A dismal debate on who's to blame

For common folks — people who just lost their jobs or their homes or about to lose them — there is one more reason to be depressed. No one is able to tell them anything about such practical things like how long the crisis will last or what actions should be taken to speed up recovery. Neither their political leaders nor the supposed experts on the economy are able to give people the confidence they badly need in these times.

That’s why the G20 summit meeting in London seems to most people a waste of money. World leaders got together with high expectations that they themselves whipped up for the summit. But they ended up with nothing more than seemingly empty assurances that they are going to do their best to save the world from a new Great Depression.

How could the politicians be credibly reassuring when the experts advising them are still deep in debate on how to deal with the crisis and who’s to blame? The only thing certain these days are the continuing job losses, teetering banks that are too big to fail and homeowners losing their homes. If the world economy was a patient waiting to be attended in an emergency room, the patient will end up waiting for Godot or even expire before getting serious treatment. The doctors are still debating on how best to save his life.

Okay, it isn’t as if nothing is being done, even if some of the doctors are saying doing nothing is the way to go because the malady is self healing… a recession is how capitalism heals itself. An emergency procedure called fiscal stimulus had been applied in the meantime but there is considerable doubt it will work at the dosage administered or that it would work at all.

Some of the economy’s doctors want tax cuts but the others say that isn’t as efficient as fiscal stimulus in reviving the patient. Still others are more concerned with making sure the emergency situation does not happen again. They want to prioritize drafting tougher rules even while the patient hovers between life and death and probably needs an immediate shock to get the economy’s heart beating normally again.

If emergency room doctors behave like the doctors of economics are behaving in recent months, the ER may end up being a morgue. But in fairness, medical doctors have more empirical knowledge to go by than economists. Despite the claim of being a science that is supposed to be based on empirical data, practical day-to-day economics is in reality still very much in the realm of social science with all the unpredictable quirks of human behavior thrown in.

The basic assumption of economists about the rational man — that man would always act in his best self interest — has effectively been thrown out the window. That much we have been told by Alan Greenspan, the economist most often blamed for the current crisis, when he said he didn’t realize the bankers would act in such self destructive manner with the subprime loans and the alphabet soup of derivative products they were risking trillions of dollars on. Apparently, no one fully understood the magnitude and the nature of the risks involved even as they were making big bets.

So, who’s to blame?

So far, Daniel Gross wrote in Slate, “bankers have been getting most of the opprobrium… But they couldn’t have created the Dumb Money debacle without a substantial assist from economists. Toiling in government and academia, at trade groups and Wall Street firms, practitioners of the dismal science provided the intellectual ballast and justification for much of the insanity of this past decade. At every step of the way, as an Era of Cheap Money devolved into an Era of Dumb Money and then into an Era of Dumber Money, Ph.D.s led the cheers. And when things started to go bad, they failed to grasp just how bad things would get.”

The cover story in the latest issue of Businessweek noted “economists mostly failed to predict the worst economic crisis since the 1930s. Now they can’t agree how to solve it. People are starting to wonder: What good are economists anyway?”

The same article answers the question: “To be fair, economists can’t be expected to predict the future with any kind of exactitude. The world is simply too complicated for that. But collectively, they should be able to warn of dangers ahead. And when disaster strikes, they ought to know what to do. Indeed, people pay attention to economists at times like this precisely because of their bold claim that they know how to prevent the economy from sliding into a repeat of the Great Depression. But seven decades after the Depression, economists still haven’t reached consensus on its lessons. The debate has only intensified in recent weeks.”

In fact, there were a few economists who did predict the crisis and are now offering solutions. But economists are human. Like you and me, they crave for peer approval which leads to a kind of herd mentality. It was thus not surprising that mainstream economists effectively managed to sideline the few who were not saying what most of them are saying. And after the crisis came upon us, the solutions offered by the few who did warn about the crisis are still being ignored.

Thus there is the criticism that the problem with economists is they are overconfident, unrealistic, and political. As Businessweek puts it, “they claim a precision that neither their raw material nor their skill warrants. Too many assume that people behave like the mythical homo economicus, who is hyperrational and omniscient. And they take sides in quarrels that freeze the progress of research. Those few who defy the conventional wisdom are ignored.”

But if we can’t live with economists, we also can’t live without them. We need them to help us get out of our current mess and we need them to make sure it doesn’t happen again. Businessweek puts it in more practical terms: “Macroeconomist — that is, those who specialize in business cycles and growth — have made important contributions. For example, research in the 1970s helped many countries eliminate chronic high inflation by highlighting the importance of having a strong, independent central bank.”

Still, the Slate article earlier mentioned, says the performance of many prominent economists during the boom was poor, their performance after it ended may have been worse. Why were they not able to give proper warning? We are now being told that there were many signs of impending trouble but were ignored for a variety of reasons… perhaps because economists are too ideologically committed to being conservative or liberal. Or maybe, most of them just want to be mainstream and enjoy the party.

Economic forecasting is hard, the Slate article admits, but it also pointed out “clearly, economic forecasters weren’t asking the right questions, or looking at the right indicators… The set of theories upon which many economists rely is out of vogue and is being replaced by a set of funkier ones, which draw from sociology, anthropology, and psychology, as well as classical economics... The behavioral economists who are ascendant will tell you that the irrational behavior on display came as no surprise to them.”

Perhaps economic forecasting is as tricky as trying to forecast the weather. While economists and meteorologists can claim to have a science with a body of knowledge they depend on, both have to deal with the fickleness of Mother Nature and human nature. The economist is further handicapped by politics and ideology. At least the meteorologists don’t have to worry about those things so that when their predictions fail, that happens with more honesty.

At some point, we have to stop this dismal debate of who is to blame. Their limitations considered, we still need the macroeconomists to help us make the world economy robust enough to survive the blunders of future politicians, bankers, and economists. But we have to first of all, harness the best brains in the discipline to help us get out of this mess as quickly as possible.

Promises, promises

“I’m thinking of leaving my husband,” complained the economist’s wife. “All he ever does is stand at the end of the bed and tell me how good things are going to be.”

Boo Chanco’s e-mail address is [email protected]