Common Economic Fallacies

A List By Lawrence W. Reed of FEE.

  1. Fallacy Of Goodwill (people will always vote for taking from others for themselves)
  2. Fallacy Of Measurement

    The first fact to understand about statistics surrounding economics is the different ways people can skew the results. People use whatever twisted statistics they think make their political point. If you want the economy to look bad use household income rather than personal income.

    This is a point Thomas Sowell makes: “household or family income can remain virtually unchanged for decades while per capita income is going up by very large amounts. The number of people per household and per family is declining.”

    Another tool for someone trying to make the situation look bad is to talk about the income gap. Saying that the gap between the rich and the poor is increasing makes it seem like the rich are getting richer, while the poor are getting poorer, or that the rich are taking from the poor. While that gap is increasing, it is mainly because it is so much easier for the wealthy to increase their incomes by large amounts. Yes, the rich are getting richer, but the poor are getting richer as well.

    This point is made brilliantly by Michael Medved in his book “The 5 Big Lies About American Business.” To paraphrase Medved, if one citizen who makes $200,000 per year shows an increase of 10 percent, he now makes $220,000. If another citizen who makes $20,000 per year has an increase of 20 percent he now makes $24,000 per year. The second person saw an increase twice as large as the first person yet the gap increased from $180,000 to $196,000. “The gap” is how you make a situation which was good for everyone look bad. There are more accurate ways to illustrate how the poor are doing.

  3. Not Accounting For Hidden Costs or HIdden Transfers.

    This is somewhat similar to “the broken window fallacy” introduced by Frédéric Bastiat. Bastiat tells a parable where a shopkeeper’s son breaks a window in the shop. As a condolence people say that at least the son has fueled a job for the man who will repair the window. While the son did circulate money, and boost one industry, the shopkeeper would have used his money to employ other labor if the window had not been broken.

    When the government spends money on something, part of the cost is not only the dollars spent, but the things that the money would have been spent on otherwise. Amazingly what the money would have been spent on otherwise is very often the same thing the government is trying to create. So politicians may have done nothing at all when all is said and done, we may even be worse off, but they can take credit for what was created.

    The current best example of this is the stimulus. Supporters of the stimulus can say that it created jobs, but because we can only speculate on what might have happened without the stimulus, the true costs remain hidden.

    Lawrence Lindsey argues convincingly that it was simply a waste of money. One of his best lines is “Since the beginning of the recession, the number of unemployed has increased by more than 8 million people. For $800 billion, we could have handed every one of these people a check for $100,000.” Not only is the cost over $800 billion, but it may very well be the case that more jobs would have been created if that money remained in the hands of the private sector. For those of us who think government is by nature horribly inefficient, that is a reasonable conclusion.

    Spending money for policies like the stimulus is usually a beneficial political move (although when you get up to $800 billion your chances get a lot worse). First and foremost, you can say you “did something about it.” That always counts for a lot in politics (this is another point made by Sowell). You don’t want to be caught sitting on your hands, not wasting money. Second, you can say that it would have been far worse if you didn’t do something, since all we can do is speculate about the alternative. Third, you can point to a concrete example of progress you have made. You were part of the effort that created hundreds of thousands of jobs. It doesn’t matter if its cost was so high, that it may have also erased hundreds of thousands of jobs.

    Generally speaking the government is so inefficient that when it says it created something, most likely it destroyed far more in order to create it. In the case of the stimulus we have reason to be especially skeptical because we know that the more money that is left in the private sector, the more likely it will be able to create jobs.

  4. Correlation does not mean causation.

    I hesitate to include this one on the list because the phrase has become overused in some circles. It can be very easy to accuse someone of this and then not have to deal with their argument, even though there is good reason to believe causation exists. Inappropriately accusing people of this fallacy is especially easy when discussing economics. Economics is like a science in which you can’t account for all of the variables. Politicians can take credit, or blame others, for things without knowing the real cause.

    One example of this fallacy is David Johnston’s assessment of the Bush tax cuts. I have no problem when he says the Bush tax cuts didn’t lead to the prosperity Bush promised, although I don’t blame Bush for that, and nearly every politician exaggerates when they are trying to sell something. The main problem I have is when he says “the data show overwhelmingly that the Republican-sponsored tax cuts damaged our nation.” This is a case of the fallacy because most of his evidence that the nation has been damaged is a decrease in average income (his case that less revenue was collected is legitimate). It very well could be the case that the tax cuts made the average income higher than what it would have been.

    The average income could have decreased for reasons other than the Bush’s tax cuts. I lean toward that conclusion because there is no conceivable way that tax cuts can cause a decrease in average income. I would be more than happy to retract my statement if someone could please tell me how this happens.
    I first became aware of this fallacy while I was in college. I was discussing minimum wage with a sociology professor. There are better arguments for raising the minimum wage, but the one she was giving me was that raising it often decreased the unemployment rate. I was baffled that someone could say this because, again, there is no conceivable way that increasing minimum wage could cause a decrease in unemployment. She pointed to certain years when minimum wage increased, and unemployment decreased. It escaped her that minimum wage could have destroyed jobs in one place while a new business may have started up in another, showing a net increase in employment.

    With both the professor and Johnston, they claim that they are just looking at the facts, and those of us with even a little understanding of what causes what in economics are blindly following an ideology with no connection to reality. All this tells me is that they have no interest in how economics actually works. They have a political position they want to advance and they hope they can find “facts” to support it, even if it doesn’t make any sense.

  5. The fallacy of collective terms. Examples of collective terms are “society,” “community,” “nation,” “class,” and “us.” The important thing to remember is that they are abstractions, figments of the imagination, not living, breathing, thinking, and acting entities. The fallacy involved here is presuming that a collective is, in fact, a living, breathing, thinking, and acting entity.

    The good economist recognizes that the only living, breathing, thinking, and acting entity is the individual.The source of all human action is the individual. Others may acquiesce in one’s action or even participate, but everything which occurs as a consequence can be traced to particular, identifiable individuals.

    Consider this: could there even be an abstraction called “society” if all individuals disappeared? Obviously not. A collective term, in other words, has no existence in reality independent of the specific persons which comprise it.

    It is absolutely essential to determine origins and responsibility and even cause and effect that economists avoid the fallacy of collective terms. One who does not will bog down in horrendous generalizations. He will assign credit or blame to non-existent entities. He will ignore the very real actions (individual actions) going on in the dynamic world around him. He may even speak of “the economy” almost as if it were a big man who plays tennis and eats corn flakes for breakfast.

  6. The fallacy of composition. This error also involves individuals. It holds that what is true for one individual will be true for all others.

    The example has often been given of one who stands up during a football game. True, he will be able to see better, but if everyone else stands up too, the view of many individual spectators will probably worsen.

    A counterfeiter who prints a million dollars will certainly benefit himself (if he doesn’t get caught) but if we all become counterfeiters and each print a million dollars, a quite different effect is rather obvious.

    Many an economics textbook speaks of the farmer who is better off because he has a bumper crop but may not be better off if every farmer has one. This suggests a widespread recognition of the fallacy of composition, yet it is a fact that the error still abounds in many places.

    The good economist neither sees the trees and ignores the forest nor sees the forest and ignores the trees; he is conscious of the entire “picture.”

  7. The fallacy of “money is wealth.” The mercantilists of the 1600s raised this error to the pinnacle of national policy. Always bent upon heaping up hoards of gold and silver, they made war on their neighbors and looted their treasures. If England was richer than France, it was, according to the mercantilists, because England had more precious metals in its possession, which usually meant in the king’s coffers.

    It was Adam Smith, in The Wealth of Nations, who exploded this silly notion. A people are prosperous to the extent they possess goods and services, not money, Smith declared. All the money in the world—paper or metallic—will still leave one starving if goods and services are not available.

    The “money is wealth” error is the affliction of the currency crank. From John Law to John Maynard Keynes, great populations have hyperinflated themselves to ruin in pursuit of this illusion. Even today we hear cries of “we need more money” as the government’s monetary authorities crank it out at double digit rates.

    The good economist will recognize that money creation is no short-cut to wealth. Only the production of valued goods and services in a market which reflects the consumer’s wishes can relieve poverty and promote prosperity.

  8. The fallacy of production for its own sake. Although production is essential to consumption, let’s not put the proverbial cart before the horse. We produce in order that we may consume, not the other way around.

    I enjoy writing and teaching but I enjoy sunning in Acapulco even more. I have labored to produce this piece and to teach its principles in my classes instead of going to Acapulco first because I know that’s the only way I’ll ever get out of Michigan. Writing and teaching are the means; sunning in Acapulco is theend.

    A free economy is a dynamic economy. It is the site of what the economist Joseph Schumpeter called “creative destruction.” New ideas supplant old ideas, new products and methods replace old products and methods, and whole new industries render obsolete old industries.

    This occurs because production must constantly change shape to conform with the changing shape of consumer demand. As Henry Hazlitt has written, “it is just as necessary to the health of a dynamic economy that dying industries be allowed to die as that growing industries be allowed to grow.”

    A bad economist who falls prey to this ancient fallacy is like the fabled pharaoh who thought pyramid-building was healthy in and of itself; or the politician who promotes leaf-raking where there are no leaves to be raked, just to keep people “busy.”

    It seems that whenever an industry gets in trouble, some people cry that it must be preserved “at all costs.” They would pour millions or billions of dollars in subsidies on the industry to prevent the market’s verdict from being heard. The bad economist will join the chorus and ignore the deleterious impact that would befall the consumer.

    The good economist, on the other hand, does not confuse ends with means. He understands that production is important only because consumption is even more so.

    Want an example of this fallacy at work? How about the many proposals to prevent consumers from buying Japanese autos in order to “protect” the American auto industry from competition?

  9. The fallacy of the “free lunch.” The Garden of Eden is a thing of the distant past yet some people (yes, even some economists) occasionally think and act as if economic goods can come with no cost attached. Milton Friedman is one economist who has warned repeatedly, however, that “there is no such thing as a free lunch!”

    Every “something for nothing” scheme and most “get rich quick” plans have some element of this fallacy in them. Let there be no mistake about this: if economics is involved, someone pays!

    An important note here regards government expenditures. The good economist understands that government, by its very nature, cannot give except what it first takes. A “free” park for Midland, Michigan is a park which millions of taxpaying Americans (including Midlanders) actually do pay for.

    A friend of mine once told me that all one needs to know about economics is “What is it going to cost and who is going to pay for it?” That little nutshell carries a kernel of advice for the economist: don’t be superficial in your thinking!

  10. The fallacy of the short run. In a sense, this fallacy is a summary of the previous five.

    Some actions seem beneficial in the short run but produce disaster in the long run: drinking excessively, driving fast, spending blindly, and printing money, to name a few. To quote the venerable Henry Hazlitt again, “The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences.”

    Politicians seeking to win the next election frequently support policies which generate short- run benefits at the expense of future costs. It is a shame that they sometimes carry the endorsement of economists who should know better.

    The good economist does not suffer from tunnel vision or shortsightedness. The time span he considers is long and elastic, not short and fixed.

  11. The fallacy of economics by coercion. Two hundred years after Adam Smith, some economists still have not learned to apply basic principles of human nature. These economists speak of “increasing output”

    but prescribe the stick rather than the carrot to get the job done.

    Humans are social beings who progress if they cooperate with one another. Cooperation implies a climate of freedom for each individual human being to peacefully pursue his own self- interest without fear of reprisal. Put a human in a zoo or in a strait jacket and his creative ener gies dissipate.

    Why did Thomas Edison invent the light bulb? It was not because some planner ordered him to!

    Why don’t slaves produce great works of art, Swiss watches, or jet airplanes? It’s rather obvious, isn’t it?

    Take a look around the world today and you see the point I am driving at. Compare North Korea with South Korea, Red China with Taiwan or Hong Kong, or East Germany with West Germany.

    One would think, with such overwhelming evidence against the record of coercion, that coercion would have few adherents. Yet there are many economists here and abroad who cry for nationalization of industry, wage and price controls, confiscatory taxation, and even outright abolition of private property. One prominent former U.S. senator declared that “what this country needs is an army, navy, and air force in the economy.”

    There’s an old adage which is enjoying new publicity of late. It reads, “If you encourage something, you get more of it; if you discourage something, you get less of it.” The good economist realizes that if you want the baker to bake a bigger pie, you don’t beat him up and steal his flour.