Posted by on December 23, 2013

Do you remember the great scene from the Witches of Eastwick? The one where Jack Nicholson, playing the devil in the middle of a vengeful assault from his formerly docile female companions, stumbles into a church and asks: “So what do you think? Women: a mistake or did He do it to us on purpose?”

Substitute the word “politicians” for “women” and you have my feelings precisely.

One of the most infuriating habits of politicians is their inability, or, more likely, unwillingness, to learn the basic rules taught in Economics 101. I will speculate below on the reasons for this failure, but let’s start by taking a look at some recent examples.

Example number one is the “Help to Buy” program in the United Kingdom, implemented by the Conservative Party, which is proof that left-leaning politicians do not have a monopoly on economic ignorance. This program was born of the observation that housing in the UK is absurdly expensive. So let’s apply the teachings of Economics 101: We have a good that is too expensive, should we (a) increase its supply in order to drive its price down through, for example, liberalizing a permitting system for new construction that has elevated NIMBY’ism to an art form, or (b) implement a government guarantee for certain mortgage loans to make home finance more accessible? Answer (b), the choice actually made by the politicians, has the inevitable effect of increasing the demand for housing which, in the absence of an increase in supply, results in higher prices that offset the intended improvement in affordability. In fact, since the supply of new housing is completely inelastic in the short run and effectively inelastic in the long run (since it is constrained by the planning process), Economics 101 will teach you that almost 100% of the benefit of this program will be transferred to the existing owners of houses in the form of higher prices. And, not surprisingly, the UK papers now report that this is precisely what is happening.

Example number two relates to the same sector, housing, but the location is Germany. Germany is experiencing a boomlet in house prices and rents, and this has become a political issue. The fact that this recent rise follows more than 10 years of stagnation in prices and construction doesn’t seem to affect the deliberations of the politicians. Likewise, they appear not to notice that the market is well on its way to curing the problem with a recent rapid increase in housing starts. Instead, the German politicians have made a different choice from the UK ones, but one which is equally ignorant of the laws of economics. They have not chosen to subsidize demand, but rather to impose further rent controls, which will inevitably undercut supply. The end result, however, will be the same: they will achieve exactly the opposite of the goals they proclaim.

Lastly, let’s look at Obamacare, to prove that economic illiteracy is not uniquely European. As I have argued elsewhere, the central issue about healthcare in America is its cost, which is grossly out of line with other advanced economies. Although I have followed the debate about Obamacare from afar, I still think it is accurate to say that almost no discussion of supply has occurred. So, we are once more in the position of legislating without really understanding the problem. Instead, the Obama administration has chosen the same mistake as the UK government: in the face of a too-costly good, it has chosen to subsidize consumption instead of trying to increase supply, which will have exactly the opposite of the desired effect.

There are many things that the government could do to enhance the supply of medical care and therefore reduce its cost. The most obvious would be reform of tort law, which is a crying need in America in general, but something that will never be undertaken by a Democratic Party dominated by lawyers. Another would be the elimination of highly restrictive procurement rules, which medical suppliers have had written into law and which greatly increase the cost of medical care; we have all read horror stories of the absurd prices paid for medical equipment and supplies. Finally, pharmacies and paramedics can be allowed to deal with routine matters, as they are in most European countries, instead of treating our expensively educated pharmacists as glorified bottle stuffers. I am sure that this list could be greatly expanded.

Now, to the interesting bit: the speculation on why politicians consistently make basic economic mistakes. The first reason is that we are inevitably cursed to be ruled by lawyers. The job of the politician is to manufacture laws and, not surprisingly, lawyers have a competitive advantage in this field. Unfortunately, my professional experience shows that the average lawyer is innumerate and usually proudly so. They are probably one of the most economically ignorant segments of our society, particularly when their legal backgrounds are linked to an almost total absence of real world experience à la Clinton, Obama, their wives, and the cadre of professional politicians who dominate, in particular, the Democratic Party. Combined with this economic ignorance is a fundamental belief, manifested in their choice of profession and reinforced through their training, that the only way to accomplish anything is by diktat. Lawyers have an in-built bias to expand government; economics teaches us that, in almost all cases, this is a mistake.

But there is another problem: virtually all politics is a simplistic narrative of good versus evil. Unfortunately, economics is a bit more complicated than that. Note that the correct policy response in all the cases cited above would appear to reward the demonized party. When it is obvious that housing prices in the UK or Germany are too high due to the predations of developers and landlords, why should we reward them with easier planning? When everyone hates medical insurers, why should we help them avoid lawsuits? The answer that, through the workings of the “invisible hand”, this will indirectly achieve the desired goal is too sophisticated for the average voter and the politicians who pander to them.

Finally, we must always consider the issue of self-selection bias. Virtually the entire political process — the electioneering, the adoring crowds, the media attention, the fleets of black limos and security guards, the Congressional subpoena powers, the God-like granting of preferences (with the money of someone else), etc. — is designed to select for and then promote egomania. If anyone doubts this, they need only consider the case of Barack Obama: a first-term, junior Senator with a completely undistinguished legislative record and virtually no life accomplishments who had absolutely no doubt, at a moment of great national difficulty, that his rhetorical gifts and exotic personal narrative aptly qualified him for the Office of the President. But Obama is not alone, this is a bias that affects nearly all politicians and makes them unwilling to accept the limitations on their actions imposed by the laws of economics. Like King Canute, they feel that they should be able to command the waves (and the markets), and they inevitably feel justified in punitive action when these fail to obey.

Government intervention is nearly always justified on the basis of market failure. This usually involves the comparison of an imperfect market to an allegedly perfect intervention. As the above examples show, the cure is almost inevitably worse than the disease.

Roger Barris
London

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Posted in: Economics, Policy

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