The Deal Economy 2013

Home | Event | Blog | Awards

Print | Share | Discuss | Reprint

The continuing critique of economics

by Robert Teitelman | Published September 2, 2011 at 1:52 PM

Labor Day weekend looms. Let's roast a pig or cook a clam or whatever barbaric ritual involving fire and alcohol works for you. For beyond Monday lurks the Rest of the Year, which as we know, starts off in September with all kinds of reminders about how bad things can happen in delightful weather.

This blog has been operating for a little over a year. We've written about all kinds of subjects, loosely related to the deal economy: sometimes good, sometimes bad, never very short. This is a weakness, I know, but who has the time in this blogospheric pressure cooker to cut? We must move on! That said, I've been mulling over the big themes of the past year: the causes of the financial crisis, the relation between politics and financial management, the flaws of corporate governance and of the belief that interests or utilities can ever be simplified adequately to create an alignment. I mean, look at our politics. But a few pieces written over the past few weeks convince me that the theme that goes deepest into our current situation may well be the crisis in economics. Now this may seem arcane, particularly compared with pitchfork and flaming-torches issues like whether to put senior Wall Streeters in jail or whether to break up the banks. But the esoteric, and exceedingly abstract, nature of economics may be the very reason that it's so central. We live in a liberal democracy in which the overpowering metric of success or failure, ascension or decline, comes down to economics. Economists occupy a central policy rule in the mandarinate tossed up by our mature and exceedingly complex political economy. And economics as an intellectual discipline makes universal claims that are far different from the argument of self-interest that you get from any of a thousand interest groups, even those as large and hazy as, say, Wall Street and Main Street.

And yet, economics--particularly the high priesthood of macroeconomics--cannot agree on fundamentals: That's what I would call a crisis. It's more than just the fact that economists mostly missed the coming of the crisis; or that they seem too hamstrung to agree on policies that can pull us out of the slump; or even that their predictive powers have been demonstrated to be less than stellar. As John Kay, a favorite of this blog (see here), pointed out in a typically calm and understated, if devastating, critique of economics in the Financial Times at the end of August, professional academic economists easily turn back such criticism by complaining "that the critics do not understand what economists really do. But if the critics did understand what economists really do, public criticism might be more severe yet."

Kay, a credentialed academic economist (London Business School, Oxford), attacks some of the rotting timbers of the discipline from the inside. In particular, he goes after the pretensions of the economic model builders, notably the business cycle crowd that wields the "dominant paradigm" of "dynamic stochastic general equilibrium," or DSGE, which he describes as a "complex model structure that seeks to incorporate, in a single framework, time, risk and the need to take account of the behaviour of many different companies and households." Closely related to that is the study of financial markets in the efficient-market hypothesis and the capital asset pricing model. Kay offers a brutal putdown of these three related models. "But the account of recent events given by the proponents of these models was comprehensively false. They proclaimed stability where there was impending crisis, and market efficiency where there was gross asset mispricing." Kay argues that these models create a kind of wildly simplified "Ricardian equivalence" that determines the behavior of households or individuals by mechanical rules; here he touches on a theme pursued by NYU's Roman Frydman and the University of New Hampshire's Michael D. Goldberg in "Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State," which we reviewed earlier in the year here.

Kay argues such "Ricardian equivalence is no more than a suggestive hypothesis," and he digs down to the fundamentals of that approach: "Consistency and rigour are features of a deductive approach, which draws conclusions from a group of axioms--and whose empirical relevance depends entirely on the universal validity of the axioms. The only complete description that fully meets the requirements of consistency and rigour are completely artificial worlds, such as the 'plug and play' environments of DSGE--or the 'Grand Theft Auto' computer game." Kay's real target here is a kind of reductionism that simplifies "science" to a single method. "What is absurd is not the use of the deductive method but the claim to exclusivity made for it. The debate is not simply about mathematics versus poetry. Deductive reasoning necessarily draws on mathematics and formal logic; inductive reasoning, based on experience and above all careful observation, will often make use of statistics and mathematics."

His conclusion: "The belief that models are not just useful tools but are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face."

Kay is hardly alone. In fact, Kay here is synthesizing a widening point of view. A few days after Kay's FT essay, Mark Thoma, the University of Oregon economist behind the Economist's View blog, posted a piece he had written for The Fiscal Times that also tackled what he called the "divide" in economics. He focuses more on policy and politics, which, he writes, are able to crawl forth in all their contradictory and ideological splendor because of the failure to achieve consensus in economics. "A big part of the problem is that macroeconomists have not settled on a single model of the economy, and the various models often deliver very different, contradictory advice on how to solve economic problems. The basic problem is that economics is not an experimental science. We use historical data rather than experimental data, and it's possible to construct more than one model that explains the historical data equally well."

Kay might argue that for all his criticism, Thoma remains captive to the notion that human reality can ever be contained in a single, universal model. Still, Thoma's notion that economic policies are so easily the tools of one ideology or the other because of the failure to create an intellectual consensus does explain a lot. An economics that can be exploited for so diverse a range of political views is a very dangerous thing in a democracy. Both Thoma and Kay do speak from within rather than without; neither of them can possibly be confused with a populist ranter. Both also have begun to raise questions that take us back to an age when economics, or political economy, was more about philosophy than math. What is the nature of economics as a discipline? What is the nature of this set of activities that we consider economic behavior? And, of course, what is the nature of the men and women who populate economic systems?

But leave that aside until next week. The pig awaits.

Share:

blog comments powered by Disqus

Free preview

This is only a preview of The Deal's sophisticated coverage. Explore the real-time intelligence as researched and reported on by our team of financial journalists with a license to The Deal Pipeline. Click here for more information.

Meet the journalists

Robert Teitelman

Editor in chief

Bob Teitelman, editor in chief and a member of the company’s executive committee, is responsible for editorial operations of print and electronic products. Contact

Movers & Shakers

Real estate investment manager Clarion Partners LLC hired Kerrisha Jenkins as a vice president in Los Angeles. For other updates launch today's Movers & shakers slideshow.

Video

A fast start toward an uncertain finish

Prime Minister Shinzo Abe and Sony CEO Kazuo Hirai are changing Japan. Third Point's Dan Loeb is trying to quicken the pace. More video

Free preview

Editor in chief

Movers & Shakers

Sectors