Thursday, March 8, 2007

7 Common Economic Fallacies


  1. Immigration causes Unemployment.

It is an argument often repeated. It goes something like this. “Immigrants who come over here are willing to work for lower paid jobs and thus they create unemployment for local people.”

This argument is wrong because.

  • Immigrants increase the supply of labour but they also increase Aggregate Demand in the Economy. This means that they buy more goods and create additional demand in the economy. They provide labour supply and increase labour demand.
  • If immigration caused unemployment why did America not have high unemployment during times of mass immigration? Because the immigrants created as many jobs as they took.
  • Often immigrants take jobs that native workers just don’t want to do. – You won’t see big multinationals cueing up to stop immigration.
  • Furthermore immigrants tend to be of working age. Therefore they tend to contribute more tax than receive in benefits. Without immigration US demographics would have a larger % of dependent old people.

2. House Prices in London will keep rising because of shortage of supply.

True there is a shortage of supply in big cities like London and New York. However this doesn’t mean house prices will always keep on rising. House prices can fall just like anywhere else. It just means that they will be higher on average than elsewhere in the country. Note house prices in Tokyo and Japan fell over 25% after the end of the speculative bubble in the 1980s. – American house prices have a lot further to go.


3. War is good for the Economy.

This fallacy is deeply embedded in many people’s mind. One reason is because it was felt the Second World War ended mass unemployment in US and UK.

To some extent it is true unemployment fell because of the Second World War. However war is not necessary to solve unemployment. The government could have intervened to create jobs through public work schemes.

  • War does create more output, but only in some industries related to war. Arms manufacturers do very well out of war. But total output of the economy doesn’t increase instead there is a change in economic priorities. Resources are diverted from peaceful industries to industries for creating the mechanisms of war.
  • Increase in government spending for wars create either taxes and or higher debt payments. This is a burden on current and future taxpayers. Note The UK is still paying off debt from second world war.

4. Tax Cuts make people work harder.

  • Ronald Reagan’s economic advisers told him something along the lines of “cut taxes” and you can increase total tax income. This theory is based on the laffer curve which states that if taxes are 100% people won’t work. Therefore if you cut taxes more people work and you can increase tax revenue.
  • The problem is that this may work if you cut taxes from 95% to 90%. But when you cut income tax from 25% to 23% it doesn’t make any difference.
  • Some people want a target income of say £20,000. Thus if taxes fall they can earn the same by working less. Empirical evidence suggests there is little if any supply side incentive for cutting US or UK tax rates.


5. A Current Account deficit doesn’t matter.

Maybe this fallacy isn’t so common. But it is a common belief in the Current US administration. A current account deficit of 7% of GDP does matter. See: Does a Current Account deficit Matter?


6. Trade Wars. - Retaliation is Best

  • The instinctive reaction of politicians is that if one country places a tariff barrier on our exports, we should respond by doing the same. However economic theory suggests that placing a tariff barrier on imports leads to a loss of economic welfare. It is better to not retaliate.

7. Tax Cuts will boost the Economy.

  • Another justification given for cutting income tax is that it will increase Aggregate Demand and hence increase economic growth. However this is not always true because:
  • If you cut income tax for high-income earners, they are likely to save a high % of their extra disposable income. Their marginal propensity to consume is low.
  • If you cut income tax the government has to either cut government spending or borrow. If the government has to borrow from the private sector then they will have less income to spend causing a decline in private sector spending.
  • This is called crowding out. (Although there are certain times when a government deficit can boost AD – like in a recession.)

See also: Ten Economic Fallacies

21 comments:

Anonymous said...

Nice red herring about immigration.

Nobody objects to LEGAL immigration.

Illegal immigration is what is objected to, and people like you never break your statistics out to differentiate between LEGAL and ILLEGAL immigrants.

The reason, of course, is because your arguments fall apart for ILLEGAL immigration, so you slyly lump them together.

paul graham said...

It may not change how hard a salaried employee works if you change the income tax rate from 25 to 23 percent, but it does affect people's willingness to invest in and/or work for startups.

Anonymous said...

Good stuff!

Though it might be worth also noting for point #3 on war, the UK economy (and likely the US economy) pre- and during WW2 was primarily a manufacturing based economy. Increased govt. expenditure on manufacturing goods to feed the war effort would then probably have had a greater effect on the economy as a whole, as opposed to now with our modern services-based economies.

bill said...

I believe that in your first paragraph, you meant to say 'over here' rather than 'over hear'.

Anonymous said...

Surely high-income earners are more likely to invest their higher earnings, rather than save them, hence producing investment consumption. This is a much better stimulus to economic growth than non-investment consumption.

Richard said...

Bill, Thanks for typo.

RE: illegal immigration.

The argument about immigrants is the same whether it is illegal or legal. The legality of an immigrant doesn't change the fact that he will increase AD. However it is worth noting the argument means that immigration won't cause unemployment.There are of course many other issues when dealing with the issue of immigration

mark vincent said...

So higher taxes increase economic output hugh?
Really do not agree with that fallacy. Especially when you see whos hands it falls into.
Less money in the hands of consumers is not a good thing for econmic growth, no matter what your defintion of "high income earners" are. According to your column, they will sock this money away, and not contribute to the 7% of debt to GDP ratio. Oh wait, that may be a good thing.

Misesian said...

I disagree with what you said about Immigrants filling jobs that Americans are unwilling to do. If a job is uncomfortable or unappealing then the wage rate will increase to compensate for it. Once the wage rate increases to the point where the potential worker values wages foregone more than the discomfort of the work he will accept the job and fill the position. This would cause less production and higher prices of course. The immigrant is just less skilled and less productive and therefore will work for a lower wage. However, I believe that the act of immigration is not inherently immoral. The immigrant has not commited an act of violence or aggression by moving from one location to another and freely bidding on employment. If you believe in individual liberty there is no such thing as illegal immigration.

mark vincent said...

As I wrote in November, your #7 point I do not agree with, in fact the current goverment is proving my point as each day dawns you said:
If you cut income tax the government has to either cut government spending or borrow. If the government has to borrow from the private sector then they will have less income to spend causing a decline in private sector spending

I guess you missed or just print money to buy our own debt and increase our deficit by 100% in 2 months to 13% of GDP. Just solidifies my point goverment is not the answer, in limited form is good, but not in the current form. I guess my point is the "less income to spend causing a decrease in the private sector spending" makes little sense, as much of the current spending is in the public sector, and does not help the private sector. The private sector would be better off given more funds in thier own hands than the govt. Now much of the large financial institutions are a hybrid of public and private sectors. I just have a feeling this will not end well. I will just let this saga unfold, and it will make my point for me. I just hope to God it will be reversable, although I feel we are getting to the point of no return.

RHOmea said...

>>Misesian said...
If a job is uncomfortable or unappealing then the wage rate will increase to compensate for it.<<

That might be what's taught in an Econ 101 classroom, but you need go no further than out the door to see how unrealistic that claim is. What are the lowest paid jobs in America? The worst, the most tedious, and often, the most dangerous. i.e. scrubbing toilets, waiting tables and firemen/police, respectively.
In a domestic market where a family member getting seriously ill can bankrupt one of the almost 50 million without health insurance, the pool of people who see 10 hrs a day of backbreaking work worth getting paid minimum wage will always exist.
And if they don't, then America's neighbors to the south will.

Wayne Johnson said...

You stated: "Some people want a target income of say £20,000. Thus if taxes fall they can earn the same by working less. Empirical evidence suggests there is little if any supply side incentive for cutting US or UK tax rates."

I disagree with this statement. In America, if someone was making 50k a year take home pay and their taxes were cut as to give them a take home pay of say 55k, they would not work 5k less in order to only make 50k, they would increase their spending each month. Their standard of living would increase instead of their number of hours worked decreasing. I would like to see some factual information behind your statement. I would be shocked if were actually true.

-er said...

Well done article. I would be interested in your thoughts on producer vs consumer sovereignty.

-er said...

I positively agree with #4. I think that the reason for this fallacy can be traced back to the way people perceive themselves versus others.

Ask someone "would you take a promotion with a $10,000 per year raise even if you had to work harder and pay 60% of the increase in taxes?"

I suspect that you'll hear something like: "I would, but most people wouldn't".

Anonymous said...

these arguments really are Econ101 type arguments, very black and white analysis. i agree somewhat with many of your points, but in relation to number 1, high levels of immigration from countries of lower standards of living, can tend to produce a decrease in salaries and/or a temporary displacement of the local labour force from one sector to another, while they adjust and retrain. so while long term it might benefit the economy, it is certainly not necessarily a short term benefit if it happens too quickly. also not all the money earnt by migrants is spent in that country, as some can be transferred out to the home country. surely this does not increase demand as much as a local worker who spends it in the country.

Anonymous said...

What you left out is that the private sector is more efficient than the public sector. So ctting taxes will allocate more money into the more efficient private sector increaseing welfare for all

Anonymous said...

'7. Tax Cuts will boost the Economy' as a fallacy is simply wrong. Putting more money in the hands of the consumer in simple terms is a pay raise for every worker paying taxes. To many times tax cuts are looked at from the wrong side (the effect on the government) and not the
effect it'll have on the millions of individuals who suddenly have more money to spend.

This increases their disposable income no matter how small it was before therefore allowing them to buy that new tv, Xbox360, Ipod, get a latte every morning on the way to work, new patio furniture, remodel the house, buy a new lawn mower, new appliances, finally go on vacation, etc, etc. The list just goes on.

What does the government do with it? Don't get me wrong, building roads and big ships helps the economy in the regions where the work in being performed but the vast majority of the money spent in my opinion is on creating regulating agencies and therefore regulators whose soul job is to make our lives miserable and everything else we do more expensive.

Ok, now that I've depressed myself I think I'll go lie down.

Brist74 said...

Anonymous said you missed saying that the private sector is more efficient than the public. But doesn't define what is meant by 'efficiency'. Efficient with respect to what ? For example, the British National Health Service is more efficient at delivering health care to 100% of the population 100% of the time whilst the US private sector delivers only to some and only some of the time. In the field of energy some 90%+ of the energy contained in natural gas is delivered when used in a gas appliance, when used for generating electricity that falls to around 30%. The free market price mechanism led to gas being used for electricity generation, efficient in terms of profitability but an inefficient use of energy

Anonymous said...

I've never heard the argument that tax cuts make people work harder. I think the benefit of tax cuts is that they lead to more money in the private sector. From what I've experienced, government tends to be far less efficient than the private sector. More money in the hands of the private sector means resources (i.e. money), on average, will be used more efficiently leading to a more productive economy overall.

Anonymous said...

I agree with the premise of one, but not the totallity. Immigration/illegal immigration has a huge impact on the work force and labor supply. Sorry but you are half right. If supply significantly changes the it does change employment. If the illegal population is 10 percent or less perhaps. However, as is truly the case in the U. S. yes it does impact employment. Lets see, there are in reality a far larger number of immigrants both legal and illegal in the U. S. (A huge undercount of illegals). Having worked int he field for years. I can pretty much tell you the 10-12 million illegals is way undercounted. Lets try 24-30 millions. A bit closer to the number. Althought it shifts based on the multiple amnesties (6) over the past 20 years. But still they keep coming. No this highly affects labor, wages, employment/unemployment.

David Breaker said...

Most of these "fallacies" are in fact "truths". This has got to be the most economically illiterate economics blog on the web! I know you're aiming at A Level students but this really is nonsense dressed as fact.

Immigration can cause unemployment. Although it increases AD, immigration will still increase unemployment unless the increase in AD is greater than the increase in Labour Supply. Generally immigrants don't greatly boost demand, and often send money to relatives overseas as well. As for the domestic unemployed "unwilling" to do the jobs, this is because they're paid unemployment benefits rather than having to take available jobs! There's also the matter of additional costs such as healthcare, schools for kids, etc, which taxpayers pay for immigrants.

As for not cutting taxes, what planet are you on? Lower taxes increases private sector investment and increases our competitiveness globally. Payroll, Corporate and Business taxes in particular add to the costs of employing people in a country, thereby lowering AD.

Anonymous said...

•If you cut income tax for high-income earners, they are likely to save a high % of their extra disposable income. Their marginal propensity to consume is low.

Yes indeed. This was the basis of John Maynard Keynes macroeconomic policies. It is precisely what IS required to get the economy moving again. It's what Hong Kong did and made it the economic powerhouse it has become. It is what many of the Tiger economies have been doing. In the West, we are intellectually tied to a 'loser takes all' mentality. We got lost in the Cult of the Loser. We worship losers. We reward losers. We support and encourage losers. We finance and fete losers. But woe betide those who look like they might actually achieve something! The full weight of the Parasite Economy will be brought to bear down on them. They will be taxed, and taxed again, and yet again. They will be assessed by nosey, non-producing, none-of-your-business, Public Sector parasites who will ensure these achievers receive not one penny of the taxes they pay out, no benefits, no support or assistance whatsoever. And so the Western economies slowly dwindle away, and their societies, no longer able to feed of a contracting tax base, begin to feed off each other.