Saturday, 2 October 2010

Economics is a religion, not a science

THINK ASIAN
By ANDREW SHENG

‘Within the cathedral of mainstream economics, there are many chapels devoted to specialised problems’

IS economics a religion? Paul Krugman argued recently in his Aug 21, New York Times column that the policy elite of central bankers, finance ministers and politicians are “acting like priests of an ancient cult, demanding that we engage in human sacrifices to appease the anger of invisible gods.”

By gods, he means the “bond vigilantes,” who advocate spending cuts to reduce the fiscal deficit to enable the bond market to become stronger, resulting in greater confidence in the economy.

The biggest advocate of deficit reduction during the Clinton Administration was former US Treasury secretary Robert Rubin.

As he put it in his memoirs, In an Uncertain Age ( 2003): “In important ways, the deficit had become a symbol of the government’s inability to manage its own affairs – and of our society’s inability to cope with economic challenges more generally, such as our global competitiveness, then much in question.

“The view that fiscal discipline was being restored contributed to lower interest rates and increased confidence, and that led to more spending and investment, which in turn led to job creation, lower unemployment rates, and increased productivity.”

Rubin is the mentor of former economic adviser to US President Barack Obama, Larry Summers, and the current US Treasury Secretary Tim Geithner, both of whom served under Rubin in the US Treasury.

Have they adopted fiscal reduction again as the way to restore confidence, despite Krugman’s view that there is a need for further government spending to ‘get back to the job of rebuilding the economy’?

Krugman is advocating Keynesian intervention in the economy, while the bond advocates are going back to the monetarist’s “let the market work”, by cutting back over-blown government spending back to sustainable levels.

Nobel Laureate Joseph Stiglitz, who broke ranks with the Washington Consensus during the Asian crisis on the irresponsibility of tightening interest rates and cutting fiscal deficits in the midst of a crisis, has just written a new book, Freefall: America, free markets, and the sinking of the world economy.

He has written the most powerful book on the current crisis – not a blow-by-blow account of what happened and whodunit – but a damnation of the crisis in economics and the crisis in morals.

“Economics had moved – more than economists would like to think – from being a scientific discipline into become free market capitalism’s biggest cheerleader.”

The mainstream economists had become so smug in their beliefs that the market was almost efficient that “it was a theological position, and it soon became clear that no piece of evidence or theoretical research would budge them away from it.”

Stiglitz does not hesitate to see the economics profession as a religion.

He aptly describes it as: “Within the cathedral of mainstream economics, there are many chapels devoted to specialised problems. Each has its own priests and even its own catechism.”

He is right. Despite the overwhelming evidence against their utility, the mainstream economists have convinced policymakers that there is little wrong with their models or efficient market Capital Asset Pricing Models.

Let’s get back to the business of making money. In a passionate defence of the under-privileged, Stiglitz argued that there is an underlying moral deficit – “far harder to forgive is the moral depravity – the financial sector’s exploitation of poor and even middle-class Americans.”

He laments the fact that “economics, unintentionally, provided sustenance to this lack of moral responsibility.”

What Stiglitz has demonstrated of the economic theologians is that if they believe that they are right, it must be their detractors who are wrong. So their energy is not spent on what is wrong with their beliefs or assumptions, but why those who try to demonstrate that the theory does not fit with reality are infidels.

Should governments cut deficits?

But let us come back to the big debate: Should governments cut deficits or increase them to get jobs going?

My personal view is that if the United States suffers from fundamentally excessive consumption financed by excessive leverage, then simply increasing public debt to substitute for Wall Street losses does not make sense.

De-leveraging has to happen some time, either in the private or public sector and de-leveraging means cutback in consumption.

The dilemma is whether government spending is for creating temporary jobs or for getting long-term growth going that would create new jobs.

Advanced country public debt is so high because the vested interests, from bankers to healthcare, basically would not allow the government to cut spending and instead push for tax decreases. This fiscal model in the long run is not viable.

The Keynesian argument that if the private sector lacks confidence to spend, the government should spend is not wrong. But Keynes did not spell out where the government should spend. Nor did he envisage that lobbyists can influence government spending to be wasteful. Hence, every prophet can be used by his or her successors to prove their own points of view. This is religion, not science.

One of my dreams is to write a film script about how Martians came to visit Earth in the year 2200, when the world is destroyed by a nuclear war.

As Martian archeologists explore the ruins, they notice that the tallest and the most important edifices left standing are the most magnificent. Deep in their basements, they find vaults made of tungsten steel that seem to protect the most sacred items.

In almost every city they find these buildings. When they manage to open the vaults, they find ashes of paper that could have been records of something important.

They think these are religious documents. Then, they discover some small coins, objects for which the Martians have no use. In each coin, they finally decipher the words: In God we Trust.

The Martians conclude that in the last days of Earth, there flourished an important religion that worshipped a god called Money, and these temples were called banks. They did not find traces of the priests, who were called economists.

·Tan Sri Andrew Sheng is adjunct professor at Universiti Malaya, Kuala Lumpur, and Tsinghua University, Beijing. He has served in key positions at Bank Negara, the Hong Kong Monetary Authority and the Hong Kong Securities and Futures Commission, and is currently a member of Malaysia’s National Economic Advisory Council. He is the author of the book, From Asian to Global Financial Crisis.