The ‘laws of economics’ don’t exist
In a world increasingly framed by economic debates, the phrase âthe laws of economicsâ has become ever more prevalent. As the U.S. Senate prepares to unveil a new immigration bill, much of the discussion centers on the economics of illegal immigration and the incentives for employers to hire undocumented workers. Said a recent Barronâs article: âImmigration policy is a game governed by classic economic rules, especially by Say’s Law, which says supply creates its own demand âŚ Whether the new applicants are seeking stoop-labor jobs in California’s Central Valley or high-tech jobs in Silicon Valley, the laws of economics dictate the outcome: more immigration.â
How about the war on drugs? Said one recent analysis: âWeâre losing the war on drugs because itâs a war that defies the laws of economics. We might as well be fighting a war on gravity.â
And how about what history can tell us about our current policies? Said one recent review of Amity Shlaesâ biography of Calvin Coolidge, which makes the case for Coolidge as an exemplar of responsible economic policy: Â âOur current political leadership â and we who elect them â are spending the country into ruin. The laws of man can be bent and broken; the laws of economics can not.â
This is just a smattering of examples over the past few weeks. Increasingly, our debates about â and our solutions to â pressing issues such as immigration, budgets and debt are framed in the context of all-powerful economic laws that dictate what is and is not possible. Thereâs just one slight problem: There are no laws of economics.
For sure, many economists and large parts of society believe there are. The high levels of anxiety about deficits and government debt, not just in the United States but throughout the euro zone and much of the world, stem from the belief that if central banks create too much money, it will inevitably lead to inflation. Why? Because the âlaws of economicsâ say the supply of money will cause inflation if overall output stays the same. In the developed world, clearly, there has been an increase in money supply via the Federal Reserve, the Japanese Central Bank and to a lesser extent the European Central Bank, yet growth is minimal everywhere. While there is no statistically discernible inflation as of yet, the âlawsâ strongly indicate that there soon will be.
Unless, of course, those laws are wrong or simply not âlaws.â. Some, such as Paul Krugman or other equally strong (but less vociferous) believers in the precepts of John Meynard Keynes would say inflation isnât increasing because thatâs what happens in recessions. When demand is depressed, more money only closes that gap between demand and supply. That, too, depends on a basic âlaws of economics,â that of supply and demand, which is one of the first precepts students of economics learn and one of the most widely disseminated â if often misunderstood â principles of economics.
Yet even here, the idea that these are ironclad laws breaks down. So much of economics depends on the theory that we are all ârational actors.â Yet as behavioral economists such as Daniel Kahneman have shown, we are rarely rational actors. Patterns of individual behavior are very different from what economic laws assume. People sell when prices are falling, and buy when prices are rising, even though their interests would be served by doing the opposite.
Institutions and states are not much different; they make decisions all the time that do not âmaximize their utility.â To put it more plainly, they often make decisions based on fear and hope rather than on a rational calculus of what will best serve their interests over the long run. Governments cut spending when they should increase it (austerity in difficult times) and expand spending when they should cut it. Companies often donât invest when they are unclear about the future and business is soft, which is precisely when they should be investing if the goal is to maximize long-term profitability and viability.
The notion that economics is a science with irrefutable laws appeals to economists (who have long tried to elevate the profession out of the realm of observation and description and into the realm of science) and to the widespread human desire for certainty. But even science isnât quite so set, as any good scientist knows. The laws of gravity may be set, until the laws of quantum mechanics throw a wrench. Our ability to measure the world increases, and our understanding of laws evolves.
Economics is based on a limited amount of information compiled over the past hundred or so years. We have no way of knowing with any exactitude the gross domestic product of imperial Rome, of Spain in its 16th century golden age or of the United States in 1820s. We can try to fill in the blanks retrospectively, but thatâs all. We donât know because those numbers didnât exist. All these economic laws are based on what a few cogent thinkers such as Adam Smith and David Ricardo observed at the end of the 18th century and what a new set of 20th century statistics (GDP, unemployment, inflation) suggest.
In short, even if there are laws of economics, we havenât been observing them for long enough to know what they actually are. And given the vagaries of human behavior and the mercurial nature of states, people and institutions, the notion that thereâs some grand mechanistic, master system that explains all and predicts everything is at best a comforting fiction and at worst a straitjacket that precludes creativity, forestalls innovation and destroys dynamism.
Referencing âthe laws of economicsâ as a way to refute arguments or criticize ideas has the patina of clarity and certainty. The reality is that referencing such laws is simply another way to justify beliefs and inclinations. I may agree that the war on drugs is flawed, but not because it violates âlaws of economicsâ but rather because it fails in most of its basic goals. The test of whether government spending or central bank easing is good policy should be whether they succeed in ameliorating the problems of stagnant growth and high unemployment, not on what the âlaws of economicsâ erroneously say about certain future outcomes.
Liberating ourselves from the fictional cage of these laws will not suddenly reveal hidden answers. But it will allow for more pragmatic examination of what is working and what is failing and why. Economic theories are guides, ones that have substantial utility. But once elevated to the realm of laws, they fall short and do us no good.
PHOTO: Adam Smith etching in the public domain.Â