Seven Major Sources of Economic Progress

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

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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.

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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.

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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.

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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

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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!

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Source 2

• Competitive Markets
• Competition promotes the efficient use of
  resources and provides a continuous stimulus for
  innovative improvements.

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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!

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Source 3

• Limits on Government Regulation
• Regulatory policies that reduce trade also retard
  economic progress.

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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.

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Source 4

• An Efficient Capital Market
• To realize its potential, a nation must have a
  mechanism that channels capital into
  wealth-creating projects.

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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.

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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.

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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.

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Source 5

• Monetary Stability
• Inflationary monetary policies distort price
  signals, undermining a market economy.

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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.

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Money and Who Controls It

• The nations money consists of its currency held
  by the public, checking accounts, and travelers
  checks.
• A nations central bank controls its money by
  buying and selling assets, usually government
  bonds.

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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.

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Inflations 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 nations
  currency.

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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 nations 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 nations currency
  to provide stability. For example, the euro or
  dollar are often used.

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Source 6

• Low Tax Rates
• People will produce more when they are permitted
  to keep more of what they earn.

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High Marginal Tax Rates

1. Discourage work effort and reduce the
   productivity of labor.
2. Reduce both the level and efficiency of capital
   formation.
3. Encourage individuals to consume tax-deductible
   goods when nondeductible goods may actually be
   more desirable.

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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.

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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.

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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.

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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.

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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.

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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

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Concluding Thoughts

• How important are the following
  institutions/policies for a countrys 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

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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.