Panglossian finance

Disagreement among practitioners of the dismal science

As David Blanchflower argued in his first economics column for the NS, the crash of autumn 2008 wasn't just a failure of banking practice -- it was an intellectual failure, too. The collapse of Lehman Brothers just over a year ago wasn't just an indictment of hubris and greed on Wall Street; it was also "a body blow to those economists around the world who had designed worthless mathematical models, based on unrealistic assumptions that they then used to convince themselves that a recession of this kind could never happen again".

Blanchflower's magisterial dismissal of "useless economic models" echoed something the Nobel Prize-winning economist and New York Times columnist Paul Krugman had a written a couple of weeks earlier. Under the title "How Did Economists Get It So Wrong", Krugman chastised economists for "mistaking beauty for truth" -- for allowing themselves, that is, to be seduced by abstract mathematical models and an "idealised vision of an economy in which rational individuals interact in perfect markets". The only problem is that perfect markets have never existed and never will exist -- pace what Krugman nicely calls "Panglossian finance" -- and the sooner economists "learn to live with messiness", the better.

That's a very Keynesian view, of course. As Peter Clarke shows in his book Keynes: the 20th Century's Most Influential Economist (reviewed in the NS by Andrew Gamble), a recognition of the pervasiveness of uncertainty was a very important part of Keynes's vision. Keynes wrote that the "fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the classical political economy". In other words, the market doesn't always get it right; in fact, very often it gets it catastrophically wrong.

Compelling stuff -- but some of Krugman's fellow economists have objected to being handed such low marks, among them John H Cochrane of the University of Chicago, who returned fire in an article entitled "How Did Paul Krugman Get It So Wrong?". Cochrane boils Krugman's piece down to the thesis that (in Krugman's own words) "Keynesian economics remains the best framework we have". He then charges Krugman with making a number of incompatible arguments.

For instance, in Cochrane's view, it is only because Krugman caricatures the so-called "efficient markets hypothesis" that his call for an economics that "recognises flaws and frictions" and "incorporates alternative assumptions about behaviour" has any force at all. Cochrane is caustic about this:

I say, "Hello, Paul, where have you been for the last 30 years?" Macroeconomists have not spent 30 years admiring the eternal verities of Kydland and Prescott's 1982 paper. Pretty much all we have been doing for 30 years is introducing flaws, frictions and new behaviours, especially new models of attitudes to risk, and comparing the resulting models, quantitatively, to data. The long literature on financial crises and banking which Krugman does not mention has also been doing exactly the same.

Further, according to Cochrane, "Krugman argues that 'a more or less Keynesian view is the only plausible game in town', and 'Keynesian economics remains the best framework we have for making sense of recessions and depressions'. One thing is pretty clear by now, that when economics incorporates flaws and frictions, the result will not be to rehabilitate an 80-year-old book." Ouch! Cochrane goes on: "A science that moves forward almost never ends up back where it started. Einstein revises Newton, but does not send you back to Aristotle. At best you can play the fun game of hunting for inspirational quotes, but that doesn't mean that you could have known the same thing by just reading Keynes once more."

Cochrane is taking it for granted here that economics is a science, in the way that physics is -- that's the point of the gibe about Einstein, Newton and Aristotle. And I think that may be where the disagreement between Krugman and Cochrane is most profound. For, as Krugman surely knows, Keynes regarded economics as being a moral as much as a mathematical science. This is one of the central insights of Robert Skidelsky's recent book about Keynes, also discussed in the review by Andrew Gamble mentioned above: "One of the greatest defects of economics today is that it has become a branch of applied mathematics. [But] Keynes thought of economics as part of the human discourse."

Jonathan Derbyshire is Managing Editor of Prospect. He was formerly Culture Editor of the New Statesman.

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Politics doesn't just connect us to the past and the future – it's what makes us human

To those people who tell me that they’re not interested in politics, I often say: “But politics is interested in you!”

I have long been haunted by a scene in George Orwell’s great novel Nineteen Eighty-Four. Winston Smith, the hero, is forced to watch propaganda films depicting acts of war and destruction. He is moved by something he sees: a woman trying to protect a child by wrapping her arm around him as they are attacked. It’s a futile gesture. She cannot shield the boy or stop the bullets but she embraces him all the same – before, as Orwell writes, “The helicopter blew them both to pieces.”

For Winston, what Orwell calls the “enveloping, protecting gesture” of the woman’s arm comes to symbolise something profoundly human – an expression of selflessness and of unconditional love in an unforgiving world. Scenes such as this we now witness daily in footage from the besieged eastern Aleppo and other Syrian towns, people in extreme situations showing extraordinary dignity and kindness.

I read Nineteen Eighty-Four for the first time in late adolescence. I’d dropped out of sixth-form college without completing my A-levels and was commuting on a coach from my parents’ house in Hertfordshire to London, where I worked as a junior clerk for the Electricity Council. During this long daily journey – sometimes two hours each way – I started to read seriously for the first time in my life.

I was just getting interested in politics – this was the high tide of the Thatcher years – and Orwell’s portrayal of a dystopian future in which Britain (renamed “Airstrip One”) had become a Soviet-style totalitarian state was bleakly fascinating. Fundamentally the book seemed to me to be about the deep ­human yearning for political change – about the never-ending dream of conserving or creating a better society.

Nineteen Eighty-Four was published in 1949 (Orwell died in January 1950, aged 46), at a time of rationing and austerity in Britain – but also of renewal. Under the leadership of Clement Attlee, Winston Churchill’s deputy in the wartime coalition, the Labour government was laying the foundations of what became the postwar settlement.

The National Health Service and the welfare state were created. Essential industries such as the railways were nationalised. The Town and Country Planning Act was passed, opening the way for the redevelopment of tracts of land. Britain’s independent nuclear deterrent was commissioned. New towns were established – such as Harlow in Essex, where I was born and brought up.

To grow up in Harlow, I now understand, was to be part of a grand experiment. Many of the families I knew there had escaped the bomb-ruined streets of the East End of London. Our lives were socially engineered. Everything we needed was provided by the state – housing, education, health care, libraries, recreational facilities. (One friend described it to me as being like East Ger­many without the Stasi.)

This hadn’t happened by accident. As my father used to say, we owed the quality of our lives to the struggles of those who came before us. The conservative philosopher Edmund Burke described society as a partnership between “those who are living, those who are dead, and those who are to be born” – and I find this idea of an intergenerational social contract persuasive.

Progress, however, isn’t inevitable. There is no guarantee that things will keep getting better. History isn’t linear, but contingent and discontinuous. And these are dark and turbulent new times in which we are living.

A civil war has been raging in Syria for more than five years, transforming much of the Middle East into a theatre of great-power rivalry. Europe has been destabilised by economic and refugee crises and by the emergence of insurgent parties, from the radical left and the radical right. The liberal world order is crumbling. Many millions feel locked out or left behind by globalisation and rapid change.

But we shouldn’t despair. To those people who tell me that they’re not interested in politics, I often say: “But politics is interested in you!”

And part of what it means to be human is to believe in politics and the change that politics can bring, for better and worse.

What, after all, led so many Americans to vote for an anti-establishment populist such as Donald Trump? He has promised to “make America great again” – and enough people believed him or, at least, wanted to believe him to carry him all the way to the White House. They want to believe in something different, something better, in anything better – which, of course, Trump may never deliver.

So politics matters.

The decisions we take collectively as ­humans have consequences. We are social creatures and rational agents, yet we can be dangerously irrational. This is why long-established institutions, as well as the accumulated wisdom of past generations, are so valuable, as Burke understood.

Politics makes us human. It changes our world and ultimately affects who we are and how we live, not just in the here and now, but long into the future.

An edited version of this essay was broadcast as part of the “What Makes Us Human?” series on BBC Radio 2’s “Jeremy Vine” show

Jason Cowley is editor of the New Statesman. He has been the editor of Granta, a senior editor at the Observer and a staff writer at the Times.

This article first appeared in the 01 December 2016 issue of the New Statesman, Age of outrage