By James Kwak
Supply and demand curves were introduced to the world by the French mathematician Antoine-Augustin Cournot in 1838. These now-ubiquitous analytical tools show how many units of a product are demanded and supplied at any given price—and how prices automatically adjust so that supply exactly equals demand. This core insight dated back to at least to Adam Smith, who explained in his 1776 book The Wealth of Nations that market prices are determined by the individual, self-interested decisions of buyers and sellers.
By the late 19th century, supply and demand curves became a dominant feature of economics education, thanks in large part to a textbook, Principles of Economics, by the British economist Alfred Marshall. Marshall showed how buyers and sellers, acting in their own interests, converge on an equilibrium price that maximizes social welfare, defined narrowly as the difference between the value consumers place on goods and the total cost of producing those goods. This principle—that free markets generate the greatest possible economic well-being for society—is familiar to any student of introductory economics today.
Marshall, however, rejected the idea that we should simply let markets work their magic and accept whatever outcomes they produce. Instead, because people differ in wealth, he argued that “aggregate satisfaction can prima facie be increased by the distribution . . . of some of the property of the rich among the poor.”
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That view was echoed in the 1948 first edition of the textbook that would dominate the market for the next three decades. In Economics, Paul Samuelson wrote, “John D. Rockefeller’s dog may receive the milk that a poor child needs to avoid rickets. Why? Because supply and demand are working badly? No. Because they are doing what they are designed to do, putting goods in the hands of those who can pay the most.” For Samuelson, the competitive market model of Economics 101 was simply a useful analytical tool.
For his contemporaries Friedrich Hayek and Milton Friedman, however, it was something more: the heavy artillery in an ideological battle against the New Deal. Beginning in the 1940s, Hayek and especially Friedman built a comprehensive theory of society on the foundation of competitive markets. In his 1962 book Capitalism and Freedom, Friedman explained how virtually any social or political issue could be analyzed in terms of supply and demand—and concluded in each case that government should get out of the way and let free markets produce the best of all possible worlds.
Both Hayek and Friedman saw themselves as participants in a battle of ideas against encroaching socialism. In their hands, an analytical framework became a universal worldview: Economics 101 became economism. Economism is the belief that basic economics lessons can explain all social phenomena—that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an Economics 101 textbook. Ideally, students should learn that the competitive market model is just that—a model, which by definition abstracts from the real world. According to the rhetoric of economics, however, the lessons of Economics 101 can be transplanted directly into the real world. The central idea that free markets maximize social welfare becomes a universal framework for understanding and answering any policy question.
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Economism may not accurately describe reality, but its reduction of complex phenomena to simple concepts was a major asset in the battle of ideas. The political landscape of the United States after World War II was dominated by the shadow of the New Deal and the idea that the government could and should pay a major role in managing the economy. Businesses that opposed intrusive regulations and wealthy individuals who feared higher taxes needed an intellectual counterweight to the New Deal, a conceptual framework that explained why an activist government was bad not just for their profits and their pocketbooks, but for society as a whole. Economism filled that need.
The rhetoric of economism was taken up first by think tanks such as the Foundation for Economic Education and the American Enterprise Institute, then by the National Review of William F. Buckley, who helped make free-market economics part of the conservative synthesis. From Barry Goldwater to Ronald Reagan, the conviction that all economic problems could be boiled down to first principles and solved by the magic of competitive markets became a central tenet of conservative ideology. In the memorable words of former House majority leader Dick Armey, “The market is rational and the government is dumb.”
As the mantra of free markets, small government, and lower taxes became more popular with voters, Democrats adapted by also paying homage to competitive markets. It was Bill Clinton who said, “The era of big government is over.” And Barack Obama’s signature health care reform program is centered on the idea of using (regulated) market competition to expand access to health insurance.
Economism presents itself as an abstract, value-neutral representation of the world—one that invokes the prestige of economics, a discipline that many people find intimidating. “It’s just Economics 101,” one often hears. The role that it plays in contemporary society, however, is deeply ideological. Economism naturalizes one possible state of affairs—in which individuals and companies are left to compete in unregulated markets—and, like Doctor Pangloss in Voltaire’s Candide, celebrates the outcomes that result as the best of all possible worlds.
But in reality, things do not always turn out so well. In practice, economism often has the effect of increasing inequality, or at least justifying it in today’s new Gilded Age. Consider the minimum wage. The United States has the lowest minimum wage, as a proportion of average wages, of any advanced economy—one reason for our wide gap between rich and poor. But according to economism, raising the minimum wage would only backfire and harm poor people. On a simple supply-and-demand diagram, a minimum wage is a price floor in the labor market; like any price floor, it must cause supply to exceed demand. Therefore, raising the minimum wage must increase unemployment, and anyone who disagrees simply doesn’t understand Economics 101.
In real life, however, employment levels are the result of many factors—some businesses can pass cost increases on to customers, better-paid workers are less likely to quit, and so on. Real economists study these relationships in detail, and a significant body of recent research indicates that modestly higher minimum wages have no discernible effect on unemployment.
Despite this empirical evidence, the public relations campaign against a higher minimum wage remains clothed in the rhetoric of economism. What goes unsaid is the campaign is, in significant measure, funded by industries that benefit from low wages for unskilled labor. This is but one example of how economism provides a seemingly neutral perspective on the world that can be deployed in the service of business interests and the wealthy.
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Economism is the reduction of social reality not just to Economics 101, but to just one Economics 101 lesson: the model of a competitive market driven by supply and demand.
Paul Samuelson bemoaned the fact that a single idea—that free competition is always good and government intervention is always bad—is often “all that some of our leading citizens remember, 30 years later, of their college course in economics.” Writing in the late 1940s, Samuelson’s first concern was preventing another Great Depression and the geopolitical turmoil that followed. In his textbook, which dominated introductory courses during the decades following World War II, the theory of supply, demand, and prices did not appear until Chapter 19, more than 400 pages in.
Contemporary textbooks, however, have moved away from Samuelson’s example. Whether by the slightly right-leaning Gregory Mankiw or the slightly left-leaning William Baumol and Alan Blinder, they now lead with rational individuals pursuing their self-interest in competitive markets, guided by Adam Smith’s invisible hand to maximize their collective prosperity. While economics professors know that the world is much more complicated than an introductory textbook, many college students are still inculcated with the simplistic dogma of competitive markets. According to a recent survey of undergraduate programs around the world by students at the University of Manchester, “Economics degrees are highly mathematical, adopt a single narrow perspective and put little emphasis on historical context, critical thinking or real-world applications.” This limited focus is even more true of business programs—the most popular undergraduate concentration in the United States —whose students often take little more economics than a required introductory course.
Economists already know the cure for Economics 101: better economics. Many advanced courses deal precisely with the differences between the real world and the introductory models taught in the first year. No doubt many teachers are able to give even casual students a healthy skepticism regarding the ideology of free markets. People who are familiar with the irrational behavior of human beings, the importance of institutions, the techniques for analyzing real-world data, and the vicissitudes of economic history will understand both the utility and the shortcomings of the competitive market model.
The pedagogical problem is that the typical introductory course does not allow enough time for anything more than a cursory introduction to these vitally important subjects. Professors can and do emphasize the limits of models, but even then a course centered around supply and demand curves will often produce the students that Samuelson lamented, who remembered only that competition is good and government is bad.
If we were to redesign Economics 101, what would it look like? One possibility is to begin not with abstract models, but with the real world. How do companies use technology to produce goods, and how are those companies organized? How are products and services distributed, and how do manufacturers, intermediaries, and retailers set prices? How are wages determined—not in the theoretical model, but in real life? What factors determine the set of opportunities available to different people in different parts of the planet?
The economist Partha Dasgupta, for example, begins his “very short introduction” to economics by describing the different material and economic conditions of two families, one in the suburban United States and one in rural Ethiopia. Students who begin with a grounding in the way the world actually works will be better equipped to understand the limitations of abstract models when they do learn them.
Alternatively, we could begin with real human beings. An introductory course in behavioral economics would reveal that we all make decisions irrationally, at least compared to the utility-maximizing entities who populate the typical textbook. The same is true of organizations, which are populated by fallible human beings who often have their own interests at heart. Understanding the importance of habit, convention, prejudice, and other factors will enable students to resist the allure of models that assume superhuman actors and perfectly efficient firms.
Or, perhaps, we could do away with the idea of Economics 101 altogether. I studied history and I teach law, neither of which has a single “101” class. There could be one introductory class called “Economic Institutions Around the World,” another called “Decision Making by Individuals and Organizations,” a third called “Economic Development Through History,” and a fourth called “Abstract Economic Modeling” (what is now “Economics 101”). Economics majors could take them in any order they wanted, and non-majors could take only those that interested them. People who take only one economics class would not necessarily be indoctrinated in the myth of the invisible hand; students who are serious about the field would learn everything they need to learn, but with the context necessary to understand the uses and limits of simple models.
Such a program would also be more true to the extraordinary richness of contemporary economic thinking, encouraging a more diverse range of students to enter the field. The premise of economism is that “economics” says only one thing: that unregulated competitive markets produce the best outcomes for all people. One antidote is for people to understand that economics is a fascinating discipline that provides many answers to many different kinds of questions—and to seek out those answers for themselves.
James Kwak is a professor at the University of Connecticut School of Law. Portions of this essay are adapted from his new book, Economism: Bad Economics and the Rise of Inequality (Pantheon).
2017 April 21