Friday, February 17, 2012

Another Variation on the Dangers of Arguendo Reasoning, or: Why Are So Many Economists Crazy?

-- Posted by Neil H. Buchanan

Since the beginning of the financial crisis, and continuing into the Great Recession and its never-ending aftermath, Paul Krugman has been beside himself about the dishonesty and outright hackery of many of his colleagues in the economics profession. In my Verdict column today, I offer explanations both for the phenomenon that Krugman describes, and for Krugman's inability to process the idea that his colleagues are so blatantly intellectually dishonest. My bottom line boils down to this: Of course many economists are being clueless or worse, because they are selected and trained for a completely different set of skills, and there are no incentives to force them to be non-ridiculous.

Using cost-benefit analysis to explain why economists as a group are so useless does, of course, carry some irony. More importantly, however, the better economists really cannot see how their colleagues turned out the way they did, because (I think) they imagine that their training is what makes them useful as economists. The reality is that Krugman's ability to analyze the economy so well requires a skill set that goes far beyond what he learned in grad school. Moreover, that skill set makes it possible for Krugman (and some others) to overcome or avoid the traps that modern economics training sets for the unwary and the credulous.

Take my favorite example, so-called Ricardian Equivalence. When I was starting graduate school in the early 1980's, this theory was all the rage. It was the macroeconomic implication of the hyper-rational-actor theories that had been bubbling up for several years, claiming that people could and would engage in self-interested decisions that would perfectly neutralize changes in government spending and tax policies. If the government did something that implied that taxes would go up in the future, then people would save now to be able to pay those taxes in the future, which would reduce spending today by exactly as much as the policy was intended to increase spending.

To make the argument less arcane, here is what a person would be thinking: "I heard that the government is going to spend $400 billion this year to pump up the economy. Sometime, I don't know when, I or my heirs will have to pay my share of that $400 billion, plus interest. Therefore, I'll put my share of that $400 billion in the bank now, earning interest, to withdraw when needed (or to bequeath to my children, if it is not needed during my lifetime)."

Every non-economist who has ever heard that idea has said, in essence: "What a load of crap!" Many economists did, too. The economists, however, were intrigued by all of the ways in which the theory was ridiculous. How would a person know her share of the total? How do variations in borrowing costs among people (and relative to the government's borrowing costs) change the analysis? What if a person has no children? And on and on, with many dissertations and peer-reviewed publications dedicated to the topic.

Notably, there is no as-if story here, nothing that would allow economists to think that this reasoning is somehow being carried out at a subconscious level in people's minds. If people are not thinking as the theory claims they do, then the theory does not work. So what do people like Krugman do? They think creatively about the idea, see if there are any good insights to be learned from all of the ways in which the idea is absurd, and then move on. The very act of doing so, however, empowers those who wish to push the profession's research agenda in the direction of more such ridiculous theorizing.

I recall having a conversation with a fellow graduate student at the time, who insisted that people really do act in this hyper-rational way. When I suggested that he might want to get out more, he told me that economists do not need to look at the world, because our theories already take human self-interest into account. (Actually, he delivered that message much less politely, but that was the content of his insult.) He is now, by the way, on the faculty of a top-20-ranked economics department.

By the late 1980's, another hyper-rational-actor theory had become de rigueur among top-flight economists: Real Business Cycle Theory (RBC). RBC essentially said (and I admit that I am simplifying here, but not in a way that changes the bottom line) that the economy's booms and busts are all responses to underlying changes in preferences and technology. If the economy weakens, with higher measured unemployment, it is not that there is excess supply of labor (because markets are always in equilibrium, with no excess demand or excess supply). It is that people must have chosen not to work, for some rational reason.

Again, good economists ridiculed this idea, pointing out that one implication of RBC is that the Great Depression was a group decision by millions of people worldwide to take a decade-long vacation. Again, however, the professional agenda moved forward, with top jobs going to people who could put bells and whistles onto RBC models. I once spoke with a guy at a top-1o department about a paper that he had written using an RBC approach. I did not know him well, but I had reason to think that he was not insane. I thus asked if his paper was designed to expose the ridiculousness of RBC models, by showing some absurd implications of the theory. He looked aghast, and said that I had it completely wrong. He believed that the theory was both sensible and descriptive of the real world. Needless to say, the conversation ended soon thereafter.

Excellent economists like Krugman, therefore, see a world in which their colleagues frequently write and think about crazy theories. What they respect, however, is the technical virtuosity of those who spin those theories. Even the best economists have shown, by revealed preference, that they would rather deal with someone who can play with the latest models, using the most advanced technical methods (both mathematical theoretical modeling, and econometrics), than to change the profession to one in which one pays a price for living on a different planet.

Now, of course, the better economists are flummoxed by the tendency among their colleagues to ignore or ridicule the lessons of Keynes and his followers, in the face of a crisis that so obviously confirms the importance of those lessons. Yet the elevation of theorizing based on the kinds of things that fed Ricardian Equivalence and RBC models brought into the profession people who either do not think that those theories are crazy, or who are willing to suspend disbelief as a matter of career advancement. Once disbelief is suspended, far too many never emerge from the rabbit hole.

Finally, it is worth remembering that we are not just talking about theories that are crazy. These theories, and the methodological individualism that underlies them, are hard-wired to produce anti-Keynesian, politically conservative results. When Krugman is stumped by his colleagues' willingness to support Republican politicians, he shows that his own ability to look for the interesting aspects of cutting-edge theories has dulled his ability to see how those theories reinforce an agenda that is both immoral and destructive. It is to our benefit that the good guys can play the insiders' game in economics well enough to be taken seriously, yet still maintain their grip on reality. But the evidence shows that, for most people, it is exceedingly difficult to play with fire and not become consumed by the flames.

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