Beware of economic misconceptions – Econlib

HAlbert Stein, an economist who served in the Nixon administration, wrote a memoir about his experiences. He wrote that the two main lessons he learned were:

• 1. Economists don’t know much.
• 2. Other people, including politicians, who create economic policy know even less about economics than economists.

In my own experience, non-economists often have understandable misconceptions about economics. Below, we detail some key misconceptions and the basic economics insights needed to dispel them.

Unfortunately, trained economists often try to go beyond basic insights and arrive at more speculative theories. There are two ways in which these “advanced” economic ideas can cause non-economists to revert to natural economic misconceptions. “Advanced” thinking may prove unreliable and cause the economics profession to lose credibility, or speculative theories themselves may reinforce natural misconceptions about economics.

Pricing

One common misconception is that prices are set by individuals, especially those who run businesses. After all, most businesses have a price list for the products and services they offer.

This misconception appears when people think that business is inherently profitable and has complete power over consumers. If profitability were a given, no company would go bankrupt. The power of one business is limited by other businesses competing for customers.

This misconception is evident when politicians blame high prices on “price gouging” or “greed.” In fact, prices result from the interaction of supply and demand. Greedy businesses are held back by greedy consumers who don’t want to pay too much and greedy competitors who try to attract those consumers.

This misconception extends to inflation in general. One might think that a sudden outbreak of greed would cause inflation to spike, and that when greed disappears, inflation would recede. However, a little economic reasoning shows that high inflation is caused by governments having too much money in circulation, and that inflation would fall if governments managed their finances more responsibly. Probably.

job creation

One common misconception is that jobs are created by specific companies. As a result, people are dissatisfied with companies “sending jobs overseas.”

In fact, job creation does not come from a single company. It emerges from the combination of the actions of many people and allows for specialization and trade. If you and I live off food grown on separate farms, there is no specialization or trade. But if you grow grain and I raise cattle and we trade with each other, there is now a market exchange.

In modern economies, vast numbers of people are involved in processes that create new forms of market exchange, leading to complex patterns of specialization and trade. These patterns are only sustainable if everyone involved achieves a net benefit. New patterns are constantly being developed and tested, and others become unsustainable and disappear.

Patterns of specialization and trade incorporate foreign-based businesses, but no firm determines these patterns. Economic analysis shows that changes in the location of production reflect evolutions in skills, production techniques, and household behavior.

Regarding the latter point, let’s assume that China as a nation has a higher savings rate than the United States. China’s purchases of U.S. assets would then increase the value of the dollar, make Chinese products more competitive, increase manufacturing jobs in China, and encourage American workers to move to other industries. It will be.

Since America’s budget deficit is a contributing factor to low national savings, lawmakers who accuse companies of “sending jobs to China” should look in the mirror. It is budget deficits that lead to trade deficits, not those of individual companies.

Much of the debate about labor markets ignores the complexities of specialization and trade. Instead, they view gross job creation in simple terms. In other words, jobs create spending, and spending creates jobs. This simple and misleading idea is unfortunately very prevalent even in introductory macroeconomics courses. It leads to the idea that government deficits are effective at creating jobs and that austerity causes recession. In fact, the relationship between government fiscal policy and the processes that create sustainable specialization and trade patterns is indirect and highly uncertain.

A related misconception is that the ___ president created X million jobs. Political leaders do not create jobs. They do not control the complex processes that evolve patterns of specialization and trade. Policies influence this process, but their impact is difficult to measure precisely.

production recipe

Another misconception is that production recipes are fixed. That is, the output requires a specific set of inputs.

In reality, alternative opportunities abound. Desires can be fulfilled in different ways. Final goods and services can be produced in a variety of ways.

In foreign policy, decision makers with fixed mindsets tend to overestimate the effects of factory bombings and economic sanctions. They will be surprised at the adaptability of the other country.

The misconception that recipes are fixed also distorts domestic policy. We believe that if we don’t manage our resources, we will run out of something. Fifty years ago, we were worried that we would run out of oil. But currently, oil and other resources are still cheap.

Also, based on a misconception of fixed recipes, policy makers believe that certain characteristics of products and processes need to be mandated in order to achieve goals (such as reducing carbon emissions). Instead, market incentives are often sufficient. The carbon intensity of GDP is shrinking primarily due to the natural evolution of markets.

If fewer people hold these misconceptions about the economy, we might be able to create better economic policies. Economists need to do more to explain and debunk these misconceptions.