1. Immigration causes Unemployment.

It is an argument often repeated. It goes something like this. “Immigrants who come over here are willing to work for lower paid jobs and thus they create unemployment for local people.”

This argument is wrong because.

• Immigrants increase the supply of labour but they also increase Aggregate Demand in the Economy. This means that they buy more goods and create additional demand in the economy. They provide labour supply and increase labour demand.
• If immigration caused unemployment why did America not have high unemployment during times of mass immigration? Because the immigrants created as many jobs as they took.
• Often immigrants take jobs that native workers just don’t want to do. – You won’t see big multinationals cueing up to stop immigration.
• Furthermore immigrants tend to be of working age. Therefore they tend to contribute more tax than receive in benefits. Without immigration US demographics would have a larger % of dependent old people.

True there is a shortage of supply in big cities like London and New York. However this doesn’t mean house prices will always keep on rising. House prices can fall just like anywhere else. It just means that they will be higher on average than elsewhere in the country. Note house prices in Tokyo and Japan fell over 25% after the end of the speculative bubble in the 1980s. – American house prices have a lot further to go.

3. War is good for the Economy.

This fallacy is deeply embedded in many people’s mind. One reason is because it was felt the Second World War ended mass unemployment in US and UK.

To some extent it is true unemployment fell because of the Second World War. However war is not necessary to solve unemployment. The government could have intervened to create jobs through public work schemes.

• War does create more output, but only in some industries related to war. Arms manufacturers do very well out of war. But total output of the economy doesn’t increase instead there is a change in economic priorities. Resources are diverted from peaceful industries to industries for creating the mechanisms of war.
• Increase in government spending for wars create either taxes and or higher debt payments. This is a burden on current and future taxpayers. Note The UK is still paying off debt from second world war.

4. Tax Cuts make people work harder.

• Ronald Reagan’s economic advisers told him something along the lines of “cut taxes” and you can increase total tax income. This theory is based on the laffer curve which states that if taxes are 100% people won’t work. Therefore if you cut taxes more people work and you can increase tax revenue.
  

• The problem is that this may work if you cut taxes from 95% to 90%. But when you cut income tax from 25% to 23% it doesn’t make any difference.
• Some people want a target income of say £20,000. Thus if taxes fall they can earn the same by working less. Empirical evidence suggests there is little if any supply side incentive for cutting US or UK tax rates.

Maybe this fallacy isn’t so common. But it is a common belief in the Current US administration. A current account deficit of 7% of GDP does matter. See: Does a Current Account deficit Matter?

6. Trade Wars. - Retaliation is Best

• The instinctive reaction of politicians is that if one country places a tariff barrier on our exports, we should respond by doing the same. However economic theory suggests that placing a tariff barrier on imports leads to a loss of economic welfare. It is better to not retaliate.

• Another justification given for cutting income tax is that it will increase Aggregate Demand and hence increase economic growth. However this is not always true because:

• If you cut income tax for high-income earners, they are likely to save a high % of their extra disposable income. Their marginal propensity to consume is low.
• If you cut income tax the government has to either cut government spending or borrow. If the government has to borrow from the private sector then they will have less income to spend causing a decline in private sector spending.
  

• This is called crowding out. (Although there are certain times when a government deficit can boost AD – like in a recession.)

Labels: economics, economics explained