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May 21, 2013
The Dismal Science
Obeying the Laws
by Adam Smith

Many laws of science are so easily observable to all of us that we understand the concept of the law and what will happen to us if we try to defy the law.

For example, consider the law of gravity. In 1687, Sir Isaac Newton provided the first mathematical explanation of gravity. He did not invent gravity, but he provided a mathematical construct of how much gravitational attraction two objects will have.

It did not take Newton for people to know that there is some force at work that kept things stuck to the ground. For several millennia, people had observed that if you tripped on a root, jumped in the air, or fell from a cliff you always, always came back to earth.

The human species has always known about gravity. Newton’s contribution then was not a discovery as much as an extension of what we knew and helped us understand what it would take for us to advance in areas such as air travel and space exploration, with gravity as a know constant.

Economics is a much more difficult discipline to see the laws and to understand the consequences of trying to defy the laws.

Take the law of supply and demand. If there is a huge demand for something in an open and free economy, then there is a rush to fill that demand. And any attempts by the government to try and restrict the attempts to fill the demand will fail. Some obvious examples are alcohol prohibition in the 20s and early 30s and the ongoing attempts to stop the flow of illegal drugs.

In both of these instances, there was a large demand for a product and all attempts to restrict the supply have been of marginal success. The government cannot defy the law of supply and demand.

There is another attempt to defy the law of supply and demand that is currently more relevant.

In the 1990s and early in the 2000s, the economy in the United States was growing at a good healthy pace. In fact, it was growing so well that our unemployment rate was basically at 0. There is always going to be some churn in the economy, with companies going out of business and others starting up or expanding, but if you wanted to work there were jobs available. In fact, almost every store or restaurant you went to had a help wanted sign up in a window. There was a huge demand for labor, but there is actually a finite number of Americans available to work. The law of supply and demand certainly extends to more than beer.

There was a rush to fill the demand.

This rush came from our friends in Mexico and Central America. They came by the tens of millions, and still the unemployment rate did not increase. These immigrants were viewed with a very cautious eye by Americans as had most immigrants to America has received for the past 150 years. There was a constant cry to seal the border and stop all of these people from invading our country.

The reality is that as long as there was a demand for their services, the immigrants were somehow, someway, going to get here. You cannot defy the law of supply and demand.

Another law of economics that is constantly trying to be defied is that there is a market price that will clear the market. Distorting the pricing mechanism will distort the market in very unhealthy ways.

The most common example is rent control. The government is always trying to help those that are less fortunate. One way they have tried in the past is to put controls on how much a landlord can increase the rent for the renter.

This practice always leads to a lack of apartments available for rent. The government dictating a price lower than what the market needs to clear will always lead to shortages. With the lower price there is a greater demand for the product. But with the lower price there is less of the product produced.

And the government never seems to learn this lesson.

The government is going to be dictating the price for medical services for many if not most Americans. This price will be below the market price that will clear the market. This will, in the long run, lead to shortages in medical care.

You cannot defy economic laws without causing unpleasant distortions in the market.

Another area where economic laws are continually being misunderstood is international trade. The reality is that trading with other countries actually increases the economic pie that for both countries. However, it is easy to see the jobs lost when trade causes reduction in a specific industry because the reduction can be over such a narrow piece of the economy. But it is difficult to see the expansion of economic activity that is spread over the rest of the entire economy.

The United States has been a leader in advancing free trade for decades. If that trend ever reverses and the US becomes more protectionist, then we will see some jobs saved but economic law will ensure that overall we will be less well off than we were before. Prices will increase, and that always hurts the poor more than the wealthy.

A great book (very short) that explains the benefits of trade is “The Choice” by Russell Roberts. So much of the economic impact of trade is counterintuitive. This book does a good job of explaining the cause and effect of trade.

These are a few of the common errors that are made by our politicians. They do not make these errors not knowing the economic laws. They always have some explanation for why the economic laws do not apply in a specific instance or what they are going to due to mitigate the economy law so the market distortions do not happen.

This is similar to flapping your arms as you jump off a cliff. For awhile it may appear you are defying the laws of gravity, but it turns out a mess in the long run.

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