Economics FAQs

A basic understanding of economics is essential in order carry on an informed discourse on public policy matters. Here we present brief answers to basic economics questions that every socially responsible undergraduate should know. We describe how the economy functions without recommending any particular policies.

What is the impact of NAFTA on the U.S.?

What is the problem with taxing corporations?

Is globalization really significant for the U.S.?

Does foreign competition affect American prosperity?

Should we raise the minimum wage to $6 an hour?

Does economic growth hurt the environment?

Why do some countries grow more quickly than others?

What is the impact of NAFTA on the U.S.?

For the United States, NAFTA is essentially a foreign-policy issue rather than an economic issue. Mexico's government needs NAFTA, and the United States has a strong interest in helping that government. The economic impact for the United States is minimal. Essentially all we are doing is lowering tariffs which are already low (from 4% on average to 0%) to imports from a country which is one-twentieth the size of the U.S. economy. Consequently NAFTA will only produce a small gain in overall U.S. real income, perhaps a little over 0.1% of U.S. GDP. Mexico will benefit much more and can expect GDP to be about 4% higher than it otherwise would be. However, economic thoery suggests that there should be a slight fall in the real wages of unskilled U.S. workers. To this date there is no empirical evidence demonstrating this decline, but our best guess has to be that there will be a small negative effect. NAFTA will have no effect on the number of jobs in the United States. The number of jobs in the U.S. depends mostly on the number of workers in the U.S. and the policies of the Federal Reserve. And finally, NAFTA will not hurt and may help the environment. The U.S. has made the environment an issue, and Mexico will enfore its environmental laws more strictly than it otherwise would have. Furthermore, industrialization will shift from the Mexico City to the north alleviating the pollution in a valley a mile above sea level with over 20 million residents.

What is the problem with taxing corporations?

Like most people, economists would like to see more equity in the tax system. By equity, we mean that families with similar incomes should pay similar taxes, and that rich families should pay more in taxes than poor families. But when we tax corporations, we have no idea who is actually bearing the burden of the tax. The most important thing to realize is that people pay all taxes. If you impose a tax on General Motors, then GM may lower dividends to its stockholders, pay lower wages to its workers, or charge higher prices to its customers. It must do at least one of these, and will most likely do all three. Thus a tax on GM is actually paid by it stockholders, its employees and its customers. Will rich families pay more of this tax than poor families? Will families with similar incomes pay similar taxes? We have no idea.

Is globalization really significant for the U.S.?

One measure of the degree of globalization, though certainly not the only one, is the quantity of exports and imports as a percentage of GDP. On the table below we have the export share and import share of GDP every ten years since 1960. You can see that over time we have come to trade a larger and larger share of our goods and services.

YEAR	1960	1970	1980	1990	2000
EXPORTS/GDP	5.13%	5.75%	10.06%	9.52%	11.17%
IMPORTS/GDP	4.34%	5.36%	10.53%	10.86%	15.03%

Though the degree of globalization will certainly continue to rise over time, the pace of the change may have slowed down. The most dramatic changes occured in the 1970's when the amout of trade doubled. There were improvements in transportation like larger merchant ships along with long distance and wide-body jets. Advances in telecommunications allowed firms to communicate with customers all over the globe. The products of modern technology became lighter and easier to transport. And government trade policies became more consistent with our understanding that free trade benefits all countries.

Does foreign competition affect American prosperity?

It is important to remember that countries do not compete with each other in the same way that companies in the same industry compete with each other. One company's gain comes at the expense of another company's loss. But international trade is not about competition, it is about mutually beneficial exchange. When countries trade with each other, the trade benefits both countries. In fact, it is imports, and not exports, that are the purpose of trade. What we gain from trade is the ability to import what we want. Exports are not an objective in and of themselves. It is the burden we must bear in order to import the goods that we enjoy.

Should we raise the minimum wage to $8 an hour?

When the price of ice cream goes up, people buy less ice cream. Similarly, when the price of labor goes up, firms buy less labor. If we increase the minimum wage, firms will lay off some low-wage workers increasing the number of unemployed workers. Of course, the low-wage workers who do not lose their jobs will see their wages go up. Thus the workers who lose their jobs will be hurt by this policy while the workers who keep their jobs will benefit. It is not immediately obvious if society as a whole is better off or not.

Does economic growth hurt the environment?

There is a lot of discussion about the relationship between economic growth and the environment. Some people argue that the increased production of goods and services leads to the degradation of the natural environment, both because production uses scarce natural resources and becauses it generates pollutants as a by-product. These people argue that economic growth should not be a goal of public policy. Others argue that richer countries can afford cleaner environments. They can invest more in resources to clean up the environment and in new technologies which pollute less and use natural resources more efficiently. These people argue that economic growth is good for the environment. Who is right?

As in most difficult issues, both sides are right and both sides are wrong. If you look at measures like the amount of municipal waste per capita or carbon dioxide emissions per capita, environmental problems generally increase with economic activity. And if you look at measures like the percent of the population with safe drinking water or the percent of the urban population with adequate sanitation, environmental problems generally decrease with economic activity. But if you look at measures of air quality like urban concentrations of particulate matter or urban concentrations of sulfur dioxide, the environmental problems are the worst in the middle income countries. As countries grow, their air quality gets worse for a while, but then gets better as they become richer.

Why do some countries grow more quickly than others?

In the long run the growth rate of per capita income depends primarily on four factors. The first is the initial condition of the country. Everything else being the same, poor countries tend to grow more quickly than rich countries. The second has to do with government policies. Countries which are open to free trade grow more quickly. Countries with high savings and investment rates grow more quickly. The third has to do with demographic change. Countries with slower rates of population growth grow more quickly. And the fourth has to do with physical geography. Coastal economies with access to trade grow more quickly than landlocked countries. And countries in the temperate zone grow more quickly than countries in the tropical zone with poor health and unproductive farming.

If you have any general economics questions, submit them to lyamane@pitzer.edu and we may publish the answer here. For further explanations, come chat with one of your economics faculty.