On the Principles of Economic Principles

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A couple of weeks ago the American Enterprise Institute, in one of its weekend e-mailings, featured as its “Quote of the Week” a quip from Ezra Klein:

“There’s nothing more dangerous than somebody who’s just taken their first economics class.” — Ezra Klein, in a podcast conversation with AEI President Arthur C. Brooks

I’ve not listened to the podcast, but my guess is that what Klein is getting at here is what the typical pundit suggests whenever he or she (which is frequent) expresses the same thought – namely, that the world is far more complex than ECON 101 makes it out to be and, therefore, real-world policy proposals cannot be adequately analyzed and decided upon with basic economics.

As I say, I’ve not listened to the podcast; this thought might not be what Klein himself is expressing. But this thought is one that is indeed widely expressed. This thought is frequently thrown at me and other advocates of laissez-faire, such as when protectionists allege that our endorsement of unilateral free trade ignores “market imperfections” and other “complexities” that aren’t discussed in econ-principles courses. Ditto for our opposition to minimum-wage legislation. (“Don’t you know that real-world markets aren’t as perfect as they are in ECON 101 textbooks?!”) Ditto, indeed, for almost every endorsement issued by an economist for laissez-faire policies.

It’s this thought that I wish here to discuss.

This thought – that serious discussions of real-world policies often require more than knowledge of a freshman-level economics course – can be interpreted to be trivially true. If we’re interested in understanding, explaining, and predicting many of the details of how people will react to changes in policy – and in tracing out the details of the consequences of these likely reactions – then of course knowledge of economics beyond that which is conveyed in an intro-econ course is necessary, as is knowledge of other disciplines and of particular institutions. Similarly, if we want to understand more fully many observed business practices – for example, the reason that automobile dealerships so often locate nearby each other, or the reason that so many fast-food restaurants are franchisees – then knowledge beyond principles-of-economics is necessary. No one can doubt the usefulness of such more-advanced knowledge.

But it does not follow – from the above rather trite, if true, concession – that a knowledge of only principles of economics is “dangerous.” My strong sense, from having carefully observed public-policy making and public-policy discussion for nearly 40 years now, is that what is dangerous is a lack of knowledge of principles of economics. The problem is not that most politicians and pundits take economic principles too literally; the problem is that most politicians and pundits are utterly ignorant even of these principles.

The typical politician does not oppose free trade because he took an advanced econ course and learned there that, under just the right combination of real-world circumstances, an optimally imposed tariff can be justified on economic grounds. No. The typical politician opposes free trade because he doesn’t understand the first thing about economics. He doesn’t understand that the purpose of trade – any trade, [be it intranational or international] – is to enrich people as consumers and not to enrich people as producers. He doesn’t understand that exports are a cost and that imports are a benefit; he thinks that it’s the other way ’round. He doesn’t understand that the specific jobs lost to imports are not the only employment consequences of trade; he doesn’t understand that trade also ‘creates’ jobs in the domestic economy. He doesn’t understand that domestic producers protected by government from competition have diminished, rather than intensified, incentives to improve efficiencies of their operations. He, in short, doesn’t understand the first damn thing about the economics of trade. And nor do most of his constituents. If these constituents understood basic economics and basic economics only, they would better understand that this politician’s policies are economically harmful and that his policy statements are malarky.

The typical politician doesn’t support minimum-wage legislation because she has concluded, after careful study, that employers of low-skilled workers have sufficient amounts of monopsony power in the labor market (as well as monopoly power in their output markets) to nullify the prediction of basic supply-and-demand analysis and, instead, to create real-world conditions that enable a scientifically set minimum wage actually to improve the welfare of most low-skilled workers without reducing the employment prospects of any of them. No. She supports minimum-wage legislation because she believes that raising the minimum wage will result simply in all low-skilled workers getting the stipulated pay raise without any negative consequences befalling these workers. And most of her constituents – even those low-skilled workers whose jobs are put at risk by the minimum wage – share her economically uninformed belief.

In both of the above cases (and these are only two examples of many), economically destructive policies win favor largely because people do not understand economic principles. Public policy would be improved far more if more people learned only basic economic principles than if those people who now know only basic economic principles learned also more advanced economics.

It’s called economic “principles” for a good reason: what is taught in a good economic-principles course are the principles of the operation of an economy guided by market prices. These principles are just that – principles – because they describe the underlying logic of market economies and, as such, are a reliable guide for understanding the economy (and government interventions into the economy) in most real-world cases. It’s true that reality sometimes serves up unusual combinations of events that render a knowledge only of economic principles misleading. But economic principles would be anti-principles if they did not on most occasions – as a rule – as a matter of course – with a solid, if rebuttal, presumption – give reliable and useful insight into how real-world economies actually operate.

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The claim that I see many people (mostly on the political left) making is something like the following: “Oh, principles of economics is too simplistic. Reality is so complex that, when one learns advanced economics, the policy prescriptions that a student takes from his or her principles course are typically shown to be faulty. Here are some examples. The Minimum wage: Econ principles show that it destroys jobs for low-skilled workers, but advanced economics shows that it can be good for those workers. FDA regulation: Econ principles show that it prevents consumers from gaining access to pharmaceuticals that can benefit consumers, but advanced economics shows that such regulation can be good for consumers. Workplace-safety regulation: Econ principles show that competition for workers obliges firms to supply optimal levels of safety, but advanced economics shows why this conclusion is mistaken.”

If claims such as these are generally true, then what is being taught as economic principles would be anti-principles. If claims such as these are generally true, then what is being taught as economic principles would be, at best, simplifications of reality so extreme that they misinform students rather than inform them. If claims such as these are generally true, then the typical econ-principles student should demand a refund of his or her tuition and compensation for being defrauded by his or her college.

But, instead, if what is taught in (good) principles of economics classes (such as I am sure are featured at George Mason University) is in fact solid principles of economics, then principles-of-economics students are better informed about reality at the end of the semester than they were at the semester’s start. Such students can use these principles as a generally reliable, if not infallible, guide to understand reality and to predict the general consequences of typical government interventions such as price controls and trade restrictions.

Put differently, suppose that the knowledge conveyed to students of, say, good introductory physics courses were analogous to the knowledge of what people who disparage principles of economics believe is conveyed to students of introductory economics course. In that case, then the likes of Newton’s Laws of Motion and Boyle’s Law would be downright misleading when used to understand most instances of observed reality. Of course, in reality these basic laws of physics are not misleading, although they also are understood not to reveal all relevant details of the reality that they are used to describe. In contrast, many critics of principles of economics – being unable to discredit these principles as such (Do you really not believe that a rise in the price of Rome apples relative to the price of Macintosh apples will increase consumers’ demand for Macintosh apples?) – insist, ignorantly, that these principles are too weak and general to supply a solid grounding for assessing policy proposals.

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And in the above I ignored a related question – namely, how valuable for policy analysis is the information and knowledge conveyed in advanced economics courses. (By and large, I think the answer is ‘not very’ – at least not for economics courses beyond solid intermediate ones.)

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