A quarterly magazine of urban affairs, published by the Manhattan Institute, edited by Brian C. Anderson.
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Economics Still Doesnt Lie
Whatever its predictive powers, the dismal science remains a science.
25 September 2009
The French have heads not for economics but for politics, Alexis de Tocqueville wrote wisely in 1848. Along with this disinclination toward economics, the French tend to be anticapitalist and friendly to state intervention. So for them, for others annoyed by economics, and even more for those who cant stand the free market, the recession has an upside: its open season on economists. How could economists fail to predict the crisis? Doesnt their shortsightedness impeach the very status of economics as a science?
Not at all. Economists follow the scientific method. Based on observed facts, they measure, examine regularities, derive models from such regularities, and submit the models to criticism and to the test of reality. Thus economics progresses from one falsifiable hypothesis to another. Some models stand up to tests; these become laws that can be expressed mathematically; and the number of economic laws grows. Economics is a science because it is a system of thought that moves forward, leaving behind old notions that have proven false. And not least among its accomplishments is improving the condition of the human race.
Consider the history of the twentieth century after 1945. Millions of human beings have emerged from poverty, and millions continue to do so. Eastern Europe is rebuilding; Brazil, India, and China are making great progress. But their accomplishments are not due to cultural shifts, political changes, or the sudden discovery of natural resources. Rather, these nations moved out of poverty and toward relative well-being by following sound economic strategies: free trade, business competition, and a stable money supply.
These strategies are part of a broad consensus among economists about the way to achieve economic growth. Other elements of that consensus include the relation between wage levels and employment, Joseph Schumpeters concept of creative destruction (economic evolution spurred by innovation does not proceed in smooth linear fashion, but through alternating phases of expansion and crisis), and the advantages of securitization (namely, the spreading of financial risk). Economists continue to have lively quarrels, but these disputes generally take place within certain parameters. For an economist to contest the principle of free trade or to recommend inflation, for example, would be comparable to a physicians practicing bloodletting.
Even the American economists praised in Europesuch as Paul Krugman, because he is a social-democrat, and Joseph Stiglitz, because he opposes globalizationremain within the paradigm: Stiglitz does not deny the efficiency of free trade in alleviating poverty, and Krugman does not propose to replace capitalism with socialism. In their academic work as well as their public statements, both emphasize the imperfections of the marketbut no economist, even the most libertarian, would deny these.
Todays debate between free-marketeers and interventionists concerns not the existence of market imperfections but how best to address themhow the government should regulate the economy. Interventionists expect governments to reduce market imbalances, among which the lavish bonuses paid to financial traders are a particularly visible example. Market advocates dont deny these imbalances, but they doubt that governments are any more rational than markets. Markets produce bubbles, but governments make war. Capitalists are moved by unreasonable passions, but are politicians and bureaucrats any wiser or more disinterested? Free-market economists (like the French scholar Jean Tirole, an exception to Tocquevilles dictum) thus favor improving the quantity and quality of information available in markets. From their point of view, speculative bubbles arise not from a lack of regulation but from a shortage of information, which leads to abuses by insiders.
But whats the point of a science that cant make predictions? Economists can do everything except foresee the future, observed Gerard Debreu on receiving the Nobel Prize for economics in 1983. But Debreu wasnt entirely correct: economists can predict that certain bad policies will lead to bad results. To freeze prices or salaries, nationalize industries, block imports, or print money with abandonall of these lead quite predictably to poverty. Yet no one congratulates economists for the 25 years of growth that preceded the crisis. During the present recession, moreover, governments have agreed to preserve the free market (unlike in 1930), to shore up the banking system (unlike in 1930), and to avoid inflation (unlike in 1974). The progress of the science of economics has helped us avoid repeating past errorssomething else that economists get little credit for.
Could the crisis of 2008 have been foreseen or prevented? After the fact, one can find analysts who were prescient enough to have foretold it, but their forecasts were impossible to verify, given the state of knowledge at the time. Crises remain unpredictable because they result from the crystallization of a multitude of immeasurable factors. It may even be the case, as the French mathematician and economist Benoît Mandelbrot has argued, that financial markets are unpredictable by definition and thus that crises must remain inevitable: only a static economic system without innovation would be predictable.
This economic complexity illuminates the disagreement among economists concerning the cause of the crisis, if indeed there is a single cause. Market advocates blame the Federal Reserve for creating a speculative bubble with easy credit. Interventionists blame a lack of government regulation for the same bubble. Ten years from now, when more data have come in, perhaps the question will be settled.
Market economies are admittedly imperfect and lead only to relative material progress. Such nuances will never satisfy those who yearn for perfection. But the prophets of apocalypse are invariably disappointed: from one crisis to the next, capitalism bounces backand economists keep learning.
Guy Sorman, a City Journal contributing editor, is the author of numerous books, including the new Economics Does Not Lie. Translated by Alexis Cornel.