Naked Economics: Undressing the Dismal Science

While Chapter 3 focuses on the positive things governments can do for the economy, Wheelan examines the potential harm they can cause in Chapter 4. First, when private firms are able to provide a good or service, they ought to be allowed to; the lingering lesson from communism is that government is a poor provider of such things when it holds a monopoly. Beyond that, the government ought to be a kind of sponsor in certain areas—in charge of production overall but contracting out the actual work to the highest bidder. In this way, “a public good is delivered in a way that harnesses all the benefits of the market” (86). Then remaining fields such as public health and defense should be the sole province of government.

Much government involvement in the economy is indirect, however, through regulation and taxes. However, sometimes regulation is used to protect existing businesses from competition. Research has shown that firms and professional associations in an industry are often the source of calls for greater requirements (“barriers”) to the profession. This was the case in Illinois when the state legislature passed a law requiring more stringent licensing for manicurists; the established businesses lobbied for this as a way of keeping out cheaper shops run by immigrants.

The author also discusses how some countries have governments that can’t provide basic services but maintain very strict regulation on businesses. One study compared the necessary steps to open a new business in 75 countries. It was a simple and easy procedure in advanced places like Canada and a slow and expensive one in poor countries like Mozambique and Vietnam. This didn’t protect consumers—it lined the pockets of officials. According to Wheelan, it’s no surprise that there is a correlation between regulation and corruption.

In terms of taxes, Wheelan says they can have some benefits, such as providing certain public services and even jobs, but too often they cause harm. They leave people with lower take-home pay, decreasing their purchasing power. Moreover, they can cause “individuals to change their behavior in ways that make the economy worse off without necessarily providing any revenue for the government” (97). This is what Wheelan talked about in Chapter 2 regarding second income earners in higher tax brackets choosing not to work rather than paying hefty taxes on the extra income.

However, while cutting taxes allows the economy to be more efficient, Wheelan cautions against taking too rosy a view of “supply-side economics” (the term used to describe low taxes, low regulation, and free trade). Some argue that lower taxes actually produce more revenue for government because the lower rate doesn’t discourage work; with more people working, the taxes collected add up to a greater amount than a higher rate would have. Wheelan says this is true at very high rates of taxes, but not at lower ones. This has been proved by the tax cuts in the Reagan, George W. Bush, and Trump administrations.

In the end, reasonable people can disagree about the right amount of government intervention in the economy. Clearly, governments can both aid and harm the economy. Perhaps the greater question is whether a larger role by government that somewhat reduces economic output is actually desirable. After all, Wheelan notes that while the per capita income of the US is higher than that of a place like France, so is child poverty.

This chapter discusses the role of information in economics. As an example, Wheelan starts with the story of Hope Scholarships, put forth by President Bill Clinton as way to deal with high student loan debts. The problem was that graduates in less lucrative fields like teaching didn’t make enough to repay their student loans. Hope Scholarships offered a solution by making repayment simply a percentage of income. Thus, Wall Street traders would pay more on their loans than social workers, all calculated by average starting income in each field. Budding financiers, however, would simply take out traditional loans, which offered lower interest rates relative to Hope Scholarship loans. Conversely, those interested in social work would definitely choose the Hope loans. Thus, only low-income earners opted in, which didn’t provide enough repayments for future loans without large amounts of federal funding. The program was intended to be self-sustaining but ended after several years. It failed because students had more information about their chosen career track than Washington bureaucrats planning the program.

Information asymmetry is endemic in health care. Patients lack information relative to doctors and have no way of proving whether or not they were treated correctly. As technology allows for a wide range of increasingly expensive treatments, there are often many options to treat a condition. Sometimes, however, we don’t have enough information to know which would be most effective. Wheelan describes ways of treating prostate cancer, one of which is the wait-and-see approach. It’s a slow-growing cancer and men who are older often die of other causes before it gets too advanced. At the other end of the spectrum is a $100,000 treatment that consists of bombarding cancer cells with protons. Research indicates that no single approach to prostate cancer treatment has an advantage over the others. As Wheelan notes, “[t]he fundamental challenge of health care reform is paying for the ‘right’ treatment—the ‘product’ that makes the most sense relative to what it costs” (116).

In terms of health insurance, insurance companies lack information about each individual person who signs up. As a result, they compute statistical averages by age to formulate premium prices. In theory, all health insurance would look like the Hope Scholarships: only those who really needed it would opt in while healthy people who didn’t expect to use it would not. In reality, plans are often created for large groups, like corporations, whose employees are not able to opt out. For individual plans, insurance companies have devised features like deductibles to gain information about customers. If someone expects to use health insurance a lot, they are more likely to choose low deductibles and higher premiums.

Other aspects of information asymmetry are apparent in the phenomenon of branding. The reference to McDonald’s in the chapter title comes into play here. McDonald’s offers the same experience worldwide. If you’re traveling in an unfamiliar place, McDonald’s offers a predictable, if average, meal. A local place next door might be much better—or much worse. The traveler without that information who doesn’t want to risk the latter will typically choose McDonald’s instead. This is the idea behind branding. When you have to consume a product or use a service before learning of its quality, going with a known brand offers some reassurance.

Here Wheelan looks at the human capital and productivity, as well as the interplay between them. Human capital is the sum of an individual’s skills, education, experience, personal qualities, and so on that determine one’s value in the job market. This, Wheelan writes, accounts for most of the great differences in wealth between people. Someone like Bill Gates is a billionaire because he offers the market a unique skill set, and the market rewards uniqueness, according to Wheelan: “As with other aspects of the market economy, the price of a certain skill bears no inherent relation to its social value, only its scarcity” (133).

Investing time and money in building human capital often pays off in both employability and income. One means of doing this is pursuing education. A college graduate, for example, can expect to pay back the money spent on education plus earn 10% more in annual income than without the degree. Conversely, the poverty rate is over 10 times higher for high school dropouts than for college graduates.

Wheelan illustrates the power of human capital with a story about a Midwestern factory closing due to downsizing. Stories like this have been common in the media, with a small town and its workers hit hard by the closing. However, this plant was different; it had been part of the US Navy and produced sophisticated electronics. Instead of closing, it was bought by Hughes Electronics Corporation, not so much for the physical facilities as for the employees, who held a wide range of advanced skills.

However, other factory closings, in which lower-skilled workers lose their jobs, should be seen in the larger view of things, writes Wheelan. Many people mistakenly believe that there are a finite number of jobs, so when one person gains a job, another person must lose one (this is known as the “lump of labor fallacy”). In fact, the number of jobs created has no limit, as new skills, technology, and circumstances are constantly changing. Yes, there are short-term displacements, such as when factories close, but Wheelan argues the overall benefit to all of us is unmistakable. Millions of net new jobs have been created since the 1980s because of the personal computer revolution—though along with that some jobs became obsolete. Educated workers can adapt to such changes better than those with less education. That’s the power of human capital, the advantages of which are more than just monetary. It allows people to lead healthier lives and better equips them to raise their children, among other things. Human capital is an accurate gauge of how well-off a society is, with one economist estimating that it makes up 75% of a modern economy’s wealth.

Next, Wheelan delves into why human capital is so important, which has a lot to do with its connection to productivity. The more work that can be done in a given time period, the greater the productivity. Technology, skills, and methods are some of the aspects that determine, for example, how fast a car is assembled in a factory. In the US, productivity has steadily increased since the 19th century. We work less and are much better off. Even when people in other countries become more productive, we benefit since they will now be able to purchase our goods and services.

Productivity is dependent on investment in a range of things, from human capital to research to good government. The right mix produces the conditions necessary for increased productivity. Children must be given adequate education, research has to produce new technologies, and government institutions need to create effective tax policy and regulation to aid productivity growth. Technological innovation is especially effective when human capital exists to take advantage of it. As Wheelan writes, technology “makes smart workers more productive while making low-skilled workers redundant” (147).