There is something foul in the state of economics. At the best of times beginners economics courses are overly simplistic, at the worst of times they are ideologically driven and are training a generation of economists in idealistic concepts. It is this shocking lack of critical thinking that has led to great failures in the field, like the economic orthodoxy of the 80s assuming that efficient markets would distribute growth equitably, which you only need to look below to see was blatantly untrue. So, what is wrong in economics and how has it harmed us?
In my first-year economics course, my lecturer used the example of the housing market to explain how establishing a price floor (in the example of housing rent controls) could be a bad thing. The explanation goes that by restricting price, suppliers have less of an incentive to supply, generating a gap between supply and demand, causing a fall from Q1 to Q2 and making the situation worse.
While this might make sense in theory, it runs into the brick wall of reality pretty quickly. In that class I asked him what those landlords who find the price too low would do now, as surely a lower price would be better than the nothing you would generate by not renting it out. To this he responded that they would leave the market and sell it instead in either the commercial property market or rent out as an Airbnb. However, there is only so much demand for office and shop space (as the Irish construction sector is painfully discovering now), and such uses are only viable in a few locations i.e. no one is putting offices in residential estates.
With the case of Airbnb, we have a rather handy and simple policy tool – either make it illegal or attach a punitive tax rate to it, problem solved.
Another issue that this runs into is that high prices actually lead to less supply for residents; as house prices go up and become primarily a tool for investment rather than occupancy, they begin to quickly be bought up by shadow banking groups, international funds and Gulf princes.
If house prices were lower and generated less of a return on investment, suddenly this whole segment of international demand disappears, freeing up houses for those who actually want to live in them. For example, in 2017 the Gulf state of Qatar owned 23,253,699 square feet of London, making it one of London’s biggest property owners.
Even if private development slacks, with cheaper land prices and less prime real estate being taken up as investment tools for the rich, it will be cheaper for the state to acquire said land and develop it.
Another example that is often abused is that of minimum wages as a price ceiling. Here the government sets a minimum wage that is higher than the market’s, causing there to be excess supply than demand and hence a lower level of employment (as denoted by the fall in quantity in the graph below).
However, this all rests on the assumption that the labour market is perfectly competitive, which it is certainly not. Instead labour markets are much closer to monopsony models which is a monopoly for buyers instead of sellers.
This is for a multitude of reasons: firstly, in any certain geographic area a small number of large firms will provide most of the employment and therefore have wage setting power. Secondly, due to the fall in the power of unions most workers now have far less collective power in negotiating wage contracts, allowing them to be exploited by said firms.
This isn’t just bad economics; these ideas are actively harmful. The decline in the real value of minimum wage in the US explains 30%-40% of the rise in wage inequality between the top 10% and bottom 50% since the 80s alone. This is why most empirical studies find that increasing the minimum wage has little effect on employment. For example, the average elasticity of employment compiled from a multitude of studies is only -0.04. This means that for any 1% increase in the minimum wage there is only a 0.04% drop in employment, clearly showing that the idea of a price ceiling here is nonsense.
Most classes will cover how simple GDP growth isn’t the be all or end all, but what they don’t cover is how it can in reality be negative. In conventional economics, economic growth measures the growth in labour and capital, the two things that are used to make any good or provide any service in our production functions.
However, in reality there is a third component which are the resources used in production. Economics as a discipline presupposes that resources are finite so this term could actually be a negative, especially with the level we are exhausting the natural environment under current capitalist production. If economic growth is actually negative then it’s not only meaningless, it’s harming future generations as well. Instead of focusing on economic growth, we should be focusing on what growth is sustainable.
Consumer and Producer Surplus
A common justification given for why free markets are good is that they are the only thing that maximizes producer and consumer surplus. Consumer surplus being the red shaded area which denotes the difference between the maximum price a consumer was willing to pay and the price actually paid. Producer surplus is the blue shaded area which denotes the difference between the minimum price the producer was willing to sell at and the price they actually sold at.
Together these two measurements make up the total welfare from any given transaction. The problem with this framework is that a unit of producer surplus is assumed to be worth the same as a unit of consumer surplus. In an ideal world where producer surplus is distributed evenly this might be true but as we have seen in the first graph in this article, the gains from production are increasingly unevenly shared. Why should we care about producer surplus if it only goes to incredibly narrow section of society?
For those who only ever take one economics course as an elective these ideas are damaging their understanding of how the economy really works. For those who go on to study more Economics they quickly have to be unlearnt in order to be built upon. It is past time we rethink these courses and what their learning goals actually are.
Thomas Davern – Final year economics student in UCD