Economists Do It With Models

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It’s Funny Because It’s True, Efficiency Versus Equity Edition…

November 17th, 2010 · 11 Comments
Econ 101 · Policy

Dear Saturday Morning Breakfast Cereal: Who are you people? I’m very curious. I mean, in the past I’ve noticed that you seem to know more about economics that the average person, but the following takes things to a new level:

See, I have a suspicion that you know that, for the most part, you’re not wrong. However, and I don’t know if this makes economists better or worse than you illustrate, the implication that economists accidentally ignore the distributional implications of policies (read, whether or not they are going to fuck over the poor) is just not fair. We ignore them on purpose, obviously.

Wait, what?

Hear me out…when economists talk about economic value (surplus, in technical terms), we measure this value of everything, both tangible and intrinsic, in dollars, and we don’t explicitly model who the dollars are going to. This means that economists often make the simplifying assumption that the value of an additional dollar to me is the same as the value of an additional dollar to Bill Gates- clearly not a reasonable assumption when taken in a strict sense. Nonetheless, economists, for the most part, focus on the concept of efficiency (i.e. how close a scenario gets to the maximum economic value possible) as a starting point for analysis.

Why don’t we adjust our models to take distribution into account? Mainly because it’s hard. (Wow, I am not helping anyone’s case here, am I.) It’s hard for a number of reasons- first, it’s often hard to determine who the benefits and costs of various programs go to, especially when we consider the secondary effects of a policy. For example, it’s pretty clear that a subsidy on corn helps corn farmers and people who buy corn (at the expense of taxpayers of course), but it also technically helps the people who make stuff that corn farmers buy with the extra income they have from the subsidy, and so on. Second, the question of what a dollar means to me compared to what a dollar means to Bill Gates is more a question of philosophy than one of economics, and many economists won’t even touch such issues with a ten-foot pole. Third, if a policy maximizes the size of the overall economic pie, it is theoretically possible to devise an after-the-fact transfer that makes everyone better off then they were before, in which case the explicit equity question is irrelevant. (I worked for a professor that referred to this sort of change as “potentially Pareto improving,” where a Pareto improvement is a change that makes some people better off without making anyone worse off.)

To be fair, most economists do acknowledge that these transfers don’t happen automatically (or at all in a lot of cases), and some textbooks point out that “real policymakers” might want to care about equity in addition to efficiency. In a policy-making context, the efficiency calculations should be taken as one piece of the overall puzzle as oposed to an objective “right” answer, and I think that this subtlety gets lost in the shuffle sometimes. On the other hand, it’s unwise to automatically reject policies that increase efficiency simply because they could be viewed as unfair. (The right question is likely something of the form “is it worth sacrificing X in terms of efficiency in order to get Y in terms of equity or fairness?” or vice versa.)

For example, economists have estimated that American consumers paid about $160,000 per year in higher than necessary car prices in the 1980’s for each job saved due to export restraints placed on Japanese cars. Last time I checked, the average auto worker didn’t make $160,000 (especially not in the 1980’s), so lifting the quota would have led to increased efficiency. This doesn’t automatically mean that everyone is better off- some people get cheaper cars and others get left without jobs. Some people even get both cheaper cars and no jobs, but an important point is that the gains to the winners are larger than the losses to the losers, so if we could find a creative way to compensate people for their lost jobs (without causing too much inefficiency in a different place, of course) then everyone should be happy. Alternatively, we could take a more holistic view of the world and realize that the losers in some policy situations are likely to be winners in others, so maybe the equity consequences aren’t as dire as they might seem on the surface. Or the world could just carry on thinking that economists are big a-holes, you know, whatever.

In case you’re curious, I pick apart my friends’ jokes like this too…and no, I don’t get invited to comedy shows anymore. Luckily, I know better than to confuse correlation with causation. =P

Tags: Econ 101 · Policy

11 responses so far ↓

  • 1 Cory // Nov 17, 2010 at 1:04 pm

    One correction to your auto workers example- some auto workers don’t necessarily get left without a job by opening up to more efficient foreign markets. They are simply left without a job in the auto industry. They can switch to industry were their labor is needed and used more efficiently.

  • 2 Mitch // Nov 17, 2010 at 3:58 pm

    $160,000 per year per job saved, or $160,000 over the whole 80s per job saved? It sounds like you made the former interpretation, but that wasn’t clear from the original statement.

    Re: equity vs. efficiency – I think I’m not alone in wishing that economists would address equity/justice issues more explicitly. It seems like economists will nod in that direction, and say “diminishing marginal utility! utils != dollars!” and then proceed to ignore utility after that. But that disconnect, between what can easily be measured (dollars) and what we really care about (utility) is huge.

    Economists can’t just wash their hands of the situation and expect policymakers to figure it out. Economists’ focus on growth has a real effect on policymakers, and on voters, and encourages people to *value* growth over other concerns.

    Stop looking underneath the streetlight! That stretch of ground has been pretty thoroughly searched already. And we still haven’t found what we’re really looking for.

  • 3 David Welker // Nov 17, 2010 at 4:32 pm

    I am not sure if Jodi is trying to justify the approach of economists or not. But I will just point out a couple of things concerning why I do not think any of her points let economists off the hook.

    (1) It is completely naive to focus on “total efficiency” measure in dollars (obviously, total efficiency measured in utility is something different) and pretend that the winners can just compensate the losers. It is extremely difficult and often nearly impossible for our political system to compensate the losers. Can you say gridlock? Can you talk about ideologies that are totally opposed to taxation and government? Can you talk about an ideology that says that all taxes that are payed “belong” to the people who “earned” them. So, in the real world, if policy change X creates winners who “earn” more and losers who “earn” less as a result, the winners are going to ferociously resist any attempt to compensate the losers with a portion of whatever increased “earnings” they get from the policy change. Not only that, they will usually succeed in preventing the losers from being compensated from their increased “earnings” which are properly attributed to policy change X but which the winners will tend to attribute to their own diligence, goodness, and merit.

    So, one can easily see how policies that increase efficiency as measured in dollars will often decrease efficiency as measured in utility. Since the losers will, the vast majority of the time, never be actually compensated.

    (2) Transfers of funds to the losers is expensive. For example, there is the concern that paying people unemployment insurance causes at least some people to not look for work as diligently as they otherwise would. One cannot just say, well, we will adopt this policy that is more efficient as measured in dollars (but perhaps less efficient if measured by utility) and say that the winners can just compensate the losers as if there were no costs involved in the transfer. Transfers that do not have such costs (like the minimum income as proposed by Milton Friedman) sound too much like welfare to have any real chance politically.

    (3) It is unclear to me what value economists add when they tell me that policy X is more efficient than Y as measured in dollars when that really doesn’t mean that policy X is better. Maybe there is some value, but I tend to think that there is probably a lot of value being left at the table.

    (4) If determining the best policy is a matter of values and economics doesn’t deal with values, I wish that economists would quit using words that are warm and fuzzy and seem to imply that certain policies are best. Saying that policy X is the “most efficient,” “optimal,” “maximizes producer and consumer surplus,” or “minimizes dead weight loss” makes it sounds as though policy X is best. But what if this policy X creates a few winners and those winners are already extremely affluent while creating many losers among those who are much poorer. And suppose further we are fairly confident that the political system will not step in and compensate the losers for their lost earnings with a portion of the gains achieved by the winners. Whether policy X is actually the “best” policy depends on our values. But the warm and fuzzy words that economists use seem to imply policy X is the best and no doubt influence many people, even subconsciously, to think that X is best.

    (5) A good example of problematic rhetoric is the assertion that there is a trade-off between “efficiency” (which sounds, concrete, hard-headed, and objective) and “fairness” (which sounds, intangible, mushy, and subjective). Why would anyone but a complete wimp choose something fake and intangible like fairness for something real and concrete like efficiency? I know that this is not the intended message you are trying to convey when you talk about an “efficiency” versus “fairness” trade-off, but it really is the message that is sent. I feel as though efficiency is cold hard cash I can hold in my hand whereas fairness is some intangible thing without any real benefit. I think a better formulation would be to say that there is sometimes a tradeoff between efficiency as measured in dollars versus one’s values. Then I think it would be quite clear that sometimes the right choice is to choose one’s values.

    Economists act as though the words they choose do not matter. As if they are only referred to by their strict definitions. But that is not true, even, I suspect, for economists themselves. I for one am lured by the idea of choosing policies that are “efficient” and “optimal.”

    (5) I think we would be better of with economists who embraced subjective values and were straightforward about what those values are. I don’t completely trust economists, because I often suspect their work is often and perhaps inevitably influenced by their values. The problem is, they don’t tell me exactly what those values are. Economists say that their values deserve no special deference. That is true. But it seems to me that there is nonetheless the potential for great value in combining rigorous policy analysis that is typical of economists with stated values. That is, it is not that an economists’ statements of values are objectively better than non-economists, but that there might be great synergies from combining a statement of values with very rigorous analysis.

    (6) Historically, economics started out as a branch of moral philosophy and did not have such a narrow conception of itself as it now does. Maybe these earlier economists were actually wiser in this respect than modern economists.

  • 4 Dan L // Nov 17, 2010 at 5:30 pm

    “…it is theoretically possible to devise an after-the-fact transfer that makes everyone better off then they were before, in which case the explicit equity question is irrelevant.”

    Really? Do people really claim this kind of nonsense? Are there any real-life examples of policies that actually do this? (I don’t even understand how it’s “theoretically” possible.)

    Also, the so-called trade-off between efficiency and fairness doesn’t really make sense. Fairness is a desirable goal in and of itself, whereas efficiency is desirable only so far as it serves some normative goal. I think I’ve complained about this before, but isn’t it blatant hypocrisy to analyze everything in terms of efficiency and then claim that you’re simply addressing positive questions? The questions you choose to study inevitably belie your values.

  • 5 Drew M // Nov 17, 2010 at 6:00 pm

    “If determining the best policy is a matter of values and economics doesn’t deal with values, I wish that economists would quit using words that are warm and fuzzy and seem to imply that certain policies are best. Saying that policy X is the ‘most efficient,’ ‘optimal,’ ‘maximizes producer and consumer surplus,’ or ‘minimizes dead weight loss’ makes it sounds as though policy X is best.”

    I think that’s the first time I’ve ever heard someone describe maximizing total surplus or minimizing dead weight loss as “warm and fuzzy.” 🙂 For a good view on what I think economists should be doing (full disclosure: I am one), look at Ed Glaeser’s recent bit on Economix: http://economix.blogs.nytimes.com/2010/11/16/economics-offers-tactics-not-strategy/ .

    I think that the problem is that people expect economists to do something that is not in our job description. We provide bits of information that can be used by politicians, philosophers, voters, ect. to make decisions based their values; we’re not here to decide how that info should figure in to everyone’s values. That being said, there are many economists who are either intentionally or unintentionally bad communicators. Their language can be misleading either by design (Some bloggers are guilty of this; Krugman comes to mind, but there are many others) or by ignorance of the fact that the precise language that we use is not known to most people. The definitions we use are excellent for precise communication between each other and in journal articles, but should probably be clarified when speaking in public or to non-economists in general.

    I think that if economics as a profession focused more on expression of ideas (maybe we should require more writing/communication courses in PhD programs would help…) that there would not be the frustration with the profession that exists today.

  • 6 Amarsir // Nov 17, 2010 at 8:50 pm

    I was wondering if you’d respond to this comic. 🙂 SMBC does bring up economics a lot, doesn’t it?

    I get that the point of the joke was academics focused more on completeness then efficacy. But I dispute the premise. Economic studies and theories have to a much greater extent been motivated by helping the poor – the opposite of overlooking them.

    Capitalism gets the bad rap in light of our “central control is better if [b]I[/b] can control it” modern “enlightenment.” But a quick revisit to good ol’ Smith will remind you that his book was [u]An Inquiry into the Nature and Causes of the Wealth of Nations[/u]. A.k.a “How do we make everyone better off?”

    So if the implication is that economics means ignoring the poor, I have to say “Speak for Yourself.”

  • 7 Harley Urbatsch // Nov 18, 2010 at 12:42 pm

    Fellas and ladies, c’mon..every semi-educated voter in the US knows about efficiency…Health, Ed and Welfare could all be balanced without 20-30k illegal immigrants in this world. Hospitals, Dr’s., foreign and American both take advantage of medicare and medicaid, especially related to the elderly. Wage earners over 80k need to pay allocated SSI..without exception. Bring the troops home to guard the borders…A 2 year mandatory service to the country is a grand idea..Elected officials need more accountability, ie..Charlie Rangel, Chris Dodd and many many more. Erskine and Simpson should need no help except to ask we working or retired folk. Thanks and good luck to Americans, for a change.

  • 8 econgirl // Nov 18, 2010 at 7:46 pm

    @ Cory: You’re right, but I left that out because I figured I was already making a tough sell. The important subtlety to your point, however, is that if the new job was better than the old job, the worker would have taken it without having to have been laid off from the auto industry. Therefore, the auto worker isn’t “made whole” with the new job unless there is some chain of events whereby the money that people don’t spend on cars goes to increase demand in some other industry which then raises wages in that new industry, and the auto workers go to work in that new industry, etc…

    @ Mitch: Yep, I meant per year, and I clarified in the original post. Sorry about that. I would also argue that if policymakers knew more economics there would be less ambiguity regarding what economists do and don’t say. 🙂

    @ Amarsir: I think you have a good point- a lot of economists believe (rightly so, for the most part) that aggregate economic growth is good for everyone. However, this doesn’t mean that free-market economic growth benefits everyone equally, which is where I think people get all in a tizzy.

  • 9 Punditus Maximus // Jan 3, 2011 at 8:31 pm

    The problem with efficiency analysis is that economists refuse to give valuation to unpaid labor and to leisure. When sleeping and raising children are not part of your model, then your model is fundamentally meaningless.

    Which is fine! It just means that you shouldn’t get too excited about any given result. But this sort of mindless worship of market outcomes, when RONALD COASE HIMSELF said that firms EXIST because markets can be horrendously inefficient . . . is a sign of insanity.

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