Friday, 20 January 2012

The influence of macroeconomic ideas

Polly Toynbee says something very sad in the Guardian today. In talking about the Labour opposition in the UK, she writes
They have lost the Keynesian argument (for now): the paradox of thrift is just too paradoxical for the public. 
I agree that the line that the recession was caused by everyone (public and government) borrowing too much, and that just as consumers are now having to tighten their belts, so should government, plays well because it seems virtuous. On the other hand the idea that if consumers and government start to save more at the same time there will not be enough demand and so output will fall seems fairly intuitive, and certainly not rocket science. However I’m not really in a position to judge how someone unfamiliar with macroeconomics would see this argument, and I guess it is called a paradox for a reason.
                Obviously Toynbee is not implying that every macroeconomic idea that is incomprehensible to the layperson will be ignored by policymakers. What she does seem to be saying is that when macroeconomics enters politically contested waters, politics should look to what goes down well with the public rather than what most economists think is right.
                Is this true? Well just imagine the following. The opposition announces that it intends to cut most tax rates. It asserts that this will incentivise everyone to work harder, so tax revenues will actually increase. Now I’d like to think that if this happened in the UK today, the media would find it very difficult to get hold of an academic economist who would support the view that revenues would actually rise following tax cuts. The opposition would be asked at every turn, why do the experts not agree with you? As a result, although the policy might be popular initially, it would gradually lose votes. In addition, the opposition itself might begin to doubt their own claim.
                Now imagine another country where there is a small minority of economists who are prepared to support this view. The media would switch to describing the claim about revenues as controversial, and would revel in setting up confrontations between economists on opposing sides. The opposition gets elected and implements the policy. Similarities between this and the story of the Laffer curve and Ronald Reagan that Paul Krugman describes in  Peddling Prosperity are of course deliberate.
                It therefore seems to require a near universal consensus among economists to prevent bad but populist policies either emerging in the first place, or being enacted if proposed. We need to add at least two other factors that might be important. The first is the influence of academics on the civil service. Civil servants do try and weigh up the evidence, and will be influenced by whether a particular view is a majority or minority one among academics. However politicians can override civil service advice, particularly if they have an electoral mandate, as my little story about the first Thatcher government illustrates. Second, we need nowadays to factor in the role of think tanks which are established to promote a particular point of view, and which can often manufacture apparent expertise. (There is a very nice observation from Menzie Chinn on how many staff from various US think tanks went to the ASSA meeting in Chicago. George Monbiot follows the money financing UK think tanks.) Such think tanks can generate the appearance of ‘controversy’ among experts where little actually exists, as the climate change debate illustrates.
                What this all suggests is that the academic balance of opinion on macroeconomic issues carries very little weight when these issues are politically divisive. The chances of achieving the near consensus required for academic opinion to matter is also reduced by the two way interaction between politics and academic economics. Not only will politicians and their advisors seek out the academics whose views support their political prejudices, but unfortunately ideology sometimes seems to influence the academic debate. I have written about the influence of free market ideology on academic macroeconomics in the context of fiscal policy and Keynesian theory more generally, but in the past the influence has come from the left as well as the right.
                All this is very pessimistic from my point of view. Indeed, as the paradox of thrift is both a very old idea and obviously correct, it is enough to make someone who wants better policy despair. In another 75 years, will the paradox of thrift still be a ‘controversial’ idea in media terms? I think it may just be possible to tell a more optimistic story on this, but that will have to wait for another post when I'm feeling less gloomy. 

10 comments:

  1. "...but in the past the influence has come from the left as well as the right."

    Good to see you add that bit.

    We need to remember too that the expert consensus is not always right. Milton Friedman was once seen as part of the loony fringe in macroeconomics, but a lot of mainstream New Keynesian macroeconomics (consumption-smoothing, natural rate of unemployment) derives from Friedman. And I hate to think where we would be now if the political system had been designed by e.g. UK academic social scientists pre-1990, who were rather Marxist in orientation.

    Part of the trouble with the Paradox of Thrift is that different people mean very different things by "thrift". (I think it's really a paradox of hoarding, not thrift). "We all need to invest more for the future, both private and government sector" has a very different ring to it in the public ear, and is very different in economic theory too.

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  2. 1. The Paradox of Thrift

    As Simon has said, it's called a paradox for good reason. It is obviously counter-intuitive and apparently quite difficult to grasp, even for economists. For this reason it is natural that political arguments based on the paradox of thrift will be a hard sell at the best of times. In the current circumstances, the argument that the government should increase borrowing--at a time when it is obvious that it has been borrowing too much (the structural deficit is too big), when high levels of debt have been associated with the financial crisis, when household indebtedness is perceived to be too high, and where our European neighbours are facing sovereign debt crises--is always going to be tough. And in fact, it's far from obvious that it would be the right policy for the UK at this time.

    2. Populist Policies

    The irony of Toynebee's position is that Keynesian demand-management is inherently populist. People tend to be naturally suspicious of the free market and in favour of government intervention to protect jobs, living standards, public health, the environment etc. Throughout history, the case for laissez-faire capitalism has always been the more sophisticated and difficult to accept. The idea that the government should pull up its sleeves and intervene in the economy for the national interest, or for the benefit of the common man, can been seen in support for Keynesian stimulus just as much as protectionism, regulation of business, immigration controls, and protecting businesses/industries in the face of competition.

    Having established that Keynesian policies are populist, the question becomes: is Keynesian stimulus actually bad, or might it be populist and good? (The same question could be posed regarding tax cuts, of course). Essentially, history has shown that, in general, fiscal stimulus is bad policy. Today, most economists view monetary policy as the correct tool for preventing recessions, and regard fiscal stimulus as more costly and less effective. Milton Friedman, one of the first economists to promote such views, would also stress the political problems associated with fiscal stimulus (e.g., there's nothing as permanent as a temporary government program).

    3. The Influence of Economists on Policy-Making

    As with the previous post, UK Deja Vu, there seems to be an assumption that governments should follow the advice of academic economists when making policy. There is a lot that could be said on this, but as this comment is getting long I'll just make 2 key points. In a democracy, it is up to the people to decide, not "experts". Even if we accept a scientific consensus on climate change, say, it does not follow that we must adopt the policies advocated by the climate scientists. In that role, their opinions are no more authoritative than any other voter. Similarly, the medical profession has no authority to argue for an increase in alcohol taxation. We listen to the expert opinions (the effects of carbon on climate, the effects of alcohol on health), then we make up our own minds.

    Having said this, it is obvious that if we want to build a bridge, we should take advice from engineers; if there is an epidemic we would listen to doctors etc. So should economists enjoy the same level of respect? I think the fact is that most people believe economic knowledge is not as reliable as other fields. To put it more bluntly, scientists and engineers deal in facts, whereas economists are offering opinions. It doesn't help that economists so often make predictions which turn out to be wrong. So the question really is, why should governments base policy on consensus opinions? The consensus opinion in most UK universities would probably lead to a Labour government being elected, so why should the Tories base policies on the economic opinions of a subset of that group?

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  3. Here in America your first factor does not exist. Civil servants are not seen as a source for any policy advice. Political appointees occupy all senior policy posts in all agencies. They are, of course, chosen because they agree with the administration view of the world.

    It is rather frightening to think about which economists a President Gingrich would choose for his policy advisers.

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  4. Does the fact that you and almost 100% of UK academic economists are employed by the state make you all free of pro-state, pro-intervention bias? I don't think so. You are proud of your work for the UK Government, for others it must make us very wary of your unconscious bias.

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  10. The more people save, the lower the real rate of interest, which results in increased investment. All that happens is the investment goes into higher order goods, rather than consumer goods - which is good for the economy.

    There are three types of companies - mature firms, emerging firms and cyclical firms. Mature firms are SUPPOSED to save. They save not in corporate vaults but in banks. Banks lend to emerging firms. Emerging firms use the borrowed funds to expand, which means buying capital goods from cyclical firms, which in turn borrower to finance their own expansion. And mature firms ARE saving - and the banks ARE lending: but they are lending to the government. What's going on is not a "paradox of thrift" at all but a simple crowding out of the private sector by the public sector.

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