The Matter With Economics?

Jeff Madrick identifies seven bad economic ideas; Alan Blinder is more cautious. What do economists actually believe, and how does it stack up against what we think economics says?

Jeff Madrick, a highly respected American economic journalist, recently published a book, Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World. It was reviewed in the New York Review of Books by Alan Blinder, an even more respected (Princeton) economist. (Also here.)One of the joys of economics is its vigorous debates (although post-Rogernomics economists in New Zealand tend to avoid them, I’m afraid). Economics progresses from such debates, so it is worth following this engagement.

Blinder summarises his argument:
‘First … academic thinking and research don’t have nearly as much influence on economic policy as Madrick imagines.
Second, his characterization of what constitutes mainstream economics is heavily skewed
to the right; it’s more about conservative economics.
Third, most of what he calls ‘bad ideas’ are either good ideas, straw men, discarded doctrines, or limited to quite conservative economists.’

While none of these issues are peculiar to America, I’ll focus here on the seven bad ideas which Madrick identifies.

  1. Madrick’s first ‘bad idea’ is Adam Smith’s invisible hand, Blinder responded ‘I believe every mainstream economist sees the invisible hand as one of the great thoughts of the human mind. A “bad idea”? No, a great one.’ The difference between them is the subtlety with which one believes the notion. Economists are impressed by the miracle of the market. As a student I was impressed by how a bottle of milk arrived on one’s doorstep each morning (yes, I am that old) without any single person supervising the myriad of steps from cow to door. But I do not think the markets always operate effectively, efficiently or fairly. Nor do I think that alternatives to the market (such as central planning) always operate effectively, efficiently or fairly either. Much economic policy is choosing between some pretty unattractive options – although that is not the way it is debated in public.
  2. Blinder agrees with Madrick that Say’s Law – supply creates it its own demand – really is a bad idea. He goes on, however, to say it was mostly discarded more than seventy-five years ago following the Great Depression and Keynes’ General Theory. I hope he is right.
  3. Similarly Blinder agrees with Madrick that low inflation is all that matters is a bad idea but argues that ‘hardly any senior economist in actual policy circles acts that way’. There is a narrower version which is more pervasive: all that monetary policy can do in the long run is affect the price level. I can think of some New Zealand economists who might agree with that, but there would be a lot of caveats.
  4. Madrick says free-market fundamentalism is another bad idea, calling it ‘Friedman’s Folly’. Surely Madrick goes too far, though, when he says ‘economists in general are [Milton] Friedman’s handmaidens’ and that ‘even politically liberal economists generally argue that government must only correct what they define as market failures’. Blinder, who describes himself as a politically liberal economist, says the last proposition is nonsense. Actually it hinges on what you mean by ‘market failure’. It has a very specific meaning in economics, and many reasons which economists give when advocating particular policies – such as moderating business cycles and reducing poverty – are not usually classified as market failure.
  5. His claim that there are no speculative bubbles is another bad idea, but it is not held by most economists. Which is fortunate, since they evidently happen.
  6. The efficient markets hypothesis and that ‘faith in the rationality of free markets was pushed too far’ is another bad idea. (There is a weak form of the EMH by which an investor can only beat the market – i.e. get a higher return – by taking on more risk.) Were the strong form true there would be no extraordinary profits and incomes in the finance industry. Ironically it was used by regulators, such as Alan Greenspan, as a rationale for minimum financial regulation thereby generating extraordinary profits and incomes in the finance industry. But that does not make it mainstream. Blinder commends ‘Madrick’s wonderful chapter on efficient markets’, saying it ‘should be required reading for everyone in the financial world’.
  7. Blinder says that the last item on Madrick’s list of bad ideas, that economics is a true science, ‘is a little gratuitous, since hardly anyone ever believed it.’ But what is a ‘true science’? If you take it to mean a body of knowledge engaged with the real world which generates theories and hypotheses which are tested against the evidence and rejected when another comes along more consistent with the evidence, then parts of economics are a true science. (Blinder gives some nice examples of this process.) Of course this definition does not cover the policy dimension of economics (except insofar as one is using the best available theories – like engineers) and it certainly does not cover those ideologues and pseudo-economists who hold onto theories long after their use-by dates, ignoring the contradicting evidence.

Madrick responded that Blinder seemed to think there was nothing wrong with economics. Blinder insisted ‘I think there is lots wrong with mainstream economics. For starters, my review explicitly agreed with Madrick that (a) ideological predispositions infect economists’ conclusions far too much; (b) economics has drifted to the right (along with the American body politic); and (c) some economists got carried away by the allure of the efficient markets hypothesis. I also added a few indictments of my own: that we economists have failed to convey even the most basic economic principles to the public; and that some of our students turned Adam Smith’s invisible hand into Gordon Gekko’s “greed is good.”’

Other economists have chipped into the debate, each coming at the issue in a slightly different way, so the public gets confused. They want to be told the ‘truth’ – as if there is a simple one (like ‘you can cure cancer’).

As I followed the interchange between Madrick andBlinder I was struck that we need to distinguish ‘mainstream economics’ from ‘mainstream economists’. The former is what business people, journalists and politicians – and most people, as far as they are involved – believe and practise; what you read in a newspaper. But it is not necessarily what mainstream economists believe or what goes on in the learned journals and other professional platforms.

My reflection went on to the realisation that this distinction is also true in other disciplines: history, philosophy, psychology, theology – even climate change and medicine (otherwise how would you get beliefs in quack remedies?).

Most critics of economics criticise the mainstream of economics as if it is what mainstream economists believe. They don’t take much notice when economists say ‘it ain’t necessarily so’. After all, it is there in black and white in the newspaper and said on the screen. Everybody is saying it – except the economics profession.