Wishful Thinking…

When economic policy analysts examine the way that markets work, they use a set of long-established analytical tools that take into account the information available to decision-makers and the incentives they face. When they analyze government policies, they often substitute wishful thinking for the analytical tools they use to examine markets.

The use of wishful thinking to evaluate public policy is more than just a minor observation: it is a major reason for public policy failures.

Economists have accumulated a substantial set of tools to analyze the way markets work, and reasons why they might not work ideally. Economic policy analysis often compares real-world markets with theoretically ideal outcomes that could not be generated in the real world. If reality falls short of the benchmark of theoretical efficiency, the policy recommendation is to have the government implement a policy that, in theory, could generate the perfect outcome.

What often passes for policy analysis does not actually analyze government policy or behavior at all. It assumes government will do the optimal thing without analyzing whether government has sufficient information to find the optimal policy, or whether those in government have the incentive to carry it out. That is not policy analysis; it is wishful thinking.

One example is the use of fiscal policy to manage aggregate demand and stabilize the macroeconomy. In theory, rather than balancing its budget, a government can fine tune the economy by using budget surpluses and deficits to stabilize the economy. But the information needed to do this in theory is not available to government decision-makers in practice, and more significantly, those in government do not have the incentive to implement the optimal policy anyway. Fiscal policy, which in theory stabilizes the economy, is in practice what is responsible for destabilizing the Greek economy, and the rest of Europe. But that lesson has not migrated to the United States, where calls for additional fiscal stimulus, and the Fed’s QE3, are actively championed. This is not policy analysis; it is wishful thinking.

Another example is health care policy, where my fellow blogger John Goodman has done a great job using those tools of analysis; meanwhile, as John Goodman does real policy analysis, too much of the health care debate is based on wishful thinking.

I teach economics and have been pushing that phrase wishful thinking to my students. When we analyze “optimal” policies in classroom discussion, saying that in theory government could do this or that, I call this wishful thinking, and say we need to analyze what government actually can and will do.

The idea applies to more than just academic analysis. I have emphasized wishful thinking a lot in this post because I want you to start using the terminology! When you hear people advocate a policy proposals based on what some hypothetical omniscient benevolent government could accomplish, tell them they are not advocating those proposals based on any real policy analysis, but on wishful thinking.