Why Most People Misunderstand Economics

Chris DillowI read a very interesting Chris Dillow article, On Misunderstanding Economics. It is based upon research that shows that people are very confused about how economics work. The most obvious example of this is the idea that the macro-economy is like a household. This is where we get this nonsense from Obama in 2009 when we were still deeply in recession saying, “All across America, families are tightening their belts and making hard choices. Now, Washington must show that same sense of responsibility.” It sounds right, but it is totally wrong. It’s fine for me to tighten my belt when I’m trying to pay down my debt, but when everyone does it — when your spending is my income — it doesn’t work.

In addition to this, people make associations. For example: inflation and unemployment are both bad, so people put the two things together and think there is a correlation. That’s not true, of course; it is generally the opposite. Similarly, they associate government spending with unemployment. Again: exactly the opposite of the way things are. People are deeply confused about economics. And what I’ve noticed in my life is that those who think they understand economics the best are usually the most confused. It is a classic example of a little knowledge being a dangerous thing.

But it comes as no surprise to me that all of these misunderstandings lead to conservative policy. I think a large part of this is because conservatives run around saying that these things are correlated. For example, for decades, conservatives have claimed that tax cuts for the rich will cause economic growth because the rich will use the extra money to create jobs. They’ve been so successful at this propaganda that they no longer even have to explain why tax cuts for the rich will lead to more jobs. It is just “common sense” that tax cuts for the rich will create jobs.

The issue with government “belt tightening” is a great example. It isn’t hard to make people understand this. If everyone spends less money, everyone will see the amount of money they earn go done. As a result, everyone will have less money to pay their debts. But the debts themselves will not get smaller. Thus, everyone spending less will actually make the debt problem worse. Indeed, we have seen this in a number of EU countries, where they’ve cut their spending savagely, only to end up owning more money relative to their GDPs. This is not hard to understand.

The problem is that the our media infrastructure is totally vested in believing the “common sense” that “families are tightening their belts and making hard choices” so “Washington must show that same sense of responsibility.” No one goes around saying that billiard balls move according to Newton’s laws of classical mechanics so quarks must too. Everyone understands that reasonable sounding analogies don’t necessarily work. Indeed, I don’t know of any economist who claims that the macro-economy acts the way that a household economy does. But conservatives who have a vested interest in pushing bad economic policy are allowed to do so. And that’s the reason that people misunderstand economics.

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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

43 thoughts on “Why Most People Misunderstand Economics

  1. I wonder how much of this is economic propaganda v people not understanding that the economy is not going to be rational since people are not rational?

    Then again, I rationally think we should look at what people actually do economically speaking before we do something since unlike in the 1930s, we have a great deal of information to work from. Plus I like to punish the ultra wealthy for being generally smegheadish with 70% taxation on anything over 1,000,000 in salary.

    • Since the 2008 crisis, we’ve heard the same arguments people made in the 1930s. The truth is that for a lot of really important people, it is convenient to have learned nothing.

      • I usually expect better out of Europe when it comes to history as it is easy to do since they all live within five feet of some kind of Major Historical Event Happened Here in XXXX. Yes, I am exaggerating. But with our higher education schools infecting their schools with our lack of sense when it comes to things like economic history, the savage austerity doesn’t surprise me or you I suppose.

        • I don’t expect most people to know about this stuff. But the elites of the society should. But they are too caught in their Wall Street mentality of “Greed is good.”

          • When I was running for congress I actually told some people at a meeting I was at that I did not care about the Middle East that much. They looked aghast and asked “then why do you know so much about it?” I said “Because you do. If I am going to be your representative, I should know about what you care about. Not everything obviously but enough to figure out who best to advise me so I make the best decision I can on your behalf.”

            If one is going to be in office or work on becoming a leader in economic policy or foreign policy or whatever, one should know this stuff. Because that is partly what one’s job is. However apparently going by gut feeling is the way forward these days. *sigh*

            • Yeah, I think the form of politics you are pursuing is from the early neolithic period. Think with your gut! Embrace truthiness! That is the way to electoral success!

              • I don’t wanna! And so I get super depressed and hide from politics.

                Maybe after I move to a state that is more in tune to who I am.

                • Yes, come to the left coast! Not to start a fight or anything, that does not include southern California. But San Francisco, Portland, and Seattle are wonderful!

                  • I literally know one person (who I know meatspace) in San Francisco. I know one other person online (you) in the same area. So moving to San Fran is problematic since it is very expensive even after I get my shiny new Paralegal degree and I won’t have the funds to find a place to stay right away.

                    • Just avoid Southern California like you would bubonic plague. Unless you want to really challenge yourself.

                      The thing about Portland and Seattle is they have very liberal core cities, very rich suburbs, and very poor suburbs. In Portland especially the poor suburbs tend to be hugely conservative. Those might be affordable places where you could put your political energies to work. East Portland is pretty affordable housing-wise, could use some political education, and has a train which provides fast/cheap service to downtown where the legal offices are.

                      Just a thought! And it’s an area I know a little about that isn’t super-cold. Plus I think they’ve got meth under control now, so your neighbor’s house won’t blow up like they did when I lived there 15 years ago.

                    • My family lives there. I love my home town of Chula Vista. I miss it to this day. So moving home to Chula Vista has immense appeal-I have somewhere free to stay, I have relatives to annoy and it is home. At least until Dad’s cat eats my dog.

                    • Well, we won’t have any water by then anyway. I say, “Go north, young woman!”

  2. There’s also a correlation vs. causation issue. For example, during the Recession the deficit increased. Clearly deficits are associated with recessions, so we need to cut the deficit immediately! In reality, the deficit was caused by the response to the recession, and reducing it would require a weaker response, likely making the recession worse. But most people don’t get farther than “Debt is bad, and recessions are bad, so we need to reduce the debt to end or prevent recessions.”

    • Yeah, although this is mostly because conservative elites use it to vilify spending, even though they know full well what’s really going on.

  3. Let me gently suggest that liberals and their captive Keynesian economists bear some of the blame here for their dogged insistance on the blessings of inflation. The basic notion is that in any economy prices change, sometimes moving up and sometimes down as conditions of supply and demand vary. Ideally, these price changes just happen and we should expect things will average out.

    But in this far-from-ideal world, prices don’t just fluctuate. My rent is set at say 1500 per month by a lease; the landlord doesn’t call me each month and tell me to pay him an extra 25 dollars for January, or trim 50 bucks in March. My pay check is likewise fixed, and I expect it to increase or at the very worst hold stable at the ende of the year. And in fact, I’m going to be annoyed if candy bar prices swing between 85 cents and 1.15 every time I look into the grocery store. We’ve got lots of “sticky prices”, in other words, and the lubricant that economists prescribe is a bit of inflation. So the landlord boosts my rent 25 bucks per month every year? Not to worry — I’m getting a raise to 20 cents more per hour at work! And so on. And maybe I really ought to get to 30 cents per hour more to break even, and I’m actually falling back in real terms … but mostly people don’t notice as long as the figure on the check keeps getting bigger each year. A little inflation is just such a marvelous thing!

    But over time, most of us actually do notice we’re playing a mug’s game. The pay check doesn’t keep going up and up, but the rent payment does. And even the candy bar goes up to 1.25, and ground beef to 4.49 per pound, and gasoline to 3.999 per gallon and paper back books to 8.99 each, and so on. And if you’re on a fixed income, or no income for a couple of years, that handy dandy social lubricant the economists prescribe is something you’re drowning in.

    Which is to say that “Shit happens,” and it might all be bearable if economists were slightly more honest about why we have inflation and how the government and the Federal Reserve set inflation levels. But they’re not so honest, or they give explanations which are understandable to people who graduated from the fancy colleges that professional economists graduated from, but not clear at all to befuddled elderly folk living on social security checks or that sound downright condescending to unemployed high school dropouts trapped in Flyover Country.

    So there’s a bunch of people looking at their lives and not feeling too happy about their economic plight, and they don’t feel that Paul Krugman and Brad de Long and Mark Thoma and other liberal economists on the web are dealing honestly with them. And they go off to Fox News or Rush Limbaugh and listen to someone who at least seems to understand their beefs.

    So. I don’t know what the cure is, but it isn’t a bunch of economists singing “Drink your Inflation! It’s just like water, but even more so!” No. Inflation’s like oil, and it’s indigestable, and too much of it kills you, and the world would not be destroyed if economists started telling the truth.

    Grump!

    • “A mug’s game” — nice shout out how getting scammed used to be labeled. Ages ago, in the time before time, we took frustrations about skeezy lanbdlords/employers and used our vote to elect people who would curb the outright robbery. For some reason that’s not even thought of anymore. Those who screw us over are winners, genius entrepreneurs. We deserve to be boned. But we should channel our anger at minorities getting even more boned.

      What? Huh? It’s a mug’s game, goddamnit!

      • Out of curiosity because you are standing as my man on the street-what does “tax wealth, not poverty” mean to you?

        • Tax wealth, not poverty. What it means.

          Hmmm. The obvious answer is “progressive taxation”; i.e., people with greater income or greater than average amounts of assets should be taxed at higher rates than people with less income and less assets.

          Going on … No. I won’t go on. This is a policy. Maybe a good policy, maybe a bad policy, maybe something that works within reason, but if we want to start discussing tweaks to make this a more ideal policy, we’ll be at this all lday and all night for the next several centuries.

          (What I keep thinking here is that progressive taxation seems reasonable on some philosophical level, but it’s awful easy to find examples of taxing the rich which went horribly bad. Argentina under Peron, England after WW II, for instance. )

          • I’m a bit lost, you’ll have to simplify things for me. So progressive taxation is bad in some instances? Why? It worked for us pretty darn well, unless your argument is it didn’t. Can you put your take in a way dumbheits like me can understand?

          • Well that is why I wanted to know what James (or you) thought.

            The idea is that despite what a friend of mine things, people do like to have simple slogans to tie to.

            • Arguably, very high tax rates can be used to punish upper class political foes as well as simply finance the state. This might be a matter of ideology; it might be sheer damn stupidity.

              Any rate, there seems to be general agreement that in the interests of serving the poor, the Peronistas wiped out much of the wealth of the upper middle class in Argentina without lasting benefit. Goose, golden egg, that sort of thing.

              And England after the war for several years had a surcharge on upper incomes, such that the marginal income tax rate was 102 pounds per 100 pounds of income. I..e., the better paid you were, or the more income you got from stock dividends, the more you had to dip into your savings to settle with the tax man. It didn’t continue at this level forever, but it’s worth noting that a lot of 1960’s vintage UK rock stars settled outside England. Ever hear the term “tax exiles”?

              For a US example, consider the recent liberal recollections of the Good Old Eisenhower days when Taxmen were … uh … taxing … and top level businessment paid 90% of the salaries in income tax. Good times all around! Except that the businessmen caught on the game and persuaded their boards to pay them in stocks and options rather than just money, because the gains from stocks were taxed differently from income, and that led to a lot of business behavior that wasn’t so much aimed at improving the businessses but at increasing the value of stocks, And so on. I’m not so ambitious, but a real economist might want to argue this all had economic effect.

              Also, I went to a school for a while which had GUGENHEIM engraved high on the sides of one building. Quite a lot of buildings in this country that say “Gugenheim” actually. And some that say “Ford” and some thazt say “Rockefeller.” Old style family fortunes at work. I’m trying to think, but I can’t recall any of those old style family fortunes getting founding during the FDR to Eisenhower period. I think 90% tax levels made them hard to build. Was this good or bad? Or am I imagining things?

              • Since we are supposed to be a democracy and the Constitution specifically tells us that we should not have nobility…it seems like having long term family fortunes like the Fords, Rockerfellers, Vanderbilts, etc, is a bad idea.

                The sweet spot apparently for the highest marginal rates are much much higher than people assume: http://www.huffingtonpost.com/2014/10/22/economists-tax-rich_n_6024430.html

                Because tax policy is often a social policy at the same time, if we want to have high quality museums, zoos, hospitals and the like, then yes, we should be raising rates as high as possible on the top marginal rates. The hedge fund managers don’t want to pay the tax so we tell them “you can deduct your contributions to state colleges” and suddenly half the country gets to go to college for free.

                But it requires some serious hardball from the government on what happens if the idiots renounce their citizenship like one of the dudes behind Bitcoin. http://www.businessinsider.com/bitcoin-jesus-visa-application-denied-2015-1

                If nothing else, England’s high tax rates led to some amazing movies: Monty Python and the Search for the Holy Grail would never have been made without them wanting to have a tax write off. Of course there are also some insanely terrible movies: Uwe Boll’s entire career.

    • I hear you. The the issue with Social Security is that we elect a majority in the House of Representatives that don’t want to keep increasing payments according to CPI-E. In fact, they want to move to an even lower CPI adjustment. And let’s face it: a lot of them simply want to destroy the program. We can’t blame that on inflation itself.

      But I understand that people don’t understand it. Inflation, all by itself, is bad. But inflation is good if you need a job. And keeping up with inflation and getting your share of increased productivity is one of the main reasons we need unions.

      I don’t recommend that most people read Krugman or Thoma — much less DeLong who is really hard to understand. Robert Reich is the guy who makes this stuff understandable. But it is hard regardless.

    • Molly Ivins, waaaaaaaaaaaaaaay back in the 1990s addressed this-she said that the working class had a lot of legitimate anger that the left could address but doesn’t because they were focused on women and minorities issues which are equally important.

      There were only a few politicians addressing it here and there but nationally or congressionally rarely had anyone really pushing economic inequality. The only thing that would be pushed (because it is popular) is increases in the minimum wage. While helpful to economists because of all the natural experiments it set up, it only helps a little bit with the people at the bottom getting tiny increases in response.

      You did not have anyone, when the government’s decent pay and pension benefits were being slammed in the media saying loud and proud “So why aren’t we working to ensure that the private sector treats their workers equally well? Why do you hate the working class Mr. O’Reilly? No, you quite clearly hate them. Should I give you a tissue for the rage spittle you just flung at me?” (There may be a reason I will never be on Fox.)

      Things are changing with Sanders in the Presidential race but I am not seeing it showing up at the congressional level. That worries me.

      • Well, yes, but actually I don’t think I’m likely to get into a fistfight with any long term reader of Frankly Curiousover the issue of income inequality. What I’m mumbling about to myself is off on a tangent:

        Most folks are relatively unsophisticated about economic matters, but not totally unsophisticated. They’re aren’t at the Econ 1.01 level, let’s say, but they’ve reached Econ 0.99. They know that in “normal” circumstances it’s better to put money in banks than under beds; they know what interest is, and that bank loans are fueled in some fashion by deposits, and so forth. They can do the sort of calculations that tell them whether buying a new house would be affordable, or whether the costs of fuel and repairs would justify replacing their car, or whether shoring up the barn for another year and buying another tractor would make more sense than just replacing the old structure, and so on. (Okay, not “most folks”, but “many folks.” We’re past the level of understanding Adam Smith would have seen about him. Mass education has had its successes.)

        And most people with this Econ 0.99 level of understanding think the capitalistic economy and the various laws and regulations that surround it are basically simple and basically fair, and OUGHT to be simple and fair.

        And those of us with Econ 1.01 level understanding know it’s different, and delight in that difference, and some of us make very good livings by exploiting the difference. “Why didn’t the Robertsons get a house loan?” a simple 1950’s-vintage high school student might wonder. “They’re good folks. They go to our church. I had her as a teacher for nineth grade English.” “Because they’re f***ing n*****s,: a farmer out in his fields answers, spitting tobacco juice at a tomato plant. “Shiftless. Can’t be trusted to keep the payments up. I don’t care how good they look, it never lasts with those people!” And the banker and the real estate broker smile wryly, knowing the issue is the Robertsons applied for a Fanny Mae loan hoping to buy a house in a new subdivision which didn’t allow non-white residents, and that residential red-lining is blessed — even required –by federal statutes. And some econ prof in the state university is getting tenure with a nice long paper establishing that in the 1920’s and 1930’s blacks with sub-par incomes really were bad credit risks. And so on. Add your own embellishments!

        So the thing I wonder is, Should we try to educate “ordinary” voters to bring them up to the Econ 1.01 level of sophistication — which is what most liberals strike me as advocating. Should we just go on pretending that the economy operates as Econ 0.99 voters think it does, while actually running things qute differently — which is what I see conservatives doing. Or should we actively grab hold of the whole damned mess and try to restructure it so it actually operates on Econ 0.99 lines? Maybe we ought to set things up so the black Robertsons have the same odds of getting a bank loan as the white Jenkinses. Maybe we ought to take our rakes and pruning shears and shovels and beat to death some more small town realtors and state legislators.

        Would we all actually be worse off in a world run by Econ 0.99 principles?

        • I favor education of voters to as high a degree as possible. However at the same time that is no guarantee they know anything with Ben Carson being exhibit A.

    • When you say flyover country, I take it that in this case you mean the east and west coasts, since that is where most of the unemployed high school dropouts reside. I know the coasts are what I flyover on my trips to Europe and Asia.

      Some of these trapped high school dropouts, the ones with useful job skills, are only trapped by their own unwillingness to move to an area where there are available jobs, but for many of these dropouts and also for many graduates, from high school and college, their job skills do not have sufficient economic value to provide their desired lifestyles. Our national policies on inflation, employment and education may be pernicious, but it still remains true that the primary determinate for the quality of most peoples lives is the choices they have made.

      And Mike, it’s good to see you’re still fighting the fight.

  4. Another toxic implication of Obama’s and others’ discourse here is the pernicious separation of ‘us’ from ‘the government’. The government is supposed to act in our agency.

    Whatever the practice is, the theory is supposed to be that the government acts in our interest. So, what they spend money on is not ‘perks’ or luxuries for people in Washington, but the basis of a shared polity. Thus decrease in government spending and intervention is not properly described as ‘belt-tightening’.

    In fact, as Frank and others on the Internet have been documenting, the 35+ year trend of decreased government spending and economic action has resulted in a regime in which individual politicians have much more, not much less, opportunity for personal enrichment. Thus, for the politicians themselves, contraction of government economic activity leads not to personal sacrifice but to personal enrichment.

    • Absolutely. Another big thing is that we are playing on the conservatives’ ideological ground. I’m beginning to think that we shouldn’t worry about lifting people out of poverty. We should worry about making poverty not suck. I don’t mind being poor, because I’ve had so many advantages in life that I can get much satisfaction without money. Just the same, the fact that people have to worry about food, shelter, healthcare is an outrage. Until we can address that, we can’t even begin to think about making people’s lives worth living.

      • Yes, living first, economics second. Public property and institutions are the only proven path to widespread poverty reduction, and possibly in the pursuit of making money not always the first fact of life.

        • A big problem is that we don’t value poverty as a choice. The only acceptable choice is wealth. But this leads to all kinds of nonsense, like people continuing to work long hours rather than taking increased productivity in leisure.

      • Something I was talking about with one of my brothers — being poor meant we played baseball and made friends with the other poor kids in our housing project, in our case the Korean and Mexican kids. That’s an invaluable experience. For our parents, poverty was a terrible source of stress and shame. For us kids, there were almost positive aspects to it.

        • That’s a good point. The shame is a social thing, of course. But the insecurity is something that just isn’t acceptable. No one should have to worry about the basics of life. But this is a hard pill for Americans to swallow because they think some kind of social Darwinian struggle is the only thing that gives life meaning.

      • To paraphrase my namesake: there is only need for one shelter, food and health care, the rest are mere trifles.

    • Best part is the top comment is supposedly from one of the guys in the article and wow, does he show the title is 100% accurate. *really shouldn’t laugh but does anyway*

    • That’s an old standby: “I got a raise but I brought home less money because I was put in a higher tax bracket.” I’ve had people tell me that. Usually the people most upset about taxes are the people who understand it the least. As for the other guy, you heard that a lot from conservatives, “I’m not going to invest in something that will make me millions if my tax rate will be 39.6% instead of its current 35%.” I forget who it was (probably Warren Buffett) who said more or less, “I’ve never been in a meeting about an investment when anyone mentioned their tax rate.” All of this is just conservative folklore — a reason to justify always lowering the taxes on the rich and never asking anything of them.

      • My sister said that to me once and got a ten minute lecture on what really happens when you get paid more. So she stopped saying things like that to me since those lectures are boring. But she is used to it from me and our dad.

        I meant the fact one of the quoted guy’s in the article wrote…like…this…because…that…is…really…awful.

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