Can Economists Be Trusted?

Uwe E. Reinhardt from NYT Economix(via Mark Thoma):

"In last week’s post I argued that the analytic structure through which economists behold the world is based on certain quasi-religious beliefs on the rationality of human beings and the efficiency of markets. These beliefs can blind economists to the foibles of the real world.
Matters are worse when, wittingly or unwittingly, economists infuse their analysis with their own (or a political client’s) preferred ideology.

Consider, for example, President Bill Clinton’s 1993-94 health-reform plan. In this plan, President Clinton proposed a mandate on employers to provide their employees with health insurance.

Politically conservative economists predicted that the mandate on employers to provide employees with health insurance would lead to vast unemployment. Economists supporting the Clinton health plan predicted that the negative employment effect of the mandate would be small, and that the effect might even be to increase employment.

It can be shown with a simple mathematical model that an economist’s prediction in this regard is powerfully driven by two assumptions about the behavioral responses to mandated employer-paid health insurance.

The first is the responsiveness of the supply of labor — that is, how many workers are willing to work — to changes in take-home pay. Economists generally believe that employers reduce take-home pay to recoup their contributions to any sort of fringe benefit, including employer-paid health insurance. If workers are very sensitive to changes in take-home pay, one would predict a highly negative employment effect in response to government-mandated, employer-paid health insurance, other things being equal — i.e., the number of people with jobs should go down.

On the other hand, if the supply of labor is relatively unresponsive to declines in take-home pay, one would predict only a small decline in overall employment in response to the mandate. Unfortunately, the empirical literature on this responsiveness offers economists a wide range of estimates from which they can choose judiciously to make their (or their political client’s) preferred case.

The second effect bearing on this issue is the value workers place on having health insurance on the job. If that value is high, then the employment effect of the mandate might even be positive, other things being equal, as people choose to enter the work force just to get health insurance. Some economists in the Clinton era who supported the Clinton health plan appear to have used this hypothesized effect to predict a net increase in employment in response to the employer mandate.

This example starkly illustrates how easy it is for economists to infuse their own ideology – or that of their clients – into what may appear to outsiders as objective, scientific analysis.

We are now seeing a replay of this tendency in the debate on the relative merits of added government spending versus added tax cuts as measures to stimulate the economy.

Writing in The New York Times, for example, the Harvard professor N. Gregory Mankiw, former chief of President Bush’s Council of Economic Advisers, makes a case for stimulating the economy through tax cuts rather than added government spending.

First, he suggests that government usually spends money on things people do not want or need – like bridges to nowhere, or digging ditches and then filling them in again. To buttress his case further, he then cites an empirical study by Valerie A. Ramey, according to which the $1 of added government spending will ultimately increase gross domestic product by only $1.40, while according to another recent study by Christina and David Romer, $1 of tax cuts over time increases G.D.P. by $3.

Noneconomists may ask, of course, exactly how a $1 cut in taxes would translate itself into a $3 increase in G.D.P. at a time when traumatized households, whose wealth has been eroded, might use any new tax savings merely to pay down debt or rebuild their wealth through added savings, rather than spend it, and when businesses unable to sell their output even from existing capacity might hesitate to invest such tax savings in more capacity.

But never mind this fine point.

More interesting is that Christina Romer is to be the head of President-elect Barack Obama’s Council of Economic Advisers. In that capacity, last Saturday she released an analysis of fiscal stimulus alternatives, with a co-author, Jared Bernstein. Curiously — or perhaps not — for that analysis, the two authors assume a much larger four-year multiplier effect for added government spending (1.55) than for tax cuts (0.98), although they do confess to a high degree of uncertainty on the actual sizes of these multipliers.

So there you have the flexibility, shall we say, that economists enjoy when they apply their professional skills to affairs of state in what may seem, to outsiders, like purely scientific analyses.

In the first lecture of my freshman economics course at Princeton titled “The Art of Siffing Among Seasoned Adults,” I demonstrate how seasoned adults routinely structure information felicitously (i.e., “sif”) to further their own agenda, and I point out that economists can be among the most skillful practitioners of this art.

“If at the end of this course you still trust me,” I warn them, “I have failed in my mission. When economists advise on public policy, the operative mantra is Caveat Emptor!”

I am sad to teach it, but consider it fair and full disclosure.