Monday, February 12, 2007

Economies that Don't Work

Economists frequently suffer from an overconfidence in the reliability of their numbers. The complexity of economies makes the isolation of variables difficult. As a result, many economists often fail to consider the inadequacies of their particular models or the limitations of their studies. On the other hand, some economists will become so focused on one set of cause and effect relationships that they fail to discern other elements of the big picture.

Thus, Edmund Phelps discounts the notion that the prevalence in Europe of extensive and expensive social insurance programs is a contributing cause to the failure of European economies to keep pace with those of the United States and Canada. Phelps explains that the "consequent reduction of after-tax wage rates is unlikely to be an enduring disincentive to work, for reduced earnings will bring reduced saving; and once private wealth has fallen to its former ratio to after-tax wages, people will be as motivated to work as before." However, the accumulation of wealth is not the only relevant factor in worker motivation. A floor that is sufficiently high may also disincentivize a person from seeking to achieve more. In addition, Phelps explanation suffers from the standard and inaccurate economic assumption that people will know what is in their economic best interest and act rationally. Frequently, in reality people are not aware of the range of available options and, in any case, make decisions based on considerations other than economic self-interest.

Phelps continues to explain that the real distinction between American and European economies lies in the differences in "economic dynamism." Continental economies feature less economic innovation and drive for achievement. Unfortunately, Phelps fails to note that this lack of dynamism and drive may also result from confiscatory levels of taxation and the prevalence of welfare programs that reduce the incentives of achievement.

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