Sunday, January 11, 2015

Seven Bad Ideas

I was interested in reading Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World by Jeff Madrick after reading Don Boudreaux's comments on it at Cafe Hayek, in which he quotes Madrick as saying:

On the other hand, prosperity hardly guarantees democracy and protection of human rights. Russia became wealthy in the 1930s but was a dictatorship until the 1980s [p. 26].

I wrote my senior thesis on Collectivization at the Jackson School, so I know about as much on this subject as anyone, so I wondered how anyone could honestly make this claim. Upwards of seven million people died from starvation alone, not to mention the millions who died from labor camps and other atrocities. "Wealthy" would be about the last way I would describe it. Is his next book going to praise the "wealth" of 1990's Somalia?

So I picked up a copy of the book from the library to find out. Unfortunately, he doesn't address the issue any further, other than in general to show his bias against free market economics (he spends most of the book railing against the "invisible hand"). Although some portions were interesting, I am actually rather sympathetic to his argument that economics is not as scientifically rigorous as it should be, the book on a whole is full of overly broad statements and strawman arguments. In fact in all honesty the book should be titled "Seven Bad Ideas: How I Misrepresent My Opponents' Arguments and Thereby Defeat Them".

Madrick's central thesis is that modern economics has been taken over by "bad ideas", which are essentially free market economics, mostly those espoused by Milton Friedman, and that Keynesian economics has been banished from mainstream economic thought. This would be news to the faculties of just about every major university, as well as the publisher of every major macroeconomics textbook, since about, oh, 1935. In his view, with the exception of the first 2 years of the Obama administration, the US, as well as Western Europe, has been reduced to some sort of winner take all, no holds barred, unregulated economic free for all out of a Mad Max movie.

How does he support this argument? Well, that is hard to say. The book is largely devoid of analysis (although in his defense 226 pages is hardly enough space to look into a subject this large) and barely mentions any actual economic numbers at all. In the introduction, for example, he argues:

In Clinton's last year in office, the level of federal public investment as a proportion of GDP was lower than in Ronald Reagan's last year in office, especially for physical infrastructure and education spending. It was substantially lower for research and development. The policy was part and parcel of the laissez-faire revolution.

He fails to actually state any numbers though, nor give any idea as to the scope of these supposed cuts. The end notes reference one of his own books, and then point the reader to an OMB Report. After perusing the report for a while, one does find, yes from 1988 to 2000, under the title "Table 9.1 —TOTAL INVESTMENT OUTLAYS FOR MAJOR PUBLIC PHYSICAL CAPITAL, RESEARCH AND DEVELOPMENT, AND EDUCATION AND TRAINING: 1962–2013" one does in fact find that spending decreased from 4.2% to 2.6% of GDP.  This does not tell the whole story though, as almost all of this was in military spending, which decreased from 2.5% to 1.0%, a result of the famous, but short lived "peace dividend". Non-defense spending during that time decreased a barely perceptible 1.7% to 1.6%, and in fact nearly doubled in terms of constant dollars (2006) from $84.5 billion to $157.7.

And neither I nor Don Boudreaux have even left the introduction yet!  In any case, to move along, Madrick then analyzes Adam Smith's "The Invisible Hand" metaphor, and then basically goes on to argue that the theory is invalid if there exists any sort of market imperfection whatsoever, and acts as if he were the first person ever to discover asymmetrical information. He summarizes the chapter with:

 We assume away monopolies, business power, lack of access to information, the likelihood of of financial bubbles, economies of scale.

Except I don't know anybody who actually does that.  Madrick essentially rests his argument on the 2007 financial crisis, which he blames entirely on the unregulated derivatives market (to his credit, he does state that it was Clinton who initially neglected to regulate the market, most liberal writers attribute some unidentified Bush deregulation as having caused this). He manages to make it the entire way through the book though, without mentioning a single time that the government, mostly through Fannie and Freddie, was intentionally encouraging banks to issue sub-prime loans to people who could not afford them. The only time they are mentioned at all, it is entirely the result of those "unregulated" banks. In his world, there is no such thing as a bad government decision in the world of economics.

Skipping on to another chapter, Madrick than argues that economists don't believe in speculative bubbles. He points out the various degrees of the Efficient Markets Theory, and then in a bizarre handwave dismisses the fact that there has been decades of debate on the subject, which he himself discusses, and falsely asserts that economists have en mass adopted the strictest interpretation of this. As evidence he cites Eugene Fama telling the New York Times (actually the New Yorker) "I don't even know what a speculative bubble means".

If you look up the actual interview though, Fama is much more nuanced.

I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals. 
That’s what I would think it is, but that means that somebody must have made a lot of money betting on that, if you could identify it. It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.

Much of the book is basically an attack on Milton Friedman, in fact he has two chapters named after him. "Governments Limited Social Role: Friedman's Folly" and "Globalization: Friedman's Folly Writ Large". This subject is way too in-depth for me to get into right now, but suffice to say he distorts and trivializes Friedman's argument (although not as badly as Naomi Klein thankfully). Friedman is described as standing for smaller government, bordering on anarchy, not as part of a philosophy to maximize human freedom and prosperity, but because he is simply an ideologue who doesn't care about other people. Ironically in the last chapter, Madrick mentions "Though reforming education would be expensive, it is more politically acceptable than many other social reforms, such as outright cash grants to the poor, especially those with children."[p209] He neglects to mention, however, who was one of the biggest proponents of this form of welfare, the aforementioned Milton Friedman.

The book ends with a chapter which in other contexts, I might like. "Economics is Science". Madrick argues that economics should not be treated as a science, like math or physics:

Likely nothing has pleased some economists more than giving the impression that they rely almost solely on mathematics to explain economic relationships. Math is the language of universality, of enduring ideas that are appropriate in all contexts. Physics after all is essentially math, so why not economics? [p198]

I would buy this argument, except the economists that he praises, namely Keynes, are the biggest proponents of this school! I have an MBA, and I could barely get through The General Theory of Employment, Interest and Money. It is virtually all quantitative. He had to have known this, because he cites Paul Samuelson, a Keynesian, as an example of this overly scientific school. The economists he attacks on the other hand, namely Adam Smith and Milton Friedman, often read like philosophy. In fact Smith was a philosopher, the science of economics had not been invented yet. Madrick somehow manages to spend the entire book insisting that the entire economy be micromanaged by government policy makers, and then summarizes that these economists must base their decisions on something he insists is a pseudoscience. Even more amazingly, he manages to write this entire chapter without mentioning Frederich Hayek, the Nobel Laureate and free market economist who gave his Nobel lecture on this very subject!

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences - an attempt which in our field may lead to outright error. It is an approach which has come to be described as the "scientistic" attitude - an attitude which, as I defined it some thirty years ago, "is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed."1 I want today to begin by explaining how some of the gravest errors of recent economic policy are a direct consequence of this scientistic error.

In fact, he fails to mention Hayek a single time in the entire book, an oversight, which could not be accidental. Maybe our eighth bad idea should be intellectual dishonesty?

No comments: