In the wake of the biggest economic calamity in 80 years that reputation has taken a beating. In the public mind an arrogant profession has been humbled. Though economists are still at the centre of the policy debate—think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain—their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.”But I think the most important point the Economist makes is,
In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.The current crisis points to problems in macroeconomics and financial economics and these areas are now, rightly, being severely re-examined. Which is all to the good. There are new questions about the relative usefulness of monetary and fiscal policy. And about how the financial sector affects the real sectors of the economy. Also financial economists are starting to study the way that incentives can skew market efficiency.
And if economics as a broad discipline deserves a robust defence, so does the free-market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. Their logic seems to be that if economists got things wrong, then politicians will do better. That is a false—and dangerous—conclusion.
But let us not throw the baby out with the bathwater. As noted in the quote from the Economist above,
Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.Steven E. Landsburg famously summed up economics as,
Most of economics can be summarized in four words: People respond to incentives. The rest is commentary.This is just as true now as it was before the crisis. People still respond to incentives, just as they did before the crisis and thus economics still has valuable insights to give.
(HT: Peter M Salmon)