Tag Archives: principles of economics

Economics Explained — Part II: Economic Principles in Perspective

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This is the second installment of a long post. I may revise it as I post later parts. The whole will be published as a page, for ease of reference. If you haven’t read “Part I: What Is Economics About?“, you may benefit from doing so before you embark on this part.

What Drives Us

Humans are driven by the survival instinct and a host of psychological urges, which vary from person to person. Those urges include but are far from limited to the self-aggrandizement (ego), the need for love and friendship, and the need to be in control (which includes the needs to possess things and to control others, both in widely varying degrees). Economic activity, as I have said, excludes matters of love and friendship (though not calculated relationships that may seem like friendship), but aside from those things — which influence personal economic activity (e.g., the need to provide for loved ones) — there are more motivations for economic activity than can be dreamt of by economists. Those motivations are shaped genes and culture, which are so varied and malleable (in the case of culture) that specific knowledge about them is useful only to the purveyors of particular goods.

Therefore, economists long ago (and wisely) eschewed models of economic behavior that impute particular motivations to economic activity. Instead they said that individuals seek to maximize utility (something like happiness or satisfaction), whatever that might be for particular individuals. Similarly, they said that firms seek to maximize profits, which is easier to quantify because profit is measured in monetary units (dollars in America).

Irrational Rationality

Further, economists used to say that individuals act rationally when they strive to maximize utility. Behavioral economists (e.g., Richard Thaler) have challenged the rationality hypothesis by showing that personal choices are often irrational (in the judgment of the behavioral economist). The case of “saving too little” for retirement is often invoked in support of interventions (including interventions by the state) to “nudge” individuals toward making the “right” choices (in the judgment of the behavioral economist). The behavioral economist would thus impose his own definition of rational behavior (e.g., wealth-maximization) on individuals. This is arrogance in the extreme. All that the early economists meant by rationality was that individuals strive to make choices that advance their particular preferences.

Wealth-maximization is one such preference, but far from the only one. A young worker, for example, may prefer buying a car (that enables him to get to work faster than he could by riding a bus) to saving for his retirement. There are many other objections to the imposition of behavioral economists’ views. The links at the end of “No Tears for Cass Sunstein” (Thaler’s co-conspirator) will lead you to some of them. That post and the posts linked to at the end of it also provide insights into the authoritarian motivations of Thaler, Sunstein, and their ilk.

The Rise of Corporate Irresponsibility

Turning to firms — the providers of goods that satisfy wants — I have to say that the profit-maximization motive has been eroded by the rise of huge firms that are led and managed by bureaucrats rather than inventors, innovators, and entrepreneurs. The ownership of large firms is, in most cases, widely distributed and indirect (i.e., huge blocks of stock are held in diversified mutual-fund portfolios). This makes it possible for top managers (enabled by compliant boards of directors) to adopt policies that harm shareholders’ financial interests for the sake of presenting a “socially responsible” (“woke”) image of the firm to … whom?

The firm’s existing customers aren’t the general public, they are specific segments of the general public, and some of those segments don’t take kindly to public-relations ploys that flout the values that they (the specific segments) hold dearly. (Gillette and Dick’s Sporting Goods are recent cases in point.) The “whom” might therefore consist of segments of the public that the firms’ managers hope will buy the firm’s products because of the firm’s pandering. and — more likely — influential figures in business, politics, the arts, the media, etc., whom the managers are eager to impress.

“Social responsibility” fiascos are only part of the picture. Huge, bureaucratic firms are no more efficient in their use of resources to satisfy consumers’ wants than are huge, bureaucratic governments that (at best) provide essential services (defense and justice) but in fact provide services that politicians and bureaucrats are “needed” in order to buy votes and make work for themselves.

The bottom line here is that the satisfaction of consumers’ wants has been compromised badly. And the combination of government interventions and corporate misfeasance has made the economy far less productive than it could be.

The Flip Side of Economics: Failure to Produce

Economics, therefore, is about the satisfaction of human wants through the production and exchange of goods, given available resources. It is also about the failure to maximize the satisfaction of wants, given available resources, because of government interventions and corporate misfeasance.

The gross underperformance of America’s economy illustrates an important but usually neglected principle of economics: Every decision has an opportunity cost. When you choose to buy a car, for example, you forgo the opportunity to buy something else for the same amount of money. That something else, presumably, would afford you less satisfaction (utility) than the car. Or so the theory goes. But whether it would or wouldn’t isn’t for a behavioral economist to say.

Individuals (and firms) often make choices that they later regret. It’s called learning from experience. But “nudging”, government interventions, and corporate sluggishness reduce the opportunity to learn from experience. (Government interventions and corporate sluggishness also prevent, as I have said, behaviors that are essential to economic vitality: invention, innovation, and entrepreneurship.)

Government interventions also incentivize economically and personally destructive behavior. There are many estimates of the costs of government interventions (e.g., this one and those documented quarterly in Regulation magazine) and a multitude of examples of the personally destructive behavior engendered by government interventions. It is impossible to say which intervention has been the most harmful to the citizenry, but if pressed I would choose the thing broadly called “welfare”, which disincentivizes work and is an important cause of the dissolution of black (welfare-dependent) families, with attendant (and dire) results (educational, occupational, criminal) that bleeding hearts prefer to attribute to “racism”. If not in second place, but high up on my list, is the counterproductive response (by government at the prodding of bleeding hearts) to homelessness.

Thus we have yet another principle: the “law” of unintended consequences. Unintended consequences are the things that aren’t meant to happen — but which do happen — when an actor (be it governmental, corporate, or individual) doesn’t think about (or chooses to minimize or ignore) when it or he focuses on a particular problem or desire to the exclusion of other problems or desires. Individuals can learn from unintended consequences; governments and, increasingly, corporations are too rule-bound and infested by special interests to do so.

None of what I have said about corporations should be taken as an endorsement of governmental interventions to make them somehow more efficient and responsible. (The law of unintended consequences applies in spades when it comes to government.) The only justification for state action with respect to firms is to keep them from doing things that are inimical to liberty and can’t be rectified by private action. In an extreme case, a business that specializes in murder for hire is (or should be) a target for closure and prosecution. A business that sells a potentially harmful product (e.g., guns, cigarettes) isn’t a valid target of state action because the harmful use of the product is the responsibility of the buyer, product-liability law to the contrary notwithstanding.

What about a business that collaborates (perhaps tacitly) with other businesses or special interests to prevent the expression of views that are otherwise protected by the First Amendment but which are opposed by the managers of the business and their political allies? There are good arguments for a hand-off approach, in that markets — if they are allowed to operate freely — will provide alternatives that allow the expression (and wide circulation) of “objectionable” views. If anti-trust actions against purveyors of oil and steel (two take two examples from the past) are inadvisable (as I have argued), aren’t anti-trust actions against purveyors of information and ideas equally inadvisable? There is a qualitative difference between economic rapacity and what amounts to a war that is being waged by one segment of the nation against other segments of the nation. (See for example, “The Subtle Authoritarianism of the ‘Liberal Order’“.) Government action to defend the besieged segments is therefore fitting and proper. (See “Preemptive (Cold) Civil War“.)

Economics and Liberty

This brings me to the gravest economic threat to liberty, which is state socialism and its variants: communism, fascism, and social democracy. All of them vest control of the economy in the state, when not through outright state ownership of the means of production, then through laws and regulations that dictate allowable types of economic output, the means and methods of its production, and its beneficiaries. The United States has long been burdened with what has been called a “mixed” economic system, which is in fact a social democracy — an economy that has many of the trappings of free-market capitalism but is in fact heavily managed by governments (federal, State, and local) in the service of “social justice” and various trendy causes.

The most recent of these is the puritanical, often hypocritical, and anti-scientific effort to rescue the planet from “climate change”. The opportunity cost of this futile undertaking, were it conducted according to the dictates of its most strident supporters, would be a vast share of the economic output of the the Western world (inasmuch as Russia, China, India, and even Japan are disinclined to participate), thus demoting America and Western Europe to Third-World status and rendering them vulnerable to economic and military blackmail by Russia and China. (Old grudges die hard.) You can be sure, however, that even in their vastly diminished state, the Western “democracies” would find the resources with which to cosset the ruling class of politicians and their favorites.

Proponents of state action often defend it by adverting to the paradox of collective action, which is that individuals and firms, acting in what they perceive to be their own interests, can bring about a disaster that engulfs them. “Climate change” is the latest such so-called disaster. What the proponents of state action always omit to consider (or mention) is that state action itself can bring about a disaster that engulfs all of us. The attempt to control “climate change” is just such an action, and it is of the more dangerous kind because government programs, once started, are harder to turn around than the relatively modest and inexpensive projects of individuals and firms.

You may think that I have strayed a long way from the principles of economics. But I haven’t, if you’ve been following closely. What I have done — or tried to do — is put economic activity in perspective. Which is to say that I’ve tried to show that economic activity may be important and even crucial to our lives, but it is not the only important and crucial thing in our lives. Economic activity is shaped by government and culture. If the battle to contain government is successful, and if the battle to preserve a culture of personal responsibility and respect for traditional norms is successful, economic activity will thrive and be worth the striving.

Unorthodox Economics: 5. Economic Progress, Microeconomics, and Microeconomics

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This is the fifth entry in what I hope will become a book-length series of posts. That result, if it comes to pass, will amount to an unorthodox economics textbook. Here are the chapters that have been posted to date:

1. What Is Economics?
2. Pitfalls
3. What Is Scientific about Economics?
4. A Parable of Political Economy
5. Economic Progress, Microeconomics, and Macroeconomics

What is economic progress? It is usually measured as an increase in gross domestic product (GDP) or, better yet, per-capita GDP. But such measures say nothing about the economic status or progress of particular economic units. In fact, the economic progress of some economic units will be accompanied by the economic regress of others. GDP captures the net monetary effect of those gains and losses. And if the net effect is positive, the nation under study is said to have made economic progress. But that puts the cart of aggregate measures (macroeconomics) before the horse of underlying activity (microeconomics). This chapter puts them in the right order.

The economy of the United States (or any large political entity) consists of myriad interacting units. Some of them contribute to the output of the economy; some of them constrain the output; some of them are a drain upon it. The contributing units are the persons, families, private charities, and business (small and large) that produce economic goods (products and services) which are voluntarily exchanged for the mutual benefit of the trading parties. (Voluntary, private charities are among the contributing units because they help willing donors attain the satisfaction of improving the lot of persons in need. Voluntary charity — there is no other kind — is not a drain on the economy.)

Government is also a contributing unit to the extent that it provides a safe zone for the production and exchange of economic goods, to eliminate or reduce the debilitating effects of force and fraud. The safe zone is international as well as domestic when the principals of the U.S. government have the wherewithal and will to protect Americans’ overseas interests. The provision of a safe zone is usually referred to as the “rule of law”.

Most other governmental functions constrain or drain the economy. Those functions consist mainly of regulatory hindrances and forced “charity,” which includes Social Security, Medicare, Medicaid, and other federal, State, and local “welfare” programs. In “The Rahn Curve Revisited,” I estimate the significant negative effects of regulation and government spending on GDP.

There is a view that government contributes directly to economic progress by providing “infrastructure” (e.g., the interstate highway system) and underwriting innovations that are adopted and adapted by the private sector (e.g., the internet). Any such positive effects are swamped by the negative ones (see “The Rahn Curve Revisited”). Diverting resources to government uses in return for the occasional “social benefit” is like spending one’s paycheck on lottery tickets in return for the occasional $5 winner. Moreover, when government commandeers resources for any purpose — including the occasional ones that happen to have positive payoffs — the private sector is deprived of opportunities to put those resources to work in ways that more directly advance the welfare of consumers.

I therefore dismiss the thrill of occasionally discovering  a gold nugget in the swamp of government, and turn to the factors that underlie steady, long-term economic progress: hard work; smart work; saving and investment; invention and innovation; implementation (entrepreneurship); specialization and trade; population growth; and the rule of law. These are defined in the first section of “Economic Growth Since World War II“.

It follows that economic progress — or a lack thereof — is a microeconomic phenomenon, even though it is usually treated as a macroeconomic one. One cannot write authoritatively about macroeconomic activity without understanding the microeconomic activity that underlies it. Moreover, macroeconomic aggregates (e.g., aggregate demand, aggregate supply, GDP) are essentially meaningless because they represent disparate phenomena.

Consider A and B, who discover that, together, they can have more clothing and more food if each specializes: A in the manufacture of clothing, B in the production of food. Through voluntary exchange and bargaining, they find a jointly satisfactory balance of production and consumption. A makes enough clothing to cover himself adequately, to keep some clothing on hand for emergencies, and to trade the balance to B for food. B does likewise with food. Both balance their production and consumption decisions against other considerations (e.g., the desire for leisure).

A and B’s respective decisions and actions are microeconomic; the sum of their decisions, macroeconomic. The microeconomic picture might look like this:

  • A produces 10 units of clothing a week, 5 of which he trades to B for 5 units of food a week, 4 of which he uses each week, and 1 of which he saves for an emergency.
  • B, like A, uses 4 units of clothing each week and saves 1 for an emergency.
  • B produces 10 units of food a week, 5 of which she trades to A for 5 units of clothing a week, 4 of which she consumes each week, and 1 of which she saves for an emergency.
  • A, like B, consumes 4 units of food each week and saves 1 for an emergency.

Given the microeconomic picture, it is trivial to depict the macroeconomic situation:

  • Gross weekly output = 10 units of clothing and 10 units of food
  • Weekly consumption = 8 units of clothing and 8 units of food
  • Weekly saving = 2 units of clothing and 2 units of food

You will note that the macroeconomic metrics add no useful information; they merely summarize the salient facts of A and B’s economic lives — though not the essential facts of their lives, which include (but are far from limited to) the degree of satisfaction that A and B derive from their consumption of food and clothing.

The customary way of getting around the aggregation problem is to sum the dollar values of microeconomic activity. But this simply masks the aggregation problem by assuming that it is possible to add the marginal valuations (i.e., prices) of disparate products and services being bought and sold at disparate moments in time by disparate individuals and firms for disparate purposes. One might as well add two bananas to two apples and call the result four bapples.

The essential problem is that A and B will derive different kinds and amounts of enjoyment from clothing and food, and those different kinds and amounts of enjoyment cannot be summed in any meaningful way. If meaningful aggregation is impossible for A and B, how can it be possible for an economy that consists of millions of economic actors and an untold, constantly changing, often improving variety of goods and services?

GDP, in other words, is nothing more than what it seems to be on the surface: an estimate of the dollar value of economic output. It is not a measure of “social welfare” because there is no such thing. (See “Social Welfare” in Chapter 2). And yet it is a concept that infests microeconomics and macroeconomics.

Aggregate demand and aggregate supply are nothing but aggregations of the dollar values of myriad transactions. Aggregate demand is an after-the-fact representation of the purchases made by economic units; aggregate supply is an after-the-fact representation of the sales made by economic units. There is no “aggregate demander” or “aggregate supplier”.

Interest rates, though they tend to move in concert, are set at the microeconomic level by lenders and borrowers. Interest rates tend to move in concert because of factors that influence them: inflation, economic momentum, and the supply of money.

Inflation is a microeconomic phenomenon which is arbitrarily estimated by sampling the prices of defined “baskets” of products and services. The arithmetic involved doesn’t magically transform inflation into a macroeconomic phenomenon.

Economic momentum, as measured by changes in GDP, is likewise a microeconomic phenomenon disguised as a macroeconomic, as previously discussed.

The supply of money, over which the Federal Reserve has some control, is the closest thing there is to a truly macroeconomic phenomenon. But the Fed’s control of the supply of money, and therefor of interest rates, is tenuous.

Macroeconomic models of the economy are essentially worthless because they can’t replicate the billions of transactions that are the flesh and blood of the real economy. (See “Economic Modeling: A Case of Unrewarded Complexity“.) One of the simplest macroeconomic models — the Keynesian multiplier — is nothing more than a mathematical trick. (See “The Keynesian Multiplier: Fiction vs. Fact”.)

Macroeconomics is a sophisticated form of mental masturbation — nothing more, nothing less.

Unorthodox Economics: 2. Pitfalls

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This is the second entry in what I hope will become a book-length series of posts. That result, if it comes to pass, will amount to an unorthodox economics textbook. Here are the chapters that have been posted to date:

1. What Is Economics?
2. Pitfalls
3. What Is Scientific about Economics?
4. A Parable of Political Economy
5. Economic Progress, Microeconomics, and Macroeconomics

A person who wants to learn about economics should be forewarned about pernicious tendencies and beliefs — often used unthinkingly and expressed subtly — that lurk in writings and speeches about economics and economic issues. This chapter treats seven such tendencies and beliefs:

  • misuse of probability
  • reductionism
  • nirvana fallacy
  • social welfare
  • romanticizing the state
  • paternalism
  • judging motives instead of results

MISUSE OF PROBABILITY

Probability is seldom invoked in non-technical economics. But when it is, beware of it. A statement about the probability of an event is either (a) a subjective evaluation (“educated” guess) about what is likely to happen or (b) a strict, mathematical statement about the observed frequency of the occurrence of a well-defined random event. I will bet you even money that the first meaning applies in at least six of the next ten times that you read or hear a statement about probability or its cognate “chance,” as in 50-percent chance of rain. And my subjective evaluation is that I have a 90-percent probability of winning the bet.

Let’s take the chance of rain (or snow or sleet, etc.). You may rely heavily on a weather forecaster’s statement about the probability that it will rain today. If the stated probability is high, you may postpone an outing of some kind, or take an umbrella when you leave the house, or wear a water-repellent coat instead of a cloth one, and so on. That’s prudent behavior on your part, even though the weather forecaster’s statement isn’t really probabilistic.

What the weather forecaster is telling you (or relaying to you from the National Weather Service) is a subjective evaluation of the “chance” that it will rain in a given geographic area, based on known conditions (e.g., wind direction, presence of a nearby front, water-vapor imagery). The “chance” may be computed mathematically, but its computation rests on judgments about the occurrence of rain-producing events, such as the speed of a front’s movement and the direction of water-vapor flow. In the end, however, you’re left with only a weather forecaster’s judgment, and it’s up to you to evaluate it and act accordingly.

What about something that involves “harder” numbers, such as the likelihood of winning a lottery (where there’s good information about the number of tickets sold) or casting the deciding vote in an election (where there’s good information about the number of votes that will be cast)? I will continue with the case of voting, which is discussed in chapter 1 as an example of the extent to which economics has spread beyond its former preoccupations with buyers, sellers, and the aggregation of their activities.

An economist named Bryan Caplan has written a lot about voting. For example, he says the following in “Why I Don’t Vote: The Honest Truth” (EconLog, September 13, 2016):

Aren’t we [economists] always advising people to choose their best option, even when their best option is bleak?  Sure, but abstention [from voting] is totally an option.  And while politicians have a clear incentive to ignore we abstainers, only remaining aloof from our polity gives me inner peace.

You could respond, “Inner peace at what price?”  It is only at this point that I invoke the miniscule probability of voter decisiveness.  If I had a 5% chance of tipping an electoral outcome, I might hold my nose, scrupulously compare the leading candidates, and vote for the Lesser Evil.  Indeed, if, like von Stauffenberg, I had a 50/50 shot of saving millions of innocent lives by putting my own in grave danger, I’d consider it.  But I refuse to traumatize myself for a one-in-a-million chance of moderately improving the quality of American governance.  And one-in-a-million is grossly optimistic.

Caplan links to a portion of his lecture notes for a course in the logic of collective action. The notes include this mathematical argument:

III. Calculating the Probability of Decisiveness, I: Mathematics

A. When does a vote matter? At least in most systems, it only matters if it “flips” the outcome of the election.

B. This can only happen if the winner wins by a single vote. In that case, each voter is “decisive”; if one person decided differently, the outcome would change.

C. In all other cases, the voter is not decisive; the outcome would not change if one person decided differently.

D. It is obvious that the probability of casting the decisive vote in a large electorate is extremely small….

H. Now suppose that everyone but yourself votes “for” with probability p – and “against” with probability (1-p).

I. Then from probability theory: caplan-on-voting-probability-of-tie

J. From this formula, we can see that the probability of a tie falls when the number of voters goes up….

K. Intuitively, the more people there are, the less likely one person makes a difference….

IV. Calculating the Probability of Decisiveness, II: Examples

A. What is neat about the above formula is that it allows us to say not just how the probability of decisiveness changes, but how much….

I. Upshot: For virtually any real-world election, the probability of casting the decisive vote is not just small; it is normally infinitesimal. The extreme observation that “You will not affect the outcome of an election by voting” is true for all practical purposes.

J. Even if you were to play around with the formula to increase your estimate a thousand-fold, your estimated answer would remain vanishingly small.

What Caplan and other economists who write in the same vein ignore is the influence of their point of view. It’s self-defeating because it appeals to extremely rationalistic people like Caplan. One aspect of their rationalism is a cold-eyed view of government, namely, that it almost always does more harm than good. That’s a position with which I agree, but it’s a reason to vote rather than abstain. If rationalists like Caplan abstain from voting in large numbers, their abstention may well cause some elections to be won by candidates who favor more government rather than less.

Moreover, Caplan’s argument against voting is really a way of rationalizing his disdain for voting. This is from “Why I Don’t Vote: The Honest Truth”:

My honest answer begins with extreme disgust.  When I look at voters, I see human beings at their hysterical, innumerate worst.  When I look at politicians, I see mendacious, callous bullies.  Yes, some hysterical, innumerate people are more hysterical and innumerate than others.  Yes, some mendacious, callous bullies are more mendacious, callous, and bully-like than others.  But even a bare hint of any of these traits appalls me.  When someone gloats, “Politifact says Trump is pants-on-fire lying 18% of the time, versus just 2% for Hillary,” I don’t want to cheer Hillary.  I want to retreat into my Bubble, where people dutifully speak the truth or stay silent.

Thus demonstrating the confirmation bias in Caplan’s mathematical “proof” of the futility of voting.

Nor is his “proof” really probabilistic. A single event — be it an election, a lottery drawing, of the toss of a fair coin — doesn’t have a probability.  What does it mean to say, for example, that there’s a probability of 0.5 (50 percent) that a tossed coin will come up heads (H), and a probability of 0.5 that it will come up tails (T)? Does such a statement have any bearing on the outcome of a single toss of a coin? No, it doesn’t. The statement is only a shorthand way of saying that in a sufficiently large number of tosses, approximately half will come up H and half will come up T. The result of each toss, however, is a random event — it has no probability. You may have an opinion (or a hunch or a guess) about the outcome of a single coin toss, but it’s only your opinion (hunch, guess). In the end, you have to bet on a discrete outcome.

An election that hasn’t taken place can’t have a probability. There will be opinion polls — a lot of them in the case of a presidential election — but choosing to vote (or not) because of opinion polls can be self-defeating. Take the recent presidential election. Almost all of the polls, including those that forecast the electoral vote as well as the popular vote, had Mrs. Clinton winning over Mr. Trump.

But despite the high “probability” of a victory by Mrs. Clinton, she lost. Why? Because the “ignorant” voters in several swing States turned out in large numbers, while too many pro-Clinton voters evidently didn’t bother to vote. It’s possible that she lost some crucial States because of the abstention of voters who believed the high “probability” that she would win.

The election of 2016 — like every other election — isn’t even close to being something as simple as the toss of a fair coin. And, despite its mathematical precision, a statement about the probability of the next toss of a fair coin is meaningless. It will come up H or it will come up T, but it will not come up 0.5 H or T.

REDUCTIONISM

This subject is more important than probability, so I will say far less about it.

Reductionism is the adoption of a theory or method which holds that a complex idea or system can be completely understood in terms of its simpler components. Most reductionists will defend their theory or method by agreeing that it is simple, if not simplistic. But they will nevertheless adhere to that theory or method because it’s “the best we have.” That claim should remind you of the hoary joke about the drunk who searched for his keys under a street light because he could see the ground there, even though he had dropped the keys half a block away.

Caplan’s adherence to the simplistic, mathematical analysis of voting is a good example of reductionism. Why? Because it omits the crucial influence of group behavior. It also omits other reasons for voting (or not). It certainly omits Caplan’s real reason, which is his “extreme disgust” for voters and the candidates from whom they must choose. Finally, it omits the psychic value of voting — its “feel good” effect.

Economists also are guilty of reductionism when they suggest that persons act rationally only when they pursue the maximization of income or wealth. I’ll say more about that when I get to paternalism.

NIRVANA FALLACY

The nirvana fallacy is the logical error of comparing actual things with unrealistic, idealized alternatives. The actual things usually are the “somethings” about which government is supposed to “do something.” The unrealistic, idealized alternatives are the outcomes sought by the proponents of a particular course of government action.

There is also a pervasive nirvana fallacy about government itself. Government — which is a mere collection of fallible, squabbling, power-lusting humans — is too often thought and spoken of as if it were a kind of omniscient, single-minded, benevolent being that can overcome the forces of nature and human nature which give rise, in the first place, to the “something” about which “something must be done.”

Specific examples of the nirvana fallacy will arise in later chapters of this book.

SOCIAL WELFARE

Wouldn’t you like to arrange the world so that everyone is better off? If you would — and I suspect that most people would — you’d have to define “better off.” Happier, healthier, and wealthier make a good starting point. Of course, you’d have to arrange it so that everyone would be happier and healthier and wealthier in the future as well as in the present. That is, for example, you couldn’t arrange greater happiness at the cost of greater wealth, or at the cost of the greater happiness or wealth of those living today or their descendants.

It’s a tall order isn’t it? In fact, it’s an impossibility. (You might even call it a state of nirvana.) In the real world of limited resources, the best that can happen is that a change of some kind (e.g., the invention of an anti-polio vaccine, hybridization to produce healthier and more abundant crops) makes it possible for many people to be better off — but at a price. There is no free lunch. Someone must bear the costs of devising and implementing beneficial changes. In market economies, those costs are borne by the people who reap the benefits because they (the beneficiaries) voluntarily pay for whatever it is that makes their lives better.

Enter government, whose agents decide such things what lines of medical research to fund, and how much to spend on each line of research. A breakthrough in a line of research might be a boon to millions of Americans. But other millions of Americans — many more millions, in fact — won’t benefit from the breakthrough, though a large fraction of them will have funded the underlying research through taxes extracted from them by force. I say by force because tax collections would decline sharply if it weren’t for the credible threat of heavy fines and imprisonment tax collections.

A voluntary exchange results when each of the parties to the exchange believes that he will be better off as a result of the exchange. An honest voluntary exchange — one in which there is no deception or material lack of information — therefore improves the well-being (welfare) of all parties. An involuntary exchange, as in the case of tax-funded medical research, cannot result make all parties better off. No government agent — or economist, pundit, or politician — can look into the minds of millions of people and say that each of them would willingly donate a certain amount of money to fund this or that government program. And yet, that is the presumption which lies behind government spending.

That presumption is the fallacious foundation of cost-benefit analysis undertaken to evaluate government programs. If the “social benefit” of a program is said to equal or exceed its cost, the program is presumably justified because the undertaking of it would cause “social welfare” to increase. But a “social benefit” — like a breakthrough in medical research — is a always a benefit to some persons, while the taxes paid to elicit the benefit are nothing but a burden to other persons, who have their own problems and priorities.

Why doesn’t the good outweigh the bad? Think of it this way: If a bully punches you in the nose, thus deriving much pleasure at your expense, who is to say that the bully’s pleasure outweighs your pain? Do you believe that there’s a third party who is entitled to say that the result of your transaction with the bully is a heightened state of social welfare? Evidently, there are a lot of voters, economists, pundits, and politician who act as if they believe it.

ROMANTICIZING THE STATE

This section is a corollary to the preceding one.

It is a logical and factual error to apply the collective “we” to Americans, except when referring generally to the citizens of the United States. Other instances of “we” (e.g., “we” won World War II, “we” elected Barack Obama) are fatuous and presumptuous. In the first instance, only a small fraction of Americans still living had a hand in the winning of World War II. In the second instance, Barack Obama was elected by amassing the votes of fewer than 25 percent of the number of Americans living in 2008 and 2012. “We the People” — that stirring phrase from the Constitution’s preamble — was never more hollow than it is today.

Further, the logical and factual error supports the unwarranted view that the growth of government somehow reflects a “national will” or consensus of Americans. Thus, appearances to the contrary (e.g., the adoption and expansion of national “social insurance” schemes, the proliferation of cabinet departments, the growth of the administrative state) a sizable fraction of Americans (perhaps a majority) did not want government to grow to its present size and degree of intrusiveness. And a sizable fraction (perhaps a majority) would still prefer that it shrink in both dimensions. In fact, The growth of government is an artifact of formal and informal arrangements that, in effect, flout the wishes of many (most?) Americans. The growth of government was not and is not the will of “we Americans,” “Americans on the whole,” “Americans in the aggregate,” or any other mythical consensus.

PATERNALISM

Paternalism arises from the same source as “social welfare”; that is, it reflects a presumption that there are some persons who are competent to decide what’s best for other persons. That may be true of parents, but it is most assuredly not true of so-called libertarian paternalists.

Consider an example that’s used to explain libertarian paternalism. Some workers choose “irrationally” — according to libertarian paternalists — when they decline to sign up for an employer’s 401(k) plan. The paternalists characterize the “do not join” option as the default option. In my experience, there is no default option: An employee must make a deliberate choice between joining a 401(k) or not joining it. And if the employee chooses not to join it, he or she must sign a form certifying that choice. That’s not a default, it’s a clear-cut and deliberate choice which reflects the employee’s best judgment, at that time, as to the best way to allocate his or her income. Nor is it an irrevocable choice; it can be revisited annually (or more often under certain circumstances).

But to help employees make the “right” choice, libertarian paternalists would find a way to herd employees into 401(k) plans (perhaps by law). In one variant of this bit of paternalism, an employee is automatically enrolled in a 401(k) and isn’t allowed to opt out for some months, by which time he or she has become used to the idea of being enrolled and declines to opt out.

The underlying notion is that people don’t always choose what’s “best” for themselves. Best according to whom? According to libertarian paternalists, of course, who tend to equate “best” with wealth maximization. They simply disregard or dismiss the truly rational preferences of those who must live with the consequences of their decisions.

Libertarian paternalism incorporates two fallacies. One is what I call the rationality fallacy (a kind of reductionism), the other is the fallacy of central planning.

As for the rationality fallacy, there is simply a lot more to maximizing satisfaction than maximizing wealth. That’s why some couples choose to have a lot of children, when doing so obviously reduces the amount of wealth that they can accumulate. That’s why some persons choose to retire early rather than stay in stressful jobs. Rationality and wealth maximization are two very different things, but a lot of laypersons and too many economists are guilty of equating them.

Nevertheless, many economists do equate rationality and wealth maximization, which leads them to propose schemes for forcing us to act more “rationally.” Such schemes, of course, are nothing more than central planning, dreamt up by self-anointed wise men who seek to impose their preferences on the rest of us. They are, in other words, schemes to maximize that which can’t be maximized: social welfare.

JUDGING MOTIVES INSTEAD OF RESULTS

If a person commits what seems to be an altruistic act, that person may seem to sacrifice something (e.g., a life, a fortune) but the “sacrifice” was that person’s choice. An altruistic act serves an end: the satisfaction of one’s personal values — nothing more, nothing less. There is nothing inherent in a supposedly altruistic act that makes it morally superior to profit-seeking, which is usually thought of as the opposite of altruism.

To illustrate my point I resort to the following bits of caricature:

1. Suppose Mother Teresa’s acts of “sacrifice” were born of rebellion against parents who wanted her to take over their business empire. That is, suppose Mother Teresa derived great satisfaction in defying her parents, and it is that which drove her to impoverish herself and suffer many hardships. The more she “suffered” the more her parents suffered and the happier she became.

2. Suppose Bill Gates really wanted to become a male version of Mother Teresa but his grandmother, on her deathbed, said “Billy, I want you to make the world safe from the Apple computer.” So, Billy went out and did that, for his grandmother’s sake, even though he really wanted to be the male Mother Teresa. Then he wound up being immensely wealthy, much to his regret. But Billy obviously put his affection for or fear of his grandmother above his desire to become a male version of Mother Teresa. He satisfied his personal values. And in doing so, he make life better for millions of people, many millions more than were served by Mother Teresa’s efforts. It’s just that Billy’s efforts weren’t heart-rending, and were seemingly motivated by profit-seeking.

Now, tell me, who is the altruist, my fictional Mother Teresa or my fictional Bill Gates? You might now say Bill Gates. I would say neither; each acted in accordance with her and his personal values. One might call the real Mother Teresa altruistic because her actions seem altruistic, in the common meaning of the word. But one can’t say (for sure) why she took those actions. Suppose that the real Mother Teresa acted as she did not only because she wanted to help the poor but also because she sought spiritual satisfaction or salvation. Would that negate her acts? No, her acts would still be her acts, regardless of their motivation. The same goes for the real Bill Gates.

Results matter more than motivations. (“The road to hell,” and all that.) It is arguable that profit-seekers like the real Bill Gates — and the real John D. Rockefeller, Andrew Carnegie, Henry Ford, and their ilk — brought more happiness to humankind than did Mother Teresa and others of her ilk.

That insight is at least 240 years old. Adam Smith put it this way in The Wealth of Nations (1776):

By pursuing his own interest [a person] frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

A person who makes a profit makes it by doing something of value for others.

Unorthodox Economics: 1. What Is Economics?

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This is the first entry in what I hope will become a book-length series of posts. That result, if it comes to pass, will amount to an unorthodox economics textbook. This first chapter gives a hint of things to come. Here are the chapters that have been posted to date:

1. What is Economics?
2. Pitfalls
3. What Is Scientific about Economics?
4. A Parable of Political Economy
5. Economic Progress, Microeconomics, and Macroeconomics

A book about economics should begin by explaining what the author means by the word. Many economists have given many definitions of economics. You can look them up.

Regardless of where it started, economics seems to have become the study of how human beings make choices and how those choices affect them directly (e.g., the demand for and supply of new automobiles, enrollment in an employer’s retirement plan) and indirectly (e.g., the effects of government actions on the income available for the purchase of new automobiles or on the benefits paid out by retirement plans). The parenthetical examples are about choices that usually come with dollar signs attached. And most non-economists probably think of economics as having something (or everything) to do with money – earning it, spending it, making a profit (or not) by making and selling things, adding up the dollar value of items bought and sold to arrive at an estimate of aggregate economic activity, and understanding why the aggregate grows and shrinks, for example.

But there are many economists nowadays who have taken the study of choice into areas that would seem strange to economists of yore. Here’s just one example: voting, as in whether or not to vote and how much time (if any) to spend in the pursuit of information about the candidates or issues on the ballot. Some economists tackle voting as they would any other aspect of economics: by arguing (pro or con) that voting is rational (or irrational) given the amount of time involved (time that could spent on other pursuits, such as making money), the vanishingly small chance that an individual vote will tip the balance in an election (at least in an election where there are more than a few hundred voters), and the effect of the election results on the individual voter’s well-being (usually in terms of money).

On the other hand (as economists are supposedly fond of saying), there are economists who recognize that casting a ballot is a “feel good” act, and that voting is therefore rational if it makes one happier. But that’s only a local, short-run effect. Some economists understand that voting leads to the enactment of policies that harm voters (or many of them), regardless of why they choose to vote. This points to two conclusions: (1) Voting should be discouraged, and (2) the power of government should be curbed so that voters can feel good without causing harm (or as much of it as they do now).

So, which is it? Is voting a waste of time or is it a good use of time if it makes the voter feel good? And is it worse than a waste of time if it leads to harm? This conundrum illustrates a key point about economics (and analysis in general): It leads to conclusions that are built into the assumptions (usually implicit) that guide the economist who studies an issue. If the economist cares about liberty, he is likely to tackle the issue of voting as it affects persons other than the voter. If the economist isn’t interested in liberty – or if he sees it only as a peripheral issue — he is likely to tackle the issue of voting as it affects the voter.

Unfortunately, too many economists take the view that if government can do something to promote economic well-being, it ought to be empowered to do so. But economic well-being is in the eye of the beholder. And in this era of massive redistribution, one person’s benefit is another person’s cost. Who, other than an arrogant economist, presumes to weigh one person’s benefit against another person’s cost? My list begins with the greedy voter who believes that he can get something for nothing; the smug pundit; and the power-hungry, vote-buying politician.

There is much more to be said about the wayward paths taken by economists, and the essays in this book say a lot of it. But more than that, this book is a defense of liberty against economists who – wittingly or not – undermine it. And, ironically, the diminution of liberty results in the diminution of prosperity, which economists claim to love.

In sum economics is fraught with dangerous error. This book is meant as a warning and antidote.

The Essence of Economics

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This is the first entry in what I expect to be a series of loosely connected posts on economics.

Market-based voluntary exchange is an important if not dominant method of satisfying wants. To grasp that point, think of your day: You sleep and awaken in a house or apartment that you didn’t build yourself, but which is “yours” by dint of payments that you make from income you earn by doing things of value to other persons.* During your days at home, in a workplace, or in a vacation spot you spend many hours using products and services that you buy from others — everything from toilet paper, soap, and shampoo to clothing, food, transportation, entertainment, internet access, etc.

It is not that the things that you do for yourself and in direct cooperation with others are unimportant or valueless. Economists acknowledge the psychic value of self-sufficiency and the economic value of non-market cooperation, but they can’t measure the value of those things. Economists typically focus on market-based exchange because it involves transactions with measurable monetary values.

Another thing that economists can’t deal with, because it’s beyond the ken of economics, is the essence of life itself: one’s total sense of well-being, especially as it is influenced by the things done for oneself, solitary joys (reading, listening to music), and the happiness (or sadness) shared with friends and loved ones.

In sum, despite the pervasiveness of voluntary exchange, economics really treats only the marginalia of life — the rate at which a person would exchange a unit of X for a unit of Y, not how X or Y stacks up in the grand scheme of living.

That is the essence of economics, as a discipline. There is much more to it than that, of course; for example, how supply meets demand, how exogenous factors affect economic behavior, how activity at the level of the person or firm sends ripples across the economy, and why those ripples can’t be aggregated meaningfully.

More to come.
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* Obviously, a lot of people derive their income from transfer payments (Social Security, food stamps, etc.), which I’ll address in future posts.