This newsletter originally appeared in the Wall Street Journal with links added back, a defense of economics.
Nearly every week, someone writing for a major news outlet argues that economics has failed. Our models are too abstract. Our predictions are always wrong. President Trump’s recent firing of Bureau of Labor Statistics Commissioner Erika McEntarfer is the latest notable example of this anti-economics sentiment.
Let me make what appears to have become a radical argument: Simple economics is surprisingly good at making real-world predictions.
When Mr. Trump imposed steel and aluminum tariffs in 2018, the University of Chicago surveyed dozens of top economists. These weren’t partisan hacks; they included Nobel laureates and advisers to both parties. Not one of them thought that Americans would be better off because of the tariffs.
Seven years later, what have we learned? Sure enough, study after study—using customs data, retail prices and scanner data from stores—has found that American businesses and consumers bore virtually 100% of the tariff burden. The economists were right: As consumers, Americans weren’t better off.
Americans were also hurt as workers. Economists have discovered that about half of U.S. imports are used as inputs in the production of other goods. Aluminum goes into beer cans. If the price of aluminum rises, beer companies will buy fewer cans. Fewer cans mean fewer workers. Researchers found that because of the 2018 tariffs, downstream American industries—the companies that use aluminum to make everything from beer cans to car parts—lost jobs, swamping any gains to aluminum producers. Tariffs intended to protect American workers destroyed more jobs than they created. Empirical studies confirm a basic idea from economics: If you tax something, the price rises, and people use less of it.
We don’t need fancy statistics to see the predictive power of simple supply and demand. Take the recent controversy over egg prices. After egg prices roughly doubled at the start of this year, Sen. Elizabeth Warren (D., Mass.) urged the Justice Department to investigate price gouging. Alvaro Bedoya of the Federal Trade Commission called for a probe into “anticompetitive conduct” in the egg industry. Their theory mostly involved blaming Big Egg.
But the boring story proved more accurate. The supply side collapsed when avian flu killed more than 100 million birds. When supply shrinks and consumers aren’t very price-sensitive (there aren’t many other options for your morning omelette), the price will rise significantly. That’s a textbook case of supply and demand.
The power of economics comes from using supply and demand to predict what happens next. We know that a high price for eggs is an incentive to do two things: import eggs and rebuild the supply of chickens. The latter can’t happen immediately. Farmers who lose flocks wait months for new chicks to mature before they begin laying new eggs. But understanding this process provides a time frame for when prices will fall again.
Economists’ prediction of recovery through imports and restocking has come true, with egg prices falling in recent months.
No model captures everything. Sometimes, supply and demand aren’t the only factors at play. When Russia invaded Ukraine, a simple supply-and-demand model wasn’t enough to predict what would happen. But even with something as uncertain as war, the basics went a long way. To predict what would happen, economist Rüdiger Bachmann and colleagues constructed a model to map how gas flowed through Europe’s economy.
The model was intricate, but its foundations came straight from Economics 101: When prices rise, people and businesses economize. The feared catastrophe never materialized. European gas storage filled ahead of schedule, and the Continent avoided the worst outcomes. Markets didn’t erase the pain, but they softened it, as many economists had predicted.
The simple economic idea in these examples is that prices change, and those changes in turn change people’s behavior. Supply and demand give us the tools to understand those price changes. Understanding economics helps not only with prediction but also with designing policies.
When the late Nobel laureate Ronald Coase first proposed auctioning the electromagnetic spectrum to the highest bidder instead of giving it away, a member of the Federal Communications Commission asked, “Is this all a big joke?” Coase prevailed. Since then, U.S. spectrum auctions have generated more than $200 billion while accelerating wireless innovation.
More recently, New York City’s congestion-pricing scheme confirmed that pricing scarce road space reduces traffic and improves commute speeds—as economics predicts.
Rather than abandoning economics because it’s politically inconvenient, we should celebrate its remarkable ability to explain how the world works. There’s always more to learn. But the basics aren’t broken; they’re underappreciated.
Another needed post! I'll note some older writings that make similar points--which emphasizes that economists need to again and again re-emphasize the usefulness of our approach. Michael Salemi wrote--in 1998!-- about how economists should and could do a better job of educating students ("How economists can improve economic education," The Region, Federal Reserve Bank of Minneapolis, vol. 12(Dec), pages 34-37). His opening paragraphs were about how a journalist wrote only about the unfairness of "price gouging" in the Triangle area of NC during a Special Olympics. The journalist wrote: "Don't bother telling me that raising prices is business as usual for the hotel trade. Of course it is, but that doesn't make it go down easier. It was that mind set—supply and demand—that jacked up the prices for everything from ice to chain saws to generators after Hurricane Fran came through. Remember how it felt to be gouged. .."
Salemi emphasized that those higher prices increased the supply of places for visitors to stay--home rentals, shuttle bus/hotel packages from farther away, etc. He concluded: " Economists, for the most part, believe that the price system allocates hotel rooms and other scarce resources far more efficiently and often more fairly than government bureaus or appeals to good citizenship. They place great stock in the fact that allocation by price leaves each individual free to "pay and stay" or "stay away." I would add: higher prices for chain saws and ice brought forth a veritable caravan of supplies from neighboring areas not hit by the alluded-to hurricane (such as from my home town of Lynchburg VA).
I would say that "basic economics" for our type of economy rests mostly on two pillars: An assumption that individuals rationally pursue their own self-interest, and an assumption that in pursuit of their self-interest, people will, in Adam Smith's words, "truck, barter and exchange one thing for another.."
The second assumption embodies an observation that people actually trade one thing for another. It must be, then, that people's desires can be satisfied with varying quantities of different goods, and that varying quantities of goods can be produced, i.e, that there exist substitution possibilities within the economy.
Related to your point about gas in Europe, a great book documenting substitution possibilities is: Olson, Mancur Jr. 1963, “The Economics of the Wartime Shortage,” Durham, NC: Duke University Press. Olson documents the ability in the World Wars, during which both Great Britain and Germany faced serious disruptions to normal supplies of good and services, of the economies of Great Britain and Germany to produce everything from oil to gun barrels without any
of once-thought "essential inputs."
Another great article is "Economists and Public Policy: (R Coase 1975, in Daniel B. Klein,
(ed.),What Do Economists Contribute?, London, UK: McMillan. ). Coase points out numerous examples of public policy consequences easily foreseen by economists, based only on their appreciation of self-interested behavior and substitution possibilities, but unforeseen by the policy makers themselves.
I wrote about this at greater length (20 years ago! never published) in what I called "The Economist's Perspective," https://my.vanderbilt.edu/robertdriskill/international-economics-various-and-sundry-entrees/. Lots more examples.
Keep up the good work!
Is economics really a science, or is it no more scientific than tarot cards?
Let me take a nice, clean economic hypothesis I would like to test: do tax cuts for 'the rich' help or hurt the economy? Let's not test this hypothesis with a small sample set such as giving $1000 to a rich person in some tiny country and see if the economy improves. No, let's take the biggest and best documented economy in the history of mankind: the US economy. And let's not give a little tax break to a few rich people and see what happens, no, let's give tax cuts of over a trillion dollars - a fair sized fraction of the entire revenue of the largest economy on earth, and let's do it for a sustained period of ten years. In fact, let's do this test over and over, under different administrations (Reagan, Bush Jr., Trump), and then analyze the data.
Apparently the result of something as huge as multi-year, very expensive tax cuts for the rich is still subject to your political persuasion. I'm not even asking for a quantifiable number such as 'what percentage improvement in the GDP of the US resulted from the tax cuts?' I simply want a very basic yes/no answer: did it help, or did it hurt the economy? If I work for the Weekly Standard, or AEI, or the Wall Street Journal, I can find teams of economists who will tell me that tax cuts for the rich are the single greatest way to improve the economy. But if I'm Paul Krugman, or I work for the Progressive Caucus I can find teams of economists who will tell me the exact opposite.
That is not a science. That is no more scientific than tarot cards, where I can call in one 'psychic' who will tell me that a given layout of cards say my life is going to be great; while another 'psychic' will look at the very same cards and tell me I'm doomed.
The usual economists' statement that 'we don't have enough data to determine a definitive result' just doesn't wash in this case. If you take a multi-trillion dollar economy and give it a stimulus of trillion dollar tax cuts for ten years you'd better have enough data to definitively say, at the least, whether it helped or hurt the economy. If you can't answer that, then economics is NOT a science.
So what's the story? Is economics a science, or not? If it is, then why are the results of a test so dependent on the political philosophy of the person analyzing the data?