The "Laws" of Economics

Economics has few “laws”. The most notable is the Law of Demand, which simply states that there is an inverse relationship between the price of a thing and how many units people are willing to buy (i.e., when the price goes down (up), people buy more (less)). The Law of Demand is basically just the culmination of the most basic observations of human behavior; specifically, The Basics with which I started this blog.

There are a few other things that sometimes get labelled as “laws” in economics textbooks. The “law of supply” only applies to things still actively produced, for which the necessary inputs are available; but in general, the more people are willing to pay for something, the more of it producers will try to produce. The “law of diminishing returns”–typically applied in the context of production–assumes there is at least one fixed input that constrains the marginal productivity of the rest. It’s more a rule of thumb than a “law.” But it is also analogous to Rule #3 in The Basics: More more is less better.

Whether we consider them “laws” or not, one thing is for certain: when we ignore these basic principles, we do so at our own peril. And that brings me to the motivation for this post; namely a recent blog post by “The Edgy Optimist” (aka Zachary Karabell) at Reuters.com titled “The ‘laws of economics’ don’t exist.”

The Edgy Optimist is pretty pessimistic about the appeal to “laws of economics” in public policy debates, whether they be about macroeconomics, the war on drugs, or immigration. Karabell writes:

Increasingly, our debates about – and our solutions to – pressing issues such as immigration, budgets and debt are framed in the context of all-powerful economic laws that dictate what is and is not possible. There’s just one slight problem: There are no laws of economics.

In particular, Karabell seems blinded by a pretty narrow understanding (or gross misunderstanding) of just what those economic laws are. (Hint: they boil down to The Basics). His entire argument revolves around two points; one of which is overblown and the other seems to ignore all of human history.

First, he appeals to behavioral economics as “proof” that there are no laws of economics because, “So much of economics depends on the theory that we are all ‘rational actors.’” He then goes on to describe a list of examples of people, institutions and governments not making the “right” decisions because they are not rational. In every case, his understanding of those decisions and how the “laws of economics” plays out in them is pretty short-sighted–or naive (And which kind of begs the question of how Karabell knows what actions should be taken as opposed to those we observe, but I’m not chasing that rabbit down that hole.)

However, as I explain in The Basics, hyper-rationality is not required to explain or predict how most people will behave in any given circumstance. People aren’t stupid. They generally behave in what they perceive to be their own best interest (however they define that). People aren’t stupid; but they may be myopic. People aren’t stupid, but they don’t have perfect foresight. And anyone who believes individual decision makers in Washington, D.C., are more interested in the public good than their own private interests–much less having a shared understanding of what “the public good” means-is pretty naive.

The bigger failing of Karabell’s rant comes when he writes

Economics is based on a limited amount of information compiled over the past hundred or so years. … In short, even if there are laws of economics, we haven’t been observing them for long enough to know what they actually are. And given the vagaries of human behavior and the mercurial nature of states, people and institutions, the notion that there’s some grand mechanistic, master system that explains all and predicts everything is at best a comforting fiction and at worst a straitjacket that precludes creativity, forestalls innovation and destroys dynamism.

The most fundamental “law” of economics is simply that people prefer more to less, and that they act in ways that attempt to gain themselves more of what they value more. Put another way, people generally respond to incentives. This is not some revolutionary insight from the past 100 years–nor even the past 200+ years since Adam Smith‘s  insights that sparked “modern” economic thought. Throughout recorded human history, people have predictably responded to incentives. The premise of human evolution is largely based on the idea that the species adapted physically and–more importantly here–socially in response to survival incentives. Tribes have migrated; kingdoms expanded, wars been waged, regions of the world explored and conquered–all because people prefer more to less. The “laws of economics” are really nothing more than the most fundamental understanding of human behavior since the dawn of humankind; something not discovered by modern economic theorists, but revealed in human nature and simply captured in economic jargon.

Granted, there are many who take advantage of that jargon (and the general lack of economic understanding so pervasive in public circles–and especially political circles) to throw around economic arguments willy-nilly in order to bolster their arguments. Some even regularly write them up in major newspapers and blogs. But when considering the implications of policy proposals, understanding the incentives those policies would create is critical to evaluating their potential effects. There have been few “unintended consequences” of legislation that were not reasonably foreseeable by appealing to the basic rules of economics, whether you call them “laws” or not.

Which begs a different question for Karabell: If we should not evaluate policy implications by an objective, economic understanding of how people respond to incentives, then by what should we evaluate such policies?