Influence of economists

December 30, 2014

An economist is a person, President Ronald Reagan once famously
observed, who ponders over why something which works in practice does
not work in theory! Notwithstanding this somewhat jaundiced view of the
practical approach of the average economist, the academic economist has
an inordinate about of influence over public policy.
In the corporate sector, the accent being return on investment and
profitability, economic theories are not given much space. On the other
hand, in government, research and policy institutes and universities and
such statist environments, economists are still very influential. Economists
write learned papers, contribute columns to newspapers, advise politicians
and policy makers and offer expensive consulting services.
What is the reason for economists having so much influence, when
compared to the other learned professions such as lawyers, engineers and
doctors, who by the nature of their work are at the cutting edge of practical
implementation in their various fields and naturally would have knowledge
of what will work and what will not work, in practical terms?

Self-belief in superiority
A recent research paper tries to explain the phenomenon. M. Fourcade, E.
Ollion and Y. Aglan, in a paper entitled The Superiority of Economists, start
off by saying that one reason is that economists have come to believe that
they are superior! This attitudinal aberration starts with students, and the
authors say has increased as the study of economics involved more
mathematics.

For example, in 1985, a research study found that only 9% of post graduate
students in economics at Harvard University believed that economics was
the most scientific of the social sciences. But by 2003, 54% of the same
cohort strongly agreed that economics was the most scientific of the social
sciences! This attitude extends to the views of the students expressed
online for example, one graduate student dismissed sociologists as those
who play around with big important ideas, without too much effort or
rigor!
There are other examples of this self-belief in superiority. For example, in
the journal the American Economic Review, articles refer to or cite the top
25 political science journals in academia one-fifth as often as the articles in
the American Political Sconce Review cites the top economics journals.
Economists do not even deign to comment on the research work of the
other professions!
Another research study found that in the USA, professors of economics were
less likely than their colleagues in other disciplines to agree with the view
that interdisciplinary knowledge is better than knowledge obtained by a
single discipline! The economists are so enamoured with their own
discipline!
The authors cite another reason that the other professions are more
reticent and do not express certain and definite outcomes of a process. The

public seeks strong arguments, solutions and clear answers to problems.

Academics generally, in disciplines other than economics, are far too
reticent, the authors say. The authors quote an economic historian who
jokes that for a moderate fee, an economist will tell you with all the
confidence of a witch doctor that interest rates will rise 56 basis points next
month or that dropping agricultural subsidies will increase the Swiss
national income by 14.8%!
The venerable doyen of economist, John Maynard Keynes, spotted the issue
early. He famously said, in his inimitable style: If economists could manage
to get themselves thought of as humble, competent people, on a level with
dentists, that would be splendid!
The Squam Lake Report
Economists, whose biggest failure as a collective was their failure to predict
the last financial crisis, have tried to make up by Kenneth R. French, a
Professor at the Tuck School of Business, summoning 15 economists who
met in 2008 November, at the height of the American financial crisis, at a
resort called Squam Lake in New Hampshire in the US, and thrashed out
ideas for protecting the financial system from such future crises, and have
been working on and improving their solutions since. Their goal: to map out
a long-term plan for financial regulation reform.
The group, among others, included Robert J. Shiller of Yale, who foretold the
US housing crisis, Frederic S. Mishkin, a former Governor of the Federal
Reserve and currently of Columbia University, Raghuram G. Rajan, a former
chief economist at the IMF (currently Governor of the Reserve Bank of
India), Martin Bailey a one-time advisor to President Clinton and Senior
Fellow at the Brookings Institution, Anil K. Kashyap of Chicago University,

Rene M. Stulz of Ohio State University, Jeremy C.

Stein of Harvard, John Y. Campbell also of Harvard, John H. Cochrane of
Chicago, Douglas W. Diamond of Chicago, Darrel Duffie of Stanford, David S.
Scharfstein of Harvard, Hyun Song Shin of Princeton, Mathew J. Slaughter of
Dartmouth and Jeremy C. Stein of Harvard.
Their thoughts have been published as The Squam Lake Report by
Princeton University, which distills the wealth of insights from the ongoing
collaboration that began at the Squam Lake meetings and provides a
revelatory, unified and coherent voice for fixing the worlds troubled and
damaged financial markets. Their target audience is key economic policy

decision makers worldwide.

The economists concerned felt that the 2008 financial crisis was such a
disaster that we felt an obligation to reach some common ground. They
deal with the forces that brought the world to the brink of economic
disaster, a house price bubble boosted by runaway mortgage lending in the
rich world, a lightly-regulated global financial system that found more and
more creative ways to speculate on the rising house prices and a
macroeconomic policy making environment that was far too laidback about
the dangers posed by asset price bubbles. Some say that the US
Government used easy credit as a way of softening the harsh effects of
globalisation on the less skilled and marginalised part of their work force.
The world seemed to be sitting up and taking notice, Ben Bernanke, former
Chairman of the Federal Reserve introduced the book at a conference to
herald its publication at Columbia University. Alan Greenspan, Bernankes
predecessor, has described the book as an excellent primer on the
workings and failures of todays sophisticated financial system, few can fail
to be impressed with the scholarship the Report brings to the subject of
reform.
This may be just because the 15 economists at Squam Lake managed to
agree on something, for as the revered play write George Bernard Shaw
very wisely said, Even if all economists were laid end to end, they would
not reach a conclusion!
The Dismal Science
The Victorian writer Thomas Carlyle labelled economics as the Dismal
Science, probably because of its gloomy predictions. It is believed by most
economists that the beginning of economics was with Adam Smith
publishing his Inquiry into the Nature and Causes of the Wealth of Nations
in 1776. Alfred Marshall, the great 19th century economist, in his textbook
Principles of Economics, defined economics as study of mankind in the
ordinary business of life.
The word is derived from the Greek for management of a household and is
the study of how human beings coordinate their wants by the efficient
production and distribution of goods and services. The four central issues
addressed by economics are: What to produce, the quantity to be produced,
the process of production and what the demand from the market is.

There are three well-accepted reasons for studying economics: The first is
that it will help you to understand the world in which you live; the second is
that it should help you to be a more astute participant in the economy; and
the third is that it will give you a better understanding of both the potential
and the limits of economic policy. The Oxford Advanced Learners Dictionary
defines economics in a way which brings out these aspects: The study of
how a society organises its money, trade and industry.
Charles Dickens in an essay in the first issue of his popular magazine
Household Words issued a challenge to economists to humanise their
discipline. Political economy is a mere skeleton unless it has a little human
covering and filling out. A little human bloom upon it and a little human
warmth in it.
Diverse views
From time to time diverse views have been expressed on the worlds
leading proponents of economic theory. John Maynard Keynes was
considered an exotic mix of being a Bloomsbury intellectual and civil
servant mandarin. Keynes insisted that economic crises could be prevented
if the government could act as the spender of the last resort just as the
central bank was the lender of the last resort.
Joseph Schumpeter was considered to be an obsessive scholar who spent
his spare moments riding thoroughbreds. Schumpeter declared that the
economy not only grows bigger and bigger, it goes through a process of
constant discombobulating as entrepreneurs invent new products and
processes. Irving Fisher of Yale was a health fanatic and a prohibitionist who
argued that good management of the money supply could contribute to
stability. Joan Robinson, who famously declared that Sri Lankans want to
enjoy the fruit before they plant the tree, wore Mao suits and declared that
North Korea would outperform the South. Schumpeter called her one of our
best men!
Karl Marx was considered to be so convinced that he was right and so
buried in his books in the British library that he failed to observe the world
around him. He did not bother to visit a single factory and ignored the
overwhelming statistical evidence that the working classs share of the
national wealth was increasing. Marx viewed the

capitalist system as one which wouldpauperise the poor and lead to

overproduction. He did not realise that capitalisms recurrent crisis would
actually reinforce and strengthen the system.
On the other hand, Alfred Marshall was thought to embody what was best in
Victorian high-mindedness. He was totally alive to what was going on
around him. He visited factories and firms and travelled around America.
Marshall supported popular education and incremental reform. Marshall
demonstrated that capitalism helps the poor by boosting productivity.
Amartya Sen is considered a genius who devotes his life to thinking about
eliminating the most dramatic manifestation of want: Famine.

Wonder of a market economy

The most humongous economic policy mistake of the past has been to
expect too much from government. Mainstream economists who supported
Statism could always be found. These sentiments reflect a failure to
appreciate the wonder of a market economy Adam Smiths invisible hand
how workers, firms and households, acting without visible coordination
and guided by self-interest, manage to produce amazing developmental
results, pulling millions out of poverty and marginalisation, as in
contemporary India and China.
Norman Macrae, who was for 23 years Deputy Editor of the Economist
newspaper, always made the point that markets had made a remarkable
equalisation in peoples lives. Rich and poor had access to the same
consumer goods the same television programs, the same household

goods and access to the same Wal-Mart mega markets, Keells Supers or
Arpico Super Centres or Cargills Food City outlets.
Markets may fail, and readjust and reinvent, governments also fail, advised
by expert dismal economists, with much more drastic negative results and
are incapable of adjusting, and they have to be dismissed from office at
elections or by violent or silent revolution.

Markets today are subject to standards of openness and disclosure to

ensure competition; there are also prohibitions against unfair labour
practices and environmental damage. Governments should ensure this, but
an objective assessor would describe only a minute part of what
governments attempt to do as even an endeavour to improve overall
welfare.
Judging from the fact that the largest interventions by governments are
collecting taxes and spending, it is obvious that governments are principally
interested in self-serving redistribution; reducing one groups welfare so as
to improve anothers, often mis-targeted and misdirected and misallocated!
Andrei Shleifer of Harvard University and Robert Vishny of the University of
Chicago, state in their book The Grabbing Hand: Government Pathologies
and their Cures, the assumptions behind most economists thinking on the
role of the state is plain wrong. As we Sri Lankans well know, political
parties in government are most often principally interested in winning
power, exercising power, abusing power and hanging on to power!
The words of the Lord Protector of England, Oliver Cromwell, to the
Parliament of his day in 1653 reverberate in our ears: You have sat too
long for any good you have been doing lately Depart, I say; and let us
have done with you! So much for the helping hand model of government!
The invisible hand is much more efficient.

Frederic Bastiats theories

One of the most brilliant economists, who used satire to communicate his
theories, was Frenchman Frederic Bastiat. Bastiat, who was born two
centuries ago, is best known for an essay in which he petitions the
authorities on behalf of the candle-makers of France; he complains against

the ruinous competition of a foreign rival who works under conditions so far
superior to our own for production of light that he is flooding the domestic
market with it at an incredibly low price. The rival is the sun!
Bastiats proposed remedy is the shuttering of all windows. That, he claims,
using all the standard protectionist arguments, will benefit not only candle
industry but also all the industries that supply it with inputs. As a
compelling statement of the case for free trade, this essay is hard to beat. It
should be compelled reading for all proponents and opponents of the IndoLanka CEPA and the Sri Lanka-China FTA!

Noting the popular view that exports are good and imports bad, Bastiat
wondered whether the best outcome would be for ships carrying goods
between countries to sink, thus creating exports without imports! To solve
the problem of lack of jobs, Bastiat suggested that to parcel out the limited
amount of work available, people should be required to do whatever work
there is using only one hand or even have a hand chopped off.
France did something like this in the recent past, imposing a maximum
working week of 35 hours per person to share out whatever work available.
Bastiat described the state as the great fictitious entity by which everyone
seeks to live at the expense of everyone else! He was critical of the welfare
state, which he said, by protecting the rights of the producers rather than
the consumers, often came to commit legal plunder. Bastiat argued that
the main role of the state should be to protect liberty and property.

Squam Lake recommendations

What of the Squam Lake recommendations? They recommend among other
things that government, rather than setting pay levels for senior managers
of banks and financial institutions, should be required to withhold a share of
each senior managers pay for several years, this money would be forfeited
if the company went bankrupt.
Holding back a fraction of each years bonus would make bank executives
act more like taxpayers and less like shareholders. Taxpayers do not benefit
when the entity makes profits but bears the cost when it has to be bailed
out, while shareholders often favour short-term risks in the hope of scoring

a quick profit.
Another recommendation is for a debt instrument known as contingent
convertible bonds; banks would be encouraged to issue such debt, which
would automatically convert into equity in a crisis, which would speed up
the recapitalisation of an ailing bank at no cost to the taxpayer, the
bondholders would have to bear the cost of the failure. They also
recommended that each country should have a single regulatory
organisation to oversee the health and stability of the financial sector.
The group also called for better disclosure of the risks of financial products,
particularly the mutual funds used in retirement accounts and an entity to
protect consumers from abusive financial products.
Will the Squam Lake proposals make a difference? President Obama has
also signed into law new legislation, saying: Never again will the taxpayer
have to bail out reckless financial institutions. Pious hope or famous last
words!?
But the publication of An Economic Program for American Democracy in
1938 after the Great Depression could not forestall the economic crisis of
2008. The factual coincidence that the then Chairman of the Federal
Reserve Ben Bernanke studied the Great Depression for his doctoral thesis
and the Timothy Gaitner, the then US Treasury Secretary, was earlier an
undersecretary who was directly involved in handling the build up to the
crisis, were probably of more help in alleviating the negative effects of the
economic crisis.
Books are always there, in all the sciences, especially in economics, the
dismal one, but it is experience that finally counts. The Squam Lake
proposals may not forestall the next economic crisis; as Will Rogers said:
An economists guess is liable to be just as good as anybody elses!
(The writer is a lawyer, who has over 30 years of experience as a CEO in
both State and private sectors. He retired from the office of Secretary,
Ministry of Finance and currently is the Managing Director of the Sri Lanka
Business Development Centre.)
Posted by Thavam