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
1. 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
1. Encourage people to use their
property productively.
2. Promote wise stewardship.
3. Encourage people to develop their
property in ways beneficial to others
for possible exchange, transfer or
sale.
4. 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?
1. In which year(s) did experts
predict that the U.S. would
run out of oil in the near
future?
a.
b.
c.
d.
e.
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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
1. Limiting entry into some businesses
and occupations
•
Licensing requirements, completing
bureaucratic forms, etc.
2. 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.
3. 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 wealthcreating 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 nation’s money consists of
its currency held by the public,
checking accounts, and
traveler’s checks.
• A nation’s 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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Inflation’s 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 nation’s currency.
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The Keys to Sound Money and
Price Stability
1. Central banks and their officials should be held
accountable for following a sound money policy
and keeping the nation’s rate of inflation within a
narrow range; or be dismissed.
2. 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.
3. A country could adopt another nation’s 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
1. How important are the following
institutions/policies for a country’s
prosperity?
a. Secure protection of privately owned
property
b. Even-handed enforcement of
contracts
c. Stable monetary environment
d. Low marginal tax rates
e. Minimal barriers to trade
f. 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.
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