Over the past few months, many people have tried to come up with an explanation for the rise of populism and nationalism – the way the rhetoric of Trump and Sanders, Le Pen and Wilders, seems to resonate throughout the world.
But there’s one contributory factor that people are reluctant to admit to: that the voters don’t know what they’re doing.
By this, I don’t mean that the public are too stupid to have a say in their own government – the argument made in the House of Commons yesterday by Kenneth Clarke. I mean the failure of economic and political education whereby the forces that have driven the world to prosperity in the last century have gone unnoticed by voters.
One Group Is in the Dark
Much of this can be explained by what is known as information asymmetry. This economic theory explains that markets break down when one party has more information than their counterpart in a transaction.
The classic example is a used car salesman and an ignorant buyer. The salesman has a better knowledge of the true value of their car relative to the customer and is able to take advantage of him or her – creating an inefficient market.
Information asymmetry allows politicians to pursue re-election incentives without needing to pursue good governance incentives.
In some markets, information asymmetry is so pervasive that you would be fortunate to realize that anything has gone wrong at all. The governing of nations falls into this category.
As the world becomes a progressively more complex place, voters are being asked to understand an ever-expanding range of policy points. And those policies are not proposed on their merits, as ways to secure long-term benefits for the people, but in order to gain a short-term election victory.
This is where another economic concept comes in: the principal/agent problem. This occurs when a principal hires an agent to act on their behalf, but the agent instead behaves in a way that serves their own self-interest.
Politicians are, effectively, agents hired on the voter’s behalf. But as we all know, they often tend to follow their own interest rather than ours.
The Difference between Social Policy and Economic Policy
On some issues – particularly social policy – this is not actually so much of a problem. On topics such as euthanasia, abortion, gay marriage, drug legalization and so on, politicians may go along with the majority view, whether out of pragmatism or moral conviction. Or they may vote against it, pleading their conscience. Either way, the process takes place out in the open.
But when it comes to economic policy, the situation is different. It tends to contain underlying concepts too complex and specialized for most voters to grasp. Making informed decisions on trade, immigration, government spending and taxes all require at least an elementary knowledge of economic theory.
We have to look at the unseen as well as the seen, this is not as difficult as it sounds because bad ideas are rarely without precedent.
This information asymmetry allows politicians to pursue the re-election incentive without needing to pursue the good governance incentive – for example by buying votes via economic policies that privilege one group over another, or deliver a short-term boom at the expense of a long-term bust. This creates a political market failure.
Allied to this is the problem that picking a side in politics has become comparable to choosing a favorite football team: they tend to demand blind faith in and unquestioning support of their chosen solutions.
But one of the most widely disregarded truths in politics is also one of the simplest: that as Thomas Sowell said, “in economics, there are no solutions, only trade-offs”.
Trading for Higher Prices
As a topical example, Trump’s followers would surely be surprised to learn of the extreme consumer cost and industrial inefficiency that protectionism brings.
We have to look at the unseen as well as the seen, this is not as difficult as it sounds because bad ideas are rarely without precedent. As Robert Colvile pointed out on CapX recently, Barack Obama’s experiment in implementing tariffs of between 25 and 35 per cent on Chinese tyres saw 1,200 manufacturing jobs salvaged, at a benefit to the economy of $48 million a year. Seemingly, a great accomplishment – until you factor in the loss to US consumers of over $1 billion dollars of value in higher prices, resulting in the decimation of 2,500 retail jobs.
Now imagine those tariffs were instead set at 45 per cent, and covered all Chinese products – that is what Trump sold voters. Alongside the obvious diplomatic fallout, and high possibility of economic retaliation, the prices of goods would skyrocket, obliterating consumer spending and creating an uncompetitive domestic industry with no incentive to innovate.
The simplest long-term solution is to include economic theory in the education curriculum.
So why has it persisted as a policy? Because of information asymmetry: the benefits to grateful manufacturers are obvious, but not the costs to retail workers and consumers.
The same principle applies to the Left’s support of the minimum wage. Young people especially push for high minimum wages, without realizing the question they’re asking is: “How high a barrier to employment should government establish?”.
This is not to say if everybody understood the forces of supply and demand, there would be no debate around the minimum wage. Only that it would be a lot more reasoned, and a lot more cautious about the unemployment trade-offs.
The examples are endless. If it was widely understood that a 1 per cent tax increase results in a fall in GDP of 2-3 per cent, that skilled immigration is currently essential to keeping our economies growing, or that socialism brings poverty wherever it goes – movements such as Occupy Wall Street, the European far-right and Hugo Chavez’s Bolivarian socialists might never have made it from the fringes of economic thought.
So how can we realign the government’s incentives, and begin to have open discussions about why one imperfect solution is likely to bring greater value than another?
If we recognize that information asymmetry is the reason we are in this quagmire, then the simplest long-term solution is surely to include economic theory in the education curriculum seems to be the best solution. That would enable students to understand the concepts behind the issues, as opposed to the issues themselves.
True, teaching the marginal propensity to consume or how to maximize the profits of a multinational conglomerate might exceed the scope of the curriculum. But Adam Smith and Frederic Bastiat could easily be slotted in, given their clear explanations and the lack of complex mathematics.
Anybody watching knows there is something pretty awful happening to politics – a dumbing-down and repackaging of tried and failed ideas. And it’s happening because politicians expect only the few who benefit to care, rather than the many more who lose out.
Reprinted from CapX.