Vinoth Ramachandra

Who Needs Economists?

Posted on: November 26, 2011

One week before the Great Crash of October 1929- which precipitated the Great Depression- Irving Fisher of Yale University, perhaps the most distinguished US economist of his time, claimed that the American economy had attained a “permanently high plateau”. Three years later the national income had fallen by more than 50 per cent. No one, not a single economist, had seen it coming.

The usefulness of economics, observed that wittiest of economists, John Kenneth Galbraith, is that it provides employment for economists.

I thought of Galbraith when I read that the new Italian cabinet comprises economists, industrialists and masters of finance- the very people responsible for the debt crisis in the first place! And I do not understand why the European Central Bank, which lends any amount of money to every debt-ridden bank in the Eurozone,  does not lend to countries, thus forcing the Italian government to borrow at much higher rates of interest on the open market. And how is it that the United States, whose public debt is more than five times that of Italy, continues to borrow at the low rate of 2 per cent while Italy’s has reached a supposedly “unsustainable” level of 7 per cent? And why do the media go into a frenzy whenever a credit rating agency downgrades the credit rating of a country when all those rating agencies were caught with their pants down during the 2008 subprime mortgage crisis?

Can any economist out there help me understand these mysteries?

My puzzlement seems to be shared by the Queen of England.  When attending a presentation in November 2008 at the London School of Economics, the Queen asked all the distinguished economists assembled there (and I paraphrase her words): “How come none of you nerds could tell us beforehand that this would happen?”

The economists went away and puzzled over the Queen’s question. The British Academy convened a meeting of the country’s top economists, and the results of that meeting were conveyed to Her Majesty in a letter, dated 22 July 2009, written by Professor Tim Besley, of the LSE and Professor Peter Hennessy, an eminent historian of British government from Queen Mary College (also of the University of London).

In that letter, the professors stated that individual economists were competent but that “they had lost sight of the wood for the trees”. There was, according to them, “a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”

I take this story from Ha-Joon Chang’s recent book 23 Things they Don’t tell You About Capitalism. Chang is a well-known economic historian at Cambridge University, and here he continues the valuable work of myth-busting that he began with his more academic books Kicking Away the Ladder and Bad Samaritans (where he showed, for instance, that the Western nations became rich by pursuing the very policies that, through the IMF and World Bank, they dissuade poorer countries from following).

Chang calls our attention to the phrase collective imagination in the professors’ letter. Hadn’t most economists (though not all) assured us, and still assure us, that markets are free and work well because we are rational, self-seeking individuals and so know what we want for ourselves and how to get it most efficiently? Where is there any discussion of the imagination, let alone of the collective kind, in economics textbooks or economic conferences? Conventional, neoclassical economics works with a reductionist understanding of human nature (selfish, rational). The complexity of human motivations and the socially embedded character of rationality are ignored in the pursuit of an abstract, ahistorical “economic science”. There is no room for notions of moral imagination, social solidarity, or the common good.

The failure of the economists, Chang points out, was understated in the letter to the Queen. It wasn’t simply that economists were wrong-footed in a once-in-a-century disaster that could not have been predicted. They played a crucial role in creating the conditions that paved the way for the 2008 crisis (and dozens of smaller ones that came before it in the 1980s and 1990s). They advanced theories that justified unregulated financial flows, high income inequalities, job insecurity, and the neglect of manufacturing in favour of financial “services”. The brightest and best of them told the rest of us that all was well with the global economy, and that the US had found the magic formula that combined high growth with low inflation.

The architects of the so-called East Asian “miracle economies” were not slaves to economic ideologies of the right or the left. They too were very clever people, but most came from backgrounds in engineering or law, not economics. Chang’s target is clearly not all economists (he is an admirer of Pigou, Minsky, Keynes, Sen, et al.) but the free-market economists whom the Anglo-American world (and some in South Asia and Latin America) has followed for the past three decades. This kind of economics, he says, has been worse than irrelevant; it has “been positively harmful for most people”.

More on Chang’s economic myth-busting in later posts.

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15 Responses to "Who Needs Economists?"

Excellent blog! I just recently watched the movie ‘Inside job’ and realized that the so called ‘credit rating agencies’ were hand in glove with the corrupt individuals who brought about the 2008 crisis. Some of my right-wing (their description for themselves) friends support Ludwig von Mises’s views on economic and insist it is solid and unassailable. Any response to this? I will try and read one of Chang’s books.

The science of economics has come a long way since 1929. Unfortunately, the politics of economics has not. Excellent food for thought!

The problem is that only two major schools of Economic thought have been active in Western economic policy. You either chose Structuralist or Keynesian. Both of them see government as the source and solution to all economic woes of a nation. Keynes is so dominant because he feeds into politicians belief that they are the solution to every problem. There is a school of economic thought that long ago predicted the economic collapse. It is those from the Austrian school. One of the major figures, Hayek was Keynes’ major rival. Europe’s aging population and falling demographics do not bode well for the Continent, while Asia is still enjoying the demographic dividend of a young and energetic population. Most of Europe’s economic policies are unsustainable, but most European’s and especially the politicians and economist seem at best blissfully unaware and at worst–deceptive.

I totally agree with Galbraith’s comment about economists. They make simple things complicated in order to keep their jobs.

However, I am skeptical of Chang based on his admiration of Keynes. The Austrian school of economics seems to have an edge in their explanation of our current financial crises since based on their prophetic prediction of it. While I believe that Keynes was brilliantly wrong in his understanding of macroeconomics, even he would gasp at what modern “Keynesian economists” are proposing as solutions.

Some claim that capitalism in its neoconservative form has saved much of the world — however we are now seeing its shortcomings. How can we move forward with a new system that corrects the shortcomings without societies becoming slaves of the state rather than to the market??

Rather strange comments about Hayek and the “Vienna school”. Surely, it is hardly government expenditure on public welfare that is the prime cause of the economic woes of the US or parts of Western Europe, but rather a combination of low productive output, financial mobility, low taxation (especially in the US during 8 years of the Bush regime) and massive tax evasion by corporates. Even today, the super-rich in these countries continue to prosper. They don’t experience any “crisis”.

In other words, it is the narrow, blinkered view of “freedom” espoused by Hayek and his disciples that lies at the root of the lack of “collective imagination” that I mentioned in the post. Moreover, the idea that “state” and “market” are independent, opposing realities is another fallacy. States define markets, and Marx’s dictum that the state is an instrument of the mercantile class has been amply demonstrated in the past three decades of neoliberal economics in the US and some parts of Western Europe (the ones most affected by the present “crisis”).

First of all Dr. Ramachandra, you seem to misunderstand the basis of my post. The first half of your blog assails economists for failing to foresee the economic meltdown. However, as I stated in my comment, there is a vigorous economic school to predicted the economic meltdown. Contrary to your assertions, it is not the Austrian school that teaches the state and markets ARE independent it is the Austrian school that teaches they SHOULD be independent. A good reading of history would show you the same thing…of course you might run into the failures of nationalized industries, but hopefully that would shatter any Marxist utopian fantasies.

Herman Daly reviews Economics Unmasked: From Power and Greed to Compassion and the Common Good (Phillip B. Smith and Manfred Max-Neef, Green Books, UK, 2011)- “the book argues that modern neoclassical economics is a mask for power and greed, a construct designed to justify the status quo. Its claim to serve the common good is specious, and its claim to scientific status is fraudulent. ” Both book and review (http://steadystate.org/economics-unmasked/ ) might contribute to the interesting questions your post raises.

Luke, I confess I am at a total loss to understand what you are saying. What has my post got to do with “Marxist utopian fantasies”? Does acccepting the truth behind the Marxist analysis of the capitalist state entail my embracing Marxism?

Isn’t the real “utopian fantasy” the neoliberal belief that state and market CAN be separated? That would only be possible if all political boundaries between states were abolished, so that there was free movement of peoples as well as commodities and capital. Who in the world is advocating this? Markets are political creations, and all we can do is exchange one set of political boundaries for another. Otherwise, we all move to another planet.

It is precisely the selective “freedom” preached by Hayek and others that leads to perpetual financial crises and global economic instability. Doomsday preachers also “predict” economic meltdowns, etc, and sooner or later their “predictions” are bound to come true. But the question is: are the reasons they give plausible or not? I’m still waiting to hear the reasons behind the “predictions” of the followers of Hayek.

Vinothifes, markets are not political creations. They exist and operate all the time. Even in the USSR there was a market although government and politicians tried to abolish them. People were trading goods and services on the black market.

You are right. I wasn’t thinking of black markets or the informal economy- and of course there are global markets in illicit drugs, prostitution. etc. But even these don’t operate according to simple supply and demand. They are strongly manipulated by power-brokers, usually criminal networks.

Not all economists are dogmatic neoliberals. Straight from the Chicago School, I recommend Raghuram Rajan’s Fault Lines or Rajan and Zingales’ Saving Capitalism from the Capitalists.

Great book…I heartily agree…

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