CHAPTER 2 THINKING LIKE AN ECONOMIST Ignoring for now whether you agree with these statements, notice that Polly and Norma differ in what they are trying to do. Polly is speaking like a scientist: She is making a claim about how the world works. Norma is speaking like a policy ad- viser: She is making a claim about how she would like to change the world In general, statements about the world are of two types. One type, such as Polly's, is positive. Positive statements are descriptive. They make a claim about positive statements how the world is. A second type of statement, such as Norma's, is normative. Nor- claims that attempt to describe the mative statements are prescriptive. They make a claim about how the world ought world as it is to be normative statements a key difference between positive and normative statements is how we judge claims that attempt to prescribe how their validity. We can, in principle, confirm or refute positive statements by exam- ining evidence. An economist might evaluate Polly's statement by analyzing data the world should be on changes in minimum wages and chang olves values as well as facts. Nom on- statement cannot be judged using data alone. Deciding what is good or bad policy is not merely a matter of science. It also involves our views on ethics, religion, and olitical philosophy Of course, positive and normative statements may be related. Our positive views about how the world works affect our normative views about what policie are desirable. Polly s claim that the minimum wage causes unemployment, if true, might lead us to reject Norma's conclusion that the government should raise the minimum wage. Yet our normative conclusions cannot come from positive analy is alone. Instead, they require both positive analysis and value judgments As you study economics, keep in mind the distinction between positive and normative statements. Much of economics just tries to explain how the economy works. Yet often the goal of economics is to improve how the economy works When you hear economists making normative statements, you know they have crossed the line from scientist to policy adviser ECONOMISTS IN WASHINGTON President Harry Truman once said that he wanted to find a one-armed economist When he asked his economists for advice, they always answered,"On the one On the other hand Truman was right in realizing that economists' advice is not always straight- forward. This tendency is rooted in one of the Ten Principles of Economics in Chap- ter 1: People face tradeoffs. Economists are aware that tradeoffs are involved in most policy decisions. A policy might increase efficiency at the cost of equity. It might help future generations but hurt current generations. An economist who says that all policy decisions are easy is an economist not to be trusted Truman was also not alone among presidents in relying on the advice of econ- omits. Since 1946, the president of the United States has received guidance from the Council of Economic Advisers which consists of three members and a staff of several dozen economists. The council, whose offices are just a few steps from the White House, has no duty other than to advise the president and to write the an nual Economic Report of the President. The president also receives input from economists in many administrative de partments. Economists at the Department of Treasury help design tax policy. Econ- mists at the Department of Labor analyze data on workers and those looking for
CHAPTER 2 THINKING LIKE AN ECONOMIST 29 Ignoring for now whether you agree with these statements, notice that Polly and Norma differ in what they are trying to do. Polly is speaking like a scientist: She is making a claim about how the world works. Norma is speaking like a policy adviser: She is making a claim about how she would like to change the world. In general, statements about the world are of two types. One type, such as Polly’s, is positive. Positive statements are descriptive. They make a claim about how the world is. A second type of statement, such as Norma’s, is normative. Normative statements are prescriptive. They make a claim about how the world ought to be. A key difference between positive and normative statements is how we judge their validity. We can, in principle, confirm or refute positive statements by examining evidence. An economist might evaluate Polly’s statement by analyzing data on changes in minimum wages and changes in unemployment over time. By contrast, evaluating normative statements involves values as well as facts. Norma’s statement cannot be judged using data alone. Deciding what is good or bad policy is not merely a matter of science. It also involves our views on ethics, religion, and political philosophy. Of course, positive and normative statements may be related. Our positive views about how the world works affect our normative views about what policies are desirable. Polly’s claim that the minimum wage causes unemployment, if true, might lead us to reject Norma’s conclusion that the government should raise the minimum wage. Yet our normative conclusions cannot come from positive analysis alone. Instead, they require both positive analysis and value judgments. As you study economics, keep in mind the distinction between positive and normative statements. Much of economics just tries to explain how the economy works. Yet often the goal of economics is to improve how the economy works. When you hear economists making normative statements, you know they have crossed the line from scientist to policy adviser. ECONOMISTS IN WASHINGTON President Harry Truman once said that he wanted to find a one-armed economist. When he asked his economists for advice, they always answered, “On the one hand, . . . . On the other hand, . . . .” Truman was right in realizing that economists’ advice is not always straightforward. This tendency is rooted in one of the Ten Principles of Economics in Chapter 1: People face tradeoffs. Economists are aware that tradeoffs are involved in most policy decisions. A policy might increase efficiency at the cost of equity. It might help future generations but hurt current generations. An economist who says that all policy decisions are easy is an economist not to be trusted. Truman was also not alone among presidents in relying on the advice of economists. Since 1946, the president of the United States has received guidance from the Council of Economic Advisers, which consists of three members and a staff of several dozen economists. The council, whose offices are just a few steps from the White House, has no duty other than to advise the president and to write the annual Economic Report of the President. The president also receives input from economists in many administrative departments. Economists at the Department of Treasury help design tax policy. Economists at the Department of Labor analyze data on workers and those looking for positive statements claims that attempt to describe the world as it is normative statements claims that attempt to prescribe how the world should be
30 PART ONE INTRODUCTION Let's switch. I'll make the policy, you implement it, and he'll explain it work in order to help formulate labor-market policies. Economists at the Depart ment of Justice help enforce the nations antitrust laws Economists are also found outside the administrative branch of To obtain independent evaluations of policy proposals, Congress relies on the ad vice of the Congressional Budget Office, which is staffed by economists. The Fed- eral Reserve, the quasi-governmental institution that sets the nation s monetary policy, employs hundreds of economists to analyze economic developments in the United States and throughout the world Table 2-1 lists the Web sites of some of these agencies The influence of economists on policy goes beyond their role as advisers: Their research and writings often affect policy indirectly. Economist John Maynard Keynes offered this observation The ideas of economists and political philosophers, both when they are right and the world is ruled by little elso powerful than is commonly understood. Indeed, lse Practical men, who believe themselves to be quite exempt from intellectual influences, are usually the slaves of some defunct economist Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back Table 2-1 Department of Commerce www.doc.gov WEB SITES. Here are the Web ureau of Labor Statistics www.bls.gov sites for a few of the government Congressional Budget Office www.cbo.gov agencies that are responsible for Federal Reserve board www.federalreserve.gov collecting economic data and
30 PART ONE INTRODUCTION work in order to help formulate labor-market policies. Economists at the Department of Justice help enforce the nation’s antitrust laws. Economists are also found outside the administrative branch of government. To obtain independent evaluations of policy proposals, Congress relies on the advice of the Congressional Budget Office, which is staffed by economists. The Federal Reserve, the quasi-governmental institution that sets the nation’s monetary policy, employs hundreds of economists to analyze economic developments in the United States and throughout the world. Table 2-1 lists the Web sites of some of these agencies. The influence of economists on policy goes beyond their role as advisers: Their research and writings often affect policy indirectly. Economist John Maynard Keynes offered this observation: The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. “Let’s switch. I’ll make the policy, you implement it, and he’ll explain it.” Table 2-1 WEB SITES. Here are the Web sites for a few of the government agencies that are responsible for collecting economic data and making economic policy. Department of Commerce www.doc.gov Bureau of Labor Statistics www.bls.gov Congressional Budget Office www.cbo.gov Federal Reserve Board www.federalreserve.gov
CHAPTER 2 THINKING LIKE AN ECONOMIST Although these words were written in 1935, they remain true today. Indeed, the academic scribbler" now influencing public policy is often Keynes himself QUICK QUIZ: Give an example of a positive statement and an example of a normative statement. o Name three parts of government that regularly rely on advice from economists WHY ECONOMISTS DISAGREE "If all economists were laid end to end, they would not reach a conclusion " This quip from George Bernard Shaw is revealing. Economists as a group are often crit icized for giving conflicting advice to policymakers. President Ronald Reagan once joked that if the game Trivial Pursuit were designed for economists, it would have Why do economists so often appear to give conflicting advice to policy makers? There are two basic reasons: Economists may disagree about the validity of alternative positive theories about how the world works Economists may have different values and, therefore, different normative views about what policy should try to accomplish Let's discuss each of these reasons DIFFERENCES IN SCIENTIFIC JUDGMENTS Several centuries ago, astronomers debated whether the earth or the sun was at the center of the solar system. More recently, meteorologists have debated whether the earth is experiencing"global warming"and, if so, why. Science is a search for understanding about the world around us. It is not surprising that as the search continues, scientists can disagree about the direction in which truth lies Economists often disagree for the same reason. Economics is a young science, and there is still much to be learned. Economists sometimes disagree because they have different hunches about the validity of alternative theories or about the size of important parameters taxa or example, economists disagree about whether the government should levy es based on a household's income or its consumption(spending). Advocates of a switch from the current income tax to a consumption tax believe that the change would encourage households to save more, because income that is saved would not be taxed. Higher saving, in turn, would lead to more rapid growth in pro- ductivity and living standards. Advocates of the current income tax believe that household saving would not respond much to a change in the tax laws. These two groups of economists hold different normative views about the tax system because they have different positive views about the responsiveness of saving to tax incentives
CHAPTER 2 THINKING LIKE AN ECONOMIST 31 Although these words were written in 1935, they remain true today. Indeed, the “academic scribbler” now influencing public policy is often Keynes himself. QUICK QUIZ: Give an example of a positive statement and an example of a normative statement. ◆ Name three parts of government that regularly rely on advice from economists. WHY ECONOMISTS DISAGREE “If all economists were laid end to end, they would not reach a conclusion.” This quip from George Bernard Shaw is revealing. Economists as a group are often criticized for giving conflicting advice to policymakers. President Ronald Reagan once joked that if the game Trivial Pursuit were designed for economists, it would have 100 questions and 3,000 answers. Why do economists so often appear to give conflicting advice to policymakers? There are two basic reasons: ◆ Economists may disagree about the validity of alternative positive theories about how the world works. ◆ Economists may have different values and, therefore, different normative views about what policy should try to accomplish. Let’s discuss each of these reasons. DIFFERENCES IN SCIENTIFIC JUDGMENTS Several centuries ago, astronomers debated whether the earth or the sun was at the center of the solar system. More recently, meteorologists have debated whether the earth is experiencing “global warming” and, if so, why. Science is a search for understanding about the world around us. It is not surprising that as the search continues, scientists can disagree about the direction in which truth lies. Economists often disagree for the same reason. Economics is a young science, and there is still much to be learned. Economists sometimes disagree because they have different hunches about the validity of alternative theories or about the size of important parameters. For example, economists disagree about whether the government should levy taxes based on a household’s income or its consumption (spending). Advocates of a switch from the current income tax to a consumption tax believe that the change would encourage households to save more, because income that is saved would not be taxed. Higher saving, in turn, would lead to more rapid growth in productivity and living standards. Advocates of the current income tax believe that household saving would not respond much to a change in the tax laws. These two groups of economists hold different normative views about the tax system because they have different positive views about the responsiveness of saving to tax incentives
32 PART ONE INTRODUCTION DIFFERENCES IN VALUES Suppose that Peter and Paul both take the same amount of water from the town well. To pay for maintaining the well, the town taxes its residents. Peter has in- come of $50,000 and is taxed $5,000, or 10 percent of his income. Paul has income of $10,000 and is taxed $2, 000, or 20 percent of his income Is this policy fair? If not, who pays too much and who pays too little? Does it matter whether Pauls low income is due to a medical disability or to his decision to pursue a career in acting? Does it matter whether Peter's high income is due a large inheritance or to his willingness to work long hours at a dreary job? These are difficult questions on which people are likely to disagree. If the town hired two experts to study how the town should tax its residents to pay for the well, we would not be surprised if they offered conflicting advice This simple example shows why economists sometimes disagree about public policy. As we learned earlier in our discussion of normative and positive analysis, policies cannot be judged on scientific grounds alone. Economists give conflicting advice sometimes because they have different values. Perfecting the science of eco- nomics will not tell us whether it is Peter or Paul who pays too much PERCEPTION VERSUS REALITY ecause of differences in scientific judgments and differences in some disagreement among economists is inevitable. Yet one should not state the amount of disagreement. In many cases, economists do offer a Table 2-2 contains ten propositions about economic policy. In a survey of economists in business, government, and academia, these propositions were en- dorsed by an overwhelming majority of respondents. Most of these propositions would fail to command a similar consensus among the general public The first proposition in the table is about rent control. For reasons we will dis- cuss in Chapter 6, almost all economists believe that rent control adversely affects the availability and quality of housing and is a very costly way of helping the most needy members of society. Nonetheless, many city governments choose to ignore the advice of economists and place ceilings on the rents that landlords may charge their tenants The second proposition in the table concerns tariffs and import quotas. For reasons we will discuss in Chapter 3 and more fully in Chapter 9, almost all econ- omists oppose such barriers to free trade. Nonetheless, over the years, the presi- dent and Congress have chosen to restrict the import of certain goods. In 1993 the North American Free Trade Agreement(NAFTA), which reduced barriers to trade among the United States, Canada, and Mexico, Passed Congress, but only by a narrow margin, despite overwhelming support from economists In this case, economists did offer united advice, but many members of Congress chose to ig nore it Why do policies such as if th are united in their opposition? The reason may be that economists have not yet convinced the general public that these policies are undesirable. One purpose of to make you understand jects and, perhaps, to persuade you that it is the right
32 PART ONE INTRODUCTION DIFFERENCES IN VALUES Suppose that Peter and Paul both take the same amount of water from the town well. To pay for maintaining the well, the town taxes its residents. Peter has income of $50,000 and is taxed $5,000, or 10 percent of his income. Paul has income of $10,000 and is taxed $2,000, or 20 percent of his income. Is this policy fair? If not, who pays too much and who pays too little? Does it matter whether Paul’s low income is due to a medical disability or to his decision to pursue a career in acting? Does it matter whether Peter’s high income is due to a large inheritance or to his willingness to work long hours at a dreary job? These are difficult questions on which people are likely to disagree. If the town hired two experts to study how the town should tax its residents to pay for the well, we would not be surprised if they offered conflicting advice. This simple example shows why economists sometimes disagree about public policy. As we learned earlier in our discussion of normative and positive analysis, policies cannot be judged on scientific grounds alone. Economists give conflicting advice sometimes because they have different values. Perfecting the science of economics will not tell us whether it is Peter or Paul who pays too much. PERCEPTION VERSUS REALITY Because of differences in scientific judgments and differences in values, some disagreement among economists is inevitable. Yet one should not overstate the amount of disagreement. In many cases, economists do offer a united view. Table 2-2 contains ten propositions about economic policy. In a survey of economists in business, government, and academia, these propositions were endorsed by an overwhelming majority of respondents. Most of these propositions would fail to command a similar consensus among the general public. The first proposition in the table is about rent control. For reasons we will discuss in Chapter 6, almost all economists believe that rent control adversely affects the availability and quality of housing and is a very costly way of helping the most needy members of society. Nonetheless, many city governments choose to ignore the advice of economists and place ceilings on the rents that landlords may charge their tenants. The second proposition in the table concerns tariffs and import quotas. For reasons we will discuss in Chapter 3 and more fully in Chapter 9, almost all economists oppose such barriers to free trade. Nonetheless, over the years, the president and Congress have chosen to restrict the import of certain goods. In 1993 the North American Free Trade Agreement (NAFTA), which reduced barriers to trade among the United States, Canada, and Mexico, passed Congress, but only by a narrow margin, despite overwhelming support from economists. In this case, economists did offer united advice, but many members of Congress chose to ignore it. Why do policies such as rent control and import quotas persist if the experts are united in their opposition? The reason may be that economists have not yet convinced the general public that these policies are undesirable. One purpose of this book is to make you understand the economist’s view of these and other subjects and, perhaps, to persuade you that it is the right one
CHAPTER 2 THINKING LIKE AN ECONOMIST PROPOSITION (AND PERCENTAGE OF ECONOMISTS WHO AGREE) TEN PROPOSITIONS ABOUT 1. A ceiling on rents reduces the quantity and quality of housing available. WHICH MOST ECONOMISTS agree 2. Tariffs and import quotas usually reduce general economic welfare. (93%) 3. Flexible and floating exchange rates offer an effective international monetary arrangement.(90%) 4. Fiscal policy (e. g, tax cut and/or government expenditure increase)has a gnificant stimulative impact on a less than fully employed economy. (90%) 5. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly (85%) 6. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%) 7. A large federal budget deficit has an adverse effect on the economy. (83%) 8. A minimum wage increases unemployment among young and unskilled workers (79%) 9. The government should restructure the welfare system along the lines of a negative income tax. "(79%) 10. Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%) SOURCE: Richard M. Alston, J. R Kearl, and Michael B. Vaughn, "Is There Consensus among Economists in the 1990s?" American Economic Review (May 1992): 203-209. QUICK QUIZ: Why might economic advisers to the president disagree bout a question of policy? LET'S GET GOING The first two chapters of this book have introduced you to the ideas and methods of economics. We are now ready to get to work. In the next chapter we start learn- ing in more detail the principles of economic behavior and economic policy. As you proceed through this book, you will be asked to draw on many of your intellectual skills. You might find it helpful to keep in mind some advice from the great economist John Maynard Keynes The study of economics does not seem to require any specialized gifts of an unusually high order. Is it not . a very easy subject compared with the higher branches of philosophy or pure science? An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher-in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the
CHAPTER 2 THINKING LIKE AN ECONOMIST 33 QUICK QUIZ: Why might economic advisers to the president disagree about a question of policy? LET’S GET GOING The first two chapters of this book have introduced you to the ideas and methods of economics. We are now ready to get to work. In the next chapter we start learning in more detail the principles of economic behavior and economic policy. As you proceed through this book, you will be asked to draw on many of your intellectual skills. You might find it helpful to keep in mind some advice from the great economist John Maynard Keynes: The study of economics does not seem to require any specialized gifts of an unusually high order. Is it not . . . a very easy subject compared with the higher branches of philosophy or pure science? An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher—in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the Table 2-2 TEN PROPOSITIONS ABOUT WHICH MOST ECONOMISTS AGREE PROPOSITION (AND PERCENTAGE OF ECONOMISTS WHO AGREE) 1. A ceiling on rents reduces the quantity and quality of housing available. (93%) 2. Tariffs and import quotas usually reduce general economic welfare. (93%) 3. Flexible and floating exchange rates offer an effective international monetary arrangement. (90%) 4. Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%) 5. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. (85%) 6. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%) 7. A large federal budget deficit has an adverse effect on the economy. (83%) 8. A minimum wage increases unemployment among young and unskilled workers. (79%) 9. The government should restructure the welfare system along the lines of a “negative income tax.” (79%) 10. Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%) SOURCE: Richard M. Alston, J. R. Kearl, and Michael B. Vaughn, “Is There Consensus among Economists in the 1990s?” American Economic Review (May 1992): 203–209