Why a micro solution may not work in macro

  • By James McCusker
  • Thursday, January 9, 2014 2:45pm
  • Business

P.J. O’Rourke nailed the distinction between the two areas of economics when he wrote, “micro-economics concerns things that economists are specifically wrong about, while macro-economics concerns things economists are wrong about generally.”

O’Rourke’s humor doesn’t just illuminate the silliness in our pretensions. He has a rare gift for making his victims laugh as hard as everyone else — even while being skewered.

In classrooms across America, introductory course students learn that macro-economics is the study of economic aggregates such as investment, consumption and government. Microeconomics, by contrast, looks at how individuals and firms make decisions and allocate resources.

What is not discussed usually is that macro and micro do not play well together. There is no unifying economic theory that satisfactorily integrates what we have learned about the two areas of study.

The gap between the two received a lot of attention and discussion during a recent economists’ pow-wow in Philadelphia — and that is very good news for economists and for our economy.

There is a reason behind the newly fired-up concern about this gap, which had been gathering dust for decades: the colossal failure of the economic models to predict either the economic collapse of 2008 or the persistent, recession-like recovery we have endured since then.

There have been efforts to incorporate microeconomics into the models’ math, primarily by adding functions and algorithms based on the behavior of individuals and institutions. This eventually resulted in the current generation of the forecasting tools known as Dynamic Stochastic General Equilibrium models, or DSGEs.

The DSGEs were always a work in progress, although that was rarely admitted, and they had some theoretical and practical issues that were unadvertised specials.

The primary theoretical issue questioned the structure of the models. Could a model based on the statistics of past behavior be an accurate predictor of economic growth, which is inherently based on behavior change?

The second issue was a practical one, not unrelated to the first as it turned out. What is the correct test for an economic model’s validity, the ability to explain the past or its ability to predict the future?

The interaction of these two issues produced a family of economic models that turned out to be more than satisfactory, even excellent, at predicting small changes — and were totally clueless about large ones.

All of this may seem (besides boring) too airy-fairy theoretical to interest anyone still connected to the real world, but it is the critical factor in a pocketbook issue for all of us.

There have been many arguments in favor of a government mandate raising the minimum wage, some based on the vaguely-defined “living wage” and others rooted in adjusting the wage floor to match today’s devalued dollar and resultant price levels.

One argument gaining support is based loosely on a book, “The Good Jobs Strategy,” by Zeynep Ton, an adjunct associate professor at MIT’s Sloan School of Management. Professor Ton’s important book explores the experience of some successful companies in the competitive retail sector that have raised their wage scales substantially.

The idea behind the strategy was that firms would use their knowledgeable, motivated employees to improve customers’ shopping experiences, thereby boosting sales and profitability.

There are certainly some success stories — Costco, and, more recently Ikea, for example — but there is a big difference between a business strategy and an economic policy, a difference that is just about the same size as the gap between micro- and macro-economics.

Depending on the market a business is in and the characteristics of its mid-level management, a higher wage, “good jobs” strategy can be an effective way to gain an advantage over the firm’s competitors and capture their customers, sales and profits.

What is a good, sensible strategy for one business, though, doesn’t work if all the businesses do the same thing. If all businesses pay higher wages there is no longer a competitive advantage for any of them; all they’ve got is a higher-cost structure and lower profits, a situation that can often lead to layoffs.

It is possible that instead of layoffs in that market sector, the entire sector expands — initially, at least, at the expense of other sectors. That, among other things, is what happened when Henry Ford doubled the prevailing wage for workers on his newly-conceived assembly line for the Model T. If the wage hike had been a government mandate for all workers, though, it would have been a different, unhappier story; one we should bear in mind when considering minimum wage increases.

The “What’s good for one isn’t necessarily good for all” problem is called the “Fallacy of Composition.” It’s an exception to P.J. O’Rourke’s definition; one of those things that economists got right – specifically and generally.

Talk to us

> Give us your news tips.

> Send us a letter to the editor.

> More Herald contact information.

More in Business

Lily Lamoureux stacks Weebly Funko toys in preparation for Funko Friday at Funko Field in Everett on July 12, 2019.  Kevin Clark / The Herald)
Everett-based Funko ousts its CEO after 14 months

The company, known for its toy figures based on pop culture, named Michael Lunsford as its interim CEO.

The livery on a Boeing plane. (Christopher Pike / Bloomberg)
Former Lockheed Martin CFO joins Boeing as top financial officer

Boeing’s Chief Financial Officer is being replaced by a former CFO at… Continue reading

Izaac Escalante-Alvarez unpacks a new milling machine at the new Boeing machinists union’s apprentice training center on Friday, June 6, 2025 in Everett, Washington. (Olivia Vanni / The Herald)
Boeing Machinists union training center opens in Everett

The new center aims to give workers an inside track at Boeing jobs.

Some SnoCo stores see shortages after cyberattack on grocery supplier

Some stores, such as Whole Foods and US Foods CHEF’STORE, informed customers that some items may be temporarily unavailable.

People take photos and videos as the first Frontier Arlines flight arrives at Paine Field Airport under a water cannon salute on Monday, June 2, 2025 in Everett, Washington. (Olivia Vanni / The Herald)
Water cannons salute Frontier on its first day at Paine Field

Frontier Airlines joins Alaska Airlines in offering service Snohomish County passengers.

Amit B. Singh, president of Edmonds Community College. 201008
Edmonds College and schools continue diversity programs

Educational diversity programs are alive and well in Snohomish County.

A standard jet fuel, left, burns with extensive smoke output while a 50 percent SAF drop-in jet fuel, right, puts off less smoke during a demonstration of the difference in fuel emissions on Tuesday, March 28, 2023 in Everett, Washington. (Olivia Vanni / The Herald)
Sustainable aviation fuel center gets funding boost

A planned research and development center focused on sustainable aviation… Continue reading

Helion's 6th fusion prototype, Trenta, on display on Tuesday, July 9, 2024 in Everett, Washington. (Olivia Vanni / The Herald)
Helion celebrates smoother path to fusion energy site approval

Helion CEO applauds legislation signed by Gov. Bob Ferguson expected to streamline site selection process.

Pharmacist John Sontra and other employees work on calling customers to get their prescriptions transferred to other stores from the Bartell Drugs Pharmacy on Hoyt Avenue on Wednesday, July 2, 2025 in Everett, Washington. (Olivia Vanni / The Herald)
Bartell Drugs location shutters doors in Everett

John Sontra, a pharmacist at the Hoyt Avenue address for 46 years, said Monday’s closure was emotional.

Support local journalism

If you value local news, make a gift now to support the trusted journalism you get in The Daily Herald. Donations processed in this system are not tax deductible.