Tuesday, November 17, 2015

Distinguishing Between Positive Economics and Normative Economics

Okay, I am late to this one, but I have been wanting for some time to comment on this column and this follow up (via  Paul Krugman) on why politicians don't follow economists' suggestions.  The author says that their decisions are often political rather than economic, and that it is perfectly legitimate to make policy on a political basis:
Economists tend to assume that there is a single right answer (even if they disagree bitterly among each other about what the right answer is). They explore what is “correct” from a theoretical point of view and are puzzled when their “correct” ideas are not followed. Political scientists don’t usually start from the basis that there is a single correct way to do things. Instead, they assume that there is more than one interpretation of what is correct, and try to come up with theories about which “correct” answer is chosen. There is no correct answer when there are competing rival views that are not easily testable in a complex world where one cannot readily carry out controlled experiments with obvious real world interpretations.
. . . . . . 
Instead of relying on expertise, we should figure out what people actually want from policy (and map the forces that block or channel their efforts to express and act on their desires).
And in the later column:
More broadly, and more contentiously, one might push back at the notion that all that matters therefore is an analysis of the facts and the correct theory. That certainly matters, but we live in a world of fundamental uncertainty. Thus, there are many judgment calls, where the facts are ambiguous or unhelpful.
. . . . . . . . 
Values – and not just smarts and theory — help shape how you come down on uncertainty.
This struck a chord with me for two reasons.  It is about the difference between positive economics and normative economics -- the economics of description and the economics of prescription.  When I took freshman economics in college, at a time when inflation and nominal interest rates were unusually high (yes, I date myself), the difference was explained that positive economics says, "As long as X continues, interest rates will remain high."  Normative economics says, "We've got to get interest rates down."

We had a book on normative economics, applying economic analysis to public policy decisions. However, it tended to blur the distinction between positive and normative economics.  Policy decisions are typically made for political rather than economic reasons and yield an outcome different from the one that the free market would have made on its own.  But this is, properly speaking, mere description rather than prescription, a positive observation and nothing more.  The authors tended to treat such policy decisions and outcomes as inherently illegitimate without seriously justifying that underlying assumption.

The author here makes the opposite error.  He takes for granted the legitimacy of making decisions on a political basis.  But he seems strangely indifferent to the economic results of such decisions.  

Or, put differently, macroeconomists generally agree that when the economy hits the zero lower bound (i.e., when the economy remains below capacity even when the central bank cuts short-term interest rates to zero), austerity causes the economy to get worse, and that a shrinking economy raises the debt burden relative to GDP.  They also generally agree that raising interest rates under such circumstances worsens the recession.  These opinions are in the realm of positive, not normative, economics.  

It is possible to believe that deficits are so evil, or tight money so virtuous, that we should pursue fiscal and monetary tightening in a recession, regardless of the harm to the economy. That would be an instance of normative economics -- as is the assumption that we should always fight recessions rather than let them play themselves out.  A good discussion of normative economics should be grounded in a solid background of positive economics.  A proper debate on deficit reduction at the zero lower bound would take into account the general macro consensus that the economy would be hurt as a result and consider whether the value of deficit cutting outweighs the harm it will cause. Conflicting values and interests would play out, but with their eyes open to the probable outcomes of their actions.  

The error of the author is to ignore what economists are saying about probable outcomes and treat values and interests as the only important thing.

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