The Dismal Science? Hardly!
Wall Street Journal
June 4, 2003

Weeks ago, I had lunch with the smartest woman in the world: Marilyn vos Savant, the "Ask Marilyn" columnist in Parade magazine.

According to the folks at the Guinness Book, Marilyn has the world's highest recorded I.Q. She is interested in economic education, of all things, and we met at a board meeting of the National Council on Economic Education. I told her I think economics is a good major for smart students, but if they are really, really smart, I'd rather they become doctors so they could do somebody some good. She said, "Yes, but doctors help people one at a time, while an Alan Greenspan can help millions of people at a time." She has a point. Mr. Greenspan is an excellent example of someone making a big difference by applying good economics.

My take on training in economics is that it becomes increasingly valuable as you move up the career ladder. I can't think of a better major for corporate CEOs, congressmen or American presidents. You've learned a systematic, disciplined way of thinking that will serve you well. By contrast, the economically challenged must be perplexed about how it is that economies work better the fewer people they have in charge. Who does the planning? Who makes decisions? Who decides what to produce?

For my money, Adam Smith's invisible hand is the most important thing you've learned by studying economics. You understand how we can each work for our own self-interest and still produce a desirable social outcome. You know how uncoordinated activity gets coordinated by the market to enhance the wealth of nations. You understand the magic of markets and the dangers of tampering with them too much. You know better what you first learned in kindergarten: that you shouldn't kill or cripple the goose that lays the golden eggs.

You've learned other useful things as well. You understand why free trade is a good thing, even though you have difficulty convincing your dads and uncles. You know from Irving Fisher's example the hazards of forecasting the stock market, or anything else for that matter. Especially if it's about the future. The public looks askance at economists because they think of them primarily as forecasters. Don't let yourself be labeled a forecaster.

Economics training will help you understand fallacies and unintended consequences. In fact, I'm inclined to define economics as the study of how to anticipate unintended consequences. Most fallacies in economics probably are fallacies of composition: What's true of the individual may not be true of the whole. You may be able to see better if you stand up—but not if everyone stands up. John Maynard Keynes' paradox of thrift provides a currently relevant example: Individually, most consumers need to save more. But, if all or many consumers start trying to save more, the economy will be in deep trouble.

However, little in the literature seems more relevant to contemporary economic debates than what usually is called the the broken window fallacy. Whenever a government program is justified not on its merits but by the jobs it will create, remember the broken window: Some teenagers, being the little beasts that they are, toss a brick through a bakery window. A crowd gathers and laments, "What a shame." But before you know it, someone suggests a silver lining to the situation: Now the baker will have to spend money to have the window repaired. This will add to the income of the repairman, who will spend his additional income, which will add to another seller's income, and so on. You know the drill. The chain of spending will multiply and generate higher income and employment. If the broken window is large enough, it might produce an economic boom! (Other catalysts to such booms might be a hurricane, a tornado or just about any government spending boondoggle.)

Most voters fall for the broken window fallacy, but not economics majors. They will say, "Hey, wait a minute!" If the baker hadn't spent his money on window repair, he would have spent it on the new suit he was saving to buy. Then the tailor would have the new income to spend, and so on. The broken window didn't create net new spending; it just diverted spending from somewhere else. The broken window does not create new activity, just different activity. People see the activity that takes place. They don't see the activity that would have taken place.

The broken window fallacy is perpetrated in many forms. Whenever job creation or retention is the primary objective I call it the job-counting fallacy. Economics majors understand the non-intuitive reality that real progress comes from job destruction. It once took 90% of our population to grow our food. Now it takes 3%. Pardon me, Willie, but are we worse off because of the job losses in agriculture? The would-have-been farmers are now college profs and computer gurus or singing the country blues on Sixth Street.

If you want jobs for jobs' sake, trade in bulldozers for shovels. If that doesn't create enough jobs, replace shovels with spoons. Heresy! But there will always be more work to do than people to work. So instead of counting jobs, we should make every job count. We will occasionally hit a soft spot when we have a mismatch of supply and demand in the labor market. But that is temporary. Don't become a Luddite and destroy the machinery, or become a protectionist and try to grow bananas in New York City.

Labor productivity is growing rapidly and substituting in the short run for employment growth. But when businesspeople get their animal spirits back and take advantage of historically low interest rates to invest in America's future, we'll have employment growth in addition to productivity growth. That's a recipe for prosperity. In the meantime, just think what Michael Dell and Bill Gates could have accomplished if they'd gotten degrees in economics.

About the Author Mr. McTeer is president and CEO of the Federal Reserve Bank of Dallas. This is adapted from his May 17 commencement address to economics graduates at the University of Texas. A complete version is at www.dallasfed.org. Reprinted with permission of The Wall Street Journal © 2003 Dow Jones & Company, Inc. All rights reserved.