Tuesday, January 27, 2015

An Empirical Test for Economic Theories

Is economics a hard science, like physics? Or is it more like sociology and history? Many economists would like us to believe that the first is true, that economics is now firmly rooted in mathematics and empirical evidence.
In Seven Bad Ideas: How Mainstream Economists have Damaged America and theWorld, author Jeff Madrick asserts that the myth that economics is a science is one of the ideas that have inflicted damage on our country. In particular, he writes that for all the talk about being a science, many economists don’t care much about how their theories work in the real world. In Paul Krugman’s review of the book, he wrote, “Economists presented as reality an idealized vision of free markets, dressed up in fancy math that gave it a false appearance of rigor.”
It seems to me it’s time to do an empirical test of economic theories; an objective analysis of real-world results. For forty years from about 1930-1970, the policies of John Maynard Keynes were followed. Keynesianism included a strong role for government in regulating business and the markets.
In the 1970s a different economic model began to gain popularity, and in the U.S. the main proponent was Milton Friedman, so I’ll call this model Friedmanism. This model claimed that markets work best without government interference, because markets had an inherent tendency to always find perfect states of equilibrium. By 1980, with the ascendancy of Ronald Reagan and Margaret Thatcher, this new economic thinking began to dominate western economic thinking.
We now have forty years of Friedmanism to contrast with the forty years of Keynesianism. How do those two periods compare? Keynesianism produced strong economic growth and a relatively equal society with no major financial crashes. Friedmanism has led to poor economic growth, an increasingly unequal society, and regular and painful financial crashes. Interestingly, somehow these crashes are, in the end, only painful to the middle and lower classes; they are strangely rewarding to the 1%.
Paul Krugman’s recent column, published the day after the recent Greek elections, provides evidence for this comparison of economic theories. In 2010 the European Central Bank, the European Commission, and the IMF had imposed austerity measures on Greece, promising that there would be little effect on growth and the Greek economy would quickly improve. This was Friedmanist policy in action.
What actually transpired was an economic and human nightmare. Far from ending in 2011, the Greek recession gathered momentum. Greece didn’t hit the bottom until 2014, and by that point it had experienced a full-fledged depression, with overall unemployment rising to 28 percent and youth unemployment rising to almost 60 percent. And the recovery now underway, such as it is, is barely visible, offering no prospect of returning to precrisis living standards for the foreseeable future.
What went wrong? I fairly often encounter assertions to the effect that Greece didn’t carry through on its promises, that it failed to deliver the promised spending cuts. Nothing could be further from the truth. In reality, Greece imposed savage cuts in public services, wages of government workers and social benefits. Thanks to repeated further waves of austerity, public spending was cut much more than the original program envisaged, and it’s currently about 20 percent lower than it was in 2010.
Yet Greek debt troubles are if anything worse than before the program started.
Why were the original projections so wildly overoptimistic? As I said, because supposedly hardheaded officials were in reality engaged in fantasy economics.
The “elite delusions” of certain economists (Krugman’s characterization) have been at work in our country too. We’re suffering from the same mistaken conservative economic ideology that the markets are infallible. Stubbornly high unemployment, rising income inequality, a shrinking middle class, high levels of financial anxiety—does that sound like an economic system that is working well to you?
We’ve been sold a story that economic matters are too complex for ordinary people to understand. The experts will take care of it for us. The truth is it’s not too complex; it’s just in the interest of certain people to make it appear complex so they can run the economy in their interest, not the interest of the general population. If you’d like a primer on economics, I highly recommend Economix, which uses a comic book format to convey the history of economic thought in a clear and entertaining fashion. 
I would like to see someone write a popular, easy to understand book that lays out the contrast between Keynesianism and Friedmanism as they manifest in the actual world.

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