Saturday, 9 August 2008

Economics does not lie

In this recent article in the City Journal Guy Sorman tells us Economics Does Not Lie. Sorman writes
If economics is finally a science, what, exactly, does it teach? With the help of Columbia University economist Pierre-AndrĂ© Chiappori, I have synthesized its findings into ten propositions. Almost all top economists—those who are recognized as such by their peers and who publish in the leading scientific journals—would endorse them (the exceptions are those like Joseph Stiglitz and Jeffrey Sachs, whose public pronouncements are more political than scientific). The more the public understands and embraces these propositions, the more prosperous the world will become.
The list is
  1. The market economy is the most efficient of all economic systems.
  2. Free trade helps economic development.
  3. Good institutions help development.
  4. The best measure of a good economy is its growth.
  5. Creative destruction is the engine of economic growth.
  6. Monetary stability, too, is necessary for growth; inflation is always harmful.
  7. Unemployment among unskilled workers is largely determined by how much labor costs.
  8. While the welfare state is necessary in some form, it isn’t always effective.
  9. The creation of complex financial markets has brought about economic progress.
  10. Competition is usually desirable.
The Sorman article discusses each of these in more detail. While you can always pick holes in any list such as this, this one isn't bad.

When looking to the future, Sorman writes
In the future, the threat to the beneficent influence of economic science will come less from tired socialist revolutionary rhetoric than from new dangers, such as terrorism and epidemics. Terrorism is, in part, a consequence of globalization: young, uprooted people unable to adapt to a dynamic, capitalist world invent new global ideologies and seek to put them into practice with global weapons. Globalization can also accelerate the proliferation of deadly illnesses. The AIDS epidemic was the first global attack by a mutant virus; SARS, avian flu, or some unknown illness could follow, surging from uncontrolled Chinese, Indian, or African backwaters and following the massive migrations of a global economy. Terror and epidemics could both unleash political upheavals that would undermine the market order itself.

Then there’s the fear of ecological disturbances, which could result in incoherent policies that wouldn’t necessarily diminish risks to the environment but might prevent development and thus harm the interests of the poorest peoples. One example: prohibiting genetically modified organisms—which, evidence suggests, pose no threat whatsoever to the environment—will hurt the productivity of farming at a time when global demand for food will grow.
Sorman see another danger in the very nature of economic systems: the cyclical nature of growth. While he thinks that recessions on the scale of the Great Depression are less likely to happen today because the political mistakes that aggravated it, such as protectionism and the drying-up of credit, aren't as likely to be repeated in the future, he does see smaller crises as being inevitable. Such problems are bound up with innovation and the forces by which the new drives out the old in periods of creative destruction. Similarly he argues that free trade will mean that some people will lose their jobs, that foreign competition will wipe out entire companies or even entire industries. Sorman points out that
We all know it because, as Friedman argued, layoffs and closings get disproportionate media coverage. Meanwhile, nobody talks about the ongoing reduction in prices for consumers and investors, scattered among a huge number of beneficiaries. That helps explain why politicians are prone to deride free trade and voters are too often ready to agree.
Sorman goes on to say
To help the losers in the free market, government shouldn’t back away from either free trade or creative destruction and start subsidizing doomed and obsolete activities, a protectionist course that guarantees only economic decline. Instead, it should help the losers change jobs more easily by improving educational opportunities and by facilitating new investment, which creates more employment. An essential task of democratic governments and opinion makers when confronting economic cycles and political pressure is to secure and protect the system that has served humanity so well, and not to change it for the worse on the pretext of its imperfection.
Sorman closes this piece by noting that one of the hardest ideas to translate into language that public opinion will accept is the fact that even the best of all possible economic systems is still imperfect. Markets are one of the many human institutions that are the result of human action, but not of human design. But they are based on people and without perfect people you are unlikely to get perfect markets. But for all these imperfections, we have yet to find a better economic system.


Anonymous said...

Some of this is quite disingenious - misleading if not false. Other parts are vague enough to mean very little.

" 1. The market economy is the most efficient of all economic systems."

Only if you're talking about a market economy within appropriate regulatory limits and government control. The success stories of capitalist nations include those with anti-trust laws, regulation of the finance industry (notably banks), consumer protection laws (such as our consumers guarntee act) and strong regulation of property sales and rentals.

This isn't just a claim that "strong institutions" are also important. It's an attempt to prevent hte false dichotomy that libertarians so love. It's too easy to pretend there are only two options: govt control of the economy or free market. Actually both extremes are bad - and while we're better off down the market end of the spectrum you don't want to get too close to that end of the spectrum.

" 5. Creative destruction is the engine of economic growth."

As presented that's quite misleading. Secretary of the US Treasury Andrew Mellow swore that you needed a bust now and then to drive out bad businesses. And advised his president Hoover to take no action to ameliorate the Depression. The result was a disaster. Milton Friedman's analysis of this is classic: he blamed the Depression's severeness on the govt, in particular on the lack of early govt intervention under Hoover to save drowning businesses.

Schumpter's very popular amongst the libertarians who hate to see govt intervention - but it's hard to think of "top economists" who'd rate this claim unless it was qualified.

" 6. Monetary stability, too, is necessary for growth; inflation is always harmful."

The first half of that is true, the second is false. Deflation is worse, but more importantly there's a lot of good evidence that a low (around 2%-3%) inflation rate is better for you than nil inflation as it permits rebalancing of labour costs across sectors. So again I can't imagine "top economists" signing up what's written here.

" 8. While the welfare state is necessary in some form, it isn’t always effective."

So vague as to be almost meaningless. It's like saying "While medicine is necessary in some form it isn't always effective".

" 9. The creation of complex financial markets has brought about economic progress."

The creation of large and liquid financial markets has brough about economic progress. The more complex parts of the markets aren't very helpful - the ability to undertake a rainbow option or power-swap don't do much.

If these 10 aphorisms are really the best the science can do, then it's certainly dismal.

Anonymous said...

Of course it's Mellon not Mellow...


Paul Walker said...

As noted in my piece "The Sorman article discusses each of these in more detail"

"Only if you're talking about a market economy within appropriate regulatory limits and government control." Too vague to be of much use. What exactly is "appropriate"? As many economists would point out "regulatory limits and government control" are more likely to be the problem rather than the solution. For example, Dominick T. Armentano makes the case against anti-trust in this book "Antitrust: The Case for Repeal". Sir Arnold Plant made a case against copyright and patents back in the 1930s and so on.

As to deflation, in his book "Less than Zero: The Case for a Falling Price Level in a Growing Economy", George Selgin argues that the aim of those who make monetary policy should be not merely price stability but falling prices when productivity change suggests it. So deflation may not be so bad.

Milton Friedman and Anna Jacobson Schwartz showed convincingly that the Federal Reserve's monetary policies were largely to blame for the severity of the Great Depression. This argues against the ideas we need "regulation of the finance industry". According to Friedman and Schwartz, it was a complete abdication of the Fed’s core responsibilities—responsibilities it had taken away from the commercial bank clearinghouses that had acted to mitigate panics before 1914—and was the primary cause of the Great Depression.

You should check the true reason for the term "dismal science" and you would understand why economists are happy to be the "dismal science"

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