Two Caveats in Economic Policy

Economics is more like story telling than most economists admit. There is a close relationship between an economic theory like supply and demand and a story. It is true in all the sciences but especially true in economics. Try this story, which is a true story. Some years ago the Mayor of the District of Columbia decided to raise some tax revenue by increasing the gasoline tax on each gallon of gas. The tax failed and had to be repealed. Interviews with motorists found they were angry about higher prices and so they checked their gas gage and made sure they would never need to buy gas in the District of Columbia. Instead they bought gas in nearby Maryland and Virginia. Gas stations in the District started to go broke and the gas tax was repealed by the City Council. Because all of us are in the habit of saving money, the why in this story is easy to understand. We hear the story and say, “Of course, people want to save money and will pick the lowest price.” The story highlights a general principle: self interest. People will avoid taxes by changing their behavior.

Notice I started with a story and suggested a general principle. Adam Smith’s book the Wealth of Nations is full of stories. In the first chapter he describes his observations in the manufacture of pins. “The greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labor.” He goes on to explain how pin making is divided into 18 distinct operations that increase quantity as a result of improved dexterity, saving of time and the use of machinery devised by the workman. Chapter by chapter stories about his observations guides the reader to general principles including the self regulating character of competitive markets. Adam Smith did not draw demand curves or build economic theories, he was an observer and a storyteller.

It is reasonable to reverse the procedure and start with a theory. Having a theory means stating assumptions and a hypothesis using logical reasoning. For example, assume people act out of self interest. Hypothesize that consumers who can buy the same product at different prices will always choose the lowest price. Now there is a theory and we can tell the story of the DC gas tax as an illustration to show a general point. A theory first and then a story afterwards can illustrate principles that may have many applications.

By definition theories and stories have a point. In the story of the boy who cried wolf or the story of the hare and the tortoise, there is a moral to the story. A story without a point is mostly description and generally boring or unreadable. It also follows that a story that makes a point is trying to persuade you of something. In the child’s story of the hare and the tortoise where the slow tortoise wins the race against the fast hare, the person telling the story is arguing a particular view of life. There is the immediate point that plodding and perseverance can be successful over speed and skill, but in exposing a child to the story the teller may be making another point, this is a good thing; adopt perseverance for yourself.

In the theory of pure competition assumptions are stated and a market process is described. Many buyers and sellers pursuing self interest in markets cause price to find its own level and generates an economy where value is maximized. Presented alone, without stories or evidence, the theory of pure competition appears to be scientific. There is no apparent sign of an argument or persuasion; the description of resource movements sounds very nearly like the flow of electrons through a conductor or a copper wire. Economists like to describe the movement of resources in pure competition as positive economics as opposed to normative economics. Positive economics is said to be the study of what is; normative economics is said to be the study of what ought to be. If someone says, “This country needs better schools,” an economist will classify that as normative economics because it is a suggestion about what ought to be, how resources should be allocated if one group interferes in the market process and moves resources contrary to a natural scientific process. The idea is that economists are no more qualified to enter discussions about normative economics than anyone else because their science does not permit them to make better judgments about things that ought to be.

What is implied by the distinction economists like to make between positive and normative economics is that there are parts of economic study which are universally true and inevitable, and therefore beyond argument or persuasion. Suppose we hear a lecture by Professor Schwartz, an economist. He suggests that education can be bought and sold like bread and peanut butter. By education he means all of it, starting with pre-school and going through graduate school and professional school. Suppose further that he explains that parents of children would continue to recognize the importance of education and continue to send their children to school. The need to make a living or desire to earn a profit would motivate individuals and groups to start schools and enter education. Tuition would be charged instead of taxes, costs would be covered, profits would be made, competition would result, students would be educated.

In his story of market education Professor Schwartz is trying to persuade his listeners that education through the market place is a good idea, but in doing so he is trying to avoid the notion that it is really his idea. Instead he is trying to get us to think it is science or positive economics or pure competition that justifies such a policy; he is merely an impartial messenger who has learned the specialized science. It is common to avoid the use of first person in writing and speaking in science and economics. Doing so takes the weight of responsibility off the individual and places it on the science. After all, who could argue against the laws of gravity or the laws of economic science?
If I gave a lecture on education I would say that no society has ever achieved a reasonable level of literacy without publicly supported compulsory education. Apparently when the burden of educational cost is shifted to individuals it is such a crushing burden that many parents are forced to make short run decisions and do not invest, or do not invest adequately, in the long run benefits of education. I reach a different conclusion about education than Professor Schwartz. Partly that is because I look at the story first and then see if the theory of pure competition helps see any general principles that apply in education. Most markets have some unique characteristics that make it difficult to apply one theory to many markets without some adjustments or alterations. Professor Schwartz applies pure competition as a universal science while I look more closely at the individual case.

It is not that I am right and Professor Schwartz is wrong. The point is that I am trying to persuade you of one thing and Professor Schwartz is trying to persuade you of another. But that is always true and leads to the first caveat in economics. Economic science, with or without a story, with or without verification, with or without supporting evidence is always trying to persuade you of something. Economic theories are not just science. Beware.

Good stories are usually more persuasive than technical science. Suppose you are a college student sitting in the family parlor with your Uncle Wilbur and in the course of the conversation you talk about your college economics class. Of course you would tell him microeconomics is about price determination and resource allocation, but suppose you happen to mention that monopolists are price searchers who do not have a supply curve but always price in the elastic portion of the market demand curve. If you are on good terms with your uncle he might be impressed with your technical knowledge and feel that your expensive education was really worth it. However, whether or not he is impressed will probably depend on whether you are on a subject that affects his pocket book; an area where he has prior personal experience and feels justly competent.

Suppose he is talking about sales taxes and says the consumer always pay all the sales tax. In answer you reply “No that is not correct Uncle Wilbur, it all depends on elasticities. For all the tax to be shifted to the consumer price elasticity would have to be zero and supply elasticity would have to infinite. That is rarely the case so business does pay some of the tax most of the time.” Now, it will not matter whether Uncle Wilbur is impressed or not, he will not be persuaded. He is likely to say something like “That’s double talk.” Or, How come they always add just the amount of the tax to the price?” Technical material alone will not be successful to persuade Uncle Wilbur or anyone; what you need is a better story.

Try this one. “Ok, lets say we have a 5% sales tax on retail goods. If everything goes up 5% that’s a significant bite out of your budget. Certainly people who get 5% raises spend more money so wouldn’t you suppose a 5% loss would mean less buying? If Corner Drugs sells 2000 bottles of aspirin at a $1.00 a bottle that’s $2,000 for the drug store, but if they add 5 cents to every bottle they will probably sell less even if its only a little. Remember they have to pay 5% to the government so they still only get a $1.00 a bottle. Any fewer sales and they lose revenue and the tax bite hurts.” Now I’m not sure if that would persuade Uncle Wilbur, or even if it is the best story. It is a better story because it does not use technical terms from economics. To persuade someone it is better to have a story with familiar terms.
Remember everyone has personal experience with economic issues and policies. If an economic model contradicts someone’s personal experience, resorting to scientific terms is not likely to overcome long held beliefs. Statements like, “Hey this stuff is complicated, but it really works,” are not persuasive like a good story, but that leads to the second caveat in economics. Good stories are really good science and more persuasive as well.

All over the country college students study economics in their classes. Many spend hours and hours figuring out functions, graphs and charts because their instructors prefer theorizing over stories or data. Too bad. In the study of economics, theorizing is only half the story.