Economics is a very useful tool for discussing the real world.
This includes breaking down fallacies about economics in the news.
Here are three fallacies in the areas of labour markets, consumption and downturns.
1) Lump of labour fallacy
Suppose there’s a fixed amount of work in the economy.
That would mean any automation would decrease employment.
Similarly, any immigration would decrease employment of people already in the country.
And finally, any increase in labour productivity would also lower employment.
This is the lump of labour fallacy.
What might be the problem with this argument?
The answer is that in reality, the amount of work may not necessarily be fixed.
For instance, automation may create a new set of jobs in technology or engineering.
Likewise, immigration may increase consumer demand (as there are more consumers) and create more businesses, increasing the amount of work to be done.
Even increasing productivity may lower firm costs and increase profits. This allows the firm to expand and hire more workers.
Now there may be some truth in some of the claims mentioned above.
For example, maybe automation, such as driverless lorries, may lower employment in sectors like lorry driving and at the macro level.
Immigration may make some workers better off but others worse off (as discussed in a recent newsletter).
Yet to prove this is the case, we may have to compare these against the countervailing, opposite forces.
Question to consider: if each worker halved their hours worked, could we double employment? Why or why not?
2) Paradox of thrift
Saving money may help people build a “rainy day” fund, put money towards a house or large purchase, and to retire for instance.
Thus, choosing to save can be a good idea at the individual level, depending on the circumstances.
However, what if everyone chooses to save more at the same time?
This means consumer spending falls.
A fall in consumer spending means lower revenues and profits for businesses.
These businesses may then fire their workers or reduce pay, making workers worse off.
This is the paradox of thrift.
 The paradox of thrift; individual case and everyone case |
What’s worse is that this can spiral downwards quite quickly.
If workers are worse off, they may cut their own spending too. This then leads to fewer jobs, further lowering incomes. A vicious cycle.
While saving (being “thrifty”) may be desirable at an individual level, if everyone saves at once, consumption falls and workers / businesses become worse off.
Another way to think of this is that at the level of one household, their income and spending are independent.
If I cut my spending by 5%, this is unlikely to affect my income.
But if all households cut spending at once by 5%, incomes may well fall.
One person’s spending is another person’s income.
Questions to consider:
- Can you think of an example of how the paradox of thrift applies to real world economies, like the UK?
- Are there any weaknesses to the paradox of thrift? Why might saving be desirable at an economy-wide level?
3) Broken window fallacy
Suppose someone breaks a window.
Well, I assume you would pay someone to repair it.
This creates a job, that wouldn’t exist without the broken window.
So, will breaking things boost economic growth?
This is the “broken window fallacy”.
Why is it wrong to say that breaking a window boosts growth?
Think about this for a second. See if you can come up with the answer yourself.
One answer is the idea of “displacement“.
Think about what the window fixer would be doing, if they were not fixing that window.
Perhaps they would already be fixing another window, that they are now having to leave broken.
In other words, that worker has been “displaced” from their original activity.
The idea of the broken window fallacy can apply to other downturns.
For example, consider the effects of wars or natural disasters on the economy.
After wars, many countries see a boost in growth. Take for instance economic growth after WWII, often called the “golden age of capitalism”.
However some economists will argue this growth may well be making up for lost growth during the war period itself.
The idea of displacement is also at the heart of cost-benefit analysis in government.
Suppose the government is considering a subsidy to a company. The government hopes to create jobs at the company this way.
Nevertheless, the government will need to consider whether those newly hired workers would have already been working instead or if they are unemployed.
In other words, whether the workers are “displaced” from old jobs.
Question to consider: is there another explanation for the broken window fallacy?
Related Posts
How the UK tackles market power, mergers and big tech
Why governments save some firms but not others
Will robots take our jobs? What economists say about AI
How free markets can provide public goods
Behavioural biases in decision making and how to avoid them
Why Goldin won the Economics Nobel Prize | 5 Key Takeaways
Key “marginal” economics equations and how they apply to the real world