Blame economists, not economics

Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks - at least those used in advanced courses - are fine.
As the world economy tumbles off the edge of a precipice, critics of the economics profession are raising questions about its complicity in the current crisis. Rightly so: economists have plenty to answer for.
It was economists who legitimised and popularised the view that unfettered finance was a boon to society. They spoke with near unanimity when it came to the 'dangers of government over-regulation.' Their technical expertise -- or what seemed like it at the time -- gave them a privileged position as opinion makers, as well as access to the corridors of power.
Very few among them (notable exceptions including Nouriel Roubini and Robert Shiller) raised alarm bells about the crisis to come. Perhaps worse still, the profession has failed to provide helpful guidance in steering the world economy out of its current mess. On Keynesian fiscal stimulus, economists' views range from 'absolutely essential' to 'ineffective and harmful.'
On re-regulating finance, there are plenty of good ideas, but little convergence. From the near-consensus on the virtues of a finance-centric model of the world, the economics profession has moved to a near-total absence of consensus on what ought to be done.
So is economics in need of a major shake-up? Should we burn our existing textbooks and rewrite them from scratch?
Actually, no. Without recourse to the economist's toolkit, we cannot even begin to make sense of the current crisis.
Why, for example, did China's decision to accumulate foreign reserves result in a mortgage lender in Ohio taking excessive risks? If your answer does not use elements from behavioural economics, agency theory, information economics, and international economics, among others, it is likely to remain seriously incomplete.
The fault lies not with economics, but with economists. The problem is that economists (and those who listen to them) became over-confident in their preferred models of the moment: markets are efficient, financial innovation transfers risk to those best able to bear it, self-regulation works best, and government intervention is ineffective and harmful.
They forgot that there were many other models that led in radically different directions. Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks -- at least those used in advanced courses -- are fine.
Non-economists tend to think of economics as a discipline that idolises markets and a narrow concept of (allocative) efficiency. If the only economics course you take is the typical introductory survey, or if you are a journalist asking an economist for a quick opinion on a policy issue, that is indeed what you will encounter.
But take a few more economics courses, or spend some time in advanced seminar rooms, and you will get a different picture.
Labour economists focus not only on how trade unions can distort markets, but also how, under certain conditions, they can enhance productivity. Trade economists study the implications of globalisation on inequality within and across countries. Finance theorists have written reams on the consequences of the failure of the 'efficient markets' hypothesis.
Open-economy macroeconomists examine the instabilities of international finance. Advanced training in economics requires learning about market failures in detail, and about the myriad ways in which governments can help markets work better.
Macroeconomics may be the only applied field within economics in which more training puts greater distance between the specialist and the real world, owing to its reliance on highly unrealistic models that sacrifice relevance to technical rigour.
Sadly, in view of today's needs, macroeconomists have made little progress on policy since John Maynard Keynes explained how economies could get stuck in unemployment due to deficient aggregate demand. Some, like Brad DeLong and Paul Krugman, would say that the field has actually regressed.
Economics is really a toolkit with multiple models -- each a different, stylised representation of some aspect of reality. One's skill as an economist depends on the ability to pick and choose the right model for the situation.
Economics' richness has not been reflected in public debate because economists have taken far too much license.
Instead of presenting menus of options and listing the relevant trade-offs -- which is what economics is about -- economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favouring one set of social arrangements over others.
Furthermore, economists have been reluctant to share their intellectual doubts with the public, lest they 'empower the barbarians.'
No economist can be entirely sure that his preferred model is correct. But when he and others advocate it to the exclusion of alternatives, they end up communicating a vastly exaggerated degree of confidence about what course of action is required.
Paradoxically, then, the current disarray within the profession is perhaps a better reflection of the profession's true value added than its previous misleading consensus. Economics can at best clarify the choices for policymakers; it cannot make those choices for them.
When economists disagree, the world gets exposed to legitimate differences of views on how the economy operates. It is when they agree too much that the public should beware.
Source

What the world's big guns say about the meltdown

The financial crisis -- that has ravaged global markets, bankrupted many investment banks, brought about a tectonic shift in world economies, turned many a topcat into a homeless tramp and caused thousands to lose their livelihood -- is said to be the most horrific fiscal calamity ever to have visited mankind.
Worse, the full impact of this onrushing tsunami has not even been felt yet: experts promise more pain in the coming months and years. Pain that will take years to fade away.
And here's what the world's top leaders and economic brains have to say about the global meltdown. Read on. . .
We are right now teetering on the verge of panic: George Soros, billionaire investor, head of Soros Fund Management
The government's intervention is not intended to take over the free market, but to preserve it: George W Bush, president, US .
It's wrong to ask teachers, farmers and small-business owners to fill the gas tanks of the helicopters of Wall Street tycoons: John McCain, Republican presidential hopeful .
Washington has to recognise that economic recovery requires that we act not just to address the crisis on Wall Street, but also the crisis on Main Street and around kitchen tables across America: Barack Obama, Democrat presidential hopeful .
The Masters of the Universe have bitten the dust, the same dust that is now in the mouths of the rest of us. The impact on the developing world would be profound. Projects are already stopping because of the lack of liquidity and financing. The debt crisis would become worse. The decline in commodity prices and exports would hurt the developing world: Nirupam Sen, India's permanent representative at the UN .

I can say with certainty that if investment banks were still private partnerships, where the partners have all their personal capital at risk, the financial meltdown would never happen. They would not let another Lloyds of London capital call happen, ever: Mark Cuban, US billionaire.
The financial tsunami we now face is a global crisis. Its destructive force is much stronger and more widespread than the Asian financial turmoil in 1997. The recovery will take longer, be more difficult and certainly cannot be taken lightly: Donald Tsang, chief executive, Hong Kong .
What is the nature of the crisis? The details can be insanely complex, but the basics are fairly simple. The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further: Economic Nobel laureate Paul Krugman.
What we needed and didn't have two or three weeks ago was a good diagnostic of the problem: It was not a liquidity problem; it was a solvency problem. And once you start from that position, the British solution is the only way forward: Philippe Martin, professor of economics, the Sorbonne, Paris
I'm a strong believer in free enterprise, so my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course, but these are not normal circumstances: George W Bush, President, US .

For the poor, the costs of the crisis could be lifelong. The poorest and most vulnerable groups risk the most serious -- and in some cases permanent -- damage. 100 million people have already been driven into poverty this year and that number will grow: Robert Zoellick, president, World Bank
Wall Street had it coming. . . The nature of America's financial crisis is the failure of Wall Street's business model in and of itself: Japanese columnist Hideo Tamura .
We live in an interdependent world and the fate of all countries is related to the international financial system. Our value markets are opened to the world and, if they are affected, this will affect our capacity to finance our development. If the financial crisis causes a recession in the main economies, this will compromise our exports: Manmohan Singh, Prime Minister, India
The age of Reaganism is over. The no-regulation, low-taxes philosophy has broken the back of our economy: Former Harvard University economist Jeffrey Sachs, now special adviser to the UN Secretary-General Ban Ki-moon
Where was the IMF? This is the sort of crisis that should be at the heart of what the IMF was set up to do, but no one in the U.S. or in other G-7 countries seems to turn to the IMF for advice: Mohamed El-Erian, co-CEO, investment firm PIMCO, and a former IMF economist who was in the running to head the fund four years ago.

Seeing big American banks saved by privatisations, one almost wants to scream, 'Marx, come back, they've gone crazy!' We're seeing, in renewed form, the most debatable aspects of Anglo-Saxon capitalism called into question: Arnaud Lagardere, general partner and CEO, Lagardere Group
I know too well how disastrous these slumps can be. During the 1991 recession I was basically bankrupt -- it all happens very quickly. So what's the use in finger-pointing? I don't want to see the Americans go down the pan. Everyone knows that we'll follow: Stephen Brown, British citizen
The financial world still has a number of serious problems. However, time and money will eventually heal them: Barton Biggs, Wall Street strategist
Although a great many policy actions have since been taken, they have been neither comprehensive nor global. Indeed, the approaches taken have been so varied and inconsistent, especially with regard to deposit guarantees, that they are intensifying problems for other countries: Dominique Strauss-Kahn, head, IMF
The situation is going to get better when you feel good about buying Citigroup stock. Right now, nobody feels good about buying it: John Catsimatidis, supermarket billionaire and New York mayoral hopeful .

It's a good warning for the Chinese economy, but I believe China will make the exact same mistake in future: Kelly Yu, Chinese citizen
You can't just blame the banks, you also can blame the people that took out mortgages... We were brought up that you first had to put some savings together and then enjoy. But this whole society has gotten to the fact that we're a 'now, give it to me today' kind of society. I think regulation has not been adequate. There's no one person to blame other than all of us: Mike Bloomberg, mayor, New York, former Wall Streeter, founder, financial services company Bloomberg
My own view right now is that cash is king; liquidity is king: Don Marron, US billionaire
The Wall Street crisis has been caused by the years of excesses and the fee-based economy where the only goal is to make fees at any cost without any benefit to the economy: Carl E Berg, US billionaire
We have counted on emerging economies, which collectively account for half of global GDP, to hold up. However, with the credit crisis reaching shores of emerging market countries, their growth is now likely to fall well below trend by the end of the year: Moody's Economy.com