Back in the olden days when I ran the Dallas Fed, we had an extensive outreach program for economic education, including seminars for teachers who taught economics in high school, often without much training themselves. Whenever I spoke to the teachers, they invariably asked my advice on what they should be teaching. What are the most important things for students to learn about economics, especially those who won’t be taking college level economics? My answer was based in part on my experience and observation that typical elementary micro and macro instruction doesn’t take or last if the material isn’t repeated in subsequent courses. The teachers, I thought, should concentrate on memorable economic lessons or “stories.”
Early on, I wrote a piece I thought would be useful to teachers titled “Profit Is Not a Four Letter Word,” where I described very simply how Adam Smith’s invisible hand worked—the role of profit as a motivator and financer, the role of prices in allocating resources, the role of private property rights, the role of competition as a regulator, and how it all came together to result in individually-motivated actions leading to the common good, as if by some “invisible hand.” So, the first item on my recommended list usually was Adam Smith’s invisible hand.
The greatest economic educator ever, in my opinion, was Frederick Bastiat, a French economist of the first half of the 19th century who would likely be labeled a Libertarian today. See “Why Bastiat is My Hero.” Economics students usually hear of Bastiat first via his famous Petition on Behalf of the French Candle Makers, where he, tongue-in cheek, implored the French Parliament to require the closure of all blinds, shutters, etc. because sunlight was providing unfair competition to the candle makers in the provision of light. Of course, many jobs would be created by closing the blinds. Bastiat’s particular cause was free trade, but his arguments applied to free markets in general. He made his points with wit and satire, which make him a joy for students to read. So, the next couple of items on my list were from Bastiat: the petition of the candle makers, the negative railroad, and the broken window fallacy, which led in to his discussion of the seen versus the unseen. More about that later.
Other stand-alone economic “stories” that I recommended to teachers usually included the following:
–The magic of compound interest
–Decision making at the margin, the implications of fixed or sunk costs
–Productivity as the key to standards of living
–Free trade: absolute and comparative advantage
–The tale of the Goose that lays the golden eggs (avoid goose abuse)
–The tragedy of the commons
–The fallacy of job counting (Don’t count jobs; make jobs count)
–Rainbow stew (from a Merle Haggard song)
Even though I included Bastiat’s “Broken Window Fallacy” and his classic discussion of “the seen versus the unseen” high on my list, I would give it even more prominence today and connect it to the contemporary term, “counterfactuals.” Policymaking during the financial crisis and its aftermath has been hobbled by policymaker’s refusal to recognize or take account of counterfactuals, or what might have happened as well as what did happen. In other words, they only consider the seen and ignore the unseen.
These concepts are extremely relevant today and would help clear up much of the confusion over such questions as whether the stimulus program worked, whether monetary policy has been successful, whether TARP was a success or a failure. We don’t see complete success and we ignor what we don’t see, that is the counterfactual of what might have happened.
Ignoring or minimizing counterfactual leads to extreme conclusions about economic policy measures and to crippling political polarization. Policy measures that did some good, but not as much as hoped for or needed are rejected as total failures. These might include the Fed’s quantitative easing programs that in my mind did some good, but not enough good to pull us out of sub-par growth. While I’m no fan of the administration’s stimulus program, which I thought was poorly designed and executed, I still can’t agree with those who call it a total failure because it didn’t reduce unemployment to the promised 8 percent level. Why not acknowledge that it did a little good, but not enough, and at a high fiscal price?
By ignoring counterfactuals, or the unseen, we tend to forget that successful policies usually means nothing bad happens, since nothing is seen happening. If a successful policy averts a bad outcome, but with some negative second order consequences, the success won’t be noticed, but the bad side effects will be. For example, the Fed’s monetary policy in 2002 and 2003 was intended to stimulate a faltering economy, avoid a double dip recession, and prevent falling inflation from morphing into deflation. It achieved those goals, but since nothing happened, there was no parade. On the other hand, those policies, years later, would be blamed for stimulating the housing boom that eventually led to a bubble that burst.
Ignoring counterfactuals leads to extreme policy positions, which, as we saw in the recent debt-limit debate can be very damaging. Policy makers are thinking too much of flipping a switch that can only be on or off, up or down, or black and white. I once articulated a management philosophy that would rely more on dials than switches. Turning a dial rather than flipping a switch allows for nuance and makes consensus decision making possible. I wish our leaders had used a dial during the debt limit and other budget debates. That and a proper appreciation for counterfactuals and the unseen would lead to better outcomes.
My point, buried way down here, is that if I were making my topic list today, training on looking for counterfactuals would be high on my list.