Monday, 7 September 2009

A strange pair of allies


Bob Brown is a strange ally for Malcolm Turnbull to have gained in the current economic debate about when and by how much should the Labor economic stimulus package be reduced. The Turnbull position on the evils of deficit spending is predictable enough. He is on the side of what Paul Krugman would call the neoclassical dreamers who cannot surrender the beauty of their one true free market theory. Surely the Greens leader has not converted to that foolhardiness but is rather just trying to show that he is not a slave either to a simplified view of Keynes.
Perhaps his latest comments questioning whether we do need to continue full-on with the rollout of Labor’s economic stimulus package will be modified if Treasury secretary Ken Henry is called on to give evidence again to the Senate economics committee. Clearly, the Australian Treasury has learned the lesson from the last year of economic turmoil that the simplified version of the world presented by the neoclassicist economists has severe limitations.
Perhaps Senator Brown should spend an hour or two reading the very lengthy summary of the debate between differing schools of economists written by the Nobel Prize-winning Krugman and published at the weekend in the New York Times magazine under the headline “How Did Economists Get It So Wrong?”.
I found it a rattling good read as he tried to explain how the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.
Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealised vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealised market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives.
But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
Unfortunately, this romanticised and sanitised vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets  — especially financial markets  — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.
It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice  — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.
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