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Have a look at the most attractive and compelling incorrect ideas in economics. Some are logical fallacies. A few are myopic opinions that don't take into account the big picture. And others are poorly thought out examples of economic reasoning. All are to be avoided.
The lump of labor fallacy
The argument that there's a fixed amount of work that you can divide up among as many people as you want is often presented as a cure for unemployment. The idea goes that if you convert from a 40-hour workweek to a 20-hour workweek, firms will have to hire twice as many workers. France, for instance, recently reduced its workweek to only 35 hours in the hope that firms would hire more workers and cure France's persistent unemployment problem.
It didn't work; such policies have never worked. One problem is that hiring workers involves many fixed costs, including training costs and health insurance. So two 20-hour-per-week workers cost more to employ than one 40-hour-per-week worker. What's more, two 20-hour-per-week workers don't produce any more output than one 40-hour-per-week worker.
So if laws were passed that forced firms to move from a 40-hour work week to a 20-hour work week, firms wouldn't double the size of their workforces. They'd hire fewer than twice as many workers because costs would go up.
In addition, even if cutting the work week in half actually did double the number of workers used, it would only hide the overall unemployment problem by spreading it around. If 100 percent of workers are working half-time, they are all 50 percent underemployed. That situation is not a significant improvement over having 50 percent of the population employed full-time and 50 percent unemployed.
The world is facing an overpopulation problem
Various versions of this myth have been floating around since the late eighteenth century when Thomas Malthus first asserted it. He argued that living standards couldn't permanently rise because higher living standards would cause people to breed faster. He believed that population growth would outpace our ability to grow more food, so we would be doomed to return to subsistence levels of nutrition and living standards.
Even at the time that Malthus first published this idea, lots of evidence indicated that it was bunk. For generations, living standards had been rising while birth rates had been falling. And because that trend has continued up to the present day, we're not going to breed our way to subsistence.
Indeed, many nations now face an underpopulation problem. In most developed countries, birthrates have fallen below the replacement rate necessary to keep the population stable. As a result, their populations will soon start shrinking dramatically. And because birthrates are falling quickly all over the world, the total human population is predicted to max out at around 9 billion people in 2050 before beginning to shrink dramatically.
A related problem is that rapidly falling birth rates are wreaking havoc on government-sponsored retirement systems because there aren't enough young workers to pay all the taxes needed to fund retirees' pensions. In desperation, some countries are going so far as to pay mothers cash bounties for each new child they give birth to.
While many countries with relatively high birth rates do have poverty and malnutrition problems, economists now believe that the high birth rates aren't to blame. Rather, poor government policies are typically the problem. When these policies improve, living standards rise, birth rates fall, and whatever population crisis seemed to exist quickly disappears.
The fallacy of confusing sequence with causation
Post hoc ergo propter hoc is a Latin phrase that translates roughly as, "Because you see one thing precede another, you think that it causes the other." That is, if A happens before B, you assume that A causes B.
Such a deduction is false because A and B often don't have any relationship. Sometimes it rains in the morning, and you get a headache in the afternoon. That doesn't mean that the rain caused your headache.
Politicians try to pull this logical fallacy all the time when discussing the economy. For instance, suppose that politician A gets elected, and a few months later there's a recession. The two may have nothing to do with each other, but you can be sure that during the next election, an opponent of politician A will claim that the recession was the result of politician A's policies. The only proof offered is that one event happened before the other.
If it's worth doing, do it 100 percent
We all value safety. But was a famous U.S. politician really being sensible when he said that we should spend whatever money might be necessary to make flying on commercial airlines "as safe as possible"?
Economists would say, "No!" The problem is that making commercial airline travel "as safe as possible" would mean making it prohibitively expensive. Although safety is a good thing, achieving complete safety is not a worthy goal if doing so makes flying so expensive that only the extremely wealthy can afford it.
The politician failed to apply marginalism — the idea that the best way to approach a problem is to compare marginal benefits with marginal costs. Applying marginalism to airline safety, you realize that making flying "as safe as possible" is wasteful.
The first few airline safety innovations (such as seatbelts and radar) are sensible to undertake because the extra, or marginal, benefit that each brings is greater than the extra, or marginal, cost required to pay for it. But after the first few safety innovations are implemented, successive innovations become more costly and less effective. At some point, additional innovations bring only small marginal increases in safety while running up high marginal costs.
Low foreign wages mean that rich countries can't compete
You often hear that U.S. firms can't compete with firms based in developing countries because of vast differences in hourly wages. To see the problem with this thinking, let's compare a factory in the United States with a factory in a developing country.
Say the U.S. factory pays its workers $20 per hour while the factory in the developing country pays $4 per hour. People mistakenly jump to the conclusion that because the foreign factory's labor costs are so much lower, it can easily undersell the U.S. factory. But this argument fails to take into account two things:
- What actually matters is labor costs per unit, not labor costs per hour.
- Differences in productivity typically mean that labor costs per unit are often nearly identical despite huge differences in labor costs per hour.
Compare how productive the two factories are. Because the U.S. factory uses much more advanced technology, one worker in one hour can produce 20 units of output. The U.S. worker gets paid $20 per hour, so the labor cost per unit of output is $1. The factory in the developing country is much less productive; a worker there produces only 4 units in one hour. Given the foreign wage of $4 per hour, the labor cost per unit of output in the developing country is also $1.
Obviously, the developing country's lower hourly wage rate per hour does not translate into lower labor costs per unit — meaning that it won't be able to undersell its U.S. competitor.
People who focus exclusively on the difference in labor costs per hour never mention the productivity differences that typically equalize labor costs per unit. And don't think that my example uses happy-happy numbers. Wage differences across countries really do tend to reflect productivity differences.
Tax rates don't affect work effort
Some politicians argue for raising income taxes as though the only effect of doing so will be to raise more money. But it's been demonstrated over and over again that beyond a certain point, people respond to higher taxes by working less. And that reduction in labor denies society all the benefits that would have come from the extra work. (Because people work less, the increased tax rate also doesn't bring in nearly as much revenue as expected.)
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