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Phlogiston Economics: The Need to Dispel the Free Hand and Create Jobs Instead

We can laugh now at phlogiston theory – the 17th century idea that all materials that could be burnt contained phlogiston

We can laugh now at phlogiston theory – the 17th century idea that all materials that could be burnt contained phlogiston, an odorless, colorless substance. The concept seemed sound, because it was based in an elegant idea – handed down from the Greeks – that everything is created from four elements: earth, air, fire and water.

In fact, so sound was the elegant concept that there was no need to test it. However, an experiment by Robert Boyle in 1753 demonstrated that it was false.

Phlogiston is good for a laugh today, but economic ideas that control current decision-making are based not on tested experiments but on elegant theories. Economics’ equivalent of phlogiston appeared 23 years after Boyle’s experiment, in Adam Smith’s 1776 book, “The Wealth of Nations.” Its phlogiston equivalent was the self-regulating market, described as an “invisible hand.” The invisible hand’s efficient market was created by individual self-interest; interference with the market through regulation risked economic catastrophe.

Today’s economics have embellished those basic ideas through concepts such as supply and demand, rationality, market clearing and marginal utility. Today’s mainstream economics is a Gothic cathedral constructed from elaborate mathematical analyses – with almost no experiments to test the validity of the theories.

Phlogiston economics theorizes that employees and employers bargain freely about wages and working conditions. Elaborate justifications have been made for why employees have chosen to be at-will employees – meaning they can be fired for any reason – rather than have just-cause employment – meaning they can only be fired if there is cause, such as misconduct or business needs.

When Washington University law professor Pauline Kim tested those theories, she found that roughly 80-90 percent of employees thought that their employers could only fire them for cause. Of course, nothing could be farther from the truth. In almost all states, by law, the default is at-will employment, and it is almost impossible to bargain out of at-will because most employees do not have enough bargaining power, let alone the information to change the default.

In recent years, economic theories have been tested through experiments that, in some cases, have cast doubt on the basic underpinnings of economics, including the roles of rationality, self-interest and information in shaping decisions. At best, the experiments have been inconclusive. These results mean that continuing to rely on textbook theory to craft policy is unwarranted, if not unforgivable.

Yet, despite these results, classical economic theories continue to control important decisions.

The most important of these today revolve around how to handle the effects of the economic recession. Theory now advanced and popular with the right is that cutting taxes, getting rid of regulations and paying down debt are the only way out. On the other hand, we have some natural experiments, in particular from the Great Depression, that demonstrate that those actions made the situation worse in the years just after the 1929 stock market crash, and again in 1937, when President Roosevelt instituted policies based on those theories.

We face complex problems that require serious, thoughtful solutions – not phlogiston economics, even when it is built on elegant constructs.

The natural experiment from the Great Depression showed that creating jobs led to a growing economy as new workers spent their incomes and created the need for more jobs. The evidence supports a jobs policy to get people back to work and to fill the enormous needs we have for workers to build and repair infrastructure and provide important services, such as promoting better education and health. Those newly employed workers, especially those who have been unemployed for months, will spend money on long-deferred needs and pay taxes that will reduce the deficit – actions that have been shown to create new jobs in past recessions.