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Economics Has a Major Blind Spot

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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The longer I work in the news media, the more I notice a problem with the way economics interacts with the world at large. Just to cite one example, economists often don’t take politics into account. As a result, econ models leave out important pieces, and the advice of economists often falls on deaf ears or is seen as impractical.

Traditionally, economists think of themselves as policy advisers. Politicians and their appointees make the laws, levy the taxes, set the regulations, make spending decisions, and chart the course of monetary policy; economists stand at their side, faithful technocratic advice-givers neutrally relaying the latest insights from academia. That’s the typical vision, anyway.

That may have been accurate in the period after World War II, when wise public servants whispered in the ears of strong leaders like Dwight Eisenhower and John F. Kennedy. But we live in the increasingly complex, gridlocked world of 2016 -- if the old stereotype were ever accurate, it no longer is.

First, economic policy is mostly not in the hands of a single strong, dynamic executive. Congressional paralysis is now the norm. What’s more, lots of important economic policy decisions are made by the central bank.

That means that one hand of the government often doesn’t talk to the other. For example, most economists would probably agree that fiscal and monetary policy both have an effect on aggregate demand and economic growth. But models of monetary policy often don’t consider the way that Congress’ tax and spending decisions react to changes in interest rates. And models of fiscal policy often assume that the central bank will follow some fixed rule no matter what happens to taxes and spending.

This leaves many models incomplete. Low interest rates might encourage the legislature to run higher deficits, because of reduced borrowing costs. On the other hand, low rates might make Congress tighten deficits out of fear of inflation. This interaction is so important that with certain assumptions about fiscal policy, it’s possible to completely reverse a model’s predictions about the effects of monetary policy.

Incomplete models aren’t the only way that econ fails to take politics into account. Another is that economists rarely think about the political feasibility of their proposals.

In many cases, this just makes economic models useless. For example, some academics spend huge amounts of time and energy creating intricate, complex models of optimal tax policy. But real taxes are usually not these finely tuned solutions; instead they’re a huge pile of different taxes, each of which is simple on its own, but all of which interact. Real-world taxes are the result of political bargaining, legacy legislation, well-intentioned mistakes and the isolated efforts of clever technocrats.

If academics spend their time on complex models that might only be used by some hyperadvanced future civilization, that’s not really a problem. The danger is that any attempt to change tax policy in the direction of an optimal solution might actually make things worse. This is a principle known in economics as the theory of the second-best -- in a real-world economy with lots of inefficiencies, moving in the direction of the perfect solution can actually make things less efficient. The perfect is often the enemy of the good. And because of politics, the perfect is never available.

Finally, economists generally disregard the way their own advice affects politics itself. For many decades, free trade was the policy idea that united economists more than any other; although much of the public was skeptical, and some models warned of potential dangers, economists presented a united front and pushed leaders to drop barriers to international trade. This may have ended up causing some harm in the 2000s, when the sudden increase in U.S.-China trade was harder on workers than previous trade booms.

But it also might have had an unhealthy impact on U.S. politics. A new paper by David Autor, David Dorn, Gordon Hanson, and Kaveh Majlesi shows that China trade might have increased political polarization. They write:

Has rising trade integration between the U.S. and China contributed to the polarization of U.S. politics? …We find strong evidence that congressional districts exposed to larger increases in import competition disproportionately removed moderate representatives from office in the 2000s.

So the harder a region was hit by exposure to Chinese competition, the more likely it was to vote for extreme liberals or extreme conservatives. Political polarization in turn feeds back into economic policy -- a more polarized electorate might flip rapidly back and forth between conservative and liberal policies, and will almost certainly increase gridlock. It could even put the country at risk of dangerous brinkmanship, as in the 2011 debt-ceiling crisis.

Not all economists need to take politics into account, but the ones who give policy advice definitely do. All policy is political as well as technocratic, so econ and political science aren’t really the separate fields you might think from looking at academic departments. The era of dispassionate, wise technocratic advisers is over. Like it or not, economists and their models are now in the thick of the political arena. If only more were aware of it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net