Economics: What A Mess

Most of you won’t care too much, but the state of the economics profession – if that isn’t dignifying it too much – is appalling. Sometimes I trip across snippets of ideas being articulated in a serious manner and end up aghast at their stupidity. Which be all well and good were it not for the small detail that those ideas undergird public policy. I am one of those who criticize the standard Republican response to most policy problems, they appear simplistic, nostalgic, and naive most of the time, but they are the very apotheosis of complex and sensitive reasoning compared with the tripe flowing from some economists.

Utter tripe at that.

We are all aware that unemployment is a massive and horrible problem at the moment. The human misery that the loss of a job induces is truly awful: fear being paramount amongst the emotions a newly fired person feels. Very few people ever want to experience losing their job.

That’s not something Casey Mulligan, the University of Chicago economist, believes.

His interpretation of rising unemployment is that people are choosing to opt for greater leisure time. Were they not so choosing they would be employed, albeit in menial low wage jobs. His point being that any time a worker fails to seek work, however low the wage, they must, by definition, be choosing leisure over work.

Nice for a tenured professor to say. How nice indeed.

But how abominably stupid. And what a colossal misinterpretation of the facts. Nothing could highlight more graphically the utter and venal bankruptcy of the Chicago school of economics than Mulligan’s crass and inhuman thinking.

He’s not just a stupid idiot, he’s also a nasty, vile, stupid idiot.

Unfortunately for me I can grasp the logic of his argument. It is like watching a sensible and well articulated justification for the Holocaust. The fact that it is a supremely logical and mathematically framed point of view is all that Mulligan and his ilk need for it to be accepted. The inconvenient fact that it is devoid of moral sentiment or human sensitivity is not important to them. Instead they marvel at, and are blinded by, the intellectual tour de force underlying the logical conclusions they are willing to drive their theories towards.

In short: Mulligan thinks that the Great Depression was, in fact, the Great Vacation.

And from that same well we drew Reaganism.

How?

Because the logic that compels Mulligan to his lunatic fringe commentary, and which sustains his abject spite for real people and their plight, is the self-same logic that results in statements such as ‘government is the problem’.

Nothing is more abominable to a Chicago trained economist than government ‘interference’ in the workings of a ‘free market’. In their eyes unemployment insurance is a terrible sin because it interferes with the proper workings of the incentives within a market. Apparently tenure is not such a sin. Maybe that’s because it is not a government program.

The Chicago school has dominated economics for the past few decades. It was fully articulated and launched by Milton Friedman, and then extended and rounded out by Nobel Prize winners like Robert Lucas and Garry Becker. Ed Prescott, also a Nobel Prize winner, chipped in with further work, but he’s not a Chicago guy, so I have to spread my vitriol wider than simply Chicago. Their fellow travelers include Eugene Fama who holds the dubious honor of having fathered the thoroughly pernicious and, dare I say, specious, Efficient Market Hypothesis upon which the rickety structure of the securitization market stood before it crumbled ignominiously last year.

Truth be told I had paid little attention to these folks for years. I knew about Fama because he is a hero in business school finance classes – he along with other denizens of the lunatic fringe like Messrs Black and Scholes invented most of what we now know as modern finance – but Lucas and Prescott labored out of the business oriented public view and hence away from my gaze.

Their ideas are even more nutty than Fama’s. They make Mulligan look positively warm and fuzzy. And they dominate the profession.

Since in their world markets, when left to work in their own sublimely perfect way, will always produce a perfect result with respect to the allocation of resources – the objective in their eyes of what an economy ‘is for’ – anything, absolutely anything, that mucks with that perfection, should be done away with. Hence ‘government is the problem’.

The only issue that they have, these maestros of wonder mathematics, is that they cannot ‘prove’ what they assert. They rely on axiomatic reasoning and abstraction. In other words they are content with constructing ‘models’ of economies and then extracting conclusions from those models, rather than using real world examples and real world situations.

Their utopian and fanciful thinking provides the intellectual force that dominates finance and banking today. I use the word ‘intellectual’ broadly with respect to banking. It has hardly covered itself with the glories of learning lately.

This mode of thought is why the Federal Reserve Board seems content with re-establishing the banking industry as it was back in 2007, rather than reforming it.

It is why leading bankers can stand up in meetings and give speeches decrying the way in which they have been misunderstood and treated badly by the ‘dead hand’ of the government.

It is why Republicans can oppose programs to mitigate the harm of recession.

It is why the very uttering of the words ‘public option’ turns ordinary people into vicious and hateful villains.

It is why Reagan could justify his statement about government being the problem; and how Bush could look on passively while the government was gutted of its ability to respond to Hurricane Katrina.

It is why investment bankers could honestly believe they were dispersing, rather than concentrating, risk when they traded derivatives that were based upon sub-prime mortgages.

All these things, all of them, are enabled and given credence by Chicago school economics: the market will sort it all out sooner and better than the government ever can.

To a Chicago economist there is no involuntary unemployment. It is not possible. So Mulligan can say what he says with both a straight face and the feeling of intellectual superiority. He is being genuine. He is being true to his school.

The reason we seem to be unable to reform finance is that the entire structure is infested with Chicago thinking. It is pervasive. Regulators and bankers, legislators and academics, all are reading from the same textbook. They all worship markets forces without ever considering what that means ‘in extremis’.

No wonder all that is being said and done – or not done – seems so fraught with bureaucratic avoidance: from within the cozy world of free market doctrinal teaching all we need are few tweaks to get those market forces unleashed properly. We certainly do not need reform.

Even critics such as Larry Summers and Paul Krugman are not completely opposed to all that the Chicago fringe teaches. They accept parts of the lunatic doctrine. They may not be fully indoctrinated, but they are too scared to throw the entire edifice out. Instead they ‘adjust’ and ‘modify’. In particular they allow that the real world has a few flaws in it that prevent the pure Chicago vision being realized here on earth. They are ‘New-Keynesians’.

It may surprise you to hear that Krugman, who has made quite a living lately from his advocacy of Keynes, is not a pure Keynesian. He adheres to the 1935 version of Keynes. He disagrees with the 1937 version.

The difference?

In the 1935 version Keynes is seen as modifying classical economics by arguing that there are conditions in which markets can fail to operate the way the classical thinkers portrayed. There are occasional glitches. In particular factors within the real world make short term smooth adjustments to changes in fundamental components of an economy impossible. So bumps can be encountered and the economy thrown off kilter. It will right itself eventually, but the cost may be too great for us to wait. So the government should step in and speed the correction process. Krugman refers to this phase of Keynes as his repudiation of Says Law. Deficit spending is a logical result of this set of ideas, and was advocated by Keynes.

But Keynes meant to go further. In an explanatory essay he wrote in 1937 to clarify parts of his masterwork ‘General Theory’ he went much further. He argued clearly that the existence of irreducible uncertainty in an economy – in the entire world for that matter – implies, inevitably, that markets are flawed. Irreducibly flawed. All decision making, including the allocative process within a market, is bound to fall short of perfection due to the existence of this uncertainty.

Not risk. Uncertainty. Do not muddle those two concepts. Since the work of Frank Knight there has been no excuse to confuse risk and uncertainty.

Risk is something with a known outcome but a limited chance of occurring: ‘there is a 30% chance of rain’. Is not the same thing at all as ‘I have no idea what the weather will be’. The first is an assessment of risk. The second an admission of uncertainty.

Why is this a problem?

Because the classical edifice, the Chicago school, and the New Keynesians, all fail to recognize uncertainty. That’s a different kind of mathematics. It disrupts their models. And it is extremely hard to include in the kind of models economists like to use.

So the 1937 version of Keynes is beyond the pale even for Krugman.

Which makes him wrong.

Just not as wrong as Mulligan, Lucas et al.

My conclusion?

We are trying to fight a major battle with rotten theoretical weapons. Some we know – the Chicago weapons – will destroy us rather than provide a cure. Others – the New Keynesians weapons – will merely wound us. Neither will destroy the enemy.

Oh well.

What a mess.