So Why are Economists Behind the Wheel?

April 17, 2009 by  
Filed under Economics

sobriety_testYou knew that eventually there would be open verbal warfare among experts in economics and finance about how to predict and intervene in a bad economy.

This cover story in Business Week describes the battles that are now waging. I think the article is worth reading so here is a little taste:

Critics are scathing. Nassim Nicholas Taleb, the scholar of rare events who wrote Fooled by Randomness and The Black Swan, says: “We have to build a society that doesn’t depend on forecasts by idiotic economists.” Says Paul Wilmott, a quantitative finance expert: “Economists’ models are just awful. They completely forget how important the human element is.”

This recent piece on “voodoo economics” from NPR is also worth reading, including this expose of Nobel prize-winning economists:

Myron Scholes of Stanford University and Robert Merton of Harvard won the Nobel Prize for Economics in 1997. They were on the board of Long-Term Capital Management, a hedge fund that relied on models created by the academics. In 1998, the much ballyhooed fund went belly up — losing billions of dollars practically overnight and requiring a major bailout from banks and investment houses.

Here is my first question:  With so many economists failing to predict the present recession and now disagreeing on how to fix things, can we really call any of them “experts?”  I thought being an expert meant that you knew more than we did about the subject at hand. In this case, the subjects are “why you tanked my retirement plan” and “what are you going to do about it.” I’m still waiting for some good answers out of Washington.

The finance guys are disturbed that economics guys don’t give proper consideration to the operation and regulation of financial institutions and the housing markets. If you want some proof of that allegation, read this NPR piece on the complete failure of the $300 billion “Hope for Homeowners Act” that was passed last summer.

Thus, the Business Week article has these encouraging words for us:

Even now, progress is being made. Scholars of all stripes are belatedly getting up to speed in modern finance.

They are just now “getting up to speed?” The operation of our economy is kind of important, maybe worthy of  “getting up to speed” before you start spending trillions of tax dollars.

This brings Mr. ToughMoneyLove to his last questions: Why are economists still in charge of driving our economic strategy? Haven’t they had enough opportunities to demonstrate the benefits of massive government intervention in the fine tradition of previous misguided economists?

We need to give all of our central planners a DWI test: Driving while incompetent. The problem may be that we don’t have anyone whom we can trust to write the test.

So who do you think should be behind the wheel?

Image credit:  El Greg

Feed Mr. ToughMoneyLove

FREE UPDATES: If you enjoyed this, please subscribe to receive the newest hard truth from Mr. ToughMoneyLove automatically by RSS feed (what is RSS?) or by spam-free Email.

  • Banner


9 Responses to “So Why are Economists Behind the Wheel?”
  1. Marc says:

    I read an interesting article (can’t remember where) about the models, the gist of the article was the models broke because everyone was following a similar or the same model. The models counted on people behaving differently and doing different things (and therefore spreading risk out), but everyone was doing exactly the same thing (concentrating risk on the same failure point) and effectively nullifying the model as the model became reality.

  2. TMN says:

    There have been plenty of people out there pointing out that deregulating the industry would lead to exactly this kind of problem. Lets let them drive for a while.

  3. Rick Beagle says:

    TMN, LOL!

    Why does every “expert” willing to give a quote have a book out there?

  4. MasterPo says:

    Write a book, become an expert.

    Wish I had $1.00 for every time I [foolishly] listened to “expert” advise and either lost money or didn’t make what I could have.

    Citibank at $.96/share anyone?

  5. Kevin Feasel says:

    I’ll defend economists here (and not just out of self-interest), while still agreeing with you in broad terms.

    There were economists who had significant portions of what would happen pegged. Mark Thornton was one of them: is an article he wrote in 2004 decrying the housing bubble, noting in his penultimate paragraph, “Given the government’s encouragement of lax lending practices, home prices could crash, bankruptcies would increase, and financial companies, including the government-sponsored mortgage companies, might require another taxpayer bailout.”

    The problem with government economists isn’t their competence, in the sense that some other group of economists (or laymen) would have done a much better job managing things. Rather, the problem is in what people–including government economists–expect economists to do. With this, you get one of two ideas: either the person who predicts stock market movements (which economists, frankly, cannot do, and most gladly tell people they cannot do) or an Alan Greenspan or Ben Bernanke pulling the strings and coordinating everything so all of our decisions end up working out. This is FA Hayek’s “fatal conceit” in action: the idea that some individual or group of individuals has the ability to collect, aggregate, interpret, and disseminate the ridiculously large number of facts necessary for the coordination of human actions. There are economists who understand the impossibility of this and note that the extent of economic “management” should be the installation of a good, slowly evolving set of generic, abstract rules which limit action at the boundaries (e.g., prevention of theft, potentially setting up welfare for certain groups of individuals, etc.) but not directly written for any particular circumstance or individual/set of individuals. These economists generally do not end up in government positions because they don’t want to waste their time and they can’t give politicians what they want–intellectual cover to implement their own ideas or pad the wallets of favored constituencies. Unfortunately, this leaves the economists who do believe in government coordination of markets, or those who believe that they can “guide the economy” in ways favorable to individuals, like Alan Greenspan attempted. Even more unfortunately, these individuals also work within political constraints, even at the nominally free Federal Reserve (over on my blog, I tend to make a regular point of noting that the Federal Reserve is not an independent institution and has lost some level of its previous independence–to the extent that it was–over the past several years). This constrains their actions and leads to a tendency for Federal Reserve chairmen to drop interest rates and ride the booms, and that inevitably leads to the busts.

    To answer your final question, nobody should be “at the wheel.” I would say that, in an ideal world, politicians would be elected to set certain rules that a) pass popular muster and b) are good for long-run growth. After that point, the legislature should step out of day-to-day dealings of economic entities, and the executive and judiciary should be limited to acting within the general rules. The entire notion of having “a wheel” to be at is the problem, not the “driver.” I’d much rather have Ben Bernanke and Hank Paulson/Tim Geithner “at the wheel” than Chris Dodd and Barney Frank or a pair of bureaucrats or regulators, as at least Bernanke and Geithner have an idea of what they’re trying to do (even though they’re doing a rather poor job of elaborating on that idea or being consistent). The problem, though, is that they can’t do what they’re trying to do–it’s just not possible for anyone.

  6. MasterPo says:


    At any time regardless of the economy you can ALWAYS find an economist somewhere claiming the end if just around the corner.

    Back in the 80’s I recall seeing dozens of books in B&N entitled things like “The Great Depression of the 1990s” and similar. That didn’t happen.

    Even in the 90’s these bokks were dusted off and retitled “Great Depression of 2000″. Even with this drop (which took 8 years after the turn of the century) we aren’t anywhere near 1929.

    Always some one claiming doom&gloom.

    ps- Regarding economists over pols, while in general I agree, don’t get too comfy. I’ve read supposedly “expert” economists who actually *favor* CRUSHING taxes as an *incentive* to make people work harder and be more productive!! :-O

  7. TMN says:

    Just because we found ways to string out the bubble far beyond their expectations doesn’t make the people predicting problems wrong. Deregulation and the “ownership society” combined to create a stock bubble that started in the early 80s and lasted long past when it should have.

  8. MasterPo says:

    Define “ownership society”.

  9. Rob Bennett says:

    The missing piece is Behavioral Finance.

    The economists who dominate today turn finance questions into numbers exercises. There’s nothing wrong with looking at the numbers; they comprise a legitimate part of the story. But they can never be the entire story or even half of it. Leave out half of what you need to analyze to get things right and you get things terribly, terribly wrong.

    I believe that the biggest problems today are institutional. Behavioral Finance turns most of the conventional wisdom on its head. Today’s Big Shots are threatened by new insights. They are embarrassed to have been discovered to have been so wrong about so much.

    The economic crisis is going to force some questions to the table that for a long time have been improperly ignored.


Speak Your Mind

Please leave a comment and tell us your version of the hard truth...

You must be logged in to post a comment.