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Should People Just Ignore Economists?

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May 05, 2009 – Comments (10)

from Mises.org by Mark Brandly:

"What Good Are Economists Anyway?" asks BusinessWeek's April 27, 2009 cover story.

The article makes the important point that, since most economists failed to predict the current crisis, the worst economic collapse in nearly 80 years, we need to consider whether or not their work has any value.

Unfortunately, after bringing this failure to our attention, the article, written by economics editor Peter Coy, concludes that it's important to accept advice from the same economists who demonstrated their incompetence by not seeing this financial collapse in advance.

Peter Coy begins by quoting some noneconomists critical of the economics profession. Fans of Mises.org, I suspect, would tend to applaud these observations. Coy appears to be unaware of the Austrian School of thought and his assessment applies to the mainstream of the economics profession.

First, a blogger is quoted as saying,

"If you are an economist and did not see this coming, you should seriously reconsider the value of your education and maybe do something with a tangible value to society, like picking vegetables."

He's right.

Few economists saw this crisis coming, and many economists openly argued that there would be no recession. Such economists should question the investment they have made in their education. Society would be better off if these economists accepted work outside of the economics profession where they could produce something of value, and, more importantly, they could stop harming society with their destructive economic views.

Nassim Nicholas Taleb, author of The Black Swan, says, "We have to build a society that doesn't depend on the forecasts by idiotic economists."

Taleb is also right.

Some economists — those versed in Austrian business-cycle theory — did predict this crisis. Those who didn't see it coming might be considered "idiotic."

Next, finance expert Paul Wilmott asserts that "Economists' models are just awful. They completely forget how important the human element is."

Right again. Mainstream economists depend on mathematical models for understanding economic relationships. The false precision of the models may give them intellectual comfort, but the models provide a mechanical view of economic decision making. While Austrian theorists are focused on human action (Austrians call this analysis "praxeology"), the modelers overlook the purposeful behavior of decision making. Models fail to incorporate the full spectrum of human decisions, giving us, at best, an incomplete view of economic relationships (for an explanation of the limitations of economic modeling, see Gene Callahan's "Models: What Are They Good For?"). Recent events show that models can show us trends in economic variables, but have difficulty predicting changes in these trends.

The BusinessWeek article also takes a swipe at the last two chairmen of the Federal Reserve. Coy notes that before the collapse, Alan Greenspan argued that there was no housing bubble, and admitted in his Senate testimony last year that his earlier pronouncements regarding the soundness of our economy were flawed.

Coy also quotes current Fed chairman Ben Bernanke. In a 2002 speech commemorating Milton Friedman's 90th birthday, Bernanke noted the Fed's role in the Great Depression, addressing Friedman: "You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

That was a false promise. Under the leadership of Greenspan and Bernanke, they have done it again. In fact, they were doing it, pumping up the economy just as they did in the 1920s, at the time of Bernanke's quote. Given the events of the last year, that statement alone shows that Bernanke does not understand what caused or what will solve this crisis.

Because of economists' demonstrated incompetence, Coy is tempted "to ignore the whole profession." But, according to Coy, "that won't do." He concludes that in order to recover from this crisis, we must listen to the best economists, and by that he means the top mainstream economists.

To make his case that economists have made important contributions to society, Coy points to research from the 1970s that shows "the importance of having a strong, independent central bank" in order to eliminate chronic high inflation. Coy's brief defense of central banking indicates that he does not link the current financial collapses to Federal Reserve policy. The Federal Reserve pumped large amounts of newly created money into credit markets, much of which went into the housing and stock markets. The artificially low interest rates generated by these policies caused malinvestments; the downturn occurs when investors realize their mistakes.

A strong central bank is the creator of, not the cure for, inflation and the business cycle (for more on the Austrian view of the financial crisis, see the Mises.org Bailout Reader).

Coy wants us to follow the "very best thinking of a generation." While he doesn't specifically say who the best thinkers are, Coy's article mentions several top mainstream economists, including recent Nobel Prize winner and hyper-Keynesian Paul Krugman. While these economists do not escape criticism, Coy argues that the profession (apparently meaning these economists) needs to come to an understanding about the cause of this crisis and lead us out of the recession. The "next agenda for macroeconomists will be to help make the economy far more robust — enough to survive the blunders of politicians, bankers, and economists of the future."

First of all, making the economy robust falls outside the job description of any economist; second, we cannot construct an economy that will withstand future attacks from political operatives and central bankers.

On the plus side, Coy leaves us with a story that should make us skeptical about Obama's Keynesian stimulus program:

As World War II ended, many economists worried that growth would lapse as military spending fell. Sewell Avery, the CEO of Montgomery Ward, was so anxious about a postwar depression that he refused to open new stores. Economists still aren't sure why he was wrong, so they can't say reliably whether fiscal stimulus will end this recession or just interrupt it.

The post–World War II economy tells us why the government's current program to stimulate the economy by spending trillions of dollars of revenues generated by borrowing and creating new money will fail. As Robert Higgs has shown, when the federal government drastically cut spending after World War II, the economy boomed. The recovery from the Great Depression was due to the reduction of government spending after the war.

Reducing the amount of government predations (Murray Rothbard's term for the government burdens on the economy) improves productive economic activity just as the massive increases in predations today will harm our economy. The economists who worried at that time that spending cuts would lead to a recession were wrong, just as the economists who are now in positions of political leadership are wrong about the causes and cure for the current panic.

BusinessWeek has done us a favor by pointing out that most economists continue to accept the very theories that prevented them from anticipating the financial collapse. However, the magazine errs in concluding that we should now listen to those same economists. It would make more sense to ignore those economists that not only failed to predict but also had a hand in creating the crisis.

BusinessWeek would have done their readers a favor if they had pointed out that one school of thought, the Austrian School, foresaw this downturn and understands how markets will correct the errors of the central bankers.

The magazine should have advised their readers to listen to Congressman Ron Paul and financial advisor Peter Schiff, and pointed their readers to the writings of Ludwig von Mises (The Theory of Money and Credit), F.A. Hayek (Prices and Production), Murray Rothbard (America's Great Depression), Jesus Huerta de Soto (Money, Bank Credit, and Economic Cycles), and Tom Woods (Meltdown).

10 Comments – Post Your Own

#1) On May 06, 2009 at 12:09 AM, MikeMark (29.64) wrote:

Well put. Thank you again David.

I find myself only trusting the thought processes of confirmed Austrian School economists. Others seem warped or at least purchased and owned with no conscience.

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#2) On May 06, 2009 at 2:25 AM, ives87 (< 20) wrote:

I am an Econ grad student.  I think that the problem with many of the economists is that they tend to push their political agenda.  When the Republicans are in power, their economists say that the economy is great, or improving.  When the Democrats are in power their economists say the same thing.  Which ever side is out of power says that the economy is awful or soon will be terrible.

Another big problem are the statistics used in much of the analysis.  Most of the official government statistical gathering agencies, have adjusted they way that thy report statistics to make things look good for the politicians.  This creates just a ton of confusion.  Poor information makes for poor analysis.

A lot of academics need to justify themselves.  Most academics espose Keynesian Economics because the government likes Keynesian Economics, because it gives them license to meddle in the economy.  Both political parties love Keynesian Economics.  This tends to create a positive feedback loop between the government and higher education.

That said, to a large extend the laws of economics are eternal.  People need to understand things like supply and demand, marginal utility, and marginal costs.

 However, we just need to remember to be skeptical to anything that we hear.  Just because we are told that someone is an expert, that doesn't make it accurate.

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#3) On May 08, 2009 at 2:09 AM, awallejr (83.90) wrote:

Gotta love this one: "If you are an economist and did not see this coming, you should seriously reconsider the value of your education and maybe do something with a tangible value to society, like picking vegetables."

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#4) On May 08, 2009 at 3:26 AM, JibJabs (91.83) wrote:

I don't know economics but I understand something about the bureaucracy of higher learning, which is integrally tied to the profession of economics. Academia is a bureaucracy. It is slow. Tenure allows professors married to an idea to work beyond their discrediting. Their theories do not have to be testable. Publish or perish demands innovation whether wise or not. Buffett recently said that no professor would get tenure by saying that "a bird in the hand is worth two in the bush." Simple is often a derogatory word, whether a simple utterance is wise and reveals a profound truth or not.

But, the best (the likes of Milton Friedman and Friedrich Hayek) are above this and have made astounding contributions to the world. We can take the most abstruse utterances of academics and deride them easily, but academia is large. As an institution, it contradicts itself. That is the way of the dialectic- truth born through argument (an idea as old as Socrates with staying power). The merits of the dialectic are a different discussion, but it can undoubtedly generate some astounding insights that can only be gleaned through a lifetime of strenuous study. Nothing in academia should be accepted through blind faith- it is merely a deep window into complex ideas. A world without academics, and my experience (not specifically of economics) is that a professorship can allow shallow arrogance or unfetter a powerful mind. The rare Milton Friedmans of the world are worth a thousand charlatans.

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#5) On May 08, 2009 at 4:11 AM, saunafool (98.77) wrote:

David,

Truly a great blog posting. Your best ever.

I have one question. You wrote:

As Robert Higgs has shown, when the federal government drastically cut spending after World War II, the economy boomed. The recovery from the Great Depression was due to the reduction of government spending after the war.

Do you have a link for this? I am very suspicious of this claim for two reasonsl. First, one big reason for the post-war boom in the U.S. was that our economy was the only large industrial economy not destroyed during the war. In 1950, the U.S. was about 58% of global GDP. Second, the whole world had to rebuild and there was a labor shortage (all those millions killed in the war). This meant plenty of jobs and not enough workers, setting the stage for the rise of the middle class all over the western world.

This second point fascinates me. In France, one of the reasons they are so socialist is that they attribute "les trente ans glorieuses" (the 30 glorious years 1950-1980) to socialist policy. What they don't see is that standards of living during that period rose dramatically everywhere (except the pure communist countries).

Anyway, I digress...

 

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#6) On May 08, 2009 at 5:40 AM, whereaminow (20.40) wrote:

saunafool,

I'm glad you liked the blog. I appreciate the feedback and I'll address it, but as I noted at the top, this work is presented by Mark Brandley of the Mises Institute. I'd love to take credit for it, but alas...

Robert Higgs' most famous work is Crisis and Leviathan (1987), in which he decribes the Ratchet Effect:

the old trick of turning every contingency into a resource for accumulating force in government

The topic of government spending during and after the war is discussed in great detail there.  Thomas Woods has also done a lot of work on the Depression of 1921, which lasted only 18 months after Warren Harding slashed government spending. 

France currently has a mixed economy, much like the United States, with a great deal of Syndicalism (worker ownership - to be differentiated from public ownership), Socialism, Corporatism/Fascism, and Capitalism.  The great 30 years probaby could undergo a little more vigorous analysis.  I'll see if there is any work on that. I suspect that, just like Sweden, Holland, etc..; the French economy was far less Socialized in 1950 than it is now.

David in Qatar

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#7) On May 08, 2009 at 7:33 AM, saunafool (98.77) wrote:

I suspect that... the French economy was far less Socialized in 1950 than it is now.

This is almost without a doubt true. There were two big socialist revolutions in French government. First 1968, when everyone went out in the streets and almost took down the government. The second in 1984 when Mitterand was elected.

What interests me about it is the false attribution. For the French, it wasn't socialism which created the middle class in the post-war period. It was capitalism--lack of supply of manual labor during an economic expansion. Every industrialized mixed economy in the world experienced the same rise of the middle class. Yet, everyone in France believes it was "their system" which created the economic prosperity.

Likewise, Americans attribute the wealth of the 1950's to the superiority of the American system, and the people who call themselves conservatives attribute the economic expansion of the 1980's to Ronald Reagan's policies (but they refuse to give the same credit to Bill Clinton's policies for the even greater economic expansion of the 1990's).

Personally, I would attribute both expansions to the same thing--continuously declining interest rates. Please, elect me President when the fed funds rate is 19% and I'll have a great economic record, too.

You point to the "Depression of 1921" as an appropriate response to a recession. To me, it looks like a completely different kind of recession. To my knowledge there was no speculative boom with excess leverage leading into that "Depression," particularly in the private sector. Without excessive leverage and debt throughout the private sector, recovery is always easier and faster.

In 1929, in Japan in 1989, and in the U.S. in 2007, the private sector was leveraged to the hilt. Academics like Bernanke can say whatever they want, but no one has a solution. In the end, the recovery comes only after all the bad debt has either been paid or written off.

What they are doing is buying time for that process to occur and devaluing the dollar (and every other paper currency) to make paying off the debts easier. It stinks, but I think they have made what they believe is the "less bad" choice of a longer recession and shallower recovery.

The problem with the 1921 approach right now is that we are at the end of a long period of easy money. This has left the entire economy in "weak hands." Banks, businesses, and individuals. Taking the hard medicine might be right in theory, but it would also be very risky. After so many years hooked on the junk (easy money) you just don't know if going cold turkey will kill the junky.

So, I wonder, do you run into the same problem of the economists you mention in the OP? It all looks good in theory, but it might overlook the human factors. If the economy goes down too far, too fast, people will start looking for someone to blame. Maybe they turn their backs on Wall Street and move to the extreme left. Maybe they blame minorities and go towards xenophobia or worse. Maybe they turn to God and push for theocracy. I don't know, but they probably aren't going to vote for a moderate pragmatist.

All that to say, I don't know what the answer is right now. I think the economy is in for a rough several years almost no matter what the government does.

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#8) On May 08, 2009 at 7:43 AM, automaticaev (35.85) wrote:

yup they are completely worthless and idiots.  Flip a coin is what they do they are all idiots.

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#9) On May 08, 2009 at 7:59 AM, whereaminow (20.40) wrote:

saunafool,

The Depression of 1920-1921 was no mild recession.  It was a full blown GREAT Depression brought about by the inflationary policies of the Fed during and after WWI.  The speculation of investors equaled or exceeded those of 1929. 

America's Greatest Depression

Thomas Woods' new book Meltdown covers the 1920-1921 Depression in detail, as well as Harding's response.

He discusses it here. (Audio Feed) This is really excellent!

David in Qatar

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#10) On May 08, 2009 at 8:21 AM, automaticaev (35.85) wrote:

you dont need a degree to be an economist just a coin heads is good and tails is bad.

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