Friday, November 28, 2014

The Perils of Economic Consensus

PRINCETON – The Initiative on Global Markets, based at the University of Chicago, periodically surveys a group of leading academic economists, of varying political persuasions, on the issues of the day. Its latest roundup asked whether President Barack Obama’s stimulus plan helped to reduce unemployment in the United States.

Officially known as the American Recovery and Reinvestment Act of 2009, the plan entailed government spending of more than $800 billion on infrastructure, education, health, and energy, tax incentives, and various social programs. Implemented in the midst of an economic crisis, it was the classic Keynesian response.

The economists were virtually unanimous. Thirty-six of the 37 top economists who responded to the survey said that the plan had been successful in its avowed objective of reducing unemployment. The University of Michigan economist Justin Wolfers cheered the consensus in his New York Times blog. The virulent public debate about whether fiscal stimulus works, he complained, has become totally disconnected from what experts know and agree on.

In fact, economists agree on many things, a number of which are politically controversial. The Harvard economist Greg Mankiw listed some of them in 2009. The following propositions garnered support from at least 90% of economists: import tariffs and quotas reduce general economic welfare; rent controls reduce the supply of housing; floating exchange rates provide an effective international monetary system; the US should not restrict employers from outsourcing work to foreign countries; and fiscal policy stimulates the economy when there is less than full employment.

This consensus about so many important issues contrasts rather starkly with the general perception that economists rarely agree on anything. “If all the economists were laid end to end,” George Bernard Shaw famously quipped, “they would not reach a conclusion.” Frustrated by the conflicting and hedged advice that he was receiving from his advisers, President Dwight Eisenhower is said to have asked once for a “one-handed economist.”

No doubt, there are many public-policy questions that economists debate vigorously. What should the top income-tax rate be? Should the minimum wage be raised? Should the fiscal deficit be reduced by raising taxes or cutting spending? Do patents stimulate or impede innovation? On these and many other issues, economists tend to be good at seeing both sides of the issue, and I suspect that a survey on such questions would reveal little consensus.

A consensus among economists can arise for both good and bad reasons. Sometimes a consensus is innocuous enough, as when you hear economists argue that one ignores the role of incentives at one’s peril. Can anyone really disagree with that? Sometimes it is restricted to a particular episode and is based on evidence accumulated after the fact: Yes, the Soviet economic system was hugely inefficient; yes, the Obama fiscal stimulus of 2009 did reduce unemployment.

But when a consensus forms around the universal applicability of a specific model, the critical assumptions of which are likely to be violated in many settings, we have a problem.

Consider some of the areas of widespread agreement that I listed above. The proposition that trade restrictions reduce economic welfare is certainly not generally valid, and it is violated when certain conditions – such as externalities or increasing returns to scale – are present. Moreover, it requires that economists make value judgments on distributional effects, which are better left to the electorate itself.

Likewise, the proposition that rent controls reduce the supply of housing is violated under conditions of imperfect competition. And the proposition that floating exchange rates are an effective system relies on assumptions about the workings of the monetary and financial system that have proved problematic; I suspect a poll today would find significantly less support for it.

Perhaps economists tend to agree that certain assumptions are more prevalent in the real world. Or they think that one set of models works better “on average” than another. Even so, as scientists, should they not adorn their endorsements with the appropriate caveats? Shouldn’t they worry that categorical statements such as those above may prove to be misleading in at least some settings?

The problem is that economists often confuse a model for the model. When that happens, a consensus is certainly not something to cheer about.

Two kinds of mischief may then follow. First, there are errors of omission – cases in which blind spots in the consensus prevent economists from being able to see troubles looming ahead. A recent example is the failure of economists to grasp the dangerous confluence of circumstances that produced the global financial crisis. The oversight was not due to the lack of models of bubbles, asymmetric information, distorted incentives, or bank runs. It was due to the fact that such models were neglected in favor of models that stressed efficient markets.

Then there are the errors of commission – cases in which economists’ fixation on one particular model of the world makes them complicit in the administration of policies whose failure could have been predicted ahead of time. Economists’ advocacy of neoliberal “Washington Consensus” policies and of financial globalization falls into this category. What happened in both cases is that economists overlooked serious second-best complications, such as learning externalities and weak institutions, which blunted the reforms and, in some cases, caused them to backfire.

Disagreements among economists are healthy. They reflect the fact that their discipline comprises a diverse collection of models, and that matching reality to model is an imperfect science with a lot of room for error. It is better for the public to be exposed to this uncertainty than for it to be lulled into a false sense of security based on the appearance of certain knowledge.

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    1. CommentedRoy Rotheim

      Nice piece. One historical correction: it was President Harry Truman who made the famous quote about wishing for a one-handed economist, in response to the equivocal recommendations always coming from his then chair of the council of economic advisors Leon Keyserling.

    2. CommentedEnrique Woll Battistini

      Some very unscientific proposals of mine that might be relevant and interesting in these complex socioeconomic times:

    3. CommentedRoger McKinney

      "...matching reality to model is an imperfect science with a lot of room for error."

      Except that mainstream econ doesn't even try to do that. It assumes equilibrium, perfect competition, instantaneous price adjustments, homogeneous capital and other unrealistic assumptions. That's why they can't forecast the humidity in a rain storm.

    4. CommentedPer Kurowski

      Not so! Because if you are in favor of models that stress efficient markets you could never agree with the concept behind those risk-weighted capital requirements for banks which allowed banks to earn much higher risk adjusted returns on “absolutely safe” assets than on “risky assets”. That has, and is, producing distortions that are making it impossible for banks to allocate efficiently bank credit to the real economy.

        CommentedJose araujo


        Either markets are not efficicent and regulators should step in to move markets twards efficiency or banks are getting higher returns because they are taking more risk and regulators should step in to lower the risk...

        In conclusion, whenever banks or other finantial institutions start making higher returns, regulators should step in to lower those returns.

    5. CommentedTom Shillock

      Are the practicioners of any other academic discipline so obsessed with being perceived as scientific? As Chomsky once observed there are no economic laws. Manipulating the trappings of a science such as mathematical modeling has not raised economics to the level of a science. Which is not to say that hard thinking about economic matters has no social value or cannot have social value. Yet the thinking of most economists does not seem to help society. Indeed, the economic thinking of Hayek, Friedman and the Chicago Boys created policies that led to financial crises and economic instability and made most Americans worse off. That thinking is still informing policy decisions which is why there is a heinous divergence in wealth and income increases daily.

        CommentedJose araujo

        Where does it state that in order to be considerer a science you have to use mathmatical models?

        That is nonsense, Economy is a science, but most of the economists we read about are not scientists nor are they producing science, they are just academics datamining to prove theire own convictions.

        Economy is a social science, that's whe people like Dani Rodrik should be repudiated, because they use the label but seldon do any science

    6. CommentedNathan Weatherdon

      Thank you. I think both the left and the right could benefit enormously from an understanding that there is often great legitimacy to both sides of the argument once economics is brought to bear on a question.

      Most importantly, I think that both sides will cherry pick, and therefore fail to acknowledge that one argument is more relevant in some set of (difficult to define) circumstances and that the other side of the argument can be more relevant in another set of circumstances, and to complicate things even more, that both sides of the argument can be simultaneously relevant all at the same time!
      I think some of the areas of consensus are relics of first and second year theoretical indoctrination, whereas most economists are pre-occupied with more specialized areas of analysis.

      Rent controls and minimum wages are key examples here. My counteragument is simple: the real world does not operate on the straight lines used in first year textbooks. This allows theoretical plausibility that first year textbooks do not reflect the real world. That explains difficulty finding empirical proof. Once you move beyond linear models, you can easily define conditions under which minimum wages can lead to increased employment, for example.

      But economists continue to work on other issues, and use straight lines to guide their logic on the impacts of rent controls, minimum wages and other areas of public policy where they have not been able to take the time to become more intimately familiar with the nature of the problematics, underlying data, and suitable modelling approaches.

    7. CommentedAndrew Zimin

      Economysticisms are so-o-o economysticisms.

      "Disagreements among economists are healthy." Say it to the surgeons in the operating room.

      "...a diverse collection of models..." Is not it better if the gentlemen scientists collect matchboxes?

    8. CommentedJose araujo

      American Recovery and Reinvestment Act of 2009 wasn't a Keynesian policy, 600 billion to cover a 2.9 trillion hole was far too weak to produce any results, very bad example to start with and significant of the point where Rodrik is coming

      Also many of the so called economics model have been proven wrong a long time ago. I'm talking anything from the Austrians and the supply siders.

      Invisible had is an Aristotelic concept, outdated and proved wrong many times, unless we can move forward the economic science isn't going anywhere soon.

      We are in a point in our science where prejudices and aprioris rule, and very few are doing science.

      Time to acknowledge that Ricardo and Adam Smith, were valuable for the science but were wrong. The same goes to the Austrians and to all, Neo-Classics, that believe in full employment, AKA Aristotelians

      Keynes to our science is like Newton or Darwin , who opened a window into reality but it is still not the perfect theory, but so far one of the few who provides a reasonable explanation and operating concepts of economy.

      Curious how times have changed, and the economic views that not so long ago were claiming victory are saying that disagreement among economists are healty, well they are not, and they areb't because theire views of the world are plain wrong, and they don't do science, they try to prove theire own prejudices first.

    9. Commentedoscar javier carreon cerda

      This is something I hadn't learnt till recently: if Economics is a science, all disagreements must be welcome and analyzed properly. As an Economics' student, I tend to ignore whatever issue that is off the Lectures. But then I realize, Lectures teach me nothing but theories that are to be tested time and again, improved, contrasted...

    10. CommentedPaul Daley

      Good article. Economists tend to think that there is some sort of symmetry at work that will guarantee their generalizations are true at all times in all places under all circumstances. It might help if they would take the time to identify that symmetry before offering judgments on what must come next or what must be done.