Modern Economy

The modern market economies that we know today first arose in Europe out of the ashes of the feudal system. As we have already mentioned, the feudal system was a traditional one in which people did jobs based on heredity (the miller’s son became the next generation’s miller) and received shares of their village’s total output that were based on custom. Peasants were tied to the land. Much land was owned by the crown and granted to the lord of the manor in return for military services. Some of it was made available for the common use of all villagers. Property such as the village mill and blacksmith’s shop never belonged to those who worked there and could therefore never be bought and sold by them. In contrast, modern economies are based on market transactions between people who voluntarily decide whether or not to engage in them. They have the right to buy and sell what they wish, to accept or refuse an offered work, and to move to where they want when they want. Key institutions are private property and freedom of contract, both of which must be maintained by active government policies. The government creates laws of ownership and contract and then provides the courts to enforce these laws. The material living standards of any society depend on how much it can

produce. What there is to consume depends on what is produced. If the productive capacity of a society is small, then the living standards of its typical citizen will be low. Only by raising that productive capacity can average living standards be raised. How much a society can produce depends both on how many of its citizens are at work producing things and on their productivity in their work. In spite of some short-terms ups and downs, the trend of total employment has been upward

over most of modern economies throughout the creation of new jobs. These new jobs provided employment for a rising population and for the increasing proportion of that population who wished to work. There were also large off-setting movements in male and female participation in the labor of force. In the second half of the 20th century, the percentage of women over 16 who were in the labor

force rose from 35 to 57 percent, whereas the percentage of men fell from 86 to76 percent. Labor productivity refers to the amount produced per hour of work. Rising living standards are closely linked to the rising productivity of the typical worker. If each worker produces more, then (other things being equal) there will be more production in total, and hence more for each person to consume on average. In the period from 1750 to 1850 the market economies in Europe and the U.S. became industrial economies. With industrialization, modern market economies have raised ordinary people out of poverty by raising productivity at rates that appear slow from year to year but that have dramatic effects on living standards when sustained over long periods of time. Then in the mid-1970s, this productivity growth fell substantially to around 0,9 percent. Currently the typical child 25 years younger than his or her parents can expect to be no more than 20 percent better off than his or her parents. This is a remarkable reduction in the rate that each generation is becoming better off materially. Over long periods of time, however, even 0,9 percent productivity growth is still a potent force for change because it doubles real output per worker about every 80 years, or one human lifetime. Not only the rate of increase in aggregate income slowed dramatically in recent years, but the way in which that income is distributed among the various income groups has also altered significantly.

In modern industrialized economies, incomes became progressively more equally distributed up through the 1960s. After that, the trend reversed. Following the data given by Lipsey et al. (1993), over the 1970s, 1980s, and 1990s the distribution of income has slowly become more unequal. For example, the share of income received by the lowest 20 percent in the income distribution rose from 5.0 percent in 1947 to 5.7 percent in 1968, and then fell to 4.6 percent in 1990. That is a 20 percent decrease in the share of total incoming going to the poorest group over a 25-year period. At the other end of the distribution, the share of income going to highest 20 percent on the income scale fell from 43.0 percent in 1947 to 40.5 percent in 1968, then rose to 44.3 percent by 1990. That is close to a 10

percent increase in the share of total income going to the richest group in the society. Those changes have been observed in several advanced industrial economies. This growing inequality in the distribution of income seems to a great extent to be due to the increasing need for, and hence higher earnings of, relatively welleducated workers. This in turn is associated with changes in many production processes that demand higher and higher levels of skill. Henry Ford boasted just before 1914 that any job on his assembly line could be taught in 15 minutes to an immigrant worker with an imperfect command of English. Today many jobs cannot be taught at all unless the workers have many years of education, followed by months of on-the-job training. The last few decades have shown two important trends. First, average incomes have risen much less rapidly then in earlier decades. Second, the shift in income distribution from poorer-to better-educated workers means that many of those at the low end of the scale have actually suffered declines in their income compared to what their parents earned. The growth in incomes over the centuries since market economies first arose has been accompanied by continual technological change. Our technologies are our ways of doing things. New ways of doing old things, and new things to do, are continually being invented and brought into use. The technological changes make labor more productive, and they are constantly changing the nature of our economy. Old jobs are destroyed and new jobs are created as the technological structure slowly evolves. The most dramatic change in the structure of jobs in the earlier part of this century was in agriculture. In most economies, at the beginning of the 20th century, half of the population lived on farms. Today, this figure is less than 3 percent. From the second half of this century, the most dramatic changes are associated with the decline of jobs in manufacturing and the rise in service industries. Therefore, many observers interpret this change as a deindustrialization phenomenon of economies. The strong growth in what are recorded as service jobs overstates the decline in the importance of the manufacturing of goods in our economy. This is because many of the jobs recorded as service jobs in fact are an integral part of the production of manufactured goods.

First, some of the growth has occurred because services that used to be produced within the manufacturing firms have now been decentralized to specialist firms. This often includes design and marketing. Indeed, one of the most significant of the new developments in production is the break-down of the old hierarchical organization of firms and the development of the production unit as a loosely knit grouping of organizations, each responsible for part of the total activities; some units are owned by the firms but many are on contract to it. Second, as a result of the rapid growth of international trade, production and sales have required growing quantities of service inputs for such things as transportation, insurance, banking and marketing. Third, as more and more products become high-tech, increasing amounts are spent on product design at one and customer liaison at the other end. These activities, which are all related to the production and sale of goods, are often recorded as service activities. As households’ incomes have risen over the decades, households have spent a rising proportion of their incomes on consuming services rather then goods. Today, for example, eating out is common; for our grandparents, it was a luxury. This does not mean, however, that we spend more on food. The extra expenditure goes to pay for the services of those who prepare and serve in restaurants the same ingredients that our grandparents prepared for themselves at home. Young people spend far more on attending live concerts then they used to, all of us spend vastly more on travel. In 1890 the salesman in a small town was likely to be the well-traveled citizen because he had gone 250 miles by train to the state capital. Today, such a person would be regarded by many as an untraveled stay-at-home. When we talk of each generation having more real income than previous generations, we must not think of just having more and more money to spend on the same set of products that our grandparents consumed. In fact, we consume very few of the products that were the mainstays of expenditure for our grandparents. One of the most important aspects of the change that permeates market economies is the continual introduction of new products. Most of the numerous instruments and tools in a modern dentist’s office, doctor’s office, and hospital did not exist 50 years ago. Penicillin, bypass operations, movies, videocassettes and recorders, pocket calculators, computers, compact discs, and fast, safe travel by jet aircraft, have all been introduced within living memory. So also have the products that have eliminated much of the drudgery formerly associated with housework. Dishwashers, detergents, disposable diapers, washing machines, refrigerators, and their complement, the supermarket, were not there to help your great grandparents when they first set up house. Another aspect of the constant change that occurs in the evolving market economies is the globalization that has been occurring at any accelerating rate over the last two decades. At the heart of globalization lie the rapid reduction of transportation costs and the revolution in information and telecommunications technologies. The cost of moving products around the world has fallen greatly in recent decades. Moreover, our ability to transmit and to analyze data has been increasing, while the costs of doing so have been decreasing equally. Many markets are globalizing; for example, as some tastes become universal to young people, we can see the same designer jeans leather jackets in virtually all big cities. Many corporations are globalizing, as they increasingly become what are called transnationals. These are massive firms with a physical presence in many countries and an increasingly decentralized management structure. Many labor markets are globalizing, as the revolutions in communications and transportation allow the various components of any one product to be produced all over the world. A typical compact disc player, TV set, or automobile will contain components made in literally dozens of different countries. We still know where a product is assembled, but it is becoming increasingly difficult to say where it is made.

One result of this globalization of production is that components that can be produced by unskilled labor can now be produced in any low-wage country around the world, where previously they were usually produced in the country that did the assembly. This has proven valuable for developing countries. They have a better chance of becoming competitive in a small range of components than in the integrated production of all commodities. However, unskilled labor in developed

countries is losing, as their labor becomes less scarce relative to the need for it. In short, the market for unskilled labor is globalizing, throwing unskilled labor in advanced countries into direct competition with unskilled labor in poorer countries. The globalization of the world economy has had profound effects on all economies of the world. Exports and imports are dramatically increasing and constitute nowadays a big part of the economic activity. On the investment side, the most important result of globalization is that large firms are seeking a physical presence in many major countries. In the 1950s and 1960s most foreign investment was made by U.S. firms investing abroad to establish a presence in foreign markets. Today most developed countries see major flows of investment in both directions, inward as foreign firms invest in their markets, and outward as their own firms invest abroad. As well as the well-known developed economies, the emerging economies, like the China, Latin American countries and some East- European countries, become highly integrated countries in the international economic flows of goods and services and in the technological change process. Then, these economies attract main parts of all foreign investment. The U.S. has been no exception to this rule. In 1967, 50 percent of all outward-bound foreign investment came from the U.S. and went to many foreign countries. In 1989, according to United Nations figures, The U.S. accounted for less than 30 percent of all outward-bound foreign investment. At the same time the U.K. accounted for 16 percent, while Japan and Germany accounted for just less than 10 percent each. On the inward-bound side, the change is more remarkable. In 1967, the U.S. attracted only 9 percent of all foreign investment made in that year. In 1989, however, the U.S. attracted 27 percent. Not only do U.S. firms hold massive foreign investments in foreign countries, but foreign firms now hold massive investments in the U.S. As a result, many citizens of various countries work for other countries’ firms. The world is truly globalizing in both its trade and investment flows. Today no country can take an isolationist economic stance and hope to take part in the global economy where an increasing share of jobs and incomes is created.

1. 3. Methodological issues: Economics as a social science