Attacking economics is a diversionary tactic

Forgive the numbered note form. For some reason it seems appropriate to me in this case

1. The financial crisis in the UK was the result of losses by banks on overseas assets, originating from the collapse in the US subprime market. It was not a result of excessive borrowing by UK consumers, firms or our government. As the Bank’s Ben Broadbent points out, “Thanks to the international exposure of its banks the UK has been, in some sense, a “net importer” of the financial crisis.” This overseas lending caused a crisis because banks were far too highly levered, and so could not absorb these losses and had to be bailed out by the government.
   
   
2. This is why UK macroeconomists failed to pick up the impending crisis. They did routinely monitor personal, corporate and government borrowing, but not the amount of bank leverage. Macroeconomists generally acknowledge that they were at fault in ignoring the crucial role that financial sector leverage can play in influencing the macroeconomy. There has been a huge increase in the amount of research on these finance-macro linkages since the crisis.
   
   
3. But supposing economists had ensured that they knew about the increase in bank leverage and had collectively warned of the dangers of excessive risk taking that this represented. Would it have made any difference? There are good reasons for thinking it would not.
   
   
4. The main evidence for this is what has happened after the crisis. Admati and Hellweg have written persuasively that we need a huge increase in bank capital requirements to bring the ‘too big to fail’ problem to an end and avoid a future banking crisis, and the work of David Miles in the UK has a similar message. I have not come across an academic economist who seriously dissents from this analysis, but it has no impact on policy at all. The power of the banking lobby is just too strong.
   
   
5. So the response of economists to the financial crisis has been as it should be. The error in neglecting bank leverage is being addressed. Economists have come up with clear proposals about how to avoid the crisis happening again. And these proposals have been pretty well ignored.
   
   
6. In terms of conventional monetary and fiscal policy, academic economists got the response to the crisis right, and policymakers got it very wrong. Central banks, full of economists, relaxed monetary policy to its full extent. They created additional money, rightly ignoring those who said it would bring rapid inflation. Many economists, almost certainly a majority, supported fiscal stimulus for as long as interest rates were stuck at their lower bound, were ignored by policymakers in 2010, and have again been proved right.
   
   
7. So given all this, why do some continue to attack economists? On the left there are heterodox economists who want nothing less than revolution, the overthrow of mainstream economics. It is the same revolution that their counterparts were saying was about to happen in the early 1970s when I learnt my first economics. They want people to believe that the bowdlerised version of economics used by neoliberals to support their ideology is in fact mainstream economics.
   
   
8. The right on the other hand is uncomfortable when evidence based economics conflicts with their politics. Their response is to attack economists. This is not a new phenomenon, as I showed in connection with the famous letter from 364 economists. With austerity they cherry picked the minority of economists who supported it, and then implemented a policy that even some of them would have disagreed with. (Rogoff did not support the cuts in public investment in 2010/11 which did most of the damage to the UK economy.) The media did the rest of the job for them by hardly ever talking about the majority of economists who did not support austerity.
   
   
9. The economic costs of Brexit is just the latest example. Critics have focused on the most uncertain and least important predictions about Brexit, made only by a few, to attack all Brexit analysis. The fact that this prediction involved an unconditional macro forecast, while the assessment made by a number of groups about the long term cost involves a conditional projection based largely on trade equations, seems to have completely escaped the critics. More important, the fact that the predicted depreciation in sterling happened, and is in the process of already causing a large drop in living standards, is completely ignored by these critics.
   
   
10. Attacking economists over Brexit is designed to discredit those who point out awkward and uncomfortable truths. Continuing to attack economists over not predicting the financial crisis, but failing to ignore their successes, has the effect of distracting people from the group who actually caused this crisis, and the fact that very little has been done to prevent a similar crisis happening in the future.
    

Ann Pettifor on mainstream economics

Ann has a article that talks about the underlying factor behind the Brexit vote. Her thesis, that it represents the discontent of those left behind by globalisation, has been put forward by others. Unlike Brad DeLong, I have few problems with seeing this as a contributing factor to Brexit, because it is backed up by evidence, but like Brad DeLong I doubt it generalises to other countries. Unfortunately her piece is spoilt by a final section that is a tirade against mainstream economists which goes way over the top. Let me just go through the factual errors.

“Economists dictated the terms for austerity that has so harmed the British economy and society over the past ten years.”

The only support she gives for this statement is the 20 economists who signed a letter to the Times on 14th February 2010. She neglects to mention that 58 equally notable economists signed a response in the Financial Times on 18th February arguing the 20 were wrong. Austerity has always been a minority view among academic economists, a minority that has got smaller over time. Of course those that signed the first letter, and in particular Ken Rogoff, turned out to be a more prominent voice in the subsequent debate, but that is because he supported what policymakers were doing. He was mostly useful rather than influential.

“As the policies have failed, the vast majority of economists have refused to concede wrongdoing, nor have societies been offered alternatives.“

In the case of the 20 economists who signed that letter, nearly half did revise their views just two years later. More importantly, for the last few years pretty well every macroeconomist of note, including Ken Rogoff, has advocated a substantial increase in public investment. So this sentence, in so far as it relates to austerity, is almost as wrong as it could be

“[On Brexit} All the heavyweights of the economics profession … were wheeled out to warn the British people of economic facts known, and understood apparently, only to ‘experts’... But the ‘experts’ and the economic stories they tell have been well and truly walloped by the result of this referendum. And rightly so, because while there is truth in the story that international and in particular European cooperation and coordination are vital to economic activity and stability, there is no sound basis to the widely espoused economic ‘religion’ that markets—in money, trade, and labour—must be unfettered, detached from democratic regulatory oversight, and must be left to ‘govern’ whole countries, regions, and continents.”

Where did these heavyweights talk about “economic facts known, and understood apparently, only to experts”? When they were given the chance, they explained the common sense idea that trade would suffer if we left the EU because it is easier to trade with your neighbours, and the easy to understand empirical findings that more trade increases productivity and therefore economic growth. There is no religion involved at all, but rather statistical evidence. If you are looking for religion, you need to focus on the handful of economists supporting Brexit, who really did believe that it could usher in a neoliberal nirvana that would more than offset the costs of Brexit. To the extent that the public ignored the warnings of economists, it was probably because these warnings were ‘balanced’ in the media by this handful.

When Ann talks about the failings of economists related to the financial crisis she has a point, but it is one that she grossly exaggerates. Economists hardly “led the way to the re-regulation and ‘liberalization’ of the finance sector over the past 40 years”. The way was led by the financial sector itself. If more economists had backed up rather than dismissed Rajan’s warnings in 2005, I doubt if anything would have changed. Why do I think this? Because mainstream economists have subsequently argued that the only way to prevent another crisis is to substantially increase the capitalisation of banks, but they have been completely ignored by policymakers. If economists are being ignored after the financial crisis which created untold damage, why should things have been any different before the crisis?

I think the same point applies to globalisation. Most economists have certainly encouraged the idea that globalisation would increase overall prosperity, and they have been proved right. It is also true that many of these economists did not admit or stress enough that there would be losers as a result of this process who needed compensating from the increase in aggregate prosperity. But once again I doubt very much that anything would have changed if they had. And if they didn’t think enough about it in the past, they are now: see Paul De Grauwe here for example.

There is a regrettable (but understandable) tendency by heterodox economists on the left to try and pretend that economics and neoliberalism are somehow inextricably entwined. The reality is that neoliberal advocates do use some economic ideas as justification, but they ignore others which go in the opposite direction. As I often point out, many more academic economists spend their time analysing market imperfections than trying to show markets always work on their own. They get Nobel prizes for this work. I find attempts to suggest that economics somehow helped create austerity particularly annoying, as I (and many others) have spent many blog posts showing that economic theory and evidence demonstrates that austerity was a huge mistake.         

Being honest about ideological influence in economics

Noah Smith has an article that talks about Paul Romer’s recent critique of macroeconomics. In my view he gets it broadly right, but with one important exception that I want to pursue here. He says the fundamental problem with macroeconomics is lack of data, which is why disputes seem to take so long to resolve. That is not in my view the whole story.

If we look at the rise of Real Business Cycle (RBC) research a few decades ago, that was only made possible because economists chose to ignore evidence about the nature of unemployment in recessions. There is overwhelming evidence that in a recession employment declines because workers are fired rather than choosing not to work, and that the resulting increase in unemployment is involuntary (those fired would have rather retained their job at their previous wage). Both facts are incompatible with the RBC model.

In the RBC model there is no problem with recessions, and no role for policy to attempt to prevent them or bring them to an end. The business cycle fluctuations in employment they generate are entirely voluntary. RBC researchers wanted to build models of business cycles that had nothing to do with sticky prices. Yet here again the evidence was quite clear: for example data on real and nominal exchange rates shows that aggregate prices are slow to adjust. It is true that it took the development of New Keynesian theory to establish robust reasons why prices might be sticky enough to generate business cycles, but normally you do not ignore evidence (that prices are sticky) until you have a good explanation for that evidence.

Why would researchers try to build models of business cycles where these cycles required no policy intervention, and ignore key evidence in doing so? The obvious explanation is ideological. I cannot prove it was ideological, but it is difficult to understand why - in an area which as Noah says suffers from a lack of data - you would choose to develop theories that ignore some of the evidence you have. The fact that, as I argue here, this bias may have expressed itself in the insistence on following a particular methodology at the expense of others does not negate the importance of that bias.

I do not think this is just a problem in macroeconomics. David Card is a very well respected labour economist, who was the first to present detailed empirical evidence that imposing a minimum wage might not reduce employment (as the standard supply and demand model would predict). He gave an interview some time ago (2006), where he said this about the reaction to this work:

“I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.”

As Card points out in the interview his research involved no advocacy, but was simply about examining empirical evidence. So the friends that he lost objected not to the policy position he was taking, but to him uncovering and publishing evidence. Suppressing or distorting evidence because it does not give the answer you want is almost a definition of an illegitimate science.

These ex-friends of David Card are not typical of academic economists. After all, his research was published and became seminal in subsequent work. Theory has evolved (see again his interview) to make sense of his findings, but unlike the case of macro the findings were not ignored until this happened. Even in the case of macro, as Noah says, it was New Keynesian theory that became the consensus theory of business cycles rather than RBC models.

Yet I suspect there is a reluctance among the majority of economists to admit that some among them may not be following the scientific method but may instead be making choices on ideological grounds. This is the essence of Romer’s critique, first in his own area of growth economics and then for business cycle analysis. Denying or marginalising the problem simply invites critics to apply to the whole profession a criticism that only applies to a minority.

Should economics be democratised?

In the continuing fallout from the Brexit vote comes a call to democratise economics. I tend to think about these issues by drawing an analogy between economics and medicine. The reason I like this analogy is that both are stochastic sciences: people are unpredictable in terms of their behaviour and biology, at least in terms of the current state of knowledge. There remains a great deal that is mysterious. Both can use theory to a considerable degree, but both also rely on statistical analysis and experiments/trials. I am happy to acknowledge that medicine is ‘better’ in some sense than economics (although I do not really know, or know how that could be ascertained), but I would argue that any difference is of degree rather than kind.

One other similarity that is worth mentioning because it always comes up: both are hopeless at forecasting. Your doctor will not tell you how long you have to live, and can often only give you a rough idea even if you have a fatal disease. Economists get involved in macroeconomic forecasting not because users think it is accurate, but because it is marginally better than guesswork. But while doctors cannot tell you how long you will live, they can tell you that smoking will be very likely to shorten your life. Equally an inability to do good macro forecasts does nothing to refute the claim that if we make trade with our neighbours more difficult we will do less of it and this will reduce people’s welfare and incomes.

The two subjects are also similar in that key decisions are often delegated to expert committees: in the UK the MPC and NICE, for example. But when it comes to other policy decisions, the two subjects differ. Occasionally government or policymakers clash with medical experts on medical matters, but that is rare. In contrast politicians quite routinely ignore economic expertise, or choose minority views over the consensus. The difference is not hard to explain of course: political interests and economic decisions are often intertwined. This can in turn influence the discipline itself. But if you accept my analogy, this is not good for society. Those who voted for Brexit were told it would produce positive results for them in the long term, and will almost certainly be disappointed.

Is the solution to this to democratise economics? I cannot think of anyone, or at least no economist, who would object to the public knowing more economics. Some might go further, and suggest that knowledge of economics among policy makers is dangerously deficient. I would also agree that sometimes economists can learn from interactions with policymakers or even the public. But when it comes to medicine people generally do not want to know about medical science. What they want to know is what medical opinion is on key issues, and they want policymakers to make decisions that embody that knowledge.

I think the same is true of economics. Most people do not want to know the theoretical basis for why fiscal consolidation when interest rates are at their lower bound is bad for the economy, let alone the arguments that a few make against that consensus opinion. (If you read this blog, you may be an exception to this generalisation.) Instead they want to know what the consensus opinion is and how strong that consensus is. If the economics conflicts with their intuition, they might want to check that economists are answering the same question as they are. This the broadcast media generally fails to do, and the tabloids only do if it suits their political line. There are reasons for this in the way the media works, which I have discussed many times, but it would be negligent for economists to imagine it was not their problem as well.

For example in medicine I suspect you could rely on medics to be able to tell you what the consensus opinion on issues was. Unfortunately that would be less true in economics. But that is partly economists own collective fault, because the number working on subject areas can be quite large and not as well connected as they might be. To take just one example, there seemed to be a widespread perception among macroeconomists that many of the top schools taught little Keynesian economics at graduate level. It turns out according to survey data I and Andre Moriera collected that most schools do teach quite a bit of Keynesian economics.

Which leads to my punchline. Economists need to act more as a collective. We need to regularly survey economists (all economists, not just selected groups) about what they think on key policy issues, recording at the same time whether this is their area of expertise. We need spokespeople to explain any consensus in the media. When policymakers, City economists or think tanks depart from this consensus, these spokespeople need to be aggressive as a discipline in pointing this out, and not leave this to individual academics. Much as the medical profession does when rogue claims become popular. We do not so much need to democratise economics, but to organise it.

Encouraging dialogue between economists and social scientists

In a way this is a rather trivial post, about language and attitudes as much as anything, that follows from some of the reaction to this post and related debates. One big difference between most (not all) mainstream economists compared to their heterodox or other social science colleagues is insularity. Political scientists will talk to sociologists who in turn talk to international relations people as a matter of routine. Economists by and large talk to each other. This is not because their subject matter is narrow - economists are notorious for applying their tools way beyond economics.

Most of the time I think that is fine, but sometimes it is not. How do we deal with the times that are not? I want you - as either an economist or social scientist or interested spectator - to think about a visit to your doctor. Why? Because economists should really think of themselves like doctors. (I know some want to think of themselves as physicists, but what can we do.) They are trying to understand highly complex and erratic systems based on a small number of principles, where most of the time they have very little idea of what is going on. But they have data, and some of the time they can make a lot of difference to people’s lives.

Now supposing your doctor prescribes you a course of treatment. It involves drugs that you have read a little about, and you have some concerns. If you were a social scientist would you say to your GP something like the following:

“I’m a little worried about this. I feel that you may not have adequately addressed the ontological and epistemological issues that are raised here. What exactly is ‘treatment’, and when is it necessary? Have you thought about the complex social and economic interrelationships that lay behind your prescription? Is the nature of what you call ‘illness’ really independent of the nexus of interactions that could be loosely called the medical profession?”

I kind of hope you wouldn’t, because I do not think you would get very far if you did. You might be much better off asking something like the following.

“I’m a little worried about this. Have you thought about whether this treatment is appropriate to my particular circumstances (HT Ben Goldacre), or are you reacting to pressure from the drug company or someone else? Has that company published all its trial data, or only the trials that were successful, and how was success defined in this case. Is this really going to make me better, or just increase someone’s profits?”

It is a simple and obvious (I did say trivial) point - you will get much further if you talk specifics in a language your doctor will understand, rather than in generalities and terminology they will not. Economists want (or need) to know why their approach is missing key issues or linkages which compromise their analysis, just as the doctor needs to know why they might be recommending the wrong treatment. You would not insist that your doctor needed to have studied economics before they can be a good doctor.

But if you were an economist, would you think it legitimate for your GP to respond like this.

“How inappropriate of you to ask me these questions. I’m a doctor, and I know from my years of knowledge and experience what is the right treatment for you. As you cannot know what I know, then you should not get involved in these issues. Some of the things you mention are really none of my business, and I do not see why I should worry about them.”

Now as an economist you know that such a response from your doctor would be both arrogant and naive. The doctor should ask about the quality and objectivity of the information they receive, and know full well that drug companies exist to make money. But might your response to a social scientist be as arrogant and naive?

Let me take a real world economic problem: the response to the financial crisis. Some have suggested that banks have become too large and need to be broken up, or that the activities of high street banking need to be separated from the activities of the casino. Your economic analysis tells you that networks of many small entities can be as subject to crises as networks involving a few large banks. You are also able to devise a system of Chinese walls that mean that the activities of the casino can be separated from those of the high street even within the same company, and your political masters seem to prefer this approach. You recognise that different assets differ in their liquidity, and so you devise complex weighting algorithms for computing capital ratios. Your suggestions form the basis of negotiations between officials and bankers, and a set of rules and regulations are agreed.

Over the next few years you watch in dismay as your complex system begins to unravel. The CEOs of the large banks seem to constantly have the ear of politicians, who in turn gradually compromise your elaborate controls to render them less and less effective. Those in charge of administering the rules find it much more lucrative to work for the banks, and so regulators gradually lose expertise and resolve.

And you realise that right from the start you made the wrong choice. You decided to focus on what you knew, which was how to design systems that worked well as long as those systems remained unchanged, but which were not robust to intervention by self-interested parties. In short, they were too open to rent-seeking. You realise that actually the best thing to have done was to break up the banks so that their political power was forever diminished. And you recall a conversation with your social science colleague when this all started, who might have been trying to tell you this if only you had understood the words he was using.      

Anti-intellectualism

The question in the title of this post - What Are Academics Good For? - was meant to be rhetorical. I took it for granted that as a collective academic economists did know rather more about economic policy than business leaders or city economists, and the point of my post was to ask why this often appeared not to be recognised by some journalists or some politicians. I included some quotes from a journalist suggesting otherwise because I found them rather shocking.

It serves me right of course. What I got almost universally in comments was a discussion of all things wrong with academic economists. Even the estimable Chris Dillow joined in. So what I should have done first is establish what academic economists are good for, and then complained about those who do not recognise this. But better to do things in the wrong order than not at all.

First a point on scope that I did make but is worth repeating. When it comes to short term macro forecasting, you are no better off asking academic economists. In fact you may be worse off, because most academics spend very little time looking at the latest indicators. The best macro forecasts, whoever makes them, are only marginally better than intelligent guesswork - this is a well established fact.

One area where academics typically have expertise relative to other people is on issues involving economic policy - for macroeconomics, for example, on issues involving monetary and fiscal policy. Issues like whether austerity is expansionary or contractionary. I took this for granted because academics spend a large amount of their time doing research on these issues. Much of this research involves assessing evidence. They do this in a highly competitive environment, constantly subject to peer review. In addition, they often compete for research grants, where the opinions of end users (like the Bank of England) can matter a lot.

Of course there are things that could be improved within academia, and as Chris notes I have not been shy of giving some of my own opinions about where this might be. But since economics first started being studied, we have accumulated a substantial body of knowledge which policymakers have found useful. Policymakers should never take advice uncritically, but they should and do treat academic advice as a bit more than just another opinion.

What evidence do I have for this claim? First, a lot of the time politicians and their civil servants do seek out and make use of this knowledge. Indeed I ventured that the previous UK government might have represented a high point in the influence of academic economics generally, including macro. I described the evaluation of the 5 tests over whether the UK should join the Euro as an exemplar of how the interaction between academics and policymakers should work.

You could also look at central banks. When it comes to issues of how best to conduct monetary policy, central banks predominantly look to academics (mainstream rather than heterodox) for ideas and analysis, rather than city economists or business leaders. The analysis they use in house is often based on techniques initially established by academics, and they hire new PhDs to undertake that analysis.

If you are not convinced by any of that, have a look at the simple test I described in that recent post. The assertion that the 2013 UK recovery validates 2010 austerity is not a complex issue or a matter of judgement – it’s a simple mistake. Most academics understood that, but only half of city economists did.

So that is why I found those quotes from a well known journalist shocking. As I suggested in that post, I think it reflects an anti-intellectual theme that affects other subjects as well. You will find this kind of thing on both sides of the political spectrum, although for whatever reason it seems to be more influential on the right than the left right now. I got sent today some correspondence about austerity involving an MP, where the MP said this. “You may come at this from an academic viewpoint - I come at it from a real world viewpoint and as someone who has worked in a sector where you have to earn money before you can spend it.” That statement is so wrong for many reasons, but it also illustrates a damaging contempt for academic knowledge.