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Article Excerpt
"IF ALL ECONOMISTS WERE LAID END TO END, THEY WOULD NOT REACH a conclusion" is a standard witticism about my discipline and one that relates to two made in this paper. First, the witticism itself it simply wrong--a problem that is more characteristic of the field is not excessive disagreement, but its opposite: the propensity of its practitioners to agree too much. One need merely look at the standard economics texts, the subjects they encompass, the tools they utilize to analyze those subjects, and the conclusions they derive to recognize that there are no profound differences in analytic approaches. Of course, economists do disagree, sometimes passionately, primarily because their varied political orientations, which are patently not derived from economic analysis (nor are they claimed to be so derived) do frequently lead them to differ sharply in their recommendations. But that is, evidently, a very different matter from incompatible analysis.
Second, the jest can be interpreted to imply that because economists allegedly so often disagree, at least some of them must frequently be wrong. Of course, I can hardly deny my own errors or those of my colleagues. Indeed, I will offer a number of illustrations in the text that follows. But economists are hardly the only source of economic errors. My discipline is particularly vulnerable to mistaken ideas contributed from the outside.
Unfortunately, unlike fields such as physics, economics is a subject on which even the most ill-informed of individuals are apt to feel themselves qualified to make authoritative pronouncements. After all, everyone participates in the economy in one way or another. Moreover, where widespread misconceptions passionately held are the result, democratic government can be forced to act in accord with them. Politicians, too, frequently just assume that they understand the workings of complex but common economic phenomena, and have been content to proceed to their conclusions with little evidence or analysis.
In this paper, I will deal with a variety of illustrative errors, focusing among others on two that are critical for policy: the notion that a budget deficit constitutes a burden for our grandchildren, and the idea that rising costs of health care and education mean that society will be increasingly incapable of financing them and that cutbacks in both of these vital services are therefore unavoidable.
ECONOMIC ERRORS THAT DAMAGE THE INDIVIDUAL
Sometimes it is the individual committing an economic error who alone bears the cost. An example is the investor who seeks out and follows financial analysts' advice on the purchase and sale of stocks, despite overwhelming statistical evidence demonstrating that, even if such advice were offered without cost, it would generally be valueless or worse. Professional recommendations on stock market purchases and sales have repeatedly been shown to be totally unreliable. Indeed, they must be so because, as the data demonstrate, the behavior of securities prices approximate what statisticians call a "random walk." Random behavior is, by definition, inherently unpredictable even by the best-informed and most intelligent analyst. But stock market analysts' advice is even worse than this for the investor, on two scores. First, it is not costless. The investor is forced to pay for bad information and is thereby put in the position of a bettor in a gambling casino, where the outcomes are not just random but are systematically biased to bring a predictable rake-off to the gambling house. Second, whether or not as a deliberate dereliction of duty, frequent sales and purchases of securities that benefit the stock market analysts' own firms are characteristic of their recommendations. These transactions multiply the investor's total payments to these firms and, incidentally, materially increase the investor's tax bill.
DAMAGE TO THE SOCIETY: THE CASE OF MISTAKEN COUNTERCYCLICAL POLICY
As the next illustration will show, economic errors can burden many beside the individuals who make the mistake, and sometimes even society as a whole. A notable example was the belief that an essential step in extracting an economy from recession or depression is elimination of deficit spending by the government. While there is no longer agreement by economists that expansion of such spending is invariably a sensible step, it is recognized that the simpleminded argument that leads many nonspecialists to conclude that such deficit spending threatens to bankrupt the nation is an exercise in the "fallacy of composition." This fallacy is the presumption that a relationship that is valid for each individual must automatically be valid for the entire group of these persons. One elementary example entails voluntary exchange between two informed and rational individuals and the conclusion that such an exchange must offer some benefit to each of them, or at least no loss to either (otherwise, the prospective trade participant who stood to lose from the transaction would simply refuse to trade). The fallacy of composition enters when this insight about trade between individuals is applied to trade between two countries, where it is neither self-evident nor generally true that exchanges must invariably benefit both countries.
Turning to the issue of deficit spending, the standard view stems from the observation that an individual who is in financial difficulty because of persistent spending beyond his means must somehow succeed in curtailing his overspending now and in the future if he is to avoid exacerbation of his financial troubles. The inference from this observation drawn by analogy for a depression-beleaguered government--whose tax revenues have fallen as a consequence of reduced incomes and whose expenditure has been driven upward by rising obligations--was that, just as in the individual case, fiscal retrenchment was essential. Governments in that position characteristically find themselves plagued by rising debt and the evident, if questionable, conclusion was that material retrenchment was urgent and unavoidable if financial catastrophe for the country was to be avoided.
But, one of the central propositions to emerge in the course of the Keynesian revolution was that this prescription for retrenchment was the precise opposite of what such a situation requires. Rather, an effective governmental weapon--indeed, a critical component of the counter-depression policy that Abba Lerner dubbed "functional finance"--is enhancement of deficit spending, entailing rising public debt, with the shortfall to be made up during the other end of the business fluctuation, when inflation replaces unemployment as the primary threat to the economy.
The way in which the fallacy of composition enters the matter is quite straightforward. Increased spending by an individual (without any offsetting rise in earnings) spells financial peril. For the community of individuals, taken as a group, the situation is, at least in the simplest Keynesian view, usually the reverse of this. The more the government increases spending without a corresponding rise in tax revenues, the better off the community will be economically. This act of magic occurs because the very deficit spending must put purchasing power into the hands of the public, which in turn will serve to raise demand for goods and services. And in a depressed economy, anything that serves to offset lagging demand must be helpful, because it will expand sales, elicit enhanced production, and provide additional jobs. So deficit spending by government is a stimulus of economic activity and a source of added income for the society as a whole. This stimulus effect also helps to cut the government's budget shortfall by automatically adding to total tax revenues as private incomes rise, and by cutting needed government expenditures, such as outlays for support of the unemployed. As Keynes himself pointed out, the apt parable is that of the legendary widow's cruse, which kept refilling itself as its contents were extracted. For, if the argument is valid, it indicates that the more the government overspends, the more net income it can hope to have available in the near future.
This argument, though not universally accepted by economists today, was certainly rejected by many, including President Franklin D. Roosevelt, in the 1930s. It is at least arguable that the resulting efforts to curb government overspending protracted the Great Depression, creating a second economic decline toward the end of the decade, with termination of the Depression left to the onset...
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