The (Mis)application of economics to public policy

Although I’m harshly critical of economics in this blog, my basic objection is not to economics (I wouldn’t have taken the time to learn the theories and do the math if I thought economics had nothing to offer) but to its misapplication to public policy. Most of the time the trouble stems for taking a simplifying assumption that really does illuminate something and then applying it to a different area.

As one of many possible examples, unions play a role in equalizing the bargaining positions of employees and employers. Since bargaining power is usually not a part of economic analysis, applying Econ 101 to public policy without also considering the other social sciences can lead to poor policy making.

I mention unions because their value was not always lost on economists. The unequal power held by the contracting parties in a labor contract has been apparent since at least 1776. From Adam Smith’s The Wealth of Nations:

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily: and the law, besides, authorises, or at least does not prohibit, their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work, but many against combining to raise it. In all such disputes, the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could live a year or two upon the stocks, which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year, without employment. In the long run, the worker may be as necessary to his master as his master is to him; but the necessity is not so immediate.

Some of the over-application of Econ 101 is because it leads to results that are favorable for the people with political power. But some of it is the honest mistake of trying to make reality fit into a nice theory that can be clearly and rigorously explained through mathematics. The social sciences have always been tempted to prove themselves by mimicking the hard sciences. If the social sciences (and particularly economics) are to remain useful they need to break themselves of this habit. Making simplifying assumptions in order to understand a phenomenon is one thing. Using those assumptions to then influence policy is something else, and all to often leads to poor results.

Note: I say Econ 101 because economics is actually moving (very slowly) towards doing more analysis of actual human behavior and paying attention to the real economy, so at the higher levels of economic analysis many of these Econ 101 type mistakes are not made as much anymore. That said, I’m in graduate school and we still talk about utility functions as though prospect theory never happened. (It was developed in 1979 and is a much, much more accurate way to assess consumer choice).

Update: From EconlolcatsGrumpy Economics cat



2 thoughts on “The (Mis)application of economics to public policy

  1. Pingback: The Minimum Wage and Employment: The Case of Two Terrible, Horrible, No Good, Very Bad Assumptions | End Poverty

  2. Pingback: The Minimum Wage and Employment: The Case of Two Terrible, Horrible, No Good, Very Bad Assumptions

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