John Hood: Four economic fallacies to avoid

Published 12:00 am Tuesday, May 5, 2015

RALEIGH – Those who advocate rational public policy, based on a thorough understanding of the principles of human action and the benefits of voluntary exchange, are bound to be disappointed much of the time.

That’s not an argument against fighting for freedom. But it is an argument for realism and for keeping expectations low — so you can be pleasantly surprised when policymakers resist political temptations and make good decisions, whether they be here in North Carolina or in Washington, D.C. (Just kidding about the latter possibility.)

Why do policymakers so often get things wrong? Bryan Caplan, an economist at George Mason University, released a book about eight years ago that makes a convincing case for the role of economic illiteracy. In The Myth of the Rational Voter, Caplan identified four systemic fallacies that impede sound policymaking by biasing the perception of everyday occurrences and problems:

The Anti-Market Bias, which Caplan defines as “a tendency to underestimate the economic benefits of the market mechanism.” Common manifestations include assuming that prices are arbitrary, overestimating the profit margins of business, and failing to perceive how money-based transactions among strangers, entered into without any particular altruistic goal, can nevertheless yield public benefits.

• The Anti-Foreign Bias, meaning “a tendency to underestimate the economic benefits of interaction with foreigners.” Actually, this isn’t just a fallacy in public understanding of economics. It has often been a fatal flaw of human behavior. Think about the matter in terms of evolutionary psychology. Small bands of hunter-gatherers had good reason to view the Other with mixed emotions. On the one hand, he represented novelty and opportunity. He could be bringing something you have never touched or tasted, new technologies you could use, or powerful new ideas. On the other hand, the Other could be a thief or invader. Unfortunately, defense mechanisms that might have served primitive humans well are disastrous impediments to modern understanding of comparative advantage and free trade, and of course in extreme examples lead to xenophobia and violence.

The Make-Work Bias, meaning “a tendency to underestimate the economic benefits of conserving labor.” I see evidence of the make-work bias every day. Many North Carolinians truly believe that automation reduces overall employment by replacing human labor with machines. They simply haven’t thought about what happens when automation reduces the real cost of producing goods, which results in consumers having more money to spend on other goods and services that must be produced by human action. Nor has it occurred to them that as workers gain access to more capital, more labor-saving devices and enhancements to their productivity, their hourly work effort is worth more and their real income rises. As with the other biases, the truths that disprove the Make-Work Bias are hardly new, and aren’t at all controversial among economists, regardless of their personal political views.

The Pessimistic Bias, meaning “a tendency to overestimate the severity of economic problems and underestimate the recent past, present, and future performance of the economy.” In my view, this is by far the most serious and costly error of all. It explains otherwise-puzzling disconnects between public perceptions of the economy and actual economic performance. It also helps to explain the recurrence over the centuries of apocalyptic movements, zealous cranks endlessly predicting the end of the world, and the extreme elements of today’s environmental movement.

Based on preposterous extrapolations — “if present trends continue, we’ll be out of [fill in the resource] within the next 10 years” — many purveyors of doom manage to convince enough politicians, reporters, and less-gullible folks to advocate “solutions” that actually create shortages and costs that would otherwise be addressed by the price mechanism and market responses. It happened with oil in the 1970s, and may indeed happen again.

These biases are costly and persistent. We should certainly seek to remedy them with constant and patient public education. But we should also keep things in perspective. Human beings have created markets, benefited immensely from markets, and yet misunderstood markets since the dawn of history. It’s unlikely this will stop by next Friday.

Hood is chairman of the John Locke Foundation. Follow him @JohnHoodNC.