Has economics failed us? Hardly


My friend Fareed Zakaria has celebrated his well-deserved recognition by Foreign Policy Magazine as one of the 10 most important foreign policy thinkers of the last decade by writing an essay entitled “The End of Economics,” doubting the relevance and utility of economics and economists.  Because Fareed is so thoughtful, and echoes arguments that are frequently made, he deserves a considered response.

Fareed ignores large bodies of economic thought, fails to recognize that economists have been the sources of most critiques of previous economic thinking, tilts at straw men, and offers little alternative to economic approaches to public policy.

Many critics of economics hold out the failure of the economics profession to predict the financial crisis as an indictment.  This argument fails to acknowledge a central idea taught in every basic finance course. Market breaks are inherently unpredictable because one that was predicted would have already occurred as everyone moved to sell.  Even so, several economists including Janet Yellen, Raghuram Rajan, Robert Shillerand I (20062007, 2007, 2008) were concerned about risks to the financial system and the real economy in the years and months preceding the crisis.

Fareed quotes Paul Krugman on the economics profession’s “blindness to the very possibility of catastrophic failures in a market economy”. Yet he quotes Krugman selectively. Krugman is indeed critical of economics, but has also argued for many years that textbook macroeconomic theory could explain much of the financial crisis and its aftermath, and that the main policy failures post crisis (insufficient stimulus and foolish worries about inflation and deficits) reflected ignorance of economics and adherence to shibboleths. I have long shared Paul’s views on the excessive fetishization of mathematical elegance in macroeconomics, but this is very different from discarding textbook macro which has stood up very well.

Fareed, echoing other critics, attacks the economics profession for the use of GDP in assessing national economic performance. This is a justified concern. Yet all the serious efforts to move beyond GDP have their roots in research by card-carrying economists. Think of Jim Tobin and Bill Nordhaus with their Measure of Economic Welfare written 50 years ago, Partha Dasgupta on sustainability, Amartya Sen on comprehensive measures of Human Development or Tony Atkinson and Thomas Piketty on inequality.

It is argued that the common economic assumption that everyone is rational and optimizing is hardly valid.  Of course. This has been a major theme in economic research since before I was born, with Milton Friedman having written a famous paper talking about why people buy lottery tickets. Andrei Shleifer and I wrote a survey of the then large literature on “noise traders” more than a quarter century ago, and the argument that speculative prices are not fully rational and reflect greed, fear and human emotion is amply clear in the writings of many others including Kindleberger, Shiller, Thaler and DeLong. The assumption of rational optimizing individuals is used only as an approximation to reality, and good economists understand its limits. Many of the major insights in behavioral economics were reached decades ago and are incorporated into modern economic theory and practice. Policy ideas like transactions taxes and “nudges” that are premised on irrationality have mostly come from economists.

Fareed also asserts that countries do not profit maximize as if this is a critique of economics.  I am not aware of any economist who has held that they do profit maximize.  Nor contrary to his assertion am I aware of economists who have asserted that income is the principle determinant of voting behavior.

An assessment of changes in the relevance of economics must also consider areas where economic analysis has become increasingly important.  Issues of choice and charter schools first pushed by economists are central in debates about education policy.  Systems of paying for outcomes rather than inputs, which have the potential to revolutionize health care reimbursement, are the product of economic reasoning and research.  Environmental policy debates revolve around market-based schemes for discouraging pollution and encouraging clean approaches to production.  Few areas of society are uninfluenced by big data and machine learning which are the latest incarnation of econometrics.

Economics can only lose its role if there is something to supplant it. Fareed is enthusiastic about what other disciplines can contribute. I share his hope but would note that he does not point to specific ideas or frameworks emanating from other disciplines that have contributed to policy in recent years. There are certainly examples of research from other social sciences which have had an important impact on public policy – but, I would submit, not nearly enough to suggest that economics can be pushed to the sidelines.

I will conclude by being very explicit on one point.  I am not arguing against the importance of the evolution in thinking regarding public policy that has taken place since the Reagan-Thatcher era or even since the Clinton-Blair era.  For reasons that reflect both progress in understanding the world, and changes in its structure, I and most other economists are more concerned with issues of redistribution, regulation, monopoly and maintaining demand than we would have been a quarter century ago.  As Keynes famously said “When I get new information, I change my mind.  And you?”

Managing globalization, supporting a healthy middle class in an era of artificial intelligence, and incentivizing the preservation of the planet must be among the central challenges, if not the central challenges, of our era. If not from economic analysis, it is hard to see where resolutions will come from. Everyone, whether they like economics and economists, or whether they resent and distrust current economics, has a stake in the discipline being relevant and successful going forward.

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