Six Ways Existing Economic Models Are Killing the Economy

Americans have been hammered for decades with an economic message that amounts to this: When wealthy people like me gain even more wealth through tax cuts, deregulation, and policies that keep wages low, that leads to economic growth and benefits for everyone else in the economy. And equally, that investing in you, raising your wages, forgiving your debt, or helping your family would be bad—for you! This is the trickle-down way of thinking about economic cause and effect, and there can be no doubt that it has substantially contributed to the greatest upward transfer of wealth in the history of the world.

You would think that trying to sell such a disastrous outcome for the broad mass of citizens would be incredibly unpopular. No politician would outright say they want to shrink the middle class, make it harder to get by, or reward hard work less. No politician would outright say that rich people should get richer, while everyone else struggles to make a decent life.

But this message has been hidden under the confusing, technical-sounding, and often impenetrable language of economics. Many academic economists do important work trying to understand and improve the world. But most citizens’ experience of economics comes from hearing a story—a narrative that rationalizes who gets what and why. The people who benefit from trickle-down policy the most have deployed economists to work their magic to tell this story, and explain why there is no alternative to its scientific certitude.

One of the trickle-down economists’ main persuasive tools is the economic model, used to predict and assess the outcome of economic policies and other major economic developments. These existing models exert such great force on the political debate in large part because their predictions are treated by politicians and reporters as neutral, technocratic reality—simple economic facts, produced by experts, that reflect our best understanding of economic cause and effect.

What few understand is that these economic models do not, and never can, fully reflect the extraordinary complexity of human markets. Rather, the point is to create useful abstractions to provide decision-makers with a sense of the budgetary and economic impacts of a given policy proposal. More disturbingly, the assumptions baked into these models completely define what the models predict. If the assumptions are wrong, the models will be wrong too.

And these models are deeply and consistently wrong.

But “wrong” doesn’t capture the true problem. The deeper problem is that these models are all wrong in the very same way, and in the same direction. They are wrong in a way that massively benefits the rich, and massively disadvantages everyone and everything else.

The headlines derived from these models consistently reflect this bias: “Raising Minimum Wage to $15 Would Cost 1.4 Million Jobs, CBO Says,” or “Biden Corporate Tax Hike Could Shrink Economy, Slash U.S. Jobs, Study Shows.”

Models serve less as scientific analysis and more as incantations from the cult of neoliberalism, and if politicians and journalists continue to accept them with the same naïve credulity that they always have, they will hamper the astounding middle-out economic progress that the Biden administration has made toward rebuilding a more equitable, prosperous economy for all.

The problem is that few people take the time to explain what these faulty assumptions are, why they all promote the worldview of the rich and powerful, and why they shouldn’t be treated as science but as a trickle-down fantasyland.

Here are six of the assumptions built into most economic models that are among the most pernicious:

1. Models assume that public investments will “crowd out” private investment, and are by definition less productive than private investments.

What happens to the economy if the federal government spends $1 billion? The normal person would say that it depends what they spend it on, and how the policy is designed.

Not so in most economic models. They assume that any government spending will have less of a return than whatever private businesses spend their money on. Always.

But that’s not all. They say that government spending even comes with a penalty: It automatically causes businesses to spend less, leading to lower overall investment. Always.

Essentially, models assume that every increase in public investment is canceled out by the combination of lower returns and reduction in private investment. Taking this assumption to its logical extreme, there’s almost nothing government should ever invest in. It’s a good thing Eisenhower took office before the neoliberal style of thinking came to dominate Washington, or instead of interstate highways we’d still have dirt roads.

These assumptions aren’t even well hidden in models but baked directly into the math. As economist Mark Paul has noted, the Congressional Budget Office model assumes that all public investments are exactly half as productive as private investments. Public investments return 5 percent annually, while the same amount of private investment returns 10 percent.

The first indication that something is amiss here can be sensed in all these round numbers—a flat declaration that public spending is 50 percent less good than private spending. Precisely 50 percent. Every time. Obviously, this is not the result of rigorous data analysis. It’s simply recapitulating the old trickle-down myth that government is by definition wasteful, while private investment is always maximized for the greatest efficiency and return.

And it’s not even a little bit true. Think about health care. The U.S. government invests billions in basic research each year and is responsible for funding an incredible range of innovations, from mRNA vaccine technology to new antibiotics. Everyone benefits from this publicly funded research, sparking further innovations and benefits—much of it carried out by the private sector.

Then consider how Big Pharma invests its profits: with huge marketing budgets, predatory patent enforcement, $577 billion in stock buybacks over five years (more than was spent on research and development), and a 14 percent increase in executive compensation. It’s a bonanza for those corporations, but it’s the opposite of efficiency—except in the make-believe world constructed by economic models.

The point isn’t that government spending always returns more than private spending, just that the flat assumption that it is always worse by 50 percent simply doesn’t map to reality. We should assess policy by what it proposes to do, not who proposes to do it.

by Nick Hanauer, The American Prospect | Read more:
Image: KYODO
[ed. See also: How Policymakers Fight a Losing Battle With Models (TAP).]