May 30, 2019
Our ‘Business-Centric’ Model Is Wrong and Hurtful
Any economy is a wondrously complex affair, with far too many interactions to reasonably observe or even begin to understand through direct observation. Most of us play infinitesimal roles in a large economy and can master one, or perhaps two professions.
Families organize themselves in many different ways, undertaking complex lifetime earnings and production decisions in ways that seem mysterious to even close observers. These decisions include where to live, how to work and vacation, when to retire and what to buy across a huge spectrum of items.
Firms are simply organizations of households, be they a single hotdog vendor or a multinational organization. Households supply labor and capital to these firms, and interact with other firms in ways that dazzle. A typical Walmart in a dusty backwater will offer for sale a full 80,000 different products in a given week. These products come to us from every continent (save Antarctica) and involve the combined ingenuity of hundreds of generations of producers who transmit their ideas into the finished products that line our shelves today.
Governments intervene well and badly in this economy, enforcing contracts, locking up criminals, regulating pollution and a hundred million less valuable contributions. This complexity means we have to understand our economy through simplified models. All science works this way, and it is a mistake to suppose it can be otherwise. In fact, one way to think about the way scientists organize themselves into different disciplines involves broad agreement in one set of models.
Thus, it should be unsurprisingly that there is very little disagreement among economists about the basic models of the economy. We actually call these textbook models for that very reason. Even when we dissent from these textbook models, it is usually about the magnitude of effects. I use the minimum wage issue as an example. There is disagreement within the profession over the effects of the minimum wage on employment. But, the debate isn’t about whether or not the model is valid, but whether the supply or demand side dominate, or even more fundamentally, whether we can measure either of these well.
The most common mistake non-economists make when thinking about the economy lies not in this sort of interpretation of a model, but in choosing an entirely wrong model of the economy. By far the most common of these is what I call the ‘business centric’ model. This used to be called mercantilism, and was a common view as late as the 1700s. Why it is wrong is easy to distill into just a few observations.
For an individual firm, growing profits are fabulous. For an overall economy, growing profits could be a sign of monopoly, which might be disastrous to growth and innovation. For a firm, growing wages can be calamitous, but for an economy, it could signal broad and healthy productivity growth. Individual businesses are critical to an economy, but economies do not run like a business. This has been well known since the days of King George III.
Mistaking the economy of a nation or region as one giant company can lead to deep policy mistakes. One example is international trade. Viewing nations as two large businesses vying with one another for market share seems to inspire our current trade war. In fact, the opposite is true. Trade is not competition, but cooperation between nations. Friendly nations trade, competitors do not. The mercantilist or ‘business centric’ model of the economy cannot explain any of the results of foreign trade, like the simple fact that US economy has more than doubled in the past 30 years of trade with China.
The business model is not bad because it offers inconvenient predictions; it is bad because its predictions are nearly uniformly wrong. But, the use of the ‘business model’ isn’t only confined to the current trade war. The obsession with focusing solely on business success is an equally bad way to view the health of an economy. Let me offer two examples.
The myopic view of business costs as a primary local problem in economic development leads to the excessive use of tax incentives. Viewed through the ‘business centric’ prism, every reduction in business taxes is optimal for the region. I could explain why this is true by noting the importance of broad, low taxes in creating an environment that is conducive for both businesses and households. Instead, I’ll just note that the ‘business centric’ model would predict that high tax places like San Francisco, Boston and New York would be ghost towns.
Still, the most egregious ‘business centric’ policy is our state’s workforce development policies. As I have written before, about four years ago, the state’s broad workforce development apparatus shifted its focus from a worker-centered to a business-centered mission. One of many bad consequences is the myopic focus on delivering trained workers to Hoosier businesses. While this sounds credible (just like the tax and tariff policies), this emphasis has helped over-supply low-skilled workers while a shrinking share of Hoosiers pursued higher education. This policy shift marks a radical departure from the aspirational goals of earlier administrations.
One result is a major divergence of employment quality in Indiana. Since 2010, less than 17 percent of new Hoosier jobs have gone to college graduates. Nationwide, the share is now 74.4 percent. To be sure, there are more factors than bad workforce development policies contributing to this troubling trend. However, if our state government is going to influence decisions about college and workforce choices, it should at least apply some elementary economics to the process. Instead, our workforce policies are doing harm, precisely because those entrusted to contrive and deliver them are using a discredited ‘business-centric’ model.
Just to make sure I do not confuse the picture, this is not an argument for a state-level technocracy. I would not advise we elect or appoint public officials based upon primarily upon their understanding of economic modeling. But, it is useful to place in context the credibility of the current policy atmosphere.
The ‘business-centric’ model of the economy was discredited by the 1770s, at about the time germ theory was becoming well understood to science and more than a half century before bloodletting was fully condemned as a medical procedure. That we still derive policy lessons from the ‘business-centric’ model makes about as much sense as it would for us to have a state health commissioner who was just reading up on germ theory and still practiced bloodletting.
About the Author
Increasing Importance of Summer JobsThese jobs offer an opportunity to learn as well as earn money.
Educational Attainment, the 21st Century Fund and the Future of SchoolingIndiana ranks 42nd in educational attainment.
Big Savings for Ending Prevailing WageMy statistical models show that repealing state prevailing wage laws save taxpayers money.
Re-Thinking Economic Development A large share of the most mobile families—perhaps half—no longer need to live near where they work.View archives