No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eighteen: The “macro” view of the economy 457 these. Lower tax rates might spur investment in physical or virtual capital. Subsidized education might create higher levels of human capital. Finally, good energy and trade policies might lead to more natural resource availability for production. When Adam Smith wrote his treatise, economic growth in England was the exception that needed to be explained. However, in the intervening 200+ years, the more relevant question is “what prevents countries from growing?” M.I.T. economist Daron Acemoglu and James Robinson examine this reverse question in Why Nations Fail . Their conclusion? Consistent with what we learned in chapter 10, it is the quality of a nation’s institutions that primarily drive success or failure. For Acemoglu and Smith, if “inclusive” economic institutions characterize a nation, they can grow. Inclusive institutions are such things as property rights, rule of law, and free markets—have these good institutions, and you’ll do reasonably well. However, if “extractive” institutions characterize a nation, there will be little growth. Extractive institutions are “designed by the politically powerful elites to extract resources from the rest of society.” The lesson from Acemoglu and Smith is that not only can governments help promote economic growth with good policies, but they must also be constrained from hurting growth through extractive policies. As we learned in chapter 10, it’s all about the institutions! When the institution of central banking causes monetary instability, the result is inflation and lower growth—we’ll look at inflation in the next section. INFLATION We’ve previously learned how the fractional reserve banking system—when combined with a central bank—can lead to inflation, which we defined as a rise in the general level of prices over time. There are many ways to measure inflation, but the most common is some sort of price index, where prices of a representative basket of goods (hopefully in proportion to what people actually buy) are tracked and measured. In the United States, the most common is the Consumer Price Index for urban consumers (CPI-U). The Bureau of Labor Statistics (BLS) surveys people to find out what they actually buy, and this helps them assign weights to a particular item in the basket (e.g., how much weight should we put on an increase in the price of salt if it is a very small part of a consumer’s budget?). Once the items in the consumer basket are identified, and relative weights assigned (according to the percentage of these goods in our budget), the BLS sends data collectors out to shop! And to go online! And to make a few phone calls. All to find out what the prices are that we actually pay for these goods. To illustrate how this works, consider a two-good world: In-and-Out Burgers and surf boards (maybe you live in California?). If you buy 1000 burgers at $4/each in a given year and 2 surfboards at $600/each, we can find the price of this consumer basket in a current year (which we’ll call our base year), which is ($4 X 1000) + ($600 X 2), or $5200. The BLS uses the basket they assign and compares how prices change over time. So if they had our basket, they would annually look at the price of a basket of 1000 burgers and 2