Pop-economics and the Problem with Prescription

Basic economic ideas are polluting political discourse with contrived nonsense. As I was scrolling through some political arguments on Facebook (where else), I came across an exchange about the minimum wage in the United States. In this exchange one of the interlocutors brought up unemployment. The argument went like this: "businesses will lose money if the minimum wage is increased. When the cost to employ people goes up, businesses with lay people off to make up for the lost money."

Hidden in this argument is the intuition of a model for unemployment from the neoclassical canon of economic thought. This model, in its most basic form, postulates that labor is bought and sold at a "market price" where supply and demand intersect. When the price for labor falls below market price there is excess demand for labor, and when the price is raised above the market price there is excess supply of labor. Hence, an increase in the price of labor (a $15 minimum wage for example) will create an excess supply of labor, which is unemployment.

Anyone who has taken an introductory economics course will know about the above intuition. I think that is a problem. Before I get to that, here is another example of "econ 101" thinking: "the government has to live within its means. The government should be only spending as much money as it brings in in taxes. Budget deficits and the debt altogether are indications of fiscal irresponsibility".

Again, the above argument loosely circumscribes a neoclassical economic theory about "crowding-out" private investment. Basic economic theory indicates that government spending increases demand for a limited supply of loanable funds (money set aside for investment). With increased demand comes competition and hence a price increase. When there is excess demand for loanable funds, the price of loanable funds increases. The price of loanable funds is the interest rate, and a higher interest rate means borrowing money is more expensive and therefore people will be less likely to borrow. This all sums up to the following: too much government spending (spending which artificially raises the interest rate above the market price) will take money away from people who would otherwise use it for investment.

The loanable funds model is slightly more complex than the model for wages. But the arguments it produces are just as harmful to political discourse. Because the central thrust of the loanable funds intuition is that government spending is basically stealing, it's a perfect theory if you want people to resent the government for taking their earned income.

These "econ 101" ideas are in the minds of public officials as well. Former member of the Obama economic team, Jared Bernstein said as much in a Vox article castigating this same intuition. He explains that the tepid government response to the Great Recession was because officials feared the "crowding-out" effect of government deficits. 

Both of these intuitions (and more) are part of what I will call "pop-economics". Pop-economics is used to justify all sorts of well-intentioned but harmful policies. There are entire political parties devoted to a close adherence to simplified classical economic doctrines.

To understand and refute the popular fealty to these basic intuitions we first need to investigate where they come from and then why they are being used as a framework for both Facebook arguments and government policy.

The Contortionist's Science

If you have ever seen a contortionist perform, you've probably seen the trick where they cram themselves into an impossibly small box. It's amazing and unnerving. Basic economics is often like that. There is an argument to be made (fitting in the box), and the first principles needed to make the argument are painful and unnatural-- but after some twisting and bending, they fit.

Here is what I mean.

Take the first example of pop-economics I mentioned: the supply and demand interaction which produces the market price for labor. What are the assumptions necessary for this model to work in its idealized form? Both parties (buyers and sellers) must have perfect and symmetric information, meaning they both know everything the other knows and know all available prices for all available quantities of labor. Both parties will act rationally, that is, to maximize their own utility given the market constraints. No one firm will have enough market power to control prices, rather each firm will be a price taker meaning they must abide the prevailing equilibrium price. There must be no restrictions on exiting or entering the market for firms. And there must be no discrimination, meaning firms will add or subtract labor based on price alone. There are more assumptions which are often included, but I think you understand the point. For a complete academic list, read this.

Can you see the twisting and bending here? For "perfect competition" to prevail in the labor market and for an equilibrium price to appear, several nearly impossible criterion must be met. You might be wondering (rightfully) how this can be the case when so many people advocate for letting the market decide everything from wages to healthcare.

Here is the pertinent detail. These theories and models, like in any science, are meant to establish first principle concepts. In other words, the models have to be incredibly simple so economists have basic intuition to work from. These models are meant to be loosely descriptive. They are designed to explain the phenomena we see in the national (and global) economy. Keep this in mind, it's important in the next section.

Telling it Like it is or Telling Us What to Do?

It is important to define here the difference between descriptive and prescriptive concepts. What I have been explaining thus far have been descriptive concepts. These concepts are used to describe the world as we see it. Basic economics does this by looking at the economy and asking, "what processes make the economy work this way?" The answer, as it turns out, is quite complicated, so we can use simplified assumptions to build models which are logically sound based on those assumptions. If there is perfect competition, then there must be a market-clearing price, because the assumptions of perfect competition necessitate it logically. In this way, economists have been building logically sound models and then adapting them with modified assumptions and variables to better fit the real world. Some models have been very successful and others have not.

In any case, these concepts are not prescriptive. Prescriptive concepts work differently. If I am a doctor and I know that cigarettes cause lung cancer (descriptive) and I know that my patient does not want lung cancer (descriptive), I can advise my patient not to smoke (prescriptive) . 

Notice in the above example the key component of a prescriptive concept is intention. The patient has to not want lung cancer for the knowledge that cigarettes cause lung cancer to have any relevance. In economics we must ask ourselves about intention as well to get any use out of our descriptive models. It is not enough to say that basic economics indicates a free market will create efficient market-allocation and therefore we must make the market as free as possible. Where is the intention?

You might say the intention is efficiency, but efficiency for what purpose? Is efficiency a good unto itself even if it means some people are permanently underpaid?

Let's go back to the labor market example we began with. What is our intention? If our intention is that everyone who works a job should, at minimum, be able to afford food and housing, then we can look at our economic models to find the descriptive knowledge we need. 

So, what needs to happen to ensure people can buy the things they need? Well, the current economy is not ensuring that-- we call that a market failure. Hence, we need to increase the lowest full-time wage possible (minimum wage) to the level at which it becomes possible to buy the basic commodities needed to live. But wait! There is a descriptive model which indicates that this might increase unemployment. Ok, let's take a look at how this descriptive model has been fit to our current situation. Is there currently an equilibrium price for labor? Well, not really. If there were, the labor market would clear and we would have zero unemployment. Even if there were, how could we be sure an increase in the minimum wage would put us over the market price? What if other market failures are artificially lowering wages? In that case an increase would actually bring us closer to an efficient allocation price.

This means there are factors outside of the basic model for labor-market allocation which might help describe the current economic situation. Further, there are likely models which both clarify the current situation and propose economic solutions to ensure that everyone can buy basic commodities.

Elaborating on this model, two studies, one from LSE and one from UC Berkeley, seem to indicate that raising the minimum wage to $15 will not significantly impact the level of employment. Further, a study which aggregated minimum wage increases in the US from 1938 to 2016 indicated almost no significant increases in unemployment.

This is more descriptive information which gives credence to the prescriptive call for a higher minimum wage. Of course, this is only if there is intention to do so. 

This is the fundamental danger of pop-economics. It promotes basic descriptive claims masquerading as prescriptive injunctions. Pop-economics heralds efficiency for efficiency's sake without considering the intention inherent to human flourishing. 

In the wake of the 2008 financial crisis, the basic descriptive story that government debt crowds-out private investment meant the government pulled punches and allowed the economy to languish. The recovery from the Great Recession was painfully slow and it cost countless people their dignity---and in some cases---their lives. 

We now see that the crowding-out story is less descriptive of the real economy than we thought. But this is what happens when we give too much weight to basic pop-economics. We cut ourselves off from the nuance of models adapted to our current environment and we mistake descriptive claims for prescriptive ones. As a result, we do harm.

Back to Facebook

Now that we know all of this, what should we do? Economists have a long road ahead of them if they want to regain the trust of the general population after the recession. That may be the case again after COVID if we allow pop-economics more undeserved time in the limelight. It seems this might be the case already, as the government is failing to provide much-needed economic relief.

We would do well to take these distinctions to heart. If we continue to argue with arguments from "econ 101" we miss an entire canon of better-fit and richer descriptive data. The arguments we make are important because they become the stories we tell to shape society. If we are telling bad stories which use the veneer of scientific rigor to make cheap points, we cheapen the discourse altogether.

Ultimately, the best thing to do when we see or hear arguments made from the pop-economic perspective is to kindly and respectfully introduce some much-needed nuance. We can describe the difference between the descriptive nature of econ 101 and the detail and intention needed to make prescriptive recommendations. 

Or, if you're feeling generous, you could simply share this article in that Facebook comment section.