The Fundamental Fallacies Of Macroeconomics

The Fundamental Fallacies Of Macroeconomics

October 18, 2011
Originally published in Forbes

Do you sometimes wonder why economists are accorded such respect and influence given the fact that they claim knowledge over the unknowable, promote theories that are untestable, and make forecasts for which they are never held accountable? Isn’t that the definition of a witch doctor?

If engineers were held to the same standards, bridges would collapse as often as banks, planes would fall from the sky (if they ever got off the ground), and cyclical blackouts would be a permanent feature of our electrical grid. But at least they would get to visit the White House.

Have you ever watched engineers from different schools argue on Sunday morning talk shows about the validity of Bernoulli’s Principle or Ohm’s Law? No? Yet economists, like rival witch doctors, get red in the face promoting diametrically opposed economic remedies, sometimes sharing Nobel Prizes in the same year for theories that directly contradict each other. Take $2 trillion and call me in the morning.

Why do we allow these people to formulate economic policy?

Take a look at two popular numbers held up by various schools of economists for the rest of us to worship – the Gross Domestic Product (GDP) and the Official Unemployment Rate. Lord help any politician accused of driving these in the wrong direction.

The GDP is supposed to measure “the total market value of all final goods and services produced within a country in a given period.” Only an omniscient being could possibly know this number, even if it could be precisely defined. Subjectivity abounds. (Hey bud, is that hamburger patty final or is it destined to become a Big Mac?)

So instead we rely on extremely crude estimates subject to all sorts of biases, the accuracy of which cannot possibly be better than a 10-percent margin. Yet we obsesses over whether the GDP is growing or shrinking by one or two percent, demanding legislative action to fix it. Now.

But it gets worse. A hurricane hits Miami and blows down half the houses, which have to be rebuilt. All that reconstruction causes the GDP to go up. Hurrah, let’s have some more hurricanes! You laugh, but when Nobel Prize winning economists propose equivalent nonsense they are rewarded with columns in The New York Times.

And unemployment rates? Measuring employment is pretty straightforward, but measuring unemployment is a lot like measuring dissatisfaction. The Bureau of Labor Statistics tracks no less than six unemployment rates, imaginatively named U-1 through U-6. The broadest measure, U-6, purports to count “the total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers.” So, if you work part time because you prefer to golf every afternoon, you’re not unemployed. But if your daily golfing partner answers “yes” to the survey question inquiring whether he would prefer a full time job, he counts as unemployed.

And just how do you total up the civilian labor force, which is defined as the sum of civilian employment and civilian unemployment? (Pay no attention to that circularity behind the curtain.) Be careful, though, not to count discouraged workers who want and are available for work, have looked for a job in the prior 12 months, but answer “no” to the survey question “are you currently looking for a job.” And if you are discouraged and over 65, are you retired, unemployed, or none of the above? At least we can be sure that as more workers get discouraged, the official unemployment rate goes down. If you are comfortable promoting theories like this you have all the makings of an economist.

At the highest levels, of course, economists communicate in mathematics, not English. This “proves” that they are scientific.  To make the mathematics work they have to invent all sorts of assumptions like economies that are in equilibrium, markets that have perfect competition, and exchanges with zero transaction costs. None of these things exist in the real world, and most economic theories collapse into a heap when you take these assumptions away, but economists are hard to discourage.

They proudly conjure up functions like “aggregate demand,” which is commonly defined as “the amount of goods and services in the economy that will be purchased at all possible price levels if inventory levels were static.” Then they go on TV insisting that we don’t have enough of it to juice up the GDP and lower the unemployment rate, so we need to print up another trillion, and make sure to pass some to the unemployed so they don’t become discouraged.

It’s hard not to get discouraged yourself, especially when common sense becomes so uncommon that entire democracies vote themselves into economic suicide pacts. But have no fear, you can always call on an economist to explain it all.