A Persian Cafe, Edward Lord Weeks

Sunday, 30 March 2014

Econ 101 is in good health

Robert Atkinson and Michael Lind have an article at Salon.com entitled "Econ 101 is killing America", which complains that economists are presenting the public with an oversimplified and largely erroneous view of economics. They present 10 complaints, or "Myths", of economics, which I shall debunk here.

Myth 1: Economics is a science
Problem number one: what do they mean by science? It seems like they mean "the conclusions of economics are uncertain, as opposed to the conclusions of the sciences which are firmly known to be true." As evidence, they cite the fact that there is missive disagreement over whether an increased minimum wage would have a severe negative impact upon employment.

But this is far from being a fair picture of either economics or the natural sciences. The whole history of science is one of erroneous theories being replaced by other theories which better fitted the facts - Newtonian mechanics being replaced by Einsteinian mechanics, for example, or "group selection" being replaced by the idea that group selection takes place on the level of genes rather than organisms. The conclusions of science are not absolute, unyielding certainties - they are simply the explanations which best fit the facts. Hence, where there is no clearly-best theory, scientists have disputes. Does the fact the string theory is highly controversial mean that physics is not a science? Of course not. Equally, there are many things in economics which we are near-certain of. Giffen goods aside, the higher the price of a good is the less of that good people will want to buy. (And even with Giffen goods, we're pretty confident that we know exactly when and why they exist). The wealthier you are, the happier you tend to be. International trade is a Good Thing. These conclusions are things we would tend to reason out from first principles, but they have extensive empirical backing. Yes, we don't agree on everything, but a) neither do "real scientists" and b) a lot of the disagreement over economics arguably comes down to politics - if quantum gravity really did have progressive implications then I would expect it to be rather more controversial than it is.

To be fair, there is an important difference between economics and the natural sciences. Economists - especially macroeconomists - struggle to conduct experiments due to the absence of "controlled conditions" in the real world and so have far weaker data than natural scientists. But this is something which is made quite explicit by economists, and it's not a point which Atkinson and Lind even raise. Indeed, the quote they choose suggests the opposite, asserting that economists will continue to disagree "no matter how sound their data".

The real question here is why Atkinson and Lind feel the need to argue this. I doubt the average educated person, let alone the typical person in the street, cares strongly about whether the basis of knowledge is human reason or empirical investigation (note from a philosophy professor wannabe: it's both, but mainly the latter). They aren't making an actual argument about economics, they're simply trying to reduce its status by disassociating it and then comparing it negatively with a field-name - "science" - which educated people tend to have a great deal of respect for.

Myth 2: The goal of economic policy is maximising efficiency
This is another case of them being slippery with words in order to pretend they are making a point. A slightly modified version of this sentence would be: "The goal of economic policy is maximising static efficiency." This is the statement they are attacking, and they are quite right to do so. But in the process they are beating a dead horse: economics clearly distinguishes between productive efficiency (minimum average cost of production), allocative efficiency (price equals marginal cost of production) and Pareto efficiency (no-one can be made better-off without making someone else worse-off) plus probably a whole host of others the I haven't come across or can't remember right now. The first book on economics that I read - indeed, the book that got me interested in economics and left me impatiently waiting for the next four or five years until I could study it - was Tim Harford's The Undercover Economist (seriously, if you haven't read it then do so) and while I can only remember Harford mentioning Pareto efficiency, he clearly demonstrates that it is not the only thing we aim to improve with an example using train commuters.

Myth 3: The economy is a market
It is true that economists have put far more study into the private sector than into either the public sector or the voluntary sector. However, any basic economics course will introduce the concept of market failures, where markets lead to an inefficient allocation of goods, and will discuss remedies the government can attempt to put into practice - Pigou taxes on negative externalities, government provision of public goods, etc.

Myth 4: Prices reflect value
Sigh. In a free market, prices do reflect value - more accurately, they reflect the value of the good to the marginal consumer, the consumer who is indifferent between buying and not buying the good in question. This is basic economics, firmly part of any introductory economics course.

Atkinson and Lind argue that because some financial assets turn out to be worthless, this must be wrong. But they are guilty of conflating values from different moments in time and epistemic states. If I offer to sell you a bet whereby I roll a die, and on a 1-5 you get nothing but on a 6 I give you £10, then clearly this bet is worth somewhere in the region of £1.66. Suppose you buy it for £1.60, I roll the die, and it comes up as a three. Were you wrong to buy the bet? Was the bet actually worthless, and you fell for a trick? Of course not - there was uncertainty as to the payoff of the bet, and you paid an amount which reflected the value of the average outcome of that uncertainty. This is the case with many goods - not just financial products traded in the City of London and on Wall Street, but houses, collectibles, start-up companies... The fact that, in hindsight, one would have been better off not buying a product is not proof that one was ripped off when one bought it

Myth 5: All profitable activities are good for the economy
The authors damage their credibility with anyone familiar with the foundations of neoclassical microeconomics by describing this as an "axiom" of economics. An axiom is a starting assumption, taken as a given in order to derive its consequences. Neoclassical microeconomics has a number of axioms, but this is not one of them (the abstract of this article which I haven't read suggests there is some disagreement over what they are; the key axioms I learned were those of completeness [a consumer, given the choice of two bundles of goods, either prefers one of them to the other or is indifferent between them], transitivity [if bundle A is preferred to bundle B, and bundle C is not preferred to bundle B, then bundle A is preferred to bundle C], non-satiation [given the choice of two bundles of goods, one of which is unambiguously larger than the other, the consumer prefers the larger one] and convexity [if a consumer is indifferent between two different bundles, she will prefer a weighted average of them to either of them; this isn't always going to be true, but it's a reasonable assumption due to diminishing marginal returns]).

Indeed, basic microeconomics courses present at least one obvious example of a profit-making activity which is not necessarily good for society as a whole: one with negative externalities. A factory which produces neat goods but pollutes the entire town may or may not be a net boon to the economy, but if the factory owner does not have to pay the cost of the pollution it is considerably more likely to turn a profit than if he does have to bear this burden.

Myth 6: Monopolies and oligopolies are always bad because they distort prices
Sigh. Distorting prices is a bad thing. They may have good side effects - higher R&D investment is one touted example, although I'm sceptical - why can't outside investors spend money researching improvements to a product or process? Why must the funding come from inside the existing industry? How would completely new industries emerge if this were the case? In any case, the obvious conclusion is that this is something of a trade-off, but the distortion of prices is definitely a bad thing since it leads to a dead-weight loss. (It also transforms some of the consumer surplus into producer surplus, but there's nothing inherently wrong with that).

Myth 7: Low wages are good for the economy
Ah, yes. Low wages are good, high wages are bad, and yet we are at loggerheads over the minimum wage even though its key effects are universally agreed to be to raise wages (which is of course bad) and possibly to reduce employment (also bad). Do they seriously think anyone actually believes this?

Myth 8: Industrial Policy is bad

Well, it kinda is.

The argument here is that private and public returns from certain industries differ by substantial amounts, and therefore that the government should subsidise those with substantially higher rates of return to the public. It's true that certain projects will have a higher social benefit, relative to the private benefit, than others, and there are two reasons why this might be. The first is the existence of externalities, but as discussed above this is well covered in basic economics courses and it would be an abuse of the term to label internalising externalities as "industrial policy". The second would be that certain industries would have abnormally large consumer surpluses as compared to their producer surpluses, due to highly elastic supply or highly inelastic demand with respect to price. But for the government to promote businesses of this type would require it to be able to work out which markets had supply or demand curves like this. It's pretty well established that businesses can't work out what the price elasticity of demand is, and there are few a priori  reasons to suspect that certain markets will have more elastic or inelastic demand than others. The only one I can think of is the case of addictive goods, which would tend to have price-inelastic demand and therefore large consumer surpluses. There we go, the best industrial policy is to subsidise cigarettes and alcohol.

       Pictured: the future

(This is quite serious: at first I thought the argument led to discouraging them and wrote that, but then realised I'd mislabelled the axis on my graph and that a subsidy was indeed called for).

Myth 9: The best tax code is one that doesn't pick winners
Again, the issue of externalities! What is it with these people? The best response to externalities is well-enforced property rights and Coasian bargaining, or failing that either a Pigou tax or nothing at all depending upon how confident you are that the regulator will act in the public interest. They talk about certain industries making higher contributions to "long-run growth", without explaining why these industries would not therefore earn higher long-run profits and therefore be favoured by investors.

Myth 10: Trade is always win-win
By this, they mean international trade. And quite simply, international trade is always win-win. They claim that nations such as America, Britain, Germany and Japan have used trade protection to become powerhouses, conveniently ignoring the fact that the industrial revolution in Britain occurred precisely when we moved toward free trade, that in the USA it was always the rich, industrialised north which wanted free trade and the agriculture-based south which wanted trade protection (this was a contributing factor towards the civil war) and that the Japanese move towards becoming rich (1950 onwards) coincided with the end of a long, long period of protectionism. It is true that Germany had certain protective measures in place while they industrialised, but they are very much the exception. Everywhere else you look, it is the free-trading nations - Stolypin's Russia, Hong Kong - which have become rich and prosperous, and the protectionist nations - India between WWII and 1990, for example - which have condemned their people do poverty, hardship and misery. When Paul Krugman claimed that an economists' creed would contain the words "I advocate free trade" he was not guilty of oversimplifying: it really is that clear-cut.

It's a great shame, though perhaps not a surprise, that anyone takes this kind of bunk seriously. Just to drive a nail of two in, I feel like an ad hominem is called for. (Is this really an ad hominem? In the words of Murray Rothbard:
First of all I want to launch a pre-emptive strike against any critics who might accuse this talk of being ad hominem. The ad hominem fallacy is that instead of attacking the doctrine of a person you attack the person, and that is fallacious because that doesn’t refute the argument. I’ve never been in favour of that. I’ve always been in favour of refuting the doctrine and then going on to attack the person.
I'd also note that many great works of analytic philosophy not only refute an opposing argument, but attempt to diagnose why someone might be so confused as to make this argument - see, for example, G.E. Moore's attack on the Doctrine of Instrinsic Relations.)

In any case, let's have a look at the economic-educational backgrounds of Atkinson and Lind. Atkinson possesses a Master's in Urban and Regional Planning and a PhD in City and Regional Planning. His doctoral course may have changed in the years since he took it, but it looks like you could go through it without any serious study of economics. I doubt he avoided it completely, but I highly doubt this course involves any rigorous coverage of modern economics or economic modelling.

Lind has an honours degree in History and English, a Master's in International Relations, and a Juris Doctor from Texas Law School. Any of those could have an economics course somewhere in them as a free-credit module, so there's certainly a reasonable possibility that he took an economics course at some point. However, it would at most have been a tangentially related part of any of those qualifications.

It's certainly possible that one or both of them have done extra, informal study of economics since they finished university. However, given the misuse of terminology and the reliance on appeals to authority over actual analysis I suspect they haven't - certainly, if they have they it is not shown in this piece hack-job.

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