Has Economics Failed? Yes!
The Financial Times asked two experts to address the question of “Has Economics Failed“. The real answer to this question is it depends. It depends on whether you think the Economics profession should have a basic level of expertise on an issue before its practitioners open their mouths.
So what is this basic level of expertise Economists should have for financial crises? It seems reasonable they should be able to identify the necessary conditions for a financial crisis to occur and be able to offer policy recommendations that have been shown to end a financial crisis within 24 months of implementation.
What we have learned since the start of the acute phase of the Great Financial Crisis in 2008 is Economists don’t have this basic level of expertise. So yes, Economics has failed.
Tom Clark, the Editor of the Prospect and the expert who argued Economics has failed, starts his argument by pointing out Economists view the world and inform their policy recommendations using an outdated framework. Specifically,
It understands the world as a series of deviations from a far-fetched vision of omnipresent and flawless markets — imperfect competition, imperfectly shared information and so on.
The result of using an outdated framework is the Economics profession didn’t see the financial crisis coming. As Mr. Clark experienced,
I remember being in a pub after the storm hit with a bunch of economists and one had the honesty to ask: “So what’s going on then?” Nobody could shed much light. True, these were generalists, not macro-specialists, but the country was enduring an economic heart attack. Nobody would forgive a GP who forgot what a cardiac arrest involved.
Confirmation the Economics profession doesn’t have the basic level of expertise in financial crises needed before its practitioners open their mouth.
Chris Giles, the Financial Time’s Economics Editor and the expert who argued Economics hasn’t failed, begins by observing:
Economics is fundamentally a study of how the world works and how to make it a better place. So long as you don’t expect soothsaying, it is remarkably successful in this endeavour…
If Economics is the study of how the world works, how come the macroeconomists I have met don’t understand how the global financial system is designed? This includes 100s of Economists at the Fed, Bank of England, European Central Bank and in Academia.
Despite my interruption, Mr. Giles continues making his case.
It is important not to get hung up on mistakes, even big ones. Yes, economists collectively failed to predict the financial crisis. Macroeconomics underestimated the importance of banks for economic stability….
Isn’t the collective failure to predict the financial crisis a problem? I am not talking here about predicting the crisis would start on August 9, 2007. I am talking here widespread recognition across the Economics profession that a financial crisis had at least of 50/50 chance to occur.
As for blaming the failure to see a financial crisis coming on the underestimation of the importance of banks, this rather dramatically understates the situation. Macroeconomists didn’t include banks in their models.
His statement also conveniently sweeps under the rug the issue of what is the source of financial stability. A decade after the acute phase of the Great Financial Crisis began and macroeconomists still don’t know what is the source of financial stability or instability.
Economics is far from perfect and has much still to learn. That’s what makes the subject still so important and exciting.
But the discipline is learning from errors. It does not have its head in the sand, saying that its models which failed are still fine.
If ever there was a discipline that isn’t learning from its errors and has its head buried somewhere so it cannot hear, it is the economics profession.
It is remarkable how, with only a very rare exception, the Economists I have met are offended when you question their expertise in the design of our financial system or in how to handle a financial crisis.
Undeterred by the reality of the Economics profession, Mr. Giles presses on with his argument.
Following the new analysis, financial and economic policy has changed.
The new thinking will not stop all new financial crises. More fundamentally, even if it does prevent meltdowns in the years ahead, we will never know because you cannot spot a crisis dodged.
Shorter: we should be down on our knees praising the Economics profession because it has already prevented future meltdowns.
I admire the chutzpah Mr. Giles shows in making this statement. What the statement highlights is why Economists are undermining trust in experts. The claims made in the statement aren’t remotely supported by the facts. After all, if there was one change macroeconomists had made that would clearly stop a future crisis from occurring, Mr. Giles would have cited it.
But then Mr. Giles turns to the real issue that is so upsetting to these self-proclaimed experts.
So, when the Queen asked why nobody warned us of the financial crisis, the economists present were polite and mumbled something into their shoes, but they should have stood tall and responded: “That’s a stupid question, your Majesty. Why aren’t you interested in what we’re doing to improve things next time?”
The Economists present didn’t ask that question because they knew in response the Queen would have been laughing so hard at them she could have died. Like everyone else, the Queen knows until you take the time to acquire a basic level of expertise in financial crises so you can explain why the crisis occurred, you don’t know what to change to improve things next time.
This post is already long enough. Of course, I have the basic level of expertise in financial crises I suggest Economists should have before opening their mouths. And yes, I did see the financial crisis coming (it is a matter of public record). With that background, you might be interested in my answer to the Financial Time’s Martin Wolf’s three linked financial crisis questions is here. His questions are: what causes financial crises; what policies would best reduce the risks of such crises; and what should the policy response be to crises once they have happened.
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