On Monday, I wrote
disagreeing with John Quiggan’s piece on “Pareto optimality” being the most
misleading term in economics. My disagreement was more with his argument than his conclusion, but nevertheless, it got me thinking about what is the most misleading term in
Economics. I have four favourites, which I will list in reverses order. These
are all misleading in some way, but to different audiences.
4. Efficiency.
As I said, I don’t
entirely disagree with John’s conclusion. I believe that when economists use
the term efficiency without an adjective, it (nearly) always refers to Pareto
efficiency, which properly understood is a fairly innocuous concept. It simply
refers to a situation where no-one can be made better off in terms of the
things he or she values (more stuff, cleaner environment, better civic
amenities, living in a civil society, whatever) without making anyone else
worse off in terms of the the things they value. But I always advise my students to never use
the word efficiency when talking with non-economists. Exhibit A to explain
why is the following quote from the 1962 verison of mutiny on the bounty.
Captain Bligh (Trevor Howard) is explaining to Fletcher Christian (Marlon Brando)
why he just had a sailor flogged for something he didn’t do, saying that it
won’t be possible to run the ship in bad weather if sailors don’t fear their
captain more than they fear the weather. He goes on to say:
Now don’t mistake me. I’m not advising cruelty or brutality with no purpose. My point is that cruelty with purpose is not cruelty—it’s efficiency
This scene, which happens
early in the movie, is important for setting up Bligh as a horrible person in
the minds of the movie watchers (much like Joffrey’s encounter with the diawolf
and the butcher’s boy in the second episode of Game of Thrones). The
screenwriters knew that having Bligh use the word efficiency to describe the
treatment of people would be chilling to viewers. It invokes notions of Dickensian
eight-year-olds up chimney, of sacrificing human values to the end of
maximising material production, the total opposite of the totally
human-values-centric approach to welfare that Pareto efficiency invokes.
3. Aggregate Demand
Efficiency is a problematic
term as it can mislead those outside the subject. Aggregate Demand is worse
as it misleads our own students. I complained about this one here. A standard demand curve is a statement of intentions. It shows how much buyers
would buy if they could buy as much as they wanted at a given price. At the
equilibrium price, the desired demand will equal actual purchases. It is also possible,
however, to be on the demand curve at points where desired demand and actual
purchases are different (say as the result of a legislated maximum price). The so-called aggregate
demand curve is not analogous. It shows different equilibrium combinations of price and quantity such that demand for
output equals actual output. It is possible to be out of this equilibrium, through undesired changed in inventories or other quantity buffers, but that implies being completely off the
curve. The aggregate demand curve is a useful graphical device for teaching some basic macro
concepts, but its name pretty much guarantees that the majority of first-year
students will misunderstand its properties.
2. Investment
Here we have a term that,
I think, misleads even seasoned economists. Investment in economics, refers
to the accumulation of capital goods. The term in general usage is often used
to mean particular mechanisms that consumers use to save. So, for instance,
buying a rental property is investment in this everyday use, but, if it is an
existing house, it is not “investment” in the economics sense. I am convinced that slippage in the meaning of the word investment mid-sentence is the reason for some half-baked justifications for a capital gains
tax, as in statements like “we need a capital gains tax so that people will
switch from investing in houses to more productive investments”. As I noted here, buying an existing house is not “unproductive investment”; it isn’t
investment at all. Once that is noted, the link between a capital gains tax
and productive use of savings becomes extremely tenuous.
But these three
misleading terms are trivial compared to the granddaddy of them all:
1. NAIRU
That is, the "non-accelerating-inflation rate of unemployment". This is just embarrassing. As
a profession, we like to get smug and despondent about innumeracy in the press with respect to the number of derivatives, sighing every time we read statements
“inflation rose by 3% in the year to March”, when what is meant is either that “prices
rose by 3%” or “inflation was 3%”. But then we do the same thing ourselves with
one of our technical terms.
For goodness sake, it should be the non-accelerating-prices
rate of unemployment (NAPRU) or the non-increasing-inflation rate of
unemployment (NIIPRU). There is an alternative term—the natural rate of
unemployment. If it weren’t for the existence of NAIRU, I would have the natural
rate in my list of misleading terms. It conveys a notion of unemployment being
something that is just given to us, not something that can be affected by
policy, and certainly not something that has very real human consequences.
Again, it is a term that misleadingly conveys economics as a cold, heartless
subject. But I would rather our profession was incorrectly perceived as cold
and heartless than correctly perceived as innumerate. So as long as NAIRU is the only alternative, I will
champion the natural rate!
