In defense of economics

Taking it to the streets.
Taking it to the streets.
Image: Reuters/Jim Young
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For once in its famously fractious history, the field of economics has united everyone around a single issue: anger at economists. The profession has faced a lot of criticism lately: some of it is fair, some of it is based on misunderstandings, and some of it is outright conspiracy theories.

Economics has a great deal of influence compared with other academic disciplines. It helps inform policies that have a big impact on peoples’ lives, so economists rightly attract more scrutiny. But lately there is more criticism and skepticism of experts, and it appears to be having an effect when it comes to economic policymaking. The most salient and indisputable lessons from economics are being ignored, as mainstream politicians endorse trade and currency wars, and national rent controls.

The two main criticisms of economics are:

  1. Economists are slaves to groupthink that fetishizes free markets without recognizing their downsides. This caused the financial crisis.
  2. Economists don’t know anything, they can’t agree on much, and they fail to spot the big, important economic trends. They ignore inequality, oversell the benefits of global trade, and did not foresee the financial crisis.

There is a grain of truth to each of these arguments, but mostly they misunderstand what economics offers and how it applies its tools.

Economics never promised good predictions

Bill Gates recently said that macroeconomists (the target of most criticism) “don’t actually understand” their field. This is a fair point: they don’t. But that is not necessarily a critique of macroeconomics, which is the study of the whole economy.

Macroeconomists try to make sense of how different factors in the economy impact each other, like how interest rates or tax cuts influence GDP and employment. To try and make sense of a complex, interconnected world, economists build mathematical models that describe these relationships. They test the models’ accuracy using data from the past. Because the economy has so many moving parts, economists must make choices about what to include and what to leave out from their models.

Economic models are like a road map. If you had a map that showed absolutely everything in an area—every tree, cracks in the sidewalks, and so on—it would be highly accurate, but also unreadable. There are tradeoffs between usability and complexity. Because this comes down to judgement, economists often disagree about the best approach. To make matters even worse, the economy is always changing, so new factors need to be included and old ones discarded.

At best, economic models can explain the past; they are not great at predicting the future. That doesn’t mean they are useless. In the same way a map tells you where different landmarks and roads are relative to each other, an economic model provides guidance about how different factors relate to each other and helps users gauge the trade-offs of certain policies.

For example, economists long assumed that lower interest rates encourage people to spend more because they lower the returns from saving. Alternatively, lower rates could make people feel poorer (because their savings earn less), so they cut back on spending. Which of these behaviors dominate often depends on a host of assumptions and the current state of the economy. If interest rates have been low and are expected to stay low, people may feel poorer after a rate cut. If rates are normally high and a rate cut is assumed to be temporary, they may be more inclined to spend.

Economic models don’t offer answers, but they make it easier to understand the impact of policies using rigorous, logically consistent arguments others that can understand. Of course, macro models can always be improved. One big shortcoming is that they traditionally didn’t feature a meaningful role for risk and the financial sector, let alone the systemic risk that featured in the financial crisis. Some macro and financial economists are now working on this. It was, admittedly, a huge oversight.

Economics is not a free-market conspiracy

There is so much judgment involved in macroeconomics, it is not surprising that economists often disagree on things. So it’s strange that economists are often accused of groupthink.

Yale Law professor Daniel Moskovitz recently speculated (unchallenged) on the Slate Money podcast that because American universities are funded by “capital and finance” they have bended the economics profession in a “neoliberal direction.” A similar assertion that the economics profession’s faith in markets comes from the corrupting power of money was made in the Oscar-winning documentary Inside Job. 

Anyone who thinks economists are beholden to a market-loving groupthink has never been to an economics seminar. It is true there are few Marxists in mainstream departments, but that is mainly due to overwhelming evidence that communism does not work very well. Mainstream economists debate how much the government should be involved in various aspects of the economy, and there is a wide range of opinions. Only people on the intellectual fringe think the answer is all or nothing.

If anything, economics is one of the few academic fields that contains political diversity. Academic economists in the US have a slight skew towards the Democrats (pdf), but there are also a decent number of Republicans. In these days of extreme polarization, that economists manage to debate policy and get along (most of the time) should be praised.

A more nuanced and thoughtful argument is made by New York Times’ Binyamin Appelbaum’s new book, The Economist’s Hour: False Prophets, Free Markets, and the Fracture of Society. It argues that economists’ overwhelming adherence to free markets and influence on policy contributed to rising inequality, populism, and even falling life expectancy among the poorest Americans 1.

My favorite parts of Appelbaum’s book (which is most of it) include entertaining descriptions of the evolution of economic thought, which features lots of debate and disagreement about the right role for government. If economists thought the answer to everything was let the market work it out, they’d have nothing to do.

Appelbaum argues that economists have been indifferent to inequality, as reflected in their singular focus on growth and skepticism of unions and the minimum wage. This is an unfair characterization. Even Milton Friedman, the supposed high priest of free-market fundamentalism, supported wage subsidies like the earned income tax credit to redistribute income and eliminate poverty.

Economists’ disagreements over policy usually come down to what the right solution is to a problem—not whether a problem exists at all. Economists are traditionally skeptical of very high minimum wages not because they don’t want poor people to be paid more, but because they think it’s better for the costs of wage increases to be born by the entire tax base instead of small business owners. Tax credits can also target people who need high wages more, like low-income families instead of teenagers living at home. Policies involve trade-offs and pose costs, and many economists believe wage subsidies are less costly and more effective than high minimum wages.

Economics helps make sense of our values

The economy faces many challenges. Globalization and technology are bringing huge improvements in our standards of living (pdf), but not without dislocations. The American middle class and those with less education have not seen large wage gains. Many are seeing their jobs disappear. Some men have left the labor force entirely.

Appelbaum concedes economists are not at fault for these trends. But he does blame them for exacerbating inequality. He argues that a preoccupation with low, stable inflation made the dollar more valuable and thus American goods became less competitive. He also argues that faster growth and higher living standards may not be worth if it is not more equally shared.

These are largely value statements, not economic arguments. Low, stable inflation has many economic benefits, especially for retirees. If it is responsible for a stronger dollar, that means cheaper goods and services for all Americans. High inflation, and the uncertainty it creates, poses large costs to the economy. Perhaps a high inflation environment could have slowed the speed of globalization, but would it have been worth the costs to everyone in the economy?

One of the central lessons of economics is that resources are scarce and every policy involves trade-offs. There is conflicting evidence that inequality undermines growth. Regardless, how you reduce inequality matters, with some policies causing more harm than others. The purpose of economic analysis is not to predict the future, but to weigh different solutions to problems and see what has maximal impact for the minimal cost.

Economists assume the surest way to achieve sustainable growth is by adopting new, productivity improving technologies. But as we’ve seen, this can also cause economic pain if it eliminates jobs. Is that worth it? Traditionally, economists assume achieving better living standards is always worth it, but some now disagree (pdf).

It would be arrogant, and harmful, to assume policy can engineer the best of all worlds. Markets and people are unpredictable, and economic models are always incomplete. Attempting to strike the right balance is messy and is exactly what economics aims to achieve. The profession has learned from its mistakes, drawing on humility and an openness to disagreement—that is, the qualities that many critics of economics don’t have.