More on freshwater economics

by Linda Beale

I just discovered (via Mark Thoma’s Economist’s View) an economics blog by Maxine Udall (self-styled “girl economist”–which just goes to show how much our image of economists is one of hirsuted males forging through the marketplace…oops, I meander) that may be worth a read. I’ll add it to my “progressive sites of interest” blogroll, which, as readers are probably aware, is rather selective. One advantage of not trying to make money on my blog and of having a free hand because it is mine (and not my employer’s or mine together with a bunch of friends) is that I get to recognize whomever I want. So I’ll indulge.

Anyway, the posting that drew my attention today is “The Price of Casino-Like Finance is Higher Than We Think (jan. 2, 2010), in which Maxine “marvel[s] at the disconnect between what her economics textbooks assert and the realities.” Markets are supposed to provide us efficient information about prices and wages, so that resources are allocated to the best use, improving individual and societal well-being. But instead we see cyclical downturns from “irrational exurberance”, “casino-like behavior aimed at capturing high short-term gains” which substitutes for “sober, sound, long-term business investment supporting long-term corporate growth and survival.” Part of the reason markets don’t work this way, she says, stems from the economics profession itself. This part is worth quoting. The is where many go to gamble and have fun these days as it is more convenient.

[A]n entire cottage industry called the economics profession sprang up, firmly anchored on the shores of Lake Michigan, aimed at creating cultural narratives and myths about how “markets” (meaning some abstract aggregation of semi-rational, often ill-informed, but definitely self-interested points of light) would magically “know” and act rationally and with perfect foresight. In many ways, the birth of the cottage industry known as freshwater economics is a testimony to the power of markets. There was and is a lot of money to be made in that cottage industry, especially if one was willing to drink the “business as usual,” “just ignore the man behind the curtain,” “the business of business is business” kool-aid that until recently has characterized Maxine’s profession.

One under-recognized effect of distorted price signals in a frothy economy is the distortion of intellectual curiosity and endeavor. While a course correction, championed by Keynes, Robinson, JK Galbraith and others in the past and now led by such notables as Paul Krugman, Brad Delong, Joe Stiglitz, Mark Thoma and many others is underway, Maxine believes that considerable damage has been done. Not least because most non-economist Americans are unwittingly under the sway of several “defunct economists.” The defunct economists have provided a convenient narrative in which government of, by and for the people can never act as a countervailing force against large corporations, but instead is viewed as promoting individual freedom only when allied with and strenuously promoting the financial well-being and increased power of those very same large corporations.

Note that phrase “convenient narrative.” That is an apt description of the facility with which economic models have been used to influence thinking. I probably mentioned this in an earlier post, but it reminds me of the first year that I taught tax law after leaving practice. I had a class of about 50 students. They were still searching to make sense of the legal world and their place in it. One of my students–a third year who was at first provoked and then, apparently, convinced by my discussions of fairness and distributional concerns as the fundamental question underlying how to tax to raise a certain amount of revenue–told me about his course in the fall of his second year in “law and economics.” It was an eyeopener, he asserted. He had been at sea, trying to figure out what grounds underlay the legal world. He didn’t have any philosophy to tie it to, and none of the classes had given him any sense of what justice was all about. All of a sudden in “law and economics” he had found a theory that claimed to explain everything based on what was asserted as intuitively appropriate self-interest rationales–not just why markets are important, but also how tort law should work, and contracts–efficient breaches are fine, even if you do break your solemn word–, and even constitutional law (Gary Becker’s unconvincing work suggesting that discrimination will disappear if one only trusts in markets). With that theory in hand, he had stopped asking questions and just started applying. It made it all so easy. Greed is go; fairness is in the eye of the beholder; efficiency is king. Wealth shouldn’t be condemned; instead, condemn the lack of responsibility in the freeloaders who beg for handouts. Bigness isn’t a problem–corporations wouldn’t get so big if the market didn’t make it possible, and since they are big, the markets have spoken. When this student had my class in tax, he suddenly found that there were bucket-sized holes in the dyke set up by free marketarianism. For every ready one-liner response he’d learned from efficient market theory, I had another question. (This often was in discussions we had after regular class, so sometimes we talked for a half hour about these ideas.) Finally, by the end of the course, he had concluded that the law and economics theory that he’d been sold was, in fact, pretty much a sham–at least in terms of holding ready answers, with precise mathematical models to show how scientific it was, to every legal question. A good tool for thinking about things from a particular perspective, but not God’s Truth.

This is the problem we face today. Free marketarianism has been accepted as God’s Truth for decades. And the financial crisis has shown it to be a bunch of hocus-pocus, with the rabbit up the magician’s sleeve accounting for the magical interlude. Complete focus on self-interest results in casino banking, corporate interests that ravage the environment for a penny more’s profits, and managers/CEOs who are so out of touch with reality that they think, e.g., that it is absurd to suggest that a half a million for being an investment banker is sufficient pay. So we’ve got a lot to do to counter this casino speculation. Treasury and Congress putting my proposed New Year’s resolutions into effect would help. (See Jan 2 posting.) Educators spurring students to think more deeply rather than accept trivialized views of human society would help. And a stiff bill of financial regulation that takes the casino out and puts the safe back in would be a really important boost towards evening the balance between casino-thinking corporate powerhouses and ordinary people.

crossposted at ataxingmatter