This ended up being a pretty long piece so, for the “tl;dr” people, here is a quick summary:
We are experiencing deep economic problems and it is the fault of the economics discipline. Their macro theories suck. But, there is no mechanism forcing it to alter its models when they don’t appear to work. This is so because economists basically write for each other in a language only they understand and their jobs depend on impressing a limited number of journal editors and referees, not correcting real-world problems. The academic inbreeding that has resulted has led to dysfunctional theories and, despite the fact that there were economists who accurately forecast the Financial Crisis, because their work is incompatible with what is published in “good” journals it has been all but ignored. Economics is broken and there is no internal incentive to fix it.
Now the unabridged version:
There is no question that this has been one of the most divisive presidential campaigns on record. Hatred for each candidate runs deep and whoever becomes the new White House resident on January 20, 2017, many Americans will be bitterly disappointed — perhaps even angry.
And yet, despite all the vitriol and personal attacks, there is something about which both parties and candidates agree: a key problem facing our country is economic stagnation. The middle class is suffering, private-sector debt is weighing us down, government services are being starved of income (especially in education), and full-time jobs with a complete range of benefits are few and far between. What happened to the decades of post-war growth when each of us could safely assume that we’d have a better standard of living than our parents? That’s hard to do when you are living in their basement, trying to pay off your college debt.
The consequences of our current economic woes go well beyond our checkbooks and our borders. Many of our domestic political and social struggles are linked in some way to a lack of economic opportunity, as are a number of the conflicts and controversies around the globe. People who are not hungry, bewildered, and scared find it much easier to compromise and cooperate.
What happened? What mysterious force knocked us off track?
It is my contention (and that of many of my colleagues) that the fault lies not with the rich, not with corporations, not with China, not with the Illuminati, not with Al Qaeda, but with the economics discipline. Bad ideas have done at least as much damage to our world as anyone’s bad intentions. Decades of misguided policy from both political parties and in other nations has critically weakened the core of our economy and left us in a situation where, despite our tremendous level of technological achievement, we seem to be regressing. Just as in the Great Depression, we have the ability to solve these problems practically over night. What we lack is sound theory to guide our actions.
Economics As A Profession
Here’s something that may frighten you: the people responsible for national economic policy are economics professors. Donald Trump may develop a different plan than Hillary Clinton, but they both pick and choose from the same set whose contents is determined by that joker who stood in front of your introductory macro class–well, assuming you did so at Harvard, MIT, Chicago or the like. But make no mistake, it’s professors nevertheless. Just do a quick Google search to see who the current and past members of the Council of Economic Advisers or the Federal Reserve Board are. This means that whatever those college professors think is a good idea eventually affects whether or not you can find a decent job.
But that should be good, right, since a major part of being a professor–especially at the most prestigious universities–is doing research? They spend untold hours reading others’ analyses, building models, running regressions, and writing and publishing articles of their own. Who better to tell us how we should be running the economy than those paid to study it?
Yeah, you’d think that, wouldn’t you? Except that…
1. Economists write to impress each other in a language only they can understand.
Economics emerged as an academic discipline some time in the late 1800s. At that point, we stopped writing for policy makers and the general public and started writing for each other. That, in and of itself, is not problematic, except that a) we became increasingly insular as we spent more time with each other than those using or being affected by our policies and b) the language we used became much more specialized so that those outside our group couldn’t really look over our shoulders and say, “Hey, wait a minute, that doesn’t make any sense!” If you aren’t an economist, it’s very difficult to decipher what economists are saying.
A huge part of writing to impress each other is getting published in refereed academic journals. You spend months, maybe years, writing papers that you hope some journal editor and referee(s) believe is worthy. Typical rejection rates are at least 75%, often higher. That doesn’t prevent the individual from sending the article elsewhere, but since our etiquette dictates that the paper can only be under review at one journal at a time, it means that the lag can be considerable. Nor is this just for fun. If the portfolio you submit when you come up for tenure is inadequate, you’re fired (they give it a nice name: you are offered a terminal contract). Thus, any economist who wants to keep her job must be able to impress the senior faculty in charge of the publication outlets. There is absolutely no incentive to engage with anyone other than these individuals. Indeed, one can have a fantastically successful career having never once written something understandable by a policy maker, business person, or consumer. Furthermore, unlike, say, engineers, we don’t get clear and direct feedback from those who employed our policies. There is a very large disconnect.
2. As an economist, you are encouraged to think outside the box–except don’t!
On the other hand, there’s nothing inherently wrong with the idea that economists need to impress other economists to prove their mettle. Who else should be evaluating your new and innovative ideas except those who also spend their careers trying to understand what causes inflation or unemployment?
But, please, don’t make them too new or innovative, or they might not get published in the “right” journals!
This is problem number two. Almost every department (not ours, thankfully) maintains a list of journals that count toward tenure, promotion, and raises. They are either exclusive in the sense that “if you don’t publish here we don’t count it at all” or they are ranked from best to worst. You can submit articles to the latter if you like, but you’ll need ten of those to add up to one of the former. Given the intense time constraint under which those seeking tenure operate, the choice is obvious. Either you fall in line with what everyone else in the department thinks is “good” or you get your CV ready. Nor do these lists vary significantly from department to department so that one could choose where to work on that basis. Rather, they are all basing theirs on the same of academic articles that did the ranking for them.
Again, however, this seems reasonable enough on the surface. Surely it must be true that the review process is more rigorous at some journals than others and that the referees at one place might be better than those at another. But that’s not how they rank them because it’s extremely difficult to measure such things. Rather, the most common method is by citation. The more authors cite work that originated in a particular journal, the better that journal must be. This is considered an indirect way of getting at those other quality issues.
Yet again, this seems logical on the surface of it, but there’s an inherent bias in the system and one that creates a positive feedback loop. I explain it to my students this way. Say you had to have a publication record of a certain caliber in order to enter Heaven. You walk up to St. Peter, hand over your CV, and he peruses it and decides whether you go up or down. Further say that Heaven ranks journals and that this ranking is based on frequency of citation (just as above). Last, assume that journals are divided into different religions: Catholic journals, Baptist journals, Jewish journals, Buddhist journals, Islamic journals, Greek Orthodox journals, Flying Spaghetti Monster journals, etc.
Now the problem: if 90% of humans are Catholic, then journals from that religion will, by default, get cited more often. Hence, regardless of which faith you may actually follow, if you don’t publish in Catholic journals you don’t get to Heaven–and so you do. But that means that as non-Catholics add to the citations of the Catholic journals, so the latter’s position as the most highly ranked outlets becomes stronger. Indeed, we don’t even have to start at 90% Catholic. Everything else being equal, whichever religion starts out as the largest has the inside track to being the one that can claim the top of the ranking. (Also note that while it is also likely that there will be more Catholic journals, thus lowering citations per journal, simulations suggest that the very act of creating a ranking in the first place then creates an advantage for those who come out on top after the first calculation.)
This is precisely what happens in economics. Our Catholicism is the school of thought called Neoclassicism and our St. Peter is comprised of the university department chairs, deans, and presidents who are forced to try to maximize their position in the various rankings published by US News and World Report and the like. The result is cookie cutter departments, with everyone desperately trying to look better than everyone else but by the exact same set of criteria! Even departments that aren’t part of any university or college ranking system get caught up in wanting to emulate the big boys. So much for the theory of comparative advantage or for developing unique niches within the discipline.
All this means that while innovative research is possible, it actually has to be within some pretty narrow confines. Nor is this the fault of Neoclassicism, per se. If any school of thought were to achieve a position as dominant as theirs, it would have the same impact. The problem is the journal ranking system and so we have everyone struggling to get a publication in the same journals and even when you have earned tenure and are more free to pursue other lines of research, the fact that you’ve spent all those years establishing a reputation means that you are unlikely to stray. Either be Catholic or go to hell–which is definitely not what I learned in twelve years of Catholic school!
3. Mainstream economists have next to no knowledge of the schools of thought that did the best job of forecasting the Financial Crisis.
The story so far is that economists write to impress each other along a narrow range of topics and theories as dictated by the hierarchy of journals. Again, however, maybe that’s not so bad. If all the other schools of thought and areas of study are the economic equivalent of alchemy, then this should be encouraging.
But they’re not.
This is a huge discussion that I can’t possibly address properly here. Suffice it to say that there exists in economics a much broader range of approaches than just Neoclassicism and I think one would be hard pressed to dismiss these out of hand. I have studied Post Keynesianism, Austrianism, Marxism, Institutionalism, New Institutionalism, and Feminism and my formal training is in Neoclassicism. I have learned something unuique and useful from every single one. This is not to say that I think they are all correct–they can’t be since they contain mutually exclusive propositions. But I would argue (and have elsewhere) that Neoclassicism hardly has a monopoly on the truth. Indeed, when we look at who saw the Financial Crisis coming, their track record is actually pretty grim.
Prominent mainstream economists have claimed that no one saw it coming. Paul Krugman, for example, wrote a piece entitled “How Did Economists Get It So Wrong?“ and Her Majesty famously asked the London School of Economics why no one forecast this catastrophic event. Meanwhile, Neoclassical economists have scrambled to try to figure out how to make their curriculum more relevant since, by their own admission, at present it “…fails to give students even imperfect answers” (Blinder, Alan. “Teaching macro principles after the financial crisis.” The Journal of Economic Education 41, no. 4 (2010), p.385). The picture painted is one of a discipline that failed miserably at job #1.
This is only true, however, if we exclude from the definition of the discipline non-mainstream schools of thought. In point of fact there were actually a number of economists who correctly anticipated the coming collapse both in terms of the timing and the causes. I do not mean Polyannas, who regularly preached the end of the world and therefore had to be right at some point, nor do I mean those who used tea leaves and listened to mysterious voices. Dirk Bezemer did an excellent study of economists who “got it right,” and in his paper he limited the latter to scholars who 1) cited an actual economic model in support of their argument, 2) pointed to the specific set of forces that really did lead to the crisis, and 3) got the timing right (Bezemer, Dirk J. “The credit crisis and recession as a paradigm test.” Journal of Economic Issues 45.1 (2011): 1-18.). Not a single one of those identified used Neoclassically-based models. By the way, the journal in which that study is published is ranked #674. It is safe to say that the average economist has never seen it.
So, yes, Paul Krugman, you didn’t see it coming, but that doesn’t mean that others didn’t.
4. Academic inbreeding has led to dysfunctional theories.
This begs the question of what a “Neoclassically-based” model is. In macroeconomics, it means the assumption that the economy tends to come to full employment automatically (so long as no obstacles stand in its way) and that it is not particularly important to model the financial sector beyond saying that changes in the money supply can affect interest rates. Nor is there much discussion of the impact of policy (if it fixes itself, what’s the point?).
Those claims sound ridiculous and I wouldn’t believe me, either. So let me offer some evidence. First, here’s a quote from Christine Romer, former chair of the Council of Economic Advisers:
Just as there is no regularity in the timing of business cycles, there is no reason why cycles have to occur at all. The prevailing view among economists is that there is a level of economic activity, often referred to as full employment, at which the economy could stay forever (emphasis added).
She’s probably right that that’s the prevailing view, but then that’s why none of them forecast the Financial Crisis. According to their view, all we need to do is sit back and let the economy take care of us. On top of that, popular macro models like Real Business Cycles build into their assumptions the idea that all unemployment is voluntary. The same is true of Monetarism. Their models therefore have to argue that Great Depression, for example, was the result of masses of people deciding they just didn’t want to work any more. Do they think that’s really true? No, but they figure it’s close enough. There are also Neoclassical theories (New Classicism, for example) that assume that in the back of every person’s mind is a perfect model of the macroeconomy. Therefore, government policies can’t really have any impact because we will all anticipate its effect and alter our behavior accordingly. And these are popular views, not fringe theories. The fringe ones are those that predicted the Financial Crisis!
I can remember learning these things in my graduate macro classes and thinking that it was absolutely ridiculous. I even considered quitting the program. And it’s not just me–believe it or not, many Neoclassicals feel exactly the same way! Take this quote regarding graduate student attitudes at top PhD institutions (this journal is actually ranked #9, by the way):
In the interviews, macro received highly negative marks across schools. A typical comment was the following: “The general perspective of the micro students is that the macro courses are pretty worthless, and we don’t see why we have to do it, because we don’t see what is taught as a plausible description of the economy. It’s not that macroeconomic questions are inherently uninteresting; it is just that the models presented in the courses are not up to the job of explaining what is happening. There’s just a lot of math, and we can’t see the purpose of it” (Colander, David. “The making of an economist redux.” The Journal of Economic Perspectives 19.1 (2005), p.180).
The author goes on to explain other student frustrations with the macro classes, finally concluding, “In short, the macro that is taught to the students in the core has lost touch with both policy and empirical evidence” (Colander 2005, p.196). This sentiment echoed by James Galbraith, who argues that today’s economists are busy with their own little puzzles and don’t really care much about macroeconomics or economic policy. He blames, among other things, the hierarchy of journals discussed above.
I also mentioned above that little effort is expended in explaining the very sector that imploded before our very eyes in 2007-8. Again, you don’t have to take my word for it. They admit it:
The Great Recession, with its origins in the financial sector of the economy, highlighted limitations of existing intermediate macroeconomic models (de Araujo, O’Sullivan, and Simpson, 2013, p.75 de Araujo, Pedro, Roisin O’Sullivan, and Nicole B. Simpson. “What should be taught in intermediate macroeconomics?” The Journal of Economic Education 44, no. 1 (2013): 74-90).
In addition, Dirk Bezemer, the author of the above article analyzing which economists “got it right,” concluded that not only did those individuals take much more explicit account of financial factors, but that those aspects of their models could not simply be tacked on to existing ones because “most of these elements are incompatible with core tenets of the neoclassical paradigm” (Bezemer 2011, p.15). Let me close this section with a passage from Colander, et al. (2009) that is worth quoting at length:
The global financial crisis has revealed the need to rethink fundamentally how systems are regulated. It has also made clear a systemic failure of the economics profession. Over the past three decades, economists have largely developed and come to rely on models that disregard key factors—including heterogeneity of decision rules, revisions of forecasting strategies, and changes in the social context—that drive outcomes in asset and other markets. It is obvious, even to the casual observer that these models fail to account for the actual evolution of the real-world economy. Moreover, the current academic agenda has largely crowded out research on the inherent causes of financial crises. There has also been little exploration of early indicators of system crisis and potential ways to prevent this malady from developing. In fact, if one browses through the academic macroeconomics and finance literature, “systemic crisis” appears like an otherworldly event that is absent from economic models. Most models, by design, offer no immediate handle on how to think about or deal with this recurring phenomenon. In our hour of greatest need, societies around the world are left to grope in the dark without a theory. That, to us, is a systemic failure of the economics profession (Colander, David, Hans Föllmer, Armin Haas, Michael D. Goldberg, Katarina Juselius, Alan Kirman, Thomas Lux, and Birgitte Sloth. “The financial crisis and the systemic failure of academic economics.” Univ. of Copenhagen Dept. of Economics Discussion Paper 09-03, 2009 p.2).
The only place where I would take issue is in the first sentence. There are already models that don’t commit these errors.
5. There’s no incentive to fix those dysfunctional theories
Mainstream macroeconomic models suck. This is not just the opinion of detractors, but of many within the broader confines of Neoclassical economics (especially Neoclassical microeconomists). They assume away the key problem in macroeconomies from the get go (i.e., unemployment) and as a consequence their analyses really don’t need to address anything messy like financial systems. So they don’t. This is not to say that they are not carefully constructed, complex, and internally consistent. Unfortunately, carefully constructed, complex, and internally consistent models based on false premises come to incorrect conclusions just as much as simple, straightforward models based on false premises. It just takes longer to get there and it’s harder to see what went wrong.
Nor is there truly an incentive to fix this given that a) we are writing for each other and b) those affected by our policies can’t really understand what is being said. My promotion depends on what journal editors and referees–my sibling economists–think of my arguments and not whether the theories are applicable to the real world. As suggested above, you can have a fabulous career and never once write anything for anyone other than your colleagues, near and far. If those top-ranked journals aren’t insisting on more relevant macro models–and they aren’t–then there is no incentive to change what’s already being done. And that appears to be exactly what is happening.
The terrible bottom line here is that the school of thought that encouraged the idea that the financial system could properly price subprime derivatives is the same one that assumes the economy fixes itself and we don’t really need to pay too close attention to the banking sector. They also brought us the view that exporting jobs to China won’t really hurt us (remember, they assume we return to full employment automatically), we can allow merger after merger and not experience a decline in competitiveness (you know, like in health care), austerity measures help fix economies (they’ve done wonders for Greece), tax cuts for the rich increase investment (they actually increase saving, which lowers firm sales and thereby lowers investment), education needs to be privatized (so the poor get excluded), etc, etc.
Of course, Neoclassicism also does not have a monopoly on bad ideas, either (although their macro ones are pretty bad). The problem is that there is no incentive for communication and cross fertilization among different schools of thought, even when there is substantial evidence for the failure of one approach and the success of another. Rather, we have a strong case of institutional lock in. Creativity is discouraged and our insularity has allowed macro theories based on the idea that economies fix themselves, the financial sector is unimportant, and there is no such thing as involuntary unemployment–ludicrous to anyone outside my profession–to survive. Actually, to thrive.
There was a very clever Saturday Night Live skit, “Black Jeopardy,” that played on the fact that some of the core concerns of both Donald Trump and Hillary Clinton supporters are really the same. They are poor, confused, and scared. They are also very mistrustful of a system where they don’t think they can get a fair break. Unfortunately, from my perspective, neither candidate is going to fix that. Until the ideas coming from the ivory towers are aimed at solving macro problems and not just getting another publication, we’re screwed. As John Maynard Keynes observed in the General Theory:
“…the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else…But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”
The longer I live, the more I realize how right he was. And the more scared I am because I don’t see it getting fixed.
By John T. Harvey