Good Economics for Hard Times

1. Economic policies often ignore real-world complexity and human behavior

We economists are often too wrapped up in our models and our methods and sometimes forget where science ends and ideology begins.

Models vs. reality. Economic models and theories often rely on simplifying assumptions that don't reflect the real world. For example, standard economic theory assumes people always make rational decisions to maximize their self-interest. But behavioral economics has shown that people are often irrational, influenced by cognitive biases, social pressures, and emotions.

Policy implications. This disconnect between theory and reality can lead to misguided policies. For instance:

• Tax cuts for the wealthy are often justified based on models showing they boost economic growth, but real-world evidence doesn't support this
• Immigration policies often assume migrants take jobs from natives, when research shows they often complement native workers
• Free trade deals are promoted based on models showing mutual benefits, while underestimating localized job losses and social disruption

Need for nuance. Policymakers and economists need to:

• Incorporate insights from psychology, sociology, and other fields
• Use more realistic assumptions in economic models
• Pay attention to real-world evidence and unintended consequences
• Consider distributional effects, not just aggregate outcomes

2. Migration benefits both origin and destination countries, despite common misconceptions

There is no evidence low-skilled migration to rich countries drives wage and employment down for the natives; nor are labor markets like fruit markets, and the laws of supply and demand do not apply.

Economic impacts. Contrary to popular belief, immigration generally has positive economic effects:

• Immigrants often take jobs natives don't want or create new businesses
• They contribute to economic growth and innovation
• Low-skilled immigrants can complement, rather than substitute, native workers
• Remittances sent home benefit origin countries

Social impacts. While cultural integration can be challenging, diversity often enriches societies:

• Exposure to different cultures can reduce prejudice
• Immigrants bring new ideas, foods, and cultural practices
• Second-generation immigrants often thrive educationally and economically

Policy recommendations. To maximize benefits and minimize tensions:

• Invest in integration programs and language training
• Ensure access to education and job training for immigrants
• Combat misinformation about immigration's effects
• Consider more open immigration policies, given the overall benefits

3. Free trade can hurt workers, requiring better compensation policies

The real problem is that people are often unable or unwilling to move, within and outside their country of birth, to take advantage of economic opportunities.

Trade's mixed effects. While free trade can increase overall economic efficiency, it often has negative localized impacts:

• Workers in industries exposed to foreign competition can face job losses and wage declines
• Entire communities can be devastated when major employers shut down
• Benefits of trade often accrue to owners of capital, while costs fall on workers

Labor market rigidities. Standard economic theory assumes workers will smoothly transition to new jobs, but reality is messier:

• Workers often have deep ties to their communities and are reluctant to move
• Skills may not be transferable to growing industries
• Older workers especially struggle to retrain and find new careers

Policy solutions. To address trade's downsides while preserving its benefits:

• Expand and improve Trade Adjustment Assistance programs
• Consider wage subsidies to keep older workers employed in declining industries
• Invest in education and retraining programs
• Implement place-based policies to revitalize hard-hit communities
• Ensure trade agreements include strong labor and environmental standards

4. Preferences and prejudices are shaped by social context, not fixed traits

There are really no such things as true well-defined preferences. If people don't know how they feel about something as quotidian as a box of chocolates or a bottle of wine, why do we expect them to have clear preferences about climate change?

Malleable preferences. Our likes, dislikes, and beliefs are heavily influenced by our environment:

• Social norms and peer pressure shape our choices
• Exposure to diversity can reduce prejudice
• Marketing and framing effects can alter our preferences

Implications for policy. Understanding preference formation is crucial for effective policymaking:

• "Nudges" can encourage better choices without restricting freedom
• Education and media can shape social norms over time
• Policies should account for how they might shift preferences, not just respond to existing ones

Combating prejudice. To reduce discrimination and social divisions:

• Promote inter-group contact in schools, workplaces, and communities
• Challenge stereotypes in media and public discourse
• Design policies that emphasize shared interests across groups
• Recognize that changing hearts and minds is a long-term process

5. Economic growth is slowing in rich countries with no clear solution

The key ultimately is to not lose sight of the fact that GDP is a means and not an end. A useful means, no doubt, especially when it creates jobs or raises wages or plumps the government budget so it can redistribute more. But the ultimate goal remains one of raising the quality of life of the average person, and especially the worst-off person.

Growth slowdown. Rich countries have experienced declining economic growth rates since the 1970s:

• Productivity growth has slowed despite technological advances
• Some argue we've exhausted major innovations that drove past growth
• Others believe mismeasurement of digital economy understates true growth

Uncertain causes. There's no consensus on why growth is slowing:

• Demographic shifts and aging populations
• Rising inequality and reduced consumer demand
• Increased market concentration and reduced competition
• Environmental constraints and resource depletion

Policy implications. Given uncertainty about boosting growth, focus on:

• Improving quality of life and reducing inequality, not just GDP
• Investing in education, health, and infrastructure
• Promoting innovation while ensuring its benefits are widely shared
• Considering alternative measures of progress beyond GDP

6. Climate change demands urgent action and lifestyle changes globally

The citizens of rich countries and, more generally, the rich worldwide bear an overwhelming responsibility for any future climate change.

Unequal impacts. Climate change disproportionately affects poor countries and communities:

• More extreme weather events and natural disasters
• Threats to food and water security
• Potential for climate-driven migration and conflict

Responsibility and action. Rich countries and individuals must lead the way:

• Implement carbon pricing and regulations to reduce emissions
• Invest heavily in clean energy technologies
• Provide financial and technological support to developing countries
• Shift towards more sustainable consumption patterns

Individual choices matter. While systemic change is crucial, personal actions can help:

• Reduce meat consumption and food waste
• Choose energy-efficient appliances and transportation
• Support politicians and businesses committed to climate action
• Educate others and build social momentum for change

7. Automation may increase inequality without proper policy interventions

There is no evidence that cash transfers make people work less.

Job displacement. Automation and AI threaten many jobs across skill levels:

• Routine tasks in manufacturing and services are already being automated
• AI advances may disrupt high-skill professions like law and medicine
• New jobs will be created, but transition may be difficult for many workers

Inequality risks. Without intervention, automation could exacerbate inequality:

• Returns to capital may increase relative to labor
• High-skill workers who complement AI may see wage gains
• Low and middle-skill workers may face wage stagnation or job loss

Policy responses. To ensure automation's benefits are widely shared:

• Invest in education and lifelong learning programs
• Consider universal basic income or expanded social safety nets
• Explore ideas like robot taxes or profit-sharing schemes
• Ensure antitrust laws prevent excessive market concentration
• Support worker retraining and transition assistance programs

8. Government has a crucial role in addressing market failures and inequality

The problem is that there is no substitute for a lot of things the government does (although of course many governments do more things than they should, like running an airline in India or a cement plant in China).

Market limitations. Free markets often fail to address crucial societal needs:

• Providing public goods like infrastructure and basic research
• Addressing externalities like pollution
• Ensuring fair distribution of resources and opportunities
• Stabilizing the economy during crises

Government capabilities. While government inefficiency is real, it's often exaggerated:

• Many public programs deliver significant value (e.g., Social Security, public education)
• Government-funded research drives innovation (e.g., internet, GPS)
• Public-private partnerships can combine efficiency with public purpose

Policy implications. To improve government effectiveness:

• Focus on evidence-based policymaking and rigorous evaluation
• Streamline bureaucracy while maintaining accountability
• Invest in attracting talented public servants
• Combat corruption and regulatory capture by special interests
• Educate the public on government's positive roles to build trust

9. Universal basic income is promising but insufficient on its own

UBI imagines the government paying everyone a substantial guaranteed basic income (the amount of $1000 a month has been floated for the United States), irrespective of their needs.

Potential benefits. Universal basic income (UBI) could:

• Provide a safety net against job loss and economic shocks
• Reduce poverty and income inequality
• Give workers more bargaining power and freedom to pursue education or start businesses
• Simplify welfare systems and reduce administrative costs

Limitations and challenges. UBI alone isn't a panacea:

• Extremely expensive to implement at meaningful levels
• May not address underlying causes of inequality and job loss
• Could potentially reduce work incentives (though evidence suggests this effect is small)
• Doesn't provide the sense of purpose and social connection that work often does

Complementary policies. UBI should be considered alongside other interventions:

• Job training and placement programs
• Investment in education and skills development
• Policies to ensure fair wages and working conditions
• Community-building initiatives to provide social connections

10. Dignity and meaning, not just income, are essential for social welfare

We economists, in our fealty to standard preferences, have tried very hard to keep all of that out, but it is increasingly obvious this is a hopeless quest.

Beyond income. People derive value from work beyond just a paycheck:

• Sense of purpose and identity
• Social connections and status
• Feeling of contributing to society
• Structure and routine in daily life

Policy implications. Social programs should consider psychological needs:

• Job guarantee programs might be preferable to simple cash transfers for some
• Invest in community-building and social infrastructure
• Support meaningful volunteer opportunities for those unable to work
• Design welfare programs to minimize stigma and maximize dignity

Rethinking progress. Economic policy should prioritize overall well-being:

• Consider measures beyond GDP, like happiness and life satisfaction
• Recognize the value of non-market activities like caregiving
• Support flexible work arrangements and work-life balance
• Invest in mental health services and community support systems

Last updated: August 8, 2024