Saturday, September 18, 2010

Why economics is hard

This post is motivated as a response to a comment Justin Kraus left on my post titled "Trade" from a few days ago. He's not an economist so I think his confusion is a product of thinking economics is a simpler (and more scientific) subject than it is.

Economics is hard because, while we like to think of it as a science, it's very difficult to get good experimental data. And without experiments you can't falsify bad hypotheses. So in economics, more than in other sciences, stories or theories that make a lot of sense but, as it turns out, are wrong can hang around for a long time.

Experiments, however, are not the only way to know something fishy is going on. Sometimes economists tell multiple stories, each specific to explaining one aspect of the economy. When you put them together, though, there is something inconsistent about them. For instance an economist might have a theory that international trade (1) benefits the United States and (2) doesn't create net unemployment because (1) if people choose to trade and are rational they're benefiting and (2) if people lose their jobs because their products are now imported, the economy will find a new use for their labor.

But then that same economist might say that when, say, Kenya imports t-shirts it puts the local producers out business. This is a net negative for the local economy because, presumably, the local t-shirt manufacturers can't find anything else to do with their labor and go idle. Trade causes unemployment and a long-term decline in GDP.

The problem with these stories is that you're left to wonder why Kenya can't reallocate resources but the United States can. What are the frictions in the Kenyan economy that don't exist in the United States? And while in the U.S. trade necessarily lowers some prices and thus benefits Americans, in Kenya the economist glosses over the fact that those imported shirts have lowered the cost of t-shirts which should increase utility.

That is more or less what happened when Bill Easterly, who usually touts the efficiency free markets and the general rationality of consumers, praised importing cars from Japan on those grounds but, in the past, has seemed to agree with arguments condemning cheap (free) imports to Africa on the ground that they harm local industry. At the same time he's also attacked Dani Rodrik for making pro-industrial policy arguments that rely on the assumption he (as far as I can see) will need to explain the frictions that exist in Kenya and make imports bad but don't exist in the United States.

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