Naked Economics

More praise for

Undressing the Dismal Science

fully revised and updated

Copyright © 2010, 2002 by Charles Wheelan
Foreword copyright © 2002 by Burton G. Malkiel

All rights reserved

“Mum’s the Word” reprinted with permission. Further reproduction prohibited. © 1998 The Economist Newspaper Group, Inc. www.economist.com.

“Two Cheers for Sweatshops,” Hearts and Heads,” and “I Love D.C.” reprinted with permission of the
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Library of Congress has catalogued an earlier edition as follows:

Wheelan, Charles J.
Naked economics: undressing the dismal science/Charles Wheelan; foreword by Burton G. Malkiel.—Fully rev. and updated.
p. cm.
Includes bibliographical references.
ISBN: 978-0-393-07975-3

1. Economics. I. Title.
HB171.W54 2010
330—dc22

2009052148

W. W. Norton & Company, Inc.
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For Leah

I
t is widely believed that Scotsman Thomas Carlyle labeled economics the “dismal science” well over one hundred years ago because it seemed boring, uninteresting, unclear, and full of “on the one hand, on the other hand.” Indeed, Harry Truman is reported to have said that to avoid ambiguity, he wanted to have “one-armed economists.” In fact, Carlyle had something very different in mind. What Carlyle reminded us was that scarcity was pervasive—that we have to make choices between competing satisfactions, between jam today and jam tomorrow, and between conflicting values and goals. Above all, the dour Scot emphasized that everything has a cost and nothing can be produced without work and sacrifice.

To be sure, many people do believe that economics and economists are dismal in the popular sense, that is, extraordinarily dull. As one definition goes: “An economist is someone who is good with numbers but does not have the personality to be an accountant.” The tarnished image of economists is in large part earned by their tendency to opaque writing, their use of often inscrutable diagrams, and their excessive use of mathematics. Moreover, they often fail to admit what they don’t know.

Why is economics the butt of so many jokes, and why do students often become glassy-eyed when confronted with the study of economics as a discipline? The reasons, I think, are that economists generally do not write well and that most economics texts rely far too much on algebraic manipulation and complex diagrams. Moreover, few economists are able to transmit the considerable excitement of economic analysis or to show its relevance to everyday life. This book by Charles Wheelan changes all that. Wheelan has an anti-Midas touch. If he touched gold he would turn it to life.

This is a truly unique book. It contains no equations, no inaccessible jargon, and no inscrutable diagrams. While equations and diagrams may well be behind many of the ideas in economics, Wheelan shows that they can be reduced to plain English. He boils economics down to its essentials. He demonstrates that the term “lucid economist” is not an oxymoron.

In these pages, we see how many of the criticisms of economists are undeserved. Economic analysis is a hard and complex subject—in many cases far more complex than analysis in the physical sciences. Physics can elegantly explain simple contained systems such as the planets revolving around the sun or electrons in orbit around an atom. But even the physical sciences have difficulty understanding phenomena in nature. Weather forecasting is a case in point. Despite complex satellite observations and intricate weather forecasting models, meteorologists often cannot improve on very naive forecasting models such as “The weather tomorrow will be exactly like it is today.” To be sure, the inertia model misses all the turning points but retains an excellent overall record. And when forecasters are asked to make longer-run projections on such subjects as global warming, their range of forecasts makes economic forecasts appear precise by comparison.

Economics is more difficult than the physical sciences because we cannot usually run controlled laboratory experiments and because people do not always behave predictably. A whole new branch of behavioral economics has attracted considerable attention by combining the insights of psychologists and economists, but we still are unable to predict individual behavior with any precision. But that we are far from understanding everything does not mean that we understand nothing. We do know that individual behavior is strongly influenced by incentives. We do know that there are many logical regularities, and we have enjoyed a steady accumulation of knowledge. We do know that every sale involves a purchase and that obvious opportunities for profit are rarely overlooked—the basic idea behind the theory that our securities markets are remarkably efficient.

And as inexact as economic science may be, it has a direct impact on our lives and it has a critical role to play in government policymaking. Economists influence all branches of government. The tasks of promoting economic growth and high employment while avoiding inflation have long been recognized as the domain of government economists. Remember Bill Clinton’s most successful campaign slogan during the 1992 election? “It’s the economy, stupid!” Promoting competition and restraining monopolies (Justice Department), limiting pollution (Environmental Protection Agency), and providing medical care (Health and Human Services) are examples of major activities within different cabinet departments that have crucially important economic components. Indeed, it is hard to think of any political decisions, be they on social, tax and expenditure, international, agricultural, or national security issues, that do not have economic consequences. And however skeptical politicians may be about the ability of economists to solve these problems, the economists’ advice is not ignored. Indeed, as John Maynard Keynes once wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”

The influence of economists is also increasingly pervasive in the business and financial communities. Peter Lynch, the former manager of Fidelity’s Magellan mutual fund, once opined that if you spent fourteen minutes talking to an economist you would have wasted twelve minutes. Perhaps it is ironic that the investment performance of professional mutual fund managers is now regularly evaluated based on techniques developed by financial economists. Moreover, economists influence countless other business decisions. They project product demand for companies as diverse as General Motors and Procter & Gamble. They are employed in large numbers by consulting firms engaged in business tasks from strategic planning to inventory control. They help investment firms fashion portfolios of securities by analyzing the trade-offs between expected return and risk. They advise chief financial officers of corporations on dividend policy and on the effect of debt on the price of the firm’s common stock. In our financial markets, option traders on the floors of the major options exchanges carry hand-held computers programmed with an economic model to tell them the prices at which they should trade put and call options. The fact is that economic analysis is incredibly useful for investors and producers as well as for government policymakers.

Ordinary consumers will also find that economics can illuminate many perplexing everyday issues. Why is it so hard for individuals to buy health insurance? Why do we stop at McDonald’s along a highway even though many other establishments may make better hamburgers? Why do so many people apply to “prestige” colleges even though many other institutions offer just as good an education at far lower prices? Have you ever wondered what such common terms as “adverse selection,” “public goods,” and “the prisoner’s dilemma” have to do with everyday life? These are among the subjects treated in this delightful book.

It’s often said that if you ask ten economists the same question you will get ten different answers. But I’ll wager that if you asked ten economists why there is a shortage of cabs and apartments in New York City, all ten would tell you that limitations on the number of taxi medallions and rent control are what restrict the supply of these goods and services. There are certainly many areas where economists are in virtual unanimous agreement. Economists overwhelmingly agree that free international trade can improve the standard of living of the trading countries and that tariffs and import quotas reduce general welfare. Economists generally agree that rent controls reduce the volume and quality of housing. Economists were virtually unanimous in their forecast that the horrific tragedy of September 11, 2001, would lead to a contraction of economic activity. My own experience in government suggests that there is far less difference in the views of economists (be they conservative Republicans or liberal Democrats) than there is between economists and those who come from different disciplines. Economists of contrasting political views agree among themselves on most issues. A bipartisan majority of economists is quite likely to unite on the opposite side of a bipartisan coalition of politicians.

The reason, I believe, is that economists have a unique way of viewing the world and thinking about how to solve problems. Thinking like an economist involves chains of deductive reasoning in conjunction with simplified models such as supply and demand. It involves identifying trade-offs in the context of constraints. It measures the cost of one choice in terms of the foregone benefits of another. It involves the goal of efficiency—that is, getting the most out of limited resources. It takes a marginalist or incremental approach. It asks how much extra benefit can be achieved by incurring some extra cost. It recognizes that resources have many diverse uses and that substitutions can be made among different resources to achieve desired results. Finally, the economist has a predilection to believe that welfare is increased by allowing individuals to make their own choices and to argue that competitive markets are a particularly efficient mechanism for giving expression to individual choices. And while all economic problems involve normative issues (views about what should be), thinking like an economist involves an analytical approach that usually abstracts from or at least downplays “value” issues.

This gem of a book is both well balanced and extremely comprehensive. It recognizes the benefits of the free market in making our lives better and shows why centrally controlled economies ultimately fail to increase the living standards of their citizens. At the same time it recognizes the crucial role of government in creating the legal framework that makes markets possible and in providing public goods. It also understands the role of government in correcting situations when the free market creates undesirable externalities such as environmental pollution or where private markets will fail to produce some of the goods the country’s citizens desire.

Did you ever wonder why mohair farmers earned a subsidy from the federal government for decades? Wheelan explains how politics and economics can lead to such results. Do you really understand why Ben Bernanke is often referred to as the second most powerful person in the United States? Wheelan demystifies the effect of monetary policy on economic activity. Did you ever consider that you never fully understood the final scene from the movie
Trading Places
when the bad guys were wiped out in the commodities futures market? Wheelan makes the theory of supply and demand completely accessible. Have you ever wondered if the people who protest against globalization have a good point and whether either the developed or developing nations would be better off with less economic integration? Wheelan will make the issues crystal-clear. When you read the newspapers about disputes concerning current economic issues, are you often perplexed and dismayed at the cacophony of competing arguments? Wheelan parses the jargon and pierces the politics to lay bare the essential issues. In so doing, he successfully transforms the dismal science into a lively weaving of economics and politics into the fabric of national discourse and policy.

Wheelan has produced a delightfully readable guide to economic literacy. By boiling economics down to its essentials, he makes the reader a more informed citizen who can better understand the major economic issues of the day. He shows that economics can be explained without graphs, charts, and equations. He demonstrates that economic analysis can be intensely interesting. The book should provide a useful supplement for the college and high school basic course on the economy. More important, it can stand on its own as an introduction to the field that will change the views of those people who have rejected the study of economics as incredibly tedious and terminally boring. I have often considered writing a basic introduction to economics myself, but competing projects always intervened. Had I done so, this is the book I would have wanted to write.

BURTON G. MALKIEL
Princeton, New Jersey
January 2010