The Latest Reported Bankruptcy: Mainstream Economics

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Banks, home builders, and auto manufacturers are not the only ones going belly-up these days. If we may credit Louis Uchitelle’s January 7 report in the New York Times, mainstream economists have, in effect, declared their intellectual bankruptcy. According to Uchitelle,

Frightened by the recession and the credit crisis that produced it, the nation’s mainstream economists are embracing public spending to repair the damage — even those who have long resisted a significant government role in a market system. . . . Hundreds of economists who gathered here [in San Francisco] for the annual meeting of the American Economic Association seemed to acknowledge that a profound shift had occurred. At their last meeting, ideas about using public spending as a way to get out of a recession or about government taking a role to enhance a market system were relegated to progressives. The mainstream was skeptical or downright hostile to such suggestions. This time, virtually everyone voiced their support, returning to a way of thinking that had gone out of fashion in the 1970s.

At this point, one cannot help but recall Proverbs 26:11: “As a dog returneth to his vomit, so a fool returneth to his folly.”

Modern economics suffers from a variety of weaknesses and defects, among which faddishness ranks high. The chronic pursuit of fads, however, springs from a more serious problem: the mainstream profession’s faulty epistemological foundation — positivist presumptions that lead economists to believe that by aping nineteenth-century physicists they are acting as “scientists.” Laboring under this grave misconception, they are destined to be blown erratically by the winds of changing events. So tenuous is the contemporary appreciation of economic verities that the slightest apparent breakdown of the economic order completely befuddles the economists and sends them running about wildly in search of a new model that will predict better than the old, now discredited one.

Some are so discombobulated by unexpected turns of events that they project the breakdown of their superficial understanding onto the economic actors themselves. Thus, Professor Peter Gottschalk of Boston College tells Uchitelle: “Our models are built on the assumption that on average people behave rationally and they do the right thing, but this time people did very much the wrong thing.”

Had Professor Gottschalk so much as dipped his toes into the deep waters of Ludwig von Mises’s treatise Human Action, he would understand that even the most rational actors may make mistakes. Moreover, he would be equipped to understand how various government policies — subsidizing near-universal home ownership, generating artificially cheap credit, intimidating reluctant lenders, and in effect promising to bail out any huge financial institution on the brink of bankruptcy — created incentives that led perfectly rational people to act in a way that now seems to have been mistaken or even irrational. Gottschalk’s misconception, however, scarcely puts him in a class by himself.

According to Janet Yellen, president of the Federal Reserve Bank of San Francisco, “The new enthusiasm for fiscal stimulus, and particularly government spending, represents a huge evolution in mainstream thinking,” which she expects to persist, in Uchitelle’s words, “for as long as the profession is dominated by men and women living through this downturn.” If this forecast turns out to be correct, a profession that allowed its misinterpretation of economic events during the Great Depression and World War II to lead it in the wrong direction for three or four decades will, after having reversed course somewhat since the 1970s, be reverting to the same misguided thinking it embraced in the immediate postwar period — this time, however, without the excuse of the confusion engendered by a genuinely great depression.

As befits economists who lack sound theoretical moorings, those gathered at San Francisco had “plenty of proposals,” and “their proposals were all over the lot.” Modern economics is nothing if not trendy. Often this trendiness reflects only the high marks given to the economist who uses a new and even more incomprehensible analytical tool — a mathematical theorem or a statistical procedure cribbed from math and stats journals — but sometimes, as now, it simply demonstrates how a drowning thinker will grasp any intellectual plank he happens to notice floating past.

The assembled economists did agree, however, on one important point: “many said that once the recession ended, the nation should not go back to the system that held sway from Ronald Reagan’s election in 1980 to the present crisis. It was one in which taxes, regulation and public spending were minimized.” Is it possible that the statement I have emphasized in the preceding quotation actually represents the beliefs of most economists? If so, then we can only conclude that they have somehow removed themselves from this planet and taken up residence in another world.

The idea that since 1980 “taxes, regulation and public spending were minimized” cannot honestly be held by any sentient being who has paid the slightest attention to the events of the past thirty years — a period during which federal receipts rose from $1,137 billion in 1980 to $2,588 billion in 2007 (in constant 2007 dollars), federal outlays rose from $1,312 billion to $2,730 billion (in constant 2007 dollars), real state and local taxes and expenditures increased by more than 150 percent, and regulations spewed out of Washington and the fifty state capitals as if the bureaucrats saw no need for taking heed of the morrow. Notwithstanding all of these events and a great many others pointing in the same direction, the recent converts to active fiscal interventionism would have us believe that this ongoing blizzard of bigger and bigger government represented taxes, spending, and government regulation being minimized? The mind boggles at such flagrant nonsense.

Nor are mistaken views of recent economic history the only obtuseness reported from the AEA conference. “Nearly every economist who spoke here agreed that a dollar invested in, say, a new transit system or in bridge repair is spent and respent more efficiently than a dollar that comes to a household in a tax cut.” Say what? Politicians and bureaucrats use people’s money more judiciously than do the people who earned it? Granted that Uchitelle seems to have been referring here to whether the funds would be spent repeatedly for consumer goods, rather than being saved, and he simply misused the economic term “efficiently,” yet the observation’s inanity remains. Do today’s economists really take seriously the vulgar Keynesian idea of the Paradox of Thrift? Can they be such idiots that they suppose every dollar of income not spent for consumption goods goes under the mattress and stays there? How, one wonders, do they imagine the massive capital apparatus of the modern world came into being — by people’s spending for immediate consumption every cent of income they ever received?

Ah, yes, we must recall: modern macroeconomics proceeds in serene disregard of capital, its composition, its complex role in the time-structure of production, and its origin in saving. Macroeconomics deals in unadorned aggregates, if it deals at all. For today’s macroeconomist, the aggregate capital stock is a “given,” and the present is all that matters, indeed, all that exists. In the long run, all macroeconomists are dead.

I do not wish to conclude this little diatribe without acknowledging that a substantial amount of interesting and important work still goes on in the economic mainstream — as the saying goes, some of my best friends are mainstream economists (and I was once one myself). Yet such work is the exception to the rule. Much of the decent work takes place in fields such as economic history, the new institutional economics, public choice, and other applied areas that the profession’s aristocrats — the so-called theorists and the theoretical econometricians — view with disdain as labor fit only for the profession’s heavy-browed hod carriers.

No part of modern economics comes so close to being completely worthless as macroeconomics. Looking back at the seventy-years since John Maynard Keynes’s General Theory brought this style of analysis to prominence, one sees a series of stunningly simple-minded ideas, fallacious arguments, and utter disregard for basic questions at the foundation of the field, such as, “What does national output mean, anyhow?” and “Should government spending be included in GDP?” Although a few economists have pondered these questions, their reflections for the most part have been flushed away by the never-ending flood of mindless mathematical exercises:

call it Q, call it C, call it I, call it G;

do not trouble yourself as to what it might mean.

When in doubt, assume, assume, assume. Then write down your assumptions in an arbitrary mathematical form and proceed as if the stipulated variables and their postulated relationships bore some relation to reality.

Now, with the financial debacle, the bailout fiasco, and the onset of a recession as provocations, mainstream economists are casting overboard the few little packets of their macroeconomics that contained half-plausible concepts and ideas, treating them as expendable cargo in a storm. As if this hasty jettisoning were not enough, the frightened sailors are also snatching bits and pieces of jetsam left over from the theoretical and policy wreckage of the 1970s. It’s a pretty ugly sight, and as the storms intensify, it will probably get uglier.

Resurgence of the Warfare State: The Crisis Since 9/11
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Depression, War, and Cold War
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Against Leviathan
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Crisis and Liberty: The Expansion of Government Power in American History (MP3 CD)
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Higgs Collection
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Crisis and Leviathan
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Robert Higgs [send him mail] is senior fellow in political economy at the Independent Institute and editor of The Independent Review. He is also a columnist for LewRockwell.com. His most recent book is Neither Liberty Nor Safety: Fear, Ideology, and the Growth of Government. He is also the author of Depression, War, and Cold War: Studies in Political Economy, Resurgence of the Warfare State: The Crisis Since 9/11 and Against Leviathan: Government Power and a Free Society.

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