The Worst Economists in the World

Laypeople's intuitions about economics are systematically misguided

Photo by Dmytro Demidko on Unsplash

Once upon a time we were all poor, then capitalism flourished, and now as a result we are rich.

-Deirdre McCloskey

Humans are fairly good folk physicists: We know that unsupported objects tend to fall, and that solid objects can’t pass through one another.

We’re fairly good folk biologists: We know that living things, but not rocks or mountains, exhibit spontaneous, goal-directed movement, and that organisms are permanent members of their species: Once an aardvark, always an aardvark.

And we’re fairly good folk psychologists: We know that people’s behavior is guided by their desires and beliefs, and that past behavior is usually a good guide to future behavior.

In contrast to all this, we’re fairly terrible folk economists. If we were to make a list of all our everyday intuitions about economic matters, and then a separate list of economists’ views on the same topics, we’d find almost no overlap between the two lists.

I’m quite confident about this, because that’s roughly what the economists Amit Bhattacharjee and Jason Dana did in a fascinating recent paper titled “Lay Economic Reasoning: An Integrative Review and Call to Action,” published in the journal Consumer Psychology Review. Bhattacharjee and Dana make a persuasive case that laypeople’s views on economic questions routinely part company with those of the experts, and thus that folk economics - unlike folk physics, biology, and psychology - is systematically misguided.

Of course, in principle, the laypeople could be right and the experts wrong. But if I had to bet money on it, I know which way I’d go. Aside from anything else, it makes good sense that our untutored intuitions about economics would tend to fall short of the mark. Whereas humans have dealt with the physical, biological, and psychological worlds for as long as we’ve existed on this planet, not so the modern economic world. Thus, biological evolution hasn’t equipped us for it, and culture hasn’t either - not unless we’ve studied economics.

With that as backdrop, here are some excerpts from Bhattacharjee and Dana’s paper. Note that the excerpts only just scratch the surface of the paper’s contents. Other topics covered include the benefits of immigration, the problems with buying local, the fairness of CEO pay, the effects of markets on the environment, and criticisms of the degrowth movement. If you like the excerpts and want to read the whole paper, you can request a copy from the authors here.

Economic Exchanges as Win-Win vs. Win-Lose

Voluntary trades are the building blocks of economic analysis. A foundational (if sometimes implicit) axiom of economic theory is that voluntary exchanges are mutually beneficial. As expressed by a leading consumer psychology textbook: “the idea that trade is always good is actually fairly obvious: if both parties were not better off, one or other would not be prepared to make the trade” (Blythe, 2013, p. 15)... The very existence of a voluntary exchange thereby signals that it enhances welfare for both parties, even if one party benefits more.

Despite the disarmingly simple logic behind trades being win-win, lay consumers appear to perceive a substantial proportion of everyday economic transactions as win-lose. In particular, they tend to believe that sellers are much more likely to benefit from these exchanges at the expense of buyers than the other way around. These beliefs appear partly rooted in “mercantilist” exchange intuitions, whereby consumers think that receiving money in an exchange enhances welfare more than receiving goods and services, contrary to the notion that “money is valuable only because it can be used to purchase valuable things” (Johnson et al., 2022, p. 3).

Protectionism

Among economic experts, the consensus that free trade (international or otherwise) is mutually beneficial and positive-sum is overwhelming and nearly universal. The benefits of economic specialization and division of labor increase greatly with population size, and extending these practices to a global scale allows everyone to benefit from the wealth and efficiency gains that arise when production reflects the comparative advantages of countries, regions, organizations, and individuals around the world. However, public perceptions of international trade are strikingly different: lay people tend to believe that importing cheaper foreign goods solely benefits the nations that export them while weakening domestic industry, overlooking the possibility that domestic consumers can also benefit from paying lower prices.

Profit

One defining feature of lay industrial organization is an anti-profit bias, whereby consumers see prices as allocating wealth between sellers and buyers in a zero-sum fashion, while neglecting the incentive effects of prices that encourage both parties to behave in ways that grow the societal pie.

Surveys show that people greatly overestimate both the presence of monopolies and firms' profit margins. For example, the SAEE found that the general public believed the average profit margin made by American corporations to be 46.7%, while the actual average that year was just 3%. Contrary to the economic characterization of prices being determined by structural market forces, people seem to think that most goods have “fair” prices that are substantially lower than observed prices... When asked whether the increase in gasoline prices was due to supply and demand versus oil companies trying to increase their profits (or both or neither), 85% of economists chose supply and demand, while 73% of the general public chose the profit motives of oil companies…

Rather than asking “How do this seller’s profits reflect the value they have created for me,” consumers are more likely to ask “Would I be better off if this seller charged me less and made less profit?”

Price Controls

Economic experts emphasize the importance of price signals in incentivizing producers to supply scarce goods and resources where they are most valued, and thereby tend not to support price control policies that prevent prices from varying freely, distort supply-side incentives, and thereby risk exacerbating the problems they intend to solve…

For instance, when the Argentinian government set a maximum price on milk in 1959 to ensure that poor families could afford it, many producers could no longer operate profitably and shifted resources away from milk production toward other goods, inducing a national shortage. Price ceilings on staple foods, commodities, and petroleum products have led to similar shortages and necessitated rationing in dozens of countries around the world. Capping the prices of crucially-needed pharmaceutical drugs leads firms to divert resources away from producing more of them or investing in research to improve them, deters potential new entrants who might have applied competitive pressure and offered consumers more choices, and thereby limits the availability and quality of those drugs in the long run. In cities where affordable housing is scarce, rent control laws make it much less profitable for real estate developers to invest in building new housing, thus preventing expansions to the housing supply that could improve rental availability and drive down prices. Most economic experts regard these policies as counterproductive and emphasize the risks of crippling market pricing mechanisms.

Preserving Jobs

Another defining feature of lay beliefs about labor is what Caplan (2007) calls a “make-work” bias... Simply put, lay perspectives on labor seem to assume that firms benefit society primarily by creating as many jobs as possible, rather than producing valuable outputs as efficiently as possible…

By the logic of preserving jobs, the invention of the internal combustion engine was an economic disaster. The emergence of the automobile in the 20th century led to the replacement of carriage and harness makers (numbering 109,000 in 1900) and blacksmiths (238,000 in 1910) in the US. Today, these professions are nearly obsolete... Even the polio vaccine eliminated most jobs for manufacturers and attendants of iron lungs…

Concerns that job losses due to new technology will hurt the overall economy may neglect the benefits of “creative destruction,” a hugely influential concept popularized by the economist Joseph Schumpeter…

Indeed, technological progress in a market economy means that some jobs will become obsolete, and some firms and entire industries will disappear. But the consequences are not all bad. Over time, creative destruction makes societies more productive and richer, improves the quality and availability of goods and services, and ultimately raises living standards for everyone. At the turn of the 20th century, 40% of the US population worked in food production. Today, that figure is less than 2%. That does not mean that 38% of the US population has remained persistently unemployed throughout the last century, nor that we produce too little food. Technological advances have simply made us far more efficient at producing food with less labor and fewer resources (in fact, even as the number of American mouths to feed has grown considerably, food has only become more abundant). That, in turn, has made surplus labor and resources available to reallocate to other tasks that add value to society in new ways…

[T]he long-term societal benefits of technological innovation might be most apparent when looking back at past disruptions throughout history: Johannes Gutenberg’s invention of the printing press in the 15th century prompted petitions to the Senate to ban this technology that might otherwise “[drive] honest Italian scribes out of work” (Eisenstein, 2005, p. 322), but it seems doubtful that the lay public thinks the world would be better off today if those petitions had succeeded.

Global Inequality

People from the developed world routinely express concerns that the very purpose of global markets is to enable the wealthy to exploit impoverished populations around the world with impunity, keep them mired in poverty, and fuel the ever-increasing levels of inequality that inevitably result from global commerce. Indeed, compared to 1800, when the vast majority of the global population lived in extreme poverty, global income inequality did increase until around 1975, as the now-developed world experienced rapid growth and a tenfold increase in wealth while the developing world mostly remained poor.

But over the ensuing decades, as access to global markets has increased sharply among the global poor, global inequality has fallen dramatically. Populations from developing and emerging economies have experienced disproportionate income gains relative to the wealthy developed world, driving a convergence in global incomes that is projected to continue. And extreme poverty has declined precipitously over the last two centuries, leading the World Bank to increase its international poverty line threshold in 2017, and sparking discussions about the possibility of eradicating poverty altogether.

Do Markets Make Us Bad?

Beyond economic indicators, concerns that continued global market expansion and exposure to market incentives will degrade the promotion of human rights, welfare, and social freedoms also seem common among social scientists and the public. However, empirical studies… show that people living in market-oriented societies exhibit higher levels of trust and greater aversion to immoral behaviors like cheating and theft… Longitudinal trends from 111 countries reveal that the power of traditional cultural and religious values, rigid social controls, and authoritarianism is strongest among poor populations struggling for survival, but wanes over time in countries that experience sustained socioeconomic development. Gains in wealth tend to coincide with predictable shifts toward cultural values supporting gender equality, religious freedom, ethnic and lifestyle diversity, individual self-expression, quality of life, and environmental protection.

I made a similar point in an earlier post, noting that,

as markets have made us wealthier, we’ve arrived at a place where we no longer have to spend all our time worrying about where our next meal is coming from, and can start worrying about other stuff instead – stuff like extreme poverty and the environment. People on the edge of survival don’t have the luxury of worrying about things like that.

You can read the rest of that post here:

The Kindness Paradox

The Moral Argument for the Market

Simply put, the moral argument for the modern marketplace is that it maximizes human welfare. It enables millions of strangers to cooperate to satisfy as many people’s desires as possible, and to do so at the lowest possible cost by consuming as few resources as possible. The moral argument for profit-seeking enterprise is similar. Businesses improve societal welfare and generate prosocial outcomes simply by engaging in these cooperative exchanges on a consistent basis: they employ people who voluntarily trade their labor for a given amount of wages to enhance their own welfare, who then collaborate to produce valuable goods and services that people voluntarily purchase to satisfy their own desires. Anything they earn in return depends entirely on the willing cooperation of these exchange partners, and they can profit only to the extent that they are better at cooperating with them than other businesses. Because their profits reflect their success in giving people what they want, they can thus be seen as an indication of the “net contribution [the business] makes to the social good”…

The development of modern markets that can harness the self-interested motivations of millions of individuals and businesses, use incentives to direct them toward cooperative and mutually beneficial exchange behaviors, and thereby promote wealth generation and collective good, has thus been described as “perhaps the most important social invention mankind has yet achieved” (Schultze, 1977).

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