What Econ 101 gets completely wrong

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James Kwak is a brilliant young law professor, economics blogger and successful entrepreneur. His new book is a slim little volume that calmly and clearly blows up the major premise of most conservative policy-making—and much of the Democratic Party’s policy agenda as well.

Kwak’s target is “Econ 101,” the introductory course in economics that, for the majority of college graduates, is the only exposure to the subject that they get. Their textbooks uniformly present a world driven entirely by “supply-and-demand” curves. It is a world where an invisible market dance mediates the adjustments of volumes and prices that are infallible as human institutions can be, a shining example of the wisdom of crowds.

So long as the principles of Econ 101 are applied to easy-to-understand choices, like buying a television set or a movie ticket, or picking out a restaurant, they work fine. But when they are used to drive more complex decisions—Kwak’s examples all involve important public policies—they are often found wanting, even wildly inappropriate.

Economismby James Kwak

Pantheon Books. 256p, $25.95

Consider the debates over setting minimum wages. It is a truth universally acknowledged that increasing the minimum wage costs jobs. U.S. House Speaker Paul Ryan, along with almost all other Republicans and business leaders, firmly believes that raising the minimum wage “will hurt the economy because it raises the price of labor.” And a rising price of labor—according to the supply-and-demand curves of Econ 101—will force businesses to shed employees or decrease investment.

In fact, mainstream economists have devoted a vast amount of research to precisely this question over the past decade, and have basically split down the middle over the question. Minimum-wage increases definitely transfer money from business owners to low-income workers, which is the whole point, but there are about as many studies showing that they have no impact on employment numbers as there are studies that do find an effect. Common sense suggests that employment effects will vary based on the size of the mandated increase, the state of the economy and multiple other factors; but in the normal case, the employment effect, if any, is small.

Kwak reels through a Baedeker Guide of Econ 101 “truths.” For instance, increasing taxes on the wealthy, all Republicans and many Democrats know, will curtail the work effort of our most productive citizens and slow economic growth. But Kwak points out that in recent history, the highest average annual growth in the U.S. economy was in the 1950s and 1960s, when top tax rates were 70 percent or even higher, and that the worst period of growth was over the last 15 years, when taxes were the lowest of the post-World War II era. Yet here comes President Trump and the entire Republican Congress honking the necessity of big tax reductions for the wealthy.

The strongest, and most important, of Kwak’s examples are those where the Econ 101 dogma—that unfettered free markets always produce the best results—are completely wrong. The collapse of the financial industry in 2007-8 was the result of wholesale deregulation on the principle that informed consumers are the best judges of their needs. Absent minimal regulatory restraint, the whole industry turned predatory and nearly destroyed the world economy.

The failure of the Econ 101 model is even more glaring when it comes to health care—although virtually every health care program proposed to the Congress for at least the last 30 years, including Obamacare, is shot through with “competitive markets” claptrap. But cancer and heart disease do not fit the model of competitive shopping. Most serious diseases come in a bewildering array of forms and lethalities, and very few people can judge for themselves how to treat them. Uwe Reinhardt, a health care economist, says that health care buyers are “blind-folded shoppers in a bewildering shopping mall.”

There is a better way. A mountain of evidence shows that public provision of health care produces superior health results at a much lower cost than the American competitive-provider model. The United States consistently ranks at or near the bottom of the advanced countries in the quality of its health care while spending up to twice as much per capita for this evidently inferior product.

The ugly truth is that the American health system is designed for the wealthiest quintile of Americans. College graduates with comprehensive, very expensive, health insurance can access the top specialists, typically with low deductibles and co-pays. Health insurance for top New York investment bankers reportedly costs more than $40,000 per year and typically has no deductibles.

Per-capita health care costs in the United States run about $9,500 per year against a minimum wage of $15,000 per year. The costs of U.S. health care are driven by the high profits of Big Pharma and medical equipment vendors, but also by the rapid accretion of wonderful new interventions. In effect, under the dogmas of Econ 101, the United States withholds decent treatment from the bottom half of the population in favor of providing Cadillac care, at the leading edge of technology, to the people who can afford it. That is a disgrace.

John Walton
4 months ago

Facts may be inconvenient to Dr. Morris. The most rapid rate of real, per capita income growth for the bottom decile of wage earners in the post-WW-II period took place after the grand bargain between President Clinton and House Speaker Newt Gingrich in 1996. Capital gains taxes were reduced (leading to a spurt in labor productivity,) and welfare was "reformed".

Similar advances took place under Coolidge, Kennedy and Reagan although the 1920's data is a bit more difficult to tease out..

Poor George Bush, his economic advance was undermined by the incumbent in Albany who engineered the collapse of the mortgage market as the head of HUD.

Joseph J Dunn
3 months 4 weeks ago

From Chapter 1 of Economism: “…economism rests on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an Economics 101 textbook…Like any such framework, it implies a certain set of value judgments and policy choice…in today’s world they most often justify the existing social order—and the inequality it generates—while explaining the futility of any attempt to change it. For every well-intentioned proposal to help ordinary working people, economism provides an answer…economism is like an ideology.”

The strongest argument against this fundamental premise of the book is that so many college students and recent grads, all so recently exposed to Econ 101 textbooks and value judgments that Kwak blames for inequality, and other evils, ardently supported Bernie Sanders’ economic policies, which were the opposite of policies that constitute Kwak's economism. So either the Econ 101 textbooks lack the conservative bias that Kwak finds, or a generation of students have paid no attention to the textbooks. Since the fundamental premise of the book is obviously flawed, I’ll skip the rest of it. I’m surprised that Dr. Morris missed this.

George Perkins
3 months 2 weeks ago

John Walton and Joseph J. Dunn comment above on Charles Morris’s review of James Kwak’s Economism. Unlike Mr. Walton, I have yet to read Prof. Kwak’s little book. Mr. Dunn at least has read the first chapter. Even though I have yet to read it, my views expressed elsewhere on the sophistries formulated by students from Economics 101 warrant my engaging the comments of Messeurs Morris, Walton, and Dunn.
I might quibble with the word “completely” in Charles Morris’ title, “What Econ 101 Gets Completely Wrong”, but suspect an editor, not the reviewer, may have exercised discretion here. Or, I might suggest that Mr. Walton’s argument suffers from the propter hoc, ergo hoc fallacy and so might encourage him to read Robert Gordon’s magisterial Rise and Fall of American Growth (2016) before again asserting a causal relationship between productivity and tax reductions on such flimsy evidence. Or, I might suggest that, if Mr. Dunn insists that the “fundamental premise of this book,” the prevailing social order contributes to inequality, “is obviously flawed,” he might benefit from reading Thomas Piketty’s data driven Capital in the Twenty-First Century (2014) or Nobel Laureate Joseph Stiglitz’s The Price of Inequality (2013). Evidence counters the “obviously” in an argument built from ideology.
Instead, I would rather discuss the substance of what is taught in Econ 101 courses and what students hold onto after completing these courses. Having taught Econ 101 many times over a long academic career, I want to assure Mr. Dunn that textbooks do propound the “conservative bias” he suggests may be lacking. Like him, I too have speculated that at least a “generation of college students have paid no attention to the textbooks” used in Econ 101 although my argument is better expressed that students have paid selective attention rather than no attention. Even better, students reduce the complete textbook argument to an incomplete catchphrase.
Typically, students take away from Economics 101 the “conservative bias” that Mr. Dunn expects they should. They grasp the catchphrase, “markets work well” by which is meant that markets allocate resources efficiently. From which students then conclude that market regulation reduces efficiency. Those who study economics beyond Econ 101 dub the proposition that markets work well as the Arrow-Debreau Theorem. The theorem, however, qualifies this catchphrase by restricting the situations where markets do “work well” to a limited set of circumstances. Only in these situations can markets achieve efficiency unfettered. Morris describes these as “where an invisible market dance mediates the adjustments of volumes and prices that are infallible as human institutions can be… applied to easy-to-understand choices, like buying a television set or a movie ticket, or picking out a restaurant, they work fine. But when they are used to drive more complex decisions…they are often found wanting, even wildly inappropriate.”
For many students who take only Econ 101, the catchphrase, “markets work well,” is their take-away; the qualification, “in a limited set of circumstances” is forgotten. All textbooks devote adequate space to “market failures” such as monopoly power, externalities, jointly consumed goods, and asymmetric information. In such situations, markets “fail” to allocate resources efficiently. In these circumstances, markets need to be nudged or regulated to be efficient. Somehow this part of the message is forgotten.
Markets certainly should strive for efficiency, yet correction may be necessary to achieve this goal. Efficiency alone becomes the bitch goddess of economism. But allocations should be just and efficient, too. The relationship between efficient allocations and just allocations is addressed as a corollary of Arrow-Debreau: efficient allocations are not necessarily just allocations. As market failures to achieve efficiency deserve correction, so too do market failures to achieve justice.
John Maynard Keynes caricatured this selective retention when reflecting on the influence of ideas in tension with vested interests. In his telling, “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
Madmen in authority and their practical constituents parrot the “markets work well” catchphrase and oppose most regulation even when such nudging would be appropriate. They selectively ignore the circumstances in which markets fail. This is the economism of which Kwack writes and he does so in the good company of Wojtyla, Ratzinger, and Brogoglio.

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