The world is bigger than you can imagine

Why it is difficult to evaluate an economy

This post will begin with some silly dorm room philosophy, but eventually I’ll extend the idea to something that I’m actually qualified to discuss—the macroeconomy.

It has become an overused cliche that the universe is so vast that the puny human mind is unable to even imagine its scale. So let me begin with a claim that might be more controversial; a human life is so vast that a person cannot reasonably evaluate their own life. Try to sum up your life? It’s probably impossible.

It sounds a bit arrogant for me to tell other people that they cannot evaluate their own life, so I’ll stick to my own example. If it doesn’t apply to you, that’s fine. I won’t try to press the point. Perhaps I’m different.

In your vision, there is a blind spot that you don’t notice. The brain sort of fills in the gap, making it seem like you see the entire field of vision. I suspect that life is sort of like that. My mind gives me the impression that I can look back on my entire life, but all I’m seeing are a few tiny fragments.

When I was nine years old, time seemed to go by very slowly. My age nine life must have been vastly richer than my age 70 life, with lots more happiness and pain, boredom and drama. It was one of the most important parts of my life, at least in “utility” terms. And yet I recall almost nothing of that year, perhaps just one or two dozen events. But that’s not even a single day for a nine-year old!

Here’s another way of looking at things. I sometimes try to categorize my life by type of event. But the more I look, the more I see. You have school, and work, and time spent with friends. Then there are the days where you are sick. There are days spent traveling. That includes both lots of vacations and lots of travel for work. And time spent at work is itself quite diverse, featuring lectures, research, office hours, committee meetings, lunch conversations, commuting time, etc. And those are just the tip of the iceberg.

At age 70, I will occasionally recall some important past event that I had completely forgotten. Clearly, I had not completely forgotten it, but the memory was inaccessible most of the time, including those times when I try to look back and evaluate my life. The sudden recollection of one of those deeply buried memories triggers a feeling analogous to deja vu, but different. It triggers the feeling that life is much bigger than I had thought, that much more has happened to me than I can recall at any one time. The Dictionary of Obscure Sorrows coined the term “sonder” for this feeling.

There’s also a vast amount of time spent on things that are more passive than play, work and school. Thus, I’ve read many books and seen even more films. How should I think about the part of my life immersed in alternative worlds through the narrative arts? This is from the Taiwanese film YiYi, which I’ve seen twice:

Pangzi: My uncle says we live three times as long since man invented movies.

Ting-Ting: How can that be?

Pangzi: It means movies give us twice what we get from daily life.

I occasionally think about those medieval peasants that were not able to go into a dark theatre at age 12 and have their minds blown by the film 2001: A Space Odyssey. (Substitute Star Wars if you are a decade younger, or The Matrix if you are Gen X.) I’ve spent a lot of my life immersed in films, many of which are far more engrossing than my “real life”. How should I think about that time?

When most people evaluate their lives, they probably think about career success or failure and their family life. That’s fine, but is it possible that we underrate the importance of all the time we spent on hobbies like collecting stuff or watching sports or listening to our favorite music in college or using drugs or hiking in the wilderness or lots of other “trivial” pursuits? Are we actually evaluating our life, or are we evaluating the official version of the most important parts of life? In some ways, artists like Borges, Conrad, Velazquez, Cezanne, Kubrick and Dylan seem more real to me, a bigger part of my life, than many casual friends I’ve had over the years.

The film It’s a Wonderful Life probably describes the way that many people visualize looking back on their lives. But an honest appraisal of my life would have to include It’s a Wonderful Life. The two hours spent watching that film (big screen of course) was much more engrossing than the two hours right before of after I watched the film, when I probably did something boring and eminently forgettable. If someone asked me to “look back on my life”, I would not start by saying “Well let’s see, I watched It’s a Wonderful Life”, as that film portrays someone else’s life. But it’s also a part of my life!

After writing this, I started to recall all sorts of minor things I’d overlooked. For instance, initially I thought of “work life” as my 35 years at Bentley University. But then I recalled that I also spent lots of time doing physical labor, especially when young but to some extent throughout my life. I suspect that I did at least an order of magnitude more physical labor than most other college professors—so that’s also an important part of my life.

Some stuff that I recall seemed normal at the time, but weird in retrospect. At age 13, I would see my (divorced) dad every few weeks. We’d sit at the bar, and I’d drink soda (then called “pop”) while he consumed six or eight scotch and waters, and we’d talk about all sorts of stuff. Then he’d drive me home! (Blood alcohol level? Don’t ask.) He’d occasionally give me 40 cents to buy him a pack of Kents from the cigarette vending machine. Or at the same age, hanging around the rail yards at night with my friends, dodging the police while collecting flares to use in making fireworks. That’s part of my life too.

I honestly don’t know what sort of life I’ve had. If I look back on it when I’m feeling down, I see a vastly different life from when I look back on it when I’m happy. So, which is true? What if both are false?

Again, perhaps this agnosticism about life is just me, maybe I’m weird. But now let’s look at two issues where I do have some expertise, evaluating economic problems and evaluating economic policy regimes. Most of the bad analysis that I see in these two areas ultimately derives from a single mistake—vastly underestimating the size of the economy. Not in the sense that GDP is larger than measured due to the underground economy, rather in the sense that the economy is far more complex and diversified that it seems at first glance. I’ll illustrate the two claims, one at a time:

Part 1: There’s a great deal of ruin in a nation

I received an email from The Economist magazine, which had the following admission:

For the past year America has been running a giant experiment. What happens when you take one of the world’s most successful economies and put in place two big growth-busting changes: tariffs and a sudden stop in immigration? Many observers—including us—thought the impact would be unambiguously negative. Yet America’s economy is still the envy of the rich world. The country’s GDP grew faster than that of any other G7 country last year. Its stockmarkets have repeatedly hit record highs over the past 15 months. What is going on?

In this week’s cover story, which will be published tomorrow, we offer an answer. We have crunched the numbers. An artificial-intelligence boom, soaring stockmarkets and some of Donald Trump’s own measures have boosted the economy. But by our calculations, the president’s chaotic policymaking, sweeping tariffs and mass deportations are, in fact, hurting growth—a drag we call the “MAGA tax”. Our calculations suggest that without the MAGA tax, America’s economy would have grown more than half a percentage point faster.

I suspect that many people overestimated the negative impact of Trump’s policies because they forget how complex the economy is. If Trump’s policies reduced real output by $300 billion, they would be enormously destructive. But that’s only one percent of GDP and could be easily obscured by offsetting effects related to monetary policy changes, an AI boom, and other factors. We saw this in 2007, when the US economy continued to expand despite a dramatic collapse in home construction. Even at its peak in early 2006, homebuilding was only 6% of GDP.

In general, people tend to overestimate the impact of any single real factor on the US economy. But there is one type of shock that people underestimate—nominal (monetary) shocks. Because wages and prices are sticky, nominal shocks affect not just a single sector like homebuilding, rather they impact all markets. That’s why almost all recent US recessions (apart from Covid, which only lasted 2 months) have been caused by contractionary monetary shocks.

This also explains why there are so many false alarms, forecasts of recession that don’t pan out. People wrongly assume that a problem facing one particular sector will cause a decline in the overall economy. In a large and diversified economy, that is rarely the case. Again, Covid being a notable exception.

The fact that there is a great deal of ruin in a nation has implications for a wide range of issues. In a post entitled “Supply is elastic, installment number 1637”, Tyler Cowen cites the fact that our policy of murdering suspected drug smugglers in the Caribbean does not seem to have slowed the supply of cocaine, and the cutoff of oil from the Persian Gulf did not cause the European airline industry to shut down in 6 weeks (as had been predicted). Numerous other examples of surprisingly elastic supply could be cited, such as the almost universal failure of “sanctions” to have their desired effect. Doomsday resource depletion or overpopulation scenarios are often the result of an excessively simplistic view of the economy.

Do you recall the maxim that the best forecast is usually more of the same (which has allowed Bryan Caplan to win almost all his bets)? This is because the vast size and complexity of the economy results in no single factor having much effect.

Part 2: Policy regimes are more complex than they appear

It isn’t just the overall economy that is really big, economic policy regimes are also very large and complex. In previous blog posts, I’d occasionally point out that Singapore has one of the freest market economies in the world. They are number one in the Heritage ranking and number two (slightly behind Hong Kong) in the Fraser ranking. Commenters occasionally responded that Singapore’s government is highly interventionist, citing numerous examples. So, who’s right? Queue the “Why not both?” meme.

I asked AI Overview to estimate the number of regulations in the US:

Because there is no single agreed-upon definition of what constitutes an "economic regulation," researchers estimate there are well over 1.1 million distinct federal regulatory restrictions, filling roughly 130,000 to 190,000 pages in the Code of Federal Regulations (CFR). [1, 2, 3]

And that’s not even accounting for state and local regulations such as rent controls, zoning rules, minimum wage laws, occupational licensing laws, building codes, etc., etc.

I wonder how many regulations there are in North Korea? If the answer were 800,000, would you conclude that North Korea has a less regulated economy than the US? I hope you see my point. Modern economies are very difficult to summarize as “free market” or “socialist”. Not all regulations are equally important.

Most economies are very large and complex, and even relatively free market economies have extensive government intervention. This complexity allows people to find evidence to support almost any position on the question of optimal policy regimes. In a country that is viewed as relatively successful, it is almost always possible to find a few examples of policies that you favor. Then you merely need to claim that these policies explain the success of your chosen example.

Similarly, in a country that is widely viewed as economically unsuccessful, it is almost always possible to find specific policies that you disagree with. Then you can claim that these bad policies explain why the country is doing poorly. Due to motivated reasoning, I suspect that we usually overestimate the impact of any single policy on a country’s overall policy regime.

You can think of the wealth of a country as being due to three factors:

1. Natural resources.

2. Human capital.

3. Economic system (taxes, property rights, regulations plus cultural traits such as corruption, interpersonal trust, etc.)

Beyond oil and gas, natural resources don’t seem to have a dramatic impact on per capita GDP. Student scores on international exams provide a rough estimate of the average level of human capital. The third factor is the hardest to estimate. How in the world do we measure the extent to what a policy regime encourages wealth creation? If the US has 1.1 million regulations, how can we possibly make sense of such a complex picture?

I don’t know whether I have any persuasive answer to this question but FWIW, I rely on two primary pieces of evidence, natural experiments and basic economic theory. I look at what happens when countries undertake major changes in their policy regime, and I look at what economic theory predicts about the relationship between economic regimes and wealth creation. For instance, I notice that:

1. The sluggish West German economy took off after ending price controls in 1948.

2. The sluggish South Korean economy took off after removing some barriers to trade in 1964-65.

3. The sluggish Chinese economy took off after improving property rights in rural areas after 1979.

4. The sluggish Polish economy took off after extensive privatization in 1990.

5. The sluggish Indian economy took off after significant deregulation in 1991.

And there are many other similar examples.

I also look at the predictions of economic theory. In most cases, theory predicts that efficiency results from having prices freely move to a competitive equilibrium. Theory predicts that low marginal income tax rates on labor and capital encourage wealth creation. Theory predicts that free trade is more efficient than protectionism. Theory predicts that wealth creation will improve if people have secure property rights over their land and physical assets. This is roughly the package of policies that are labeled “economic freedom” by Heritage and Fraser.

So, we have a set of economic models that mostly (not always) predict that freer markets are more conducive to wealth creation, and we have lots of historical examples of economies taking off after reforms increased “economic freedom”. But it’s complicated, as a country like Denmark scores extremely high on free markets but also has a large welfare state. Intervention is multidimensional.

It is also important to avoid motivated reasoning. In some cases (such as Chile), it took a long time for free market reforms to produce higher output. As Marcus Nunes recently discussed in an excellent post, Milei’s reforms in Argentina have thus far produced only very small gains. Economies are quite complex and it is not always clear whether any single reform, or set of reforms, will prove to be truly transformative. There’s a lot we don’t know.

Let’s conclude with a few other examples of things being bigger than we imagine:

Physical size of Earth: I few years ago, I visited “Africa” and went on a safari, staying at four different hotels. Well, actually just one of Africa’s 54 countries—that’s more countries than America has states. After the trip, I looked on the map and saw that the seemingly vast area I covered was just a tiny part of Tanzania, up near the Kenyan border. I know nothing about the rest of Tanzania. And did I even see that small region? Land travel is basically two dimensional, along the narrow thread of a road. To the right and left you could travel 10 miles, 20 miles, or 50 miles, and there would be thousands of villages that I never saw, untouched by tourism.

But hey, I’ve been to “Africa”!

[I traveled in the rectangular area northwest of Arusha.]

People occasionally do European vacations. (If It’s Tuesday, This Must be Belgium.) More sophisticated travelers will visit a single country, say Italy. I once knew a couple that vacationed in Italy once a year, seeing just one province on each trip. But can you even do Tuscany in one trip? Isn’t it better to do Florence on one trip, then Siena & Arezzo, then Lucca & Pisa, then the hill towns, then Etruscan sites, etc. And even Florence might be too much. Spend one trip exploring the buildings and statues designed by Brunellesci and Michelangelo, another closely examining paintings in the Uffizi and Pitti palaces.

Life: The diversity of plant and animal life is almost beyond comprehension. Not just in big countries like the US and China; even medium size countries like Colombia have an amazing variety of local ecosystems.

Culture: People often say, “The Japanese are basically like this” or “The Italians are basically like that.” No, they are like 100 different things, often seemingly contradictory.

History: History is full of stuff to support almost any perspective. At one time, it was believed there was a Dark Age from 500 to 1000. Then revisionists found evidence suggesting there was no Dark Age. Then even more evidence was found, suggesting that yes, there was a Dark Age after all. Genetic research into man’s past keeps making the picture look more and more complex. You could spend your entire life reading only history books and never run out of surprising new information.

Literature: Read all the classics? The deeper you look, the more great writers you find.

Film: There are at least 50 to 100 films deserving of being in the top 10.

At least 1000 films deserving of being in the top 250. In other words, try as hard as you might in developing your list of the top 250, and I’ll easily find another 750 that are better than many films on your list.

The internet: How many great substackers have I yet to discover?

Here’s a recent Bloomberg headline:

Odd Lots: How the Invention of Rope Gave us Modern Civilization

How many words can you think of to replace “rope”, which leave the claim roughly equally plausible? The wheel? Farming? Writing? Printing press? Gunpowder? Steam engines? Banks? Roads? Sailing ships? Cement? Religion? Steel?

How many more? A hundred more? A thousand more? I can only estimate the number that immediately come to mind, not the vastly larger number that don’t immediately come to mind.

We only know what we know and vastly underestimate the universe of things that we don’t know.

PS. Here’s Scott Alexander:

I acknowledge that my inability to marvel at a live Caruso opera in Naples has cost me something deep and beautiful. But I cannot wish that the phonograph was never invented. Does the increased variety and quantity of music compensate for the decreased profundity of each musical experience? Surely this is part of it, but I would never accept this excuse in other areas that have not yet been cheapened. A thousand moderately pleasant one-night-stands cannot equal one passionate love affair.

I certainly would agree that the thought of a thousand moderately pleasant one-night-stands cannot equal the thought of one passionate love affair.

But the reality? Again, we only know what we know, and vastly underestimate the universe of things that we don’t know.

How about a thousand and one night stands, each accompanied by a clever story?