Economic Measurement

Because a national economy includes such a huge mixture of ever-changing goods and services, merely measuring the rate of inflation is much more I chancy than confident discussions of statistics on the subject might indicate.

As already noted, cars and houses have changed dramatically over the years.

If the average car today costs X percent more than it used to, does that mean that there has been X percent inflation or that most of that change has represented higher prices paid for higher quality and additional features? No one calls it inflation when someone who has been buying Chevrolets in years past begins to buy Cadillacs and pays more money for them. Why then call it inflation when a Chevrolet begins to have features that were once reserved for Cadillacs and its costs rise to levels once charged for Cadillacs?

Another Source of inaccuracy in measuring inflation is in the things that are included and not included in the statistics used to create an index of inflation, such as the Consumer Price Index. Everything cannot be included in an index, both because of the enormous time and money this would require and because "everything" itself changes Over time with the creation of new products and the disappearance of old ones. Instead, the prices of a collection of commonly purchased items are followed over the years, measuring how much those particular prices rise or fall.

The problem with this is that what is commonly used depends on prices.

Within living memory, television sets were so expensive that only rich people could afford them. So were air-conditioned cars and portable computers. At that time, no one would have dreamed of including such rare luxuries in a price index to measure the cost of living of the average American. Only after their prices fell to a fraction of what they once were did such items become commonplace possessions. What this means is that the price indexes missed all the falling prices of such things in the years before they became widely used, while counting all the rising prices of other things that were already widely used. In short, these indexes were biased upward in their estimates of inflation.

Because government policies and private contracts were often based on the cost of living, as measured by these indexes, huge sums of money changed hands across the country, as a result of exaggerated estimates of inflation. Social Security recipients, for example, received billions of dollars in cost-of living increases in their pension checks because of an inflation that was in part a statistical artifact, rather than a real increase in the prices of buying what they had always bought. This was a factor in creating an official panel of distinguished scholars to revise the indexes. But, no matter how distinguished the individuals or how conscientiously they worked, the task they were attempting could never achieve precision, even if it could be made more realistic than it was.

When considering particular markets for particular products, we are dealing with familiar concrete things, whether hamburgers or hotels, busses or barbecues. But when discussing national output as a whole, which consists of innumerable very different things that can only be added up abstractly, there is much more room for confusion by some and manipulation of that confusion by others.

The money supply and the banking system are key features of the national economy. Like so many other things, banking looks easy from the outside simply take in deposits and lend much of it out, earning interest in the process and sharing some of that interest with the depositors to keep them putting their money into the banks. Yet we do not want to repeat the mistake that Lenin made in grossly under-estimating the complexity of business in general.

At the beginning of the twenty-first century, some post-Communist Nations were having great difficult creating a banking system that could operate in a free market. In Albania and in the Czech Republic, for example, banks were able to receive deposits but were stymied by the problem of how to lend out the money to private businesses in a way that would bring returns on their investment. The London magazine The Economist reported that "the legal infrastructure is so weak" in Albania that the head of a bank there "is afraid to make any loans." Here we see again the problem of property rights discussed in the previous chapter. Even though another Albanian bank made loans, it found the collateral it acquired from a defaulting borrower was "impossible to sell." An Albanian bank with 83 percent of the country's deposits made no loans at all, but bought government securities instead, earning a low but dependable rate of return. What this means for the country's economy as a whole, The Economist reported, is that "capital-hungry enterprises are robbed of a source of finance." In the post-Communist Czech Republic, lending was more generous and losses much larger. Here the government stepped in to cover losses and the banks shifted their assets into government securities, as in Albania. As with Britain in earlier centuries, foreigners have been brought in to run financial institutions that the people of the country were having great difficulty running.

Whether such problems will sort themselves out over time-and how much time?-as private enterprises acquire track records and private bankers acquire more experience, while the legal system adapts to a market economy after the long decades of a Communist economic and political regime, is obviously a question for the Czechs and the Albanians. However, their experience again illustrates the fact that one of the best ways of understanding and appreciating an economic function is by seeing what happens when that function does not exist or malfunctions.

Understanding political functions can be as much of a challenge as understanding economic functions. What is especially challenging is deciding which things should be done through the economic system and which things should be done through the political system. While some decisions are clearly political decisions and others are clearly economic decisions, there are large areas where choices can be made through either process. Both the government and the marketplace can supply housing, transportation, education and many other things. For those decisions that can be made either politically or economically, it is necessary not only to decide which particular outcome would be preferred but also which process offers the best prospect of actually reaching that outcome. This in turn requires understanding how each process works in practice under their respective incentives and constraints.

The public can express their desires either through choices made in the Voting booth or choices made in the marketplace. However, political choices are offered less often and are binding until the next election. Moreover, the political process offers "package deal" choices, where one candidate's whole spectrum of positions on economic, military, environmental, and other issues must be accepted or rejected as a whole in comparison with another candidate's spectrum of positions on the same issues. The voter may prefer one candidate's position on some of these issues and another candidate's position on other issues, but no such choice is available on election day. By contrast, consumers make their choices in the marketplace every day and can buy one company's milk and another company's cheese, or ship some packages by Federal Express and other packages by United Parcel Service. Then they can change their minds a day or a week later and make wholly different choices. As a practical matter, virtually no one puts as much time and close attention into deciding whether to vote for one candidate rather than another as is usually put into deciding whether to buy one house rather than another-or perhaps even one car rather than another. Perhaps more important, the public usually buys finished results in the marketplace but can choose only among competing promises in the political arena. In the marketplace, the strawberries or the house that you are considering buying are right before your eyes when you make your decision, while the policies that a candidate promises to follow must be accepted more or less on faith-and the eventual consequences of those policies still more so. Speculation is just one aspect of a market economy but it is of the essence of elections. On the other hand, each voter has the same single vote on election day, whereas consumers have very different amounts of dollars to vote with in the marketplace. However, these dollar differences may even out somewhat over a lifetime, as the same individual moves from one income bracket to another over the years, but the differences are there as of any given time.

The influence of wealth in the marketplace makes many prefer to move decisions into the political arena, on the assumption that this is a more level playing field. However, among the things that wealth buys is more and better education, as well as more leisure time that can be devoted to political activities and the mastering of legal technicalities. All this translates into a disproportionate influence of wealthier people in the political process, while the fact that those who are not rich often have more money in the aggregate than those who are may give ordinary more weight in the market than in the political or legal arena.

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