According to the Wikipedia entry, “Einstellung refers to a person’s predisposition to solve a given problem in a specific manner even though ‘better’ or more appropriate methods of solving the problem exist.” The word means “installation” or “attitude” in German. Einstellungers repeat a solution even when it is not optimal.
The Einstellung effect is a failure to use lateral reasoning. One can think of deductive reasoning as going vertically from premises down to a conclusion. One can think of inductive reasoning as also vertical but from observations and facts up to a generalization. In lateral thinking, one examines the premises to determine whether they are complete or appropriate.
The Einstellung actor does not examine the completeness of his method. He thinks the method worked in the past, and in this similar situation, it will most likely work again, or else, that is the only solution he knows. He does not search for alternative methods. It is not so much that the Einstellunger is lazy, but that he has been trained and conditioned to think only along particular pathways.
Einstellungheit is particularly dangerous in economic policy. In confronting a depressed economy, the tendency of Einstellungish economists is to repeat the remedies they learned in school, without thinking laterally about alternatives.
The two remedies to economic depression are demand-side and supply-side. Demand-side policy seeks to increase overall or aggregate demand. The conventional methods are monetary and fiscal stimulus. The monetary stimulus expands the money supply to drive down interest rates. That is the policy followed by central banks such as the Federal Reserve system.
The Fed’s monetary expansions of 2009-2013 have failed to stimulate high growth. If regulatory restrictions and fear of bad loans prevent the banks from loaning out the funds, they will buy safer treasury bonds or guaranteed mortgage-backed securities. When the banks do loan out the funds, the stimulus gets misdirected into real estate purchases that later become a bubble that crashes, as happened when interest rates were pushed down after 2001. The cheap credit generated by monetary expansion distorts investment and generates perverse land speculation.
The conventional fiscal thought of demand-side Einstellung is that the expansion of greater government spending will multiply into much greater output. The Einstellung view is that there is a spending multiplier based on the amount of income consumed rather than spent, so a billion dollars of spending results in several billion of greater income and output. The US has had deficit spending of hundreds of billion per year for the past several years, and there has been no multiplier. Japan experienced the same policy failure after its boom of the 1980s. Both monetary and fiscal expansion have failed to stimulate growth.
The other policy option is supply-side stimulus. Supply-side policy is based on the economic logic that greater profit generates greater investment, and government can increase profit by reducing the costs it previously put in. Conventional supply-side policy cuts taxes and reduces excessive regulations. But the dark side of the Einstellung supply side is that lower taxes without lower spending results in greater government deficits. That is what happened with the Reagan tax cuts of the 1980s, as the economy did grow, but greater military spending expanded the deficit as well. The Bush tax cuts after 2000 also generated greater governmental debt. Conventional policies have failed in Europe as well, as austerity measures shrink their economies while conventional stimulus increases deficits when debt is already excessive, pushing up interest rates, which then reduces investment and growth.
The supply-side logic is correct, but simply applying tax cuts fails to consider an alternative policy: a tax shift. The supply-side effect can be accomplished without increasing the deficit, by reducing market-hampering taxes on wages and enterprise, while increasing market-enhancing taxes on pollution and land values. A market-enhancing tax is actually a reduction of perverse subsidies.
Polluters get subsidized when they can shift the social cost to the general public rather than the customers who buy the products. A pollution tax makes the buyer pay the full social cost, eliminating the implicit subsidy. A tax on land value removes the implicit subsidy of higher rent and land value generated by government’s public goods. By removing subsidies, taxes on pollution and land value increase efficiency — they actually help the economy.
The concept of taxing pollution has been well known to economists since the 1920 publication of The Economics of Welfare by Arthur Pigou. The concept of tapping land rent for public revenue is ancient, and was analyzed and proposed by the French economists of the 1700s, by Adam Smith, by Henry George, by many other economists, and recently by the 27 June 2013 Economist magazine.
Why more economists do not advocate an efficiency tax shift, and why policy makers mostly ignore it, and why it is not popular among the public, is ultimately due to the Einstellung Effect. I leave it to psychologists to inform us as to how to overcome this psychological disability, although their own Einstellung may block this. But there have been movements that have overcome Einstellung inertia, such as for the abolition of slavery, women’s votes, and the civil rights movements. So Einstellung is not necessarily destiny.