Available online at AEAweb: What is Economics?.
Instead, I believe that textbooks and courses should emphasize the evolution of complex patterns of specialization, production methods, trade, and innovation. I call this approach woolen-coat economics.
In this column, I contrast camping-trip economics with woolen-coat economics. The two approaches imply different ways of looking at the role of government. They also imply different ways of looking at fluctuations in total employment.
The conventional misrepresentation can be found, for example, on a page called "What is Economics?" on the American Economic Association's web site in a section for students. It begins,
Economics is the study of how people choose to use resources.
Resources include the time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services.1
For more on G. A. Cohen's camping trip metaphor, see the EconTalk podcast episode James Otteson on the End of Socialism.
The problem with this representation of economics struck me when I came across a metaphor used by philosopher G. A. Cohen.2 As one review explains it,
Cohen outlines a camping trip run along socialist lines, where "people cooperate within a common concern that, so far as is possible, everybody has a roughly similar opportunity to flourish". Cooking and washing up are distributed to each according to his abilities, and applesauce, apple pie, and apple strudel are distributed to each according to his needs. Cohen contrasts this trip to one run along market capitalist lines; in the capitalist alternative, meal preparation involves renting a potato peeler from a fellow camper and buying potatoes from another before selling the peeled potatoes to a third.3
Cohen's preference is for socialism, but he admits that the feasibility of socialism is undermined by the fact that the entire economy is more complicated than a camping trip. In this regard, his understanding of economics is more sophisticated than the conventional understanding.
Unfortunately, the conventional misrepresentation takes seriously the economics of a camping trip. There are resources to be allocated, including the time that campers have available to pitch a tent, light a fire, cook a meal, and so forth. And there are goods to be allocated, including sleeping bags, food, and water. Thus, from the conventional standpoint, there is nothing wrong with using the camping trip as a metaphor for the economy.
The conventional misrepresentation defines economic activity as choice in the use of resources. I would prefer to see economic activity defined in terms of what Peter Boettke and others term coordination. I would put it this way:
Economic activity involves complex patterns of specialization, production methods, trade, and innovation. Economists study the evolution of economic activity.
I would choose as an introductory metaphor Adam Smith's example of a woolen coat.
The woollen coat, for example, which covers the day-labourer, as coarse and rough as it may appear, is the produce of the joint labour of a great multitude of workmen. The shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others, must all join their different arts in order to complete even this homely production. How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country! how much commerce and navigation in particular, how many ship-builders, sailors, sail-makers, rope-makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world! What a variety of labour too is necessary in order to produce the tools of the meanest of those workmen! To say nothing of such complicated machines as the ship of the sailor, the mill of the fuller, or even the loom of the weaver, let us consider only what a variety of labour is requisite in order to form that very simple machine, the shears with which the shepherd clips the wool. The miner, the builder of the furnace for smelting the ore, the feller of the timber, the burner of the charcoal to be made use of in the smelting-house, the brick-maker, the brick-layer, the workmen who attend the furnace, the mill-wright, the forger, the smith, must all of them join their different arts in order to produce them.4
For an alternative definition of economics that focuses on exchange rather than resources, see Introductory Lectures on Political Economy, par. I.9 by Richard Whately, at the Library of Economics and Liberty.
Now let us return to the camping trip. When we go on the trip, we will be wearing clothes, and the process by which these found their way to us is even more complicated than the process by which a woolen coat was produced in Smith's day. Economic activity, using the coordination definition, is involved in providing the tent, sleeping bags, backpacks, food supplies, navigation aids, cooking utensils, and so on which we bring camping with us.
Once the camping trip starts, all of these products of economic activity become the endowment of resources available to the campers. All that is required at this point are a few simple tasks. We might have to gather some wood for a fire, open some packages of food, peel potatoes, pitch a tent, and so forth. On the camping trip itself, there are no long, complex production sequences. There is little or nothing to be gained from specialization. There is little advantage to trading.
A camping trip is, in fact, the opposite of an economic setting. The camping-trip setting is one of high endowment, low improvement. Close to 100 percent of the goods and services needed to make the camping trip enjoyable are provided exogenously prior to our embarking on the camping trip. Relative to our endowment, the value we add during the trip is close to zero.
In contrast, the woolen-coat economy is one of high improvement, low endowment. The coat, modest though it may be, is incomparably more valuable to the wearer than the resources used to produce it. We are thus led to focus on coordination, and the complex patterns of specialization, production methods, and trade. This coordination it what produces improvement relative to the endowment.
The improvement provided by coordination can also be illustrated using the metaphor of real estate. Appraisers separate the value of land from the value of "improvements," meaning the buildings, landscaping, soil-tilling and other man-made changes to the land. The conventional misrepresentation in economics is like a real estate appraisal system that ignores improvements and looks only at land in terms of the intrinsic value of the actual soil.
If most of the value of real estate were in the soil, then land would be characterized by high endowment and low improvement. Economic pedagogy tends to paint such a picture. Consumers are assumed to have an endowment of money or income, which they then allocate among goods. Firms are assumed to make use of a production function, in which output is produced using a combination of inputs, typically capital and labor. Just as in the camping-trip setting, the focus is on the allocation of the endowment of resources, as opposed to the coordination involved in achieving the improvement of those resources. In terms of the real estate metaphor, if government is to intervene, it will be in order to allocate land to different people for different uses in order to make the best use of the soil.
In the real world, the value of a parcel of land depends very little on the quality of soil or other intrinsic characteristics. Some value comes from the improvements that the appraiser sees (buildings, landscaping, and so on) which are the direct result of decisions made by the owner of the land. In addition, much of the value of land is due to improvements that were not made by the owner. For example, land value is improved by what is nearby. Are there opportunities for well-paid work in local enterprises? Are there attractive amenities? Is the neighborhood a good place to raise children?
Much of this intangible land value depends on institutional factors. As development economist Hernando de Soto has pointed out, the ability to obtain clear title to property, to sell it, and to borrow against it is a critical ingredient in land value. Land is more valuable in places where courts and police function well. It is more valuable when common resources, such as roads, water, and sewer systems, are efficiently provided.
Thinking about value in this way leads one to think of government's role as providing institutions that contribute to high value. Government defines and enforces property rights, provides courts and police, and helps oversee common resources.
In macroeconomics, the conventional misrepresentation treats the economy as one big GDP factory. Macroeconomists look at total output, as measured by GDP, and they think of it as produced by homogeneous labor and homogeneous capital. Again, this is camping-trip economics, with value assumed to be embedded in the endowment of labor and capital, rather than in the coordination required to create patterns of specialization, production methods, trade, and innovation.
Conventional economists use the term "potential GDP," and they will say that the economy is operating "below potential" during a recession. From a coordination point of view, the meaning of such concepts is in doubt.
A conventional economist would say that the U.S. economy was operating at its potential in early 2007, prior to the onset of recession. Subsequently, it was operating far below potential.
From the coordination perspective, one might ask what this "potential GDP" means. If the United States in 2009 had produced exactly the set of goods and services that it produced in 2007, would this have meant that it was operating at its potential? In particular, that would mean going back to building the same number of houses, creating the same number of mortgage securities backed by sub-prime loans, discarding any post-2007 innovations in health care or computer technology, and so on.
It certainly is true that there are fluctuations in the proportions of employed and unemployed workers. Thinking of the economy as a GDP factory leads to a very limited view of the causes of such fluctuations. If there is only one good produced, then the only meaningful choice that people can make is an intertemporal one. They can decide when to work more and consume more, and, conversely, when to work less and consume less. In fact, this stunted theory of economic fluctuations is what macroeconomics degenerated into in the 1980s, particularly at the "freshwater" schools of the University of Chicago and the University of Minnesota. Meanwhile, the "saltwater" schools of MIT and Berkeley retained the GDP factory with intertemporal choice issues while adding some relatively arbitrary rigidities in nominal wages or prices, to arrive at what was called New Keynesian economics.
Instead, thinking of the economy in terms of coordination, there are myriad reasons for employment to fluctuate. Consider all of the adjustments that would have to take place in order for the economy to shift some resources from woolen-coat production to the development of smart-phone apps. In fact, the U.S. government's data on JOLTS (job openings and labor turnover statistics) shows that millions of jobs are created and destroyed each month, compared to which the aggregate net gains and losses of 200,000 or so per month seem relatively minor.
Camping-trip economics is appropriate only for artificial, high-endowment, low-improvement economies. Woolen-coat economics is what describes realistic economies, in which an endowment is vastly improved by coordinated economic activity. I would like to see woolen-coat economics incorporated more deeply into every economics course, starting with introductory economics and continuing through graduate school.
G. A. Cohen, Why Not Socialism? Princeton University Press, 2009.
Alexander Barker, "On a Socialist Camping Trip," The Oxonian Review, November 9, 2009.
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, par. I.1.11. Available online at the Library of Economics and Liberty.