Economics has a blind spot

Traditionally, economists think of themselves as policy advisers. Politicians and their appointees make the laws, levy the taxes, set the regulations, make spending decisions and chart the course of monetary policy; economists stand at their side, faithful technocratic advice-givers neutrally relaying the latest insights from academia. That’s the typical vision, anyway.

That may have been accurate in the period after World War II, when wise public servants whispered in the ears of leaders like Dwight D. Eisenhower and John F. Kennedy. But we live in the increasingly complex, gridlocked world of 2016 – if the old stereotype were ever accurate, it no longer is.

First, economic policy is mostly not in the hands of a single, dynamic executive. Congressional paralysis is now the norm. What’s more, lots of important economic policy decisions are made by the central bank.

That means that one hand of the government often doesn’t talk to the other.

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This leaves many models incomplete. Low interest rates might encourage the legislature to run higher deficits, because of reduced borrowing costs. On the other hand, low rates might make Congress tighten deficits out of fear of inflation. This interaction is so important that with certain assumptions about fiscal policy, it’s possible to completely reverse a model’s predictions about the effects of monetary policy.

If academics spend their time on complex models that might only be used by some hyperadvanced future civilization, that’s not really a problem. The danger is that any attempt to change tax policy in the direction of an optimal solution might actually make things worse. This is a principle known in economics as the theory of the second best – in a real-world economy with lots of inefficiencies, moving in the direction of the perfect solution can actually make things less efficient. The perfect is often the enemy of the good. And because of politics, the perfect is never available.

Finally, economists generally disregard the way their own advice affects politics itself. For many decades, free trade was the policy idea that united economists more than any other; although much of the public was skeptical, and some models warned of potential dangers, economists presented a united front and pushed leaders to drop barriers to international trade. This may have ended up causing some harm in the 2000s, when the sudden increase in U.S.-China trade was harder on workers than previous trade booms.

But it also might have had an unhealthy impact on U.S. politics. A new paper by David Autor, David Dorn, Gordon Hanson and Kaveh Majlesi shows that China trade might have increased political polarization. They write:

“Has rising trade integration between the U.S. and China contributed to the polarization of U.S. politics? … We find strong evidence that congressional districts exposed to larger increases in import competition disproportionately removed moderate representatives from office in the 2000s.”

Not all economists need to take politics into account, but the ones who give policy advice definitely do. Like it or not, economists and their models are now in the thick of the political arena. If only more were aware of it. •

Noah Smith is a Bloomberg View columnist.

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