Kleine 1

Comparative Economic Systems

Lecture and Reading Notes
Week 6/10 6/13
Lecture 1 6/10/08
History and The Theory of the State
In one form or another, governments have been around for thousands of years.
50,000 years ago societal structures consisted mostly of clans, tribes, and nomads.
In tribes, the institutions of family, production, and government were all in one
unit. The appeal of entering a tribe was for protection.
10,000 years ago some hunter-gatherer figured out how to farm. People would
take seeds and divide them up for consumption and planting. The idea of planting
seeds for future consumption is the first example of savings and investment.
However, the nomadic attribute of the tribe had to be abolished because assets
needed to be protected.
At the beginning, the stronger would steal from the weak because of their lack of
proper protection. The strong could claim property rights on the weaks assets
simply based on the threat of physical force (extortion). Instead of simply stealing
and killing the weak, the strong would force them to continue to farm and give
away large portions of crop yields. This is the first form of taxation and slavery.
The concept of the strong imposing sanctions on the weak in the form of taxation
and slavery is the birth of the first government.
o The strong, however, have to worry about other strong people stealing
from his fleet of weak slaves. Because of this, the strong provide
protection for his slaves (national defense).
o As the strong acquires more slaves, it becomes important to keep order
among them so they stay productive. The strong provides protection for
the slaves from each other (police force).
o Some slaves, however, would have legitimate disputes among one another.
Because of this, the strong appoints an arbiter to settle any claims (court
system).
Economics Theory and Abstraction
Economics is defined as the science of purposeful human interaction and its
unintended consequences.
Economic theory provides an abstraction based on real world data that provide us
with tools to make inferences about the real world. Any type of abstraction needed
for practical purposes cannot be the real world, but it must be grounded in reality.
Economic theory organizes facts in a cause and effect relationship so that general
hypotheses can be tested.
Four Assumptions of Economics
o Scarcity people are forced to make choices because of scarcity (reverse
causation is also possible), otherwise life would be a fantasy world.

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Poverty, opportunity cost, and prices are all evidence of scarcity. If there is
no scarcity, there is no economy. Scarcity is overcome through production.
o Methodological Individualism the decision makes is always the point
of analysis. However, this does not necessarily assume isolation. Group
choices are also considered because in modern economies they are simply
a tabulation of individual preferences.
o Rational Choice the means to pursuing any end is always rational. An
end may appear to be irrational, but the means used to achieve it are
always rational. (A crack head who wants to smoke crack (a.k.a. a
commonly thought irrational decision) will provide rational means to
receive crack (i.e. sucking wang)).
o Unlimited Wants/Needs the power of imagination and greed cause us to
have unlimited wants. This causes frustration in a world of scarcity
because it means that choices must be rational.
Organization Principles
There are three main focuses of economic organization. They are:
o Tradition usually manifests itself in the form of a caste system. This is
the dominant way that economies have been run throughout history. It
provides the easiest form because you simply follow the past. The two
main effects of traditional economic systems are: they are very stable if
they are not exposed to outside sources, and since they are completely
opposed to change (even technological), they produce at subsistence levels
because of a lack of economic growth. Traditional economies can only
truly work with small communities.
o Markets the most modern type of organization. Based on private
property rights that are enforced with the rule of law. In markets the price
system is crucial; it provides the setting in which producers act to
maximize profits. The largest threats to a market system are coercion,
extortion, and fraud (any type of market failure).
o Central Planning all factors of production are owned by the state. A
strong and intrusive police force is generally used to guide the people in
the direction the state wants them to go. There is no price system (because
of government monopoly on production), no capital markets, and is
completely planned. It removes the concept of choice in making economic
decisions.
In real world economies, there is usually a combination of all three.
GDP and Economic Growth

GDP is the best measure of well being in an economy (but I think hes full of
shit). However, it leaves out crucial elements of an economy such as leisure,
externalities, non-market family production, and underground economies.
Virtually every human development indicator moves with GDP per capita. From
this, we can see political and economic freedom move together as well.

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PPF shows the different levels of production in a two good economy. On the
graph, a movement from a point within the PPF to a point on the PPF is known as
extensive growth (increasing the use of readily available resources). A shift
outward of the PPF is intensive growth (an increase in production due to an
increase in technology of productivity).
Production Function Y = A * F(K,N) where Y is output, A is the Solow
residual (technology/productivity factor), K is capital, and N is labor

Ancient Economies
For most of history there was little to no economic growth. Most economies were
tradition based and therefore did not welcome change, which in turn caused
stagnancy in productivity. The maximum intensive growth rate was about 2-3%
per 1000 years, but was most likely 0% for a very long time. The life expectancy
at the fall of the Roman Empire was the same in 1700. All capital in the ancient
world was used to build for leaders at the top; a complete misallocation of
resources. Most ancient economies were totalitarian governments.
The industrial revolution greatly increased productivity, which then caused an
increase in wealth.
Serfdom if you were born into a certain caste, you had to remain there for the
rest of your life (and also work for your fathers employer).
Magna Carta signed in 1215 by King John the Elder. It placed the government
and king under the rules and regulations of the law and outlaws ex-post facto laws
(makes laws proactive). The Magna Carta is the first document that limits the
power of the government.
Lecture 2 6/12/08
Political Systems
Divine Right used to legitimize the horribly brutal system of the state. It turned
the leaders into deities, and the people into their servants. This caused a marriage
of church and state (theocracy). Divine right eventually evolved into the concept
of the monarchy, where leaders claimed that their ancestors were appointed by
God to be superior (usually with evidence of a triumph in war). This makes the
leader the agent of the deity.
Democracy began in Athens at around 500 B.C.E. (with Solan, Cliatenes, and
Pericles few may originate a policy, we may all judge it kicked the shit out
of the divine right principle). Based on majority rule (the problem is that is the
rights of the minority are dictated by the majority, then they basically have no
rights anyway, just priveledges).
Representation Began with the Roman Empire. Establishes the idea of power
of attorney when you delegate your rights to another person. This brings up
possible exploitation issues because the people get all your legal rights and can do
what they wish with them. The Constitution is the limit to the power of attorney
for state officials.

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Public Goods
Public goods are thing people desire, but will not voluntarily pay for them. Paul
Samuelson developed the theory of the public good in 1954 and claims that they
are under produced in the market, which legitimizes the existence of government.
Taxes attempt to fix the problem of a public good because everyone shares the
burden.
Four Main Qualities
o Ones consumption does not leave less for others to consume (non-rival).
o The good is jointly consumed.
o Consumers strategically dont pay for the output of a public good (free
rider effect). Prisoners dilemma people join groups to advance a group
cause, but once in the group they advance their own cause at the expense
of others in the group.
o It is not economically viable to exclude the free riders (non excludable).
Problems
o While there may be a necessary condition for government action (there I
some type of market failure), it is not necessarily automatically a sufficient
condition (when the policy corrects the necessary condition without
causing other unintended problems).
o It assumes a given/static level of technology (technology evolves to
exclude free riders i.e. cable television is a technological advance that
helps to exclude free riders tying a private good to a public good).
o Government does not necessarily produce the optimal amount (to the point
where the good becomes a bad Cold War).
o X-Inefficiency (Harvey Liebenstein) In order for the government to
eliminate the dead weight loss created by the underproduction of a public
good, they must produce at a point where D = MC. What will happen is
the MC curve shifts up and creates another dead weight loss (studies show
that the DWL of government production is higher than private. This is
because they produce generally with 40 to 60% more costs, due to a lack
of competition dont have to be efficient because they are a monopoly
(Parkinsons Law)).
o While it may be true that there is a prisoners dilemma, people can still
cooperate. In iterated game it is not clear that there is market failure (and
the tit for tat law makes the common outcome the socially optimal one
trench warfare).
o The problem with government is that since market failure is caused by
people it cannot necessarily be fixed by people.
Public Choice
Adam Smith the man of system is to be wise in his conceit he loves
government so much that he will continue to build is without criticism. Treats
people as if they were pawns in a game of chess. Because people can tell which
move is coming next, their own interests will not allow policies to work a
originally intended in the marketplace.

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Government is like fire: if tamed it can be a servant, if not it can be a cruel master.
The Constitution is the fireplace for government. The separation of government
gives a chance for the checks and balance system to keep it under control (no
excessive power to one group).
The government cannot give rights (they are naturally endowed), the constitution
limits the rights of government and makes sure they cant take away the right of
the people. Planned economies tend to cause an infringement of rights and
genocides on their own people democracies dont tend to do this.

Economic Thought
Knut Wicksell (1907) claimed that we had a good theory of markets, but no
theory of government. We understand market problems, but we expect benevolent
rulers to fix them (men are not angels).
Anthony Downs (1957) when philosophers talk about government ethics, they
talk on normative grounds. Downs provided a positive analysis of government.
James Buchanan and Tullock (1962) they call for people to quit looking for
angels and devils in politics and start the analysis with the assumption of real
world people.
Representative Democracies

Group
Politician
Voters

Incentive
Votes
Rent seeking

Bureaucracy

Budget

Rule
Majority rule
What have you done for
me lately
Use it or lose it

Every group acts based on the rules that govern them. Actions are determined by
the rules set.
Median Voter Model
o Assumptions: single issue, two political parties, parties want to maximize
their votes, spatial mobility over spectrum, single peaked preferences (one
mode).
o Implications: candidates will claim their opponent is extremist, candidate
will claim to be mainstream, if behind in polls candidates will start to
sound like their opponents, primaries are more ideologically driven,
candidates will speak in generalities but avoid specifics.
Rational Ignorance
o When it is too costly to inform yourself on the issues (info is not free, and
the opportunity cost to receive it exists).
o Returns to voting = p(net expected benefit of your candidate) cost +
civic pride, where p is the probability that your vote determines the
election.
o Mancur Olson (1964) claims that some people are not rationally
ignorant (special interest groups). Special interest groups form to

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economize on becoming informed, and vote with their groups allegiance.

The representatives of the special interest groups are able to gain benefits
by telling politicians that they have a group of people willing to vote for
them or not (with the politicians doling out special favors).
Distributions matter in a democracy where majority rules,
special interest groups will rule over the majority. The vote
maximizing strategy is to concentrate voters with benefits (special
interest groups) then spread costs out so thinly that people (who
dont vote because of rational ignorance) dont care.
Bureaucracy
o Because governments basically hold monopolies on certain businesses,
there is no incentive to increase efficiency (the profits go to no one).
Because of this, governments tend to be very wasteful and overspend
(use it or lose it).

Political Markets
o Political markets produce regulation. G. Stigler in 1971 claimed that
regulation is the product of special interest groups asking for regulation to
increase profits (through lobbying or rent seeking). This revenue received
by special interest groups is masked as public revenue.
o Special interest groups lobby for monopoly power (which causes them to
receive large amounts of revenue due to MC=MR pricing). This, however,
leads to a DWL to society that totally blows. The profit is seen as the
rectangle on the monopoly graph, but this profit is essentially dumped
down the drain to encourage politicians to continue regulation that allows
them to act as a monopoly. This rectangle, since it is used for rent seeking
becomes a part of the DWL triangle, thus causing a HUGE DWL to
society.
o Richard Posner (1971) argues that taxes and regulation are substitutes.
They are both compulsory (legal), they both impose burdens, they both
transfer the rights of property, and they both affect the market price of
whatever is being taxed/regulated. However, taxes are much more tangible
and evident than regulation.
o Tax-farming allowing special interest groups to gain monopolistic
power, with the knowledge that said groups will continue to throw their
profits at the government to continue monopolistic regulation.
Lecture 3 6/13/08
Mercantilism (1500-1770)
Advocated government intervention in the form of regulation. All theories of
mercantilism were written by businessmen.
Felt that order had to come from the state, Adam Smith rejects this in The Wealth
of Nations, claiming that there are economic forces that direct the economy (the
invisible hand).

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Main assumptions/ problems of mercantilism.

o Government plans the economy (the king).
o Mercantilists believed that value was in money and that money was a good
(or the wealth of the nation). This is not true, money is simply a medium
of exchange for goods and services.
o They thought that in every exchange there was a winner and a loser
(David Ricardo proves this wrong with the theory of comparative
advantage).
o Felt that public interest was separate from the interests of people in the
nation.
o Believed in a favorable balance of trade (thought that imports were bad,
and that exports were good). In real economies, you want a trade balance
of zero.

French Mercantilism
Complex tax system based economy. Different taxes include:
o Taille a tax on land. It allowed many (250,000) clergyman and
politicians to be exempt. Collected by private parties (that had no rules or
regulations) who kept a percentage of the tax
o Gabelle a tax on salt. This came out of the governments monopoly on
salt production. Those who did not pay the tax were turned into
government slaves.
o Corvee a labor tax (forced labor). Required poor people to work 14 days
a year of unpaid work. They would not let people leave France because
they needed the work generated from the Corvee.
o Internal taxes and tolls taxes on crossing regions within France. Run by
private officials who set up toll collection everywhere. Made it extremely
hard to travel.
o Monopoly Guilds half of all the money collected by the king came in
this form. The king made people join guilds or else they were arrested.
o Royal Positions people were able to buy royal titles. The king could, at
any point, make people re-buy the title.
o Inflation a tax on the value of money. The French greatly monetized
inflation. There were a series of hyperinflation schemes. Assignets were
set up (titles of property being traded like money), which caused an
inflation rate of about 12,000%
o Tariffs the average tariff on things that could be imported was about
100%.
In 289 years, the standard of living declined by 80%. All the aforementioned taxes
added up to create an 80% tax rate on income. During mercantilism, france
suffered 8 periods of famine. The average per capita income was $209 U.S. PPP.
90% of the population spent 90% of their income on bread alone.
Lecture 4 6/17/08

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British Mercantilism: England
c. 1500 1760, consisted of a series of public policies that mirror the French,
which were the dominant law of economics at the time.
Policies under mercantilist England:
o Statute of Artificers enacted by Queen Elizabeth in 1563. In the mid
1300s the bubonic plague killed one third of all European. This caused a
massive decline in the amount of agricultural laborers, and a
corresponding increase in the price of food. The statute was set to provide
a maximum wage rate below the market equilibrium. This was justified by
the sentiment that the king could determine just prices. The main purpose
of this is to save money for aristocratic landowners. However, competition
in the labor market still existed due to non-price incentives. In an attempt
to suppress this:
Anyone who worked the land that was under the age of twelve had
to remain there for the rest of their lives. Crippled competition due
to worker immobility.
All craftsmen, servants, and apprentices had to harvest wheat for
the aristocracy.
All unemployed people were forced into agricultural labor.
Workers were prohibited to quit without written consent of their
employer.
Monopoly guilds are set up (based on the work of your father),
where workers had to join. This makes it so peasants cannot join
city guilds. This creates a monopsony for employment
opportunities (which causes wages below equilibrium levels, the
square is the level of oppression).
o Poor Laws the first poor laws were within parishes in 1536 and by 1572
they were throughout Britain. Poor laws required merchants to pay taxes
for the welfare of poor people. Problems that arise:
There are disincentives to work because if people know they will
receive benefits below a certain (poverty) line of income, they will
systematically remain below it.
Since taxes differed among parishes, poor people would shop
around to get the most benefits. This puts more pressure on taxes,
which then causes merchants to leave areas of high taxation.
Begins the idea of outdoor relief (as opposed to indoor relief),
which led to the pauperization of society (an individual could make
3 times as much money on benefits than the average merchant).
This ends up causing parishes to go bankrupt, so the next law is
enacted.
o Settlement Act of Relocation and Removal set up in 1662 to help the
financially strapped parishes. It allowed by force to return anybody who
came into the parish (bound poor people to their residences). This
basically reestablishes serfdom. Massive deadweight loss is created

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because surpluses and shortages between parishes could not equilibrate

due to labor immobility.
o Guilds and Monopolies basically the same as France. Half the kings
income was generated through guilds. Private parties had monopolies on
collecting taxes and electing under sheriffs (and of course giving
percentages back to the king). Exact parallel to France. The crown
basically just supported certain industries through which they could tax
farm. Example:
Woolen Industry export restrictions were set on wool (so that
only domestic manufacturers could buy it), causing monopsony
power in the industry (which depresses the prices of wool for
suppliers). Under Elizabeth, the wool manufacturers had a
monopoly on woolen products (due to import tariffs) and a
monopsony on the purchase of wool. This causes an enormous
dead weight loss. If anyone was caught breaking the law, there
were serious punitive measures taken.
o Colonialism the British established colonies throughout the world.
Colonialism is a rent-seeking endeavor for special interest groups with
possible benefits that could arise. The populace, however, loses in paying
taxes to support colonial powers (and getting nothing in return).
o Navigation Acts 1651. Required all exports and imports to be run on
British ships. This acts as a Posner tax- because a monopoly is created,
people must pay more than in competitive settings just to support British
ship companies.
o Tariffs/Export Subsidies taxes on trade (tariffs) in conjuction with
export subsidies to encourage a positive trade balance (a favorite of
mercantilists). Both create deadweight losses to society. Tariffs protect
local monopolies from outside competition, however they are more
efficient than quotas (which were set on things like cutlery, hardware, flax,
hemp, tar, etc.). This is policy schizo; the government does not allow
you to buy foreign goods, but promotes exports through tax farming
(foreign aid in a way), both domestic producers and exporters receive
benefits.
The result of mercantilist England was dismal. In 200 years, the standard of living
was halved. The upper limit of per capita income was $175 PPP, and the death
rate in between the 1500s and 1700s had risen from 31.8 to 36.6 per thousand
(keep in mind the latter period experienced no war, while the former experienced
constant war).

Decline of Mercantilism
Four main factors lead to the decline of mercantilism:
o Land Enclosures previously, most land was owned by the aristocracy
and worked by peasants. However, peasants had common grounds that
they could graze animals on. Because the land was kept in common, it led
to the tragedy of the commons (overgrazing due to open access with no
incentive to invest; based on the first takers rule). Arthur Hogue points

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out that on common land, a peasant could plant two bushels and expect a
maximum return of only 8 bushels (not a good return at all). To solve the
tragedy, land enclosures (privatization of common lands) were established.
Land yields increased greatly because of incentives to preserve and invest.
The enclosures were done through voluntary consent and monetary
compensation to those who previously used the land (although even if it
was consensual, the king demanded some cash). The privatization of land
saw a 40% increase in productivity between 1600 and 1700, and a 50%
increase between 1700-1850 (intensive growth). The lady from Cambridge
points out that because productivity increased, less labor for farm had to
be used, which set the stage for industrial labor in the revolution.
o Common Law an eventual evolution occurred in the legal system,
which caused a division in courts between royal law and common
(private) law. Under common law, people would settle disputes with a
private impartial judge. The verdicts were based on precedents and had to
be widely accessible and agreeable rules. Common law eventually began
to oppose the kings law, rendering monopoly guilds invalid (unless issued
by parliament). The main attraction of common law was equality, and by
1600 it became the institutional law of England. Common cases
concerning the disposal of royal monopoly guilds:
Davenant v. Hurdis (1599) concerned the fact that monopoly
was given to tailors in London promising them half of all cloth
trade. The judge deemed it against common law on grounds of
infraction of liberty.
Clothworkers v. Ipsowich (1614) ruled that in common law, no
man can be prohibited from trade in legal activities because it is a
basic human right.
Winton v. Wilks (1705) deconstructed the Settlement Act and
the Statute of Artificers. Claimed that all people are at liberty to
live here (England), and that trade is their life. People should be
able to work wherever and however they need to without
restriction.
o Decentralization of Political Power turmoil between parliament,
common law, and the king caused confusion about monopoly power rights
given by the king. This causes the three branches of the government to be
formed (common law and parliament often colluded to dismantle the
powers of the king). The idea of the rent-seeking monopolist becomes less
viable; they need to lobby many more people (spend more money) and
since there is a distribution of power the security of having a monopoly
recognized by all greatly falls. Mancur Olson claims that once a serious
political change occurs (resulting in the disturbance of stability) there is a
dispersion of special interest groups and competition becomes prevalent.
The decentralization of power effectively ends mercantilism.
o Intellectual Climate thinkers in England begin to promote ideals of free
trade and individual rights. Every English philosopher acts to destroy and
criticize the mercantilist system. In France, the centralization of

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government was still preferred (especially with thinkers like Rousseau),

but a few denounced it in favor of the new English system.
These four factors led to the fall of mercantilism in England (but not France).

Lecture 5 6/19/08
Industrial Revolution
Starts at around 1760, based on the fact that growth rates before 1760 were very
low at around 0.5% a year. After 1760, the growth rate jumped to 1.5%.
o Max Weber believed that the rise of capitalism came about because of
the Calvinist faith (if you are rich and do well, it is because God loves
you). He believed that a shift in religion would lead to better work ethic
and more delayed consumption (saving investment).
o Douglas North refuted Weber, claiming that historically there have been
religious regions that flourish, but there are also some that remain
stagnant. He claims that what began the I.R. is private property and
institutions.
o Others believed that the start of the I.R. was because of a great amount of
technological growth. However, the Renaissance saw a great surge in
productivity increasing inventions, but no growth.
Pre-Industrial Landscape
Before 1760, most non-agricultural production occurred in the home (domestic or
putting out system). Peasants in the agricultural sector lived in one-room hovels
where all work occurred (including living quarters for animals and such).
People would receive raw materials from a middle man and spin thread on a
jenny. The middleman would then return and purchase the thread back. He would
then take it to be made into cloth, then take the cloth to a tailor. This kind of
production is extremely unproductive.
When the land enclosures occur, output greatly increases and the population
booms. Ashton claims that the large population of children would not be possible
in pre industrial England (because families did not have enough food to feed
children). This helps spark the Industrial Revolution.
Economic Theory
Real Wages the real wage rate is a composite index of compensation (based on
nominal values and the current price level, purchasing power), meaning it
includes in-kind benefits (working conditions, amenities, sick pay, health
insurance, etc.). It is determined by the intersection of the labor supply and labor
demand curves. Ultimately, the employee pays for all the in-kind benefits. They
technically forego cash compensation in order to receive other goods and services.
Supply curve the substitution and income effects determine the elasticity of the
supply curve. The substitution effect has a positive relationship between real
wages and the quantity of labor supplied (this is a short run effect 5 years and
under). The income effect is a long run effect that shows an inverse relationship

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between wages and labor supplied. Both effects are always present, but the
important factor is to empirically determine which is dominant. Historically, the
income effect always dominates in the long run. Now that real wages have risen
so high, people enter the workforce much later and retire earlier.
o Shifters of the supply curve have to be non-wage factors that change the
wage. Unions decrease the supply of union workers (with fees and limited
membership), which shifts the supply curve to the left and causes an
increase in the wage rate, but an increase in unemployment (what ends up
happening is that people who cannot get into unions increase the supply of
non union labor, causing the wage to decrease the economy on the whole
feels no shock on wages). The surge of women in the workplace causes an
increase in the supply of workers forcing the wage rate down (it is
important to note that when more people work, more goods and services
are produced and, ceteris paribus, prices will decrease).
Demand curve the elasticity is determined by the marginal revenue product
(the marginal physical productivity times the price with a given level of capital).
It slopes downward because of the law of diminishing returns (with a fixed input,
each additional unit of a variable input will decrease the rate of output of the
variable input).
o Shifters of the demand curve also have to be non-wage factors. Occurs
when the fixed factor is varied or increased. This is effectively an increase
in productivity. Henry Fords assembly line increase productivity, which
saw an increase in wages, quantity of labor supplied and demanded, also
raises the wage rate of all other industries because of competition, and
made the car cheap (which crushed monopsony employers by increasing
labor mobility). Increased capital come from increased savings (S=I) and
entrepreneurs. Taxes on capital cause the ND curve to shift inward. Any
type of productivity shock (change in natural resources, wars, etc.) will
also shift the demand curve.

British Inventors / Industries

Josiah Wedgewood started a pottery factory in 1759. He discovered a way to
mass-produce dishes of good quality for the common people. This is the first time
in history that production was geared towards the masses. Wedgewood also began
to produce silverware and pots and pans.
James Hargreaves found a way to improve the jenny in 1770. This increased
productivity by a factor of 16:1. This increased productivity trickles down to
create cheap clothing for people.
Richard Arkwright in 1760 he creates the spinning frame that is powered by
water. This was applied to the Hargreaves jenny, which increased productivity and
quality. He then took his profits and invested in many factories.
James Watt creates the steam engine in 1769 that allowed for mechanized
industry without the need for water.
Edmund Cartwright in 1785, he created the power loom that allowed the mass
production of clothing. This creates many cotton factories that increae the British
cotton industry greatly.

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Britain became the largest producer of cotton for the masses. The shift toward
mass markets causes huge increases in productivity. Since mercantilism had no
regulations on cotton, a technology boom occurred in that industry (as opposed to
the wool industry which was heavily regulated).

Private Infrastructure Developments

There is a huge improvement of privately financed canal production (a sevenfold
increase in canals by the 1840s). Turnpikes and roads were increased in quality;
they were far better than the mercantilist protected roads that were built by forced
labor). There is also an increase in seaports and basins, railroads, locomotives,
and bridges under private financing. All capital accumulation came from private
industry for the first time in history. In addition, production of consumer goods
increases, which decreases the price. This causes the standard of living for
common people to increase greatly (because of soap, candles, printed goods, etc.)
Capital Accumulation and Growth in England
Only private enterprise is to credit for productivity growth. In this period, the
British were net investors around the world. The government reduced capital
stock because of war and deficits. Inflation does not encourage growth because of
serious capital flight.
Data:
o In the century leading up to 1760, growth of GDP per capita was only
0.5%, then increased to 2.5%. Growth during war years was 2%, as
opposed to non-war years at 4%.
o Many hypothesize different growth in real wages from 1790-1950. J.H.
Clapton estimates that they rose 50%, Brown and Hopkins suggest they
grew at 40%. The data found by Williamson and Lindert ended the debate
on real wage growth. They separated different groups of workers into
strata, and weighted the growth rate accordingly. They found that the real
growth rate was about 134%, and after it was adjusted only for negative
aspects of city living it rose to 141.6%. They then examined wages for
women and children and found that they increased at the same rate. The
implication derived from this study are: as wages increase, the income
effect will come into play, the average working class diet increased in
quality and quantity, more saving and investment occurred, and the
general standard of living rose.
Lecture 6 6/20/08

During the I.R., there is a decrease in the infant mortality rate due to increased
standard of living and increased sanity. This leads to a booming population (stage
2 of demographic transition). This decrease cannot be attributed to medical
advances (common medical procedures were bleedings, and popular medicine
contained mercury). An increase in life expectancy also occurs.

Economic Ideas

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Labor theory of value believed mainly by classical economists. It is founded in

the belief that prices arise from labor, however, they actually come from
subjective value in the margin (neoclassical approach).
Thomas Malthus in 1798 he published an essay on population. He claims that
increased wealth has no tendency to better the conditions of the poor, increased
real wages lead to higher population, and that more workers means lower wages.
He believed that when population was unchecked we will outstrip the food
supply. Shultz proves him wrong by proving that population (which does not
breed poverty) is inversely related to growth.
Ricardo in 1817 he develops the theory of diminishing returns and applies it to
Malthus. He claims that real wages will fall and that land will inevitably end up in
the hands of the rich and well revert back to mercantilism. He completely forgets
that diminishing returns is only a short run concept.

Sociological Ideas
Poverty absolute poverty is determined by an arbitrary minimum threshold (the
world is basically devoid of absolute poverty). Relative poverty is distributional
(it is logically impossible to get rid of it).
A.L. Bowley claims that the idea of progress is relative and psychological.
People do not care about the poverty of the past, they only care about what they
currently want.
Gertrude Himmelfarb in The Idea of Poverty, she talks about moral
imagination (as people get wealthier, moral values shift and the rich judge the
poor on their own values). Everyone judges others from their own standard of
living. This shit is tight, son.
Factory Act of 1833
In England, the standard of living was greatly rising. Ireland, however, was
experiencing poverty and famine. The Irish then began to move to England en
masse. This elicited negative political consequences; people were round up as
vagrants and deported, those who established residency fell under the poor laws
(which pissed off taxpayers), people claimed that the Irish would work for less,
which would drive down wages, etc. Politicians claim that the system of laisezfaire capitalism is what caused all of this.
Five factors that led to the factory act:
o Factory movement agitators Michael Sadler and Olser tried to limit the
powers of the factory owners. Olser claims that children in factories are
worse off than African slaves, and pushes for a maximum ten hour work
week. In reality, Olser was a rich land-owner and was just pissed because
kids working in factories meant they werent working for him.
o Tory humanitarianism Lord Ashley argued that it was the duty of
society to help the helpless. He believed that laisez-faire broke the social
fabric and that child labor was immoral. Tories favored serfdom and
castes a the natural order.

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o Whig pragmatism Macaulay argued that kids were worse off in

mercantilism. He said that in the short run, child labor might be good
(more money for families, etc.), but in the long run their productive
capacity (human capital) is hindered by their inability to go to school.
However, he never realizes that school costs money that people dont
have.
o Rent-seekers city factory owners wanted child labor abolished (because
it was mostly concentrated in rural factories, their competitors). This was
all to gain market share and receive a competitive advantage.
o Romantics all believed in the lost golden age (pre-industrial garden of
Eden) that was disturbed by industrialization. They all believed that
British mercantilism was best they had delusional views that children
were happier and farmers worked when they pleased)
Thomas Carlisle felt that meaningful rights came from staying
in ones place.
William Cobbet wealthy intellectual who attacked the I.R. He
believed in the benevolence of masters in pre industrial England.
He despised schools and teachers because he felt they disturbed
natural orders. Made claims about factories before even visiting
them. He established the Poor Mans Guardian, which put forth
the view that private property was the root of all evil.
Sadler Report Michael Sadlers report to parliament about the evils of the
factory system. It was completely biased because: Tories were the only party who
could present witnesses, and the witnesses were not sworn in (so they could lie
without perjuring). In 1833 the Factory Act goes into effect, and when it was
reviewed in 1834 it was concluded that all witness testimonies were invalid.

Lecture 7 6/24/08

At the time of the first factory act, the cotton industry had less than one percent of
children under the age of ten employed. In all factory related industries, there
were less than 3% of total children employed in Britain. The only industry that
had a significant amount of child labor was the silk industry (products for the
rich). Factories were generally safe for working children, coal mines, however,
were not safe but no regulation was passed against them. In factories, children
under the age of ten lost less than one week of work a year due to illness (Rustici
thinks that the children probably were sick for longer, but still went to work
even so, this is a low number).
o From 1816 to 1833, the employment of children in the cotton industry
went from 6.8% to 0.03%, and in the flax industry from 6.5% to 1%.
Macaulay
As time progresses, there is a massive drop in the illiteracy of children.
o Himmelfarb claims that England had private schools even during the
Industrial Revolution. She attributes the massive drop in illiteracy to to the
Sunday school. Sunday schools typically lasted 4 to 6 hours. They
spawned the ideas of teaching children rading, writing, and some

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arithmetic, and even gave birth to the childrens book. From 1801 to 1850,
the amount of Sunday schools increased from 2,300 to 23,000. This is
what causes the collapse in illiteracy, proving Macaulay wrong. However,
the factory act mandated that children in factories have a minimum
amount of education a day (Rustici claims that factories most likely
reduced the amount of children they would employ to avoid these costs,
forcing them to work in other, less safe industries.
Historical Lessons
Douglas North, while writing about Latin American economies, claims that their
failure to succeed is not what the Spanish took (gold and silver reserves), but
what they left. The Spanish, under mercantilism, brought similar policies to
South America that remained there after occupation. They instilled the idea that
plundering was the key to success (Rustici claims that this is not true at all).
The British colonies ended up generally better after colonialism. They established
systems of property rights and rule of law, which remained after they left. This is
why former British colonies (America, Australia, Canada, New Zealand) are in
their current economic and political states.
Production is the only key to success
Sub-Saharan Africa
The poorest region of the entire world. It is filled with autocracy, corruption,
dictatorships, etc. They have the highest percentage of tax rates on the poor in the
form of Posner taxes (regulation and tax farming).
o Monopolies and monopsonies were established in the farming sector of
many African economies (both of which exploit the hell out of the poor).
This happens through state land reforms: the government simply seizes
farmers lands and makes them work for the state. They are required to
purchase all farming implements from the African government (which
establishes a monopoly), who typically charged five times more than
world prices. Farmers then are required to sell all their crops to the African
government (which establishes a monopsony) at 20% the world price.
These two forces end up causing African farmers to pay between 70 and
90% of their income on indirect taxes. Because taxes are so high (and the
economic law that people act based on incentives), many Africans have
chosen to simply grow crops for subsistence. The problem with this is that
if there is some type of natural disaster, then all crops are completely
destroyed, and people starve because of a lack of surplus.
Examples of Dictators in Africa
o Flix Houphout-Boigny comes to power in Cote dIvoire as an average
income man, but ends up amassing billions of dollars to construct multiple
mansions and highways to connect them. He took all money from foreign
aid and used it to beautify the capital city and establishes uniqueness.
He constructed the largest basilica in the world, when 90% of the
population was not Catholic. He does all of this at the expense of the poor.
o Mobutu comes to power in Zaire (now the D.R.C.). When the Belgian left
in 1961, there were 30,000 miles of road. After his reign there were only
300 miles, which suggests that he spent all anti-Soviet foreign aid on

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himself rather than infrastructure. He rose to power through the military.
His personal wealth was larger than the GDP of all of Zaire; he spends
$14,000 a month on haircuts, and claims a third of the treasury as his
income. He imprisoned people who could not pay their medical bills.
o Colonel Mengistu was a communist dictator in Ethipia during the 1980s.
He came to power through military powers. He imposes
monopsony/monopoly taxes on his political opponents: this results in the
death of 1,000,000 in just one year. When food aid was given, he ordered
that rich countries pay a $500,000 docking fee. The food was then ordered
to be distributed through the government and was then sold on the black
market.
o Idi Amin of Uganda borrowed millions of dollars to build a modern
international airport in a country where 99% of its citizens will never fly.
The people who ended up having to pay back the loans, of course, were
the people. He then returns to the UN, claiming that Uganda was now a
Constitutional Republic, then kills 300,000 of his political opponents.
o The important thing to note from these examples is that these people took
the easy route to power (military regimes). The hard thing to do would
have been to establish a government based on law, human rights, and
equality. North claims that the Western world took millennia to become
what it is.
Lecture 8
Collectivist Economies where the government tries to centrally plan the economy
(always fails).
Government owns all factors of production in the state; individual property rights
are antithetical to the goals of planners. Communists/Fascists/Nazis all have
similar characteristics. Marxism inevitably leads to fascism (Hayek view).
All property ownership is turned over for the state or national goals (race, class,
domestic nationalism, etc.). Because of this, all collectivist economies are poised
to become totalitarian (Hayek view).
Von Mises points out that collectivists will always tend to be utopians. They tend
to believe that leaders are infallible beings (meaning they can do whatever they
want as long a they connect it back to the national plan, even the use of coercion
by force).
Collectivist views are not new at all; they date back to Platos Republic. Plate puts
central control under the philosopher king. He claims that the best thing for
people is to have a leader, and to not think for oneself (this relates back to
Smiths chess board). Plato makes everything common property (even children
and wives) in order to promote the idea of the state as one autonomous unit.
All of the collectivist ends are nice, except the means to achieve them require
everyone to essentially be cogs in a machine. The real problem occurs when
certain people do not want to be a part of the machine; they are then forced to fit
in or exterminated (pointed out by Adam Smith).

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Famous Collectivists all seem to believe that collectivism is a religion; socialism will
bring us a new era of no police or courts because people will love each other endlessly.
Charles Fourier claimed that once all property is communalized, people wll
basically be in harmony. He is the one who brings up the idea of the anti-lion.
William Goodwin believed that the only obstacle between man and immortality
is private property.
Karl Kotsky a superman will arise once socialism starts.
Trotsky man will become more harmonious; the average man will be smarter
than Aristotle.
Marx believed that once exchange is eliminated, a man can do multiple tasks
without any type of formal training. He claims that in socialism each according
to his ability, each according to his means. He forgets that man will do the bare
minimum as his ability and who decides your ability? Also forgets that man has
unlimited needs. Marx claims that capitalism has forced people into a new type of
wage slavery. Marx claims that the surplus value created by labor is not
rightfully transferred to workers.
o The problem with Marx is he does not realize that surplus value is a part
of accounting profits, and is a product of interest (economic profits are
only results of disequilibrium). Economic profits are what drive economic
choices; Marxs problem is that he believes that these economic profits are
real profits (does not take into account the opportunity cost of the
entrepreneur).
o Marx argues that since the workers are getting exploited, they will band
together and the state will wither away (he bases this all on Historicity
the belief that history creates mechanistic laws and that they dictate our
behavior). Marx never explains how this will come about, but implicit in
his ideas are that government will have to control everything because of
the abolition of the market.
o Marx could not ignore the Industrial Revolution; he claims that capitalists
have created more wealth than of all history, but its only in a few hands
(this is not true).
o Marxs grand plan is to have government control of everything and run it
like a factory.
Von Mises
He goes against all types of collectivism in many different works. He claims that
utopian Nazis are generally economically ignorant. He predicts that collectivism
will lead to war, disintegration, etc. Mises claims that if the government takes
control of all means of production (through abolishing competition), then all
inputs in production will have no prices that determine their value (and there will
also be no money a unit of account that is facilitated by the price system). This
is because an all encompassing monopoly cannot figure out the relative scarcities
of inputs with respect to human wants without a price system (which also means
no accounting, no cost-benefit analysis, essentially barter). Because of this, no
economically efficient outcome can occur. Even if a central planner means good,
the government will not be able to produce an optimal outcome because they will
irrationally allocate resources. Certain industries can still be socialized within a

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market system because they still benefit from the indicators of the market (think
the postal service).
Hayek makes the point that all freedoms are tied to economic freedom, and if the
economy goes to shit, everything else goes to shit. Vilfredo Pareto claims that
socialism can work if they operate based on marginal theory, but Mises and
Hayek say this is bullshit.
Soviet Union
Lenin started the collectivization of land (abolished property, abolished trade) and
in 4 years there was a famine that caused 4,000,000 people to starve. The Soviets
blamed bad weather. Lenin goes back and starts the New Economic Program,
which is basically capitalism.
Stalin then comes into power and reverses Lenins decree he collectivizes land
(10,000,000 Ukrainians starved because of the tragedy of the commons).
Khrushchev privatized 1% of all agricultural land this 1 produced 37% of all
food in the Soviet Union. Khrushchev denounces Stalin, but food imports still
exist to avert famine.
Gorbachev decides to stop terrorizing people and murdering them; this ends up
being the fall of the Soviet Union.
Professors in the West put forth the idea that socialism is best. Samuelson makes
an extremely popular textbook and admires the Soviet system of planning (every
edition of the text predicted that the Soviets would exceed the wealth of the U.S.
by 1989) his ideology went against his economic sense. In 1989, the CIA
estimated that the GDP of the Soviet Union in 1985 was 60% of Americas (and
half the standard of living in GDP per capita terms). Later, the actual data proved
that the Soviets GDP was 27% of the U.S.s (only in Russia proper), and 15% in
the entire Soviet Union. These estimates were wrong for six main reasons:
o Soviet planning data was always biased upper. Pejovich points out that
bureaucratic managers were given top down directives (to produce a
certain amount of whatever), and everyone lied about how much they
made (data was about 50% too high). This is for external propaganda
purposes, and was able to happen because the government literally
controlled everything.
o The price system in the Soviet Union was nonexistent (prices did not
reflect values vis a vis scarcity) the Soviets still monetized values
completely arbitrarily (they used a Sears catalogue from 1900 to estimate
values in the 1980s). The price-quality connection has no information (in a
market economy, higher quality means higher price). In the USSR, quality
was not necessarily a determinant of price. Gertude Schroeder points out
that in the USSR they had washing machines that were of lower quality
than the U.S., but they still attached an arbitrary price to it.
o The GDP measures do not take into account the loss of leisure time.
Hegdrick Smith estimated that the average time spent in line was 14 hours
per week. This kills any type of leisure time. In a market economy, a
labor-leisure tradeoff is assumed, but this is not true in the Soviet Union.
There is a forced system of labor that is not factored against GDP.

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o The GDP data does not show that output for the military has no effect on
GDP. Kusnitz claims that this is the way because military output is
dependent on government spending, and since there was no price system is
could not be determined. More than 50% of all output in the USSR went
into the military.
o The GDP statistics still do not measure environmental quality. It is
impossible to compute the value of environmental resources. Lake Baikal
(which holds 80% of Soviet freshwater), was polluted because the USSR
dumped untreated toxic waste into it (the maximum fine was 50 rubles). In
the 1960s, the Soviets diverted all streams away from the Aral Sea to
stimulate cotton production. This ends up fucking up salinity levels and
creates deserts.
o Political Pilgrims. These were political travelers who can see exactly
where they are wrong, but refuse to admit it. The Webbs and George
Bernard Shaw felt that capitalism had ruined the west and were avid
Stalinists. The Webbs wrote propaganda about the USSR after traveling
there and claimed that Stalin was elected and was not a dictator (false).
Argued that he was amazing for having a 100% confession rate, soviet
mock trials were superior to common courts, and that Soviet concentration
camps were fantastic. Shaw argued that there were no food shortages and
to prove it he ordered his entire rail car to throw their food out the window
before entering Soviet territory. He claimed that being in a Soviet jail was
a privilege. Sinclair claims that famine and violence were necessary for
the revolution.
Lecture 9
Poverty
Poverty is the original state of humanity. Easterly claims that the typical rate of
infant mortality in the upper 5th of countries is 5/1,000, and the lower 5th is
200/1,000.
Economists have had a constant quest for growth, finding out why some become
rich and others remain poor. Everywhere we see capitalism, people are generally
rich when compared to socialist planned economies.
In the 40s and 60s, we has development model that were used by the IMF, UN,
World Bank, etc. (they all attempt to increase technology in the production
function).
IMF and World Bank
The IMF is started after WWII. Leaders met and tried to find a way to get the
economy running again. They did this by fixing exchange rates to the U.S. dollar,
and then fixing that to gold. All currencies were convertible. The problem with a
fixed exchange rate is that there is always a shortage and surplus (it is not based
on PPP). What the IMF does is lend out many currencies to bail out those who
cannot make a balance of payments (so they can cling to the fixed exchange rate).
The IMF then begins to re-peg exchange rates (crawling) many times. In 1971,
the Smithsonian Institute de linked the U.S. dollar with gold. The world then

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began to operate on completely flexible exchange rates, which allows the
exchange market to constantly stay in equilibrium. This makes it so there is no
justification for the IMF after 1971, so they begin to give out structural
development loans (the same thing as the World Bank).
The World Bank is established as a development bank, claiming that capitalists in
rich countries would not invest in poor countries. This is because of political
instability in poor countries with no guaranteed return to investment. The World
Bank fails greatly: they have a 33% failure rate; 37/66 countries that they lend to
are no better off, and 20 out of those 37 are actually worse off. Their failures are
mainly due to:
o Governments have no incentive to use the money wisely, because
taxpayers ultimately have to pay back the loan.
o The World Bank has no incentive to worry about losing money, because
they can always be bailed out by taxpayers.
o Unlike the recipient of private capital investments, there are no constraints
to government borrowing. By giving capital to governments you create
moral hazard (instead of decreasing risk of investments, it is increased).
When governments refuse to pay back international loans, ALL private
investment flees.
S. Herbert Frankel discovers that all investment made by the British in colonies
went to shit (Kongwa example of ground nut investments). He claims that capital
is heterogeneous, and that the proper labor must be applied to the proper capital in
order for it to be effective (an Easterly type claim of piecemeal development).
Easterly shows that if all loans in Zambia were used properly, their GDP per
capita would be at $20,500 per years. But just because capital is pumped into a
country does not mean it is useful.
Hong Kong
Freest economy in the world. They have the second highest GDP per capita. They
always had the idea of private property established because of the British. The
reason they were able to prosper is because they received all the benefits of
government without the rent-seeking aspect. They attained the fastest growth rates
ever recorded.
Malaria
In 1980-1995, 73 billion dollars was lost in Africa due to malaria (the detruction
of human capital). About 1/5 of each Africans income is lost to defend against
malaria. Approximately 1.2 million die each year from Malaria. DDT is the best
defense against malaria (it was almost eradicated completely until DDT was
banned worldwide). This is done completely by rich countries who employ their
moral imagination.