The visible hand in economics

The economist’s economic growth bias

Posted on: February 19, 2008

Reading the titles of the last two posts (the birth rate vs the growth rate and growth forecasts and government) I realised that neither rauparaha or myself defined what ‘growth’ we were talking about. Like all economists, we took ‘Growth’ to be synonymous with growth in gross domestic product.

Could this possibly imply that economists such as rauparaha and myself have an inherent bias when discussing normative statements about welfare that points us towards pro economic growth policies – even when there is a hefty trade off in other social values. Do economists focus too strongly on technical and allocative efficiency without taking social efficiency and equity into account?

If economists viewed the results of such analysis as positivist statements (statements of fact) there would indeed be a problem with this linguistic bias that we have towards growth in the economic pie (the size of the economy). However, economists realise that this growth focused view of welfare only provides part of the story when it comes to policy – we realise that in policy terms you have to make some pretty steep value judgments to truly believe that all that matters is gross domestic product.

If economists accept this, there is still a good reason why they are keen to focus on issues of production and expenditure ahead of welfare. The reason is that they can be (relatively) objectively measured – its an area where we can work out what happens, without relying on a swathe of value judgments.

Many people find the focus on production irritating as there are other social issues – other things that matter. However, the trade-offs between these value laden concepts is best left to policy analysts, sociologists, psychologists, and experts of the given field. Economists are the guys you can come to in order to frame a problem for you. But if the problem involves value judgments we require a little help from our friends in the other social sciences.

When an economist says that something will happen to growth, it comes from his relatively objective analysis of the economic system. Whether the social trade-offs required to create this product is worthwhile is a question that must be answered before policy is implemented – it is not a question that most economists will attempt to answer.

One issue of difficultly arises when potential social values influence peoples incentives, thereby influencing production. In this case the very value of product depends on normative analysis – a difficult position for the typical economist.

Given these interdependencies, we are left with a question. Should economists learn to make normative judgments and dive into policy, or should they steer away from normative statements and stick to positive statements that the ‘experts ‘ can work with?

This distinction strikes at the heart of the difference between political economists (as the pre-marginalist economists) and economists. Tyler Cowen is a strong proponent of the pro-normative school, while Dani Rodrik tends to stick closer to the typical economists positivist focus.

For now, I’m siding with Dr Rodrik.

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24 Responses to "The economist’s economic growth bias"

“Whether the social trade-offs required to create this product is worthwhile is a question that must be answered before policy is implemented – it is not a question that most economists will attempt to answer.”

Hold on, economists are responsible for concepts like pareto and kaldor-hicks efficiency, and welfare economics is a pretty big field too. Economics has plenty to offer in these areas.

GDP has its faults, but in reality increasing GDP has almost always proved to be a pretty good shorthand for increasing whatever variable you might prefer to measure: education, health, life expectancy, happiness. So the economic focus on increasing efficiency, which had become synonymous with increasing the size of the GDP pie, really isn’t that much of a distortion.

And although pro-growth policies may have trade-offs, a bigger pie tends to reduce the number of trade-offs we face in a way that no other solution does.

“Should economists …stick to positive statements that the ‘experts ‘ can work with?

I have no problem with normative statements, just as long as we remember that these should have no particular weight in our decision (much like the political opinions of actors). The problem is that it is not “experts” working with the statements, it’s usually the fairly uninformed public that decides these issues. If you know that the political process will produce biased results from objective facts, can you increase efficiency through providing biased facts?

This guy: Positive Economist has excellent discussion on this topic and related ones.

“Hold on, economists are responsible for concepts like pareto and kaldor-hicks efficiency, and welfare economics is a pretty big field too. Economics has plenty to offer in these areas.”

It is difficult to apply these concepts if you can’t quantify the costs and benefits. The ‘social tradeoffs’ are issues that the economist cannot quantify – I don’t know how we can apply pareto optimality if we can’t measure something.

The only time we can have pareto optimally it when we know that everyones welfare will rise from a policy – these policies are very rare but definitely an area where economists can suggest policy (as for kaldor-hicks, I’m not interested unless the policy comes with the required redistribution – otherwise we are trading off between different individuals, which involves making assumptions about the cardinal ranking of peoples utility).

“So the economic focus on increasing efficiency, which had become
synonymous with increasing the size of the GDP pie, really isn’t that much of a distortion”

I never said it was a distortion – the method is great. For things economists feel they can objectively measure this is perfect – however in the case they can’t quantify something the method is useless (beyond framing a problem). Now I believe this is what economists actually do, I’m defending us economists not bagging us.

I feel that people think we are assuming away their social trade-offs, when actually we are leaving these details up to the policy analysts and other social sciences to determine.

“And although pro-growth policies may have trade-offs, a bigger pie tends to reduce the number of trade-offs we face in a way that no other solution does’

They don’t reduce the number of trade-offs – they offer a benefit which changes the payoff associated in each trade-off. This benefit then needs to be compared with a cost that economists aren’t trained to measure.

“I have no problem with normative statements, just as long as we remember that these should have no particular weight in our decision’

Fundametally we are actually agreeing here – we only want to frame the problem, not fill in the juicy assumption gaps where we need to make specific normative statements by defining the weight of different value judgments.

The issue is though, when we make a normative statement we are applying a weight to the value judgment, which does have an impact on the optimal decision. By changing the weight on our value judgments we can create almost any result we want.

“The problem is that it is not “experts” working with the statements, it’s usually the fairly uninformed public that decides these issues”

How can we say that the public has a worse idea at applying value judgments than we do. How do we determine value judgments? These are public choice problems that we are not trained to cover – we have a great method but I think applying it requires a wider range of skills.

Even if you do believe that we are more effective at policy than the general public – this does not exclude the situation when there is a better way to form policy. The economist combined with social scientists that are more comfortable with normative statements could form some beautiful policy.

Hi Andrew,

Thanks for the link, it looks good. I noticed this post as soon as I went on:

http://positiveeconomist.blogspot.com/2008/02/affluent-society.html

bah, you’re such a normative nihilist. :-) You seem far to willing to pass the buck for normative judgments, and have too much faith in other professions to solve them. There are no solutions. Market prices, which economists do know a lot about, are often one of the most valid methods of hazarding a guess.

You’re right to point out that seemingly objective instruments often include normative judgements. But taking your position to the extreme seems to suggest there is no point in economics at all. Why study allocative decisions if we can never quantify anything? Your view of economics seems to be one where every choice is 3 apples vs 2 oranges.

“How can we say that the public has a worse idea at applying value judgments than we do?”

We don’t have to, I was just saying that the public can have worse ideas about objective values e.g. that they over or underestimate the costs/benefits or risks from certain policies. And pointing out their wrongness objectively doesn’t cause them to stop being wrong.

Oh, and as a sidenote, how can you be against kaldor-hicks? I think its a good principle (given that pareto improvements are close to non-existent). Without it, I don’t see how you can support any government intervention. Bye bye externality taxes :-)

Am I right to think (he says, feeling a little out of his depth in the economic jargon) that Matt is emphasising that not everything can be measured in dollars, while CPW is saying that dollars are the measure we have? No need to take it to extremes.

CPW also seems to be saying that where the dollar measure differs from the public’s opinion, the public is wrong. Which is something I disagree with. Too many things are hard to measure in dollars, to the point where it’s pointless to try. Of course, economists resist that just as engineers like me often lament the irrationality of the people who use our products (no, really, just read the freakin’ manual).

My understanding is that the objective measures you’re talking about are designed to approximate the collective value people put on whatever it is you’re measuring. To me that means that when many/most people disagree with the result of applying an objective measure, the objective measure must be wrong, not the people.

Again, the argument from engineering or science is that when theory disagrees with observation the theory is wrong. It does not matter how theoretically brilliant your proof of a geocentric universe is, observation tells us that you are mistaken.

Of course, if your economic measure is not actually trying to approximate human values then by all means, people can and do misunderstand it. But in that case I think you’re counting angels on pinheads until you do bring it back to people.

Hi Moz. To clarify I meant that the public can be wrong about specific facts, and that can inform their decisions. An example (which i think is true but it doesn’t really matter) is that the American public strongly supports reducing government spending on foreign aid. However the American public also thinks that the US government spends around 5 times as much on foreign aid as it really does. In this situation, what validity does the public opinion have?

This is a good article on similar issues. (There is also some great comments to the post about the correlation between political ignorance and voting in NZ).

Just in case my earlier comments seem too critical, I’ll point out that I mostly agree that Matt’s views represent best practice in a theoretical ideal world. I just don’t think that they’re of much use in reality. In reality, I would say that most economics writings for public consumption feature plenty of normative judgements. Matt’s columns certainly do (petrol tax, fat tax). All economist’s have normative opinions, and surely these tend to affect their research, career choices etc.

In reality it is also very hard to identify normative from objective arguments. Most of us would claim our opinions are shaped by facts not prejudice.

“Oh, and as a sidenote, how can you be against kaldor-hicks?”

Well, as I’m sure you’re aware, the primary problem with it is that it does not take distributive consequences into account. Is it also not the subject of the Scitovsky paradox? I could be wrong about that: I’m sure Kaldor’s criterion suffers from it, but I’m not sure that the Kaldor-Hicks criteria do. Perhaps a welfare economist could help out here…

I’d phrase that as “the primary advantage with it is that it does not take distributive consequences into account”. Surely all non-pareto policy interventions (ie all policy interventions) are based on a philosophical appeal to the idea that it is OK to do things that increase aggregate welfare, even if some people are worse off? What’s the alternative (apart from anarcho-capitalism)?

Technical objections duly noted, Wiki says Kaldor-Hicks overcomes the Scitovsky problem but is still non-transitive. I’d also assumed that you can allow individual utility functions to include a value for distributive consequences, at which point Kaldor-Hicks becomes a pretty solid criteria all by itself. Maybe that assumption is against the rules…

“Market prices, which economists do know a lot about, are often one of the most valid methods of hazarding a guess”

Definitely. However, I don’t think that economists are the best placed people to make normative judgments – that is what it comes down to. Think of it as specialisation – economists bring the model to the table and other social science help in the discussion of appropriate social values. If we believed that economists were also the most apt at making value judgments there would be no point having other social sciences.

Furthermore, I think the discipline already does this – I’m just stating why people shouldn’t treat economists statements like they are the be all and end all of policy.

Hi Moz,

“Matt is emphasising that not everything can be measured in dollars, while CPW is saying that dollars are the measure we have”

Not really, I think things can be measured in dollar terms – in this sense CPW and me are in 100% agreement. My point is that economists are not the best people to make judgments on what the $ value should be.

Back to CPW ;)

“But taking your position to the extreme seems to suggest there is no point in economics at all. Why study allocative decisions if we can never quantify anything”

No, as economics provides the framework to make these decisions. Economists provide the base then we can all work together to fill it with the beautiful normative jelly.

“We don’t have to, I was just saying that the public can have worse ideas about objective values e.g. that they over or underestimate the costs/benefits or risks from certain policies. And pointing out their wrongness objectively doesn’t cause them to stop being wrong”

True, but are economists the best people to figure out where peoples biases lie. Would sociologists, political scientists, and psychologists be able to paint a better picture.

“Oh, and as a sidenote, how can you be against kaldor-hicks?”

I’m not against kaldor-hicks, I just can’t see how it can be taken as a completely objective measure of optimal policy unless distributional factors are taken into account. This of course implies that using it involves making a significant value judgment – which economists have not been aptly trained to make.

Ultimately, I’m not criticising economics with this post – I am stating that people mis-interpret economists when they say things. I think we do stick closely to the more objective parts of our analysis – and I think we are clear when we impose a value judgment.

I’m also not against making normative statements as an individual – but not as an economist. When I apply value judgments I am saying how I feel, I have departed from the comfortable world of strict economics.

The confusion in the general public about when economists are doing economics or making normative statements tends to make them dis-trust everything we say. This is no good, and maybe indicates that economists have to be more careful to separate these issues when they do talk to the public.

“This of course implies that using it involves making a significant value judgment – which economists have not been aptly trained to make.”

I really don’t understand this: who’s trained to make value judgments? How do you make ‘better’ value judgments? Isn’t the whole point of them that there’s no objective criterion for them being better or worse, there are just different judgments based on different value sets? I don’t see why economists can’t make an effective judgment, given a specific value set. I don’t see why our training in optimisation routines doesn’t equip us to do this. If you’re suggesting that we don’t know what the value set is, then I’d say that the policy makers you’re talking about are just bolder about picking their own value set and imposing it upon people than we are.

“How do you make ‘better’ value judgments?”

Don’t other subjects such as sociology and public policy focus more on comparing normative statements than economics does. If this is the case, these people will have a better handle on what approximates an appropriate value judgment.

As I believe in specialisation, I think that subjects that focus on normative analysis will be better at it than subjects like economics which focus on theoretical models.

“I don’t see why economists can’t make an effective judgment, given a specific value set”

If the economist is given the value set, then they don’t need to make a judgment. If we can treat the values as facts, economists can just apply their beautiful method to find the optimal solution.

“If you’re suggesting that we don’t know what the value set is, then I’d say that the policy makers you’re talking about are just bolder about picking their own value set and imposing it upon people than we are”

That is what I have been saying since the beginning. Other people are better placed to make value judgments than economists are – that is my value judgment ;)

“Other people are better placed to make value judgments than economists are”

I suppose what I’m asking is this: if there are no objective criteria for rating a value judgment, how is it possible to meaningfully say that one person makes them better than another. By that, I don’t mean that we don’t know the objective criteria for rating them, I mean that there is, by definition, no appropriate concept for rating such judgments. If there is no way to be ‘better’ at making them then why would experience or training make one iota of difference?

“there is, by definition, no appropriate concept for rating such judgments”

True true, which is why I generally stay away from the normative side – its too smart for me.

“how is it possible to meaningfully say that one person makes them better than another”

I don’t know. But isn’t that what a bunch of other social sciences focus on. Public policy definitely focuses on the normative issues of distributive and social justice and as a result must have some ability at defining cardinal rankings.

All I’m saying is that the normative side of policy creation requires value judgments etc. I tend to believe that individuals who have been trained to understand value judgments are likely to do a better job at it than economists – in the same way that I believe the economic method provides a better way of framing problems.

As you said, this is a value judgment by me – I have made a value judgment that other disciplines are better at making value judgments then economists ;). There is definitely no objective criteria to support this supposition – however, a value judgment is necessary in this case to define who should be determining policy.

“however, a value judgment is necessary in this case to define who should be determining policy.”

As you say, this is awfully circular: we can’t know who’s best at making them without making one. Yet, if we’re not best, can we accurately make a value judgment about who is best? It makes my head hurt; I’m going to go and do some equations on the whiteboard and then maybe the world will make sense again :)

“As you say, this is awfully circular”

Thats one of the issues – it is incredibly difficult for us to say anything without making some value judgment. God damn in.

However, the value judgment about who is best placed at making value judgments relating to policy is different to the value judgments relating to policy, unless we have enough information to map the judgment on who makes policy onto the value judgments on policy. If we had this much information we would not need to rely on other agents to help us, we could just make up the value judgments ourselves.

However, I do realise that I am making a value judgment – and I do not expect us to all agree on this specific point, as you say we can’t objectively determine who is the best at creating policy related value judgments.

To re-iterate, I am not criticising economics – I am trying to defend economists from the claim that our focus on production is too narrow. If we state that economists are merely performing the role that they have a comparative advantage in, realising that this then needs to be combined with the work of other experts – then this criticism of economics seems unfounded.

I’m all for economic imperialism. Bring it on!

“The confusion in the general public about when economists are doing economics or making normative statements tends to make them dis-trust everything we say.”

I think that this is a plausible explanation. The WSJ op-ed page has a lot to answer for. But I think there is a lot of shooting the messenger that goes on. A lot of economic criticism comes from people who simply don’t like the results that consensus economics spits out. Example: the idea that fiscal and monetary policies don’t have any impact on long-run unemployment is about as close to an objective truth as economics gets, but it’s a concept that a lot of lefty types clearly hate. If the economic consensus was still advocating Keynesian type policies, would these same people criticize economics to the same extent?

And a lot of criticism seems directed purely at the methodology: people are rational, respond to incentives, systems move to equilibrium. I don’t see greater objectivity helping here. No matter how objective you try to be, some people are still going to claim that the methodology is intrinsically bound with value judgments.

Hi CPW,

I can buy all that, except:

“the idea that fiscal and monetary policies don’t have any impact on long-run unemployment”

Most of us would agree, but don’t forget about Hysterisis ;) :

http://en.wikipedia.org/wiki/Hysterisis

CPW, I was with you until “people are rational”. Then I went “see, the problem is that economists assume so many proven falsehoods are true and run from there”. Could you explain why you think people are rational and what evidence you have for that? The evidence I’m aware of says that even in the economic domain people are wonderfully irrational.

The link between fiscal policy and unemployment is much loved by many in politics, left and right. Politicians in general are keen to claim credit for lowering unemployment (or anything else that’s popular and usually have economic rationalisations for why it’s their fault. Except John Key, of course, who would rather claim credit for raising unemployment, lowering wages and increasing disadvantage. Why, I don’t know, but hopefully the Nats will keep him on.

I’m probably not the best person to defend the rationality assumption, although my problem with the way economists use it is that it basically an unfalsifiable claim – hence I would strongly disagree with the idea that it is a “proven falsehood”. In a nutshell, for most seemingly irrational behaviour, there is a semi-plausible chain of “rational” beliefs and practices that could lead you there. Saying that people “maximise utility” is equally vague.

But to farm an answer out to Tim Harford:

Harford’s new book is overwhelmingly about one concept: rationality. He offers a simple and attractive definition: rational people will make decisions based on the costs and benefits of a specific choice, the effect on their total budget, and the future consequences of their actions. But he is quick to warn us of the usual simplifying assumptions made by economists. First, people are motivated by all sorts of emotions: “I do not suggest that people are wholly self-interested or obsessed with money.” Second, he acknowledges that people are not “blessed with the omniscience or perfect self-control” often assumed in economic models: “I do not deny that humans have irrational quirks and foibles.” Finally, he rejects the idea that economic agents are constantly calculating supercomputers that consider every possible outcome: “When we act rationally, we often do it unconsciously, just as when someone throws a ball for us to catch, we aren’t conscious of our brain solving differential equations to work out where it’s going to land.”

Having said all that, the rationality assumption leads to lots of testable models, many of which have been quite successful at explaining sociological phenomena. I’m thinking of Gary Becker‘s work in particular.

“The evidence I’m aware of says that even in the economic domain people are wonderfully irrational.”

CPW is right here in saying that rationality is true by default as it is a tautology. People make decisions that maximise their utiltiy – therefore people maximise their utility which is rational. Such a claim is empirically unfalsifiable – but also empirically worthless.

The point of it is too frame a problem – given the problem we can then apply value judgments and see if this holds empirically. However, if the data rejects the model is is rejecting the value judgments not the underlying premise that people are rational.

No discussion of rationality is complete without a reference to the work of Daniel Kahneman and Amos Tversky, the founding fathers of behavioural economics and the creators of prospect theory. They have a vast body of work but

http://www.econ.tuwien.ac.at/Lotto/papers/Kahneman1.pdf

is an interesting summary of Kahneman’s view of economics. It’s wel worth reading and quite short, too :)

[…] do believe that in the search for simplicity, economists often do take on a default pro-growth stance – however, I find the idea of a “no-growth” stance even more confusing, as I am […]

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