Wednesday, January 7, 2015

“Rational” Ignorance Costly to Our Economic Health

This was published in newspapers across Indiana late last month. It will also appear in the next issue of the IPR Journal...

The use of government for economic “development” and economic “stimulus” is quite popular. Unfortunately, its popularity greatly exceeds what it deserves, given both theory and data.

The theoretical reasons are easy to understand. In terms of economics, it is difficult for government to create net economic activity by moving money from one use to another. But in terms of political economy, the benefits of government spending are usually concentrated and obvious, while the costs of government spending are spread through the population and nearly invisible. Given this combination, one can confidently predict that government will be too active in attempts to foster economic growth.

In any area of life, if you see the obvious — and miss larger but more subtle consequences — you’ll often end up with bad choices. Quite reasonably, most people spend little energy in thinking about public policy. When they combine this ignorance with naive views on political economy, they will tend to see the benefits of government activism and ignore its costs. Making it worse, members of the media often make the same mistakes. And of course, in the public arena, “interest groups” will tend to exaggerate benefits and downplay costs.

Let me offer four reasons why economic development and stimulus will look better on paper than in reality.

FIRST, the benefits are typically exaggerated. We’re often given a success story or two: Subsidy X led to “economic development” opportunity Z. Or we’re invited to imagine only the benefits: Giving taxpayer money to others will lead to more purchases which will stimulate the economy. From a few anecdotes, we imagine dozens of similar stories. But a few success stories do not necessarily imply many other success stories. And of course, the recipients of the money are likely to emphasize its benefits.

SECOND, Henry Hazlitt’s “Lesson” teaches us to focus more intently on the subtle costs. In particular, how are we paying for government activism? Let’s say the government devotes $10 million for local “economic development.” How do politicians pay for this? First, they can increase taxes by $10 million, moving economic activity from the private sector to the public sector. How is this a net gain? Second, they can lower spending elsewhere, moving economic activity within the public sector. That’s a shell game. Third, they can borrow the $10 million, resulting in higher taxes down the road. Even in a best-case scenario, this will take prosperity from the future to finance the present.

So, why do we imagine that government spending will routinely create net economic activity? Because it’s easier to see the economic activity of the $10 million in a few hands than to imagine that lower overall tax rates will do the same thing. It’s difficult to follow the government’s shell game when the benefits are obvious and the costs are nearly invisible.

THIRD, the “Austrian Economics” school of thought focuses on “the knowledge problem.” Do government actors know enough to implement effective policy? With the Affordable Care Act (ObamaCare), legislators famously bragged about not having read the bill. This sort of negligence is routine, especially with massive omnibus legislation. If a politicians haven’t read something, why should we trust their knowledge?

But there’s a larger knowledge problem. For example, ObamaCare purports to know how to intervene in the markets for healthcare and health insurance at the federal level in a way that will improve outcomes. What are the odds that federal legislators will have enough general knowledge — and enough specific knowledge about people in various states and communities — to impact these markets positively? Mailing out checks and blowing up stuff is one thing, government is pretty good at those things. But manipulating healthcare and health insurance is quite another thing. In the context of economic development, what is the likelihood that government knows how to “pick winners” better than those spending their own money in the market?

FINALLY, the “Public Choice Economics” school of thought focuses on incentives and motives within political markets. Will government actors be incentivized and motivated to do effective public policy? As we noted above, the media and especially the general public are not likely to be knowledgeable about the costs of public policy. What will interest groups and public policy do with their power and knowledge advantages?

Jonathan Gruber was recently grilled for saying that voters are “stupid.” In contrast, a Public Choice economist would say that voters are “rationally ignorant” and apathetic. It’s not that voters are stupid. Instead, it’s simply not worth their energy to figure much out in the political realm. In other words, it’s “rational” to pay little attention to politics. Of course, interest groups and politicians might not take advantage of our ignorance. But even a casual observer of today’s politics will have at least the general sense that there’s more to political markets than benevolence and self-sacrifice.

What can we do as voters? We can stop believing in the tooth fairy and Santa Claus in political markets. Don’t let politicians promise you something for nothing — or entice you to play a shell game when you get easily distracted from following the ball.

Eric Schansberg, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Indiana University Southeast.


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