Why we need better economics

In Washington DC, a fellow bus traveller asked about my job. I said I was an economist. “Oh” he said in disgust “you economists don’t know nothing.”

This was a cruel, yet accurate comment. The world is staggering under multiple problems, but economists of all stripes have failed to come up with convincing remedies.

Once, Alan Greenspan was viewed as a know-all, second only to God. He opined it was difficult to say when a market bubble had formed, so it’s better to let bubbles burst and clean up afterwards. Ben Bernanke, his successor, repeated this philosophy. In effect, this guaranteed huge private gains in the cyclical upswing, but government rescues in the downswing. The public is now baying for the blood of financiers who profited from the Bernanke Put.

No economist has produced a convincing theory of how to spot a bubble early, or engineer several small recessions to prevent a super- recession. If at the sign of market exuberance politicians are told to deliberately engineer a slowdown costing jobs and incomes, they will say you are mad, and that your suggestion would be political suicide.

In India, RBI Governor YV Reddy got credit for tightening credit and real estate regulations during the boom. Yet the stock market in India rose seven-fold and the real estate market even faster. Central bankers’ theories and tools look very weak today: raising interest rates has not cured inflation in India, and cutting them has not yielded growth in the US or Europe.

Eugene Fama’s efficient markets hypothesis once seemed likely to fetch him a Nobel Prize, but is now widely derided. Yet there is no clear rival theory. Merely saying financial markets need more regulation is not enough.

In 2008, financial markets were the most regulated of all US markets, with over 12,000 financial regulators. If a giant financial bubble and bust nevertheless occurred, the problem was not lack of regulation but the wrong regulations.

Everybody agrees there were gross financial excesses in 2001-08. But there is still no consensus on how much leverage is safe, breaking up banks that are too big to fail, and separating investment banking from retail banking.

Disagreement on macroeconomics is as deep and frustrating. The world economy is floundering five full years after the subprime crisis of 2007. Democrat-economists like Paul Krugman and Joseph Stiglitz claim the way out is a bigger stimulus. But cumulative fiscal deficits for five years, the mother of all stimuli, have raised US national debt by over $ 5 trillion without reviving decent growth or reducing unemployment below 8%. Republican economists cite this as clear proof that Keynesian deficits have failed.

Krugman and Stiglitz say the problem is not too much but insufficient stimulus, and want even more. Critics compare this to Marxist apologists claiming that the Soviet Union’s collapse was caused not by too much but too little communism, and that an additional dose would have done the trick.

I personally am reminded of a Laxman cartoon showing a Minister beating a tiger skin with a stick, saying it will come alive if stimulated hard enough. Yet conservative economists preaching prudence and reduced fiscal deficits have not fared much better.

US Republicans are dead against Keynesian stimuli for building roads and bridges, but if you suggest cutting defence projects, they protest that this will cost jobs! Krugman rightly calls this weaponised Keynesianism.

Greece and other troubled Eurozone nations first tried to stimulate their way to success. When that failed, they resorted to austerity. Alas, austerity reduced growth and revenue, and so fiscal deficits stayed high. Both stimulus and austerity failed.

Economists like Martin Wolf say the European Central Bank must print enough euros to rescue troubled Eurozone economies. This is a short-term fix, but cannot rectify the fundamental problem of a monetary union without a fiscal union.

The European Central Bank and US Fed have already pumped trillions into their respective markets, and the day of reckoning will come soon in the form of inflation. Krugman finds that acceptable. But others will call it a betrayal.

The UK has attempted to stimulate growth through austerity, hoping that budgetary rectitude and spending cuts would revive animal spirits in business and restart fast growth. Alas, Britain has gone into double dip recession, with Krugman chortling “I told you so.”

The Baltic States are contrarian examples. They accepted a sharp dip of up to 25% in GDP during the Great Recession, and have now recovered. Yet their recovery is weak, and the steepness of the initial crash would have been called failed economics in most democracies. The Baltic States are small economies linked through trade and investment with the Scandinavian nations, which grew reasonably fast after 2008.

Others have not been so fortunate. China, India and other emerging markets were initially amused by the Eurozone’s travails, and patted themselves on the back for surviving the Great Recession. But their economies have all slowed sharply this year, ending complacent expectations of a return to fast growth.

Structural factors have defeated both fiscal expansion and compression. Economists do not know enough about these structural factors to prescribe convincing remedies. Protectionist sentiment in most countries is rising as conventional economics, both rightist and leftist, fails to deliver jobs or growth. We need a better economics.

What do you think?