How Laypeople Understand Economics
Dept. of Psychology – Ben Gurion University of the Negev
Ben-Gurion University of the Negev
October 22, 2015
Economic Psychology: The Science of Economic Mental Life and Behaviour. Rob Ranyard (Ed.) Wiley-Blackwell, Forthcoming
This chapter presents various known limitations in lay understanding in general, and documents how lay people (mis)understand economics. Economic and Political consequences are discussed.
How Laypeople Understand Economics – Introduction
1. Understanding Economics is hard yet expected
Economics is notoriously hard to understand. The domain is inherently difficult (Arthur 2000) and, in contrast to some other domains, the human mind is not particularly equipped to think about economics (Pinker 2002; Rubin 2003), as it constitutes a domain that was irrelevant to humankind’s evolutionary past. As a consequence, lay people understanding of economics frequently contradict accepted professional knowledge regarding economic matters. An article in The Economist recently wondered about the policies of Turkey’s Mr. Erdogan:
Mr Erdogan seems desperate to prop up growth, which increased by a feeble 1.7% year on year in the third quarter of 2014…. Lower rates, the president believes, are the answer. In fact, the central bank has been lowering rates, even though inflation is well above the target of 5%(…) Yet Mr Erdogan denounced its most recent cut, of a quarter of a percentage point in late February, as insufficient. He accused … the governor of the central bank, of “selling out the homeland” […] Mr Erdogan claims—against all the evidence and in complete contradiction to orthodox economics—that cutting rates will somehow lower inflation.
How lay people understand economic phenomena is poorly understood, though of late there has been a significant increase in the number of studies investigating the topic (Caplan 2011; Gangl et al. 2012; Leiser and Drori 2005; Loix and Pepermans 2009; Ranyard et al. 2008; van Bavel and Gaskell 2004; Williamson and Wearing 1996). This chapter will sketch what is known about lay understanding of economics by first discussing several key features of lay understanding in general, and try to suggest how they account for lay economic understanding.
Beyond the inherent interest of the topic, it is of capital practical significance for two distinct reasons. First, citizen understanding is essential for democracy (Caplan 2011; Davies 2015) and it affects public policy through the political process (Fornero 2015). Policy makers may hesitate to pursue what they consider the best policy if they know that the public will not understand its rationale or its necessity and oppose it. Indeed, the public tends to judge unpopular policies as more necessary if they match its understanding (Huston 2010; 2012). Second, economic beliefs affect economic behavior (Roos, 2006, 2008), and constitute an important component of the economic model (Darriet and Bourgeois-Gironde 2015).
i. The complexities of macroeconomics
Why is economics so difficult to understand? Several reasons may be mentioned. One is that economic theory functions as a complex causal system, whereas people are remarkably poor at combining causal links into a system (Grotzer 2012; Perkins and Grotzer 2005). Even when aware of a given link (A causes B), people tend to not think of the feedback effects (B affects A in return) or of further, indirect effects (A affects B and B affects C, so A affects C too.) This means that the scope of explanations tends to be overly narrow, and to involve too few aspects. Another reason is that many of the basic factors in economic theory, and especially in macroeconomics, are aggregate variables, such as money supply, inflation rates, and Gross Domestic Product. Consider for instance a definition of money supply: it is the sum total of currency and other liquid instruments in a country’s economy as of a particular time. The kind of causality that links such variables is the cumulative outcome of countless individual transactions, that are not individually known. People understand other people well (Shahaeian, Peterson, Slaughter, & Wellman, 2011), they can grasp their motivations and actions, yet are ill-equipped to cope with the aggregate effects of the individual decisions of many. Relatedly, the type of causality invoked by economic theory is not intuitive. It routinely explains outcomes by the “equilibrium seeking” of a complex dynamic system. A striking implementation of this way of thinking was the MONIAC hydraulic economic model of 1949 (Ng and Wright 2007): a physical model of the economy in which flows of consumption, saving, investment and other economic forces were represented by liquid moving through tubes and pipes as monetary and fiscal variables varied, and the whole system could be observed as it came to an equilibrium (Ng and Wright, 2007).
And yet, despite the difficulty to understand economics without proper formal training in the discipline, discourse addressed to the public on matters economics implicitly conveys that it is expected to understand it, and such discussions are exceedingly common. Newscasts and the written press will discuss whether the present time is a good time to buy a house and why, the economic circumstances of the latest decisions by the central bank governor and its likely consequences, or the probable economic significance of a “Brexit” (UK withdrawal from the European Union). This state of affairs is very different from that observed in other domains. News programs, for example, do not invite civil engineers to talk to the public about the precise technical mishap that caused a bridge to collapse, doubtless on the reasonable ground that it wouldn’t be capable to follow the explanation.
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