7 Fallacies of Economics; L. Reed

It certainly does seem that way! If economics is a ((science," then why does it defy the precision, the cer tainty, and the relative unanimity of opinion which characterize so many other sciences-physics, chemistry, and mathematics, for in stance? If laws of economics and human action exist and are immutable, why do we find economists all over the board on matters of critical impor tance? Economist A champions a tax cut while Economist B favors a tax increase. Economist C argues for tariff protection but Economist D Mr. Reed is Assistant Professor of Economics at Northwood Institute in Midland, Michigan and Direc tor of the college's summer Freedom Seminars. 210 calls for free trade. Another econo mist proposes socialization and is opposed by yet another who ad vances the market economy. Indeed, if there is anything which all econ omists can agree on, it is that, well, they disagree.

Perhaps the cynic will glance at this economic Tower of Babel and condemn the study of anything eco nomic. But that would be unfair to the many eternal truths which do exist in the field of human interac tion in the marketplace. Such a view, moreover, is what some would call a ((cop-out." It offers no plausible· ex planation for the confusion and no guides for sorting out what is correct from what is incorrect. Yes, there are methods to the ((madness" of economists. The fact that they do not all think alike is capable of explanation. Where might we start?

SEVEN FALLACIES OF ECONOMICS 211 First, economics is simply not physics, chemistry, or mathematics. It is the study of human action, and humans are not programmed robots. Yes, certain immutable laws of na ture do indeed exist, but one of thenl is that humans are-each and every one of them-inner-motivated, cre ative, self-interested organisms. They range from docile to irascible, meek to daring, complacent to ambitious, smart to not-so-smart. As Adanl Smith pointed out more than two hundred years ago, HIn the great chessboard of human society, every piece has a principle of motion of its own, altogether different from that which the legislature might choose to impose upon it." This inherent variability can eas·· ily give rise to dissent among those observing it and it can just as easily confound the predictions of those bold enough to place a mathematical handle on it. Being individuals themselves, economists will differ in their value and ethical judgments. One who is a socialist will differ on a policy mat·· ter with one who is a libertarian.

They may even agree on the out·· come of that policy while disagree·· ing on whether that outcome is ~~good" or ~~bad." People who are well·· intentioned and truth-seeking yet operating from divergent ethicaJl premises frequently arrive at diver·· gent conclusions. In addition, economists may dis·· agree because they have different data or insufficient data or no reli able data at all. These are some, and I am sure not all, of the reasons why good econo mists may clash. The purpose of this essay, however, is to look for reasons for economic confusion in another direction. In brief, economists clash because, as Henry Hazlitt has so succinctly put it, ((Economics is haunted by more fallacies than any other study known to man" (empha sis mine). Is there such a thing as ~~bad eco nomics?" You bet there is, just as surely as there is good plumbing and bad plumbing. If one means by ~~bad economics" the promotion of false reasoning, mistaken assump tions, and shoddy intellectual mer chandise, then Hazlitt's comment ought to be enshrined as a law!

It may be an oversimplification, but I believe that the essence of ~~bad economics" can be distilled into the following seven fallacies. Each of them is a pitfall which the good economist will faithfully bypass. 1. The fallacy of collective terms. Examples of collective terms are Hsociety," ~~community ," ~~na tion," ~(c1ass," and ((us." The impor tant thing to remember is that they are abstractions, figments of the imagination, not living, breathing, thinking, and acting entities. The fallacy involved here is presuming 212 THE FREEMAN April that a collective is, in fact, a living, breathing, thinking, and acting en tity. The good economist recognizes that the only living, breathing, thinking, and acting entity is the individual. The source of all human action is the individual. Others may acqui esce in one's action or even partici pate, but everything which occurs as a consequence can be traced to par ticular, identifiable individuals.

Consider this: could there even be an abstraction called ((society" if all individuals disappeared? Obviously not. A collective term, in other words, has no existence in reality indepen dent of the specific persons which comprise it. It is absolutely essential to deter mine origins and responsibility and even cause and effect that econo mists avoid the fallacy of collective terms. One who does not will bog down in horrendous generalizations. He will assign credit or blame to nonexistent entities. He will ignore the very real actions (individual ac tions) going on in the dynamic world around him. He may even speak of ((the economy" almost as if it were a big man who plays tennis and eats corn flakes for breakfast. 2. The fallacy of composition. This error also involves individuals. It holds that what is true for one in dividualwill be true for all others. The example has often been given of one who stands up during a foot ball game. True, he will be able to see better, but if everyone else·stands up too, the view of many individual spectators will probably worsen.

A counterfeiter who prints a mil lion dollars will certainly benefit himself (if he doesn't get caught) but if we all become counterfeiters and each print a million dollars, a quite different effect is rather obvious. Many an economics textbook speaks of the farmer who is better offbecause he has a bumper crop but may not be better off if every farmer has one. This suggests a widespread recognition of the fallacy of compo sition, yet it is a fact that the error still abounds in many places. The good economist neither sees the trees and ignores the forest nor sees the forest and ignores the trees; he is conscious of the entire ((pic ture." 3. The fallacy of Umoney is wealth." The mercantilists of the 1600s raised this error to the pin nacle of national policy. Always bent upon heaping up hoards of gold and silver, they made war on their neighbors and looted their treas ures. If England was richer than France, it was, according to the mer cantilists, because England had more precious metals in its possession, which usually meant in the king's coffers.

It was Adam Smith, in The Wealth 1981 SEVEN FALLACIES OF ECONOMICS 213 of Nations, who exploded this silly notion. A people are prosperous to the extent they possess goods and services, not money, Smith declared .. All the money in the world-paper or metallic-will still leave one starving if goods and services ar€~ not available. The CCmoneyis wealth" error is thE! affliction ofthe currency crank. Froml John Law to John Maynard Keynes:, great populations have hyperin·· flated themselves to ruin in pursuit of this illusion. Even today we hear cries of u we need more money" as the government's monetary author·· ities crank it out at double digit rates,. The good economist will recognizE~ that money creation is no short-cut to wealth. Only the production of valued goods and services in a mar·· ket which reflects the consumer's wishes can relieve poverty and pro·· mote prosperity. 4. The fallacy of production for' its own sake. Although production.

is essential to consumption, let's not put the proverbial cart before the horse. We produce in order that we may consume, not the other way around. I enjoy writing and teaching but I enjoy sunning in Acapulco even. more. I have labored to produce this: piece and to teach its principles in. my classes instead of going to Aca·· puleo first because I know that's the~ only way I'll ever get out of Michi·· gan. Writing and teaching are the means; sunning in Acapulco is the end. A free economy is a dynamic econ omy. It is the site of what the econ omist J osephSchumpeter called CCcreativedestruction." New ideas supplant old ideas, new products and methods replace old products and methods, and whole new industries render obsolete old industries. This occurs because production must constantly change shape to conform with the changing shape of consumer demand. As Henry Haz litt has written, CCit is just as neces sary to the health of a dynamic economy that dying industries be al lowed to.die as that growing indus tries be allowed to grow."

A bad economist who falls prey to this ancient fallacy is like the fabled pharaoh who thought pyramid building was healthy in and of itself; or the politician who promotes leaf raking where there are no leaves to be raked, just to keep people ttbusy." It seems that whenever an indus try gets in trouble, some people cry that it must be preserved Uat all costs." They would pour millions or billions of dollars in subsidies on the industry to prevent the market's verdict from being heard. The bad economist will join the chorus and ignore the deleterious impact that would befall the consumer. The good economist, on the other hand, .does not confuse ends with 214 THE· FREEMAN April means. He understands that produc tion is important only because con sumption is even more so. Want an example of this fallacy at work? How about the many propos als to prevent consumers from buy ing Japanese autos in order to ((pro tect" the American auto industry from competition?

5. The fallacy of the "free lunch." The Garden of Eden is a thing of the distant past yet some people (yes, even some economists) occasionally think and act as if eco nomic goods can come with no cost attached. Milton Friedman is one economist who has warned repeat edly, however, that ((there is no such thing as a free lunch!" Every ((something for nothing" scheme and most ((get rich quick" plans have some element of this fal lacy in them. Let there be no mis take about this: if economics is in volved, someone pays! An· important note here regards government expenditures. The good economist understands that govern ment, by its very nature, cannot give except what it first takes. A ttfree" park for Midland, Michigan is a park which millions of taxpaying Ameri cans (including Midlanders) ac tually do pay for. A friend of mine once told me that all one needs to know about econom ics is ((What is it going to cost and who is going to pay for it?" That littIe nutshell carries a kernel of ad vice for the economist: don't be su perficial in your thinking!

6. The fallacy of the short run. In a sense, this fallacy is a summary of the previous five. Some actions seem beneficial in the short run but produce disaster in the long run: drinking exces sively, driving fast, spending blindly, and printing money, to name a few. To quote the venerable Henry Hazlitt again, ((The bad economist sees only what immediately strikes the eye; the goodeconomist also looks beyond. The bad economist sees only the direct consequences of a pro posed course; the good economist looks also at the longer and indirect consequences. " Politicians seeking to win the next election frequently support policies which generate short-run benefits at the expense of future costs. It is a shame that they sometimes carry the endorsement of economists who should know better. The good economist does not suf fer from tunnel vision or shortsight edness. The time span he considers is long and elastic, not short and fixed.

7. The fallacy of economics by coercion. Two hundred years after Adam Smith, some economists still have not learned to apply basic prin ciples of human nature. These econ omists speak of ((increasing output"

1981 SEVEN FALLACIES OF ECONOMICS 215 but prescribe the stick rather than. the carrot to get the job done. Humans are social beings who progress if they cooperate with one another. Cooperation implies a eli·, mate of freedom for each individual human being to peacefully pursue! his own self-interest without fear of reprisal. Put a human in a zoo or in a strait jacket and his creative ener·· gies dissipate. Why did Thomas Edison invent the light bulb? It was not because! some planner ordered him to! Why don't slaves produce great works of art, Swiss watches, or jet airplanes? It's rather obvious, isn't it? Take a look around the world to day and you see the point I am driv ing at. Compare North Korea with South Korea, Red China with Tai wan or Hong Kong, or East Ger many with West Germany. One would think, with such over whelming evidence against the record of coercion, that coercion A Dangerous Power would have few adherents. Yet there are many economists here and abroad who cry for nationalization of industry, wage and price controls, confiscatory taxation, and even out right abolition of private property.

One prominent former U.S. senator declared that Hwhat this country needs is an army, navy, and air force in the economy." There's an old adage which is en joying new publicity of late. It reads, «If you encourage something, you get more of it; if you discourage something, you get less of it." The good economist realizes that if you want the baker to bake a bigger pie, you don't beat him up and steal his flour. Well, there you have it-not the final answer to confusion in econom ics, but at least a start. I for one am convinced that good economics is more than possible. It is imperative, and achieving it begins with the knowledge of what bad eCQnomicsis all about. (I) IDEAS ON LIBERTY THE STATESMAN who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

ADAM SMITH, The Wealth ofNations Paul L. Poirot The Past as Prologue THE people of the United States last November clearly voiced dissatisfac tion with the results of the massive political intervention of recent years. But a strong vote of protest does not necessarily signify an understanding of a better alternative. Since 1946, FEE has been exploring the market alternative to coercive political management of our lives. Names and places may change-the political leaders, the warring fac tions, the specific victims of intervention. But the patterns and principles and consequences are much the same. This is the sense in which the past is prologue. Therefore, it seems appropriate at the beginning of a new political admin istration to carefully reconsider what some of the outstanding spokesmen for liberty have said earlier about these perennial problems. The prolonged negotiations for return of the hostages from Iran and other current events in the Middle East, Africa, Latin America and elsewhere call to mind what Dr. Hans Sennholz said in 1957 about ((Welfare States at War." So, what better advice may we find today with regard to our foreign policy? If we would be at peace among nations, let us act at home in ways that do not provoke violence.