Monday, September 7, 2009

Krugman on contemporary economists & thier big disagreement

Paul Krugman in the NYT today asks a very interesting question: “How Did Economists Get It So Wrong?” Krugman argues that in addition to lax regulation by Washington and reckless risk taking Wall Street, faulty thinking in academia also contributed to the crisis. He recounts that a growing but weakly grounded meeting of minds between Keynesians (or Neo-Keynesians) and Classical economists (updated via Milton Friedman). Indeed, he posits a difference between fresh water (Chicago orbit) and saltwater (coastal schools) economists. He recounts that even the monetarist Friedman didn’t deny the ability of the government spending to boost the economy; rather, he argued that this could be handled more effectively via monetary policy. Like the successors of many a genius, his disciples took it too far. Some Chicago economists argue that we have high unemployment because people don’t want to work! Wow, nuts.

Krugman takes the problem deeper, and posits two shortcomings of classical free market economics: the belief that humans are constantly making rational decisions and its corollary, that economists can create precise mathematical models to predict behavior because things like bubbles just don’t exist. How can someone believe that humans are always rational? It allows that math to work, but beautiful equations do not necessarily square with reality. It comes back to the point that you can start with any faulty premise and use logic (and beautiful math) to arrive at just about any crackpot conclusion. Don’t the economists who believe in perfectly rational humans and perfectly operating markets know about other economists like Herbert Simon (satisficing), Daniel Kahneman, and Vernon Smith, not to mention to spate of younger researchers, who publish in the area of behavior economics (given a shout-out by Krugman) and human decision-making? Also, Eric Beinhocker in The Origin of Wealth (a book I’ve dipped into but need to read in full) describes the economy as a complex system, and he very effectively critiques the shortcomings of neo-classical economics. Of course, there is also Nasim Taleb, a veritable holy warrior against contemporary economics based in part on ancient skepticism.

All this makes my glad that I trained in history and political science and resisted the invitation to become an economics major (okay, the math had a lot to do with it, I admit). But in history and political science, you can crunch number and perform mathematical analysis, but in the end, you are constantly reminded that you’re dealing with irrational human beings: people motivated by reason, passions, and interests—and not necessarily in that order!

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