Skip to main content
Navigate Up
Sign In

University of Colorado Denver | Anschutz Medical Campus

University of Colorado Denver
 

A Few Economic Myths

Barbara Goodrich, Ph.D.


Puzzle: Why is it that, during the great depression of the U.S. in the 1930s, people who were literally starving to death could only watch while "overproduced," and hence "under-priced" grain was burned to lessen the surplus supply? Doesn't this violate the laissez faire "law of supply & demand"?

We'll come back to this later.

Myths of basic laissez faire economic theory:

For the pernicious myth that "money makes money," that investors "create wealth," go back to my index and click on "Economics Terms for Smith and Marx."

desc Myth #1: The distinguishing feature of capitalism, what makes it different from any other possible economic system, is that:
In it, you can acquire whatever you can, and buy and sell at whatever prices you can get.
(Without regard to fair prices. Recommended: Nozick's "motorboat and life-jacket" example.)

 Reality:

The description above is not of capitalism, but of an entirely free market, which is distinct from it. Instead, "capitalism" refers to an economic system in which a business can be owned by a person or persons who do not participate in managing the business or in the actual work of the business (e.g. self-employed people, family owned and operated businesses, worker coops). Instead, the owner(s), a.k.a. shareholders or capitalists, merely provide capital as investment in return for dividends, rather than contributing any productive activity.

Because capitalist economies have tended to have (or at least appear to have) free markets, people often confuse the two.

In fact, one can exist without the other. For example:

a) Employee-owned businesses trading in a free market would not, strictly speaking, constitute a capitalist system.
Instead, it would be a kind of free-market socialism.

b) Corporate capitalist monopolies would not be using a free market.
Instead, those in power - economic power, here - would set the price, the output, etc.. This would be a non-free-market capitalism.

What might this myth "enable"? Whom does it benefit?
Among other things, this myth obscures the two above possibilities. ..........

Myth #2: Economists try to discover and study impersonal laws of economics, which describe how the world -- or at least humanity in it -- just is.

Reality: There is no such thing as an impersonal law of economics describing how people always act and will act.

We can make inductive generalizations about historical economic actions to try to understand larger patterns of tendencies, given certain contexts, worldviews, and values.

However, prediction of people's present and future actions on the basis of "impersonal economic laws" (e.g. "people respond to incentives, and if we just know enough data we can predict how people will act") has not been successful enough to warrant taking seriously.

(Nobel laureate economist Paul A. Samuelson, in 1960: "The stock market has called 9 of the last 5 recessions.")

Its failure makes sense: people act according to their values -- stated and tacit -- and these cannot be generalized into laws. (If people were to start acting in really predictable ways in any single society, we would probably have good reason to suspect that a narrow ideology was being imposed on them.)

What might this myth "enable"? Whom does it benefit?
Well, it helps people avoid responsibility for their values and the actions reflecting those values. ......

Myth #3: Adam Smith's famous "invisible hand" will guide economic agents, through seeking their own enlightened self-interest, to benefit the whole of the society through the equilibrium of supply & demand.

Reality: The famous equilibrium of supply & demand in their technical senses means very little, since it is almost a tautology. All that it shows is that markets will tend to clear, other things being equal. But neither "supply" nor "demand" reflects actual human benefit, real need or use-value or "natural costs."

"Demand": not what I need or want, but simply what is actually bought at the price quoted.

"Supply": what is actually sold at the price quoted.

Price is what determines both demand& supply, but price does not reflect any "natural" cost, since the seller's costs of raw materials, labor, etc., reflect a market price, too. (For more, see Brockway, The End of Economic Man.)

Myth #4: Smith's "invisible hand" leads economic agents at the "micro-level" to benefit the whole society at the "macro-level." "What's good for GM is good for the country."

Reality: This is an example of the logical fallacy of composition. Wall Street isn't a collection of Main Streets.

(One example is that at the micro-level, people who anticipate inflation often take action that worsens it at the macro-level.)

The main counterexample to faith in the "invisible hand":
There seems to be an inherent tendency to serious overproduction in free market capitalism, restrained only by such measures as searching for new markets and creating monopolies and oligopolies.

Here's what happens: In a capitalist, free market economy, businesses compete with each other not only for retailers and consumers, but also for shareholders, for capitalists. Such a business is under pressure to offer the highest dividends and capital gains possible while meeting requirements for reinvestment, stability, etc. necessary for survival (either long-term or merely short-term, depending on what the shareholders demand through the board of directors). One way of increasing profits is to cut production costs, e.g. wages (sometimes salaries too, though salaried employees are usually in a better position to object than wage-earners). Thus, capitalist-owned businesses in a free market are under pressure to keep wages (at least wages) as low as possible.

The consequence:

desc

a) A capitalist business tends to pay its employees as little as possible, in order to survive in competition, at the micro-level.

b) At the macro-level, the aggregate earnings of employees are not enough to form a sufficient market to buy back the products they helped to make.

Economic crises throughout history have been associated with under-production, for example, shortages caused by war, drought, etc.. In free market capitalism, over-production paradoxically causes many crises.

What might this myth "enable"? Whom does it benefit?

desc Myth #5: We have to bear the burdens of layoffs, occasional recessions, etc., because inefficiency must be punished to reward efficiency and encourage growth. Everyone will benefit more in the long run.

Objection 1: What kind of efficiency, and for whom?

For us as consumers? Possibly.

desc For us as workers? Probably not. Increasing unemployment means a tendency for wages to go down. And if we can't afford consumer goods because we're unemployed or paid too little, we can't be consumers.

For us as shareholders? Even though the middle class is investing in record numbers, nonetheless, very few of us have enough money invested there to offset the problems.

X-efficiency, i.e. micro-level efficiency within an individual firm in producing goods with minimal expenditure of labor and resources, maybe.

"Keynesian" macro-level inefficiencies often result, though, due to labor and material resources not being fully employed.

desc Objection 2: The "speculative" market isn't a neutral mechanism for rewarding efficiency.
Indeed, it can cause a great deal of damage to the productive market, and can siphon off money needed in the productive market. The end result is often merely to polarize wealth all the more.

Here is George Brockway's analysis:

There are a limited number of uses for money:

1. consumption: which expands the productive economy, ie increases sales.
2. investing in productive enterprise: which reduces the interest rate the producing economy must pay to finance existing business or expansion. I.e more manageable financing.
3. hoarding (a.k.a. "holding liquid" b/c of "liquidity preference"): this money has been taken out of the producing economy and no longer affects it.
4. investing in existing securities: this money has also been taken out of the producing economy.

Wealth generated by the producing economy can be siphoned off into the speculative economy in the form of high interest rates, for example, having to pay bankers high interest rates, and having to pay shareholders high returns, rather than reinvesting the money.

This explains why the "speculative market" crash of 1987, with its disappearance of $ hundreds of billions didn't affect the economy much.
The producing market was already having to get along without that money anyway.

The bull "speculative" market had drawn it from the producing market in 2 ways:

a) double-digit interest rates, raised to control inflation (by raising interest rates, one will slow down job production, among other things, and some economists believed -- probably still believe today in 1999, despite record low unemployment these days, with no sign of inflation -- that a certain amount of unemployment is necessary to control inflation. See Myths 7-9 for these egregious beliefs.)

b) "supply side" ("trickle-down theory") tax cuts,giving more money to people who had no real use for it. In other words, they had no use for consumption, and no use for productive investment -- after all, too many people couldn't afford to buy new products, so there wasn't a big enough consumer market to make productive investment attractive. Thus, they simply speculated with it or hoarded it for a rainy day.

Brockway: "Other people could have spent the money on the products of industry, and industry could have expanded to give many of these people jobs. The industrial expansion could have brought money back from speculation."

What might this myth "enable"? Whom does it benefit?
Certainly those who are benefiting from the layoffs are benefiting from this myth, .........

desc Myth #6: Still, though, if people are making fully voluntary transactions, and in a laissez faire economy that's what they are doing, then those transactions must benefit them, or else they wouldn't be participating in them.

Reality:

First, there's an ambiguous comparison. Do you mean "must benefit them" in comparison to their current state? If so, this doesn't follow. If a person must choose between unemployment and a wage cut, either choice is worse than his or her current state.

Second, people can only make reliably, consistently self-interested decisions if they are fully informed as well as acting in a fully voluntary way. They must be aware of feasible alternatives and of the short-& long-term consequences of each alternative. This is rarely the case in the U.S.,where insiders frequently (& systematically?) profit from others' ignorance. (Members of the libertarian Austrian school of economics also criticizes the Chicago school and others in the U.S. for ignoring these information limits.)

What might this myth "enable"? Whom does it benefit?
It obscures people being pressure to choose among a very limited set of options due to constraining circumstances, too. .........

Myths about inflation and unemployment

Myth #7: Inflation is a terrible thing for everyone, and if unchecked leads to hyperinflation. Version 1 (monetarist, e.g. Chicago School): Inflation is always caused by too much money, which is why the Federal Reserve intelligently seeks to limit the functional money supply by raising interest rates (and thus discouraging borrowing and indirectly discouraging new job creation and existing job maintenance) when more than minimal inflation seems to threaten. Version 2 (more traditional neo-Classicist): Inflation is always caused by wage-push or cost-push rising prices. This is why we can't give you a raise. We're just obeying a law of economics.

Reality:

First, inflation in itself isn't a problem. If all prices/wages/money saved& hoarded, etc. were simultaneously changed to the same degree, there'd be no problem.

What is the problem with inflation: the relative wealth of different people and their other economic relations are upset by inflation.
Inflation actually benefits debtors & speculators, in relation to creditors and hoarders.

Second, hyperinflation differs from plain inflation in kind, not just degree. Historically, it requires special conditions: the country has massive foreign debts denominated in foreign currencies. Egs: Weimar Republic, & Argentina, Brazil, Mexico today.

Third, the monetarist explanation of inflation as "too much money" doesn't fit all instances of inflation. Indeed, David Hacket Fischer, in his history of European economies, claims that there are at least seven distinct factors that can cause inflation, with expanded money supply as only one. (Others include demand-inflation and contractions of supply as described by the classicists, cost-push inflation, price-fixing of key commodities, frenzied speculation, and of course the fear of inflation itself.)

desc Fourth, raising interest rates often won't work. The functional money supply varies depending on a number of factors, and interest rates are only one of them.
High interest rates can't deter all that much borrowing and investing. Frequently businesses must borrow, despite high interest rates, to meet various urgent obligations, to catch temporary opportunities, etc.. When this happens, prices are raised to pay for the greater interest, contributing to inflation! (See Brockway, p. 116.) (E.g. the 1979 decision to let interest rates surge. The Fed had had an agreement with the treasury from 1942 until 1951, to stabilize the prices & yields of government securities, which held all the interest rates down. The prime during these years remained at 1.5%!)

Fifth, the classicist explanation of all inflation as wage-push (or more rarely cost-push) also doesn't work for all cases of inflation. And if you're worried about contributing to inflation by giving us a raise, then just give us a greater proportion of the profits; take less yourself.

What might this myth "enable"? Whom does it benefit?
Creditors, among others. I wonder who has a greater influence over the Federal Reserve: people who are in debt, or wealthy organizations who lend credit. .......

desc Myth #8: (neo-Classicist, before the Great Depression and Keynes)

In a perfectly free, competitive market, not skewed by unions or a legal "minimum wage," there would be no involuntary employment. Only "frictional" unemployment caused by people between jobs.

Paraphrase: If unemployed workers are allowed to compete freely with other workers, wages will decline, as will production costs. This will promote expansion in production, which will require more workers to be hired.

Reality:

First, historically this hasn't worked. Unemployment was frequently very high in the "good old days" before unions and minimum wage laws. It didn't work.

Second, no mention is given in such an approach to the minimum pay needed by the worker merely to survive, much less to support children, pay any debts, etc..

Third, this presupposes a great deal:

(a) that the employer can expand production, which presupposes in turn that tools, raw material, and work space are available and at a low enough price,

(b) that the employer will expand production if wages go down (instead the employer might simply replace existing workers with cheaper ones, or use the threat of doing so to drive down wages, to compete more effectively for investors), and

(c) that the employer will be able to sell the additional products. But if wages go down, so will purchasing power and demand. (See Schweickart.)

This argument is related to Say's Law, discussed below.

What might this myth "enable"? Whom does it benefit?

desc Myth #9: (neo-classicist, after Keynes and the Great Depression)

There is a tradeoff between inflation and unemployment:

One version: Any steps taken to achieve full employment (say 4%), such as easier money, government spending, or lower taxes, would necessarily result in high inflation anyway (see above for weaknesses in this claim).

Another version: At a certain level of extremely low unemployment, wages go up considerably, causing wage-push inflation. (Marx spelled this claim out more bluntly: maximizing profits requires a "reserve army" of the unemployed, first to fill jobs during upswings and be laid off during downswings, and second, to keep the employed workers' wages down by fear of being replaced.)

The (A.W) Phillips Curve showed a correlation between extremely low unemployment with higher inflation (especially during wartime) during a century of British history. Thus, there is a "natural rate" of unemployment that we must just live with.

Reality:

(Again, indebted to Brockway.)

First, the empirical evidence doesn't support this. For instance, inflation continued in the '60s, '70s. and '80s, even with an increase in unemployment (e.g. the "stagflation" of the 1970s). The ad hoc response that this "stagflation" must be an anomaly is undermined by further, more detailed historical research indicating cyclical occurrences of stagflation throughout centuries at least. (See David Hackett Fischer.)

Second, the hypothesis commits several fallacies simultaneously: Hasty generalization, small sample, confusing correlation with causation, and worst of all only 2 of many factors are being considered here, unemployment rate and price level. Other key variables are not even studied, much less controlled for, such as land, with its cost of rent; capital, with its cost of interest, entrepreneur-ship, with its cost of profit, and government, with its cost of taxes.

Brockway thus lists seven other factors here besides price level:

1. aggregate takings of working rich,
2. aggregate salaries of working middle class,
3. aggregate wages of working poor,
4. aggregate rents,
5. aggregate interest,
6. aggregate planned profits for entrepreneurs, and
7. aggregate taxes.

He then asks: are any of these factors reliably correlated with inflation?

Not rent; it has fallen as a % of GDP since the early 1960s.
Not profit; it has fallen as a % of the GDP since the late 1960s.
Not corporate taxes; they've fallen from 23.4% of federal income in 1960 to 9.7% in 1990.
Not salaries of working middle class: the average hourly private-sector cost of wages & benefits, when adjusted for inflation, has fallen more than 10% since 1979.
Not salaries of working poor: despite the 1991 increase, the minimum wage hasn't kept up with inflation, and the bottom fifth of wage distribution has fallen more than 10% since 1979.

The two remaining factors have risen considerably:

desc Salaries of working rich have risen, and
Interest as a % of national income has grown from 1.6% in 1951 to over 20%.

What might this myth "enable"? Whom does it benefit?
"Don't pity the poor unemployed. Their fate is the necessary sacrifice to keep the rest of us comfortable." ........

desc Myth #10:

Say's Law: "Production, i.e. supply, creates its own demand."

Paraphrase: Because a company must hire people and pay suppliers and dividends, etc., the very process of its producing something will generate enough public wealth to constitute demand to buy that product.

Reality: The problem with Say's law: Often the market just doesn't clear.

Not enough people may be the recipients of this wealth to constitute a market, e.g. if most of that created wealth goes to a few shareholders. Thus, not enough people may be able to buy the product, or similar ones.

Or not enough people may want to buy the product. There are flops. (Examples of actual patent applications: A poultry disinfector which blows insecticide at hens; a foot-warmer that makes use of "wasted" heat from the wearer's breath (he breathes into a tube that goes down to his feet); a "device for producing dimples;" a "chewing gum locket"; and a toilet seat comprised of four rollers arranged in a square which prevents standing on the seat: "although affording a secure and comfortable seat, yet, in the event of an attempt to stand upon them, will revolve, and precipitate the user onto the floor..." (From A.E. Brown and H.A. Jeffcott, Jr.,'s Absolutely Mad Inventions (New York: Dover), 1932.)

Myths involving bad methods and hypotheses:

Myth #11

ceteris paribus: "all other things being equal," i.e. controlling for all other factors, known as "partial analysis." A useful qualification.

Objection: The difficulty arises when it is used not merely as a qualification, but to "prove" claims such as psychological egoism. (E.g. "All other things being equal, Mother Theresa will prefer to maximize her utility by .... Thus we all are driven by greed.")

It proves "too much."

If you can prove greed with it simply by writing off every other factor, you can prove any motivation.

(Related: the attempt to "prove" that people are always acting from the grossest egoism by simply defining egoism to include all possible motivations: "Well, if Mother Theresa didn't really prefer it that way, she wouldn't do it.")

What might this myth about egoism "enable"? Whom does it benefit?
It allows the most sociopathic behavior to stay camouflaged, by painting it as not much different from all other motivations. ....

Myth #12:

The "Law of Diminishing Returns": The first part of production, or of consumption, is more rewarding than the later parts. First formulated by Anne Robert Jacques Turgot in the 18th century, accepted without question by Say, Marx, even Keynes until late.

Paraphrase: In medieval Europe, when agricultural production was increased, it had to be extended into less fertile land. Similarly, when industrial expansion is increased, the company must use progressively lower quality supplies and less efficient employees. (See Brockway.)

This "law" underpins general equilibrium theory and marginal analysis.

Reality: Bad analogy. We're not faced with limitations in that way.

Example from Brockway: Diminishing returns is supposed to keep any firm from expanding beyond a certain point & becoming a monopoly; it's supposed to be an automatic return to the equilibrium of perfect competition.

But Piero Sraffa, in his 1926 article "The Laws of Returns under Competitive Conditions," shows that this won't work. Modern mass production is founded on economies of scale;

"Expanding production generally makes possible the utilization of more - not less - efficient machines & processes; & large enterprises, by exploiting opportunities for the division of labor, are able to employ more specialized& more productive laborers. Progressive division of labor makes possible progressive expansion of the market. . . . [then] there is nothing to prevent any given firm from expanding so vigorously & cutting costs & prices so aggressively that all other firms are driven from the market" (after a wasteful & inefficient battle for the monopoly. Brockway, pp. 256-257)

What might this equilibrium myth "enable"? Whom does it benefit?
Multinational corporations, oligopolies, ......

desc Myth #13:

Marginal analysis allows us to compute the "contribution" of a worker's labor, and thus what a just wage would be (Vilfredo Pareto), as well as the "contribution" of technology and of capital. Workers will tend to receive, under capitalism, the fair amount due to their labor, "to each according to the wealth he produces" (for others).

Marginal analysis studies the consequences of adding to or subtracting from the current, existing state of affairs, e.g. the marginal benefit of hiring another employee (the additional goods or services produced) and the marginal cost of doing so (the additional wages required).

Reality: (Here's another analysis from Brockway; he really is the clearest thinker available that I've found.)

First, because marginal analysis begins with a preexisting state of affairs, it assumes the status quo. The margin is a function of costs already incurred, & prices already charged. As Wicksell, commenting on Pareto, noted, all he proved was "simply that under free competition the worker received the greatest possible wage compatible with the state of rents & interest." Pareto assumed the price system, & the wage scale is part of the price system. (Fallacy of begging the question!)

One can apparently determine the "contribution" of land or other capital by marginal analysis, by determining the marginal product of a unit of labor (man-hours) and a unit of, e.g., land. If we define the contribution of each worker and each acre in this way, then the total contribution of workers and land will indeed equal total output. But defining contribution in this way simply begs the question of what constitutes a contribution to the production process, and thus begs the question of what is fair payment for one's contribution.

After all:

(a) Manual laborers, designers, researchers, etc. produce wealth,

(b) Managers coordinating these activities, etc., produce wealth, but

(c) Merely owning& making availablecapital, in the form of land, factories, or plain cash, is not a productive activity.

So, where does the money paid to capitalists come from? How is it generated? From the first two sources, (a) and (b), out of whose paychecks it must come.

What might this myth "enable"? Whom does it benefit?
"Don't ask for a raise. You don't deserve any more than whatever the boss offers you. He knows best."

desc Myth #14:

Nonetheless, investors still deserve their interest profits, as a reward for abstinence or sacrifice (Alfred Marshall), or as a reward for risk-taking.

Reality: (Again, Brockway offers the clearest analysis:)

By this reasoning, the employees should be paid more. They are abstaining too.

Further, if a shareholder is taking a risk by investing money, then employees are also taking risks by investing effort, by providing their services before they are paid for them, and they are probably risking a much higher proportion of their actual and potential wealth.

What might this myth "enable"? Whom does it benefit?
People who get a large percentage of their income from their capital, e.g. dividends, rather than having to work for it, .......

Now, how to answer the puzzle at the beginning?

"Supply" and "Demand" and their equilibrium don't address needs, only desires, and only insofar as the buyers can afford them.

The messed up "exchange value" still trumps the "use-value" of the food.

Large farms chose to ignore desperate human need. The "impersonal laws of economics" were an excuse.

Large farmers and business owners fell into the myth of money as an end-in-itself. Here, a true end, human life, is lost, because farmers wouldn't, for example, barter their labor for food. Why not? Would it upset the other customers who could pay? Or was there no need for labor, because supply already far outstripped functional demand?

Brief Bibliography (of some of the books your boss doesn't want you to read)

Bairoch, Paul, Economics and World History: Myths and Paradoxes (Chicago: University of Chicago Press), 1993.

Versus the myths on the right that protectionist policies regarding international trade hurts growth, & on the left that colonial imperialism always helped the imperial power (he admits that the colonies themselves lost far more than they gained).

 

Brockway, George P., The End of Economic Man (New York: Norton & Co.), 1995.

If you only look at one book from this list, look at this one. Splendid paraphrase of current economic theories, and erudite, sensible evaluations and suggestions. References to Brockway are to this book.

Economists Can Be Bad for Your Health (New York: W.W. Nortion & Co.), 1995.

A series of articles from Brockway's column, "The Dismal Science," in The New Leader.

Carson, Robert B., Microeconomic Issues Today: Alternative Approaches, and companion volume Macroeconomic Issues Today: Alternative Approaches (New York: St. Martin's Press), 1991.

Good general introduction to the competing analyses and claims of conservatives, liberals, and radicals in a number of different areas. If you want to sort out the various ideologies and historical backgrounds behind the different claims people make, this is the book. Easy to read, non-technical.

Dewdney, A.K., 200% of Nothing (New York: John Wiley & Sons), 1993.

Highly recommended; a mathematician takes on misleading statistics in a clear, entertaining way.

Eisner, Robert, The Misunderstood Economy (Boston: Harvard Business School Press), 1994.

Very useful graphs and stats, good paraphrases. One suspects Eisner is a Clinton flunky, though, & may not be fully objective.

Fischer, David Hackett, The Great Wave: Price Revolutions and the Rhythm of History (Oxford University Press), 1996.

Respected historian tackles economics through a historical perspective, bringing patterns to light unknown to most economists. He argues that four similar patterns of price revolutions can be detected since the high middle ages in Europe, with similar stages of stability, growth, excessive demand and population growth, leading to higher prices, social inequity, instability, and crisis, gradually returning to stability.

Herman, Edward S., Triumph of the Market (Boston: South End Press), 1995.

A series of articles by a leading leftist intellectual.

Hudson, Michael, ed. Merchants of Misery: How Corporate America Profits from Poverty (Monroe, Maine: Common Courage Press), 1996.

Nozick, Robert, Anarchy, State, and Utopia (New York: Basic Books), 1974.

The central book by the leading libertarian philosopher in the country today.

Sawyer, Malcolm C., The Challenge of Radical Political Economy (Savage, Maryland: Barnes & Noble), 1989.

Highly technical introduction to the alternatives to neo-classical economics.

Schweickart, David, Against Capitalism (Boulder: Westview), 1996 (originally published by Cambridge University Press, 1993).

Schweickart, holding two doctorates, in philosophy and math, rigorously demonstrates the feasibility of a variety of market socialism he calls "economic democracy," involving worker ownership of the means of production, a free market system, and a democratically elected alternative to speculation. The content is superb, though technical.

 

© The Regents of the University of Colorado, a body corporate. All rights reserved.

Accredited by the Higher Learning Commission. All trademarks are registered property of the University. Used by permission only.