Economist's View: Baumol: Errors in Economics and Their Consequences

New Economist notes William Baumol's essay on the consequences of errors in economics:

    Errors in economics a reason for modesty: Baumol: NYU's William Baumol thinks economics "is particularly vulnerable to mistaken ideas contributed from the outside." His article, Errors in economics and their consequences, appeared in a special issue of Social Research on errors (hat tip: Political Theory Daily Review). His concluding remarks...

Here's the section of the article just before the conclusion highlighted by New Economist, along with the conclusion itself. Those of you who have been critical of economists will want to read this, and there's plenty for everyone else too:

    Must Outsourcing to Other Nations Always Benefit Both Affected Countries?

    I come to my last illustration, this time as a misunderstanding widely current among economists, and one on which the unspecialized general public seems to have arrived at a more defensible conclusion than many of the professionals. Not without reason, economists are usually strongly predisposed to favor free trade, globalization, and market-driven apportionment of industries among nations. But this orientation has led many of them to conclude that when a portion of an economic activity or even an entire industry moves from a high-wage to a low-wage country as a result of an increase of productivity in the latter, both the gainer and the loser of the industry can be expected to benefit. In particular, while some individuals in the country from which the activity has emigrated will evidently be harmed, on this view the country as a whole will normally benefit ... sufficiently to compensate for the damages and more.

    Here, a colleague and I have been driven to disagree with many other economists and have shown that, in what we believe to be a large range of cases, the country that loses the activity can be expected as a result to suffer a decrease, possibly substantial, in its overall per-capita income, that is, in its standard of living, and this damage need not just be a transitory loss (see Gomory and Baumol, 2000 and forthcoming).

    Those who believe that macroeconomic policy can effectively limit involuntary unemployment have reason to conclude that loss in the total number of jobs is not an inevitable consequence of globalization... But though we may reject the popular view that globalization is a major threat to employment and an instrument of extensive job loss, we cannot deny that there is reason to be concerned with at least the short-term effects on wages in both developing and developed lands. International competition can influence relative input prices and thereby determine whether machinery will be substituted for labor, for example, or whether skilled labor will be substituted for unskilled. There are, also, more direct implications for wages. Surely, the increased use of computer programmers in India can be expected to reduce the demand for such skills in the United States below what it might otherwise have been.

    For the developing countries, economic history suggests that an industrial revolution initially tends to depress real wages and real living standards, thus supporting the concerns of those who fear the consequences of globalization for the world's less prosperous nations. Though the British industrial revolution is usually considered to have taken off about 1760, it was probably not until approximately 1840 that wages began to rise. Data on life expectancy and average height also indicate that the spread of innovation was accompanied by worsening of the economic status of wage earners, perhaps in part as a result of the move from the countryside to crowded, unsanitary slums; the evidence indicates that the US labor force underwent a parallel trajectory. One may surmise that part of the explanation was a rise in the power of employers and an inability of the workers, in the absence of labor organizations, to resist.

    The opponents of globalization draw attention to a similar phenomenon in twenty-first-century globalization, with multinational employers subjecting their employees to disturbingly low wages and shocking working conditions, particularly on the criteria widely accepted in the affluent economies (though by no means always adhered to even there). Thus, even if globalization is a very promising influence for the more distant future prospects of the developing countries, there is good reason to fear that in the short run the workers in those lands may gain little and may even lose out in the initial stages of globalization.

    It can be argued that all this is transitory and that in the long run the lower-income groups in the developing countries will be better off, as has indeed been true in the developed economies. But the process can easily take decades. We cannot just ignore decades of very substandard earnings that amount to preservation of grinding poverty in a developing country or the permanent structural unemployment in a developed economy that can beset older workers whose skills are made redundant by innovation, and for whom the acquisition of new skills is not a practical option. These are hardships that constitute an extremely painful economic pathology for the affected individuals. At the very least, one can argue that those who stand to benefit from the process should be expected to agree to provide systematic and substantial assistance to the victims, presumably through government channels, and supported liberally by the wealthier communities. If that is not acceptable politically, there is surely little that can be said convincingly in support of a contention that the suffering of the victims will be justified by the promised future benefits to their descendants.

    Possible Longer-Run Damages from Globalization

    Though it can be hoped that, in the longer run, globalization will help to reduce (and even eliminate) poverty in the developing countries, as I have stated earlier (and contrary to widely held views), globalization can also permanently damage economic well-being in some of the affected countries, notably those countries that are now in the economic vanguard. This possibility may seem surprising, and even paradoxical. The simple explanation is that competition and mobility of products tend to equalize wages, raising those that are low, but also reducing those that are especially high. ... [T]his scenario shows the possible dangers to wealthier nations that arise from globalization. It does not mean that globalization is inherently undesirable, or that wealthier nations should never make sacrifices to help impoverished societies. But it does mean that we should not proceed under the illusion that we will assuredly profit from the process.

    What Have We Learned and What we Need to Learn

    The approach taken here is quite different from most current discussions of globalization. ... The approach ... has been used to investigate that overall effect, and has told us that the net consequence for a country of improved productivity abroad is neither always beneficial nor always deleterious but can be either, depending on the circumstances characterized above. To this result there is also something contributed by the more popular discussions that characteristically focus on the possibility that displaced workers will not find new jobs or will only obtain jobs that provide a lower wage than before, because these workers can no longer use the accumulated skills and know-how of a lifetime.

    Of course, that is not the end of the story, at least in the long run. For there is a powerful countervailing force that works to produce long-run benefits to all countries affected by globalization. The power of international competition has arguably contributed much of the unparalleled, sustained economic growth and the unrivalled explosion of innovation that the free-market economies have experienced in the past two centuries. In the countries that have participated in this process, the economic benefits are so spectacular that they could hardly have been imagined by our ancestors. Globalization can extend this process to other nations and can strengthen such developments substantially even in the world's leading economies. Although difficult to quantify, this may well be the greatest economic promise of globalization.

    Anyone Can Err

    If the arguments of this paper are not themselves in error, what I have shown is that the economics profession can, indeed, sometimes show the layperson the error of his or her more common-sense thoughts. But not always. Sometimes the errors and the route toward correction go the other way. This observation is not meant in any way to denigrate the work of my colleagues. After all, it is only through careful analysis that one can discover where it is the specialist who has been wrong and where the often exceedingly fallible common sense of those with no formal training in the field has turned out to be closer to the underlying reality.

    We have also seen that misunderstanding in the field of economics can have consequences beyond pushing researchers and teachers in misguided directions. Perhaps as much as any discipline, erroneous economic analysis and conclusions can elicit policies severely damaging to the public interest. And, in this, I believe that we economists do have something to answer for. We are all too prone to put more faith in the implications derived from our quite appropriately simplified models, and to draw from those implications policies that really only apply universally in the artificial world of the constructed model.

    The recommendation to ourselves that seems appropriate here is advocacy of somewhat enhanced modesty when we do offer advice, and more ready willingness to remind our listeners that, though we are offering the best advice we are in a position to provide, they must recognize that the recommended course may yet prove dangerous to the public health.