3 Common Economic Fallacies That Need to Die

Seemingly every day, there are news reports and political commentators repeating economic fallacies that should have been dead and buried long ago.

Unfortunately, these misconceptions are often taken by the public to be true at face value, typically because their frequent repetition has given them an unwarranted sense of legitimacy. It is in fact all too common for claims about the nature of the economy to be used to push specific political narratives and policies, making it all the more important to skeptically investigate them.

1. Imports Subtract From Economic Growth

Our first fallacy is the misconception that the value of goods imported from foreign countries directly subtracts from a country’s overall economic performance (measured as Gross Domestic Product, or GDP).

Indeed, anytime new economic growth data are released by the government, the accompanying news cycle is filled with reports containing erroneous statements like, “trade subtracted 3.2 percentage points from overall GDP growth, as exports fell sharply and imports soared.”

This logic implies that every dollar Americans spend on imported goods reduces the size of America’s economy by one dollar. Now, if that were true, we might as well stop importing any goods at all – but as it happens, this belief is completely based on a misunderstanding of how GDP is calculated.

GDP = private consumption + private investment + total government spending + (exports – imports)

When we look at the GDP equation, it appears as though the last component, net exports, implies that imports do in fact subtract from GDP. What is unseen in the equation is that imports are already included in government and private sector spending and investment, only to be subtracted out in the net exports part of the equation. Per the Bureau of Economic Analysis, “U.S. production would be overstated if the [GDP] formula didn’t remove imports.”

The net effect here is that imports have no impact on how GDP is calculated. Just think about it, GDP is a measure of the total economic output of the domestic economy and therefore imported foreign goods should have no direct impact on GDP.

Now, although imports don’t affect how GDP is calculated, they can affect GDP itself by influencing factors such as productivity, employment levels, wages, prices, the creation (or collapse) of domestic companies, etc. Much has been written on the subject, and research generally finds that lowering barriers to imports (such as tariffs) leads to faster economic growth by increasing economy-wide efficiency.

2. Middle-Class Stagnation

In the United States, there appears to be a widespread belief that the economy “does not work” for most Americans. Typically, the go-to evidence for this claim is that wages have stagnated for middle-class Americans despite decades of economic growth.

At face value, this concern is not without merit. US Bureau of Labor Statistics data shows that median wages have only grown some 11 percent when adjusted for inflation between 1979 and 2021. Paradoxically, consumption for middle-income and lower-income families has grown steadily over time. If wages are stagnating, how can this be the case?

As it turns out, the ‘stagnant wages’ observation is entirely dependent on the use of the Consumer Price Index (CPI) to adjust for inflation. It so happens that the CPI has long been known by economists to overstate past inflation rates due to a variety of measurement biases, such as failing to accurately take into account product quality improvements and consumer substitution of relatively more expensive goods for relatively less expensive goods over time. As we go further back in time, the bias gets worse.

Surely, no price index is perfect—and there are many—but economists generally consider the Bureau of Economic Analysis’ Personal Consumption Expenditures (PCE) index to be a more accurate measure of consumer inflation over time since it better accounts for changes in consumer behavior and provides more comprehensive coverage of goods and services.

When using the PCE to measure living standards over time, the ‘wage stagnation’ myth implodes. As demonstrated in the graph above, PCE-adjusted wages grew 33 percent between 1979 and 2021, consistent with other analyses also showing rising median wages.

On top of this, the nonpartisan Congressional Budget Office uses the PCE to measure the well-being of American households over time. They find that before government taxes and transfer payments are taken into account, households in the three middle quintiles of the income distribution (what we would broadly consider to be the “middle class”) saw their incomes rise 43 percent between 1979 and 2019. After taxes and transfers are accounted for, these households saw their incomes rise by an even greater 59 percent.

What about the poorest households? Well, they saw their incomes rise by 45 percent before accounting for taxes/transfers and an impressive 94 percent after. Maybe income growth could be stronger, but it certainly hasn’t stagnated over the course of the last forty or so years.

3. The Gender Wage Gap

The belief that women are paid substantially less than men for the same work (i.e., “the gender wage gap”) is so ingrained in our society that the US Census Bureau even has a day of the year dedicated to it symbolizing how many extra days women must allegedly work to reach pay parity with men.

This statistical reality of a difference in average annual earnings for men and women is often twisted to imply that businesses are intentionally paying women less than men for doing the same job. In other words, statistical disparity is conflated with discrimination.

The reality, however, is that men and women don’t work the same jobs, don’t have the same experience, don’t work the same hours, etc. If we were truly interested in whether women were unfairly being paid less, we would compare men and women working the same job, with the same qualifications. A PayScale study actually did this and found that women earned 99 cents for every dollar a man earns. Myth debunked right? Not in their eyes. An accompanying PayScale article declares, “no gap is acceptable, so the pay gap is real.”

Really? Or perhaps what little remains of the “unexplained” gap is the result of unmeasured factors that may not be related to discrimination. For instance, a PLoS One study analyzing an anonymous online labor market found a 10.5 percent gender pay gap despite gender discrimination being an impossibility. And the gap didn’t completely disappear when other factors were considered either, leading the authors to conclude that:

“…gender pay gaps can arise despite the absence of overt discrimination, labor segregation, and inflexible work arrangements, even after experience, education, and other human capital factors are controlled for.”

It may very well be the case that, due to gender discrimination, stereotypes, and social pressure, women are not always afforded the same economic opportunities as men, contributing to a divergence between the average wages of men and women. That seems like an entirely reasonable thing to believe, but it is also a completely different claim than the one that women are being paid much less than men for the same work.

Now, don’t just take this article for granted either! Think critically and investigate these points yourself too.

The post 3 Common Economic Fallacies That Need to Die was first published by the Foundation for Economic Education, and is republished here with permission. Please support their efforts.

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