Henry Farrell on economists and austerity

Henry Farrell has an article in the Washington Post that links a forthcoming paper by him and John Quiggin with a debate that several bloggers have been involved in over the role of academic economists in promoting (or otherwise) austerity. The paper is very rich in historical detail, but the line he takes in the article is that politicians went with fiscal expansion when economists appeared united in their advice, but the switch to austerity began when economists appeared more divided.

I tend to agree with Kevin Drum in this: he says that basically politicians did what they wanted to do, and economists were simply used to provide some kind of cover for politicians’ decisions. This is the argument I make in my General Theory of Austerity paper. The clearest case of this is probably the UK. George Osborne opposed the fiscal stimulus in 2009, and what changed is that he became Chancellor in 2010. So in this case there was no change of view, just a change in who was in power.

The example which fits Farrell’s case much better is Germany. He argues that German politicians were persuaded to conduct stimulus in 2009 by the (surprising) unanimity of their own economists, but switched to austerity when German economists reverted to type. On this he may be right. But even here I think you can tell a different story, which stresses what politicians were most afraid of. In 2009 they were (rightly) concerned that we might be seeing another Great Depression, and so their instinct was to follow their economic advisors who had exactly the same fear. By 2010 it appeared that this fear had been averted, and now a new concern (for both politicians and austerity inclined German economists) arose over European debt.

In the case of Germany, therefore, the story is one of ‘events, dear boy, events’. In the US and UK it was that Republicans and Conservatives gained enough power to enact the policy they wanted to implement all along. The policy was what I call deficit deceit: reducing the state using fears about the deficit as a pretext. You could perhaps argue that the Treasury and the Governor of the Bank encouraged George Osborne, but I think he would have done it anyway: he was never one to let economics get in the way of achieving a political goal.

But as Drum says, it is not all gloom for economists. To quote: “If we had responded to the 2007-08 financial crisis the same way we did to the 1929-32 financial crisis, we'd still be waiting for a rerun of World War II to pull us back to normal.” I get very annoyed when people ask me what economists have done to deserve respect over the last decade. We avoided another Great Depression, that’s all. It may have been politicians top priority, but we told them what needed to be done, as Farrell makes clear.

But when Farrell suggests that austerity could have been avoided if only economists had stayed united, I think he is wrong. If you view 2016 as an experiment to see if policy can really ignore the united view of academic economists, the result is that it can. While it is important to hammer home what a mistake austerity was, and that it was never the policy recommendation of the majority of economists, the key question is why on occasion that often overwhelming majority can be so easily ignored on issues economists know more about than anyone else.           

Economics is an inexact science

When I wrote about why the BBC should treat a clear consensus in economics the same way as it now treated climate science, I got a number of comments about why economics is not a science. A common theme was that economics couldn’t prove theories ‘beyond doubt’ the same way as the hard sciences could. A more sophisticated version of this complaint is that most economic theories cannot be disproved in the same way that Popper thought scientific theories could be disproved.

All this ignores a key feature of any social science, which is their inexact nature. Instead we have accumulations of evidence that confirm the applicability of some theories and reject the applicability of others. Economists’ views about what models are applicable change as this evidence accumulates.

A good example involves the minimum wage, as Noah Smith suggests. The basic economic model suggested even a modest minimum wage should significantly reduce employment, but economists discovered that the evidence did not show this. As this evidence accumulated, alternative theories and models (monopsony and search) were thought to be more relevant. It is this response to evidence that makes economics a science.

Jo Michell writes “The scientific method of forming a hypothesis and then testing that hypothesis against reality can never be the final arbiter of knowledge, as it can in the physical sciences.” He is right that no single experiment or regression can kill a theory, but wrong that the accumulation of evidence is not the final arbiter, because no other arbiter is available. He links to a post by Noah Smith which talks about the failures of forecasting. But as that post makes clear, this is not about data rejecting models, but the inability of models to predict the future. We would never dream of condemning medics because they cannot predict the exact time of our death, still less suggest that this failure indicates they are not doing science.

Of course economics involves cases where economists appear too reluctant to give up their favoured models. You can find similar stories in the hard sciences. There will be more such stories in economics because the inexact nature of economics makes it easier to discount any single piece of evidence. What I cannot understand is what leads someone like Russ Roberts to argue against the use of evidence, and instead that “economics is primarily a way of organizing one’s thinking”. Astrology is also a way of organising one’s thinking, but it fails because evidence does not back it up.

That comparison is slightly unfair, because while the theory behind astrology is obviously implausible, the basic principles of microeconomics are not. In a class on economic methodology I once drew a huge tree that showed how most of economics could be derived from principles of rational choice. But go beyond the basics, and add in complications involving information and transactions costs (to name but two) and you very quickly derive competing models. There is no single model that comes from thinking like an economist, so for that reason alone we need data to tell us which models are more applicable.

So thinking like an economist does not tell me at what point raising the minimum wage will reduce employment. But why would anyone want to keep their models from being proved relevant or otherwise by data? The only reason I can think of is that some models give answers that are ideologically convenient. Of course allowing data to establish the relevance of some models over others does not make economics ideology proof. For example people can always select the one study that suggests that fiscal policy does not influence output and ignore the hundreds that show otherwise. That is why the accumulation of evidence, which includes its replicability, is so important. If you think economics has problems in that respect, have a look at psychology.

This is why economists views about the long term impact of Brexit should be treated as knowledge rather than just an opinion. Here knowledge is shorthand for the accumulation of evidence consistent with plausible theory. Sometimes the theories are common sense, like making trade more difficult will reduce trade. Estimates of the size of trade reduction based on evidence are uncertain, but they are better than estimates based on wishful thinking. Empirical gravity equations consistently show that geography still matters a lot in determining how much is traded. Finally there is clear evidence that trade is positively associated with productivity growth. To say that all this has no more worth than some politicians opinion is ultimately to degrade evidence and the science which interprets it.

The Brexit depreciation and exports

I’ve read a number of people say, observing the lack of growth of UK exports, that this illustrates how depreciations have little impact on trade flows these days. This is a classic case of reasoning from a price change. I think the phrase ‘never reason from a price change’ was popularised by Scott Sumner, although I got it from Nick Rowe.

The depreciation of sterling happened because of Brexit. Some of the depreciation might have been a result of the expected cut in UK interest rates, which means it should be temporary. The rest was to compensate for the impact of Brexit on UK trade. In both cases, therefore, exporting firms in aggregate get a temporary boost to their competitiveness (or profitability of trading), which will come to an end when interest rates rise again or Brexit actually happens, perhaps imposing tariffs or other costs that reduce competitiveness.

The temporary boost to competitiveness/profitability will be good for firms that already compete in overseas markets. But I learnt many years ago when I estimated aggregate trade equations that a lot of the effect from a depreciation comes from firms trading in new markets that they had previously considered unprofitable. To do that requires some investment: in distribution and marketing, for example. A firm is unlikely to make that investment if the gain in competitiveness is temporary.

This helps explain an otherwise puzzling feature of aggregate trade following a depreciation that - unlike Brexit - leads to a permanent improvement in competitiveness. It takes many months before the full improvement in trade volumes comes through. If it was just a matter of goods getting cheaper and people buying more of them you would expect a fairly instantaneous impact, but if firms are having to invest to expand markets, the full impact will take longer to come through. [1]

In the case of Brexit the gain to competitiveness is temporary. It is a mistake to start with the depreciation, and then be disappointed by the lack of any reaction. Once you ask why there has been a depreciation, it becomes clearer why any gain to exports is likely to be modest. [2]

[1] As tariff changes are perhaps likely to be more permanent than exchange rate changes, this may also help explain the puzzle discussed here.

[2] This argument apart, one other thing you quickly learn if you monitor aggregate trade is how erratic it is. We will not know for sure what the impact of the Brexit depreciation has been until well after Brexit itself.  

Brexit and the BBC

Simon Jenkins is completely wrong when he says that the Brexit “campaign was ironically [the BBC’s] finest hour”. The exact opposite is true. The BBC treated the referendum like a general election, with a rule book which said focus on the two campaigns and ensure any coverage is even handed. It mattered not that this produced a blue on blue campaign where opposition politicians were hardly heard. It mattered not that this allowed the Leave campaign to state facts that were simply untrue: by and large journalists kept their head down. It mattered not that their viewers wanted more information about the EU and the BBC has a duty to inform. The BBC had a good campaign only in the sense that they played by rules they designed to keep them out of trouble.

The area where this BBC failure mattered most was the economy. The Remain campaign, for better or worse, focused on the economic costs of leaving. They were on strong ground, with a near unanimous view among economists that Brexit would hurt the UK economy in the longer term. A view that was backed up by international institutions like the OECD or IMF. Yet the BBC’s rules meant that this view had to be treated as just one side’s opinion, to be always and everywhere offset by an opposing opinion from the other side.

In essence the BBC’s key mistake was to not treat the consensus among economists as knowledge. Knowledge that their viewers should be informed about and the reasoning behind it explained. The view that Brexit would reduce average incomes was no more of an opinion than man made climate change is an opinion. They are both almost certain facts. That the BBC did not treat it that way meant that Leave won the vote.

That this lost the referendum is unquestionable. Many surveys pointed to a belief among Leave voters that they would not be worse off after Brexit. Surveys also showed that most Leave voters were not willing to pay anything, in terms of loss of personal income, to reduce immigration. That is not because immigration does not matter to them, but because for many Leave voters it mattered because they believed reducing immigration would improve their access to public services. In that they were completely wrong, but the BBC failed to tell them why they were wrong.

I mention climate change because almost the same fate befell this science. The non-partisan media’s default mode is to treat anything that is politically contentious as a clash of opinions, and with some politicians adopting a climate change denial view, the BBC began to treat climate change as a clash of opinions. But the BBC is open to reason and pressure from scientists. So when scientists complained about the BBC treating climate change as a controversial opinion rather than knowledge, the BBC changed their policy. Debates between climate change scientists and climate change skeptics were largely dropped. When man made climate change was in the news, it was to be treated as a fact: as knowledge.

I have heard no good reason why the consensus views of economists about trade should be treated differently from climate change science. What the BBC’s policy in effect says is this. Forget that society spends large sums of money on research in economics: at the end of the day this research has less worth than a politician’s opinion. Forget we teach large numbers of students about economics in our universities. What is good enough for university students is not good enough for BBC viewers. It is an untenable position for the BBC to have, yet they will continue to hold it until it is challenged, and the only people who can challenge it are economists

The key difference between climate change and economics is that scientists have more institutional clout than economists. The Royal Society in the UK has a staff of over 150. I fear economists have a hopelessly naive and individualistic view about how public policy works. That naive view is that the better ideas will win out. Policy makers will come to economists and choose the policies that most economists think are best. They often don’t. The BBC will represent the consensus view of economists as knowledge: it didn’t.

This is not a one-off, some kind of soon to be forgotten nightmare. I have argued that the 2015 general election was very similar. What I call mediamacro continues to represent austerity as economic common sense, and it represents the government as if it was equivalent to a household. We are now having to tell our students to ignore what they hear in the media.

This is not about individual economists learning media skills. It is about having a collective voice that can, at the very least, speak up for the consensus when it exists. In the UK the Royal Economic Society (RES), rather than the Observer newspaper, could organise polls of academics on key policy issues to establish when a consensus exists. This is better than relying on the selective surveys that already exist. A few angry letters from the RES to the BBC are not enough. We need to force the BBC to defend what they did publicly. If they say they fairly represented academic opinion, we should challenge that by looking at the data. We need to start defending economics, because I do not think anyone else will do it for us.

Economists as medics

I got some stick on twitter the other day for my (longstanding) view that economics is in many respects like medicine. It is of course not exactly like medicine: as the man said, economics is an inexact and separate science. But think about what most doctors spend their time doing. They are in the business of problem solving in a highly uncertain environment in which they only have a limited number of clues to go on. They have solutions to a subset of problems that work with varying degrees of reliability.

If you read Dani Rodrik’s book Economics Rules (which if you have not you should, and can the person who borrowed my copy return it please!), you will see that economists have a large number of distinct models, and the problem that many economists spend their time solving is which model is most applicable to the problem they have been asked to solve. Where doctors have biology as the underlying science behind what they do, they also rely on historical correlations to see if the science is appropriate. Think about solving the problem of why there had been an increase in lung cancer in the middle of the last century.

The science for economists is microeconomic theory, now enriched by behavioural economics. Most of the models economists use are derived from this theory. But as Rodrik emphasises, the trick is to know which model is applicable to the problem you have been asked to solve. To help solve that problem, economists, like doctors, want data. Many have observed how journal articles are now more likely to be about investigating data than establishing theoretical results. Economists have recently started adopting the terminology of medicine in economic studies, talking about treatment effects for example. We both do controlled trials (for economists, mainly in development economics).

Sometimes the paths of the two disciplines cross (as they do all the time, of course, in health economics). One of the big empirical discoveries of recent years has been by Case and Deaton, looking at mortality rates of the US white population. Here is a key figure from their 2015 study.

Mortality has been falling steadily almost everywhere, except since just before 2000 among US whites. Focusing just on the US, the problem seems to be mainly for non-college educated whites (this graphic comes from here).

As with anything to do with race and class in the US, this work has been controversial, but some excellent analysis from Noah Smith shows that the problem suggested by the data is real enough.

Case and Deaton have a new study which tries to understand why this is happening. They describe it as evidence of ‘deaths of despair’. In each age cohort among this group, deaths from suicide, drug overdose or alcohol have been steadily rising. Some useful data is shown here. The interpretation the authors give for the despair is the decline in economic circumstances and status of the white working class in the US.

One of the factors that they describe as an ‘accelerant’ in this development has been the overprescription of opioids drugs that provide short term pain relief, but which have negative consequences in the longer term. US policy over the last 20 years has led to what some describe as the

“worst drug epidemic in U.S. history. Enough opioids are prescribed in the United States each year to keep every man, woman and child on them around the clock for one month.”

They go on

“It is hard to believe that medicine, which prides itself on empiricism, could have taken such a wrong turn.”

Of course individual doctors make mistakes all the time, but the profession as a whole can make major mistakes. It is of course subject to pressures from individuals and large organisations (drug companies). In this, again, it is like economics.

Consider this chart, taken from Alan M. Taylor, ‘The Great Leveraging’, NBER WP 18290.

The blue line shows the percentage of high income countries experiencing a financial crisis each year. Crises were endemic until after WWII, when it appeared for two decades or more that they were a thing of the past. In the 1980s they returned, but without any major impact on high income countries. Then there was Japan’s lost decade, and plenty of papers were written about how that was a particularly Japanese problem. The 2000s seemed quiet, and some called it the Great Moderation, until the global financial crisis arrived.

Looking at this chart, it is hard to believe that economics, that prides itself on its empiricism, could have made the mistake of believing that now things were different. But economics, like medicine, can make big as well as small mistakes. The point I want to make here is the different nature of the response to these mistakes from outside these disciplines. No one says that medicine has failed us, and we need to find fresh voices. No one will say that ‘mainstream medicine’ is in crisis, and we need to look at alternatives.

They do not say that because it would be stupid to do so. With the opioid epidemic something has gone very wrong and it needs to be corrected, and the same is true for economics and the financial crisis. So why the overreaction when it comes to academic economics? One reason is that doctors are not generally asked how long people will live, and even when they do their forecasts are not published almost every day in the press. Most economists are as honest as doctors would be about that kind of unconditional forecasting, but it suits the media to appear shocked and surprised when things go wrong. Another reason is that ordinary people can see doctors doing good things all the time to themselves, their friends and families, but the work of economists is felt less directly. It also seems intuitive that medics are in some sense better than economists, although how you could measure that I do not know. Both factors may explain why medicine is internally policed to a large degree (doctors can be stopped from practicing), whereas economics is not.

Another big difference involves politics. Economists bring unwelcome news to both left and right, so it suits both sides to occasionally bash the discipline that brings the message. We have seen a great deal of that from the right over Brexit. For the left more than the right there are also non-mainstream economists who have an interest in arguing that the mainstream has been corrupted by ideology. Quite why so many on the left choose to attack mainstream economics rather than use the mainstream to attack the right I do not know. All I do know is that they have been doing it for 40+ years, as I remember being told by many economists that the mainstream was fatally flawed back in Cambridge in the early 1970s, which was before Thatcher and Reagan.

But these differences should not obscure the similarities between economics and medicine. We both deal with people, and their mind and body can be pretty complicated whether as individuals, or as a society. In some areas we have developed quite detailed degrees of quantitative understanding that allow us to make successful interventions (more so than in other social sciences I suspect). In other areas we do things that work most of the time but sometimes fail, but there are many important areas where if we are honest we do not have any real idea of what is going on. So we make mistakes, which can sometimes be extremely costly for huge numbers of people, but we also learn from these mistakes.

Why rejoining the EU is so problematic

In his latest piece Wolfgang Münchau writes that if Brexit happens then

“the EU you may wish to rejoin will be different from the one you are leaving. From a British perspective, the EU was little more than a customs union and a single market. If the UK ever decides to rejoin, it would have to do so under Article 49 of the Treaty on European Union. That would be the full Monty — with the euro, the Schengen zone, EU involvement in home affairs, no opt-outs, and no budget rebates.”

He is probably right. Probably because no one can be sure how the EU will evolve, but its history suggests it is unlikely to evolve in the direction of reducing its scope.

However he draws the wrong implication from this. He says that those arguing for Remain should give up, accept that the UK will leave the EU, and start thinking about making the case for rejoining. Münchau has gone from misunderstanding the economic arguments to simply discounting them.

If I was asked whether the UK should rejoin the EU on the terms in Article 49, which means joining the Euro, I would not know how to respond. Joining the customs union and Single Market is unquestionable beneficial from an economic point of view, but joining the Euro with its current structure is almost certainly bad for the UK.

Austerity may have ended in the aggregate Eurozone, but the lessons from the Eurozone crisis have hardly been learnt. The fiscal rules that EU countries are meant to follow are a disaster. The ECB was forced to create OMT, and therefore can act as a lender of last resort, but whether it invokes OMT or not remains entirely in the hands of this largely undemocratic and unaccountable institution. No other central bank in the world has this kind of power over whole countries, power that we have seen it deploy against EZ members during the crisis and after the crisis.

None of this means that the Euro has to fail. As we have seen, there is no popular will to leave the EU in Ireland or Greece. In addition most countries have no desire to formalise a two speed EU (which is in my view a shame). As a result, a country like the UK should think very seriously about giving up so much of its freedom by adopting the Euro. This is why the decision not to join in 2003 was correct, and why the opt out from the Euro within the EU was so useful to us. The arrangement that we had, and which we have decided to leave, is so valuable it is worth fighting for every inch centimetre of the way.  

Misrepresenting academic economists

Brad DeLong entered the debate between myself and Unlearning Economics with a post entitled “The Need for a Reformation of Authority and Hierarchy Among Economists in the Public Sphere”. He writes

“Simon needs to face that fact squarely, rather than to dodge it. The fact is that the "mainstream economists, and most mainstream economists" who were heard in the public sphere were not against austerity, but rather split, with, if anything, louder and larger voices on the pro-austerity side.”

The dodge, and I think it is a pretty good dodge, is that politicians and a good part of the media choose the economists they publicise. If you accept that austerity came from what I call deficit deceit - an attempt to reduce the size of the state using the false pretext of deficit reduction - then obviously politicians and their supporters in the media would choose those economists whose views were useful in promulgating that deceit. As the UK discovered during the Brexit debate, even a tiny proportion of economists (8!) can appear much larger if the media gives them much more attention than they deserve.

But the argument remains a dodge in the following respect. How were people outside economics, including much of the non-partisan media, meant to know that particular academic economists were unrepresentative of the majority? Indeed how can even economists be sure of this? I’ve argued that the majority of academic macroeconomists were always against austerity, particularly once the reason for the Eurozone crisis had been resolved by Paul De Grauwe, but the evidence I use to back this up is piecemeal and indirect (see here, pages 3 to 4).

Part of the problem is a certain disregard for consensus among economists. If you ask most scientists how a particular theory is regarded within their discipline, you will generally get a honest and fairly accurate answer. In contrast economists are less likely to preface a presentation of their work in the media with phrases like ‘untested idea’ or ‘minority view’. In macro it also reflects periods in the past, which still resonate today, when there was deep division and antagonism between different groups. This extends to not being sure what is taught at masters level in the top schools: it turned out, when André Moreira and I did the research, that there was more consensus in one key respect (Chicago excluded) than some had imagined.

Part of Brad’s post it seems to me is simply a lament that Reinhart and Rogoff are not even better economists than they already are. But there is also a very basic information problem: how does any economist, let alone someone who is not an economist, know what the consensus among economists is? How do we know that the people we meet at the conferences we go to are representative or not?

To help fill that gap we have in the US the IGM Economic Experts Panel survey, and in the UK/Europe the CFM survey. (The IGM survey has recently started a European version.) The US IGM survey has asked a question about the Obama stimulus package on more than one occasion, and the latest result is here. It is one key part of the evidence for my claim that most academics were and are against austerity.

However all these surveys share a common feature which I find problematic, and which also reflects on Brad’s concern. They are selective, and deliberately designed to only include the academic elite. IGM writes that panel members are all senior faculty at the most elite research universities in the United States. So they tell us not what academic economists think, but what a chosen sample of ‘elite’ economists think. Now if those samples are well chosen, as I think they mostly are for these surveys, that may not matter too much, but how representative they are can always be questioned. It also gives the impression that it is only this elite that are worth listening to when it comes to policy issues, something I think is simply wrong as well as being elitist.

As part of the build up to the Brexit vote, the Observer newspaper commissioned Ipsos MORI to email all members of the Royal Economic Society. 91% of those who responded thought Brexit would have a negative impact on UK GDP in the longer term. As most UK academic economists are RES members, it was therefore possible to say that there was a clear consensus among academic economists that Brexit was harmful. To be able to say this about all economists, rather than just a select few, in my view strengthens the power of the survey. (Some defend elitist surveys because the elite is ‘influential’, but if they influence their fellow economists that will show up in a larger sample.)

I think the experience with austerity and Brexit suggests it is time for national economics associations (like the RES or AEA) to start representing the opinions of economists by conducting such polls of their members under their own initiative. With email addresses the technology makes it easy to do. It is time these organisations started telling both us and the world about what the consensus (if any) is on key policy issues. It would be an important step towards ending the misrepresentation of economists and economics.