Economic man: fallen from laurels to funeral wreaths…
This edition continues Prospect’s ongoing dissection of the causes and consequences of the financial meltdown. In addition to Geoff Mulgan’s cover story, “After Capitalism,” we have two big pieces on economics: one from Anatole Kaletsky on the failure of economic models (not to mention the economic modellers who built them) and another from Gerry Holtham on what the G20 must do next.
Kaletsky’s piece picks over two economic theories in particular—theories which, although seemingly discredited, still hold great sway over our business schools and investment banks. These are the rational expectations theory, and the efficient markets hypothesis. These theories may not have gone unchallenged in the past in Ivy League seminar rooms and central bank boardrooms, but they formed important building blocks in the theoretical understanding of the global economy which lead to policy mistakes contributing to the current crisis. Equally importantly, they were taught in all graduate level macroeconomics classes. Kaletsky charts their influence, and lays the blame for the crisis squarely on the shoulders of academic economists who promoted them. In response, only an economist’s reformation will do.
But what of the future? In our lead Opinion pice this month, Gerry Holtham isn’t much cheerier on the economic understanding of the current moment leading up to the G20. The problem? No one has yet grasped the type of global coordinated fiscal stimulus needed to put the world economy back on its feet. Uncomfortably, this mean certain countries—especially those prudent nations not as at risk of having their currency sink (i.e. not Britain)—shouldering much more of the burden of reflation. Equally, it means a much greater effort to reform the IMF, with less power for Europe and the US, reflecting their relatively smaller role in the current international set-up. How to mark this change? Holtham thinks moving the IMF itself would help. If the EU would act as its largest member, it could, within the rules, claim its HQ. Bratislava, he thinks, would work nicely.
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Or even Slovakia.
Add the non ‘modelist’ abstract mathematician economists Aristotle and Hannah Arendt (Human Condition); what the detached economists you rightly disfavor as having plunged us into this crisis have really left out of the ‘equation’ is ‘phronesis’, the virtue of contemplating not just ‘what it is’, but, perhaps on the basis of a true understanding of what is, the well weighted deliberation of what is best to be done.
Of all the misleading explanations of Rational Expectations that I have ever seen, this article presents, by far, the most confused and wrong one. REH has many good things and many bad things, but the author of these piece does not seem to understand any of them. It would be helpful for him to sit in an introduction to economics class.
If you are reading an article/blog about the current economic crisis and see the work “blame” in the first 10 sentences, stop reading immediately. What nonsense.
Anatole Kaletsky hits the nail precisely on the head. I have been trying for years to convince econometricians of the old cliche that it is “garbage in, garbage out” only to several decimal places. It also reminds me of the old joke about “alchemy became chemistry; astrology became astronomy; I wonder what economics will become?”
I’ve just retired from 30 years of teaching macroeconomics at the college level. Gladly. The field had become theology, filled with tautologies, unbothered by empirical refutation, riddled by
“models,” ignorant of actual economic history, scornful of the
other social sciences, and basically a wholely-owned subsidiary of the U.S. Republican
party. Fools all.
Jesus, I suspect that Mr. Kaletsky might have had to sit in on an economics class at some point in order to obtain a masters in the aforementioned discipline from Harvard.
I completely agree.
I stopped following very closely Brad DeLong’s blog for his take on everything happening around us.
I realized he has got nothing more to offer than smart sounding rhetoric and- occasionally- interesting stories.
For that, I can visit him once a month.
Franco:
If Mr. Kaletsky did, he did not understand anything. By the way, having a masters in economics in the U.S. is usually a sign that you failed the preliminary exams to continue to your Ph.d.
Kaletsky is angry with economists. Perhaps he should reserve a little of his anger for his own poor judgement in deciding which economists to listen to.
It is bizarre that he dismisses the work of Robert Shiller, who was writing about irrational exuberance in financial markets ten years ago, as insufficiently “radical” or “challenging.”
There are others, closer to home. In 2002 my Warwick colleague Andrew Oswald warned that UK house prices were bubbling dangerously.
In the same year others including my Warwick colleagues Marcus Miller and Lei Zhang warned in the Economic Journal of the “Greenspan put,” a “one-sided intervention policy on the part of the Federal Reserve which leads investors into the erroneous belief that they are insured against downside risk.”
Compare this with Kaletsky himself who, two years ago, declared the risk of a house price crash to be “overstated,” and, one year ago, expected that “the worst may be over.”
I understand that Kaletsky is not himself an economist. And the point remains that economists (with a few honourable exceptions) have plenty to reflect on. Should the same not apply to the cheerleaders that chose the wrong team to follow?
I agree with much of what Kaletsky says, but I think he goes too far. We need both types of economics (see my Truth vs. Precision in Economics) The problem is the intolerance of formalist economists towards more practicsl economists.
A move that even Obama would like: send IMF to Bratislava, Slovenia and nobody will ever find it. The place does not exists, but … never mind, neither does the money for IMF to lend.
In the cunundrum of nature, humanity is constantly wrangling with the factor of ‘certainty’. As certainty does not exist in nature (uncertainty being the paradigm), at least in the long term, experts, in this case economists, are placed in an untenable position of providing it, thus farcefully becoming or acting as ‘God’ in peoples’lives.
However, in the process, not only do they fool themselves (some may be conscious of their shortcomings) but they also fool the rest of us.
And, since mathematical constructs for certainty are merely able to capture ‘the moment’, as Anatole Kaletsky correctly concludes , let’s maintain a comprehensive view of all social systems which affect our lives, especially economics–the imprecise science.
Crisis ? What Crisis ?
The essential problem with Economists’ standard models is not that they are simplistic – it’s just that they are plain wrong. The models used by both Keynesianists and Monetarists ignore such basics as – if Business wants more money back than it paid out, where does the extra money come from ? Adding such real World ‘complexities’ does not turn the models into unfathomable rocket science – the models are still fairly simple – but for the first time ever they become actually useful. At http://www.worldnews.blog-city.com you can have a look and play around with some ’simple’ free Excel based models that cover such necessary real world basics. With a few clicks you can create a virtual depression, a virtual bubble or a virtual credit crunch – and the good news is you can fix them as well. Remember this ‘recession’ is only about numbers, we haven’t actually run out of anything real – so it’s actually quite straight forward to fix. It’s not models that are bad – its bad models that are bad.
Although quite simplistic (obvioulsy, this is not an only-for-academics-review), I found very convincing the deep argument (the risk of numbers that go too far from real experience). The problem is not only in academics: political science seems to gon on the same way (of course, their irrelevance make political science quite less dangerous…).
As the author of Debunking Economics, I’m pleased to see commentators like Kaletsky bagging neoclassical economics in the press. For far too long neoclassical economics got a free ride there, while the work of rival theoreticians like Hyman Minsky, Richard Goodwin, etc. was ignored.
I don’t believe that economics is capable of undergoing an intellectual revolution from within. My solution is to instead remove the franchise to the discipline from economics departments, and allow engineering schools (where systems dynamics reigns) and physics schools (where econophysics is being developed) to give courses on economics too.
Of course, I expect academic neoclassical economists would complain vehemently about losing their monopoly over the subject…
Not only is this article riddled with intellectual error, it is riddled with factual errors too. For example, there is nothing subtle about the relationship between Paul Samuelson and the EMH. It was Samuelson who published a proof of the EMH in the 1960s. Similarly it is not true that the University of Chicago economists who developed the EMH have all won the Nobel prize. Eugene Fama has not won the prize. Nor has Michael Jensen (who got his PhD from Chicago). Mind you Stiglitz who published a paper on the impossibility of efficient markets has won the Prize. The argument that EMH theorists justified corporate excess is simply false too. Michael Jensen is one of the founders of agency theory – a theory that explains how and why corporate excess occurs. Bottom line, Kaletsky couldn’t even be bothered to do a basic fact check.
To Sally Stewart:
The answer to your musing is “Vitanomics”. It’s the name of the new science on the subject founded and exponded by Nino Gasparini in his books “The Vitanomic Explanation” and “VITAOMICS: thee revolutionary alternative to economics”. Note, revolutionary alternative TO economics and not alternative economics. I’m pointing that out because vitanomics has nothing to do with economics. Nothing aat all. That being so even though the the “economy” (redefined as the vitanomy in vitanomics)is the subject to both.
Vitanomics is radically different from economics as radically different as chemistry is from alchemy.
Vitanomics is precise, logical and non ideological as all true sciences are, and, unlke economics, it can be understood by anyone with a modicum of common sense.
Basically, Vitanomics is now what economics would be in a thousand years, if ever.
Kaletsky’s message is very timely. Even if economists don’t like the message, we should all sit up and listen.
However, I think Kaletsky underestimates the number of heterodox economists who have no time for these naïve theories of mainstream economics to which he objects. Our approach to economics is very different indeed. But almost all of us have to work outside the main departments of economics – precisely because our heterodox approach would be unwelcome there.
Secondly, Kaletsky suggests that the business schools are the worst offenders in teaching the theories to which he objects. As one who has worked in business schools for most of my career, I have to say that is definitely not my experience. I do mention the ‘efficient market hypothesis’ (EMH) in my MBA lectures on the ‘credit crunch’, but only so that the students can have a good laugh. No MBA student would be taken in by EMH! MBA students all know the famous saying attributed to Warren Buffett, which I shall paraphrase politely for ‘Prospect’: he would be a poor man if the markets were always efficient.