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The Assumptions Economists Make

The Assumptions Economists Make

Copyright Date: 2012
Published by: Harvard University Press
Pages: 384
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  • Book Info
    The Assumptions Economists Make
    Book Description:

    Economists make confident assertions in op-ed columns and on cable news—so why are their explanations at odds with equally confident assertions from other economists? And why are all economic predictions so rarely borne out? Harnessing his frustration with this contradiction, Schlefer set out to investigate how economists arrive at their opinions.

    eISBN: 978-0-674-06552-9
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. A Personal Note
    (pp. ix-xviii)
  4. ONE The Metaphor of the Invisible Hand
    (pp. 1-23)

    Adam Smith’s remark that individuals seeking their own self-interest in markets are led “as if by an invisible hand” to promote the good of society has received mixed reviews—beginning with Adam Smith. His most important work, An Inquiry into the Nature and Causes of the Wealth of Nations (1776), paints markets as powerful engines of growth but also of harm. If British banks in his day were allowed to charge exorbitant interest rates of 8 to 10 percent, he warned, they would lend only to “prodigals and projectors.”¹ The ensuing speculation would end in financial crashes, like the one...

  5. TWO What Do Economists Do?
    (pp. 24-31)

    In his well-known textbook Economics, Paul Samuelson depicts our economic world as being like the universe of Newtonian physics. Though he concedes that deciding on policies may involve value judgments—eliminating rent control may hurt individuals, even though it benefits the economy—he promises to focus on the economic science of cause-and-effect. “Positive economics describes the facts and behavior in the economy,” he insists.¹ The emphasis is his. Questions in this realm may be “easy or tough,” but they “can be resolved only by reference to facts.” In another popular text, Walter Nicholson similarly tells students: “‘Positive’ economists believe that...

  6. THREE In Search of a Model
    (pp. 32-45)

    You can’t help liking Adam Smith, and you can’t help arguing with him. His Wealth of Nations reveals an enormous intelligence struggling to incorporate incredibly thoughtful and varied observations into a theory. He made a start toward what’s now called classical political economy, or classical economics—the approach sharpened by his successor David Ricardo into a coherent model and, I will argue, muddled by Ricardo’s successor Karl Marx. Classical political economy assumes that the division of income between profits and wages is not determined by supply and demand in markets, but rather by society—social custom for Smith and Ricardo,...

  7. FOUR Economics When Society Matters
    (pp. 46-65)

    In the half-century after Adam Smith published The Wealth of Nations, the shock of industrial revolution, as well as the American and French political revolutions, struck Britain close to home. Not surprisingly, conservatism launched a counter-revolution. Just as Gothic revival sought to recreate a disappearing architecture, political conservatism sought to restore an eroding social order. The restored order would be guided not by individualism and the market but by what the Romantic poet and political Tory Samuel Taylor Coleridge called “the spirit of State.”¹ Amid revolutions and counter-revolutions, David Ricardo published The Principles of Political Economy and Taxation (1817), seeking...

  8. FIVE Chasing a Chimera
    (pp. 66-71)

    In the 1820s British pamphleteers who were later dubbed “Ricardian socialists” drew on Ricardo’s model to launch working-class critiques of capitalism.¹ Though Ricardo saw capitalists and workers as sharing progressive interests that backward landlords frustrate, the class-structure framework of his model certainly leaves room for conflict between capitalists and workers. In Labour Defended against the Claims of Capital, an effort to dissuade Parliament from passing anti-labor legislation in 1825, Thomas Hodgskin leaves no doubt that he sees such conflict: “Wages vary inversely as profits; or wages rise when profits fall, and profits rise when wages fall; and it is therefore...

  9. SIX Utopia
    (pp. 72-92)

    As the so-called Ricardian socialists roused the British working class, academic economists and their politician allies—often the same individuals—worried.¹ Even Ricardo’s close friend James Mill confided concerns about Hodgskin’s lectures in a letter: “If they were to spread they would be subversive of civilized society.”² By the 1830s, these economist-politicians were crafting proto-neoclassical ideas to extricate society from classical theory and replace it with individual-utility maximization.³

    George Poulett Scrope, a member of Parliament whose countless pamphlets earned him the nickname “Pamphlet Scrope,” asked if Ricardian political economy would reconcile workers to “the hardships of a condition of almost...

  10. SEVEN This Imperfect World
    (pp. 93-98)

    Before proceeding to a closer examination of neoclassical production theory, I want to take up the criticism perhaps most often heard—that “economics,” for short, is oblivious to real-world market imperfections. The syndicated columnist Bob Kuttner, whom I’ve quoted as attacking many economists for being “mathematical theorists … astonishingly innocent of actual economic institutions,” takes this line: “Most standard economic models assume what economists call ‘perfect competition’ in which supply, demand and price are set by pure market forces. But in the real world, governments often intervene to promote economic development, military R&D spending spills over into commercial technology and...

  11. EIGHT Entering the Realm of Production
    (pp. 99-120)

    Workers’ Day, celebrated on May 1 in countries around the world, from Britain to Kenya, China to Mexico, stands as a memorial to workers’ struggles to better their lives. The fact that it is not celebrated in the United States stands as a memorial to Americans’ success at forgetting our role in those struggles. In 1886, a small labor group in Chicago proposed a general strike for May 1 of that year, demanding an eight-hour day for the same pay—in other words, a raise.¹ Local organizers of the Knights of Labor seized on the idea, and it spread to...

  12. NINE What Caused Income Inequality?
    (pp. 121-136)

    The debate that heated up in the 1990s about why U.S. income inequality has sharply worsened since the 1970s features John Bates Clark in updated guise. As George Johnson of the University of Michigan wrote in the Journal of Economic Perspectives, the economics literature reached “virtually unanimous agreement” about the causes of this unfortunate situation: “During the 1980s relative demand increased for workers at the high end of the skill distribution and thus caused their relative wages to rise,” while it decreased for workers at the low end of the skill distribution, causing their wages to fall.¹ The information revolution...

  13. TEN Understanding an Uncertain World
    (pp. 137-164)

    Born near the end of the Victorian age and reaching adulthood in the Indian summer of the Edwardian age, neither John Maynard Keynes nor his contemporaries imagined the cataclysms awaiting them. World War I destroyed a generation of men and what had seemed a pan-European order. England fell into deep recession in the 1920s, as unemployment hardly dipped below 10 percent, and then, along with the rest of the world, sank into the Great Depression. Economic doldrums ended—as a result of World War II. The uncertainty of the human condition, deflating the confident predictions of neoclassical theory, shaped Keynes’s...

  14. ELEVEN In the Long Run
    (pp. 165-188)

    Never imagining that a single Mexican citizen had quite forgiven the United States for grabbing half that nation’s land in 1848, I was taken aback by a conversation with a Mexico City taxi driver in 2009. On a radio talk show blaring in the background, a woman was explaining how she had suffered from cosmetic surgery gone bad. The doctor had not been legally licensed to do the operation. She had gone to another doctor to have the problems fixed, but he had only made them worse. The second doctor wasn’t properly licensed either. On and on the gruesome story...

  15. TWELVE In the Short Run
    (pp. 189-214)

    All economists who espoused Keynesian theory in the 1930s saw in it a hope to combat the Depression, but they disagreed about what it meant. When it left Cambridge, England (I use that town to designate Cambridge University and its allies), it was a theory about a profoundly uncertain future, an indispensable but perilous thing called “money,” and an economy that might settle at almost any level of unemployment, good, bad, or indifferent. When it arrived in Cambridge, Massachusetts (I use that town to designate Harvard, MIT, and their allies), it was an addendum to neoclassical theory. It assumed that...

  16. THIRTEEN The Puzzle of the Golden Age of Capitalism
    (pp. 215-237)

    In the 1950s and 1960s, sometimes called the Golden Age of capitalism, the world economy grew faster and more steadily than ever before or since. As Western Europe emerged from depression and war, growth per person surged from almost nothing to 4.1 percent a year; Asia did nearly as well.¹ U.S. and Canadian growth per person rose from 1.6 percent a year over the previous two decades to 2.5 percent a year, and Latin America did better. The implications were profound. In those years factory workers bought homes and cars and sent their children to college, and the ranks of...

  17. FOURTEEN Economies in Crisis
    (pp. 238-262)

    When Truman Bewley of Yale was doing interviews during the 1990s to try to learn why wages don’t fall during recessions—a “stickiness” blamed for causing unemployment—several colleagues asked him why he was even bothering, since there wouldn’t be another recession.¹ By the late 1990s, many economists began to think the economy had entered what would they would dub the “Great Moderation,” a pronounced softening of business cycles.² In January 2000, three months before the technology-weighted NASDAQ index began its precipitous plunge, the President’s Council of Economics Advisors declared not only that the economy still appeared “young and vibrant,”...

  18. FIFTEEN Thinking about Economies
    (pp. 263-282)

    Logos was, for Plato, the perfect truth lighting our imperfect existence, the luminous utopia standing above this shadow world. Logos meant “reason”—the English term “logic” derives from it—but had powerful spiritual dimensions, too. What the King James Bible translates as “the word” was logos in the original Greek. John echoes Plato when he says, “In the beginning was logos, and logos was God, and God was logos.” Logos was the absolute underlying our uncertain world.

    However scientific many economists may profess to be, at some level the neoclassical ideal holds sway as an unerring reality comparable to Plato’s...

  19. Notes
    (pp. 283-316)
  20. References
    (pp. 317-330)
  21. Index
    (pp. 331-356)