1,001st Post: Economics, Ideology or Science?

This is my 1,001st post since the site redesign, and the 2,093rd overall. Phew.

And after all that what have I learned about economics?

That it is ideological and not scientific.

That this is so is easy to demonstrate, and I tip my hat to Paul Krugman for giving me the answer, although I am sure he didn’t mean it that way.

In today’s Wall Street Journal there is a brief article postulating what Milton Friedman’s thoughts would have been about QE2. The suggestion is that he would have approved. His entire intellectual history backs up that claim. Indeed there are many comments he made back when Japan started down its current path of deflation and malaise to support that view.

In one instance he made the claim that if only the Japanese would boost their money supply – actually he was talking about the money base which is the physical cash the central bank prints and not the money banks create when they make loans – then their problems would soon go away.

Well.

The Japanese actually did that. They doubled the money base inside three years.

The result?

Nada. Nothing. The money ended up in bank vaults.

Monetary policy failed abysmally. It is one reason that the supremacy of monetarists plummeted in the late 1990’s.

But.

Here we are in 2010 with what policy?

Monetary policy. No fiscal policy.

Argh.

What do I conclude?

That no matter how much evidence accumulates against them, economists will always seek to cling onto their ideas. They do not want to learn. They want to advocate. They are ideologues first and foremost. They search for ways in which to create theories to justify their a priori opinions.

Not all do this. But do we ever hear from them? No. They are crowded out by the noise of the orthodox crowd called the neoclassical economists. These are the most egregious offenders and die hard defenders of the market magic faith. Amongst their ranks stand countless Nobel prize winners. Names like Friedman, Stigler, Schultz, Becker, and Coase – all from Chicago – clutter the intellectual landscape of free market thought. All were driven not by science but by a burning desire to prove the efficacy of markets. At all costs. Even to the extent of making stupid – yes stupid – assumptions. When need be they all threw scientific method overboard in search of a way to ensure their cherished market mechanism was “proven” efficient and socially beneficial.

A cursory look at their work, intellectually gifted as it is, shows, without any doubt that these people were ideologues not scientists. Yet they genuinely imagined, dreamed perhaps, that they had discovered a scientific law or logic. Friedman even defended their way of thinking by coining the phrase “positive economics” to make clear that he thought their method to be scientific.

He was not the first to use an Orwellian twist in his words, but the notion that neoclassical economics is in any way, shape, or form, “positive” is a farce.

Why does this matter to you?

Because these are the people who dominate the textbooks. It is their ideas that permeate policy thinking. It is because they so dominated economics for thirty years that is has become extraordinarily difficult to implement fiscal policy solutions to our crisis. Those long lines of unemployed are a real world manifestation of the error perpetrated by Friedman et al.

As someone who dabbles in economics I feel this intensely. The profession is morally culpable for the malaise our country is in. If these false ideas had not penetrated into modern finance through the works of Modigliani, Miller, Sharpe, Scholes, and Merton – all Nobel prize winners too – our derivatives markets would never have exploded the way they did, and our banks would never have become as risky as they did.

Science is about learning. Learning is about the rejection of hypotheses proven false by experiment and evidence. The last three years have thrown up ample evidence that neoclassical economics and the financial theories based upon it are flat out wrong.

We have been lied to.

They still teach this stuff as part of Econ. 101 and as part of the basic MBA curriculum. It is wrong. We are producing hundreds of thousands of students a year all taught the Friedman error. Is it any wonder that we are having a hard time getting back on track?

One last thing: I just discovered another defense of Keynes. He was a very successful investor. He produced a 12% annualized return on his investments even through the trough of the Great Depression. At a time when the market was producing a -15% return. His ideas fly flat in the face of modern finance with its efficient market hypothesis and its capital asset pricing model. Those modern ideas produced the epic failure that was Long Term Capital Management, a disastrous investment company that counted several of the aforementioned Nobel prize winners amongst its management team. They lost billions [of other people’s money] implementing their own theories. They failed appallingly while other investors have flourished. People like Warren Buffet typify the successful capitalist of our era. He has made a fortune for his investors. He is the model we should be teaching at business school.

And who follows in Keynes’ footsteps? Who agrees with him?

Warren Buffet.

QED.