Suppose our fire department was staffed with deformed incompetents who did not know how to handle a fire hose. That would be really bad news, but it wouldn’t be obvious most of the time as we don’t often see big fires. The inadequacy of the fire department would only become apparent when a major fire occurred, and we were left with a large amount of unnecessary death and destruction. It is essentially the story of modern economics.
The problem is not that the modern economy does not have the tools to understand the economy. Just like with firefighting, the basics have long been well known. The problem stems from the behavior and incentive structure of the practitioners. There is overwhelming pressure to produce work that supports the status quo (eg, redistribution to the rich), that does not challenge authority, and it is needlessly complex.
The result is a discipline in which much of the work is of little use except to legitimize the existing power structure. When it comes to the poor quality of work, it is easy to point out the failure to recognize the scale and risks posed by the housing bubble over the past decade. This failure has been incredibly costly for the United States and the rest of the world.
If we compare the most recent estimates of the potential GDP of the US economy from the Congressional Budget Office (CBO) with projections made in 2008, before the seriousness of the crash was recognized, the difference is $ 1.8 billion. of dollars. It is an annual figure; this implies a loss of $ 18 billion over the decade. This amount averages over $ 54,000 for every inhabitant of the country. Other countries suffered even greater losses.
CBO is not God, so he could have been too optimistic before the crash and is arguably too pessimistic now. But even if we halve the number, we’re still looking at a loss of $ 9 billion over a decade, or $ 27,000 per person. It should also be noted that the CBO numbers are useful here not only because they are considered authoritative, but they are central to the profession by design. CBO increases or decreases its numbers if they do not match the consensus of economic forecasters.
Retrospective analyzes of the global crash have focused on the financial crisis in particular. These analyzes worked hard to convince people that seeing an impending financial crisis is an extremely difficult business, but the reality is that the financial crisis was very secondary. The main reason for the slowdown and weakness of the recovery was the collapse of real estate bubbles in the United States and elsewhere, which were boosting growth.
It was not difficult to recognize these bubbles. House prices had risen at an unprecedented rate between the mid-1990s and the crash, with no remote plausible basis in housing market fundamentals. This could be seen by a variety of measures, but most evident from the fact that rents always followed the headline inflation rate, as they usually do. The record vacancy rate – even before the crash – could also have been a red flag, especially for people who believe that supply and demand determine prices.
Moreover, the fact that housing was the engine of the economy was evident from the record share of residential construction in GDP, as well as an unprecedented consumer boom fueled by real estate wealth. Of course, these sources of demand would disappear with the bursting of the bubble; what can be expected to replace six percentage points of GDP in annual demand (about $ 1.1 billion in the current economy)?
When I tried to raise these questions a few years before the crash, my arguments were widely criticized by a wide range of economists. I did not have the stature, and besides the argument was far too simple. This is not the first time that I have found it difficult to present too simple arguments.
During the debate over President George W. Bush’s social security privatization plan, I pointed out that his administration’s assumed rates of return on the stock market were impossible given price-to-earnings ratios (P / E) current on the market. and the rates of economic growth assumed by social security administrators. It was an argument based on a simple algebra.
Brad DeLong wanted to make it a Brookings article and enlisted Paul Krugman in the effort. Together, they produced an article (generously leaving me as the lead author) that had an intertemporal optimization model with declining workforce growth as its main feature. (You don’t need to know what an intertemporal optimization model is; just that it adds complexity.)
This pattern had nothing to do with the underlying point (the stock market would produce the assumed returns if its price / earnings ratio was close to its historical average of 15, rather than the near P / E level of 25 that we were seeing. at the time), but you had to have something more complex than a simple algebra to be taken seriously at Brookings.
It is easy to expand the list of failures in the economic profession. There is only growing recognition that our business structure imposes substantial costs on large segments of the workforce. It did not require new or innovative innovations. This is a prediction from the quite mainstream Stolper-Samuelson theorem, first published three quarters of a century ago.
And why is there so little research devoted to analyzing alternatives to patent funding of prescription drug research? The mark-ups associated with patent protection in the sector are equivalent to tariffs of several thousand percent. Any competent economist knows that such a large gap between a government protected price and a free market price is a recipe for massive waste and corruption. The gap between the prices of patent-protected drugs and open market prices is now approaching $ 400 billion a year in the United States alone (over 2% of GDP). It does not require new economic thinking; you need economists who know introductory economics.
And how about a little responsibility for economists when they get it wrong? There is an abundant literature on the importance of being able to fire workers who do not do their job well. We all know and expect that a dishwasher that keeps breaking dishes or a janitor who can’t clean the toilet loses their job.
I have suggested that economists who prescribe policies that go wrong, or who can’t see multibillion-dollar real estate bubbles coming and collapsing the economy, should pay a career price. Invariably people think I’m kidding. When they realize I’m serious, they think I’m crazy or vindictive.
Leaving the motives aside, let me just talk about the economics. If we have a profession in which people are rewarded with high pay and career advancement for saying the same thing as everyone else, and never face consequences when accepted wisdom turns out to be wrong, then we should expect to see economists like the firefighters mentioned. at the start of this piece. They are not qualified to do the job and our only hope is that we don’t see any more major fires.
This piece was first published on Democracyjournal.org