Warren, a patron of Cafe Hayek, e-mailed me over the weekend to ask what, in my opinion, are “the silliest ideas ever held by serious economists.” I take his question to refer to modern economists – that is, post-1871 and the marginal revolution. And I take “held by serious economists” to mean “held by a significant number of serious economists.” Finally, I take “silliest” to refer to something worse than mistaken. The labor theory of value, for example, is mistaken, but it’s not silly (at least not if — like Adam Smith, David Ricardo, and other classical economists — you’ve not been exposed to marginalism). Likewise, the Keynesian notion that more consumer spending is key to creating jobs is mistaken but not silly.
Warren’s question is interesting. I have five candidates for really silly ideas held by serious economists, offered here in no particular order.
1. The belief of many Keynesians (including John Maynard Keynes himself) that modern capitalism suffers a paucity of attractive investment opportunities.
2. The belief — especially prominent among a number of antitrust scholars in the 1970s and 1980s — that innovation is a means of monopolistic predation that should be policed by antitrust authorities. (I wrote on this topic of “nonprice predation” many years ago in Regulation.)
3. The fear that economic growth causes inflation.
4. The theory of Perfect Competition — and the equally static theory of Monopolistic Competition.
5. The Phillips Curve notion of an inherent tradeoff between unemployment and inflation.
Dishonorable Mention: the notion that government debt isn’t a problem to the extent that it’s held domestically — to the extent that “we owe it to ourselves.” Jim Buchanan’s 1958 book, Public Principles of Public Debt, exposed the foolishness of this idea.
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It's a tough call. I remember my macro econ class and testing out of micro econ where it discussed item #4 on your list. I never understood why we needed to know it. The constraints in either case ensure that neither is feasible anywhere but in simulation.
The thing I hate most about monopolistically competitive models is that they teach that variety is not worth anything.
What I like about the perfectly competitive model is that it teaches that cost saving innovations are passed completely on to the consumer.
I would have added the Laffer Curve(http://en.wikipedia.org/wiki/Laffer_curve), but most economists knew that was crap. It is only politicians and voters who were fooled/lied about it.
I'd have thought Libertarians would've dismissed the Laffer Curve as Governments aren't supposed to run at a profit (if exist at all).
Hi,
I am a computer science student and so do not have much knowledge in the field of economics.
I have a question on your following point:
3. The fear that economic growth causes inflation.
Could you please explain why its a silly idea, in a new post or point to any existing link?
The reason is India has 8-9% GDP growth in the last five years and but also has had high inflation. Currently it's 12%. The government often states that run away growth is increasing inflation and economy needs to cool down.
I am interested in your take on this whole issue.
Thank you,
Avadhoot
I've listed my creds (or the absence thereof elsewhere, I'll not do that again.
I am surprised that after your "Walmart" item you would list #2 as a 1970's and 1980's thing.
It seems to me that it is a worsening problem even as we speak–Walmart, Microsoft, "fast food" (especially in New York and California), others that I'm sure you could mention.
To my untrained eye that may be the problem that does us in. If it does not, #3 will, but frankly I'm not bright enough to draw the line between the two.
Don,
Do you believe in the short-run Phillips Curve? It seems to still linger, and policymakers, as well as Russ Roberts and Tyler Cowen (in the recent podcast on money), all seem to feel that it's there.
I don't think anyone today really believes that there is a long-run Phillips Curve for which we must thank Milton Friedman for his impassioned critique of what he called 'naive Keynesianism'.
I most certainly do not think that the Laffer Curve is a silly — or even a mistaken — idea. It is merely an application of the concept of elasticity to tax rates. The Laffer Curve is no sillier than is the idea that a firm's revenue sometimes rises when it raises the price it charges for its product (if demand for its prodcut over the price-change range is inelastic) and sometimes falls when it raises the price it charges for its product (if demand for its product over the price-change range is elastic).
It might well be true that a particular application of the Laffer Curve idea was mistaken, but to call the idea of the Laffer Curve silly is, well, silly.
What makes none of these ideas "silly" is the fact that they've had such negative consequences and they've been so hard to dispatch in a simple and obvious way attractive to careerist economists and "who cares what the truth is" politicians.
avadhoot, economic growth really cures or lessens inflation, holding all else important constant (HAEIC).
With growth, HAEIC, you have the same amount of money chasing more goods, so average prices should go down.
What causes inflation is more money chasing goods.
Example: If growth is 9% and the money supply increases by 9%, inflation should be zero. But if the government increases the money supply by 21%, you'll get 12% inflation.
Governments claim inflation is caused by something else to deflect their responsibility.
Read "Money Mischief" to learn more.
What is really silly (and not many, if any economists believe it) is that inflation can cause growth.
The Laffer Curve is simple Calculus.
At a tax rate of zero, revenues are zero.
At a tax rate of 100%, revenues would also be zero.
There has to be a max in between. So there must be range where lowering rates would increase tax revenue.
How about the concept that economic activity requires prices to rise at a steady rate. Since I am a saver I would like to see the price of assets, goods, and services fall as we find ways to produce them more efficiently.
More specific but equally ridiculous is the suggestion by some that we blow up excess housing inventory to solve or economic problems. As a citizen of this nation I find this suggestion disgusting and offensive given the fact that so many people desire to upgrade their shelter.
6. Money is a commodity rather than a record of credit or an entitlement to consume/invest.
The Laffer Curve is laffable, but it doesn't qualify for the list, because most economists never took it seriously. The idea isn't false. It's simplistic and practically tautological, so it isn't very interesting. It's more politics than economics. To be fair, Laffer himself well understands this.
http://en.wikipedia.org/wiki/Laffer_curve#The_Neo-Laffer_curve
Perfect Competition is not a silly idea. It's a reductionistic, theoretical model that describes real markets imperfectly. That the model is called "Perfect" Competition indicates well enough that its proponents know the difference between a theoretical model and the reality a model seeks to describe. Market Efficiency and the Random Walk Hypothesis are similar, but they aren't silly ideas either. They help to explain capital market dynamics, even if real markets aren't perfectly efficient.
Economic growth need not cause inflation, but more rapid growth arguably is more inflationary. Essentially, advancing more rapidly along an innovation trajectory requires more factors organized entrepreneurially, and this organization essentially requires that more factors be organized unprofitably.
Entrepreneurship implies risk, and risk implies that some ventures ultimately don't profit. Inflation is an excess of entitlement to consume (money) without correspondingly profitable production. If more and more of us supply (or attempt to supply) innovative goods or goods produced innovatively, then more and more factors will not profit.
An economy organized this way could advance faster than others and even leapfrog other economies, but it could also end up producing goods that can't effectively be consumed by the current generation of consumers. It's clearly possible for practically everyone in an economy the size of the U.S. economy to drive a personal automobile, but it wasn't possible a century ago. Even if we could somehow transmit all of the necessary technological knowledge a century back in time, people a century ago trying rapidly to transform their economy into ours would encounter inflation.
I'm also a CS not an economist and would like to query Smith's reply. What about goods like land, or champagne? There is a fixed supply of these goods and as people's income increases, they can spend a proportionally higher amount of their income in a marketplace with a restricted supply of goods. Also, there will be a lag on production increases for some types of goods to meet demand and a higher expense (e.g. – those that are not impored and which need to be produced with labour that is competing against a healthy sector). This would be particularly the case where the growth is fueled by something like offshore mineral sales (as has been the case in Australia of late). I suggest that this situation is one in which an increased pool of value is chasing an fixed sized group of goods. Surely these factos would lead to a general decay in the purchasing power of a unit of money (inflation), even if part of the effect is only temporary – ?
I made the last post and not Dave Smith. This was the result of a copy and paste error I made – sorry for the confusion.
Craig, when something becomes more desirable, like fine champagne as people become more wealth, demand for that item rises. As demand rises, the RELATIVE price (the price you learn in supply and demand analysis is a RELATIVE price) rises. A person's, HAEIC, dollars suddenly have less purchasing power than they did before.
But because the relative price of something went up, the relative price of something else must go down. (Again, economists don't do a very good job explaining how supply and demand gives us relative prices, we are sloppy to make things easier, which is not a problem until we start talking about inflation. Changes in supply and demand for land or wine or whatever cannot be inflationary)
Changes in demand and cost (technology) make the relative prices of goods change all the time. Don't believe that some goods fall in price? Check this out: http://mjperry.blogspot.com/2008/07/for-some-products-theres-been-major.html
To sum up, what you are describing are changes in supply and demand that have nothing to do with inflation.
Craig, I would also dispute the fact that land is of fixed quantity. This notion of mine is crazy to anyone who is not an economist.
Here is what I mean as the price of land increases, we can build higher, clear areas that were thought not usable, etc.
So in a strict geographically sense, the amount of land is fixed, but not in a way that has and meaning economically.
Craig,
In addition to dave smith's comment, the main reason that land becomes scarcer is government restrictions on building. There is a definite lack of understanding between cause and effect. In Prince Georges County, MD, there was an initiative to reduce the number of new houses built from 2500 to 25 (I think this was 2004). That is not a typo. A reduction by two orders of magnitude. Thankfully, someone pulled their head out and this got quashed. The fact that this idea was even introduced, in a county that has seen DRAMATIC demand increases in the last decade do something like this illustrates perfectly the disconnect between cause and effect.
Even in densely populated areas, most land isn't developed and MUCH effort is made to keep undeveloped land undeveloped, basically screwing over the less well off. Living in MD (the Baltimore-Annapolis-DC triangle), I am in the 75th percentile for income, yet cannot afford a house (selling at $450K), except in the worst neighborhoods. Townhouses sell for $300K in the decent neighborhoods in Anne Arundel county, with apt style condos selling for $250K. Anyone who has driven around Anne Arundel county knows there is PLENTY of land to build on. There a very powerful and loud group of people who fight development tooth and nail because looking at trees is more important to these wretches than making sure people who are not in the 90th income percentile can afford to buy a house/townhouse/condo.
I know Don doesn't like it when posters compare Martin to Gil, and I too would like to see Martin do a little better, but once again, Martin and Gil come out on the side of the fruitcakes with the Laffer curve. Martin links us to a ridiculous article at Wikipedia that says the Laffer curve is bunk because it isn't a perfect curve except at the two extremes, then shows a graph of corporate taxes for Norway and a few other socialist countries to support their ridiculous conclusions! The Wikigraph is patentedly flawed because it uses Corporate taxes, not the Corporate and personal tax rates combined. It doesn't support the data with any numbers and appears to be just pulled out of the air.
If you go back to the Reagan tax cuts, when we had 70% top rates, and look at total revenues 6 years later, the total treaury revenues were almost doubled. (the effect was, of course, chopped off at the knees because the Democratic Congress spent the new revenue like drunken sailors) Last year, as the Bush tax cuts finally took hold as they were phased in over 5 years, we had record revenues. The evidence is overwhelming that cutting taxes increases Federal Revenues. It doesn't happen overnight, as the money saved does have to be plowed back in to investments that take time to become profitable, but it clearly and overwhelmingly is demonstrated to work.
Martin does try. He did a nice job trying to to support the supposition that Adam Smith was the first to publish the embodied theory of Labor, and was the therfore the first Markxist, but, but I'm sorry, it just doesn't pass the muster, just like that ridiculous article over at Wickipedia.
The difference between Martin and Gill, is that Gill doesn't have a sincere bone in his body, but Martin really does try, and he does get it right many times.
Sorry to give you such a hard time Martin. I appologize for my past posts that often confused you with Gillduck because at times I also falsely accused you of being Gillduck to in a poorly thoughtout attempt to illustrate an error I thought you made.
Don didn't list "trickle down" economics on his list, likely because it never was a theory profered by economists, but by journalists/commies who invented the term and tried to pin it on Reagan. Reagan never proposed "trickle down". It has ALWAYS been "trickle up". Before the rich can trickle down a dime of their newly un-confiscated revenue, they have to go buy land and hire workers to construct the business, those workers are paid first, as their matching withholding are as well, only many months later, after the building is completed, paid for and new employees are hired, does that "rich guy" see a dime of his money returned, and it may take years to get that initial money back, much less see a "return" from the non- confiscated invested funds.
To try to say that the laffer curve is bunk and use bogus propaganda to support the supposition, is ridiculous. The federal revenues by year, is too easy to pull up on Google.
I don't follow your logic again Martin, about inflation. You started off brilliantly, with you insight about both perfect competition and random walk, both which are excellent theories but rotten in the real world.
It doesn't follow that high growth or in- efficiencies in an economy are inflationary.
Ouch! What a grumpy, pecking, honking jpm_goose! Actually I never said the Laffer Curve is bunk per se. What I said was :
"I'd have thought Libertarians would've dismissed the Laffer Curve as Governments aren't supposed to run at a profit (if exist at all)."
If any one said the Laffer Curve was bunk it's M. Brock:
"The Laffer Curve is laffable, but it doesn't qualify for the list, because most economists never took it seriously. The idea isn't false. It's simplistic and practically tautological, so it isn't very interesting."
I don't know if the Laffer argument qualifies for a tautology but I didn't say the concept of the Laffer Curve is invalid rather it isn't someting a Libertarian would get excited about because he'd say "taxes are theft!". If someone believes 'taxes are theft!' then you wouldn't want someone giving tips on ontimising that theft. Imagine a Burglar Laffer Curve – if you're too soft you risk getting caught and get nothing but if you kill the occupants you'll get a one-off windfall but that'd be it, however if you can scare the occupants enought to have over their money but not too much that they'd have more money next time you visit then you'll have a steady income. Hence I'd have thought Libertarians wouldn't like the Laffer Curve because, if anything and depennding on the day, it could in fact mean more taxation. I mean does not a theoretical simple perfect Laffer Curve imply an idyllic rate of 50%? Libertarians have always said that governmnets should be stripped down to the bare bones and only allow to tax for the bare necessities (say a max. flat tax rate of 5%?) and nothing more or are outright abolished and all services are provided by the private market.
To Dave Smith;
I just wanted to let you know there is a perfectly fine phrase that serves your purpose, "ceteris paribus".
You don't need that bizarre acronym. Even if you said "CP", I think most economists, or economic hobbyists would know what you mean.
I have a Ph.D. in economics. I know what ceteris paribus means.
In class when I say "holding all else important constant" it means much more to students than a bizarre Latin phrase "ceteris paribus."
I used the acronym to save typing.
Also, I was responding to a computer science student who stated they had little knowledge of economics. So that gave me another reason to avoid what may have been jargon.
Aren't three and five a bit repetitive?
Agreed. Much of the "Laffer curve" rhetoric amounts to statesmen saying to other statesmen, "We'll let you have more toys if you'll let us have more toys." It's nauseating.
The "neo-Laffer curve" is a joke first suggested by the mathematician Martin Gardner in the eighties. The curve at Wikipedia illustrates the joke with budget data from real states. It's supposed to be ridiculous. You apparently didn't get it, because you apparently didn't read the surrounding text.
You're comparing the depths of a recession to a period of recovery; however, again, the "Laffer curve" idea isn't false as much as it's dull. Personally, I'd cut marginal income tax rates on the very wealthy practically to zero with a progressive consumption tax, but I'd raise the marginal rate on consumption (the income you don't accountably reinvest to defer the tax) back to levels in the fifties, when the top marginal rate was 90+% and tax revenue also grew rapidly with the economy. Growing tax revenue is not the goal however. The progressive consumption tax approach addresses this concern. This tax is essentially voluntary for the wealthiest, since a high income earner may choose between consumption and investment.
Rubbish. I never anywhere suggest that Smith was "the first Marxist." That Smith proposed a labor theory of value is an historical fact, as Don reiterates here. In fact, Smith's theory of value is much closer to what we call "labor theory of value" today than the Marxist conception. The Marxist theory of "socially useful labor" is closer to marginalism, not surprisingly since Marx was a contemporary of the marginalists.
Goes with the territory.
Can I nominate the Harrod-Domar growth model?
To suggest that sustained growth could only occur when a set of extremely unlikely factors hit a "razors edge" was ludicrous.
"The situation seems here to be that, before we can explain why people commit mistakes, we must first explain why they should ever be right." – Hayek
Brian Arthur and Paul David's love affair with 'path dependence' would have to be on any 'silly list'.
what about the idea that an economy can be centrally planned, work without a price mechanism etc. – all the stuff socialism believed in?
i think that was quite silly.
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