Political Science Political Economy Rational Choice, Types of Economies & Economic Problems
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Overview
Thinkers and politicians throughout the ages have discussed economic issues, but they usually subordinated a strong economy to other goals, such as a centralized government or the acquisition of more territory. Adam Smith’s publication of The Wealth of Nations in 1776 brought economics into the modern era. Smith and later scholars focused on how the economy works best and most efficiently, but they did not consider what moral goals the economy should serve. Smith argued that the most efficient economy was a free-market economy, with little government interference. When Britain and other nations began to put Smith’s theories into practice, their economies expanded rapidly and vast wealth was created. Even though economics has changed greatly since his time, it is fair to say that we live in Adam Smith’s world.
Today all governments must work to implement sound economic policy. But there are no easy answers to economic issues. Often, different parts of society want different things, and what helps one part hurts another. And sometimes dealing with one problem causes another. In a democracy, politicians who fail to fix the economy—or even those who appear to be doing nothing to solve economic problems—face very angry voters. So politicians need to pay attention to economics.
Politics and money frequently intersect, and political scientists call that intersection political economy. The two realms interact and affect each other in complex ways, making it difficult to tell where one begins or ends. The state is expected to play a role in shaping the economy, so naturally the state affects and alters the economy. But the economy also affects the state: A state that cannot make the economy grow, or distribute it in a manner seen to be fair, could be in a great deal of trouble. And a booming economy can save even inept or corrupt leaders.
Rational Choice
As different academic fields, political science and economics utilize different research methods and techniques of analysis. The study of political economy brings together these diverse methods and techniques. One of the most prominent examples of this interdisciplinary blending is rational choice theory. Scholars use rational choice, a model derived from economics, to understand people and behavior. According to this view, humans act to maximize their outcomes—that is, to get the most benefit and profit from their actions. To this end, people make decisions rationally based on whatever information they can get. To put it crudely, people act in a selfish manner, using reason to get what they want.
Minimaxing
The rational choice approach is also sometimes called the minimax approach, a term that comes from the military. People act to minimize their maximum losses and to max-imize their minimum gains.
Rational choice defines reason in a very specific way: Humans use reason to get what they want. But this is not the only way of defining the term, and this definition of reason applies only to a narrow range of study and behavior. Economists and political scientists do not assume that people always act this way. Rational choice only looks at certain types of human behavior and decision-making, but this model has become very influential in political science. The rational choice approach has been adopted to explain a great variety of behaviors—from how members of Congress act in their home districts to how individuals decide to join (or not join) interest groups.
Types of Economies
An economy is a system whereby goods are produced and exchanged. Without a viable economy, a state will collapse. There are three main types of economies: free market, command, and mixed. The chart below compares free-market and command economies; mixed economies are a combination of the two.
| Free-Market Economies | Command Economies |
| Usually occur in democratic states | Usually occur in communist or authoritarian states |
| Individuals and businesses make their own economic decisions. | The state’s central government makes all of the country’s economic decisions. |
Free-Market Economies
In free-market economies, which are essentially capitalist economies, businesses and individuals have the freedom to pursue their own economic interests, buying and selling goods on a competitive market, which naturally determines a fair price for goods and services.
Command Economies
A command economy is also known as a centrally planned economy because the central, or national, government plans the economy. Generally, communist states have command economies, although China has been moving recently toward a capitalist economy. In a communist society, the central government controls the entire economy, allocating resources and dictating prices for goods and services. Some noncommunist authoritarian states also have command economies. In times of war, most states—even democratic, free-market states—take an active role in economic planning but not necessarily to the extent of communist states.
Example: During World War II, the United States largely took control of the American economy, forcing businesses to build tanks, planes, and ammunition instead of normal consumer goods. Supplies were also rationed. For example, to buy more toothpaste, people were obliged to return the empty tube because metal was in short supply.
Inefficiencies of Command Economies
Command economies are often very inefficient because these economies try to ignore the laws of supply and demand. In most cases, a black market arises to fill the demands overlooked by the central plan. Economic growth overall is often slower than in states with free markets. Some command economies claim to act to promote economic equality, but often the elites in the government live far better than others.
The Triumph of Capitalism
Although command economies were once considered viable alternatives to free-market capitalist economies, poor economic performance in countries with planned economies proved that capitalism was much more efficient. The former Soviet Union’s centrally planned economy performed so poorly, for example, that the government literally collapsed in 1990–1991. North Korea’s command economy also failed completely more than a decade ago, causing rampant starvation, which has been alleviated only by international food donations. Chinese leaders, in contrast, recognized more than twenty years ago that the centrally planned economy could not meet their nation’s needs, which is why they have privatized agricultural production and many other industries. China has since legalized the ownership of private property and courted massive amounts in foreign investments, despite the fact that the state remains severely authoritarian.
Mixed Economies
A mixed economy combines elements of free-market and command economies. Even among free-market states, the government usually takes some action to direct the economy. These moves are made for a variety of reasons; for example, some are designed to protect certain industries or help consumers. In economic language, this means that most states have mixed economies.
Example: Agricultural subsidies, which exist in many countries (including the United States), are a common way governments intervene in the economy. In some cases, these policies are designed to keep food prices low without bankrupting farmers. In other cases, they work to protect domestic agriculture. Even the price of milk is strongly influenced by government policy in the United States.
Economic Problems
Every government struggles with unemployment, inflation, and recession/depression, and each government must enact policies to combat these problems. In the United States, both unemployment and inflation have been fairly low (5 percent or lower) for much of the past two decades. But even low unemployment and inflation affect and undermine economic growth. The following chart summarizes the economic problems faced by states.
| Unemployment | Inflation | Recession/Depression |
| Not everyone who wants to work has a job. | The price of goods increases. | Economic failure or collapse occurs in many sectors of the economy. |
Unemployment
Unemployment occurs when there simply are not enough jobs for everyone who wishes to have one. Every economy has some unemployment because people leave jobs (by choice or against their will) and are usually unemployed for a time before they find new employment. Others are unemployed for longer periods.
Example: Analysts measure unemployment as a percentage of the work force who cannot find jobs. What counts as high or low unemployment is, to some extent, relative. In the United States, analysts consider a rate of unemployment above 5–6 percent to be high, even though many western European countries frequently have unemployment rates above 10 percent.
Measuring Unemployment
Analysts have difficulty measuring unemployment because polling every eligible person to find out whether he or she has a job is impossible. Therefore, analysts rely on other methods to measure unemployment. In the United States, the official jobless (or unemployment) rate is based on the number of people claiming unemployment benefits. But not all jobless people file for unemployment benefits, and people whose benefits have expired are not counted, so even this method has potential flaws.
Underemployment
Underemployment, a condition related to unemployment, occurs when a person does not work full time or does not use all of his or her skills (as when a person with a PhD in biology waits tables in a restaurant). The underemployment rate sometimes indicates more about the state of the economy than unemployment because many people want full-time work but cannot find it and thus might take whatever part-time jobs they can. Some analysts see underemployment as being better than unemployment because the underemployed are not as prone to poverty as the unemployed. In reality, underemployed people usually do not qualify for unemployment benefits, so the underemployed may be worse off than those without jobs.
Why Be Unemployed?
The rational choice approach helps political scientists understand why some people will stay unemployed rather than take part-time work. This decision seems irrational because any job is better than no job. But in many cases, it makes financial sense to stay unemployed: The unemployment benefits might be higher than the wages from a part-time job. Similarly, those without jobs often qualify for programs, such as free or cheaper health care, that are unavailable to the underemployed. Sometimes it makes sense for people to choose to stay unemployed.
Dangers of Unemployment
Unemployment is a problem because it means that some people in society are not making any money, which puts them in grave danger of tremendous poverty or worse. When unemployment rises to high levels, those without jobs may become hostile to the government, blaming it and their leaders for their situation. At such times, political shakiness or insecurity can result.
In extreme cases, governments have fallen due to their high rates of unemployment.
Example: During the Great Depression, unemployment was extremely high around the world—approaching 30 percent in some places. The large number of jobless people created tremendous instability in many countries, including Germany. There the high unemployment, along with hyperinflation, contributed to the rise of Nazism. The middle class was financially wiped out, and many citizens began to blame the new democratic government and saw the Nazi Party as a positive regime change.
Unemployment rates vary from place to place within a country. In the early years of the twenty-first century, for example, unemployment in Washington State was higher than in most other places in the United States because the Seattle-area economy is heavily dependent on high-tech industries, which underwent a serious slump around this time. Likewise, the closing of a factory can devastate the local economy even if the rest of the nation’s economy is strong.
Inflation
Inflation occurs when the prices of goods and services begin to rise. Analysts measure inflation as a percentage increase in price over the course of a year. So, if inflation is 10 percent, an item that costs $ 1 will cost $ 1.10 a year later. The official inflation rate is an average of price increases for all goods and services, so it may not apply exactly to any one given good.
Inflation also means that the currency becomes worth less. In the above example, one dollar is now worth less than it once was. Economists refer to this decrease as a decline in buying power, which is the amount of goods and services money can buy. In other words, if a person’s salary stays the same but inflation occurs, her buying power will go down. This person will be poorer because she can no longer afford the things she used to buy as the price of those goods increases.
Example: According to the Bureau of Labor Statistics, $ 1 from 1989 had the buying power of $ 1.73 in 2009. In other words, if a hamburger cost you $ 1 in 1989, you’d have to pay $ 1.73 for it today.
This difference of $ 0.73 many not seem significant until you start purchasing more expensive items. A car that cost you $10,000 in 1989 would cost you more than $ 17,000 today, and a $ 100,000 home in 1989 would now cost you more than $ 170,000.
Excess Demand
In general, the basic law of supply and demand causes inflation. When the demand for something exceeds supply (what economists call excess demand), the price goes up. Excess demand and high inflation have a variety of causes:
- A bad harvest
- Shortages due to war
- A natural disaster
- Increased consumer desire (that is, more people wanting a particular good)
- Increased consumer spending power
Other factors contribute to inflation too, such as when a company intentionally underproduces an item to drive up prices or when a government steps in to increase or decrease inflation. We cover the economic policies of governments later in the chapter, particularly in the sections on fiscal policy.
Dangers of Inflation
High inflation (defined as more than 5 percent in North America and Europe) can do the following:
- Create economic turbulence
- Exaggerate a person’s financial success or failure so that he becomes rich or poor very quickly
- Increase the number of people who are at risk for poverty (if things cost more, then more people may be considered poor)
- Cause political instability (historically, many authoritarian regimes have risen to power during periods of extremely high inflation)
Inflation Around the Globe
In the industrialized world, inflation has remained low since 1990. But severe inflation—called hyperinflation—does happen sometimes. In 1994, for example, inflation in Brazil was more than 3,000 percent. In the 1930s in some European countries, inflation was similarly high, and stories were told about people hauling money in a wheelbarrow to the store in order to pay for a single loaf of bread.
Balancing Unemployment and Inflation
All governments must balance the effects of unemployment with those of inflation. In most cases, reducing unemployment usually requires spending more money, which causes prices to increase. Similarly, reducing inflation often means re-ducing the amount of money spent, which usually increases unemployment. Balancing these goals is a difficult but necessary governmental task.
Recession and Depression
All governments want to avoid an economic recession, which is a period of decline in the economy. Recessions often are accompanied by high unemployment and, sometimes, high inflation. Even worse is a depression, an economic downturn that dips deeper and lasts longer than a recession.
Example: When the stock market crashed on October 24, 1929, the world fell into the Great Depression, one of the most severe economic downturns of the industrial era. Unemployment skyrocketed, reaching about 33 percent in the United States. Many people suffered from dire poverty, and some starved. The depression did not fully end in the United States until the nation entered World War II at the end of 1941.
