DRI-221 for week of 12-8-13: What’s (Still) Wrong with Economics?

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What’s (Still) Wrong with Economics?

Taking stock is an end-of-year tradition. This space devotes the remainder of the year to explaining the value of economics, so it’s fitting and proper to don a hair shirt and break out the penance whips as 2013 fades into the distance. What’s wrong with economics? Why doesn’t its productivity justify its title of queen of the social sciences – and what could be done about that?

This omnibus indictment demands an orderly presentation, organized by subject area.

Teaching: Although the motto of the Econometric Society is “science is measurement,” a better operational definition is “science is knowing what the hell you’re talking about.” On that score, economics has a lot to answer for. A science is only as good as its practitioners, who regurgitate what they are taught. Teaching is the first place to lay blame for the shortcomings of economics as a science.

In the past, economics has seldom been taught at the secondary level. That is changing, but only slowly. The subject is so difficult to master and absorption is such an osmotic process that an early start would vastly improve results. It would also force an improvement in the standard mode of teaching.

At the college level, economics is taught by teaching the same formal theory that Ph. D. students are required to master. Granted, college freshmen begin at the most basic level using far simpler tools, but they learn the same techniques. As the successful business economist Leif Olsen (among others) has pointed out, the tacit premise of college economics instruction is that all students will go on to study for their doctorate in the subject.

That is absurd. It forces textbooks to concentrate on force-feeding students bits (or chunks) of technique, supposedly to insure that all students are exposed to the tools and reasoning used by working economists. The use of the word “exposed” in this context should call to mind a disreputable man clothed only in a raincoat, accosting impressionable females in a public park. That captures both the thoroughness and duration of the exposure to each technical refinement, as well as the depth of understanding and relative appeal to the emotions and intellect on the part of the students.

What is needed here is textbooks and teachers that cover much less ground but do it much more thoroughly. Only a tiny fraction of students seek, let alone obtain, the Ph. D. The rest need to grasp the basic logic behind supply and demand, opportunity cost and the role of markets in coordinating the dispersed knowledge of humanity. This requires intensive study of basics – something that would also benefit today’s eventual doctoral candidates, many of whom never learn those basics. The only textbook serving this need that comes quickly to mind is The Economic Way of Thinking, by the late Paul Heyne.

In addition to the benefits accruing to undergraduate education, other advantages would follow from this superior approach. As it now stands, graduate students in economics are hamstrung by the subject’s austere formalism. The mathematical approach is now so rigorous at the highest levels of economics that the subject bears a stronger resemblance to engineering or physics than to the political economy practiced by classical economists in the 18th and 19th centuries. If this so-called rigor added value in form of precision to the practice of economics, it would be worth its cost in pain and hardship.

Alas, it doesn’t. Even worse, graduate students have to spend so much time grappling with mathematics that they lack the time to absorb the basic elements underlying the mathematics. Often, the mathematical models must eliminate the basic elements in order make the mathematics tractable. We are then left with the anomaly of an economic theory that must truncate or amputate its economic content in order to satisfy certain abstract scientific criteria. This obsession with formalism has substituted bad science for good economics – the worst kind of tradeoff.

The reader might wonder who benefits from the status quo, since beneficiaries have not been evident in the telling thus far. The current system creates a narrow road to academic success for career economists. They must fight their way through the undergraduate curriculum, then labor as part-time teachers and research assistants while taking their own graduate courses. Writing the Ph. D. dissertation can take years, after which they have a short time (usually six years) in which to write publishable research and get it placed in the small number of peer-reviewed economics journals. If they succeed in all this, they may end up with tenure at an American university. This will entitle them to job security and opportunity for advancement and a sizable income. If they fail – well, there’s always the private sector, where a small number of economists attain comparable career success. It is the survivors of this process, the tenured faculty at major American colleges and universities, who benefit from the system as it exists.

Perhaps this privileged few are an extraordinarily productive lot? Well, there are a tiny handful of the professoriate who produce research output that might reasonably be classed as valuable. Most articles published in professional journals, though, are virtually worthless. Nobody would pay any significant money to sponsor them directly. That’s not all. In addition to the arid mathematics employed by the theoretical research, there is also the statistical technique used to generate empirical articles. For several decades, the primary desideratum in statistical economics has been to obtain “statistically significant” results between the variable(s) in the economic model and the variable we are trying to understand. If questioned about this, the average person would probably define this criterion as “a large enough effect or impact to be worth measuring, or large enough to make us think what we are measuring has an important influence on what we are studying.”

Wrong! “Statistical significance” is a term of art that means something else – something that is more qualitative than quantitative. Essentially, it means that there is a likelihood that the relationship between the model variable(s) and the variable of interest is not due to random chance but is, rather, systematic. Another way of putting it would be to say that statistical significance answers a binary, “yes-no” question instead of the question we are usually most interested in. The big question, the one we most want the answer to, is usually a “how much” question. How much influence does one variable have on another; how great is the importance of one variable on another? The question answered by statistical significance is interesting and useful, but it is not the one we care about the most. Yet it is almost the only one the social sciences have cared about for decades. And, believe it or not, it is apparent that many economists do not even realize the mistake in emphasis they have been making.

Yet it is not the small number of beneficiaries or even their ghastly mistakes that indicts the current system. Rather, it is economic theory itself, which insists that people benefit from consumption rather than production. It is consumers of economics – students and the general public – who should be reaping rewards. The benefits earned by tenured professors are not bad if they are earned by providing comparable benefits to consumers rather than merely reaping monopoly profits from an exclusionary process. But students are lowest on the totem pole on any major university campus. Tenured faculty members teach as little as possible, usually only two courses per semester. Teaching is little rewarded and often poorly done by tenured and non-tenured faculty alike. Academic lore is filled with stories of award-winning teachers who neglected research for teaching and were dumped by their university in spite of their teaching accomplishments.

The late Nobel laureate James Buchanan characterized the position of academic economists today to “a kind of dole;” that is, they are living off the taxpayer rather than earning their keep. Administrators are fellow beneficiaries of the system, although they are pilot fish riding the backs of all academicians, not merely economists.

The Public: Consumers of economics include not merely those who study the subject in school but also the general public. Economists advise businesses on various subjects, including the past, present and future level of economic activity overall and within specific sectors, industries and businesses. They provide expert witness services in forensics by estimating business valuation, damage and loss in litigation, by representing the various parties in regulatory proceedings and particularly in antitrust litigation. Economists are the second-most numerous profession in government employment, behind lawyers.

For some seventy years, economists have played an important role in the making of economic policy. One might expect that economists would play the most important role; who is qualified to decide economic policy if not economists? In fact, modern governments place politicians and bureaucrats ahead of everybody when it comes to policymaking regardless of expertise. This has created a situation in which we were better off with no economic policy at all than with an economic policy run by non-economists. Still, the recent efforts of professional economists do not paint the profession in a favorable light, either.

The problem with public perception of economics and economists is that they have come to regard economics as synonymous with “macroeconomics;” that is, with forecasting and policymaking aimed at economic statistical aggregates like employment, gross domestic product and interest rates in the plural. This is the unfortunate byproduct of the Keynesian Revolution that overtook economics in the 1930s and reigned supreme until the late 1970s. The overarching Keynesian premise was that only such an aggregative focus could cure the recurrent recessions and depressions that Keynesians ascribed to the inherent instability and even stagnation of a private economy left to its own devices.

It is ironic that every premise on which Keynes based his conclusions was subsequently rejected by the four decades of extensive and intensive research devoted to the subject. It is even more ironic that the conclusion reached by the profession was that attention needed to be focused on developing “microfoundations of macroeconomics,” since it was the very notion of microeconomics that Keynes rejected in the first place. And the crowning irony was that, while Keynes ideas filtered down into the textbook teaching of economics and even into media presentation of economic news and concepts to the general public, the rejection of Keynesian economics never reached the news media or the general public. Textbooks were revised (eventually), but without the fanfare that accompanied the “Keynesian Revolution.”

So it was that when the financial crisis of 2008 and ensuing Great Recession of 2009 reacquainted America with economic depression, Keynesian economists could reemerge from the subterranean depths of intellectual isolation like zombies from a George Romero movie without triggering screams of horror from the public. Only those with very long memories and a healthy quotient of temerity stood up to ask why discredited economic policies had suddenly acquired cachet.

When the Nobel Foundation began awarding quasi-Nobel prizes for economics in the late 1960s, a good deal of grumbling was heard in the ranks of the hard sciences. Economics wasn’t a real science, they maintained stubbornly. A real science is cumulative; it creates a body of knowledge that grows larger over time owing to its revealed truth and demonstrated value in application. Economics just recycles the same ideas, they scoffed, which go in and out of fashion like women’s hemlines rather than being proved or disproved.

From today’s vantage point, we can see more than just a grain of truth in their disparagement – more like a boulder, in fact. What macroeconomist Alan Blinder referred to in a journal article as “the death and life of Keynesian economics” is a perfect case in point. Keynesian economics did not arise because it was a superior theory – research proved its theoretical inferiority. Not only that, it took decades to settle the point, which doesn’t exactly constitute a testimonial to the value of the subject or the lucidity of its doctrines. Keynesian economics did not triumph in the arena of practical application; that is, countries did not eliminate recessions and depressions using Keynesian policies, thereby proving their worth. Just the opposite; after decades of pinning his hopes on Keynesian economics, the British Labor Party leader James Cavenaugh renounced it in a celebrated denunciation in the mid-1970s.

No, Keynesian economics made a comeback because it was politically useful to the Obama administration. It enabled them to spend vast amounts of money and direct the spending to political supporters on the pretext that they were “stimulating the economy.” If economics had to justify its existence by pointing to the results of “economic policy,” economists would be thrown out into the street and forbidden to practice their craft.

In the early 1960s, Time Magazine put John Maynard Keynes on its cover and proclaimed the death of the business cycle. This obituary proved to be premature. Like Icarus, economists tried to fly too high. Their wings melted by the solar heat, the profession is now in freefall, putting up a bold front and proclaiming “so far, so good” as they plummet to Earth. The only remedy for this hubris is to straightforwardly admit that economics is not a hard, quantitatively predictive science in the mold of the natural sciences. Its fundamental insights are not quantitative at all but they are absolutely vital to our well-being. When combined with such other social sciences as law and political science, economics can explain patterns of human behavior involving choice. It can unlock the key to human progress by making the knowledge sequestered in billions of individual brains accessible in useful form for the mutual benefit of all. Thanks to economics, billions of people can live who would die without its insights. These benefits are anything but trivial.

Economics can even ameliorate the hardships imposed by the business cycle, as long as we do not expect too much and can resign ourselves to occasional recessions of limited length and severity. In this regard, success can be likened to hitting home runs in baseball. Trying to hit home runs by swinging too hard usually doesn’t work; making solid contact is the key to hitting homers. Many great home-run hitters, including Hank Aaron and Ernie Banks, were not large, powerful men who swung for the fences. They were wiry, muscular hitters who hit solid line drives. The economic analogue of this philosophy is to allow free markets to work and relative prices to govern the allocation of resources rather than trying to use government spending, taxes and money creation as a bludgeon to hammer the efforts of markets into a politically acceptable shape.

Remedies: In thinking about ways to right its wrongs, economics should take its own advice and fall back on free markets. Rather than trying to administratively reshape the academic status quo and tenure-based faculty system, for example, economists should simply support privatization of education. This is simply taking current professional support of tuition vouchers and charter schools to the next logical level. Tenure is a protected academic monopoly, unlikely to survive in a free private market. If it does, this will mean that it has unsuspected virtues; so much the better, then.

Recent decades have seen the rise of applied popular economics books written to bring economics to the masses. The best-known and most popular of these, Freakonomics, is among the least useful – but it is better than nothing. Better works have been submitted by economists like Steven Landsburg (The Armchair Economist) and David Friedman. Their worthy efforts have helped to turn the tide by correcting misapprehensions and redirecting focus away from macroeconomics. This is another good example of reform from within the profession that does not require economists to sacrifice their own well-being.

Perhaps the one missing link in economics today is leadership. Revolutions in scientific theory and practice are typically effected by individuals at the head of scientific movements. In economics, these have included men like Adam Smith, David Ricardo, Karl Marx, the Austrian economists of the 19th century, Alfred Marshall, Keynes and Milton Friedman. Today there is a leadership vacuum in the profession; nobody with the intellectual stature of Friedman remains to take the lead in reforming economics.

Given the woes of economics and economic theory, a new candidate seems unlikely to come riding over the horizon. It may be that economists will have to prop up an intellectual giant of the past to ride like El Cid against the ancient foes of ignorance, apathy, prejudice and vested interest. There is one outstanding candidate, the man who saved the 20th century in life and whose wide-ranging thought and multi-disciplinary theory is alone capable of midwiving a new sustainable economics of the future. That would be F.A. Hayek. Recent stirrings within the profession suggest a growing acknowledgment that Hayek’s economics have been too long neglected and explain the crisis, recession and current stagnation far better than anything offered by Keynes or his followers. There is no better body of work to serve as a model for what is wrong with economics and how to correct it than his.

DRI-277 for week of 11-3-13: Why Are There No Economists Among Leading Opinion-Molders Today?

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Why Are There No Economists Among Leading Opinion-Molders Today?

Today the discipline of economics occupies a strange position within the general public. The Financial Crisis of 2008 and ensuing Great Recession brought economics to the daily attention of Americans more forcefully than since the Great Depression of the 1930s. The Federal Reserve’s monetary policies, particularly its recent tactic of Quantitative Expansion (QE) of the stock of money, have made monetary policy the object of attention to a greater extent than at any time since the days of stagflation and supply-side economics during the Reagan administration in the early 1980s. One would expect to find economists occupying center stage almost every day.

Not so, surprisingly enough. Contrast the position of economics today with, say, that in the 1960s and 70s, just prior to Ronald Reagan’s election as President. At that point, three economists were familiar on sight and sound to a great many Americans: John Kenneth Galbraith, Paul Samuelson and Milton Friedman. Today, the venues, space and time available to economists far outnumber those existing forty years ago. Yet no economist today even approaches the influence and familiarity of the Big Three in their heyday. A brief recollection of each is in order for the benefit of younger readers.

The Big Three of Yesteryear: Galbraith, Samuelson and Friedman

The Big Three economists of yesteryear bestrode the 20th century like colossi and stood tall into the 21st. They were all born and died within a few years of each other: Galbraith (1908-2006) slightly outlasted Samuelson (1915-2009) and Friedman (1911-2006) in longevity although he died first, in April 2006. They were all self-made and experienced the Depression first hand. Each was a prolific writer but appealed to a different audience.

The best-selling writer of the three was John Kenneth Galbraith, whose literary zenith produced The Affluent Society (1958) and The New Industrial State (1967). Compactly put, Galbraith’s thesis was that Americans were satiated with consumer goods but starved for so-called “public goods;” i.e., the goods government was uniquely situated to provide. The economy thrived not on competition but on monopoly exercised by giant corporations, who artificially created the demand for their products via advertising rather than merely responding to the inchoate demands expressed by consumers. Since consumer wants depended on the same process that satisfied them, that process of want-satisfaction could not be justified or defended as simply “giving the people what they want.” Therefore, government was not merely allowed but morally required to tax and regulate business to restrain their behavior and acquire the resources necessary to redress the imbalance between public and private spending. Galbraith’s views resonated with the general public much more than with the economics profession itself, where only the New Left, radicals, institutionalist admirers of Thorstein Veblen and quasi-Marxists found them attractive. Needless to say, Galbraith’s ideas seem quaint today in light of the decline and fall of the supposedly invulnerable giant corporations he worshipped.

In addition to his economic works, which also included American Capitalism (1952) and A Theory of Price Control (1952), Galbraith wrote novels and memoirs of his travels and tenure as Ambassador to India. His iconoclastic views – he minted the phrase “the conventional wisdom” – and ironic style endeared him to the general public, whose distrust of authority he shared. This seems odd of a man whose World War II service as deputy head of the Office of Price Administration made him one of America’s chief bureaucrats, but Galbraith’s early life was spent on a farm in Canada. Another of his books was a novel satirizing America’s foreign-policy establishment (“Foggy Bottom”). Perhaps the chief object of his scorn over the years was the corporate hierarchy, whose morals and mores he never tired of mocking despite his exaggerated opinion of their power over markets.

Paul Samuelson was the leading theoretician among American economists and the first American awarded the economics version of the Nobel Prize in 1970. His scholarly articles numbered in the hundreds, but he is remembered today chiefly for two books: Foundations of Economic Analysis, based on his doctoral dissertation, which signaled a turning point in economics to mathematics as the formal mode of analysis; and Economics, his all-time best-selling college text that combined principles textbooks in microeconomics and macroeconomics in order to integrate the two analytically into the so-called “Neoclassical synthesis. Samuelson combined the elements of classical price theory as developed by Alfred Marshall and refined by subsequent generations with Keynesian macroeconomics as modified from Keynes by the neo-Keynesian generation that included Samuelson himself, Franco Modigliani and James Tobin, among others. This book (really, a double book) taught generations of economists through over twenty editions from the 1940s until the 21st century.

Samuelson’s central conceit was that individual free markets worked beautifully, but markets in the aggregate were prone to unemployment or inflation. This aggregate shortcoming could only be corrected by government spending directed by… well, by men like Samuelson himself; although he always refused to take a policy post in the Democrat administrations he supported and advised.

As with Galbraith, it is difficult for non-economists today to credit the veneration Samuelson inspired in certain quarters. In the late 1950s, Samuelson began predicting that the Soviet Union would soon overtake the U.S. in per-capita GDP (then GNP). He retained this prediction in successive editions of his textbook – until the final overthrow of the Soviet Union in 1991. Galbraith and Samuelson made an odd couple of Keynesians – the former supporting massive government spending in spite of his distrust of the bureaucracy and the latter embracing deficit spending by government because he had faith in the ability of government to fine-tune aggregate economic activity. Samuelson shared a forum in Newsweek Magazine in an alternating column with the third member of our Big Three, Milton Friedman.

Friedman became well-known among fellow economists long before he attracted public notice. He won the John Bates Clark medal awarded to the leading economist under the age of 40 and published a notable collection entitled Essays in Positive Economics that contains some of the best expository writing ever done in his subject. 1957 saw what he considered his best piece of work, A Theory of the Consumption Function, which successfully reconciled cross-section data on aggregate consumption among different groups over the same time period with time-series data on consumption among all groups over time.

In the early 1960s, Friedman published two books within a year of each other that catapulted him to public attention and professional eminence. Capitalism and Freedom made both the political and economic case for free markets, an analytical position that had almost deteriorated through neglect. A Monetary History of the United States, which he co-authored with Anna Schwartz of the National Bureau of Economic Research, made an empirical case for the money stock as perhaps the chief economic variable of interest both historically and for policy purposes. Milton Friedman became the world’s chief exponent of the Quantity Theory of Money, which had been around ever since David Hume in the 18th century but had never before been put to such comprehensive use in economic theory. Ironically, Friedman’s single-minded focus on the money stock proved to be his Achilles heel. Although still greatly respected for his manifold contributions to economic theory and his prodigious talents as a defender of freedom and popularizer of economic thought, Friedman’s monetary theory is little regarded among professionals of all ideological stripes.

As the 60s and 1970s wore on, Friedman headed up the disloyal opposition to Keynesian economics within the economics profession. Keynes had been posthumously crowned king in the 1950s and early 60s as Western economies began to adopt the policy of spending their way to prosperity. But the advent of simultaneous high inflation and high unemployment, or “stagflation,” in the 1970s put paid to the Keynesian tenure atop the profession. Friedman and Edmund Phelps independently and more or less simultaneously developed the hypothesis of a “natural rate of unemployment” that defied Keynesian efforts to reduce it via deficit spending. Only through continually increasing injections of money into the economy – producing ever-increasing rates of inflation and resulting unrest – could unemployment be reduced and held below this “natural rate.” Friedman’s Nobel Prize, received in 1976, was by this time a foregone conclusion.

In 1980, Friedman reached his zenith of public popularity with the best-selling book and accompanying PBS television series Free to Choose. This was a popularized version of Capitalism and Freedom, updated for the 80s. For the first time, an economist had scaled the heights of public popularity, professional acclaim and policy prominence. Like Samuelson, Friedman preferred to exercise his influence outside of government. Unlike Samuelson, though, Friedman had actually worked for government in World War II. It was Milton Friedman, of all people, who devised the concept of government tax withholding to streamline the process of revenue collection.

Vacuum at the Top

Today, economics is omnipresent in our lives. Yet there is nobody in the public square whose position rivals that of the Big Three of yesteryear. The closest would be Paul Krugman, who has written several popular books, whose Nobel Prize is spelled exactly like the one received by Samuelson and who believes that the stock of money can play an important role in economic policy. In other words, he is a pale shadow of Galbraith, Samuelson and Friedman.

Noted economist Sam Peltzman probed this seeming paradox in an article published in the May, 2013 issue of Econ Journal Watch, 10(2) pp. 205-209, entitled “Why Is There No Milton Friedman Today?” Peltzman’s analytical qualifications are impeccable. He has carved out a distinguished career as a critic of government regulation. His crown jewel is a famous 1975 study on automobile safety that introduced the pioneering concept of “risk compensation” to the social sciences.

Risk compensation refers to the behavioral effects created by safety improvements and regulations. When people take more risk in response to safety improvements and/or regulation, this change in behavior has been christened the “Peltzman Effect.” Thus, Sam Peltzman has been given the greatest scientific honor of all – a scientific principle has been named for him.

Peltzman notes the absence of successors to the Big Three. He especially abhors the vacuum created by the loss of Milton Friedman. Peltzman’s explains it by citing Friedman’s unique talents. The first of these was his knack for communicating economic insights to the masses. The same expository skill Friedman brought to his professional work equipped him to educate the general public.

Peltzman illustrates Friedman’s style with a revealing anecdote from his own (Peltzman’s) academic career. Peltzman’s first graduate-school class was Friedman’s legendary class in Price Theory at the University of Chicago. The students “eagerly awaited our introduction to the technical mysteries of our chosen profession. Instead, we got an extended paraphrase of an article entitled ‘I, Pencil,’ in which a humble pencil tells us of the herculean coordination problem required to get itself produced and distributed and of the virtues of markets in solving that problem.” Peltzman correctly attributes the essay to Leonard Read, founder of the Foundation for Economic Education and its journal, The Freeman, in which the essay originally appeared. Peltzman’s points are that Friedman’s pedagogy was time-tested and simple and he employed it before professional audiences as well as public ones.

Friedman’s second unique virtue was his zest for combat. Libertarian economists were scarce in Friedman’s day and he knew his arguments would be received with scorn and incredulity. Nevertheless, his rejoinders were cheerful and clever; he relished the opportunity to buck the tide of collectivist conformism. And his devotion to his principles was unyielding. “All against one makes for a good show,” observes Peltzman, “and Friedman liked the odds.” This brings to mind the answer made by John Wayne’s character J.B. Books, the dying gunfighter in the movie The Shootist, when asked to account for his luck in surviving so many gunfights over the years: “I was willing.”

It is clear that even Galbraith and Samuelson couldn’t measure up to Milton Friedman by Peltzman’s criteria. Galbraith had the communication skills and debating talent but little worthwhile to communicate; his theory badly needed shoring up. Samuelson had the theory but communicated largely by writing letters to his fellow economists in the language of differential equations. His text worked well enough for a captive academic audience but nobody ever characterized his persona as “dynamic.” Both these men were, to some greater or lesser extent, arguing for the status quo, while one of Friedman’s books was titled The Tyranny of the Status Quo.

So far, so good. Peltzman makes a concise, compelling case for Milton Friedman as sui generis. Now, though, Peltzman tries to explain why today’s economists do not measure up to the standard set by Friedman. Although his observations of the economics profession seem descriptively accurate, his attitude toward their change in behavior is disturbingly complacent.

The Contemporary Economist as Engineer

In assessing the state of the profession today, Peltzman at first sounds optimistic. It’s true that there is no Milton Friedman leading the charge for freedom and free markets. But that isn’t due to a lack of free-market economists. “There are…numbers of them within our gates, perhaps more than in Friedman’s time…But they lack something that Friedman had in…his time.” Actually, they lack several somethings.

First, they lack the kind of dedicated, first-rate opponents Friedman had in abundance. “…The range of belief within economics has narrowed, partly because of Friedman’s efforts…the modal economist is less [interventionist]… than the modal economist of Friedman’s era…Market solutions…are given a respectable hearing or are part of the consensus today (think flexible exchange rates or unregulated railroad rates). There is less room today for a good fight among economists.” Apparently, Peltzman does not read Paul Krugman’s column in the New York Times.

If this sounds dubious, just listen to Peltzman’s next assertion. “Consider…what has happened in the aftermath of the financial crisis of 2008. The chattering class pronounced with excited joy that Capitalism is now Dead, but the political center hardly moved, and in some countries even moved right – to fiscal rectitude, labor market reform, etc. Hardly any left party that moved away from socialism in Friedman’s heyday has moved back since. What is a committed free-market economist spoiling for a good fight to do when the other side is not so far away?”

This narrative hardly sounds like a description of the multi-trillion dollar stimulus, multiple bailouts of big banks and financial firms, government seizure and handover to autoworkers of two of the Big Three auto companies, impending nationalization of health care, regulatory reign of terror and Federal-Reserve money-creation and asset-purchase binges that have characterized the U.S. since 2008. Contrary to Peltzman, events since 2008 have conformed more to Newsweek‘s famous cover headline: “We Are All Socialists Now.” And what has today’s “modal economist” done in response to this overwhelming frontal assault on free markets?

If Peltzman’s judgment that the economics profession has gravitated toward freer markets were correct, we would expect to read protests from our modal economist. Instead, he has, according to Peltzman, turned into “a much cooler customer. This one tends to be less committed to any politico-economic system.” Wait a minute – what happened to all those “numbers of …free-market economists…within our gates” just a minute ago? We could sure use them, because it now turns out that among the cooler customers, “the animating spirit is more the engineer solving specific problems than the philosopher seeking a unified world view. The questions asked tend to be smaller than, say, the connection between capitalism and freedom.”

Strangely, Peltzman doesn’t seem perturbed about this loss of ideological fervor, because “the skill with which the question is answered tends to be greater than in times past.” What about their professional duty to educate the public in the great truths of economics? “At some point,” Peltzman declares airily, “today’s leading economists may want to communicate their results to a wider audience. But this is an afterthought, in the sense that what is valued within the profession – the skill in obtaining the result – is not what the outside audience is interested in.”

Peltzman is surely wrong about the outside audience, who is intensely interested in “the skill in obtaining the result” because (at least in principle) it should affect the veracity of the result. Presumably what Peltzman meant to say is that the audience doesn’t care what method economists use to get the answer as long as they get the right one. And in this connection, it is hard to see what economics profession Peltzman is referring to – surely not the one that actually exists. For over two decades, Deirdre McCloskey and Steven Ziliak have proclaimed that econometric practice within the social sciences – in economics and elsewhere – is scandalously incompetent. Most empirical articles in the leading professional journals over-rely upon and misuse the principle of “statistical significance.” Thus the foundation of empirical economics has rotted away – and with it has gone Peltzman’s claim of greater skill.

Peltzman is not merely blind to the failings of his profession today; he is complacent about its future prospects. “It is hard for me to see a reversal of the kind of trends I have described…in…fields where the engineer has replaced the philosopher. Perhaps an economic calamity will shake things up in economics. But we had one in 2008, and very little changed within the profession. There was a period of befuddlement [after which] economists went back to their tinkering and were largely irrelevant to the political response to the crisis.”

Peltzman’s complacency even extends back to Friedman’s work. He attributes the fact that “there is no serious socialist faction left within economics” to “Friedman’s success,” which “makes it harder for someone to follow in his footsteps.” Peltzman declares flatly that “there is no serious political/economic alternative to some form of capitalist organization in any major economy.” Peltzman cannot have forgotten – can he? – that this was exactly the point made by Ludwig von Mises and reinforced by Mises and his student F.A. Hayek in the Socialist Calculation debates of the 1930s. This was a central contention of Hayek in his great polemic The Road to Serfdom in 1944. It was Hayek, the guiding spirit behind the Mont Pelerin Society of worldwide free-market economists who sparked Friedman’s interest in political activism in the late 1950s. Friedman admitted all this in his Introduction to the 1994 edition of The Road to Serfdom and in interviews with Hayek’s biographer, Alan Ebenstein.

Peltzman’s most outrageous error is his claim that “the Fed chairman learned from Friedman not to permit a credit freeze to turn into a monetary implosion.” Milton Friedman would have slit both wrists and reclined in a warm bath before endorsing the policies followed by Ben Bernanke before, during or after the Financial Crisis of 2008. Friedman’s criticism of Federal Reserve policy during the Great Depression did not pertain to a “credit freeze” but rather to the wholesale failure of banks throughout the U.S. and resulting nosedive taken by the money stock when deposits were destroyed. A credit freeze – whatever else it might entail – implies no such rapid decline in the money supply and therefore does not demand a “helicopter drop” of money, a la Milton Friedman, in order to cure it. Peltzman’s jaw-dropping attempt to imply a posthumous endorsement of Bernanke by Friedman is as inexcusable as it is inexplicable.

Peltzman has chosen the wrong model for his model economist – Friedman rather than Hayek. He has also chosen the wrong model for his modal economist – the engineer rather than the philosopher. In The Counter-Revolution of Science (recently republished under its original planned title, Studies on the Abuse and Decline of Reason), Hayek outlines the disastrous effects of subjecting society to control by the “mind of the engineer.”

The engineer strives to bring all aspects of a problem under his conscious control in order to achieve a technical optimum. He chafes at external constraints such as prices, incomes and interest rates; they are not “objective attributes of things but reflections of a particular human situation at a given time and place.” He sees them as meaningless, irrational interferences with his optimization techniques. When an engineer confronts a machine, for instance, he typically strives to gain the maximum power or energy output from given inputs of resources. In fact, as Hayek points out, the engineer’s technical optimum is usually just the solution that would obtain if the supply of working capital or resources was unlimited or the interest rate was zero. In adopting the perspective of the engineer, the economist is losing his own unique perspective. A good real-world example of the engineering perspective gone wrong in economic practice would be the misguided activist economic policies of former-engineer Herbert Hoover in trying to combat the Great Depression.

Peltzman correctly recalls that Milton Friedman advanced the view that the profession should pursue “positive economics” by formulating hypotheses and testing them empirically. But Peltzman neglects to inform his readers that today this viewpoint is as dead as the dodo – deader, actually, since today we can clone dodos back to life but we are not about to resurrect the canard that econometrics can be used to test predictive hypotheses in the social sciences in the same way that laboratory experiments test natural scientific hypotheses. In academic economics today, nobody believes that anymore. The massive, sausage-producing enterprise of submitting articles to refereed professional journals for acceptance continues, but purely as a ritual for granting tenure. Nobody now pretends that this process has any value above the purely ceremonial. It is now axiomatic in economics that econometrics does not prove anything, test any hypotheses or rule out (or in) any part of economic theory.

The format mathematical models economists swear by give the appearance of scientific rigor, but this is spurious. In order to reduce actual human activity to systems of solvable equations and stable equilibria, economists have to remove so much realistic detail that their models are unrecognizable to the layman. They are virtually useless for making quantitative predictions. We know this because, as the former Donald McCloskey put it, economists cannot answer “the American question: If you’re so smart, why aren’t you rich?”

Today, economic policy is taking measured that economists have warned against for centuries. The attempt to create wealth and induce prosperity by massive money creation is traditionally a tactic of desperation, one that inevitably ends in crisis and chaos. Yet economists sit silent instead of rising in indignant protest. And Peltzman appears to approve both the desperation tactics and the compliance of his profession.

Actually, Peltzman does betray deep-seated doubts about the current path of economics profession in his last sentence. It reads: “But one wonders still: is this only the calm before the storm?” And one wonders if Peltzman will have cause to regret his failure to speak out.

Whither Economics?

Sam Peltzman has courageously taken on one of the great contemporary mysteries. It is a missing-persons case. Where did the economist go in our public discourse? Peltzman succeeds in finding his quarry, all right. But having found him, he is distressingly indifferent to the runout. His confidence in the methods and motives of today’s economists seems utterly misplaced. Without realizing it, Peltzman himself is providing part of the explanation for the absence of economists from public discourse. He is sanctioning the abandonment of what they do best – teaching the philosophy behind economics – in favor of what they do worst – pretending to employ the methods and techniques of engineering in the foreign realm of economics.