Understanding Political Economy

This book is a brief (150 page) introduction to the field of political economy, written for advanced undergraduates, graduate students (master’s and doctoral), and their teachers and supervisors (p. ix). The book is divided into three sections: the first section (two chapters) covers the intellectual history of the field of political economy. The second section covers theory, including three chapters on (respectively) interests, ideas, and institutions. The third section is composed of four chapters of applications, covering market failure, the welfare state, inequality, and international relations. An afterword concludes.

I had high hopes for this book. It is adapted from the authors’ university courses, and at only 150 pages, I expected a book which could be easily covered in a semester course. Unfortunately, the book is marred by serious flaws, and it is difficult to tell for whom this book might be useful. 

The writing itself is lucid, clear, and engaging, but frequently brief and overly simplistic or one-sided. Despite being a book on political economy, there is almost no discussion of public choice, government failure, or the various tradeoffs between market and government solutions. Instead, this book seems to assume the public interest theory of regulation, and it will contribute little to anyone’s ability to critically engage in comparative institutional analysis. A few specific examples will clarify.

Chapter 6 covers market failure—including asymmetric information, externalities, adverse selection, moral hazard, and public goods. The authors offer a brief summary of why markets work to promote efficiency, and then remark, “This is, at least, what you would read in a traditional economic textbook. But an impressive collection of economic crises in recent decades suggests an inconvenient truth: markets also fail—and they do so quite often and quite spectacularly” (p. 78). This implies that market failure is a topic covered only outside of economics and neglected by Principles of Microeconomics. Friedrich Hayek is said by the authors to have believed that relying on the market-based price mechanism as an “information pooling device” will “achieve perfect [sic] efficiency” (p. 82). The Austrian understanding of the market as a discovery procedure—imperfect but the best yet discovered—is conflated with the proofs of mathematical economics.

George Akerlof’s seminal analysis of the market for lemons (poor-quality used cars) is accurately summarized (p. 84). However, the authors do not ask whether the used car market truly is such a market for lemons—i.e., whether or not Akerlof’s model describes reality. Akerlof shows that severe information asymmetry results in the nonexistence (or severe diminution) of the used car market. Given that we do not have a market for (exclusively) lemons—we do have a thriving market for high-quality used cars—the implication is that real-world information asymmetry must not be so severe. This invites scholars to inquire how information asymmetry has been mitigated and critically compare market-based mechanisms to government regulatory solutions.

And yet the authors never explore endogenous market responses. In fact, every market failure is a potential profit opportunity for any entrepreneur who can benefit consumers by solving that market failure. If consumers do not trust used car salespeople, then a salesperson can profit by convincing consumers that they are trustworthy. Institutions such as CARFAX (often provided for free by the used car vendor), certified pre-owned vehicles with warranties, and independent inspections by third party mechanics are all market institutions which communicate information. The company Lemon Squad will inspect any used car—anywhere in the USA—and prepare an inspection report. But the authors do not evince any awareness of this. Instead, they say (p. 85), “consumers in many countries have the right to return cars within the first few months or even years of purchase if a serious defect with preexisting causes manifests itself.” But the cited government intervention does not even accomplish what the authors claim.

In the United States, each state has its own lemon law, typically covering only brand-new cars. These lemon laws do not usually apply to used cars, which are sold “as-is” and “caveat emptor” (buyer beware). Now, in Europe—where the authors live—lemon laws are more comprehensive. Typically, European laws presume that any defects discovered within one year in a dealership-sold used car must have been preexisting, and the burden of proof is on the seller to refute. Such laws mandate a sort of one-year limited warranty. But are European consumers benefited or harmed by such a law? A mandatory warranty may increase the average quality of used cars, but it is also likely to reduce the supply of used cars and therefore increase their price. Furthermore, even in Europe, these laws apply only to dealerships, not to private sales of used cars. So, two questions remain unanswered by the authors: first, how and why does the used car market exist? Second, how do government solutions to information asymmetry compare with market solutions?

The end of the chapter on market failure briefly discusses (p. 88) Pigouvian taxes, tradable credits, and command-and-control regulation. Command-and-control is needed, they say, when the goal is to entirely eliminate something rather than disincentivize it. But nowhere do the authors mention that taxes and tradeable credits—when feasible—are preferable to command-and-control because the former incentivize entrepreneurs to discover the least-cost methods of internalizing externalities. Nor does this book discuss any potential pitfalls or unintended consequences of Pigouvian policies. For example, in Europe, reduced taxes on diesel fuel, intended to reduce CO2 emissions, increased emissions of particulates and nitrous oxides (Brad Plumer, ​“Europe’s Love Affair with Diesel Cars Has Been a Disaster,” Vox).

Chapter 5 covers “institutions and the wealth of nations.” In this chapter, the authors discuss and compare the conclusions of different explanations of economic growth, including Adam Smith’s, Max Weber’s, Robert Solow’s, and Jared Diamond’s. They insightfully observe the vast differences in economic outcomes between North and South Korea, and between the cities of Nogales, Sonora, Mexico, and Nogales, Arizona, USA—each united by geography, culture, and/or history, yet divided by a political border. And yet they proceed to erect a strawman, saying (p. 63), “Economic actors are, therefore, not as free as classical economists, with their homo economicus as the central player, would like. Institutions constrain . . .” But classical economists like Adam Smith never claimed that institutions are irrelevant. On the contrary, the Wealth of Nations was an attempt to study which political institutions are most conducive to the wealth of nations. As Smith said, “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.” While Smith may have arguably been wrong, he was clearly making a statement about political institutions, not about a homo economicus living in a social vacuum.

Nowhere in the entire chapter on institutions do the authors talk specifically about which particular institutions promote or retard economic growth. There is no mention of due process, rule of law, private property, constitutional limitations, antitrust, etc. Nor is there any mention of how improved scores in the Economic Freedom of the World Index are positively correlated with nearly everything good. The reader will learn abstract theories of whether institutions are causes of human behaviors or whether they are refractory filters which constrain and influence human behavior. But readers will learn almost nothing about why specific institutions actually matter. Readers would learn much more from articles such as ​“The Facts of Economic Growth” by Charles I. Jones (NBER working paper), “Why Do Some Countries Produce So Much More Output Per Worker Than Others?” by Robert Hall and Jones (Quarterly Journal of Economics 114:1 [1999]: 83–116), and “Institutions Rule” by Dani Rodrik et al. (Journal of Economic Growth 9:2 [2004]: 131–65). Even James Gwartney et al.’s principles textbook, (Macro)Economics: Private and Public Choice (Cengage) contains a deeper discussion of the most important aspects of institutions (chap. 16) than the book under review.

In addition, even the chapter on democracy (chap. 2) does not distinguish between limited (liberal) and unlimited (illiberal) democracy, nor between procedural and substantive democracy. Nor does it discuss the value of constitutionally limited government. No distinction is made between the rule of law, the arbitrary rule of man, and the rule of the majority. Institutions of limited democracy such as bicameralism, federalism, and judicial review are not mentioned. This is surprising, because these distinctions are common in political science, and are not unique to political economy nor constitutional economics. Instead, the chapter primarily asks whether democracy and free markets are compatible, and if so, in what way. Milton Friedman and F. A. Hayek are classified as “pessimists” (pp. 27f.) who believe that “democracy will ultimately undermine capitalism.” This will be surprising to those familiar with the “Hayek-Friedman hypothesis” that free markets are a necessary condition for political freedom. (See Robert Lawson and J. R. Clark, “Examining the Hayek–Friedman Hypothesis on Economic and Political Freedom” [Journal of Economic Behavior & Organization 74:3 (2010): 230–39]; Christian Bjørnskov, “The Hayek–Friedman Hypothesis on the Press” [Journal of Institutional Economics 14:4 (2018): 617–38]; Gabriel Benzecry, Nicholas Reinarts, and Daniel Smith, “You Have Nothing to Lose But Your Chains? Re-examining the Hayek-Friedman Hypothesis” [Public Choice, 2025]). No mention is made of the fact that what Friedman—and particularly Hayek—opposed was unlimited, nonconstitutional democracy, not democracy per se.

Chapter 8 on inequality addresses one and only one question: why do the poor not vote to soak the rich? They offer three distinct but complementary explanations: the median-voter theorem, institutions such as first-past-the-post vs proportional representation, and domination by special interests. This discussion is insightful and interesting. But what is missing is a discussion of why inequality matters in the first place. The authors simply take it for granted. But why should relative inequality be more important than absolute living standards? If the poor are getting richer, does it matter if the rich are getting richer, faster? What if reducing relative inequality caused absolute living standards to decline—would that be good or bad? Is there a tradeoff between reducing inequality through redistribution, versus increasing economic growth rates through market liberalization? Nor do they mention the fact that according to the Economic Freedom of the World: 2025 Annual Report, there is zero correlation between relative inequality and economic freedom, but there is a positive correlation between economic freedom and absolute living standards of the poor. 

In general, this book fails to introduce readers to the tradeoffs among different types of public policies, as well as the tradeoffs between market and political solutions. There is no mention of many of the basics of public choice. The authors criticize neoclassical economics for predicting perfect efficiency and neglecting market failure, and yet ironically, they end up implicitly endorsing the worst form of neoclassical economics: the belief that any market failure always justifies intervention by an omniscient, omnipotent, well-meaning government. Students will learn more about comparative analysis from books like Randall Holcombe’s Advanced Introduction to Public Choice (Elgar, 2016), Eamonn Butler’s Public Choice: A Primer (Institute for Economic Affairs, 2012), and Randy Simmons’s and Gordon Tullock’s Beyond Politics (Independent Institute, 2011). In fact, the chapters on market failure, government failure, and economic growth in Gwartney et al.’s introductory textbook (Micro/Macro)Economics: Private and Public Choice (Cengage) are more detailed and comprehensive than this book. Unfortunately, this is simply not the appropriate book for introducing political economy to anyone.