Political economy (PE) is an allocative system or a system for solving the allocation problem.

Resource allocation is the calculated assignment of goods and services to production, distribution, consumption, and wealth and prestige accumulation.

PE deals only with the reason or logic behind resource allocation, but not with the determination of the quantities transferred, nor who gets what, when and how.

These four areas of economic activity sum up the human, individual and society's, needs or economic wants.

PE exists primarily because in everyday life our economic and political decisions are not independent or free of one another.

PE as a theory that asserts this obvious truth has been long and arduous, and PE did not emerge until after World War II.

Why? Jealousy between political scientists and economists, each followings different methods, each denying the relevance of the other.

Evidence of this academic jealousy: the continuing separation between the departments of Economics and Political Science and the absence of undergraduate political economy programming in most universities.

This academic jealousy has spilled over into an uncompromising ideological split between pro-market conservatives (in the US, Republicans) and pro-government liberals (in the US, Democrats).

Economists concentrated all their analysis and method of problem solving on the market.

A market is any mechanism that brings potential buyers and suppliers together.

The wide range of markets is usually grouped into four: labor, capital, consumer and industrial markets, with different degrees of competition.

The most enduring market principles are competition, free enterprise, individual decision making, private ownership of property, exchange, and the determination of prices through the free interaction of the market forces of supply and demand, called market determinism.

Political scientists concentrated their analysis and method of problem solving on government also the state.

The most enduring political principles are power, authority and subjugation to authority, the people, the polity, public decision making called, policy, bureaucracy, legislature, executive, judiciary, and public ownership of property.

This division has many negative consequences of which three are important:

It diverted attention and analysis away from the many things politics and economic share in common such as improving the welfare of citizens.

It let to extremism on both sides with economists preaching market determinism and politicians seeing expanded government as the solution to all social problems.

It creates a distorted view of political economy as a question of personal preference for or against government.

But several recent developments internal as well as external to the US have forced analysts to seek ways of bridging the gap between politics and economics:

1. First is Increased Economic Interdependence popularly called globalization.

Increased economic linkages between countries takes away the opportunity of countries to operate successfully as separate economic entities governed by governments that are largely autonomous from other states.

Interindustry trade refers to the exchange of similar industry products between two or more countries.

It differs from traditional trade that is based predominantly on the exchange of specialized goods and services.

More than traditional trade, interindustry trade could take jobs away from countries with higher labor costs even while their citizens can find most things from imports.

Attempts to save the environment and our ecosystem can be effective only through cooperation among governments and by making market decisions subject to public environmental concerns.

Thus increased environmentalism forces governments to intervene in decisions once thought of as purely market decisions.

Rapid diffusion of technology breaks down the traditional division of global labor which in turn accounts for much of the division of the world into advanced and developing worlds.

Like interindustry trade, rapid diffusion of technology could potentially create huge unemployment in advanced countries with higher labor costs, even though their resources are spent developing the technology that fuels production around the world.

Increased financial linkages among countries limit their ability to use monetary policy to gain competitive economic edge over other countries, or to avoid the negative effects of economic problems of other countries.

2. Second was the Arab Oil Boycott of 1973 and 78.

The impact on western economies of OPEC’s quadrupling of crude oil prices in the 1970s reminded the world of the relevance of political economy and served as a wake up call for new efforts to acknowledge the close relationship between politics and economics.

The oil boycott force countries with oil reserves to learn to share with oil-importing countries.

It also showed the increased power of economically poor but oil-rich countries and the need for the developed oil importing countries to court their cooperation.

3. Third Increasing significance of economic power over purely military solutions to global conflict.

The use of oil by Arab countries as a successful weapon where their military capability had failed is yet one more evidence of the increasing significance of economic power over military power.

Other similar landmarks signaling this changing trend would include the defeat at the hands of the Vietnamese of the powerful American military, the need for America to call on Japan, Germany, and Saudi Arabia for financial assistance to successful prosecute its Gulf War, and the incompleteness of recent US military campaigns in Haiti, Somalia, Bosnia-Herzegovina, and Kosovo.

It is also evident in citizens’ changing conception of personal security from protection against foreign invaders to protection against job, health, educational and other social welfare forms of insecurity.

Under this new concept of security, the powerful countries is not necessarily one that dominates militarily over others, but rather one that has a sound political economy.

And maintaining a sound political economy in our globalized environment of today means successfully balancing the demands of economic growth and technological progress with citizens’ cry for inter-racial justice, equal opportunity and political representation, and democratic freedom.

4. The fourth major development that contributed to the re-emergence of political economy is the end to American economic hegemony and the appeal of industrial policy programming in the United States.

While the US retains its 1960s preponderance of military power over its allies and rivals, it no longer commands similar preponderance in the economic area, and so becomes equally vulnerable to the demands of economic globalization.

To lesson this vulnerability, the US has joined other countries in the promotion of industrial policy in channeling public funds to augment the competitiveness of its domestic companies.

The one thing all these developments call for is an interdisciplinary approach to problem solving.

This initial response to this call took the form of market failure analysis.

In market failure analysis, PE is treated as so many areas where the market system fails.

These few areas aside, all goods and services should be allocated through the market system.

Why? Two reasons.

First, according to this view, only the market is efficient, that is, capable of eliminating all waste; political allocation is wasteful but necessary in those areas of the allocative process where the market fails to eliminate all waste.

Second, according to this view, only the market transforms individual pursuits into the collective good–the so-called invisible hand argument of Adam Smith. How?

To stay in a competitive market (the sum total of all economic transactions in which goods and services are exchanged through the medium of money) suppliers (producers, sellers) are forced to produce only the best and to sell at the lowest cost-efficient prices, in other words, the best society can hope for.

Where may government enter the allocative process because the market fails?

To produce Public goods

To regulate and control human violations of the market

To create a welfare state through wealth redistribution in order to overcome the income polarizing effects of capitalism.

The areas where the market fails are referred to as "market failures."

Market failure analysis is inadequate because it treats PE as a case of pathology.

Pathology means an abnormal variation from a sound condition.

According to this view, market allocation is the norm (the normal healthy body) and government allocation an unavoidable violation of the norm (the doctor with painful needles and bitter medicine when the body gets sick).

Our author approaches PE as so many cases of mutual interdependence between politics and economics, between state and market processes.

Two things are interdependent if their full potential cannot be realized without help from the other.

According to the view, PE assumes or is based on the following:

1^st Premise: Political economy presumes all resources (whether political or economic) are scarce relative to needs: We allocate resources because resources are always scarce, meaning human wants always exceed the resources to satisfy them.

2^nd Premise: Political economy recognizes two distinctive aspects to the allocative process: Some allocative functions can only be efficaciously performed when based on individual decision making, while others require collective decision making to be effective.

3^rd Premise: Politics and Economics are two very distinct systems with two equally different methods of solving the scarcity problem.

Economics as economic thinking or economic calculation starts with the reality that material wants are unlimited while economic resources are limited or scarce.

The need to allocate or ration out resources arises in the conflict between the two.

Whereas political constraint arises from our social milieu, economic constrain is between society or the individual's own competing needs.

Whereas the solution of political conflict requires government intervention, the resolution of economic conflict is internal and needs no external intervention.

ationing is the method of allocating economic scarce resources.

But rationing, whether political or economic, imposes painful choices or tradeoffs.

The best alternative value we give up to enjoy our most preferred choice is the opportunity cost of our choice.

But scarcity forces us to be efficient; either to do more with the same amount of resources, or to achieve previous records using less.

Rationing is the first of the two-stage process by which the scarcity problem is resolved in the market system; the second is economic exchange.

Rationing a logical process of selection and can occur only under three assumptions:

1. That there are many options to select from;

2. That these options can be rank-ordered from most desirable to least desirable;

3. That a higher ranked value is selected above a lower one.

Each consumer must ration his or her resources, chose and select from his or her range of wants the best combination that not simply matches, but maximizes his resources.

The individual nature of economic choice is illustrated in the very different choices and tradeoffs made by Tom and Larry.

The ordering of the individual's preferences is termed, a "preference schedule" which is very personal, reflecting each individual’s ordering of values.

Economic exchange is the logic behind economics, the mechanism through the economic scarcity is resolved in the market place.

Economic exchange can happen only if three conditions are met:

1. That there be at least two or more partners engaged in the exchange;

2. That each of two partners has two things: a need and a value;

3. That the exchange values must match;

4. That neither party to an exchange can provide his or her own needs.

Pareto optimality: Given these conditions, economists claim that exchange would yield nothing but pure gain (gain net of cost).

Economists' claim that economic solutions are more efficient than political solutions is based on three assumptions:

1. that economic rationing is rational, that is, based on a well-calculated analysis of costs and benefits;

2. that economic rationing is not zero-sum;

3. that economic exchange results in only net gains.

Politics as analyzed in this book emphasizes the logic behind political allocation; or the logic behind the exercise of power as authority–legalized use of force.

So used, politics has two meanings: As social conflict and as the means of removing social conflict.

Morgenthau's approach to power best represents political economy's understanding of politics as a social constraint.

Political economy understands political constraint as a clash over social values and resources which are scarce relative to needs.

Political constraint (this clash between social values) originates in the human condition of man as a social being.

Schattschneider's approach to politics represents Political economy's second understanding of politics as the power to settle the clash between social values.

Political constraint precludes any opportunity for mutual voluntary settlement.

Therefore, political constraint can only be settled through intervention by a third party, which at the state level is government.

Because it calls for third-party intervention, politics sets up a power relationship between the law-giver and the subject.

Private authority relies upon love relationship to ensure compliance.

At the state level, authority is backed by a legal punitive capacity with which to compel subjects to compliance.

Politics allocates resources either by rationing or through a zero sum method.

Rationing, for example in the distribution of scarce budget dollars, involves giving each of several competing units a little less than they ask for.

Other social values and resources are nondivisible and so cannot be shared, meaning one person wins all and the other loses all--zero-sum.

Both forms of political solution on arbitrary decisions that leaves all parties very unsatisfied.

4th Premise: Only politics and economics have all the requirements for solving the scarcity problem on a large scale, that is, nationally.

Synonyms for politics: the state, the collective, and government or power or control or authority.

Synonyms for economics: the market or the exchange system, and capitalism or the private enterprise system

Efficacious, or the ability to deliver the most desired effects: Economics is efficient in eliminating all waste; and only politics can solve social or collective conflict.

Systematic or ability to operate according to clear logical (cause and effect) reasons why resources should exchange hands.

Political allocation is based on the logic of authority or legitimate use of force.

Economic logic is based on the mutual gains from market exchange.

Reliability or the ability to deliver same effects under same conditions.

Legitimacy or voluntary systems that are approved as lawful by all involved, and therefore backed by a system of laws.

Other means of transferring resources from one hand to another such as coercion, mutual reciprocity, persuasion, love and charity, communalism, and communism lack some or all of these prerequisites.

5th Premise: The efficacious solution to certain scarcity problems requires the use of both political and economic means of problem solving, the essence of political economy.

PE is situated (can be found) where politics and economics merge, or must be combined for the efficacious allocation of certain resources.

By merger, we mean where allocation process responds to (takes into account) both political as well as market considerations at the same time.

Politics and economics must merge because by themselves neither provides a perfect solution to all of society’s scarcity problems.

6^th Premise: PE does not posses an independent logic of its own.

PE is a third dimension in the allocation process, but not an independent system.

In PE, politics and economics are dialectically related–their interaction does not constitute a third and separate entity as in a synthetical relationship.

All the abstract definitions used in PE are taken from Political Science and Economics. So how is a PE decision different from a purely economic or purely political decision?

In a purely economic system, an economic agent will respond to only one set of incentives (or logic, or reason) that are economic, e.g., paying someone to mow your lawn, other things being equal.

In a purely political system, an agent will respond to only one set of incentives that are political; e.g. attending a political convention, other things being equal.

In a political economy system, a political economic agent will respond simultaneously to two sets of incentives, one political, the other economic, e.g., locating an auto plant to meet environmental requirements while ensuring maximum profit.