WSJ.com - Knowledge Deficit

The Wall Street Journal Online asked bloggers Russell Roberts, a professor of economics at George Mason University, and William Polley, an economics professor at Western Illinois University, to discuss what the public doesn't know about economics, and whether and how that knowledge gap might hurt.: "I break economic literacy into two components -- factual and conceptual. Alas, most well-educated Americans are illiterate in both areas. First, the facts. Whenever I teach a seminar on basic economics, I always survey the audience: What proportion of the American labor force earns the minimum wage or less and what is the standard of living of the average American today relative to 100 years ago?

Even among highly-educated groups such as journalists or congressional staffers, the median answer is depressingly similar -- they think 20% of the American work force earns the minimum wage or less. In fact, the actual number is something less than 3%. Usually a non-trivial portion of each group thinks that our material well-being is lower today than 100 years ago. Their median answer is that we are 50% better off than we were 100 years ago. In fact, the average American is at least five and maybe 30 times better off than we were in the good old days. There's a dramatic range because it's hard to value the opportunity to listen to your iPod while recovering from open heart surgery. But 50% is a very bad answer.

Conceptual literacy means mastering the economic way of thinking -- understanding tradeoffs, market forces, and the full effects of a proposed public policy. What is the essence of the economic way of thinking? A good starting point is Frederic Bastiat's idea that what is seen, the direct effect of a policy, is often just the beginning of its impact. Equally or more important is what is not seen. The world would be a better place if people understood that the intention of a policy (no price gouging after a hurricane, for example) does not capture the full effect on our well-being.

For better or worse, understanding economics isn't a particularly useful investment of time and energy for most people. Understanding the true impact of Katrina or the true impact of price controls on gasoline in the aftermath of Katrina isn't valuable to the average person. Think of the economy as an ant colony. In an ant colony, an individual ant, even the queen, is oblivious to how the colony functions or achieves goals like providing food or fighting off competitors. Yet, the colony as a whole is "smart." Similarly, our economy functions beautifully even when people fail to understand how a market economy functions. We each go about our lives, trying to do our jobs, unaware of how the whole system works. The result is a network of cooperation and coordination that no one of us intends or understands.

Policies that violate logical fallacies often sound attractive. Many astute voters might say they sound too good to be true, but they can't put their finger on why. Protectionism and export-led growth are good examples, so are the ones you mention. Economic literacy at an introductory level can put to rest many such fallacious claims. Just getting people to realize that there are "no free lunches" and to recognize rent-seeking behavior when they see it would be a good start.

I don't think that a lack of healthy skepticism is our problem. People can tell when they are being led down a path, but if they can't see the alternative, they will probably just follow where they are led. The task for us is getting people to realize that they don't have to be led down a path of faulty reasoning. There are alternatives. The economic way of thinking helps them to put structure on their skepticism. There's a great deal of social value in a citizenry able to recognize free lunch claims and refute them.

I'm talking to the woman next to me and she asks me what I do. When I tell her I'm an economist, she says, "Too bad my husband isn't with me today, he'd love to talk to you." "Why's that?" I ask. "He's fascinated by the stock market," she replies. I had to tell her that I knew nothing about the stock market other than the virtues of indexed mutual funds. A useful thing to know -- one of the most useful insights of economics into personal finance -- but it would have made for a short conversation with her husband.

Maybe we need a new name for what we do when we talk about tradeoffs and unintended consequences, emergent prices, market forces and the seen and the unseen -- the whole range of creative ways that economics helps you see the world. When people hear the word "economics," they think of either the stock market or someone talking about the Fed's latest move. Those things are related to economics, yes, but if that's all people think we think about, it's like hearing the word football and assuming it's about the ball of your foot. It leaves out the most interesting stuff.

Any suggestions for a better name to describe economics and the economic way of thinking?

Perhaps a return to the ideas of Adam Smith as expressed in both "The Wealth of Nations" and "The Theory of Moral Sentiments" would yield some suggestions though, because I think it would reveal how much more broadly we have to think.

"The Wealth of Nations" is a treatise on man's interaction with his fellow man in the marketplace. That is, it's a study of prudence. Today, it ends up being taught as constrained maximization, and in the rush to cover all of the techniques, essential insights can be lost if you're not careful. A thorough examination of the virtue of prudence as Adam Smith perceived it would be time well spent, and it's a nice complement to the idea of constrained maximization for those who are technically inclined.

"The Theory of Moral Sentiments," on the other hand, is a treatise on temperance. It is a study of propriety, sympathy, and justice. Sadly, many people don't even know the book exists or that it was written by the man who is sometimes called the "father of capitalism." Ignorance of Smith's other major work leads people to think that economics is only about greed, self-interest, and rational maximization. As a result, many intelligent people who would be quite capable of becoming economically literate are turned off to economics because they see it as promoting a "greed is good" mentality that doesn't square with their world view. Unfortunately, this perception is so well embedded in the pop culture view of economics and economists that it may be very difficult to reverse."