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Basic Economics: A Citizen's Guide to the Economy
Classical Economics Reconsidered
Knowledge and Decisions
Marxism: Philosophy and Economics
Say's Law
Thinking Beyond Stage One


A Member of the Perseus Books Group
New York
Copyright © 2004 by Thomas Sowell
Published by Basic Books,
A Member of the Perseus Books Group

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Library of Congress Cataloging-in-Publication Data

Sowell, Thomas, 1930-
Applied economics : thinking beyond stage one / Thomas Sowell
p. cm.
Includes bibliographical references and index.
ISBN 0-465-08143-6 (alk. paper)
1. Economics”Political aspects. 2. Economic policy”Social aspects. 3. Equality.
4. Social problems. 5. Economic development. 6. Economics. I. Title.

HB74.P65S66 2003

03 04 05 / 10 9 8 7 6 5 4 3 2 1
To Professor Arthur Smithies,
who taught me to think beyond stage one
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Preface ix

1 Politics versus Economics 1

2 Free and Unfree Labor 31

3 The Economics of Medical Care 69

4 The Economics of Housing 97

5 Risky Business 129

6 The Economics of Discrimination 161

7 The Economic Development of Nations 193

Sources 223
Index 241

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It is one thing to know the basic principles of economics. It is an-
other to apply them to the problems of the real world. Yet that is
ultimately what these principles are all about. Instead of focussing
on establishing the principles of economics, as I did in Basic Eco-
nomics, here the focus will be on dealing in depth with particular
real world problems, using economic principles to clarify why and
how things have happened the way that they have. This is a book
to enable the general reader, with no prior knowledge of econom-
ics, to understand some of the key economic issues of our time”
medical care, housing, discrimination, and the economic
development of nations, for example. Because these are political,
as well as economic issues, some political principles will need to be
considered as well. That is, we will need to consider what incen-
tives and constraints apply to political decision-making, as well as
those which apply to economic decisions-making.
Neither economics nor politics is just a matter of opinion and
both require thinking beyond the immediate consequences of de-
cisions to their long-term effects. Because so few politicians look
beyond the next election, it is all the more important that the vot-
ers look ahead.
It is helpful to have something of a sense of humor when con-
sidering economic policies. Otherwise, the study of these policies
and their often painful unintended consequences can get to be too
depressing or you can get too angry. Save your anger until you are
in the voting booth on election day. In the meantime, enjoy the
process of getting more understanding of issues and institutions
that affect your life and the future of the country.
x Preface

Because this is a book for the general public, the usual footnotes
or endnotes are omitted. However, for those readers who want to
verify what is said here, or to read further on some of the subjects
covered, the sources of the many facts discussed here are listed in
the back of the book.

The Hoover Institution
Stanford University
Chapter 1

Politics versus Economics

When we are talking about applied economic policies, we are
V V no longer talking about pure economic principles, but
about the interactions of politics and economics. The principles of
economics remain the same, but the likelihood of those principles
being applied unchanged is considerably reduced, because politics
has its own principles and imperatives. It is not just that politi-
cians' top priority is getting elected and re-elected, or that their
time horizon seldom extends beyond the next election. The gen-
eral public as well behaves differently when making political deci-
sions rather than economic decisions. Virtually no one puts as
much time and close attention into deciding whether to vote for
one candidate rather than another as is usually put into deciding
whether to buy one house rather than another”or perhaps even
one car rather than another.
The voter's political decisions involve having a minute influence
on policies which affect many other people, while economic
decision-making is about having a major effect on one's own per-
sonal well-being. It should not be surprising that the quantity and
quality of thinking going into these very different kinds of deci-
sions differ correspondingly. One of the ways in which these
decisions differ is in not thinking through political decisions
beyond the immediate consequences. When most voters do not


think beyond stage one, many elected officials have no incentive
to weigh what the consequences will be in later stages”and
considerable incentives to avoid getting beyond what their con-
stituents think and understand, for fear that rival politicians can
drive a wedge between them and their constituents by catering to
public misconceptions.
The very way that issues are conceived tends to be different in
politics and in economics. Political thinking tends to conceive of
policies, institutions, or programs in terms of their hoped-for
results”"drug prevention" programs, "profit-making" enterprises,
"public-interest" law firms, "gun control" laws, and so forth. But
for purposes of economic analysis, what matters is not what goals
are being sought but what incentives and constraints are being cre-
ated in pursuit of those goals. We know, for example, that many”
if not most”"profit-making" enterprises do not in fact make
profits, as shown by the high percentage of new businesses that go
out of business within a few years after being created. Similarly, it
is an open question whether drug prevention programs actually
prevent or reduce drug usage, whether public interest law firms ac-
tually benefit the public, or whether gun control laws actually con-
trol guns. No economist is likely to be surprised when rent control
laws, for example, lead to housing shortages and fail to control
rent, so that cities with such laws often end up with higher rents
than cities without them. But such outcomes may be very surpris-
ing to people who think in terms of political rhetoric focussed on
desirable goals.
The point is not simply that various policies may fail to achieve
their purposes. The more fundamental point is that we need to
know the actual characteristics of the processes set in motion”and
the incentives and constraints inherent in such characteristics”
rather than judging these processes by their goals. Many of the
"unintended consequences" of policies and programs would have
Politics versus Economics 3

been foreseeable from the outset if these processes had been ana-
lyzed in terms of the incentives and constraints they created, in-
stead of in terms of the desirability of the goals they proclaimed.
Once we start thinking in terms of the chain of events set in mo-
tion by particular policies”and following these events beyond
stage one”the world begins to look very different.
Politics and the market are both ways of getting some people to
respond to other people's desires. Consumers choosing which
goods to spend their money on have often been analogized to
voters deciding which candidates to elect to public office. How-
ever, the two processes are profoundly different. Not only do
individuals invest very different amounts of time and thought in
making economic versus political decisions, those decisions are
inherently different in themselves. Voters decide whether to vote
for one candidate or another but they decide how much of what
kinds of food, clothing, shelter, etc., to purchase. In short, politi-
cal decisions tend to be categorical, while economic decisions
tend to be incremental.
Incremental decisions can be more fine-tuned than deciding
which candidate's whole package of principles and practices comes
closest to meeting your own desires. Incremental decision-making
also means that not every increment of even very desirable things is
likewise necessarily desirable, given that there are other things that
the money could be spent on after having acquired a given amount
of a particular good or service. For example, although it might be
worthwhile spending considerable money to live in a nice home,
buying a second home in the country may or may not be worth
spending money that could be used for sending a child to college or
for recreational travel overseas. One consequence of incremental de-
cision-making is that increments of many desirable things remain
unpurchased because they are almost”but not quite”worth the
sacrifices required to get them.

From a political standpoint, this means that there are always nu-
merous desirable things that government officials can offer to pro-
vide to voters who want them”either free of charge or at reduced,
government-subsidized prices”even when these voters do not
want these increments enough to sacrifice their own money to pay
for them. Ultimately, of course, the public ends up paying as tax-
payers for things that they would not have chosen to pay for as
consumers. The real winners in this process are the politicians
whose apparent generosity and compassion gain them political
In trying to understand the effect of politics on economics, we
need to consider not only officials' responses to the various pres-
sures they receive from different sources, but also the way that
the media and the voting public see economic issues. Both the
media and the voters are prone to what might be called one-stage


When I was an undergraduate studying economics under Profes-
sor Arthur Smithies of Harvard, he asked me in class one day what
policy I favored on a particular issue of the times. Since I had
strong feelings on that issue, I proceeded to answer him with en-
thusiasm, explaining what beneficial consequences I expected from
the policy I advocated.
"And then what will happen?" he asked.
The question caught me off guard. However, as I thought about
it, it became clear that the situation I described would lead to other
economic consequences, which I then began to consider and to
spell out.
"And what will happen after that?" Professor Smithies asked.
Politics versus Economics 5

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