[ Economic models do not, and never can, fully reflect the
extraordinary complexity of human markets. The point is to create
useful abstractions to provide decision-makers with a sense of the
budgetary and economic impacts of a given policy proposal.]
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SIX WAYS EXISTING ECONOMIC MODELS ARE KILLING THE ECONOMY  
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Nick Hanauer
April 5, 2023
The American Prospect
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_ Economic models do not, and never can, fully reflect the
extraordinary complexity of human markets. The point is to create
useful abstractions to provide decision-makers with a sense of the
budgetary and economic impacts of a given policy proposal. _

Illustration By Rob Dobi / The American Prospect,

 

Americans have been hammered for decades with an economic message that
amounts to this: When wealthy people like me gain even more wealth
through tax cuts, deregulation, and policies that keep wages low, that
leads to economic growth and benefits for everyone else in the
economy. And equally, that investing in you, raising your wages,
forgiving your debt, or helping your family would be bad—for you!
This is the trickle-down way of thinking about economic cause and
effect, and there can be no doubt that it has substantially
contributed to the greatest upward transfer of wealth in the history
of the world.

You would think that trying to sell such a disastrous outcome for the
broad mass of citizens would be incredibly unpopular. No politician
would outright say they want to shrink the middle class, make it
harder to get by, or reward hard work less. No politician would
outright say that rich people should get richer, while everyone else
struggles to make a decent life.

But this message has been hidden under the confusing,
technical-sounding, and often impenetrable language of economics. Many
academic economists do important work trying to understand and improve
the world. But most citizens’ experience of economics comes from
hearing a story—a narrative that rationalizes who gets what and why.
The people who benefit from trickle-down policy the most have deployed
economists to work their magic to tell this story, and explain why
there is no alternative to its scientific certitude.

One of the trickle-down economists’ main persuasive tools is the
economic model, used to predict and assess the outcome of economic
policies and other major economic developments. These existing models
exert such great force on the political debate in large part because
their predictions are treated by politicians and reporters as neutral,
technocratic reality—simple economic facts, produced by experts,
that reflect our best understanding of economic cause and effect.

What few understand is that these economic models do not, and never
can, fully reflect the extraordinary complexity of human markets.
Rather, the point is to create useful abstractions to provide
decision-makers with a sense of the budgetary and economic impacts of
a given policy proposal. More disturbingly, the assumptions baked into
these models completely define what the models predict. If the
assumptions are wrong, the models will be wrong too.

And these models are deeply and consistently wrong.

But “wrong” doesn’t capture the true problem. The deeper problem
is that these models are all wrong in the _very same way_, and in the
same direction. They are wrong in a way that massively benefits the
rich, and massively disadvantages everyone and everything else.

The headlines derived from these models consistently reflect this
bias: “Raising Minimum Wage to $15 Would Cost 1.4 Million Jobs, CBO
Says
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or “Biden Corporate Tax Hike Could Shrink Economy, Slash U.S. Jobs,
Study Shows
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Models serve less as scientific analysis and more as incantations from
the cult of neoliberalism.

Models serve less as scientific analysis and more as incantations from
the cult of neoliberalism, and if politicians and journalists continue
to accept them with the same naïve credulity that they always have,
they will hamper the astounding middle-out economic progress
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the Biden administration has made toward rebuilding a more equitable,
prosperous economy for all.

The problem is that few people take the time to explain what these
faulty assumptions are, why they all promote the worldview of the rich
and powerful, and why they shouldn’t be treated as science but as a
trickle-down fantasyland.

Here are six of the assumptions built into most economic models that
are among the most pernicious:

1. MODELS ASSUME THAT PUBLIC INVESTMENTS WILL “CROWD OUT” PRIVATE
INVESTMENT, AND ARE BY DEFINITION LESS PRODUCTIVE THAN PRIVATE
INVESTMENTS.

What happens to the economy if the federal government spends $1
billion? The normal person would say that it depends what they spend
it on, and how the policy is designed.

Not so in most economic models. They assume that _any_ government
spending will have less of a return than whatever private businesses
spend their money on. Always.

But that’s not all. They say that government spending even comes
with a _penalty_: It automatically causes businesses to spend less,
leading to lower overall investment. Always.

Essentially, models assume that every increase in public investment is
canceled out by the combination of lower returns and reduction in
private investment. Taking this assumption to its logical extreme,
there’s almost nothing government should ever invest in. It’s a
good thing Eisenhower took office before the neoliberal style of
thinking came to dominate Washington, or instead of interstate
highways we’d still have dirt roads.

These assumptions aren’t even well hidden in models but baked
directly into the math. As economist Mark Paul has noted
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Congressional Budget Office model assumes that all public investments
are exactly half as productive as private investments. Public
investments return 5 percent annually, while the same amount of
private investment returns 10 percent.

The first indication that something is amiss here can be sensed in all
these round numbers—a flat declaration that public spending is 50
percent less good than private spending. Precisely 50 percent. Every
time. Obviously, this is not the result of rigorous data analysis.
It’s simply recapitulating the old trickle-down myth that government
is by definition wasteful, while private investment is always
maximized for the greatest efficiency and return.

And it’s not even a little bit true. Think about health care. The
U.S. government invests billions in basic research each year and is
responsible for funding an incredible range of innovations, from mRNA
vaccine technology
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Everyone benefits from this publicly funded research, sparking further
innovations and benefits—much of it carried out by the private
sector.

Then consider how Big Pharma invests its profits: with huge marketing
budgets, predatory patent enforcement
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billion in stock buybacks
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five years (more than was spent on research and development), and a 14
percent increase in executive compensation. It’s a bonanza for those
corporations, but it’s the opposite of efficiency—except in the
make-believe world constructed by economic models.

The point isn’t that government spending always returns more than
private spending, just that the flat assumption that it is always
worse by 50 percent simply doesn’t map to reality. We should assess
policy by what it proposes to do, not who proposes to do it.

 

A semiconductor factory being constructed in Arizona. The CHIPS and
Science Act has already sparked $200 billion in private investment.
 (KYODO  //  The American Prospect)
The other idea, that public investment leads to lower private
investment, is usually expressed with a fancy term: “crowd out.”
It is a bedrock principle of neoliberal economics, and most models
simply assume it’s true. The Penn Wharton Budget Model, for
example, explicitly holds
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government investments reduce the amount of private capital
investment. Because the model also assumes that private investment is
“productive” and public spending is “unproductive,” this
automatically results in any large-scale government investment causing
lower growth and lower returns. That informs their budget model’s
analyses that the bipartisan infrastructure law will somehow lead to
a 0.2 percent decline in productive private capital
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that the $2 trillion Build Back Better proposal would reduce GDP
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0.2 percent, and that the COVID relief package would also reduce GDP
by a similar amount
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The State Tax Analysis Modeling Program (STAMP)
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Beacon Hill Institute makes an even stranger decision, modeling
government simply as a pass-through entity that causes “no indirect
or induced effects” whatsoever.

Thankfully, President Biden rejects this nonsense. A central plank of
Biden’s middle-out approach is to attract private investment in key
industries through the strategic use of public dollars. As Secretary
of Commerce Gina Raimondo explained
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the implementation of the CHIPS and Science Act, “If we do our job
right, the $50 billion of public investment will _crowd in_ $500
billion or more of private investment of additional funding for
manufacturing, for research and development, for startups” (emphasis
added).

This strategy is already working. According to the Semiconductor
Industry Association, the CHIPS and Science Act has already sparked
$200 billion
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private investment. The Climate Smart Buildings Initiative
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by the Inflation Reduction Act—is expected to attract over $8
billion of private-sector investment for modernizing federal
buildings. The Biden administration has allocated $2.8 billion in
public funds for investments in battery manufacturing for electric
vehicles, which has already leveraged $9 billion
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additional private investments. The story is much the same across the
Biden administration’s constellation of strategic middle-out
investments—public dollars are attracting private dollars, not
displacing them, wholly disproving model assumptions in the court of
reality.

2. MODELS ASSUME WORKERS’ WAGES ARE A DIRECT REFLECTION OF THEIR
PRODUCTIVITY.

Does Jamie Dimon produce 917 times what the average JPMorgan Chase
worker produces? Does the CEO of McDonald’s produce 2,251 times the
average cook or cashier? The answer is obviously no.

People are not paid what they are worth. They are paid what they have
the power to negotiate. You don’t ask for a raise when the company
just laid off an entire division and unemployment is high. If the
company just posted a bunch of job openings? That’s a good time.
We’d like to think that our hard work and worth to the company
determines our salary, but just look around the office. Most of the
time, bargaining power, not the value that worker provides, tells the
story.

But the Econ 101 assumptions embedded in these budget models
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that wages are a direct and perfect reflection of a worker’s
economic contributions—that every worker is paid _exactly_ what
they’re worth.

There’s no discrimination in the alternate universe created by
models, so structurally lower pay for women, immigrants, and people of
color must necessarily reflect their lower productivity. Separately,
Wall Street speculators—who produce pretty much nothing of value for
anyone but themselves—are of the highest economic value because they
get paid the most. Does anyone really believe that private equity
barons are more productive in society than teachers? The models do,
because they assume wages perfectly reflect productivity.

If the models correctly understood that power plays the primary role
in wages, they would see raising the minimum wage as correcting for
the power imbalance of a loose labor market or an exploitative
industry. But since the models connect wages with productivity,
raising the minimum wage, by definition, lifts a worker’s income
above their economic value, and thus should cause substantial job
losses. That’s just what the REMI model
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the synthetic University of Washington model
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Institute model
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the CBO model
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The Baker Institute’s Diamond-Zodrow model even reached the
ludicrous conclusion that a higher minimum wage negatively impacts
children’s health
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modeling that a 1 percent increase in minimum wage caused a 0.1
percent _decrease_ in their height-for-age, in spite of empirical
evidence to the contrary
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These predictions occurred throughout the Fight for $15 as minimum
wages rose across the country. And if the models were right, Seattle
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York
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have seen substantial job losses. But guess what? It never happened.
On the contrary, businesses, particularly those affected by the
minimum wage, like restaurants, boomed. Not once did these increases
cause predicted job losses in the real world.

That reflects a simple fact about the economy. When more workers have
more money, they will spend at more businesses. And that broad-based
consumer demand sparks growth and innovation, which in turn drives
productivity. In other words, higher wages are a _cause_ of
productivity, not a _reflection_ of it.

3. MODELS ASSUME THAT HIGHER TAXES ON CORPORATIONS AND HIGH-INCOME
PEOPLE REDUCE GROWTH AND INVESTMENT.

While corporate lobby groups and the zillionaires they represent
regularly complain that taxes kill jobs and slow overall economic
activity, no such relationship is detectable in the historical record.
If anything, the opposite is closer to the truth: When the top
marginal tax rate was above 90 percent in the 1950s, overall economic
growth was remarkably strong and broad-based. When the top rate was
slashed to 28 percent in Reagan’s trickle-down revolution,
inequality exploded, and growth sagged for decades as money was
redistributed upward.

But the economic models that control the D.C. policy debate take as
absolute truth the trickle-down assumption that people will work less
if they are taxed more, and that this effect is very large. Any
increase in tax rates on the rich therefore reduces the amount of work
performed by the very richest people—and since rich people are in
the world of these models the most productive people around, that
means a sharp reduction in economic output.

In reality, of course, rich people don’t organize their lives as a
tax-avoidance strategy
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much less work less if they earn less. The model assumes away any
factor that drives people to make a lot of money; ego, to use one
example.

A corollary assumption is that high incomes arise in a world of
perfect competition, where new products are able to beat out
incumbents by force of their genius alone, supply and demand are
always in perfect equilibrium, and monopoly is just the name of a
board game. In this world, all taxes and regulations must simply
reduce productive corporate spending, and thus reduce economic growth.

Models have no way to interpret things that generate economic activity
but that we might want less of—for example, carbon emissions or
water pollution.

The Tax Foundation’s Taxes and Growth model, for example,
arbitrarily assumes
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all payroll taxes are fully borne by workers, and corporate income
taxes are assumed borne 50 percent by capital and 50 percent by
workers. Therefore, corporate tax cuts will always “increase the
capital stock and expand the whole economy, including wages and
employment,” while a payroll tax cut will do nothing for investment
and economic expansion. By contrast, a corporate tax increase would
harm investment and growth.

It’s no accident that this is entirely untethered from actual human
behavior or productivity measures—it’s the point of the model. In
the real world, dominant market players regularly take advantage of
their position to extract excessive rents and stifle innovation.
Anyone who has flown on a commercial jet or tried to buy concert
tickets has experienced the wildly imperfect competition that exists
in the American economy.

Well-designed public policy can get at these problems by aiming taxes
specifically at those places where rents are extracted, making the
entire economy more productive. And antitrust enforcement can
similarly spark meaningful competition where it may have been eroded
by predatory market actors. The only place where this doesn’t make
sense is in the middle of an economic model.

4. MODELS ASSUME THAT INVESTING IN POOR PEOPLE REDUCES ECONOMIC
ACTIVITY, AND THAT IMMIGRANTS ARE LESS PRODUCTIVE THAN DOMESTIC
AMERICAN WORKERS.

What happens if the government gives people in need financial help?

If you get $50 for food, will you eat more food? If you get $100 for
health care, will you go to the doctor more? If you get $100 for rent,
will you be able to afford an apartment? And will any of these
benefits enhance your personal well-being?

In the world of models, all of that is irrelevant. No matter what the
money is for, the result of any federal assistance is that you will
work fewer hours. Always.

While the models insist that rich people must be offered higher wages
or lower taxes to incentivize them to work more, they hold that more
economic support to lower-income people leads to them working less. In
other words, rich people require the promise of even more wealth to
motivate them to be productive, but the poor must be threatened with
destitution in order to motivate them.

The Baker Institute’s Diamond-Zodrow model
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the explicit assumption that “any increases in government transfers
… reduce labor supply as individuals choose to ‘consume’ more
leisure because their income level has increased.” The Tax
Foundation’s model
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a similar assumption: that people choose between leisure and work, and
that such choices are sharply impacted by taxes and transfers. These
kinds of assumptions are how the Penn Wharton Budget Model’s
analysis
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Biden’s Build Back Better proposal could find that “lowering the
Medicare age to 60 and making the ACA subsidies more generous lower
households’ financial risk, so they save and work less,” and that
reducing Medicare drug prices similarly reduces hours worked (and,
oddly, reduces household savings as well).

This is nefarious stuff. These models assume negative consequences
from the government investing in affordable housing or food
security—basic necessities that make it possible for people to
participate in society. It’s an Ebenezer Scrooge understanding of
the economy: People are poor due to their own laziness, so any dime
you flick in their direction just encourages them to do even less.

Most experiments with basic income
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tax credits
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and other transfers find that basic investments enable people to
participate more fully in the economy and in their communities. Plus,
providing a basic standard of living can also spur future economic
gains. Only a sociopath could unequivocally conclude that giving
people food always makes them work less.

The models are even more direct when it comes to immigrant workers.
The Penn Wharton model incorporates a baseline assumption
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as a natural law of economics, immigrants produce less
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workers do
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This is stupid and wrong, not to mention racist. While immigrant
workers do tend to get _paid_ less than other workers, there is no
data whatsoever showing that they _produce _less. In fact, research
even suggests the opposite: that increased immigration is tied to
higher employment, higher incomes, and higher productivity
[[link removed]].

 

The ten-year budget window shortchanges investments in children that
pay off over their lifetimes.
 

5. MODELS WORK ON TEN-YEAR BUDGET HORIZONS THAT FORCE SHORT-TERM
THINKING.

By the rules of Congress, the country’s best-known model, the CBO
model, is required to estimate budget impacts of policy proposals over
a ten-year window. For this reason, Penn Wharton
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the Tax Foundation
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follow suit. That decade-long window creates the jaw-dropping
multitrillion-dollar numbers that make headlines when Congress debates
economic policy.

This arbitrary time frame is the worst of both worlds. It’s long
enough that the accuracy of the estimates becomes highly questionable,
and it’s also far too short to even begin to assess the economic
impact of interventions on generational issues like climate change or
early-childhood education.

For example, essentially everyone agrees that universal pre-K produces
extraordinary benefits to children’s education, and essentially
everyone agrees that these investments will create better outcomes for
the entirety of a child’s life.

But over ten years, that investment won’t be realized. Children
enrolled in pre-K at three years old are still in middle school ten
years later—not really time to see much (if any) economic impact,
now that child labor is (generally
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frowned upon. So universal pre-K is basically worthless to these
models, no matter how much economic growth it may create over the next
six or seven decades. Investments in children are mostly thought
to pay for themselves
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except in the case of a budget model.

Some policies have a short enough scope that the impact is realized in
the budget window. But the arbitrary ten-year cutoff cannot possibly
be appropriate for all policy interventions. It literally shortchanges
long-term planning, which is about as wrongheaded as you can get.

6. MODELS MEASURE GDP AND REVENUE RATHER THAN WELL-BEING.

Economic growth is generally a good thing. It brings more people into
the economy, and creates more resources to produce solutions to human
problems. This is fundamental to how markets work.

But not every positive human outcome can be measured in terms of
growing GDP or increased revenue. As Bobby Kennedy so eloquently
pointed out in his March 1968 remarks at the University of Kansas
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an exclusive focus on these strictly numerical measures of the economy
counts napalm and nuclear weapons as positives, ignores the value of
health, education, and community, and ​“measures everything, in
short, except that which makes life worthwhile.”

This measurement gap stubbornly persists in today’s budget models,
which have no way to interpret things that generate economic activity
but that we might want _less_ of—for example, carbon emissions or
water pollution. Viewed as a model input, reduced carbon emissions and
pollution could tend to reflect less economic activity—a net
negative.

It’s certainly true that the economic value of these reductions is
hard to measure solely in terms of dollars. And it might not even be
desirable for economic models to attempt to calculate a literal price
on mass shootings or the net present value of a climate apocalypse.
But to the extent that we continue to let the numerical results of
these flawed models drive our economic decision-making, we preclude
even the possibility of reducing the factors we want less of in order
to build a better society for generations to come.

WHEN WE CLARIFY THE EXTENT TO WHICH the dominant economic models we
use to judge policy are rigged against working families and the
broader economy, the cause of the extraordinary upward transfer of
wealth in the past four decades becomes much easier to understand.
Policymakers in Washington have based their decisions on models that
are consistently biased toward the status quo, the rich, and private
capital. They often amount to little more than a Mad Libs version of
trickle-down economics, their exalted status in media and politics
notwithstanding.

The basic structure of these models always remains fixed. Government
is too inefficient and public investments are too expensive to make a
difference; competition is perfect, market concentration is imaginary,
and corporate power should be left alone; discrimination does not
exist, all markets are at equilibrium, and wages perfectly correspond
to productivity. The adjectives, policies, and numbers may vary a bit,
but the story is always the same. Any policy benefiting capital,
industry, or the rich is an unalloyed good. Any policy that benefits
people directly is inefficient, kills incentives, and will harm the
overall economy.

By tilting the playing field to restrict investment, undermine
regulation, push down taxes, and lower wages, these economic models
are doing their best to kill the economy. They may produce dense
economic jargon and elegant mathematics that sounds super-impressive
and scientific when it’s quoted on the front page of _The New York
Times_. But on closer inspection, it looks a lot more like a
protection racket for the rich and powerful than a social science.

Until we build models that reflect how the economy really grows, our
leaders and the media should eye models from mainstream economists
with skepticism. Models trying to convey the effects of policy should
reflect the basic understanding that when more people have more money,
that’s good for business. We need models that understand the basic
principle that when the economy grows from the middle out, that’s
good for everyone, and when more people participate in the economy,
their consumer demand drives job creation and sparks innovation. In
other words, our economic models must reflect the world as it really
is—not as it was portrayed in the trickle-down Econ 101 classrooms
of the 20th century.

_[NICK HANAUER is a Seattle-based entrepreneur and venture capitalist,
and the founder of Civic Ventures, a public-policy incubator.]_

_This article appears in the April 2023
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Prospect magazine. Subscribe here
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_Read the original article at Prospect.org
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Used with the permission. © The American Prospect
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