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More on the Principles of Economic Principles

Here I riff on my previous post entitled “On the Principles of Economic Principles.”  In particular, I argue in this follow-up post that it is closer to the truth to say that “there’s nothing more dangerous than somebody who’s just completed a PhD in economics” than to say (as Ezra Klein said) that “there’s nothing more dangerous than somebody who’s just taken their first economics class.”

It’s true, of course, that a little bit of knowledge can be a dangerous thing.  But a good principles-of-economics course conveys not just a little bit of knowledge.  It conveys a lot of knowledge – enough knowledge to enlarge the dangerous little bit of economics knowledge possessed by people who haven’t been exposed to formal economics (“More consumer demand for haircuts means more employment for barbers and, so, more employment economy-wide!”) into fuller knowledge that is no longer dangerous because it nurtures wisdom and helps make visible that which is typically invisible to non-economists (“More consumer demand for haircuts means more employment for barbers and, therefore, less employment for people in other trades.”)

A good principles-of-economics course drives home to attentive students the profound point that a market economy is far more complex than most popular discussions of the economy suggest.  A good principles-of-economics course teaches, for example, that

    • market prices are not arbitrary;
    • even in market settings, money prices are not the only form in which costs are incurred;
    • “firms,” “governments,” “markets,” and “society” never choose or act; all choosing and acting are done by flesh-and-blood individuals; (the fact that individuals are often, or even typically, influenced in their choices and actions by the opinions of others does nothing to undermine this point);
    • people respond to incentives;
    • all voluntary trade typical makes all parties to such trades better off;
    • high profits earned in markets are evidence that firms that earn them are performing more valuable services for humanity than are firms that earn lower profits;
    • competition need not be “perfect” (as “perfect” is bizarrely defined in mainstream economics) in order to be intense and highly effective;
    • almost no human being is without the ability to produce and supply something of value in exchange for things produced by other human beings.

These are just some insights that a good course in econ principles conveys.  Such a course, by alerting students to the fact that much in the economy is unseen, helps econ-principles students realize that the world is vastly more complex than they likely assumed it to be when they first enrolled in the course.  Simplistic explanations that made sense before the course is taken (“The rise in the price of propane after a natural disaster is caused by sellers’ greed!”) are understood after the course to be not only simplistic but silly.

Alas, modern graduate training in economics too often (although not at George Mason!) tends to whittle away the wisdom won at the undergrad level.  It does so in a number of ways.

One way that modern training in economics makes the economy appear simpler than it really is – and simpler than it appears to a good principles-of-econ student – is that, by enabling the grad student to describe a hypothetical economy mathematically, advanced modern economics gives the student the false impression that he has at his fingertips a model close enough to reality to convey detailed knowledge of reality.  Mastery of the mathematical complexity of the model is mistaken for mastery of the complexities of reality.  While I don’t doubt – in fact, I can personally attest – that manipulation of such models imparts some abstract understanding of complex economic relationships, the understanding that is imparted is never of the details of real-world economies.  The real-world economy is always vastly more nuanced and complex than even the most impressive model can hope to capture.

Stated differently, the difference between the simplicity of a ‘mere’ supply-and-demand graph and the complexity of the real-world that it is meant to illuminate is practically no different than is the difference between a ‘complex’ multi-person, multi-output, multi-factor, multi-time-period mathematical model of an economy and the complexity of the real-world that it is meant to illuminate.  That the ‘complex’ mathematical model is vastly more complex than is the supply-and-demand graph does not mean that the ‘complex’ mathematical model is sufficiently complex to convey useful knowledge of the details of any real-world economy.

Another way that advanced training in economics makes the world appear excessively simple to the unwise econ grad student is through its focus on econometrics.  No matter how complex an econometric model and no matter how ‘granular’ are the data used in that model, the complexity of economic reality is too often lost when the results of economic activity are quantified and turned into data.  Not only are means and medians often highly misleading proxies for the individual elements (persons, prices, wages, etc.) that form the groups from which the means and medians are calculated, but far too many economically relevant factors are simply unobservable or unquantifiable.  These latter factors, therefore, are usually ignored (or, sometimes, imperfectly proxied) in econometric studies.

Consider, for example, this list – constructed by me from one first offered by my colleague Dan Klein – of the many different ‘margins’ on which employers can adjust when the minimum wage rises:

– the extent and strictness of work demands

– flexibility in scheduling

– kindness and amiability in the workplace

– consideration and respect in the workplace

– upward mobility

– health insurance

– on-the-job training

– lockers for workers

– food for workers

– transportation (or transportation allowances) for workers

– the quality of air conditioning and lighting

– the number, quality, and cleanliness of restrooms for use by workers

– workplace comfort

– workplace safety

It is practically impossible for outside investigators even to observe, much less to accurately quantify, any movements along most of these margins.  And yet who can doubt that movements often occur along these margins?  Who can doubt that, say, an employer can become more amiable (or less amiable) toward her employees, or that the workplace can become a bit more safe (or less safe) because an employer increases (or decreases) the diligence with which he conducts workplace fire drills or stocks the workplace with more (or fewer) first-aid kits?

Workers who are on the spot can, over time, get a reasonably good sense of the sum of these different margins.  Such a sense will, at the margin, prompt some workers to remain with an employer when those workers would otherwise have quit had the sum of these margins been a bit worse, or to quit when those workers would otherwise have stayed with an employer had the sum of these margins been a bit better.  So employers over time have incentives to get the sum of these margins ‘right.’  But no outside observer can hope to observe, and much less to quantify the value of, each and every one of these margins.  Outside observers can get data on mean (or median) money wages, on the money value of some fringe benefits, on mean (or median) number of hours worked, on mean (or median) number of paid vacation days, as well as on some other observable workplace factors.  But many workplace factors remain unobservable and unmeasurable – and, hence, are ignored in empirical studies.  The complexity of real-world employment contracts is far greater than empirical investigators can possibly capture.

The bottom line is that the best training in formal economics – introductory, intermediate, advanced – teaches that the economy is inconceivably, immeasurably more complex than our puny minds (and even our state-of-the-art econometric methods and high-powered computers) allow us to fathom, much less to engineer.  Therefore, a solid understanding of basic economic principles (see the above list for partial run-down) supplies what is perhaps the most profound lesson that any economist can ever learn:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.