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A Slight Problem With Assumptions In Economic Models



It’s entirely necessary to prepare and use models to try and understand the economy. It’s too vast and complex a matter to be grasped in the whole. But as with any model that output is going to depend upon the assumptions made about relationships within the model. This is just the way such things work.

So, if we assume that people won’t change their behaviour in the face of higher taxation then we can show that higher tax revenues can be gained from those higher tax rates. If we go that next step and acknowledge that we are dealing with human beings, who do respond to incentives, then we have a trickier position here. Some tax rises will produce extra revenue, some won’t. Our assumptions, our modelling parameters about the income effect (I just need the cash, higher taxes will mean I work more to gain it) and the substitution effect (they’re taking that much out of my wages? I’m off fishing) will be what drives the outcome from the model. And whether or not our assumptions accord with reality is something the Treasury will no doubt tell the Chancellor at some future date.

Similarly, if we assume that government is worth the cost of providing it – which is what we do assume in the national accounting that leads to GDP – then doubling bureaucrat wages makes us richer. This may or may not accord with the universe outside the window.

The assumptions made in an economy model matter.

So, to Joe Biden and the idea of spending $8 trillion or so on that progressive vision of a nirvana economy. In analysing it folks from Moody’s analytics say:

Analysts Mark Zandi and Bernard Yaros say the long-term dividend from education spending and the investment multiplier would raise the growth speed limit, and close the relative gap over time.

Yes, this is a minor point and yet still, it illustrates the problem of assumptions and outcomes.

Will higher education spending increase the growth rate of the US economy?

As Adam Smith pointed out spending on elementary schooling is indeed productive. Being part of a generally literate and numerate society is a public good, so much so that tax subsidy to primary schooling works as an economic concept. To the extent that Baltimore’s K-12 system doesn’t provide this literacy and numeracy – it doesn’t, generally – it’s pissing wealth up against the wall not an investment in the future productivity of the nation. More money wasted in this manner doesn’t work either, Baltimore is already one of that nation’s highest funded school districts.

Or perhaps we should examine the idea of more people going to college? The expansion of college access over the decades is associated with a slowdown, not a speed up, in the growth rate of the economy in general. With 50% or whatever of the age cohort going the major effect has been to bring down the entry bar. Things that used to ask for a high school graduation now ask for a full degree. Things that used to ask for a degree now ask for a Masters and so on.

There is also the point that taking 50% of the age cohort out of work – out of producing anything – for four years is a negative on that economic growth front. We might posit that the knowledge gained makes up for it, sure, but that is us assuming, not proving. When we try to prove the concept we have to look at proxies. Like, say, the value of the education to the student in higher lifetime income. That itself contains an assumption, that productivity is indeed paid for, something that we’d not want to wholly and insistently support but which seems reasonable as a general assumption. The UK experience is already that arts degrees for men lose lifetime income. That is, that we’re over the curve peak in education adding to economic prosperity.

Which, when we think of critical studies and grievance degrees seems a likely outcome. That the American system has people spending 7 years on a PhD in queer folks in Jane Austen adds gloriously to the joyousness of the nation – it’s an easy joke at least – but that connection to greater economic output is difficult to discern. Especially as the only job training that provides is to become an adjunct teaching gay folks in Jane Austen to undergraduates at $3,000 a class. A “class” here being the year’s worth of education, not the one hour in the room itself.

It’s entirely possible to argue with all of the above details. Go for it. The underlying though is that we’ve an assumption in our model. Higher education spending will increase the future production and productivity of the economy. Given the education system we’ve got, the recent results from increasing the size of it, how supportable is that assumption? I would say not. Even if you want to say it will then you’ve got to go prove that, not assume it.

And yet this is the way that policies to improve our world are scored. By assumptions that don’t – necessarily – have a great deal of truth to them. This underlying not being something restricted to the economic illiterates on the left it afflicts all discussion of everything.

You know, as Hayek said, we can only ever have the pretence of knowledge about something as complex and chaotic as the economy. Thus we’d do better not to rule it by our misunderstandings.



  1. There is another problem with giving half of every year group a qualification that used to denote membership of an elite. 50% of the population is way too many to form an elite. Thus we have maybe 45% of the population seeing themselves as part of an elite when they aren’t. And since its such a beguiling fantasy many of them will go along with any idea that enables them to cling to it, regardless of reason.I
    Also with so many having elite qualifications, expect much bitter division as they compete for status.

  2. And since its such a beguiling fantasy many of them will go along with any idea that enables them to cling to it, regardless of reason.I Also with so many having elite qualifications, expect much bitter division as they compete for status.

    Meanwhile the supply/demand curve of piano wire and lamp posts remains steady…

  3. Talking about proxies, a degree is a proxy for intelligence. Would the smartasses have done just as well without a degree? Maybe not in science where the drumming in of facts and formulae is essential. I wouldn’t like to be operated on by someone doing on the job training, but that’s how most geeks learn when they find that their degree in confuser science hasn’t prepared them for a real job.

    • a degree is a proxy for intelligence

      Not necessarily, since the absence of a degree does not mean someone is unintelligent. Plenty of people are very smart (high IQ) but don’t go to university because they need to work to provide for their families. It might be true in Western Europe and the US at the present time, but the time and place in which your “so called proxy” might even correlate is astonishingly small.

  4. I sometimes wonder how my 1980s’ degree “pass” would compare to today’s degree courses. Judging by some of the coding coming out of today’s satanic mills, today’s graduates have the coding skills of concussed slugs. It would be instructive to track down some modern exam papers and compare them with mine stored somewhere in my basement.

    • I agree. The problem here is that modern programmers are too reliant upon IDE’s and trying to solve any problems they encounter using solutions pasted from the internet rather than their own knowledge and experience. That is never going to end well.

      As the old saying goes “You can write FORTRAN in any language”.


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