A confession of my ignorance

Published 6:40 pm Wednesday, July 31, 2013

By Daniel Sutter

When people learn that I am an economist, they often ask me, why has the price of gas been rising, why is milk so expensive now, or if I have any stock tips. I say that supply and demand determines prices, which is technically true but not very specific. Most often I have no clue as to why specific prices rise or fall. While this confession might make you doubt my professional competence, the nature of economic knowledge explains how one can understand how markets work without knowing why prices change.

Why does such an issue matter? Confusion over the nature of economic knowledge led early 20th Century intellectuals to view socialism as “scientific” and the way of the future. The confusion also explains why bureaucrats often think that they can make markets work better.

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When we think of knowledge, we often think of things like multiplication tables, chemistry formulas, and the law of gravity. Mathematical and scientific truths are general and timeless: 2 + 2 equaled 4 back in grade school and now, and is true in the U.S. and China. Economic truths, like the least expensive way to build a car or whether a good can be profitably production of a good is profitable, are very different. Economic knowledge, as Nobel prize winning economist Friedrich Hayek first pointed out, is time and place specific: what is profitable today may not be profitable tomorrow.

We observe the nature of economic knowledge in our day-to-day lives. For instance, we know that the three most important factors in real estate are “location, location, and location.” While 2 + 2 always equals 4, the value of a 4 bedroom house built in 1990 varies based on location. Buggy whips were profitable in the 1870s but no longer. Yet we can fail to grasp the meaning of these observations.

The nature of economic truth implies that no way of doing things is always best. Before the energy crises of the 1970s, flowers for Valentine’s Day were grown in greenhouses across the northern U.S. Rising energy costs made this unprofitable, and now flowers from Kenya and Colombia are flown to the U.S. But this could change in the future.

Disruption after a hurricane illustrates the changing nature of economic knowledge. Usually bagged ice is plentiful and inexpensive. Ice sells for about $2 a bag and making ice is not a way to get rich. The price of ice is so predictable that we think that this is what the price should be. When a hurricane knocks out power and lots of people want ice, the price might jump to $10 a bag. Ice, at least temporarily and locally, is now in demand and profitable. Yet intellectual confusion breeds policy confusion. Although the price spike reflects changed economic conditions, we react with outrage, and states pass laws making “price gouging” illegal.

Former Vice President Al Gore exhibits confusion over economic knowledge he writes in Earth in the Balance of peoples’ frustration with being unable to find buyers for material “they knew could be profitably recycled.”

The nature of economic knowledge allows no guarantee that recycling any specific item will always and everywhere be profitable. This does not mean that recycling is never worthwhile, or even that we shouldn’t recycle more than we do today. Mr. Gore’s erroneously calls for government action to correct a nonexistent problem based on confusion about economic knowledge.

“Experts” who confuse scientific and economic knowledge offer the greatest danger. Such experts want to impose something that works well in one time and place everywhere. And more tragically, they ignore evidence of the cost of their misconceived efforts, in part because they cannot imagine how they could be wrong. After all they know “the” truth, and 2 + 2 always equals 4. Friedrich Hayek referred to this as the “fatal conceit” of government planners.

The fatal conceit is certainly alive and well in Washington today. And if admitting ignorance is the hallmark of a good economist, I may be qualified for my job after all.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University. Talk back to him at dsutter@troy.edu and like the Johnson Center on Facebook.