Tuesday, July 09, 2013

Mythbusters: Economics Edition

Robert Atkinson and Michael Lind posted a terribly foolish article on introductory economics yesterday at Salon. They claim economists tell a series of ten myths but fail at every turn. Let's look at each "myth" in turn.

Myth 1: Economics is a science. They claim that since there is disagreement in economics--citing a survey reporting 40% of economists agree increasing the minimum wage would make it harder for people to find jobs and 40% disagree--economics cannot claim to be a science.

Right off the bat, the survey they cite actually ask respondents if raising the minimum wage would make it noticeably harder for people to find work. "Noticeable" means different things to different people (hardly a scientific question) so you're going to get disagreement. Better wording yields 79% agreement.

But fundamentally, economics is a science. You might see economists disagree a lot because we like to talk about things we disagree about. Discussing points of consensus is boring, like two astrophysicists arguing if the earth revolves around the sun or the sun revolves around the earth...no one will take the latter argument. Sure, as a social science economics has more give than the physical sciences. But we still test our hypotheses and make accurate predictions.

Myth 2: The goal of economic policy is maximizing efficiency. They claim the actual goal is to create disruptive innovation which, in turn, causes inefficiency. The right allocation isn't the goal.

This is really just a misunderstanding between the short and the long run. In the short run, R&D spending might seem inefficient (and it is at some level; too much on R&D means you don't have income coming in to fund it). It's a payment without a benefit. But in the long run, it's worth it. It's an investment and smart investments result in greater efficiency.

Myth 3: The economy is a market. They claim that a great deal of economic activity takes place in governments, households, and nonprofits.

Let's be clear: a "market" is a gathering of people who engage in exchange. Conventional markets are an excellent (clean) way to illustrate how the economy works, but governments, nonprofits, and even households illustrate market activity, too. Government actors swap favors and votes. Bureaus and nonprofits compete for funds. Even households engage in specialization and exchange ("Who's turn is it to do the dishes?)

But all of this is really a minor point because the purpose of this "myth" in econ 101 is to discuss how this sort of activity plays out. Buying and selling (and producing!) in a conventional sense is clean world for students to discuss and understand. We set aside complexities for much the same reason you ignore air pressure when calculating how long it takes something to fall 30 meters in physics.

Myth 4: Prices reflect value. They point out sometimes prices don't reflect value, such as in stock markets bubbles.

This is why every econ 101 class covers externalities (when prices don't reflect value). The flaws of the Efficient Market Hypothesis is good to discuss in finance (I sometimes cover it in introductory but ultimately decided other things were more important). But the EMH is useful: most of the time, prices really do reflect value. If they didn't economists could play the stock market and be billionaires overnight. But, as any investor will tell you, beating the stock market is really, really, really hard. The EMH explains why.

Myth 5:  All profitable activities are good for the economy. They claim some profitable activities, like crony-capitalism (profits that come from political connections) and stock market manipulation, aren't good for the economy.

Again, this is why we cover externalities and monopolies and taxes and subsidies. No econ 101 course would claim all profitable activities are good for the economy.

Myth 6:  Monopolies and oligopolies are always bad because they distort prices. They claim that having a few producers can be good because of economies of scale and innovation creation.

Beyond the obvious contradiction between this myth and the previous two, most monopolies really are bad. But econ 101 covers the idea of economies of scale and it's connection to monopoly (called a natural monopoly). The value of monopolies (incentive to invent) is something I cover in my class and admittedly, I think it should be a larger part of the conversation.

Myth 7: Low wages are good for the economy. They claim high wages are good because you get workers with high productivity.

And they would be right, but ultimately wrong, because no economist claims wages should be high or low. Economists just want wages (like all prices) to be correct. See item #4.

Myth 8: “Industrial policy” is bad. They argue industrial policy can be good because governments can encourage firms to shift money to R&D and other activities with a high rate of return.

It's not that industrial policy is "bad" (again, economists argue subsidies and tariffs are useful policy tools) but that it's dangerous (because, again, crony-capitalism/corruption can get in the way of good policy). A handful of people (government agents) guiding the economy will be more corruptible and less informed than a hundreds or thousands of firms being paid for being right.

Myth 9: The best tax code is one that doesn't pick winners. An ideal tax code would encourage efficient innovation (e.g. R&D tax credit).

But most tax codes distortions are really undesirable and it is just as dangerous to invest too much in R&D than it is to invest too little. There is good reason to start with the idea of zero favoritism. To claim 101 students should consider all the nuances to slight modifications along this line is a waste of time; if students are in a position to influence policy, they can call an expert for advice and ask him/her about the devil which lives in the details. Besides, this general idea is covered in 101 anyway: in externalities.

Myth 10: Trade is always win-win. Industrial policy is the ultimate driver of what determines what a country is best at producing, not comparative advantage. "Koreans and Japanese are not good at making flat panel displays because they have a lot of sand"

I quoted that last bit because it is particularly unbelievable. The source of a country's comparative advantage isn't limited to natural resource but labor force skills and size, location, compatible industries, trade port quality, natural of government, etc. Governments and firms can foster comparative advantage in one direction or another (risky, for reasons mentioned above) but it really is all about comparative advantage.

What all this has to do with trade nor always being win-win is unclear but it's worth noting (in a nod to item #1) that economists really do have wide consensus on the virtues of free trade.

Much like any discipline, economics is a complex subject; the important stuff doesn't stop at the introductory level. If the authors feel econ 101 could use more nuance, they should remember a sizable portion of classroom time is taken up correcting the nonsense students enter the course with, nonsense reinforced by articles foolish journalists write.