The Most Dangerous Fallacies of Fact and Theory

Things I think about while driving: 

What is the fallacy of fact and fallacy of theory that the reasonably well-informed layperson believes about economics that are most in need of correction?  That is, which ones do the most damage?

Here's are my nominees:

For "Fallacy of Fact":  that the economic well-being of the average American is on the decline.

For "Fallacy of Theory":  that consumption (rather than savings/investment) is the source of economic growth.

Both of these are utterly wrong and believing either has a tendency to lead to policies that make matters worse, and bring out the very thing they are trying to avoid (i.e., worsening the economic well-being of the average American and destroying economic growth).

And one note about the irony of the consumptionist view:  I have often found that my left-wing colleagues think that *I* (and other free market types) believe that consumption is the key to economic growth (if not personal Nirvana).  When I tell them that not only do I not believe that and that it's bad economics, but that the most prominent expositor of that view was a strong critic of free markets, namely Keynes, they are left utterly unable to respond.  It's kinda fun, actually.

Your nominees for the most dangerous fallacies of fact and theory?

Comments

[William Freeland]

I work in public policy in Michigan at the Mackinac Center and there are two major sophisms in this state that I tend to notice on a daily basis:

First, that jobs can be created, in heroic fashion, with targeted tax credits absent any opportunity cost (savings, goods in the present, investment in firms that provided goods that are of greater demand, etc.) for the funds distributed ("what was the silly tax payer going to do with the money anyways... certainly not create economic growth like our board of central planers can...WE know what is better for them"). Not only this but the lack of consideration that if business are creating jobs based on tax cuts in their real tax burden (also known as a targeted tax credits), perhaps what is need for firms & entrepreneurs to create jobs is lower nominal tax burdens (among other liberalizing reforms).

The second is that the key to growth & revitalization of communities is to simply draw in "the creative class" through enormous urban planning efforts and subsidies to the arts or other pet projects that are directed at drawing in this mysterious "creative class."

[Art Carden]

Great question. I'm going to cross-post this at Division of Labour.

Fallacy of Fact: All human action is zero-sum.

Fallacy of Theory: greed causes prices.

The first leads to the conclusion that someone "loses" in trade and therefore sets the stage for policies based on the misguided view that commerce is combat.

The second leads to price controls and other destructive interventions, but I think the real danger comes from how it causes us to view one another. The idea that greed causes prices usually leads to the conclusion that production and allocation decisions should be made by a virtuous surrogate. In other words, this is part of a worldview holding that there is an actionable moral inequality whereby the good, non-greedy people get to use the bad, greedy people as a means to their ends--namely, their version of utopia.

[liberty]

All of these are good contenders. I will choose mine more on the basis of not expecting others here to choose them, rather than because I necessarily think they are strictly the most important.

Fallacy of Fact: Moderation, not theory, is most important in policy.

Fallacy of Theory: Static analysis can offer insight about dynamic consequences; aggregative analysis can offer insight about processes.

The first leads many people to the conclusion that it is wiser to go with the compromise, and that the person offering a compromise is also wiser. This is most obviously false when we look back on history and see the moderates of communist states, and in other periods when those who were moderate at the time represented position we would see as heinous today.

The second fallacy (or set of fallacies) are simultaneously agreed with and ignored by some, and disagreed with outright by others, all across the spectrum. Few actually make the case about them as serious theoretical flaws in most economic research; but while the two types of models have some valid use, they are most often used in the areas indicated, with disastrous and sometimes absurd theoretical consequences.

[Don Lloyd]

1. Economic transactions involve and imply equal values.

2. Prices are values.

Regards, Don

[Unit]

Fallacy of Fact: Imports are a cost, Exports a benefit.

Fallacy of Theory: Static bias. Things should stay the same, cheap "sustainability" talk, markets are unstable, the environment is unstable, and this requires engineeristic government intervention to stabilize them.

[HH]

Fact: Oil company profits are out of hang.

Theory: Trade deficits are bad.

On the fact, Mark Perry has pretty well shown that oil companies pay ridiculous taxes, and their profit margin over the last three decades is about the same as that of retail clothing. But no one wants windfall taxes against the gap.

On theory, it's pretty obvious. Even educated people don't understand that getting useful stuff for money that eventually has to be spend in the US [the only use for US dollars, in fact] is not a bad deal.

[Sandy Ikeda]

FALLACY OF FACT: That the Great Depression was a market failure. (Close second: That putting on a spectacular Olympics reflects a country's greatness.)

FALLACY OF THEORY: That value is objective. (Close second: That all social order is the result of design.)

[Steve Miller]

Fallacy of fact: Steve nailed it, but a twist might be the notion that people must now "work harder than ever" to maintain their standard of living.

Fallacy of theory: A healthy economy saves jobs (as opposed to conserving labor, i.e. producing more with less).

[Matt C.]

Fallacy of Fact: That stadium projects bring in increased revenue to the surrounding areas.

Fallacy of Theory (this comes from the horrendous Obama commercial): That those who do something (IE grow corn, etc.) can also do something else with little to no costs to everyone else. The idea of, "hey while you are out plowing corn, why don't you put up a wind turbine too." Not understanding TANSTAAFL.

[dtt]

Fallacy of Fact-Subsidies make products cheaper for consumers

Close second-Increased tax rates generate more tax revenue (see Maryland Cigarette Tax for recent example).

Fallacy of Theory-Central Planning will make us all better off and that Politicians have our best interests in mind.

[Wes Winham]

Art Carden hit on it, but the specific incarnations I run into:
Fallacy of Fact- China's and India's growth is a threat to the success of the American economy.

Fallacy of Theory- Government doesn't create monopolies, it busts them.

Looking back through history, it's pretty plain to see that the only real monopolies that have existed were there in large part to government manipulation of the market (govt land grants to telecoms for example). This causes great harm when a politician sees it as his right to hassle someone like Sirius and XM radio.

[Bob Lawson]

Fallacy of Fact: That consumption can take place before production.

Fallacy of Theory: That jobs are goods.

[Roger Koppl]

I think some of those "facts" are really theories.

The following link to an article by two Dallas Fed economists backs up Steve's optimism:

http://www.american.com/archive/2008/july-august-magazine-contents/how-are-we-doing

Don Boudreaux has blogged on the difference between today's Sears catalog and that of 1975.

Personally, I put more positive weight on moderation than "liberty." In this regard I follow a founder of liberalism, David Hume, who warned, “a regard to liberty, though a laudable passion, ought commonly to be subordinate to a reverence for established government.” If the economy is a complex adaptive system, we had better not over estimate the policy guidance theory can provide.

[liberty]

Roger,

Putting theory before moderation does not mean that one cannot also value moderation in application of said theory. I disagree with Hume, but I would also reassert the main point: moderation (relative to others at that time period) implementing a policy based on bad theory can do much harm; extreme implementation of policies based on good theory is rarely going to cause harm, and always going to be good in the long run.

Moderation is only useful when it isn't clear whether a theory is right or wrong. Some theories such as those posted above, are clearly right or wrong, there should be no dispute. This does not mean that we can guide active policy of intervention; I would argue that no theory can yet support such interventions.

But, when you boil it down, the problem with communism was not that extremists were in charge, it is their theory. Their theory caused the problems, and those problems occurred when moderates took power - Stalin began as a moderate. Bukharin began as an extremist - when his understanding of theory changed, he became a moderate. When extremists have good theories - like American revolutionaries or abolitionists or anti-communist democratic revolutionaries like Solidarity - it is not bad. In fact, it is the key to change; often vital change cannot occur without the extremists. Reform - moderation - could not end communism.

Or, as Barry Goldwater said:

"I would remind you that extremism in the defense of liberty is no vice! And let me remind you also that moderation in the pursuit of justice is no virtue."

[Renato Drumond]

A fallacy of Fact that is common among well-educated people: The rich get richer and the poor get poorer.
_________________________________________________

Fallacy of Theory: Firms can fix wages or prices without suffering any consequences.

[Roger Koppl]

Liberty,

I think Hume had a good point when he said, to "try experiments merely upon the credit of supposed argument and philosophy, can never be the part of a wise magistrate." The Bolsheviks were big on such experiments and look what happened.

You say, "extreme implementation of policies based on good theory is rarely going to cause harm, and always going to be good in the long run." I suppose so, since one can always neutralize counterexamples by saying the theory was not good enough. But how do you know you're theory is good enough to ensure no disasters follow from its application?

At the very beginning of systematic liberal theory, the beginning with Hume and Smith, we were quite conscious of our epistemic limits. Lately, we have been less humble, I'm afraid.

[liberty]

Note that Marx admired and based much of his work on Hume :)

--

As to your point: we still need to recognize that it is good theory, and not moderation, that has solved the world's problems where they have been solved. Try to end communism with moderation: it cannot work. Compare Poland's transition with Russia's. Try to end Hitler's concentration camps with moderation, you could not. It took an extreme act of war.

How did we know that the theory of markets was better than the theory of communism? Mises would say it is axiomatic and did not require an experiment with socialism.

Just because it is difficult to understand theory, does not mean it is best to prize moderation over correct theory. Why be an economist if you think otherwise?

[DPrychitko]

Fallacy of theory: "We shouldn't listen to economists."

Fallacy of fact: "We should listen to economists."

[Roger Koppl]

Liberty says, "it is good theory, and not moderation, that has solved the world's problems where they have been solved."

Adam Ferguson said, "Every step and every movement of the multitude, even in what are termed enlightened ages, are made with equal blindness to the future; and nations stumble upon establishments, which are indeed the result of human action, but not the execution of any human design."

I think Ferguson had a point. I'm not saying we should not act to end manifest evils. (I'm trying to end the evil of wrongful conviction, after all.) I'm just saying that nation building is tough work, as Chris Coyne tells us, and, in general, reform tends to be a dangerous business to be approached with Hayekian humility.

[Rafe Champion]

Reform should be done in the spirit of the scientific investigator who first of all does some historical study and a literature review to see if the experiment has been done before (and what happened). Then the experiment is done to test the theory (the old sense of "proving"), by checking to see if the result is what the theory predicts or something else. People like plumbers and motor mechanics must wonder why you have to go to university to learn that approach to practical problem-solving.

[Rafe Champion]

On the belief that the well-being of the average American is on the slide, here is a summary of an old article. The summary originally appeared in the local CIS journal "Policy". An extract from the summary: "according to the conventional wisdom American families have been struggling to maintain living standards in recent decades with a decline of 9% in real hourly earnings from 1975 to the present. Inserting the alternative CPI figures into the equation yields a 35% increase instead of the 9% decrease. Similarly, the increase in median family income over two decades shifts from 2% to 19%."

Irwin M Stelzer, '"Lies, Damned Lies, and Statistics" Revisited', The Weekly Standard, December 23, 1996.

Stelzer claimes that some key economic indicators in the US have been miscalculated by various official agencies. Consequently the accepted picture of economic performance is drastically wrong.

Consider the CPI. A panel of experts led by Michael Boskin estimates that for two decades the real rate of inflation has been 1.3% per annum below the official figure. This has massive implications for the payout in pensions (indexed to the CPI) and the perception of real wages. If pensions and other entitlements could be linked to the lower CPI, the savings in State spending would amount to $1 trillion over the next decade. As for earning power, according to the conventional wisdom American families have been struggling to maintain living standards in recent decades with a decline of 9% in real hourly earnings from 1975 to the present. Inserting the alternative CPI figures into the equation yields a 35% increase instead of the 9% decrease. Similarly, the increase in median family income over two decades shifts from 2% to 19%.

The statistics on international trade could be be equally misleading, a serious matter in view of the agony and the zenophobia generated by the supposed $100 billion trade deficit. Some 40% of exports of servics may be missing from the official figures, amounting to $85 billion. Another $60 billion is "lost" through defective accounting practices in Customs. Result of the correction: A trade surplus in the order of $40 billion!

Yet another soft spot concerns the mismatch between reported incomes and spending patterns. Many people, classified as poor and receiving benefits, spend a great deal more more than the annual income they report. Among the millions who are supposed to require State assistance, some 75% own a car and over 40% own their own homes.

[Mario Rizzo]

My nomination is a tautology masquerading as a theory. This is the Misesian idea that human action is always rational. It leads to the mistake that people necessarily always know what they are doing and "behave" in their own best interests. Welfare claims cannot be a tautology even if the positive research program embodies one.

[max]

Actually, here in Germany, it is the other-way round. People of the free trade and free market class usually argue pro-savings, whereby modern leftist/socialist economists pledge their allegiance to the idea tht consumption translates into growth.
So, that is the reason German institutes hit the alarm bell when the consumption halts, because they think consumption is more important than saving.

[Hello]

Very good question! (But it is a bit difficult sometimes to disentangle fact from theory, since a theory, for instance a causal relation, is also a fact.)

Fallacy of fact: the development of China and India is impoverishing us (i.e. the West), and will impoverish us much more in the future.

Fallacy of theory: in a free capitalist system, capitalists become rich through the exploitation of workers, i.e. by stealing riches produced by workers.

[peter phillips]

For his most dangerous fallacy, Prof Rizzo nominates "the Misesian idea that human action is always rational. It leads to the mistake that people necessarily always know what they are doing and behave in their own best interests."

But that isn't what Mises meant by "rational." He didn't mean intelligently, or even sanely, even by any sane man's standards. He simply meant purposively, that men apply means to ends, however insane the ends of inappropriate the means.

[Joseph K]

Lots of good ones have already been taken. But I think I can come up with two good ones

Fallacy of theory: The economy needs to be fine tuned to work well.

Fallacy of fact: The poor would be worse off without government help (as opposed to the opposite, that they would be better off)

The first you hear about all the time with the type of metaphors journalists and politicians use, of "tinkering" with the economy or "jump starting" the economy as if it was a car that won't run without government-grade gasoline being supplied every step of the way. Unless, of course you mean by "tinkering" reducing taxes and regulation and tariffs, which I would call letting the car fix itself instead of trying to fix it.

The second definitely ruins the lives of many poor and puts them in a cross-generational cycle of dependence from which few escape. And even some of those who escape, failing to understand the proper, will propagate ideas of entitlement and victimization and in general will promote policies aimed at "fixing" the problem instead of removing the barriers that prevent people from solving their problems themselves.

[Aaron]

How about that helping the little guy always means helping big brother?

[Ike]

Fallacy of Fact: Raising tax rates actually raises revenues.

Fallacy of Theory: Equality of Outcome and Comparison of Outcome is a proper measure of fairness and happiness.