The lies of (some) economists

by on May 10, 2006 at 6:27 am in Economics | Permalink

Let’s start with five:

1. Believe in comparative statics, the income effects will wash out in the aggregate.  (Larry Summers once taught me: "Economics is a theory of substitution effects but we live in a world of income effects.")

2. The model predicts well, don’t worry about the assumptions.  (As Paul Samuelson pointed out, don’t false assumptions, by their nature, involve a very large number of (sometimes implicit) false predictions?)

3. People may make mistakes when the stakes are small, but as they become more decisive over larger prizes, the irrationality goes away.  (Name any major politician or how about Tom Cruise on Oprah?)

4. IS-LM models make sense.

5. There are many firms in the sector, they must be price-takers.  (Does demand go to zero when your local Chinese restaurant raises prices by a penny?  Or for that matter by a dollar?)

Do you wish to suggest other lies in the comments?

Here is Guy Kawasaki with The Top Ten Lies of EngineersThe Top Ten Lies of EntrepreneursThe Top Ten Lies of Venture Capitalists.  Thanks to Chris F. Masse for the idea and the pointer to Kawasaki.

1 Quanty May 10, 2006 at 8:29 am

Yes, there may be many chinese firms in aggregate, but they serve highly localized markets — I live on the east cost, and can’t realistically buy chinese food from a supplier in California, even if their price is 0. Therefore, my local supplier has pricing power…

2 Jonathan May 10, 2006 at 8:48 am

A few from econometrics:

Instrumental variables really correct for endogeneity.
A significant coefficient is an important (or even an actual) effect.
Five percent significance levels mean something.

3 SamChevre May 10, 2006 at 8:59 am

Coase’s Theorem means that initial distribution of costs is irrelevant.

(Only true when transaction costs are zero.)

4 Dan K May 10, 2006 at 9:23 am

6. Scarce resources matter most.

5 Timothy May 10, 2006 at 9:49 am

When the model is wrong, blame the data.

6 eye56 May 10, 2006 at 11:04 am

Lie: The set of all choices is well-ordered, and money values can approximate that order.

7 PlanMaestro May 10, 2006 at 11:32 am

1. Microeconomics is a positive science (falsifible assumptions driving influential normative recomendations)
2. Entrepreneurship is about supernormal profits (what about independence and irrational will)
3. Markets are everywhere 🙂 (and organizations too)

8 Paul Johnson May 10, 2006 at 4:48 pm

If my local Chinese restaurant suddenly raised the price of every dish by a dollar, and the other restaurants kept their prices the same, the local place would lose a lot of customers, and likely go bankrupt. Consistent with (the right application of) economic theory.Economics works pretty well as long as we are not trying to do the equivalent of hammering a nail with a wrench instead of a hammer!

9 mvpy May 10, 2006 at 6:37 pm

Theres no such thing as a free lunch.

(think: free trade)

Supply side economics is for political hacks

(get real: demand side economics is bunk)

Geography is destiny

(think: Hong Kong)

Irrationality abounds

(get real: theres no $50 bills lying on the sidewalk)

Education has big externalities that merits state finance

(they’re reading Karl Marx in the sociology dept of my uni)

Fiscal policy is an effective stabilization tool

(yeah right)

Capital accumulation is the key to growth

(um, its A stupid)

The kinked demand curve in oligopoly

(george stigler was vehement that this is bunk)

Budget deficits lead to higher interest rates

(think: Japan + US)

The existence of a stable NAIRU

(doesnt even dignify refutation)

The permanent income hypothesis

(all right, its a very, very rough rule of thumb, but thats it)

The coefficient of relative risk aversion is one.

(almost all RBC models are contingent on this)

……………………………………
Okay, Ill stop there, but I could go on.

10 Mark May 10, 2006 at 7:39 pm

Pareto efficiency is a good criterion for normative policy analysis.

11 Bill Stepp May 10, 2006 at 10:53 pm

Samuelson wrote a paper showing that perfectly anticipated stock prices fluctuate randomly.
But in the real world, something that Samuelson should have bothered himself to learn about,
stock prices aren’t perfectly anticpated, and therefore don’t fluctuate randomly.
(Just look at the last five days’ prices for practically any stock, and notice the interday–and sometimes even intraday–jumps.)
Speaking of the real world, Coase taught us that lighthouses worked by charging shippers for their use of ports’ services. Samuelson protested that this still didn’t solve the free rider problem. He has since done a zillion google searches, but hey the free rider is still dat big bad bogeyman.

Samuelson had some chutzpah in taking the Austrians to task for “shadow boxing with reality.”
I submit he should be stripped of his Nobel posthaste. He sure gets my vote as the most overrated economist ever.

12 Luke Lea May 10, 2006 at 11:10 pm

The biggest lie by far in recent years was during the great Nafta debate when Paul Samuelson got up before an audience in the East Room of the White House and said that “protectionism had never caused wages to go up.” Since the issue was whether protectionism could keep wages from going down, he was being disengenuous to the point of lying, as he (co-author of the famous Samuelson Stolper paper on protectionism and real wages) knew full-well.

In general it is a lie to say that free trade makes everybody better off without regard to the principle of compensation; when the comparative advantage concerns relative factor endowments (ie, high-wage vs. low-wage countries) the principle of compensation becomes critical; otherwise, the vast majority of workers in the high-wage country will most assuredly be made worse off than they would have been under the old regime.

Basically it comes down to the laws of supply and demand; whenever economists claim that these laws don’t apply in some particular situation, they are lying. Immigration is the currently most topical example: to say that increasing the supply of low-wage labor does not depress the wages of low-wage labor is a bald-faced lie, and everybody in America (except for a few brain-washed editorial writers) knows it.

13 PK May 11, 2006 at 7:13 am

I remember many lies, myths, misunderstandings or half-truths that people say about economy. For example:

“What is good for economists is not always good for poor people.”
“Economics is only about money, but not about people.”
“The Laffer curve is a joke.”
“Reagan tax cuts caused budget deficits.”
“Speculative markets are merely good for speculators; they have no significance for the real economy.”
“Economics is no science, because you cannot do controlled experiments.”
“Economics is, in fact, accounting.”
“Free market means extreme wealth for some, but extreme poverty for many.”
“Poverty in Latin America is caused by the lack of social protection legislation in these countries.”

And so on, and so on.

Generally, economists are perceived as greedy people, which I think is nonsense.

14 jim May 11, 2006 at 12:28 pm

The facts speak for themselves.

15 jim May 11, 2006 at 1:21 pm

It can easily be shown that . . .

. . [insert theorems from graduate econometrics]

16 Jack May 12, 2006 at 4:54 am

micro factors are more important than network effects despite at least two elephant sized counter examples

current currency zones bear some resemblance to optimal currency zones

PK, I thought that surveys haad suggested that they were.

17 jim May 12, 2006 at 3:18 pm

Two economists (in the AER no less) claimed that the law of demand seemed not to apply to the NJ fast food restaurant market in the wake of an increase in the minimum wage. Because unambiguous exceptions to the law of demand do not exist, the claim of these economists was BIG news. Lots of people jumped on this bandwagon who had vested interests in undermining this bedrock economic law. This was a “Man Bites Dog” story and it got lots of press and I believe one of the economists even got recognition as the Best Economist under Forty Award.

But it appears that this was a tempest in a tea cup; just another ALLEGED exception to the law of demand, this one resulting from sloppy data collection and empiricism (as has been subsequently explained by several other economists). Unfortunately, this reverification of the law of demand was a “Dog Bites Man” story and awards were not given to any of the economists responsible for doing the careful empirical analysis on the NJ minimum wage change whose evidence came up consistent with the law of demand.

18 Thomas B May 14, 2006 at 2:27 pm

Either:

a) Individuals are usually rational.

OR

b) Individuals are usually irrational (at least whenever opportunity costs, sunk costs, or basic statistics are involved).

I don’t care whether the theory wants to categorize us as rational or irrational, but it should probably pick one and stick with it.

19 J. M. Lawrence May 21, 2006 at 6:19 pm

Jeffrey Sachs writes, in The New Republic, that “the sound solution” to developing countries’ foreign debt crisis rests with “simple bankruptcy procedures in which the debtor’s burden is comprehensively reduced, and the creditors share the losses.” This is an interesting sleigh of hand. Sacks represents that in a bankruptcy case the “burden” placed on a debtor is to have its debts forgiven. The latter, however, is the outcome of a bankruptcy case.

In a bankruptcy case, “the debtor’s burden” is to relinquish assets. In such a proceeding and ignoring all other sources of wealth, Venezuela’s foreign creditors would get a barrel of oil for every $0.60 of debt they retire. (The ratio of Venezuela’s just over $35 billion in peal foreign borrowing to its 58 billion barrels of oil is $0.60 to 1.)

Using the peak value of Mexico’s foreign debt prior to former-President Clinton’s sweetheart deal for the country, Mexico’s bankruptcy liquidation ratio is $2.04 per barrel of crude. (The ratio of just under $110 billion in foreign debt to Mexico’s, then, 54 billion barrels of oil is $2.04 to 1.)

With a barrel of oil selling in the double-digits, it is difficult to imagine that a single one of either Venezuela’s or Mexico’s foreign creditors would incur anything other than vast profits from the proceeding. Ditto Nigeria, Indonesia and many other developing countries. See http://foreigndebtforgiveness.com

20 Oz Andrew February 15, 2009 at 6:50 pm

That the perfect competition model is an attempt, let alone a good one, to model some aspect of Capitalism.

Who sets the price in a perfectly competitive market? If not the firm, who? Well, in micro theory, the government steps in whenever there is “market failure” – be it non-Pareto optimal situations, or to produce public goods when private cost-benefit does not capture all social benefits. So the job of setting prices in PC markets must by default, fall to the government.

So in the PC model we have near identical firms producing an identical product, and selling in a market where price is set by the government. There are an infinite number of firms – well not really, but its as if there were. These firms have perfect knowledge of the future – this is sent to them by the economic planning board. An internally observable quantity, called Marginal Cost, helps firms determine the appropriate level of production – they are not particularly concerned with demand conditions or future uncertainty (leave that to the planning board). They all run bare-bones profits that are just enough to cover costs.

Ah, that would be Socialism, or more precisely, Market Socialism. Capitalism is just something we project onto the PC model.

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