IPFS Glenn Jacobs

More About: Economy - Economics USA

On Ladders and Models

“President Hoover has summoned Colonel Arthur Woods to help place 2,500,000 persons back to work this winter.” – Washington Dispatch, 21 October 1930
President-elect Barack Obama claims that his economic stimulus package will create or save three to four million American jobs. Wow.  Why not five million or ten million?  How, in fact, did Obama’s advisors arrive at three to four million?  Well, they used sophisticated economic models.  But there is a problem with those models.  The 14-page analysis of Obama's $775 billion plan, which was posted on the Internet, concedes that the estimates are "subject to significant margins of error, both because of the assumptions that went into their economic models and because no one knows the final outlines of the package that will emerge from Congress” [emphasis added].
There’s an old joke about economists.  An economist, a lawyer, and an engineer fall into a pit.  Not having a way out, each one sets about solving their problem.  Unfortunately, they don’t have any materials to build a ladder.  Thus, the lawyer’s rhetorical skills and legal knowledge are useless.  The engineer can design a ladder but has nothing with which to build it.  The economist, however, fails to see a problem.  He just assumes that they have a ladder!!!
Obama’s advisors are assuming that Keynesian economics will be the ladder that allows the U.S. to climb out of the hole into which the Keynesians pushed us in the first place.
If, however, their plan doesn’t work, it won’t be the fault of the planners.  It will be your fault.  You see, according to mainstream economists, individuals cannot be trusted to act rationally.  For example, Professor Peter Gottschalk of Boston College says that “our models are built on the assumption that on average people behave rationally and they do the right thing, but this time people did very much the wrong thing."  
Perhaps if the good professor had studied Austrian economics he would realize that his entire statement rests on a fallacy.  People do act rationally.  They act in ways in which they believe will yield the greatest utility—i.e., satisfaction of their most important needs and desires.  Whether their decisions prove to be good or bad is another story.  No one has perfect knowledge and, thus, ex ante we can only speculate on the end result of the decisions that we make.  It is not until after the decision is made, ex post, that we can determine if our action was sound.  Even then, whether the decision was sound or not depends on the subject valuation of the individual; not on some objective measure applied by another individual.
Since we all have different value scales, what may be a good decision for one person will seem stupid to another.  For example, Warren Buffet is advising that folks buy American stocks.  Good decision for Mr. Buffet.  He can afford to lose a few billion dollars waiting for a stock market recovery.  However, the average person who could not afford to lose a few thousand has already seen his savings decimated.  He’ll choose to keep his money where it is perceived to be safe, in cash or perhaps government securities.  Although this may prove detrimental in the long term, is it really irrational?  Of course not; the individual is doing what he thinks is in his own best interests.
Alan Greenspan summed up the elitist economist attitude when he coined the phrase “irrational exuberance.”  According to Greenspan, it is irrational exuberance on the part of investors and consumers leads to bubbles and then to busts.  Sorry, Maestro, you’ve got it backwards.  “Irrational exuberance” is simply people trying to take advantage of your irresponsible policies.  It’s not irrational exuberance that causes the business cycle; it’s the central bank’s inflationary monetary policy.   For instance, is it irrational for folks not to save when interest rates are set near zero so that there is no reward for saving?  Is it irrational to think of your home as an ATM when home prices are skyrocketing due to fiscal and monetary policy? 
But, hey, don’t blame Greenspan.  His policies would have worked if only everyone had acted in ways he thought prudent—if they’d only been rational.
Mainstream economists assume that people are robots and that they will act in predictable ways.  In reality, people act in ways which they believe will best satisfy their needs and desires.  Since we all have different needs, desires, abilities, and resources, it is impossible to accurately predict how individuals will act. 
Economic models are based on aggregates.  But the aggregate is composed of diverse individuals acting in their own self-interest.  In order to address this contradiction, economists make assumptions—they assume there is a ladder where there is in fact none.  Thus, while economic models work well in the laboratory, they are virtually useless in the real world.
However, there are some assumptions which we can make about Obama’s stimulus plan:
Ramped up government spending will crowd out private investment. Resources and capital will be transferred from the productive sectors of the economy to less or non productive sectors. Government job “creation” will mean that fewer jobs are created in the private sector. FDR used the New Deal for political patronage; there is no reason to believe Obama’s administration will be any different. More government economic control will mean less individual liberty in all areas.
Finally, and most importantly, the free market—the one ladder which would allow us to escape this morass—will be crippled by more regulation, intervention, subsidies, and taxation.  A real economic stimulus package would unfetter the market, bringing about real growth and real prosperity.  Unfortunately, unleashing the market would mean that politicians would have to relinquish their power and control, and elitist economists would have to admit that their models are a fraud.
Don’t count on that happening any time soon.  Indeed, because the market is not under their control, policy makers and their statist advisors regard the free market as out of control and thus as the enemy.  Instead of allowing the free market to work, the Power Elite will do everything they possibly can to demonize and eventually kill it.
By the way, Colonel Arthur Woods established his Emergency Committee for Employment at the behest of President Hoover in October of 1930.  By 1931, the unemployment rate had doubled, mostly thanks to Hoover’s incessant intervention. 
Let’s hope President-elect Obama has better luck with his incessant interventions.