January 26, 2023 | Tags: BEACON
Legend has it that an art collector once asked Michaelangelo to describe the challenges he faced in sculpting one of his most iconic works.
“It was actually quite easy,” Michaelangelo drolly replied, “I just chipped away the parts of the stone that didn’t look like David.”
The story may be apocryphal, but we’ve found the great artist’s strategy helpful in communicating the essence of economics to our freshman students.
Much of the learning in Econ 101 is subtractive. It consists in removing false notions about what economics is and the sorts of claims economists can make. By gradually chiseling away the things that economics is not, the true nature of what economics is and what insights it can provide come into sharp relief.
In that spirit, here are five things that economics isn’t.
Critics routinely accuse economists of making unrealistic assumptions about human psychology.
In particular, they often dispute economists’ insistence that human beings are rational. (Perhaps confusion would dissipate if a different word had prevailed, but we only report on the rules—we don’t write them!)
By “rational,” economists don’t mean to imply that people are omniscient (if they were, economics would be of little value). Nor do we mean to suggest that they are Vulcan-like cyborgs who absorb all information to perfectly calculate the cost and benefits of every action. Such a wooden anthropology doesn’t describe anyone we know.
Instead, economists mean only that people are purposive. They are goal-oriented beings who use what they believe are the best means available to achieve their desired ends.
Rationality doesn’t preclude error or regret. Indeed, a big part of economics is explaining why people make what they later judge to be mistakes and the process through which markets help them correct those errors.
But purposive beings don’t act randomly like atoms colliding in the quantum realm. They have goals and act with intent to achieve them.
Rationality also doesn’t imply that people are (or ought to be) “selfish” or “self-absorbed,” as critics contend. Rather, rationality means that people pursue their own goals, however they choose to define them.
Economists readily acknowledge that most people do care about more than maximizing profits or amassing a vast personal fortune. People’s demonstrated choices reveal that they pursue many non-monetary goals, like the well-being of others (family, friends, etc.) or spiritual edification.
People have goals. But beyond that, economics is completely silent on cognitive psychology—the inner workings of the human mind.
Too often, admissions like this get interpreted as economists dismissing important matters of cognition, perception, and physiology. Far from it, this is an attempt at intellectual humility.
Economists aren’t interested in cosplaying as psychiatrists or psychologists. We are quite content to leave these questions to experts in other disciplines. Why some people perceive what others don’t, are impulsive or resilient, are self-absorbed or outwardly-focused, etc., are all important questions. They’re just not ones that economics can answer.
Rationality, while seemingly simple, undergirds one of the most important ideas in economics: people respond to incentives.
Why does mandating seat belts lead to higher traffic fatality rates? Changing the rules shifts the costs and benefits people face.
Seat belts lower the cost of reckless driving, thereby incentivizing more of it. A reckless driver wearing a seat belt might escape a horrendous accident with only minor injuries. However, the cyclist or pedestrian he hits probably won’t be so lucky.
In short, economics doesn’t explain the psychology of why people like what they like (i.e., why do some men really like fast cars?). But it does explain how the incentives and constraints people face influence how they behave.
Economics also isn’t an ideological discipline.
Ideologies tell people what policies they should support to achieve their political and ethical goals. Should voters agitate for policies that seek to reduce income inequality, even if that goal comes at the expense of reduced economic growth?
Economics qua economics is silent on this question.
The so-called “dismal science” is positive, not normative. Its analysis is descriptive, not prescriptive. It teaches us about what is, not what ought to be. Economics tells us what tradeoffs we face, not which tradeoffs are worth making.
Consider a policy aimed at reducing inequality: capital gains taxes. Economics teaches us that capital gains taxes discourage people from investing their savings. As a result, there will be fewer savings available to finance business investments, other things equal.
Economics cannot, however, tell us whether those tradeoffs are worth bearing. Whether or not a government should tax capital gains is a normative question. It is best suited for a course on ethics or political philosophy, not an economics class.
Critics often accuse economists of being apologists for free market ideology, since economists so frequently highlight the tradeoffs associated with government intervention.
Yet, such criticisms notwithstanding, economics is ideologically neutral. Good economists point out the tradeoffs associated with policies; they don’t tell you which policies to support.
It’s true that economists are more likely to favor market-oriented policies and to be wary of the efficacy of regulation than are their counterparts in other disciplines. This support, however, doesn’t stem from dogmatic adherence to “laissez-faire” ideology. It flows from a dogged insistence that no policy ledger is complete until it has taken a full accounting of the costs of an action.
In any case, economists’ apparent affinity for markets isn’t ideological. It’s logical. While it’s relatively easy to identify benefits of government intervention, economics trains our vision on the “unseen” costs, the drawbacks, of such actions.
Which brings us to the closely related field of ethics. If ideologies speak to political values specifically, then ethics speaks to the values that govern all aspects of our lives.
Critics often accuse economists of espousing an egocentric system of ethics—one that lauds the virtues of selfishness and wealth accumulation above all else.
Adam Smith, arguably the most seminal figure in all of economics, famously described how the “invisible hand” of the market works to align individual self-interest with the greater good of society. “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
To critics, Smith’s quote betrays an ethical rot at the heart of economics: its belief that pursuing one’s self-interest is not only permissible but desirable. Indeed, many critics think that economics argues that people are ethically obligated to only pursue their own interests—even if they come at the expense of “society” writ large. They conclude that the ethical creed of economics is, to quote Gordon Gekko from Wall Street, “Greed is good!”
Once again, these critics neglect that economics is descriptive, not prescriptive. Smith did not argue that individuals ought to place their personal interests and desires above all else. Nor did he argue that individuals always place their personal interest above all other factors.
Smith argued instead that market institutions translate self-interest into outcomes that support widespread well-being. The beauty of the “invisible hand”, according to Smith, is that even if the vast majority of people are motivated solely by self-interest, they must nevertheless serve the needs of their fellow man to achieve their self-aggrandizing ends.
For all we know, Steve Jobs might’ve started Apple for purely selfish reasons, perhaps because he sought to amass a fortune. The only way he could accrue that wealth in a market economy, however, was by serving the needs of others (i.e., his customers). In pursuing his self-interest, Jobs made society richer—creating innovative products, while employing hundreds of thousands. If no one chose to buy Apple products, Jobs would’ve been just another failed entrepreneur with an empty bank account.
Still, economics can inform our understanding of the tradeoffs associated with policies that pertain to ethical debates. It just can’t answer those ethical questions directly.
Take clashing perspectives over drug policy, for example. Economics provides a simple and compelling explanation for why drug overdose rates tend to increase under prohibition. Black markets don’t discipline rogue producers the way that legal markets do. Without brands, it’s costly to identify the producer of a tainted batch, and it’s therefore difficult to punish them by refraining from future purchases.
Yet, economics can’t tell us whether drug use is immoral or whether governments should prohibit it. Similarly, economics can explain why hedge fund managers get paid more than high school teachers, or why professional athletes get paid more than firefighters. It cannot tell us which job is morally superior. Such moral pronouncements belong in the realm of ethics, not economics.
If your only impression of economics comes from talking heads on CNN, MSNBC, or Fox News, it’s forgivable that you’d think economists specialize in predicting next month’s interest rates, price level, unemployment rate, or stock prices.
That they can’t is itself a lesson in economic reasoning.
If economists were capable of such feats, would they be moonlighting on CNN, or would they be sipping mojitos from their island villa in the Caribbean?
Or ask yourself this: If economists possessed crystal-ball knowledge, wouldn’t their courses always have the longest waiting lists? What student could afford to be without this enriching knowledge?
We want to be careful. If economics was incapable of making any predictions, that would strip it of any scientific relevance.
Economic theory permits—even demands—that economists make pattern predictions. Pattern predictions are more humble and circumscribed in nature. They predict that certain outcomes will emerge, but remain silent on the timing and magnitude of such events.
For example, economics predicts that loose monetary policy will result in rising prices. But economists cannot pinpoint precisely when those higher prices will kick in, exactly how high prices will rise, or which prices will increase first.
When it comes to understanding social phenomena, the economic point of view grants us clarity, not clairvoyance.
Economists understand better than most that the economy is far too complex to treat like an abacus or a game of tic-tac-toe. There are too many variables at play, too many entangled relationships to unwind, to render such bold and precise predictions.
Not to mention, economics examines volitional beings. Humans are quite a different beast from the subject matter of the natural sciences. Inanimate matter—the object of examination in the physical sciences—never talks back. It behaves mechanistically. The determinism of the hard sciences makes point predictions much easier.
This leeriness of making pinpoint forecasts also helps explain why economists are so wary of large-scale government intervention.
Throughout the 20th century, governments have tried to enlist economists to help devise policy “tools” to improve on the “invisible hand” of the market. As many of these planners learned the hard way, economics is not a how-to guide for social engineering.
Quite contrary to the lofty aspirations of social tinkerers, economics teaches us humility. Its core task is not to advise policymakers about how they can engineer the economy in top-down fashion. Its task, as F.A. Hayek argued, is instead to “teach men how little they truly know about what they imagine they can design.”
Nothing better illustrates this than what was arguably the greatest economic debate in history: the clash over markets vs. central planning—capitalism vs. socialism.
In the early 20th century, many intellectuals held that Soviet-style central planning was the wave of the future. Wouldn’t the economy be more efficient if it were scientifically managed by a cadre of experts rather than being left to the whims of the invisible hand?
Living in an era of unprecedented scientific achievement, it’s easy to see why many thought so. In the decades leading up to the Bolshevik Revolution, engineers had developed the internal combustion engine, the automobile, the airplane and many more groundbreaking inventions. In one generation, mankind went from walking to driving to flying. If the world’s greatest minds could accomplish all this with such limited resources, just imagine what great heights they could reach if they were given control over all of the economy’s resources.
Or so the thinking went.
Good economists, however, objected. For them, the economic problem of how to efficiently allocate scarce resources wasn’t an engineering problem. It was an institutional problem and an epistemic one—one that market economies were best suited to solve.
Why would markets outperform central planning? The first reason revolves around incentives. The key institutions of market economies—respect for private property, voluntary exchange and contracts—give people better incentives to work hard and produce things people value.
Ask yourself: would Steve Jobs or Bill Gates have any incentive to create world-changing products if they were born in the Soviet Union? It’s unlikely they would’ve taken the risk necessary to start Apple or Microsoft if they’d had the misfortune of being stuck in a system where they couldn’t keep their hard-earned wealth or run their businesses as they saw fit.
The second reason why markets outperform central planning has to do with what economists call “ economic calculation.” Market institutions that protect private property and facilitate voluntary exchange led to the emergence of market prices. These prices allow entrepreneurs to calculate profits and losses. Profit and loss signals give them critical information about not only what consumers want but also how to produce it efficiently (i.e., at a lower opportunity cost).
When it came to producing cars, Soviet planners had the same raw materials and technology at their disposal as Henry Ford. The difference was that Ford could rely on market prices to help guide his decisions. He could also manage his business as he liked and keep the fruits of his good decision-making—he didn’t have to wait to receive production quotas from bureaucrats with no skin in the game. Ford thrived where the Soviets failed because he operated in an economic system which guided his decision-making in a way that ultimately satisfied consumer preferences. Planners don’t have an analogous guide.
Good economists understand the economy is not some machine that could be fine-tuned or engineered in a top-down fashion. It is more like a complex and delicate garden. Policymakers seeking the flourishing of their populace will not try to recreate or redesign that ecosystem.
Contrary to popular belief, economics isn’t a branch of psychology holding that people are omniscient robots or self-absorbed hedonists.
It isn’t a political ideology aimed at defending free market orthodoxy.
It isn’t a system of ethics that argues for atomized individualism or declares “greed is good.”
It isn’t a crystal ball for forecasting the economy that will help you “get rich quick” playing the stock market.
It isn’t a tool for social engineering that allows politicians to design utopia.
Rather, economics is a framework for making sense of society. It is a remarkably powerful lens for understanding the seemingly chaotic social world we all inhabit.
Economics claims a limited scientific scope. It examines the implications of the fact that people are decision-making beings, and that their decision-making occurs in the context of scarcity, time, and uncertainty.
Occasionally, students become frustrated when we insist that “economics can’t say such and such.” Ultimately, our seemingly unsatisfactory reply carves out space for disciplines like ethics, psychology, and political philosophy to speak to these other aspects of human life.
Economics is not a substitute for these other branches of social science. Still, its insights can complement those fields and provide us with a much richer understanding of the social world. What is remarkable is the sheer volume of social phenomena that can be rendered intelligible when these insights are taken seriously. And to our minds, there’s no more thrilling task than teaching these insights to our students.
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