4 January 2017

Economics isn’t in crisis – but economists may be


Folk seem terribly keen on pronouncing economics to be in crisis. “The economists are the idiots savants of our time,” says Lord Skidelsky. “[A]s a discipline, the dismal science has quite simply lost the plot,” says Jeremy Warner. “Economists overall have to recognise that their profession is in crisis,” says Michael Gove.

The charge-sheet is lengthy: recommending that the UK join the euro, not predicting the 2007-09 financial crisis, saying that austerity would lead to economic calamity, saying that austerity wouldn’t lead to economic calamity (yup – apparently we collectively did both of those and were wrong both times…), recommending quantitative easing, saying that voting to leave the EU would lead to an immediate recession, being too interested in mathematics and not interested enough in philosophy or politics, and being covertly politically biased when political bias is inevitable and should be disclosed.

I ought to side with the critics on many of these points. I opposed joining the euro, said that voting to leave the EU wouldn’t lead to an immediate recession, have taught philosophy at university level and am quite overt about my politics.

But, in fact, I don’t really see this alleged “crisis” at all.

I suspect the real root of the notion is the financial crisis. We were supposed to have predicted it. The fact that it’s a tenet of modern economic theory that financial crises, such as the one in 2008, are intrinsically impossible to predict only reinforces a sense of crisis. When economists say, “We told you things like this were impossible to predict, so it’s hardly a criticism of us that we didn’t!”, it just makes people angry.

The reply is: “Well, if you can’t predict things like that, what’s the point of you?” Our answer? “Well…everything else we do, including all the stuff we did before the financial crisis that you seemed to quite like…” is deemed lame – even though the vast majority of what economists do is not about making forecasts of GDP growth or stock market performance.

The underlying assumption is that there must be some way systematically to predict financial crises. But to see why that’s wrong, consider the following: could there be a technology that, systematically, publicly and reliably predicted every earthquake that killed more than 5,000 people?

Any attempt to produce such a technology would be self-defeating, because as soon as it started to be seen as in any way reliable, folk who lived near an earthquake site would begin moving away in response to the predictions. Pretty soon the only earthquakes that killed more than 5,000 people would be ones it hadn’t predicted.

Financial market crashes are the same. If there were a way of predicting them, they would be avoided. The only ones that would take place would be ones your models hadn’t anticipated.

So would our mass-killing-earthquake-prediction technology be deemed “in crisis” at the end of the scenario above? Obviously not. If, as a society, we decided then to abandon it we’d be fools – and, in due course, many of us would be dead fools.

This latent (and erroneous) sense that economics cannot be relied upon because of 2008 has been given a new lease of life following the UK’s post-EU referendum economic performance.

The Treasury predicted an immediate recession. Three quarters of economists in a Bloomberg poll, conducted days after the vote, agreed. That we have had no such recession is deemed to support the notion that economics is worthless.

But the trouble with economists’ predictions about Brexit (if indeed most of them were wrong and I was right – which is, of course, to a large extent yet to be proved) was nothing to do with the economics. (Here Skidelsky’s criticism that economists don’t reflect enough about politics, philosophy or history might have some merit.)

I have no problem with how the Treasury, for example, moved from concluding that Brexit would lead to the UK being a less open economy, with no more trade agreements with non-EU countries, with no improved performance by the EU without us, with no better regulation, and choosing to impose additional tariffs on imports from the rest of the world, to quantifying the impact of those things.

The problem with the Treasury’s model – as indeed with almost all the quantitative models economists produced for the impacts of Brexit – was nothing to do with the quantification. It was the political assumptions dressed up as if they were economic assumptions.

It wasn’t economics that said the UK would get no additional trade agreements with non-EU countries from being outside the EU. It wasn’t economics that said the EU will not function any better without the UK, or that the Union will not be any more secure, or that future UK-only regulation will not be any better suited to dealing with tomorrow’s regulatory challenges. Those were political judgements made by economists, on questions on which they had no particular expertise.

So insofar as there is a crisis, it’s a crisis for economists, not economics. When economists make judgements about politics, and then patronise politicians or political commentators as “non-experts” who ought to respect their “technical judgements”, there is a crisis of hubris.

One last point. If the Treasury had been right that the UK economy would be 6 per cent smaller in 2030 because of the vote to leave the EU, then it should also have been right to expect an immediate downturn, if not an outright recession, following the result.

That’s because forward-looking consumers (in accordance with another of the central tenets of modern economic theory) should have anticipated lower future incomes by cutting back significantly today.

That they did not should tell us something about 2030 – namely, that the economy does not believe that it will be smaller. If it does not believe that then, on standard theory, that should be a powerful indicator that it will not, in fact, be smaller.

Yet in the FT survey of economists published this week, most of those who predicted that Brexit would lead to economic harm profess themselves now more pessimistic about its economic impacts. This can only mean they do not believe we can infer anything about the future from the rational expectations of forward-looking consumers.

That most respected economists are ready to disregard such a basic tenet of modern economic theory suggests that perhaps they do believe economics is in crisis – even if I do not.

Andrew Lilico is an economist and political writer.