A theory past its prime.

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The Ways That Pop Economics Hurt America

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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Someone needed to write a book about how economic theory has been abused in American politics. And someone finally did. James Kwak’s “Economism” is a very important and timely book, and anyone who is interested in public affairs should pick up a copy and read it.

Kwak, a law professor at the University of Connecticut, spins a tale of how simple supply-and-demand theory fed a free-market ideology that led to a financial crash, a dysfunctional health-care system, spiraling inequality and a threadbare social-safety net. The basic idea is that by getting everyone to think in Econ 101 terms -- perfectly competitive well-functioning markets, rational well-informed consumers and so on -- free-marketers were able to redefine the terms of the national debate to favor their own interests. With Econ 101 as the default lens through which everyone views the world, Kwak argues, government programs and regulations start to seem dangerous and inefficient, while inequality begins to feel like the natural and just order of things.

There is much truth here. When competitive free markets and rational well-informed actors are the baseline assumption, the burden of proof shifts unfairly onto anyone proposing a government policy. For far too many years, free-marketers have gotten away with winning debates by just sitting back and saying “Oh yeah? Show me the market failure!” That deck-stacking has long forced public intellectuals on the left have to work twice as hard as those safely ensconced in think tanks on the free-market right, and given the latter a louder voice in public life than their ideas warrant.

It’s also true that simple theories, especially those we learn in our formative years, can maintain an almost unshakeable grip on our thinking. For example, the basic Econ 101 theory of supply and demand is fine for some products, but it doesn’t work very well for labor markets. It is incapable of simultaneously explaining both the small effect of minimum wage increases and the small impact of low-skilled immigration. Some more complicated, advanced theory is called for. But no matter how much evidence piles up, people keep talking about “the labor supply curve” and “the labor demand curve” as if these are real objects, and to analyze policies -- for example, overtime rules -- using the same old framework. An idea that we believe in despite all evidence to the contrary isn’t a scientific theory -- it’s an infectious meme.

Academic economists are unsure about how to respond to the abuse of simplistic econ theories for political ends. On one hand, it gives them enormous prestige. The popularity of simplistic econ ideas has made economists the toast of America’s intellectual classes. It has sustained enormous demand for the undergraduate econ major, which serves, in the words of writer Michael Lewis, as a “standardized test of general intelligence” for future businesspeople. But as Kwak points out, the simple theories promulgated by politicians and on the Wall Street Journal editorial page often bear little resemblance to the sophisticated theories used by real economists. And when things go wrong -- when the financial system crashes, or millions of workers displaced by Chinese imports fail to find new careers -- it’s academic economists who often get blamed, not the blasé and misleading popularizers.

The solution -- which Kwak discusses, and which I endorse -- is empirical evidence. The economics discipline itself has been shifting from theory to data for years now, and the world is taking notice. Every time studies show that tax cuts don’t do much to encourage investment, or that the impact of minimum wage hikes is modest, the public loses a little faith in the power of traditional Econ 101. The cure for economism isn’t less economics -- it’s more and better economics.

So you should read Kwak’s book. But there’s one big question it doesn’t answer to my satisfaction. Why was economism -- or as I’ve called it, 101ism -- really so successful at capturing hearts and minds? Kwak chalks it all up to the purposeful influence of business leaders, the wealthy and their enablers. He writes:

A way of seeing the world, such as economism, does not become widespread and influential because it is more accurate or correct than the alternatives. Instead, worldviews become powerful because they reflect the beliefs and serve the purposes of an important interest group.

I don’t really believe this. It seems clear to me that the real-world usefulness of a worldview or ideology really does have an effect. Russia and China have given up communism not because they stopped having working classes, but because it became obvious that their communist systems were keeping them in poverty. And Americans are now starting to question economism because of declining median income, spiraling inequality and a huge financial and economic crisis.

So I wonder if economism was really as unrealistic and useless as Kwak seems to imply. Did countries that resisted economism -- Japan, for example, or France -- do better for their poor and middle classes than the U.S.? Wages have stagnated in those countries, and inequality has increased, even as those countries remain poorer than the U.S. Did the U.S.’s problems really all come from economism, or did forces such as globalization and technological change play a part? Cross-country comparisons suggest that the deregulation and tax cuts of the 1980s and 1990s, although ultimately excessive, probably increased economic output somewhat.

Economism has obviously gone too far. The worldview it promulgates is too simplistic, and it sometimes ends up hurting the many to benefit the few. But as we search for new ideologies and worldviews, I think we shouldn’t forget economism. It should be just one tool in our mental toolbox.

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