Wednesday, November 17, 2010

Wanted: Common sense in economics

Nov 17, 2010
By David Brooks

MANY of the psychologists, artists and moral philosophers I know are liberal, so it seems strange that American liberalism should adopt an economic philosophy that excludes psychology, emotion and morality.

Yet that is what has happened. The economic approach embraced by the most prominent liberals over the past few years is mostly mechanical. The economy is treated like a big machine; the people in it like rational, utility maximising cogs. The performance of the economic machine can be predicted with quantitative macroeconomic models.

These models can be used to make highly specific projections. If the government borrows US$1 and then spends it, it will produce US$1.50 worth of economic activity. If the government spends US$800 billion (S$1 trillion) on a stimulus package, that will produce 3.5 million in new jobs.

Everything is rigorous. Everything is science.

Conservatives, who are usually stereotyped as narrow-eyed business-school types, have gone all Oprah-esque in trying to argue against these liberals. If the government borrows trillions of dollars, this will increase public anxiety and uncertainty, the conservatives worry. The liberal technicians brush aside this soft-headed mush. These psychological concerns are mythological, they say. That's gaseous blathering from those who lack quantitative rigour.

Other people get moralistic. This country is already too profligate, they cry. It already shops too much and borrows too much. How can we solve our problems by borrowing and spending more? The liberal technicians brush this away, too. Economics is a rational activity detached from morality. Hard-headed policymakers have to have the courage to flout conventional morality - to borrow even when the country is sick of borrowing.

The liberal technicians have an impressive certainty about them. They have amputated those things that can't be contained in models, like emotional contagions, cultural particularities and webs of relationships. As a result, everything is explainable and predictable. They can stand on the platform of science and dismiss the poor souls down below.

Yet over the past 21 months, it has been harder to groove to their certainty. To start with, the economy has not responded as the modellers projected, either in the months after the stimulus Bill was passed or this summer, when it was supposed to be producing hundreds of thousands of jobs. It has become harder to define how much good the stimulus package is doing. An US$800 billion measure must leave a large footprint, but it is hard to find in a US$70 trillion global economy.

Moreover, it has been harder to accept that psychological factors like uncertainty and anxiety really are a mirage. The first time a business leader tells you she is holding off on investing because she is scared about the future, you dismiss it as anecdote. But over the past few years, I've had hundreds of such conversations.

It's been harder to dismiss morality as a phantom concern, too. Maybe in a nation of robots the government can run a policy that offends the morality of the citizenry, but not in a nation of human beings, as the recent mid-term congressional elections showed.

Nor has the world come to look simpler and easier to manipulate since the stimulus passed. It now looks more complicated. It's one thing to hatch an ideal policy in an academic lab, but in the real world, context is everything.

Mr Ethan Ilzetzki of the London School of Economics and Messrs Enrique Mendoza and Carlos Vegh of the University of Maryland examined stimulus efforts in 44 countries. In a recent National Bureau of Economic Research paper, they argued that fiscal stimulus can be quite effective in low-debt countries with fixed exchange rates and closed economies.

Stimulus measures are generally not as effective, on the other hand, in countries like the United States with high debt and floating exchange rates. The authors of the paper pointed to a series of specific circumstances that complicate, to say the least, the effectiveness of increasing public spending: How much stimulus money ends up flowing abroad? What is the relationship between fiscal policy and monetary policy? How do investors respond to fear of future interest rate increases?

One could go on. It's become harder to have confidence that legislators can successfully enact the brilliant policies that liberal technicians come up with. Far from entering the age of macroeconomic mastery and social science triumph, we seem to be entering an age in which statecraft is, once again, an art, not a science.

When you look around the world at the countries that have come through the recession best, it's not the countries with the brilliant and aggressive stimulus models. It's the ones like Germany that had the best economic fundamentals beforehand.

It all makes one doubt the wizardry of the economic surgeons and appreciate the old wisdom of common sense: simple regulations, low debt, high savings, hard work, few distortions. You don't have to be a genius to come up with an economic policy like that.


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