Turning economics research into policy

Hat tip to the inimitable GoodLiberal for pointing me in the direction of an excellent article I would certainly have missed otherwise. It’s by Noam Scheiber and it’s about Barack Obama’s advisers; in particular some of the economic policy advice he’s been getting. You can find it here, but get it while it’s hot because it might move behind the subscriber’s wall at the New Republic. To be clear, the economic policy parts are most interesting to me, but there’s more to it than that.

It’s interesting both how Scheiber characterizes the type of economic theory that’s apparently fueling some Obama policy, and how the path from one to the other winds. There are so many fun lines I might just go ahead and start quoting. On the distinction between academics and nonacademics:

“In economics, it’s the academics who are first-rate engineers and the nonacademics who are either dreamers or technicians.”

Very well put, though I fear a little harsh on dreamers. Research and teaching in academia are indeed geared towards the sterile positivism; the engineering analogy is well drawn. I do wish we had a bit more dreaming in the dreamy spires of academia though.

The article starts out by describing “behavioral economics”, that field that’s trying to figure out how people act and how to build it into economics.

“Behaviorists like Thaler believed that the perfectly rational, utterly selfinterested maximizers of economists’ imaginations had little in common with actual human beings, who frequently err when making simple calculations, who have trouble with self-control, who often act out of altruism or spite. But what’s really interesting is how Thaler and his fellow behaviorists responded to this fairly critical insight. Though rational self-interest was the central tenet of neoclassical (i.e., modern) economics, they didn’t take a wrecking ball to the field and replace it with some equally sweeping theory of human behavior.”

Behavioral economics is possibly the least revolutionary revolution ever to hit an academic discipline, because, as Scheiber is alluding to, the behavioral school is absolutely not changing or abandoning the methodology of economics. As I’ve noted before, the “perfectly rational” economic man can happily do whatever the behavioralists want him to do to be more “realistic”; it’s therefore not necessary to come up with a whole new way of modeling people.

Instead the behavioral school is writing down models of “perfectly rational, utterly selfinterested maximizers” who act in accordance with the behavioral evidence. That is, writing rationalization of the “irrationality” we observe. Contrast this with the traditional criticism of economic man, which is to throw up ones hands and loudly reject the whole idea of trying to predict what people will do. I prefer the behavioral way.

Anyway, what’s coming from having this type of economist on the Obama team?

“For example, one key behavioral finding is that people often fail to set aside money for retirement even when their employers offer generous 401(k) plans. If, on the other hand, you automatically enroll workers in 401(k)s but allow them to opt out, most stick with it. Obama’s savings plan exploits this so-called “status quo” bias.”

Does it take an economist to suggest this? Of course it does not; the article argues, however, that the “engineers” in academia are the ones who can tell you if the opt-out policy will increase saving or not. That’s a nice example of the value of positivist economic science: it gives you the evidence that switching from opt-in to opt-out might increase retirement saving, which is handed off to the policymaker, who says “I want to increase retirement saving”, and proposes opt-out. Presto. Did any part of the economic science at the bottom of the pyramid require esoteric math or have an ideological bias? Doubtful.

Here’s an even better one:

“Obama wonks tend to be inductive–working piecemeal from a series of real-world observations. One typical [economic adviser Austan] Goolsbee brainchild is something called an automatic tax return. The idea is that, if you had no tax deductions or freelance income the previous year, the IRS would send you a tax return that was already filled out. As long as you accepted the government’s accounting, you could just sign it and mail it back. Goolsbee estimates this small innovation could save hundreds of millions of man-hours spent filling out tax forms, and billions of dollars in tax-preparation fees.”

How simple, how wonderfully useful that would be. How fickle am I that I would vote purely on the basis of an easier tax return?

“The Clintonites were moderates, but they were also ideological…. The Obamanauts are decidedly non-ideological. They occasionally reach out to progressive think tanks like the Economic Policy Institute, but they also come from a world– academic economics–whose inhabitants generally lean right.”

Oh really? Aside from the repetition of this common error about economists’ politics, this implies that the positivist approach to academic economics is bleeding into economic policymaking, drastically shrinking the gap between the science and the normative judgment informed by the science. The crucial distinction remains – for example, I could argue that it’s wrong to make people opt-out of a retirement scheme rather than opt-in, a violation of their right to be left alone, and I couldn’t be wrong, despite what the science said would happen – but the information on which the policy is based is very close to the policy itself.

Does positivism indocrinate?

Somewhere in the history of the practice of economics we went positivist. Research and teaching of the subject both became technical and methodological, preoccupied with the “if this, then what?” questions of economic science, and rejected policy debate as unscientific. A semi-famous quotation from Keynes:

“The Theory of Economics … is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps the possessor to draw correct conclusions.”

Weirdly, this sterilization has in fact had the paradoxical effect of reducing the scope of economics that’s presented to students and researched by economists. Ronald Coase puts it like this:

“Mainstream economics, as one sees it in the journals and the textbooks and in the courses taught in economics departments has become more and more abstract over time, and although it purports otherwise, it is in fact little concerned with what happens in the real world…. economists since Adam Smith have devoted themselves to formalizing his doctrine of the invisible hand, the coordination of the economic system by the pricing system.”

I’m not arguing for anarchy in the profession. It just seems strange that we sterilized the science, freed it from value judgments and the real-world status quo, then presented it using nothing but the status quo to illustrate our tools. We worked so hard to show that our method gives you all the levers and buttons you could ever want, then obsessed over one or two of them.

Did the positivist revolution lead to a sterilization of normative economics as well as positive economics? Keynes’ “correct conclusions” are positivist conclusions; there cannot be “correct conclusions” to the actual, real-world questions that the science of economics is supposed to inform.

There’s a crucial difference between carving normative judgment from economic science and ignoring normative judgment altogether. It’s particularly difficult to illustrate in classes the difference between the two sides of our coin when we never hold normative debate. Does that make the positivist content of our classes seem like ideological indoctrination?

If we either presented a full diversity of positive models when we taught our methods, or engaged in actual normative policy debate to illustrate the application of our methods to real, difficult problems, we can preserve the positivist revolution and show the next generation of economists that Keynes was right. Economics can be a method for everyone, not a doctrine of the status quo. Economics can be scientific, but teaching economics like a natural science would certainly not be my first choice.

Visiting the real world

Economists don’t spend a great deal of time in the real world. We’re especially bad at having arguments, which is strange, considering that we have an infinitely flexible method and a bunch of unanswerable normative questions.

Unfortunately we’re all adrift on the ocean of economic science. The work that researchers do generates the kind of tedious methodological debates that help seminar audiences catch up on their sleep, but it doesn’t generate actual ideological debate: perhaps that’s the biggest possible endorsement of positivism in economics, but we didn’t need to lose it.

I always liked the Oxford Review of Economic Policy; it’s one of the few examples of a true economic policy journal, which means that while it’s still a bit dry, it’s non-technical and, more to the point, actually talks about real stuff. For example, this issue from last year is a survey of what’s going on with pensions – not exactly riveting, but if you’re into that kind of thing, an invaluable look at how economic science can inform ideological debate on pension reform. This one does much the same for growth and development in India.

The saddest misconception about positivism in economics is that we must sweep out all normative debate in order to be “scientific”. Yes, we have to avoid ideological prejudice when we research what’s actually going on, but doesn’t it seem like we’re building a fancy machine and never turning it on? Our “scientific” results don’t change the fact that our economic models don’t provide any “answers” to the great normative questions of what we should be doing.

It all must be especially boring for the poor undergraduates who are the cannon fodder of scientific economics. They get the distilled versions of some of our scientific methods and modeling – without, mind, necessarily finding out about their flexibility – but don’t get any practice in using economic analysis to engage in real policy debate. Perhaps it’s another casualty of the loss of the essay in economics; perhaps that comes from our huge enrollments, victims of our own success.

Just because positive economic modeling is supposed to separate itself from ideology, it doesn’t mean that economists should. Perhaps if we argued a bit more, we’d bring some life back to our discipline.

Do as I say, not as I do

Another Arts & Letters tipoff today. The teaser for the article reads:

“Do professors indoctrinate students by expressing a political ideology in the classroom?”

Similar to what I was talking about the other day when I was arguing that ideology leaks into economics courses when we start using them as civics lessons. The article being referred is from the Chronicle of Higher Education, asking why academia is liberal. Yesterday I reported a survey that found majority liberal political views among economics grad students; it’s not controversial to suggest that university and college faculties are predominantly more liberal than the population.

The article also mentions the real source of the Arts & Letters teaser quote: a study by Matthew Woessner and April Kelly-Woessner called, delightfully, “My Professor is a Partisan Hack” (you can read the whole study (pdf) here). That study tried to figure out how students perceive the political leaning of their professors, and how similarity with the students’ own views affected their enjoyment and perception of their courses.

The authors asked students to complete course evaluations that, among other questions, asked them to identify their professors’ political and ideological views, and to report their own confidence in their answers. The surveys were all done after political science courses. The Chronicle article summarizes one of the big results:

“their research showed that students were turned off when professors expressed views that were contrary to their own…”

Perhaps not surprising. The article goes on:

“Mr. Maranto asked the Woessners to contribute a chapter to his book on why conservatives don’t pursue doctorates. Typically, he says, there are a few answers to the question. Liberals say conservatives want to make more money than professors earn, while conservatives argue that they get less encouragement from professors than liberal students do.”

I would love to do a similar study for economics courses. Some interesting questions:

  • Can students confidently identify political ideology of economics professors? Should they be able to, given the supposed neutrality of what we teach?
  • Would students correctly guess that the majority of economists identify themselves as liberal? Does the content of economics courses skew this perception of the professors’ beliefs?
  • Are non-conservatives turned off by economics courses?
  • Do students see economics professors as spreading ideology? If so, is the ideology consistent with the professors’ beliefs? Is it consistent with the students’ perception of the professors’ beliefs?

We need to know how the teaching of economics meshes with the students beliefs and opinions. I strongly believe that the economic method is capable of accommodating and being used by people of any political or ideological belief, but I’d be astonished if such a survey of economics students revealed that this was in fact the case.

Here’s my pitch: do economics professors indoctrinate students by expressing ideology in the classroom? If they do, I believe they are committing a far graver sin than political science professors who do the same. We can separate policy debate from opinion in economics; we can separate out method from our beliefs. Do we?

The Woessner article concludes:

“professors may be well advised to strive for political balance—vigorously challenging students’ viewpoints and presenting multiple perspectives without identifying their own political orientations.”

If we could accomplish something like this in economics – value-free and varied economic method, plus lively ideological debate on economic policy – we might get economics courses that are interesting, useful and diverse. That would beat the mangling of positive and normative economics that too often passes for a real economics course.

Principles of Economics

Here at Brown University, our Econ 101 course is actually numbered EC0110 and is called “Principles of Economics”. Like a lot of introductory undergraduate-level economics courses, it uses Greg Mankiw’s book of the same name. What is a principle of economics? Here’s the list that Mankiw suggests in the book:

1. People Face Tradeoffs
2. The Cost of Something is What You Give Up to Get It

3. Rational People Think at the Margin
4. People Respond to Incentives

5. Trade Can Make Everyone Better Off

6. Markets Are Usually a Good Way to Organize Economic Activity

7. Governments Can Sometimes Improve Market Outcomes

8. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

9. Prices Rise When the Government Prints Too Much Money

10. Society Faces a Short-Run Tradeoff Between Inflation and Unemployment

Are these principles? I cannot square any of 5 through 10 with any definition of “principle”; those are, at best, positive economic results (not to be too facetious, but by 10 I think many students must be asleep). A principle, to me, is something that you hold as a fundamental truth, before, during and after you do anything. I see the logic in writing a list that looks like this: it summarizes a lot of the “received wisdom” in our discipline.

That, however, is exactly the problem. How can I teach an anti-capitalist student economics if my first lesson says “Markets Are Usually a Good Way to Organize Economic Activity”? “Good” is a normative judgment; the statement is loaded with value and intent. It’s a huge result built on so many layers of qualifications that I couldn’t possibly say it with a straight face. It’s not possible to sell economics as scientific and flexible if we recite dogma in lesson one. Economics is not capitalism. Maybe that should be a principle.

I should probably make some kind of attempt to define “principles” as I see them.

1. Economics tries to describe and predict things about the world around us.
2. Economics is divided into value-free positive method (what will happen, or how do I achieve a particular goal) and normative opinion (what ought to be done). It can inform debate through the former, but cannot settle it, because there are no right or wrong opinions.
3. Economists assume people act as if they try to get their preferred outcome of the ones that are available, but they don’t restrict what people’s preferences are.
4. Positive economics uses simplified models or empirical observation to describe or predict what will happen, and must never make value judgments. We can try to interpret the validity of positive results by testing them against real-world data or by figuring out what would happen if we made different simplifying assumptions.

I’m just thinking (typing?) out loud, and certainly a more thoughtful attempt would be justified. My “list” is certainly less snappy, that’s for sure. In general, though, I really believe that “principles” should describe the foundations of economics, not its received wisdom. The foundations of economics can accommodate everyone, not just those who would find themselves nodding agreement at a statement like “A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services”. With no exaggeration, I can say this is like opening Music 101 with a list of principles that includes “Only Rock Music Is Good Music” or something equally ridiculous. It is heartbreaking.

Rather delightfully, this list of “Principles of Feminist Economics” – again, I must confess, I don’t often see how “[blank] economics” is distinct from “economics”, especially since the [blank] is usually a value judgment – is, despite dripping with normative statement, actually more palatable to me than Mankiw’s list. At a bare minimum, looking at them side by side reveals how neither of them can possibly be considered “principles of economics”. I’m sure mine can’t either, but you get the point: I think a minimum requirement for a list of principles is that they be basic and as agreeable as possible to the people who care.

I applaud the goals of this page entitled “Great Ideas For Teaching Economics”, even if a few of them are really more “how to get people interested”. Allow me to quote at length this contribution from Hugh Himan:

“For a number of years I have devoted 6-9 class meetings in the Principles of Economics course to class debates on current economic issues.

Objectives:

1) to acquaint students with the reality that economists as well as people in general do not think alike on economic issues;

2) to have students realize that disagreements on issues reflect both different positive economic views (cause and effect) as well as normative difference (values)

3) to challenge their own thinking about economic issues

4) to have each student experience through a debate on the beliefs and values of the three major paradigms of Conservative, Liberal and Radical.

The debates are evaluated by the students and instructor on the basis of specific criteria with final scores tabulated on a 100 point scale. The evaluations are based upon how well the team presented their assigned position, not whether the evaluator agrees or disagrees with that particular paradigm.

It has been my experience that the students truly get involved with these debates, well beyond the proportion of the final grade their scores represent. Most enjoy the role playing, some even dressing as they think a Conservative, Liberal or Radical would appear.

Beyond the enjoyment many experience, I like to think that they have gained deep insight into issues i.e., that problems can be viewed differently based upon one’s belief as to “truth” causes and effects as well as on the basis of values (no good vs. bad but in terms of relative priorities). For so many students I have taught over the years who tend to think there are single, simple answers to such problems as poverty, unemployment, national defense, acid rain, exposure to the complexity of such issues is important to their education.”

This is, indeed, a great idea. Is there a better way of understanding the very concept of normative judgment than to force students to debate from all sides? I think it might be fun to ask students to shout out anything they can think of, and to write down an “economic model” that proves it. This really invites students to think of 1) how flexible positive economics is, 2) the importance of assumptions, 3) how to judge an economic theory, and 4) the role of normative opinion.

We need all three levels of understanding in economics: positive, value-free, empty economic science; interpreting whether the positive results are correct, either empirically or by exploring the implications of alternative assumptions; normative, value-laden opinion. Exercises that can explore these distinctions are the most valuable in our teaching arsenal. A list of “principles” pregnant with loaded statements is not the right way to present our discipline.

Psychologists are evil

This is just an outstanding quotation, from a New York Times article:

“Often introducing money into the exchange — putting it into the marketplace — is what people find repugnant. Mr. Bloom asserted that money is a relatively new invention in human existence and therefore “unnatural.”

Economists are asking the wrong question, Mr. Bloom said at the panel. They assume that “everything is subject to market pricing unless proven otherwise.”

“The problem is not that economists are unreasonable people, it’s that they’re evil people,” he said. “They work in a different moral universe. The burden of proof is on someone who wants to include” a transaction in the marketplace. (Mr. Roth, who acknowledges that “economists see very few tradeoffs as completely taboo,” did not take the criticism personally.)”

Sadly, it seems that Bloom was kidding. Isn’t it nice that “economists are evil” is a statement that can be mistaken for seriousness, but “psychologists are evil” is so clearly ridiculous?

How can economists plausibly evil, but psychologists cannot? I think the idea that economists “assume that “everything is subject to market pricing unless proven otherwise.”” is wrong. It’s a common criticism: economists reduce everything to dollars and cents, trying to measure the value of stuff that’s invaluable (the article is talking about how “repugnance” affects trade, using the example of selling organs).

As the social science of the allocation of scarce resources, how could economics operate without trying to figure out some concept of the value of something to someone? I think environmentalists have long despised economists for this reason. Say we’re talking about a scarce natural resource, a rain forest for example. Again, positive economic science cannot possibly hope to tell us what the “best” use of this resource is, but it can hope to tell us the consequences of each use. Unfortunately, it’s clearly easier to measure, say, the value of this resource to the logger and grazer who seek to use it today than it is to measure the value to humanity of preserving the forest.

Similarly, it’s easier to measure the willingness to pay for an organ by a terminally ill individual, and to measure the willingness of another individual to give up an organ, than it is to measure the potential consequences of allowing the sale of organs. The question at hand is: do we do what we can, even given this imbalance, or does the imbalance justify making no valuation, even the ones that are possible? Is attempting to value anything an assumption that “everything is subject to market pricing”?

Trying to understand more about the consequences of a particular allocation of resources is not the same as either propagandizing for that allocation or method of allocation, that is, markets. Even in jest, the charge that we “operate in a different moral universe” is a serious one. It actually makes me very sad, because I’m very familiar with the particular problem of introducing myself as an economist: it alienates a decent percentage of people you meet. (“I’m an economist, but I’m not evil, honest”.) Economists are evil, or at least morally bankrupt, to some people. I wish that wasn’t the case.

It’s understandable. Let’s take the ideal world where all positive economics is done scientifically and without normative judgment. Is it surprising that value-neutral economic science seems evil, while value-neutral physics, or chemistry, or psychology, seems like the noble pursuit of knowledge? The Methodology of Positive Economics by Friedman is, again, eloquent on this subject:

“The subject matter of economics is regarded by almost everyone as vitally important to himself and within the range of his own experience and competence; it is the source of continuous and extensive controversy and the occasion for frequent legislation. Self-proclaimed “experts” speak with many voices and can hardly all be regarded as disinterested; in any event, on questions that matter so much, “expert” opinion could hardly be accepted solely on faith even if the “experts” were nearly unanimous and clearly disinterested. The conclusions of positive economics seem to be, and are, immediately relevant to important normative problems, to questions of what ought to be done and how any given goal can be attained. Laymen and experts alike are inevitably tempted to shape positive conclusions to fit strongly held normative preconceptions and to reject positive conclusions if their normative implications – or what are said to be their normative implications – are unpalatable.”

It’s not just confusion between positive and normative economics, between the practice of the science and its interpretation, it’s the very attempt to be value-neutral, to be agnostic, that makes economics seem evil. This is all the more true if, as Friedman is arguing, that there’s temptation to attach value judgment to positive economics. If there’s any hope of us shedding the “evil” tag, this is a temptation that all economists must resist and fight.

Getting what you want: when should politics invoke economics?

The health policy exchange during the Democratic debate on Thursday shows exactly where economics should fit into policy, and politics. I’m not in the business of policy analysis, so instead let’s ask how an economist could help Senator Clinton achieve the goal she stated in the debate:

“But if you don’t start by saying you’re going to achieve universal health care, you will be nibbled to death.”

As I said before, I think there are two places for positive economics in the formulation of policy. One is when we ask “what will happen if we do this?”, and the second is when we ask the question Hillary’s statement invites: “how can I achieve that?”. America is no technocracy, so there’s no way positive economics can tell us what to do; that question is for every person and every candidate to decide.

This doesn’t just apply to questions within the rules of the game. If we take the biggest possible economic question, “how should our resources be allocated?”, it’s still the case that positive economic science cannot tell us, for example, which of capitalist markets, socialist planning, or making decisions by rolling dice is “best”. It’s not even difficult – it’s impossible. The furthest positive economics can go is to say that if you want to achieve some particular objective then one of the systems might be the most successful, but that obviously relies on the purely subjective notion of what you want.

Even when our questions get more specific – for example, not “how should our resources be allocated?” but “what should we do about health care?” – exactly the same principle applies. So, with that in mind, Senator Clinton has taken the subjective position in support of “universal health care”. Let’s take a look at the second part of the quotation from the debate:

“But if you don’t start by saying you’re going to achieve universal health care, you will be nibbled to death.”

The argument there is that if you don’t define your normative goal well enough, even getting close to it becomes more difficult, which is probably true. Even more fundamentally, it’s impossible for a politician to be “wrong” when taking a normative position. Like I said, I won’t try a policy analysis asking whether Clinton’s policies will really achieve her goal, and I make no judgment on that question.

With that in mind: unfortunately, actual policy has to be made to try to achieve the normative goal. If there’s significant doubt that the policy will lead to the outcome stated in the goal, then the politician is misguided or, worse, lying. Political campaigns sometimes seem to promote either depressive pronouncements of how we’re all going down in flames, or their ideological counterpart, the Utopian “I can make it all better”, neither of which have much in common with the real goals of the candidate. Realism doesn’t often sell well, but noble aims without realism run dangerously close to fraud.

To put this in a real context, even if I don’t care about your immigration policy, I care about whether or not you are honest in presenting it. Again, positive economics can’t say whether you should close the borders; it can (perhaps) describe some of the likely consequences of doing so, and to convince me that your plan to close the borders is sensible you must convince me that, on balance, the many dimensions (moral, financial, political) of the problem favor your plan. If, in doing so, you fail to acknowledge or deny the consequences your argument is immediately bankrupt. That doesn’t only apply to whatever consequences economic science can help us figure out – it applies to everything.

Even though I believe that economics can be a tool for analyzing more than just financial consequences, it would be wrong to claim that economic science can tell us everything we need to do. If it could, we might as well just cede to a technocracy. What we can do is help set out the means to your chosen end (as in the example of achieving universal health care), or describe the consequences of your policy (as in the example of closing the borders). To argue that other things matter more than what economic science tells us is defensible; to lie about what economic science tells us is wrong.

Arguing in economics: the gray area

Despite being interested in figuring out exactly what economics is, really, I have to confess that I don’t really care about the common question “is economics a science?”. Trying to answer it seems to tie people in knots, and I don’t think the question by itself is very important. However, I just found a nice article on the subject which set me thinking.

My economics education was very essay-centric, and, perhaps paradoxically, I think was a good means to understanding what it takes to be “scientific” in a social science. A good essay has to contain more than raw emotion, but similarly should not avoid interpretation. It’s equally difficult to argue using facts alone as it is to argue without them.

Is “good economics” the same? A theorem or result is, by nature, empty in itself – it’s just a logical chain from start to finish. With the right starting point, you can “prove” anything; with an unproveable starting point, you’re really in business. However, for the result to matter, it has to be put in context. What does it mean? Maybe it’s semantics, but the search for meaning – the interpretation – is the birth of a normative judgment, still value-free but certainly pushing that label as far as it can go, before the true normative judgments of what we want are made.

The separation of the “scientific method” of economics and the use of its results must be sacred. The former, done from a position of honesty, can never be “wrong”, since it’s just logic. Why, then, must we introduce interpretation at all? The best reason to do so is the problem of “underdetermination”, the idea, captured in the Friedman quotation I mentioned in a previous post, that if there exists another theory at least as consistent with the evidence, our theory is “underdetermined”: all, perhaps, related to the problem of the unproveable starting point.

The underdetermination issue is, I think, especially relevant to theories which rely on behavioral assumptions, given that we know that humans are (sometimes) capable of being pretty nuanced in their behavior. Whether or not any scientific theory can be airtight is up for debate; in economics, I am convinced that no theory can be airtight. That’s not to say we can’t be nice empiricists and check predictions against evidence like scientists do, but it is to say that the alternative, consistent theories must be addressed before we can cross the line from positive science to normative policy. I have to show that my theory can be right, but also argue that mine is the most right, especially if I want to take my theory from the sterile, all else equal, scientific vacuum into inference about the real world.

Just like a debater or an essay writer, any position I occupy can be attacked, and defense is the only response that will preserve that positive, scientific position. If we can prove anything, if any hypothesis is underdetermined, then whether or not economics can be called a science, the scientific method alone won’t be enough. Somewhere between that scientific method and the politicking of normative selection lies that subtle gray area which all of our correct, consistent theories must cross. There we must decide what we want to use them for, and how they should be received; the “useful” ones must be the only ones allowed to survive.

Who was Pareto anyway?

Students of economics will hear about “Pareto efficiency” very early in Econ 101. It’s a tool to compare outcomes. Sadly, poor Pareto now has his name attached to a disastrously misunderstood concept – Pareto efficiency is everywhere used and frequently abused.

From a biography of the man himself, Vilfredo Pareto:

“Like Irving Fisher (1892), Pareto stumbled on the idea that cardinal utility could be dispensed with. Preferences were the primitive datum, and utility a mere representation of preference-ordering. With this, Pareto not only inaugurated modern microeconomics, but he also demolished the “unholy alliance” of economics and utilitarianism. In its stead, he introduced the notion of Pareto-optimality, the idea that a society is enjoying maximum ophelimity when no one can be made better off without making someone else worse off.”

Two reasons to be cheerful: apart from featuring the excellent word “ophelimity” (n., economic satisfaction), this could not be clearer on the definition of Pareto optimality (now synonymous with Pareto efficiency). A situation is Pareto optimal if no one can be made better off without making someone else worse off.

Why, then, is this type of statement easily the most common mistake in economics (not intended to pick on the source, which is certainly not unique):

“There is no connection between Pareto efficiency and equity! In particular, a Pareto efficient outcome may be very inequitable. For example, the outcome in which I have all the goods in the world is Pareto efficient (since there is no way to make someone better off without making me worse off).” [Emphasis mine]

To get the cheapest criticism out of the way first, saying “there is no connection between Pareto efficiency and equity” is a bit like saying “there is no connection between Pareto efficiency and the color of my shoes”; why should there be? It’s just a definition. It is, or it isn’t. The criticism that’s actually important is that the bit in bold is a logical falsehood.

The true statement would be “the outcome in which I have all the goods in the world can be Pareto efficient”. In fact, equally true: “outcome _____ can be Pareto efficient”. Why? The missing link is that Pareto efficient is, inherently, a concept built on utility. The “better off” part implies that our test of Pareto efficiency centers on the relative satisfaction enjoyed under alternative outcomes. This is, again, not the same as the relative levels of income, consumption or stuff enjoyed under alternative outcomes.

A simple proof by contradiction: I have all the goods in the world. I am also ascetic and thus get more satisfaction from having less goods. You always like more goods. The outcome in which I have all the goods in the world is Pareto inefficient.

Simple, no? Again, it’s a case of confusing utility with goods or money, a case that would probably have irritated Pareto himself. The hidden assumption in the mistake quotation is the assumption on what the preferences of the person with all the goods are. We can imagine many ways in which that person’s preferences would result in the falsehood of the assertion of Pareto optimality, yet we are anyway confronted with this manifestation of the prejudice that the concepts used by economists to compare outcomes are evil manifestations of an imagined money-centric, capitalist doctrine.

So is Pareto efficiency a normatively loaded term? Is the concept of Pareto efficiency part of positive economics or normative economics? Those who would argue that the boundary between the two is fuzzy frequently point to the Pareto efficiency tool as evidence. It’s a concept that is, however, firmly positive, at least up to the scale of the interpretation of language. It either is raining, or it isn’t. An outcome either is Pareto efficient, or it isn’t. This cannot be a normative statement.

Perhaps the problem arises because, like all concepts that rely on assessing utility or satisfaction, Pareto efficiency might be inherently untestable. Unless it’s actually possible to know or deduce preferences, we can’t make physically true statements about Pareto efficiency or the like; the best we can do is to say “if these people have these preferences, this outcome is or is not Pareto efficient”. To do better than conditional truth we somehow have to know preferences, and whether that’s possible is, to me, a huge open question. Pareto efficiency might then seem normatively loaded because the assumption on what preferences people hold is folded into the statement of Pareto efficiency, as in the mistake above that omitted “if people only care about their own material possessions”.

The irony is that Pareto, the man, for whom “Preferences were the primitive datum, and utility a mere representation of preference-ordering”, might perhaps be the first to object to the misuse of his most famous concept.

Is John McCain an economist?

I think John McCain’s being a little too hard on himself:

“They are complicated,” McCain said of economic issues, “and I freely admit I am not an economist.”

It probably depends on whether he’s thinking of economics or economic policy. Senator McCain also says:

“But I know there are some people who have literally immersed themselves on issues of economics, how Congress works on it, the tax code, that sort of thing. I would look for that kind of talent not in a vice president but in close advisers.”

What economist doesn’t like the sound of that? However, studying or doing research in economics is very different from formulating economic policy.

“Economic policy” is simply policy that influences the way we organize our use of resources, and I think Senator McCain is probably a lot better at it than he gives himself credit for.

If Senator McCain asks his advisers “What would happen if I did this?”, we need to figure out the chain of causes and effects that trickle through the whole country’s decisions and their response to the proposed change in policy. If he asks “How can I achieve that?”, we need to do the same thing backwards to somehow ask if there’s any action the policymaker can take to alter the end product. These are positive economics questions: what’s going to happen? I think this is what McCain might be worried about answering.

Deciding what policy is best is where it gets tricky; we have to somehow compare countless options, many of which have outcomes which aren’t even certain. Then we have to deal with the familiar problem of measuring the satisfaction of the people, at least notionally, if we’re to make any headway in choosing the “best” policy. These are normative economics questions, and I think John McCain is just as qualified as anyone to answer these.

In the ideal world where our policymaker – or anyone – has figured out or been appraised of the true and full consequences of a policy, it’s out of the hands of “science” and becomes all about a value judgment. In a democratic society, who better than our elected representatives to make the value judgment on behalf of his constituents?

Being a normative economist is easy: all you need is an opinion. How informed that opinion is relies on the honest work of true positive economists. The study of economics should never confuse the two. The perception of economics might be inescapably tied to capitalism, but economics is not about promoting one system of organizing our resources over another. It’s about figuring out what the consequences of the system would be (positive), seeking a means to compare them (normative) and then asking “what do you want?”.

Of course, it is election season. Maybe McCain, normative economist of the people, is just trying to distance himself from economists – it makes him more likeable, I imagine…