In science, if your hypothesis can't stand up to new evidence, it is discarded, and a new hypothesis is constructed to fit the new evidence. That is apparently NOT the case in economics. If what we are seeing is any indication, economics seems to believe that if events occur that don't fit into your neat little model, you just pretend the events didn't happen, or that they are total anomalies caused by a once-in-a-lifetime event that will never happen again, or that it's the government's fault. But you can never, ever question the model. No sirree Bob. Then no other economists will take you seriously. Just ask Raghuram Rajan.
We are heading toward yet another serious economic crisis, one that may end up being even more far-reaching and horrific than the one we are still enduring, because we have been implementing superficial yet shockingly costly temporary solutions. The people who helped create these problems are not only NOT being punished, but are still being allowed to craft economic policy.
I believe the reason for this is the domination of American financial and economic thought by a particular school of economics. This school of economics, variously known as the "freshwater" school, the "Friedman" school, the "Chicago" school, or the "neoclassical" school, among others, has steadfastly believed that it had everything figured out. In their minds, capitalism is a virtually perfect system. Actors within the system are rational. Governments should not regulate or otherwise interfere with markets. The only possible role of government in economic matters is to use the central banks (such as the Federal Reserve) to occasionally do a slight bit of tweaking, mostly to control inflation, and that's it. Otherwise capitalism is a perfect machine that will grow and grow forever.
Oh, really?
The question that should be asked is, why do so many economists continue to believe in an economic model that cannot account for major economic events that seem to be happening on a pretty frequent basis? Their model could not really explain the market crash of 1987, or the savings and loan failures of the late 1980's, or the Asian financial crisis of the late 1990s, or the Internet bubble, or the gigantic corporate failures of the early 2000s (think Enron or WorldCom), or the collapse of Argentina's economy in 2002, or this latest crisis of real estate and derivative collapse. Maybe I am naive, but to me a model that can't explain shit IS shit. It is useless - no, WORSE than useless, because belief in the flawed model actually prevents people from doing anything to solve the real problems.
So again, why is anyone still listening to these people? Why are they still getting jobs in government?
"You know, the only trouble with capitalism is capitalists. They're too damn greedy."
- President Herbert Hoover to columnist Mark Sullivan, 1929.
"Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades."
- Dr. Robert Lucas, Nobel laureate for economics, in an address to the American Economic Association at its 2003 annual convention
I want to begin by saying that I am not an economist. But I am a historian, and I use my knowledge of history to interpret past events and patterns. Hopefully this study of history gives me some insight on future possibilities and probabilities. And what I see is yet another disaster coming down the road, because the fundamental issues that brought about the massive financial collapse of the last three years have not been addressed. In fact, some of those issues have been made worse by the consolidation of the banking industry, the failure to implement any regulation or other safety measures, and the failure to punish anyone who caused the mess in the first place.
That is what is happening. Why? For the love of God, WHY??? Well, that is the question, isn't it?
I am guessing that much of it has to do with the state of economics as an academic field in America. Broadly speaking, the field in the last thirty years has been dominated by a view of economics that I can only describe as seriously flawed. It believes that people make rational decisions, that markets and capitalism in general require little government intervention, that any regulation is inherently bad, and that ultimately the purpose of the financial industry is to use money to make more money, period. Many economists honestly believe that capitalism is a nearly perfect system which required only the slightest occasional tweaking by central banks like the Federal Reserve, and then only to control inflation. They also believe that there is no such thing as a lack of demand. Ever. And they also believe that unemployment is not a market problem as much as it is a problem with the attitudes of those people who are unemployed. They literally believe that unemployment is a choice, a deliberate decision made by workers to be unemployed. They have come up with sophisticated mathematical models that, conveniently, fit the limited data they have chosen to use for their model. It's a perfect circle of rationality. So in their world, they have figured it all out. Their model accounts for the entire sum of humanity, and all of the variations of products and services. Like the eminent Dr. Lucas, said, the problems have been solved, right? We will never have another Great Depression. Right?
I beg to differ.
Ok, sure, I do not have a PhD in economics. But it seems to me that ANYONE who believes in an academic model that assumes that people are rational and will always make rational decisions has apparently not met many actual people. Guess what, guys? People are pretty dumb, generally, and so they often make dumb decisions. In fact, sometimes they make spectacularly dumb decisions. Sometimes, people have clouded views of reality. Sometimes they are outright delusional. Perhaps you should go have a chat with your counterparts in the field of psychology, and they can fill you in regarding the flaws in your assumption of a broad-based human rationality.
But that is hardly the only gaping hole in this argument. The prevention of depressions has not been solely due to the study of macroeconomics or to the genius of Dr. Lucas and his cohorts at the University of Chicago, but largely because of the measures taken as a result of the Great Depression to prevent such an economic disaster from ever happening again. These measures included the Banking Act of 1933, commonly known as Glass-Steagall, which created the Federal Deposit Insurance Corporation and gave it authority to insure deposits as well as regulate some banks. It also gave the Federal government oversight (for the first time) over all commercial banks and formally separated deposit banks from investment banks. So from the enactment of this law in 1933 until the 1980's, there were no major bank failures and not a single bank customer lost their deposit money. That in itself would seem to be a major accomplishment, but obviously it gets downplayed by the economists who believe regulation is bad. Besides, we all know you can't accept facts that conflict with the basic premises of your economic model, now can we?
Regulation is bad, huh? Of course, these economists would say. Since people are rational, there is no reason for government to hold back people from their pursuits. So whatever people can dream up, no matter how destructive, psychotic, and greedy, MUST also be rational and therefore a good thing. So Enron's pioneering work in converting generated electricity into a commodity that could be traded, and then manipulating the hell out of that market by shutting down power plants, overloading transmission lines, and cheering for forest fires, must also have been perfectly rational and good. And any customers in California who complained about their utility bills skyrocketing to four or five times their previous amounts are just silly hippies who hate capitalism and don't know what they are talking about. And of course rewarding the Enron traders with bonuses was also perfectly justified. And rational. I suppose it is also rational for corporations to calculate how much money their defective, harmful product will cost them in lawsuits, and weigh that against the amount of money it would cost them to actually fix their product and make it safe. I know, it sounds too much like what Edward Norton's character was doing in Fight Club, right? Except that little scenario also seems to describe, quite aptly, what the tobacco industry has been doing for most of the last 50 years. And I am sure if we looked we could find many more examples.
If you wonder why so many politicians can get on TV and say, with a straight face, that unemployed people want to be unemployed, look no further than this school of economics. It gives them intellectual cover, so to speak. As long as a lot of economists are willing to repeat this horseshit, and "back it up" with academic papers that explain how corporate layoffs and downsizing really don't have anything to do with growing unemployment rates (it's STILL the fault of the people without jobs, dammit!), business leaders and politicians will continue to say it. They will also continue to spout off other nonsense that would not hold up against an eighth grade debate team in any normal world. After all, it is in all of their interest to do so. The economists don't want to admit that their model they have been devotedly following for decades is fucked up like a soup sandwich. The business people know that these economists think that the market (and therefore the private sector in general) can do no wrong, and so therefore they start to believe it too. They are, after all, the indispensable John Galts of industry, and the world would just go to pieces without them. And of course the politicians (at least the ones who weren't business people to begin with) will buy into it because they know that it is what the business community wants to hear, and as long as they tell them what they want to hear, they will get all the campaign contributions they need.
People assumed that in a rational world, real estate prices would always go up. Oh, sure, there would be local fluctuations that might cause prices to go down, but that was just a temporary thing and limited to a particular area. It would never happen everywhere at the same time. And based on that assumption, banks figured out that home loans would always be a good investment for banks. And what's more, we can use these mortgages as the basis to create new investment vehicles. And we will encourage people to refinance their existing mortgages so they can spend the money on other things. And then we can create even more investment vehicles based on mortgages. We can even create investments based on those investments failing! We just won't tell anyone about that last part. So don't tell anyone. Besides, it will never happen anyway, right?
No one in the financial industry (at least no one that anyone was listening to) realized that eventually, the middle and working classes would be tapped out. Wages were largely flat for thirty years, but so what? Having second and third jobs and using their home equity like an ATM machine would keep things going for a while longer. Nobody figured that it all might come to an end. Nobody figured out that forcing the non-rich to pay more for housing, and for gas, and for health insurance, and for college educations, and for virtually anything and everything that various industries had converted into cash cows for themselves and their shareholders, would eventually mean that the orgy of spending would come to a screeching halt, with the problem being a huge chunk of the population was now struggling under a mountain of debt. And so were the local, state, and national governments. And a huge percentage of the actual wealth in the country is now in the hands of people who refuse to use it for anything except making more money. They don't have to spend it here if they don't want. They can spend it at their place in the Bahamas. Or use it to buy a factory in China. Anything they want. But pay taxes with it? Or raise employee's wages? Hell no.
So it only took a few decades for all of the lessons of the Great Depression to be forgotten. All that hard-earned wisdom cast aside, not because they weren't making money, but because in their minds they weren't making enough money. John Maynard Keynes, the great economist of the Great Depression era, was rightfully scornful of the speculative aspects of the financial industry. One of my favorite quotes of his (also a favorite of Paul Krugman, if I am not mistaken) is this: "When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."
Well Mr. Keynes, I am sorry to say that the casino is not only controlling the capital development of the U.S., it is controlling the U.S. itself. Wall Street and the corporate world own the government, for all intents and purposes. Now that the masses of ordinary people are finally waking up to this fact and are angry about it, maybe things will change. I am trying to be hopeful. But I don't imagine that the Haves are going to want to part with anything, and they will do anything and everything to make sure that the Have Nots stay on the bottom of the food chain. Occupy Wall Street is the first real sign that the Have Nots are not going to take it lying down.