Economics As Religion

My latest Bloomberg column came out last night. It was stimulated in part by this recent paper by economists Daron Acemoglu and James Robinson, which I learned about from this short discussion by James Kwak. The paper is an excellent corrective to overconfidence in making simple-minded policy pronouncements based on incomplete theories. (The discussion brings to my mind Naseem Taleb's amusing and I think largely legitimate comment that society at large would be better off if most economics classes were immediately cancelled and replaced with something more benign, such as classes in gardening!).

The argument of Acemoglu and Robinson is fairly simple, but I think far reaching. They point out that economists in practice spend a lot of time thinking about market failures and how to prevent them, and derive much of their policy advice from this recipe. Of course, such analyses inevitably tap into the analytical machinery for welfare analysis (which, I admit, I find hard to take very seriously, but that's another story) and consider how some policy intervention, by removing obstacles to possible exchanges in the market, can improve welfare and economic efficiency. The trouble, they point out, is that the conceptual framework used in such analyses often simply dismisses as irrelevant other non-economic impacts of such policies, even though these may have huge societal ramifications. Here's how they describe one example:

Faced with a trade union exercising monopoly power and raising the wages of its members, many economists would advocate removing or limiting the union’s ability to exercise this monopoly power, and this is certainly the right policy in some circumstances. But unions do not just influence the way the labor market functions; they also have important implications for the political system. Historically, unions have played a key role in the creation of democracy in many parts of the world, particularly in western Europe; they have founded, funded, and supported political parties, such as the Labour Party in Britain or the Social Democratic parties of Scandinavia, which have had large effects on public policy and on the extent of taxation and income red istribution, often balancing the political power of established business interests and political elites. Because the higher wages that unions generate for their members are one of the main reasons why people join unions, reducing their market power is likely to foster de-unionization. But this may, by further strengthening groups and interests that were already dominant in society, also change the political equilibrium in a direction involving greater effifi ciency losses. This case illustrates a more general conclusion, which is the heart of our argument: even when it is possible, removing a market failure need not improve the allocation of resources because of its effect on future political equilibria. To understand whether it is likely to do so, one must look at the political consequences of a policy—it is not sufficient to just focus on the economic costs and benefits.

The paper goes on to analyze this problem in much greater generality, looking at the push to privatization in Russia, and the drive to deregulate financial markets over the past three decades in Western nations, and how both led to huge shifts in the wealth and political power of different social groups. In both cases, much of the intellectual groundwork for making these changes came from analyses that were ridiculously oversimplified and carried out with considerable disregard for the larger complexity of society. No doubt there were economists out there arguing against this kind of thing (Joseph Stiglitz comes to mind), but their voices certainly weren't loud enough nor were their arguments amplified well enough by others. [Note: To be clear, I am not at all against studying oversimplified models. But those who do should always make it clear that we know very little about what such models teach us about a real world that is vastly more complex.]

I've also referred implicitly or explicitly to a couple of other things in my column, which you might like to read for greater understanding or just for the sheer (and strange) pleasure of being pissed off and utterly baffled at the strange and arrogant things some people can believe. In the latter category, I strongly suggest this paper from a decade ago by U. of Chicago economist Edward Lazear entitled Economic Imperialism. He's fully in favor of it and sees the day not too far away when all the social sciences will have been set right by jettisoning older nonsense and adopting a consistent economic focus on the maximizing behavior of rational individuals which leads them to a social equilibrium. For Lazear, this seems to represent the path to wisdom every bit as much as the Bible does to a fundamentalist Christian. Lazear is (or was, at least), in particular, fond of everything done by his Chicago colleague Gary Becker. (On a related point, see Lars Syll, who quotes Daniel Kahneman remembering Becker's way of thinking: "I once heard Gary Becker [argue] that we should consider the possibility of explaining the so-called obesity epidemic by people’s belief that a cure for diabetes will soon become available.")

But on the more productive side, I really do highly recommend economist Robert Nelson's Economics As Religion as one of the most insightful books on economics I have read. His main point is to explore how economic analyses typically rest on hidden value judgements, even though they are presented as the product of a supposedly "value neutral" way of thinking. I think this is still true today as it was in 2001 when the book was published. When economists start talking about policies that will be "socially optimal", you should open your eyes wide and ask: on what conceivable grounds can you make such a pronouncement? You will inevitably find that what follows is a flurry of algebra the main purpose of which is to give a "sciency feel" to the argument and to obscure some hidden value judgements on which the entire conclusion depends (see the issues over the discounting of future costs, for example). Those judgements often enter in cost-benefit calculations where the economist decides which kinds of costs to include and which to ignore.

But maybe I'm too cynical. I would guess that most economics graduate students have probably read Nelson's book and know better today, but I don't know. I hope so.