Tuesday, 30 December 2014 00:46
An economist is a person, President Ronald Reagan once famously observed, who ponders over why something which works in practice does not work in theory! Notwithstanding this somewhat jaundiced view of the practical approach of the average economist, the academic economist has an inordinate about of influence over public policy.
In the corporate sector, the accent being return on investment and profitability, economic theories are not given much space. On the other hand, in government, research and policy institutes and universities and such statist environments, economists are still very influential. Economists write learned papers, contribute columns to newspapers, advise politicians and policy makers and offer expensive consulting services.
What is the reason for economists having so much influence, when compared to the other learned professions such as lawyers, engineers and doctors, who by the nature of their work are at the cutting edge of practical implementation in their various fields and naturally would have knowledge of what will work and what will not work, in practical terms?
Self-belief in superiority
A recent research paper tries to explain the phenomenon. M. Fourcade, E. Ollion and Y. Aglan, in a paper entitled ‘The Superiority of Economists,’ start off by saying that one reason is that economists have come to believe that they are superior! This attitudinal aberration starts with students, and the authors say has increased as the study of economics involved more mathematics.
For example, in 1985, a research study found that only 9% of post graduate students in economics at Harvard University believed that ‘economics was the most scientific of the social sciences’. But by 2003, 54% of the same cohort strongly agreed that economics was the most scientific of the social sciences! This attitude extends to the views of the students expressed online – for example, one graduate student dismissed sociologists as those who ‘play around with big important ideas, without too much effort or rigor’!
There are other examples of this self-belief in superiority. For example, in the journal the American Economic Review, articles refer to or cite the top 25 political science journals in academia one-fifth as often as the articles in the American Political Sconce Review cites the top economics journals. Economists do not even deign to comment on the research work of the other professions!
Another research study found that in the USA, professors of economics were less likely than their colleagues in other disciplines to agree with the view that ‘interdisciplinary knowledge is better than knowledge obtained by a single discipline’! The economists are so enamoured with their own discipline!
The authors cite another reason – that the other professions are more reticent and do not express certain and definite outcomes of a process. The public seeks strong arguments, solutions and clear answers to problems. Academics generally, in disciplines other than economics, are far too reticent, the authors say. The authors quote an economic historian who jokes that ‘for a moderate fee, an economist will tell you with all the confidence of a witch doctor that interest rates will rise 56 basis points next month or that dropping agricultural subsidies will increase the Swiss national income by 14.8%’!
The venerable doyen of economist, John Maynard Keynes, spotted the issue early. He famously said, in his inimitable style: “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”
‘The Squam Lake Report’
Economists, whose biggest failure as a collective was their failure to predict the last financial crisis, have tried to make up by Kenneth R. French, a Professor at the Tuck School of Business, summoning 15 economists who met in 2008 November, at the height of the American financial crisis, at a resort called Squam Lake in New Hampshire in the US, and thrashed out ideas for protecting the financial system from such future crises, and have been working on and improving their solutions since. Their goal: to map out a long-term plan for financial regulation reform.
The group, among others, included Robert J. Shiller of Yale, who foretold the US housing crisis, Frederic S. Mishkin, a former Governor of the Federal Reserve and currently of Columbia University, Raghuram G. Rajan, a former chief economist at the IMF (currently Governor of the Reserve Bank of India), Martin Bailey a one-time advisor to President Clinton and Senior Fellow at the Brookings Institution, Anil K. Kashyap of Chicago University, Rene M. Stulz of Ohio State University, Jeremy C. Stein of Harvard, John Y. Campbell also of Harvard, John H. Cochrane of Chicago, Douglas W. Diamond of Chicago, Darrel Duffie of Stanford, David S. Scharfstein of Harvard, Hyun Song Shin of Princeton, Mathew J. Slaughter of Dartmouth and Jeremy C. Stein of Harvard.
Their thoughts have been published as ‘The Squam Lake Report’ by Princeton University, which distills the wealth of insights from the ongoing collaboration that began at the Squam Lake meetings and provides a revelatory, unified and coherent voice for fixing the worlds’ troubled and damaged financial markets. Their target audience is key economic policy decision makers’ worldwide.
The economists concerned felt that the 2008 financial crisis ‘was such a disaster that we felt an obligation to reach some common ground’. They deal with the forces that brought the world to the brink of economic disaster, a house price bubble boosted by runaway mortgage lending in the rich world, a lightly-regulated global financial system that found more and more creative ways to speculate on the rising house prices and a macroeconomic policy making environment that was far too laidback about the dangers posed by asset price bubbles. Some say that the US Government used easy credit as a way of softening the harsh effects of globalisation on the less skilled and marginalised part of their work force.
The world seemed to be sitting up and taking notice, Ben Bernanke, former Chairman of the Federal Reserve introduced the book at a conference to herald its publication at Columbia University. Alan Greenspan, Bernanke’s predecessor, has described the book as ‘an excellent primer on the workings and failures of today’s sophisticated financial system, few can fail to be impressed with the scholarship the Report brings to the subject of reform.’
This may be just because the 15 economists at Squam Lake managed to agree on something, for as the revered play write George Bernard Shaw very wisely said, ‘Even if all economists were laid end to end, they would not reach a conclusion’!
The ‘Dismal Science’
The Victorian writer Thomas Carlyle labelled economics as the ‘Dismal Science,’ probably because of its gloomy predictions. It is believed by most economists that the beginning of economics was with Adam Smith publishing his ‘Inquiry into the Nature and Causes of the Wealth of Nations’ in 1776. Alfred Marshall, the great 19th century economist, in his textbook ‘Principles of Economics,’ defined economics as ‘study of mankind in the ordinary business of life.’
The word is derived from the Greek for ‘management of a household’ and is the study of how human beings coordinate their wants by the efficient production and distribution of goods and services. The four central issues addressed by economics are: What to produce, the quantity to be produced, the process of production and what the demand from the market is.
There are three well-accepted reasons for studying economics: The first is that it will help you to understand the world in which you live; the second is that it should help you to be a more astute participant in the economy; and the third is that it will give you a better understanding of both the potential and the limits of economic policy. The Oxford Advanced Learners Dictionary defines economics in a way which brings out these aspects: ‘The study of how a society organises its money, trade and industry.’
Charles Dickens in an essay in the first issue of his popular magazine ‘Household Words’ issued a challenge to economists to humanise their discipline. ‘Political economy is a mere skeleton unless it has a little human covering and filling out. A little human bloom upon it and a little human warmth in it’.
From time to time diverse views have been expressed on the world’s leading proponents of economic theory. John Maynard Keynes was considered an exotic mix of being a Bloomsbury intellectual and civil servant mandarin. Keynes insisted that economic crises could be prevented if the government could act as the spender of the last resort – just as the central bank was the lender of the last resort.
Joseph Schumpeter was considered to be an obsessive scholar who spent his spare moments riding thoroughbreds. Schumpeter declared that the economy not only grows bigger and bigger, it goes through a process of constant discombobulating as entrepreneurs invent new products and processes. Irving Fisher of Yale was a health fanatic and a prohibitionist who argued that good management of the money supply could contribute to stability. Joan Robinson, who famously declared that ‘Sri Lankans want to enjoy the fruit before they plant the tree’, wore Mao suits and declared that North Korea would outperform the South. Schumpeter called her ‘one of our best men!’
Karl Marx was considered to be so convinced that he was right and so buried in his books in the British library that he failed to observe the world around him. He did not bother to visit a single factory and ignored the overwhelming statistical evidence that the working class’s share of the national wealth was increasing. Marx viewed the capitalist system as one which would pauperise the poor and lead to overproduction. He did not realise that capitalism’s recurrent crisis would actually reinforce and strengthen the system.
On the other hand, Alfred Marshall was thought to embody what was best in Victorian high-mindedness. He was totally alive to what was going on around him. He visited factories and firms and travelled around America. Marshall supported popular education and incremental reform. Marshall demonstrated that capitalism helps the poor by boosting productivity. Amartya Sen is considered a genius who devotes his life to thinking about eliminating the most dramatic manifestation of want: Famine.
Wonder of a market economy
The most humongous economic policy mistake of the past has been to expect too much from government. Mainstream economists who supported Statism could always be found. These sentiments reflect a failure to appreciate the wonder of a market economy – Adam Smith’s ‘invisible hand’ – how workers, firms and households, acting without visible coordination and guided by self-interest, manage to produce amazing developmental results, pulling millions out of poverty and marginalisation, as in contemporary India and China.
Norman Macrae, who was for 23 years Deputy Editor of the Economist newspaper, always made the point that markets had made a remarkable equalisation in people’s lives. Rich and poor had access to the same consumer goods – the same television programs, the same household goods and access to the same Wal-Mart mega markets, Keells Supers or Arpico Super Centres or Cargills Food City outlets.
Markets may fail, and readjust and reinvent, governments also fail, advised by expert dismal economists, with much more drastic negative results and are incapable of adjusting, and they have to be dismissed from office at elections or by violent or silent revolution.
Markets today are subject to standards of openness and disclosure to ensure competition; there are also prohibitions against unfair labour practices and environmental damage. Governments should ensure this, but an objective assessor would describe only a minute part of what governments attempt to do as even an endeavour to improve overall welfare.
Judging from the fact that the largest interventions by governments are collecting taxes and spending, it is obvious that governments are principally interested in self-serving redistribution; reducing one group’s welfare so as to improve another’s, often mis-targeted and misdirected and misallocated!
Andrei Shleifer of Harvard University and Robert Vishny of the University of Chicago, state in their book ‘The Grabbing Hand: Government Pathologies and their Cures,’ the assumptions behind most economists’ thinking on the role of the state is plain wrong. As we Sri Lankans well know, political parties in government are most often principally interested in winning power, exercising power, abusing power and hanging on to power!
The words of the Lord Protector of England, Oliver Cromwell, to the Parliament of his day in 1653 reverberate in our ears: “You have sat too long for any good you have been doing lately… Depart, I say; and let us have done with you”! So much for the ‘helping hand’ model of government! The ‘invisible hand’ is much more efficient.
Frederic Bastiat’s theories
One of the most brilliant economists, who used satire to communicate his theories, was Frenchman Frederic Bastiat. Bastiat, who was born two centuries ago, is best known for an essay in which he petitions the authorities on behalf of the candle-makers of France; he complains against the ‘ruinous competition of a foreign rival who works under conditions so far superior to our own for production of light that he is flooding the domestic market with it at an incredibly low price’. The rival is the sun!
Bastiat’s proposed remedy is the shuttering of all windows. That, he claims, using all the standard protectionist arguments, will benefit not only candle industry but also all the industries that supply it with inputs. As a compelling statement of the case for free trade, this essay is hard to beat. It should be compelled reading for all proponents and opponents of the Indo-Lanka CEPA and the Sri Lanka-China FTA!
Noting the popular view that exports are good and imports bad, Bastiat wondered whether the best outcome would be for ships carrying goods between countries to sink, thus creating exports without imports! To solve the problem of lack of jobs, Bastiat suggested that to parcel out the limited amount of work available, people should be required to do whatever work there is using only one hand or even have a hand chopped off.
France did something like this in the recent past, imposing a maximum working week of 35 hours per person to share out whatever work available. Bastiat described the state ‘as the great fictitious entity by which everyone seeks to live at the expense of everyone else’! He was critical of the welfare state, which he said, by protecting the rights of the producers rather than the consumers, often came to commit ‘legal plunder’. Bastiat argued that the main role of the state should be to protect liberty and property.
Squam Lake recommendations
What of the Squam Lake recommendations? They recommend among other things that government, rather than setting pay levels for senior managers of banks and financial institutions, should be required to withhold a share of each senior manager’s pay for several years, this money would be forfeited if the company went bankrupt.
Holding back a fraction of each year’s bonus would make bank executives act more like taxpayers and less like shareholders. Taxpayers do not benefit when the entity makes profits but bears the cost when it has to be bailed out, while shareholders often favour short-term risks in the hope of scoring a quick profit.
Another recommendation is for a debt instrument known as contingent convertible bonds; banks would be encouraged to issue such debt, which would automatically convert into equity in a crisis, which would speed up the recapitalisation of an ailing bank at no cost to the taxpayer, the bondholders would have to bear the cost of the failure. They also recommended that each country should have a single regulatory organisation to oversee the health and stability of the financial sector.
The group also called for better disclosure of the risks of financial products, particularly the mutual funds used in retirement accounts and an entity to protect consumers from abusive financial products.
Will the Squam Lake proposals make a difference? President Obama has also signed into law new legislation, saying: “Never again will the taxpayer have to bail out reckless financial institutions.” Pious hope or famous last words!?
But the publication of ‘An Economic Program for American Democracy’ in 1938 after the Great Depression could not forestall the economic crisis of 2008. The factual coincidence that the then Chairman of the Federal Reserve Ben Bernanke studied the Great Depression for his doctoral thesis and the Timothy Gaitner, the then US Treasury Secretary, was earlier an undersecretary who was directly involved in handling the build up to the crisis, were probably of more help in alleviating the negative effects of the economic crisis.
Books are always there, in all the sciences, especially in economics, the dismal one, but it is experience that finally counts. The Squam Lake proposals may not forestall the next economic crisis; as Will Rogers said: “An economist’s guess is liable to be just as good as anybody else’s!”
(The writer is a lawyer, who has over 30 years of experience as a CEO in both State and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)