately the same rate as goods and services). • When a central bank expands the money supply rapidly relative to the production of goods and services, inflation results and the purchasing power of money is eroded. CommonSenseEconomics.com

  20. Inflation’s Uncertainty • How does inflation undermine prosperity by making investment projects riskier and thwarting savings? • Difficult to forge long-range plans when you cannot predict the value of money • How does inflation undermine the credibility of government? • Confidence in government declines when citizens lack confidence in the value of their nation’s currency. CommonSenseEconomics.com

  21. The Keys to Sound Money and Price Stability • Central banks and their officials should be held accountable for following a sound money policy and keeping the nation’s rate of inflation within a narrow range; or be dismissed. • A currency board in one nation could establish a fixed rate of exchange between its domestic currency and a selected foreign counterpart with a sound money policy. This is often attractive for small countries. • A country could adopt another nation’s currency to provide stability. For example, the euro or dollar are often used. CommonSenseEconomics.com

  22. Source #6 Low Tax Rates People will produce more when they are permitted to keep more of what they earn. CommonSenseEconomics.com

  23. High Marginal Tax Rates • Discourage work effort and reduce the productivity of labor. • Reduce both the level and efficiency of capital formation. • Encourage individuals to consume tax-deductible goods when nondeductible goods may actually be more desirable. CommonSenseEconomics.com

  24. Source #7 Free Trade A nation progresses by selling goods and services that it can produce at a relatively low cost and buying those that would be costly to produce. CommonSenseEconomics.com

  25. Increased Production and Consumption Among All Trading Partners • International trade makes it possible for each country to acquire goods and services more cheaply. • It allows domestic producers and consumers to benefit from the economies of scale. • It promotes competition in domestic markets and allows consumers to purchase a wider variety of goods at lower prices. CommonSenseEconomics.com

  26. Free Trade Allows: • Consumers to find the lowest prices, the best value from their expenditures, and the greatest variety of goods and services. • Domestic producers to sell their goods and services where they can get the highest price for the value of what they offer in the marketplace. CommonSenseEconomics.com

  27. Government Barriers to Trade • Include tariffs, domestic subsidies, quotas, etc. • Do not create or destroy domestic jobs; they just shuffle them around. • Create inefficiencies in the protected industries, forcing domestic consumers to pay higher prices. CommonSenseEconomics.com

  28. International Trade: Imports and Exports • Trade restrictions that reduce imports will also reduce the ability of foreigners to buy our exports. • Quotas and tariffs decrease the number of dollars earned by foreigners through the sale of imports to us. • Therefore, reductions in imports simultaneously reduce exports. CommonSenseEconomics.com

  29. Explain why you agree or disagree. “More than any other single action, unilateral removal of our trade restrictions would establish the environment for a more peaceful and prosperous world.” CSE CommonSenseEconomics.com

  30. Concluding Thoughts • How important are the following institutions/policies for a country’s prosperity? • Secure protection of privately owned property • Even-handed enforcement of contracts • Stable monetary environment • Low marginal tax rates • Minimal barriers to trade • Market versus government allocation of capital CommonSenseEconomics.com

  31. The Evidence Indicates • The countries with the highest levels of economic freedom have the highest per capita GDP and growth rates. • The institutions and policies outlined in Part III of CSE produce results. Free economies spur savings and investment resulting in economic growth and prosperity. • Differing institutions and policies explain why growth rates vary across countries and time. CommonSenseEconomics.com