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What went wrong with economics (economist.com)
32 points by danh on July 16, 2009 | hide | past | web | favorite | 37 comments

Nothing went wrong with economics. The austrian school of economics predicted the great depression, the economic failure of communism, the '01 nasdaq crash, and the recent housing bubble. If you keep looking to the keynsians after the stagflation of the 70's completely refuted the core tenant of their entire economic view, well, you've got no one to blame but yourself.

Economics isn't not a battle between Keynes and the Austrians, though. There are numerous neoclassical schools with varying degrees of prominence. Greenspan, for instance, was a monetarist, not a Keynesian. Other fields include behavioral economics. Meanwhile, while the early Austrian School provided a lot of important insights, most of them have been accepted by the neoclassicals.

Most of "Austrian economics" today is merely an apologia for anarcho-capitalism, popular among libertarians who have studied the early Austrians, lack grounding in economics otherwise, and are more interested in rationalizing libertarian economic policies than honestly learning economics.

while the early Austrian School provided a lot of important insights, most of them have been accepted by the neoclassicals.

Neoclassicals are using some of the rhetoric of the Austrian School, but they are doing the opposite in almost every single issue: central banking, fractional-reserve banking, intellectual property, etc.

Those are three of very many issues: you failed to mention trade barriers, taxes, spending, government debt, regulations, price controls, rent controls, minimum wage, subsidies, and welfare.

All issues which Chicago School economists agree with Austrians, and which a surprising number of other neoclassicals agree too.

There is really no need to pick a fight between the Austrians and the Chicago School. Austrians are sympathetic to the Chicago School, particularly as they have adopted many Austrian insights. In fact, many of today's Austrians come from a monetarist background (Friedman as a gateway drug?), but later came to see how it is misguided and incongruous to oppose price controls on rent but support them on capital (interest rates).

The real conflict today is between free market supporters (Austrians and most monetarists) and the supporters of big government (Keynesians and the mercantilist-style neoclassicals). Unfortunately the latter have been commanding government policy for some time.

"There is really no need to pick a fight between the Austrians and the Chicago School."

Ha! Rothbard would roll in his grave to hear that.

Also, how are interest rates a price control? I always thought time value of money was a relatively uncontroversial idea.

No one objects to interest. I was referring to central bank interest rate targets as opposed to floating free market interest rates.

As for Rothbard and the Chicago School -- yes, I'm aware of that.

Are there some interesting engaging books that I can read to honestly learn about economics without having to pick a side or hold political beliefs? (something that will be really useful for me to understand the world better... not something that will attempt to convert me...)

This textbook is free on line, and as far as I can tell is fairly "standard" economics:


One that is very relevant to our field is "Information Rules" by Varian and Shapiro. I can't recommend it enough.

Definitely look for standard stuff and get that figured out before you go looking at mises.org or marxist.org or whatever. Those guys definitely have an Agenda with a capital A. It's difficult to separate economics and politics completely (which is why I flagged this too), and it's a guarantee that someone will start hauling out all the mises and Austrian links on any given thread on the subject here.

In other words, learn enough to reason on the subject for yourself, rather than joining some sort of echo chamber. The best place to do that is with what's considered the "state of the art" by mainstream practitioners. Maybe they're wrong, and Marx or Mises is right, but it's certainly the best starting point.

You're basically suggesting that people learn the current fashions. Which is fine, as far as it goes, just stay skeptical, because unlearning falsehoods is extremely difficult for most people. Empirically speaking, it seems almost (but not absolutely) impossible for humans.

People should learn economics like you learn physics [1]. You don't start out with string theory (fortunately). You start with the Greeks, then move to Galileo, Euler, Newton, Laplace, Maxwell, Bohr, Einstein, Feynman, etc.

In macro economics, that might read: Bastiat, Locke, Smith, Mill, Malthus, Marx, Engels, Mussolini (who would typically be expunged, despite his continuing relevance, for obvious political reasons), Mises, Keynes, Hayek, Friedman, Rothbard.

[1] There are obvious differences, of course. Economics has more forks and fewer merges in the tree of thought (which makes knowing the history all the more important). And unlike physics, old, discredited theories get dug back up, polished, and repeated for a new generation (how many times do we have to endure CNN talking about how a hurricane will help the economy before people understand the broken window fallacy that Bastiat articulated in 1850?). And economics also overlaps with both politics and morality. Value-free economics exists only if you consider "you could do X, but more people will starve" to be a value-free argument.

I took some intro physics courses in college. We didn't take a historical approach: we just started with the most recently well-understood Newtonian framework, and then moved onto EM where we worked our way up to Maxwell's equations. We never touched the Greeks--in fact, there's no point studying any pre-Newtonian physics unless you're a scientific historian, because Newton had the first usable theory. And even then you learn it using a jumble of Newtonian and Leibnizian calculus!

In economics, we started with things everyone agreed on (supply and demand curves) and moved onto some facts about how centrally-banked currencies work (what the FED does, what M1, M2, and M3 are, what fractional reserve banking is). It's the upper level classes in econ, and the graduate classes in physics, where you really get into the controversial bits. But there's a lot of econ to learn before you get into anything that's controversial among economists (though the common beliefs of economists may be quite controversial among laypeople!)

My best advice is to avoid macroeconomics to begin with, since that seems the most heavily politicized. Microeconomics teaches you the most interesting parts: marginal reasoning, opportunity costs, supply and demand curves--basically the things that everyone agrees on. You'll be surprised to find that even liberal economists agree that minimum wage laws cause unemployment, rent control laws cause housing shortages, and price controls cause economic inefficiencies. Why? The answer is all in the supply and demand curves.

When you do get into macro, start with the pure factual basis before you get into theory. For instance, instead of diving into debates about the gold standard, get a good factual understanding about how the FED works, what M1, M2, and M3 are, how fractional-reserve banking figures in, and so forth. A gold standard may or may not be an improvement, but learning how a centrally banked fiat currency is run will teach you important facts about how most currencies in the world are run. (My macroecon course covered this, as well as a little bit about currencies like China and Hong Kong that peg themselves to the USD, using similar but distinct approaches. I don't recall exactly how China does it but Hong Kong operates a "currency board" where they hold a reserve of USD that they exchange for HKD at a fixed ratio. Interesting, eh?)

Most of the economic debates center around what should be done, or how certain economic or monetary policies affect the economy. There are even controversies about the past--what caused the Great Depression and whether the New Deal helped is a particularly sticky tarpit. It's useful to learn these controversies, but do so by reading all viewpoints involved rather than just one. Then maybe you can choose your favorite.

I would not take a historical viewpoint, starting with the oldest economists and working forward. That's not even how physics is taught, really. That's how philosophy is taught. Unlike philosophers, economists have actually gotten to a point of relative agreement about most things. Remember that you want to learn economics, not the history of economics, so while we use a lot of Adam Smith, we also use the supply and demand curves and other tools that came after Adam Smith, just as a biology class would talk about genetics when teaching evolution, even though Darwin never knew about genetics.

The most insidious form of conversion is when you don't even realize a viewpoint is being advanced on you, instead believing it to be 'objective.' Every model of the world has certain assumptions, certain axioms, built into it. To maintain the ability to think for yourself, the best material to read are those works that are very clear and honest about their axioms. In a very real sense, those are the most 'scientific' works. But those same works will often appear more partisan as well, in the same way that a research paper is both more scientific and more focused on one model of the world than is a generic textbook.

I recommend starting with Murray Rothbard's For a New Liberty, which takes a very bottom-up approach to economic principles:


There are plenty of other excellent books and materials available freely from the Mises Institute as well:



Your point is fairly well-argued but, I think, essentially untrue.

> "Every model of the world has certain assumptions, certain axioms, built into it."

This is almost a tautology. Of course it's impossible to make a truly objective model of the world, particularly if by "model of the world" we really mean "economic model that has a priori had most of the nuance stripped out of it". There's no truly objective way to approach economics, yes -- because economies are so enormous and so complex that to study them you have to ignore most of what's actually going on.

But that doesn't mean all approaches to economics are equally objective, and you're wrong to suggest that objectivity of analysis isn't worth considering. I'm quite sure that some economists have less of an axe to grind than others -- and as a result have more dedication to getting at the truth -- and I'd bet that they get better answers than their competition does. They're the ones I'd like to learn from. And I'd imagine that they wouldn't adhere too closely to any given philosophy, because it seems unlikely that any one philosophy is completely right.

So, having said all that, I'd like to reiterate the grandparent's request: does anybody know of any primers to economics that seem concerned more with trying to get the right answers to the questions of economics than with pushing a particular philosophy?

You missed my point completely. Let's see:

you're wrong to suggest that objectivity of analysis isn't worth considering

I abhor anything but objective analysis, which to me means something very close to "honest analysis." My suggestion above basically boils down to the idea that independent thinkers should read primary documents (while understanding their context).

Go read Marx's manifesto. Read Mussolini's writings on why Marx was wrong and how fascism is a better system. Read Keynes. Read Friedman's deconstructions of Keynes. Read Mises' deconstructions of socialism (particularly the problem of economic calculation). Read Rothbard's deconstructions of monetarism. Et cetera. But skip the false textbook-style 'objectivity' that just randomly assembles the ideas of history into an incongruent mush.

But that doesn't mean all approaches to economics are equally objective

Correct; I would never suggest as much. Some are logically inconsistent, or consist of arguments mired deeply in logical fallacies. Some grossly conflate cause with effect and correlation with causation. Many focus only on the benefits of a policy to a concentrated group while ignoring the diffuse costs to the rest of society. And some advocate policies that never produce the outcome that is promised.

Reading primary documents may or may not be the best way to get an unbiased view, but regardless, it's not actually what you suggested in your first post. You said:

> "To maintain the ability to think for yourself, the best material to read are those works that are very clear and honest about their axioms."

It's unclear what this means w.r.t. choosing materials to learn economics from. Luckily, you clarified your position by recommending Rothbard's For a New Liberty as an economic primer.

As far as I can tell from taking a quick look at it, For a New Liberty spends at least its first fifty pages talking about the basic principle of libertarianism and how it should be applied by a good libertarian. It is undeniable that Rothbard is up front about his biases, and when I looked through FANL I sort of figured out what you meant by "very clear [] about their axioms".

It is equally undeniable, however -- and this was my point -- that his biases are adhered to out of a mysterious near-religious conviction, and not because he thinks that they will get him to the truth, and that as a result he is probably not an ideal person to learn economics from.

And it is also true that recommending an enormous tract whose first fifty pages (at least) consist of heavily biased pseudophilosophical tripe to somebody who wants to learn economics from an unbiased source is really really stupid, and makes me think that your basic agenda is to push Rothbard's ideas or something like them.

Sure, I have an agenda. What's the point of writing if not to change minds?

My emphasis was you should be conscious that everyone has an agenda, even those who claim to be 'standard' or 'objective,' particularly when it comes to the dismal science.

I told the commenter to read strong viewpoints and think for himself. Then I suggested my preferred quadrant of the noosphere as a place to start. Why? Because I consider it more generally insightful and intellectually honest than most of the drivel out there. But of course, your mileage may vary.

In retrospect, I should have just suggested PG's essay "How to Make Wealth" [1], as it contains the single most important insight commonly missed in economic discussions.

[1] http://www.paulgraham.com/wealth.html

There is no such thing as objectivity.

For such a thing to exist an entity with no desires, interests or stakes would have to make this objective judgment.

All we can do is perhaps identify the different subjective components in a argument.

It is perhaps a semantic point, but I consider a && !a objectively false and a || !a objectively true -- but even there, you have to accept certain axioms of logic. And I consider initiating violence against a peaceful person objectively immoral -- but if you don't already accept that, I'm not sure how I could convince you.

Epistemology is interesting and complex.

I respectfully disagree. a && !a is not objectively false, and neither is a && !a objectively true. You are correct within a set of accepted axioms, defined by Mr. Boole. You might be incorrect within another set of axioms.

That's exactly what this thread is about : when you do real maths you always start from definitions and axioms. It's not objective or subjective, it's well defined.

I do prefer to read opinions of people who state their axioms first, rather than people who pretend to be objective.

Initiating violence against a peaceful person is immoral in lots of cultures (including mine). Your culture is your set of axioms here.

One of the key insights of the Austrian school is that historical mathematical analysis while useful for entrepreneurs is not economic law and is merely a forecast. You cannot predict accurately what lowering the interest rate will do, you can say that printing money causes inflation, but cannot specify how prices will actually change.

This comment is completely useless without some kind of citation or reference. (It's also annoyingly smug.)

Sometimes you just assume that people have kept their eyes open -- or at least have Google at their disposal.

I'm not sure anything is broken, we just had plain old regulatory capture.

Greenspan himself admitted he thought that people would protect their own self interest. But those people get bonuses if their risks pay off and have no real downside if they lose. They are gambling with other people's money, not their own money.

And it's not as if self interest and lack of government bailouts prevent the Dutch tulip bubble, or any other speculative bubble.

... but it did prevent the speculative losses from being socialized while keeping gains private. Only people who bought tulips lost money.

It's also widely thought today that the tulip mania was brought on in part by a parliamentary decree that weakened contractual protections on tulip contracts -- making it easy to speculate on inflated tulip prices without a correspondingly strong fear of loss.

There is also a strong case to be made that, similar to the current situation, the tulip mania was prompted or sustained by a sudden increase in the monetary base. Apparently the balance sheet of the Bank of Amsterdam was surging during this period.

Out of interest, do you have a link or source for your last comment regarding the Bank of Amsterdam?

No, it was from memory. But fortunately Wikipedia cites its sources:


Same happened before with chemestry / alchemy and astronomy / astrology - there were alchemists that were trying to please their king with promises of gold out of nothing or horoscopes, and there were scientists, that used it as a source of funding for their real research. Chemistry and Astronomy won, unfortunately our economic alchemy refuses to die.

But of course, with the current financial system it looks as though large financial companies have managed to create wealth out of nothing or horoscopes.

This article is remarkably well balanced and correctly points out that both those who previously blindly followed economicists and those who blindly ignore them now are wrong. The truth of course is in between.

Economics is both a comparitively young science (at least in terms of when it was formalized) and one that deals with (or is influenced by) a very unpedictable factor, human actions. It gets many things right, and some things wrong. With time, it will be refined though by its nature it is likely to never reach the rigour and predictive power of some of the hard sciences such as physics.

This current upset is rightly forcing a reevaluation of many beliefs, but when the dust finally settles in the future, economics will emerge stronger and more accurate than before.

But does that mean that Keynsianism is going to die? Not a chance. Keynsians control the entire monetary system. It does not matter how often their theories are debunked by history itself. They are the ones in power, and so they will continue to do what they do best: Rob from the poor and give to the rich through the hidden tax of inflation born of deficit spending and the centralized control of interest rates.

and by printing currency out of thin air.

I got hold of the article rather accidentally and was attracted by it. Somehow, it was then put aside due to some preoccupation but it keeps returning and flashing to me like owl’s-carrying-letters sent in to Harry Potter, demanding my involvement to perhaps save the world. Yes, the world is in big trouble and economists can’t help due to perhaps lack of genes and consequentially severe loss of sights.

“What went wrong with economics” is: Economics lacks at least one fundamental foundation. Installing this fundamental will elevate Economics to another platform.

What is this fundamental? It is something that sciences cling on tightly, but economics does not. So, economics has departed from this fundamental, perhaps unconsciously.

What is it then? It is the Fundamental Axiom or Law of Causality, simply means: Cause gives rise to Effect, In = Out, Debit = Credit, a Source for every Outcome, etc which are common senses or self-evident truths.

Tell us in what way the Economics runs away from this fundamental? If you ask: You win, I win, everyone wins, who then is the loser or provider of wealth? Most of economists will tell you that there is no loser. The Economics textbooks also say so. But it cannot be no loser, as it violates the fundamental Law of Causality. So, we must insist for the presence of loser, as dictated by the Fundamental Law of Causality.

On this insistence, one great researcher by the name of HNM had successfully uncovered the identity of the loser and the mask of wealth after an effort of several decades. Needless to say, he has restored the Fundamental Law of Causality back to the economics and make it a strong and real science. Using his new theory, all events in the past or present could be explained with ease, and that it could predict and even provide future policies and directions for our world.

If you are really interested to find out more, please write to me via my email: chinfuilan@yahoo.com

Let's check the index:

  What went wrong with economics. See Keynes, John Maynard

http://en.wikipedia.org/wiki/Information_asymmetry has played its role in economic depression.


I am a little baffled by the article's thesis. There is very little evidence to support a "failure" of economics in the case of this current crisis. Several economists (mainly Dean Baker) were able to see the housing bubble and to accurately predict that its burst would lead to a recession.

I suspect the real failure being discussed in the article is the belief many at the Fed (especially Greenspan) had in self-regulating markets. Good arguments have been made that the lack of regulation was a major factor in creating the bubble-prone economy the US has had for 15 years (or more). So yes, in that respect, the "economic models" have failed.

In reality, most of this was completely predictable and avoidable. I would again point people to Dean Baker as a great resource in understanding the crisis: http://www.youtube.com/watch?v=CrSrL0lBorE

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