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Economics’ Big Lie

By James H. Nolt

I promised to treat the U.S. presidential election this week, but in the interim my son, like millions of other high school students, took the Advanced Placement test in economics. As I was helping him study, we ran across his textbook’s flagrant display of the big lie at the core of economics as it is taught today. This lie is so obscured by pseudo-scientific gibberish that is it often hard for the untrained or naïve to spot it on first reading—yet my son did.

The big lie is that the economic “science” of efficiency requires that we treat rich people as vastly more important than everyone else. Once disentangled from the jargon, the logic of this argument is no more persuasive than King George III claiming to be “king by the grace of God.” It is equally undemocratic, too. This dubious assertion is not stated so baldly. If it were, it would be too easily refuted. Instead, and more insidiously, it is embedded in all the methods of economics and of public policy studies involving cost-benefit analysis.

As Duncan K. Foley argues in Adam’s Fallacy: A Guide to Economic Theology, contemporary textbook economics, otherwise known as neoclassical or marginalist economics, poses as a science but is much more akin to theology. It is a system of belief and values with very little empirical support, which is one reason there is so little real history in economics textbooks, as opposed to critical works like that of Foley. Textbooks substitute make-believe for real economic history. As Foley says, “Economics is a speculative philosophical discourse, not a deductive or inductive science.”

The “Adam” in Foley’s title is Adam Smith. His fallacy, in Foley’s view, is that it is possible to separate a distinctive economic sphere of life from the broader social, political, and moral context. In chapter three, “Political Economics,” of my book, International Political Economy: The Business of War and Peace, I quote the great mid-19th century political economist and philosopher, John Stuart Mill, who argues that Adam Smith is at his best when he recognizes that there are no purely economic phenomena. All economic relations are suffused with private power, at least. This is why I insist on the term “political economy” rather than “economics.” This reminds us that every study of the economy must also be a study of private power and strategy.

All modern economics textbooks distinguish “normative” economics—how economies ought to be run—from “positive” economics—how economies actually work. The textbook itself then claims to be doing positive economics, as if its absurd models of “perfect markets” have anything to do with how real economies, suffused with private power, actually work. This could just be bad science rather than morally offensive propaganda, until the specific bias of economics becomes clear.

My son’s textbook, Krugman’s Economics for AP, says, “An efficient market performs four important functions: 1. It allocates consumption of the good to the potential buyers who most value it, as indicated by the fact that they have the highest willingness to pay.” Stop right there. There is no need to belabor the other three. This is enough to show patent absurdity and bias.

This point is based on the ridiculous concept of consumer surplus, which I already debunked in an earlier blog. Consumer surplus is linked to the idea of a demand curve, which shows that there are many consumers who would have been willing to pay more for a good but did not because they paid the market price. But where the sleight of hand becomes truly outrageous is when you pay close attention to how “most value” is measured by “highest willingness to pay.”

This theory actually says—this is not a mistake of these particular authors—that if Bill Gates would be willing to pay $20 for a pizza, but you are willing to pay only $10, then he values the pizza more than you do! This routine feature of textbook economics and cost-benefit analysis is seldom pointed out, because if it were the so-called “experts” would be laughed out of court, even if, like Krugman, they sport a Nobel Prize. Obviously, Gates may be willing to pay more for something than you are not because he values it more than you do, but because he has a lot more money! In fact, if utility theory is correct about diminishing marginal returns, it is very likely that most anything Gates could acquire will be worth less to him than to anyone else because he already has a lot of everything, even if he would be willing to spend more to acquire it than you would.

What economics today conveniently “forgets” is what the brilliant mathematician Daniel Bernoulli already argued in the early 18th century: that one additional dollar is less significant to a wealthy person than to a poor person. This common sense notion is one consequence of “the law of diminishing marginal utility.” Economists claim to believe in the law, but then they violate it at the very heart of their system and never point that out. If they were to take this principle seriously, then they would also have to stop claiming that free markets (even if they were real) are efficient means of satisfying people. Utility theory clearly indicates that much more significant progress toward human happiness would come from greater equality of power and income. Psychological research into happiness converges on the same conclusion. Economics embraces utility theory when it seems to serve its theological purposes but ignores it when it doesn’t.

If economics presented itself, like Ayn Rand’s novels, as a speculative philosophy about why the rich and powerful deserve nearly everything they have, at least it would be honest. Instead it tries to convince the rest of us that the most efficient way to organize society is to allow unbridled power to those with the most means to pay. Economics has worked out pretty ingenious ways of teaching that. Economics textbooks and most teachers encourage critical thought even less now than they did when I first studied the subject. So it is hard to imagine how the rising generation is going to learn much truth about the operation of the economies in which they are destined to play a subordinate part. Dissenting from this prevailing myth is the major motivation for my own teaching.

*****

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James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of 401(K) 2012]

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