University of Chicago

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Partying Like It’s 1848

This is not a time to dwell on the inconsistencies and even contradictions of the recent uprising of populism in the western world. Treat it as a fact. It just is. For there can be no mistaking the trend: people, large numbers of people, in a large swathe of Europe and America really are unhappy with their lot in life. Really unhappy. Fully 52% of Republican supporters of Donald Trump tell pollsters that they are angry with the way the country is going. Not just unhappy or disappointed, but angry. Anger leads to really bad political decision making. It is not a constituent of reasoned argument. It leads too quickly to rash thought and even to hatred.

One theme that emerges from this populist moment is the identification of immigration as a source of concern. No, not just concern, but of deep unease. People in both the UK and the US can be heard demanding that they “get their country back”. Leaders in both nations have lamentably failed to identify the importance of immigration as a lightening rod for malaise. Nor have they reacted with anything sensible as policy.

Here in America the reason most often given for the failure to deal with immigration is the gridlock in Washington. It is impossible to begin a conversation about immigration policy because the pre-existing political positions are so well laid out and well established that any talk leads immediately to a conformation of gridlock. So stasis abounds and people get more and more impatient.

The same goes for economic policy. This is what interests me most of course. The failure of economics is breath-taking. The failure of politicians to implement anything resembling sound economic policy even more so. I think the two go hand in hand. After all we cannot blame politicians for bad policy of the economics profession itself is still utterly incapable of updating itself to take into account its terrible pre-crisis performance. Worse, the constant infighting and name calling within economics has produced the same gridlock we lament in Washington: nothing can change because people’s reputations are at stake.

Economics is well known for the hubris of its leading lights. They are not exactly shrinking violets. It takes a certain kind of arrogance to announce to the world that the profession has sufficient knowledge that the business cycle is defeated. It takes an even more peculiar sort of arrogance to say such a thing and then make no adjustment when the business cycle rages on after you have said it.

I have, rather naively as it turns out, always thought that academics were a group we could rely on to change their minds in the face of evidence. If there was one part of society we could turn to for fact-based discussion it was supposed to be academia. Apparently not. Facts be damned. The neo-religious zeal with which the Chicago School defends its evidently rotten ideas is wondrous to watch. And every time those folks mount such a defense they erode both their personal integrity and that of the profession as a whole. No wonder the fringes of economics teem with apostasy, the high churches are both wrong and too proud to yield.

I am tired of the argument. I have invested too much of my own time in trying to create a space for economics to engage in debate about its own failings. Perhaps I am being too hasty, but I do not detect enough effort to construct a better product. Yes there are all sorts of attempts being made, but the great redoubt remains unchanged. The textbooks remain full of error. The old ideas are simply being re-processed. And society is being short-changed.

Ultimately, I think, it will be the relevance of economics that is diminished.

Professional economics rose in status considerably post-war. It attained a status for professionalism and competence that in retrospect its core ideas were not capable of sustaining. Those ideas were industrial in origin. Its basic structures were derivatives of crises decades ago. Even its great score-keeping ability and its measurement of the center of its attention have become steadily less relevant to the world it seeks to interpret. GDP is a moribund concept and needs an overhaul, but a profession as divided as economics cannot undertake the task. It is too busy fighting the 1930’s wars over and over again.

Speaking of which:

One of the greatest disappointments of this populist moment is the absolutely awful response from the left in politics. I read time and time again that either Brexit or Trump signifies a “crisis in capitalism”. People on the left have been twittering on about a crisis in capitalism since Marx made it fashionable to do so. Leftists have become akin to those religious sects who repeatedly predict the apocalypse and who never change their minds  when their predictions repeatedly fail. Instead of re-inventing a left of center narrative – one with a certain amount of flexibility perhaps – they wander off and yammer on about technicalities, the treachery of less-than-pure colleagues, or the apparent grip on history that the right wingers must have. After all, uncle Karl was surely right.

Well maybe in 1848. Not now. The world has moved on.

And so it goes: both sides in economics, and even the Keynesian middle, seem stuck in a time warp. Yet the march of technology, the change in demographics, the rising interconnection of societies around the world, the change in the nature and methods of business, and the need to re-evisage the nature and impact of growth have all failed to cause a radical re-interpretation of the discipline’s core ideas. They are simply assumed to be timeless and to have undiminished application no matter what happens to the economy.

The last great book on economics was by Keynes. There have been critiques aplenty since, some powerful others not so much, but no one has taken the time to sit down and re-write the core from a deep understanding of the changed world. The flood of formalized work over the past few decades has simply papered over the ever decreasing tightness of the connection between the core ideas and the economy itself. The discipline has become more and more self-referential; its advances more and more arcanely technical rather than interpretative; and its center more and more hallowed rather than open to challenge.

In many ways the entire effort smacks of the 1848 spirit. It attacks with zealous accuracy problems that are, whilst never entirely gone, less and less those we face today. It fails to update its thinking at the same pace that the economy is changing. It lives in the tenured, protected, sedate world of an academia that itself is looking less and less a model for future education. It resists change with a prodigious willpower.

Will the future care?

I don’t know.

But I do know it isn’t 1848. And I do now that the people of the western world need help if they are to avoid this populist moment engulfing the great liberty and prosperity that economics was once proud to have contributed to.

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Liberty To Do What?

Continuing my peon to Judt: he reminds us of Condorcet’s fear:

“Liberty will be no more, in the eyes of an avid nation, than the necessary condition for the security of financial operations.”

No kidding.

How many times do we come across, in this avid nation of ours, some foolish comment that our social policies must not restrict commerce? How many times do we hear some politician arguing that we must become more business friendly? We scarcely can move an inch without tripping over someone cajoling us with fears that limitations on liberty are actually limitations on prosperity. As if prosperous was purely an arithmetic reference and had no qualitative content.

This is Condorcet’s fear alive and well. We seem to have reduced liberty to some small prop for the making of profit. Liberty is simply, in this ghostly shadow of what it once was, a veil behind which profits can be amassed without reference to the fabric of society as whole. And certainly without reference to any larger interest than that of the individual, or individuals, engaged in making that profit.

The invasion of the economic lexicon and way of thinking into domains where it has absolutely no right being is to blame for this diminution of our liberty. Or at least the severe limits placed on our understanding of what liberty means.

It was not always thus.

The war to gain liberty and to free ourselves from the oppression of ancient prejudice, tradition, and the burden of paternalist governance was not waged so that we could make a quick buck. It was to enable us all to have rights. It was a war to assert the right to have those rights. In that sense it is ongoing even today as successive groups manage to achieve such rights and join the rest of us in equal citizenship.

Being free to make that assertion is what liberty is in its more expansive and richer meaning.

Étienne Balibar puts it this way:

“It is always a struggle, and moreover a legitimacy of struggle, what Rancière calls the ‘the part of those who have no part’ which confers a universal signification on the demand of those who had been kept outside the common good or general will to be counted.”

This is not some petty attribute of a free market. It is a fundamental state of the human condition. It extends all the way to the roots of how we live and view each other. Placing a limit on liberty as if it were simply an enabling of market exchange is to gut the concept of its true content and replace it with a shill for capitalist aggrandizement.

Which is why we ought to search for the causes of this distortion: where did the idea of liberty get so reduced?

The answer, I suggest for our purposes, sits squarely within the libertarian screeds that pour forth from Chicago. This is, at first sight, a contradiction. How, after all did the generations that followed people like Hayek, pervert liberty so much that it now is a pseudonym for free market economics?

Well, they misunderstood it.

Being so obsessed with removing government from our lives because they imagined they had discovered the secrets of  market power, and rejecting any and all notions of such heresies as market failures, they attacked remorselessly to undo concepts of society that were not ciphers for the market. After all, having discovered the eternal truths of market power, they could hardly acknowledge any rival sources of social organization. So, like cuckoos, they had to toss those rivals from the nest.

And in so doing they eliminated alternative or grander meanings for liberty.

Thus armed they invaded all corners: in the hands of zealots like Gary Becker economic analysis bullied aside previous explanations for all sorts of relationships. In his own words:

“I believe that people make rational decisions and that they look ahead to the consequences of their decisions. They are affected by incentives. You can take markets, rationality, and incentives and illuminate issues involving race, education, and the family.”

Liberty is reduced in Becker’s hands to nothing more than the ability to be rational within the boundaries of some optimization problem, limited of course, by a set of constraints.

It is one of the great ironies of modern thought that the libertarian Milton Friedman, whose intellectual fingerprints are all over this diminution of the meaning of liberty, chose to enter the profession of economics because he wanted to do something relevant. As he explained it:

“Becoming an economist seemed more relevant to the burning issues of the day than becoming an applied mathematician or an actuary.”

But the result of his zealotry and that of his heirs has been to reduce economics exactly to a kind of applied mathematics. Why? Because that is the only way in which they could ‘prove’ the superior efficacy of markets as allocative devices. As opposed, let’s say, to the government.

In other words, not only has the entire Chicago tradition eroded the notion of liberty to a bare stub of its former self, but it has failed by its own — or rather Friedman’s —  measure of relevance. It ended up being applied math dressed up differently.

That society lost the concept of liberty along the way is a stain Chicago will have to bear until it repents. Which I doubt will be any time soon.

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The State of Economics. Hint: Bad.

This next weekend Paul Krugman has an article in the New York Times that I think it is well worth your time reading. It is called: “How Did Economists Get it So Wrong?”.

I have inveighed here, in my own inadequate way, many times about how I see the failure of economics as a body of both theoretical and practical thought as one of the main causes of our recession. Krugman, naturally doesn’t go that far, but that’s because he’s knee deep in the intellectual mire.

“It wasn’t simply greed: it was intellectually sound and risk adjusted greed.”

The simple fact is that economics as a body of thought has let us down with a thump still resounding around the hallowed halls of the University of Chicago [and Minnesota] whose intellectual tradition in the subject has now collapsed. Or rather has self-immolated.

This may seem to most of you to be a peripheral and dull thing to talk about, but I would urge you to reconsider.

Most people who are engaged enough to discuss the state of the economy bring with them a set of unstated assumptions or ‘truths’ about it. I hear statements every day such as ‘markets self correct’ or ‘markets are more efficient than government’ and so on. These are ideas bedded in a particular economic theory. They are the result of hard fought intellectual battles that extend back through time all the way to the pre-capitalist years of the late 1600’s and early 1700’s. They are not infallible, yet they are kicked around carelessly as if they were eternal truths.

They are not.

And the thrust of the Krugman article is to describe the more recent aspects of the fight between two major competing schools of thought within economics: the ‘New Classicals’ and the ‘Keynesians’. Never has an academic bun fight been more important to the public. The outcome may well determine the next thirty years of public policy.

So get involved. At least read Krugman’s side of the argument.

There is no point in my hiding my allegiance in this battle: I am firmly on the side of Krugman, although I think he has only just begun to understand the trajectory needed: he is steeped in the old way of thinking and is only now emerging into the brighter light of progress. Nonetheless he gets it. I cannot name an instance at the University of Chicago where I would say the same. Indeed they now all appear to be astrologists rather than academics.

So what?

Well, the issue before us can be boiled down to simple terms: are markets efficient?

I say no. There is no practical way of meeting, in the real world, the necessary conditions that underpin an ‘efficient’ market. So none – absolutely none – of the properties so valued by efficient market economists can be discovered out here on planet earth. That is not to say that the mathematics of the efficient market folks isn’t the apogee of elegance and rigor. It’s just that is has no earthly application or relevance.

The heroes of this school of thought – Lucas et al – represent the ‘who’s who’ of economics over the past three or four decades. To them have gone the preponderance of Nobel Prizes and awards. To them have gone the best contracts and the bulk of the recognition.

So well established did they become that they came to dominate the formation of public policy. And it is here that you all ought to pay attention. For decades the guiding ‘worldview’ of our legislative process and of the elites in business and public policy has been driven by the New Classical paradigm. Within which the notion that markets are efficient reins supreme. Flowing logically from this are the practical ideas of deregulation and limited government intervention – indeed to a Lucas influenced central banker or policy maker any kind of government action is, at best, self defeating, and at worst damaging. This viewpoint dovetails nicely with libertarian style Republicanism of the Reaganite mold – indeed it provides that form of Republicanism with a gloss of intellectual virtue.

You can see the effects all around you: deregulated banking is a primary cause of the recent debacle; weakened government institutions fail to respond to Katrina effectively; and the current health care debate is largely forged in those terms.

So to argue that the current dispute within economics is simply an academic spat of no consequence to the wider world is just not true. The outcome is essential.

The good news, as Krugman indicates, is that the lost knowledge acquired at such cost in the Great Depression, has been resurrected and used. In the nick of time we re-learned the lessons of the 1930’s. Keynesian economics is back in full force.

That is good news.

But is also just a beginning.

Financial firms all across the world are replete with analysts brought up inside the New Classical tradition. Our colleges still use text books written by New Classical heroes. The flood of PhD graduates going from the top schools to Wall Street to model, wrongly, derivatives and other arcane aspects of our financial world is unabated. Every time one of these highly educated and well meaning people run a model based upon the efficient market hypothesis they propagate a falsehood. They bake in an error. Every time a talking head on TV speaks breathlessly about the ‘market’ they, perhaps unknowingly, spread the meme that markets are good things we should pay attention to and leave well alone. The error spreads in all these small ways. It will be very difficult to root out.

The truth, such as we now see it, is very different and much more nuanced. An economy has properties that exhibit regular behavior, but markets are ’emergent’ from a group of individuals – you cannot simply sum up the various individual behaviors and get a market. So the properties we must use in our models and in finance are far deeper than the simple mechanisms taught us by the likes of Samuelson, Friedman, and so on. Complexity intrudes at every stage. This is the great lesson of the financial crisis: the very mathematics upon which we based, in good faith, our understanding of market behavior, is wrong. The point is that even wrong theories can produce good results for a time: Ptolemaic astronomy served well in the limited seas of the Mediterranean for centuries. The notion that risk is always clustered at the center of a normal curve, and that those, now famous, ‘long tail’ events are so improbable as to be sensibly ignored , is such a theory. Wrong, but useful enough to dominate thinking for a while. And it was responsible in large part for the collapse of the derivative market and hence the big banks. Cleared headed, textbook economics, perfectly executed and properly implemented destroyed the financial system. It wasn’t simply greed: it was intellectually sound and risk adjusted greed.

And it sank like a stone when the real world’s complexity intruded.

So now it’s time to import fresh ideas to buttress the Keynesian vision.

Mandelbrot, Prigogine, Minsky, and others have all something to add.

This is why Krugman is at the start not the end. He asks where does the profession go from here? I respond by saying: into complexity theory, information theory, statistical dynamics, agent based modeling and evolution. All these great traditions are inter-twined. From their nexus we will create the new economics.

What fun we will have. For those of you who have a practical bent: agent based modeling is the tool that I see as having the most immediate impact on things like risk management and portfolio analysis.

Meanwhile, remember this: markets are flawed. They work well sometimes, but there are moments when they hit barriers and need help. The one thing we know is that they are not efficient. Learning that has cost 6.7 million people their livelihoods. Perhaps one or two professors should join them.