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Monday, September 5, 2011

Where To Begin?

Macro or micro?

Choosing the right unit of analysis to tackle a problem is important in any scientific discipline. Economics offers a good example in its distinction between macroeconomics and microeconomics.

One of the first things I have to disabuse my students of in introductory microeconomics is the belief that microeconomics is about the “little picture,” while macroeconomics is about the “big picture.” First, what self-respecting scientist would deliberately choose only to study the little picture? Even microbiologists believe they’re dealing with major problems such as the nature of life and disease. Beyond that, the prefixes “macro” and “micro” don’t refer to the scope of the subject but to, you guessed it, the unit of analysis.

(To be fair, those prefixes are unfortunate choices, but it seems for the time being we’re stuck with them.)

This confusion is understandable because traditionally at the undergraduate level macroeconomics courses do deal with economy-wide output, employment, inflation, and the like, all of which are indeed big-picture issues. And courses in microeconomics usually cover things like value theory, individual choice, and market demand and supply, which, while important, do seem smaller in scale than macroeconomic problems.

However, my colleague Roger Garrison captures the relevance of making the right choice in the unit of analysis in his phrase, “There are macroeconomic problems, but only microeconomic solutions.” To understand the “big picture,” you’ve got to begin with the microfoundations.

Macroeconomic Problems

One of the great differences between, say, a contemporary Keynesian economist like Paul Krugman and a modern Austrian macroeconomist like Garrison is that Krugman sees the current recession as chiefly a problem of aggregate spending: If only economy-wide spending by consumers and especially businesses would increase, the economy would wake from its doldrums. Because Krugman doesn’t think it’s helpful to look behind these aggregates – to the fact that not all labor is substitutable or that residential construction is significantly different from bridge building – it doesn’t much matter what people spend their incomes and savings on. For him the problem is that for whatever reason people aren’t spending voluntarily.

Government spending via stimulus packages or “quantitative easing” is a blunt instrument, but because in standard Keynesian macroeconomics the variables to be manipulated are themselves pretty blunt – aggregate demand and aggregate supply – these policy tools are entirely appropriate for the task at hand. You wouldn’t think that having only a sledgehammer in your toolbox is a problem if you think your job is only to pound giant spikes. But when the job actually requires a crosscut saw or a Phillips screwdriver, then you’ve got a problem.

Microeconomic Solutions

From the Austrian viewpoint, while the recession and persistently high unemployment are indeed macroeconomic problems, that doesn’t mean the sources and the solutions are also at the macroeconomic level. In the field of public health, epidemiologists are beginning to understand something similar.

If there’s a threat of a flu epidemic, the best solution is not to spend resources inoculating everyone in sight. The social-network theorists Christakis and Fowler report that it would be more sensible to find out how flu spreads, that is, who are the most likely carriers and spreaders – say, those who come into contact with a lot of potential victims: doctors, nurses, and teachers – and make sure that they get the vaccine first.

Similarly, for an Austrian, just increasing aggregate demand is not only ineffective, it’s potentially dangerous. For example, government spending to re-stimulate the housing market, which is a sector within the macroecomy that isn’t doing too well right now in some (but not all) places, is from this perspective a bizarre remedy for a recession whose immediate cause was a housing bubble. Yet, guided by Keynesian thinking and the aggregate unit of analysis, this is precisely what Congress and the President are trying to do.

So just because national unemployment or declining cities are pressing problems, that doesn’t mean that you can solve it by spending more at the national level to get the aggregate numbers down. You need to ask what are the choices people make – the poor, the unemployed, as well as those who could help or employ them – that create these problems and what are the knowledge and incentives at the individual level that result in that aggregate outcome.

Micro-foundations of Cities

In the case of cities the great urbanist Jane Jacobs relentlessly and effectively attacked the urban-planning orthodoxy of the 1950s for imposing someone’s ideal bird’s-eye, macro-urban vision on the micro-fabric of great cities. Rather than try to understand from the ground up how cities’ spontaneous processes work – the informal neighborhood networks, the diverse knowledge and skills and tastes that both attract people to, and themselves generate the opportunities found in, great cities – the planners sought to directly shape the macro-urban landscape, gardener-like, according to their own ideal, usually rationalistic central plan. It is just like saying, “Wow, these 500-year-old quadrangles at Oxford University are lovely; let’s build some in Las Vegas!”

As Robert Caro documents in The Power Broker, his great book about New York’s city planner, Robert Moses, too often the results were massive highway and urban-renewal projects that tore apart living neighborhoods, disrupting and destroying lives and the economic vitality of once-thriving city districts.

Choosing the right unit of analysis is more than an academic exercise. It’s a matter of poverty and prosperity, even of death and life.

You can read a Portuguese version of this article here

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.