If he did, he would be confronted with the inconvenient fact that the arguments he advanced to demean the Rudd Government’s management of the global financial crisis have been debunked comprehensively. If he has read it, he will be familiar with John Quiggin’s exposé about how discredited ideas in economics don’t die, nor are they alive, they are simply ‘un-dead’ – zombie like. Of course that may simply cue Joe to just go on repeating the same old lines, the same old platitudes, the same old zombie ideas as if nothing had happened to discredit them. After all, what do facts matter, what does truth matter? It’s perceptions that can plausibly be fostered in an unthinking audience that do matter.
Zombie Economics (Princeton University Press, 2010), which has the subtitle: How dead ideas still walk among us, is a good read, even for a non-economist. At times it is heavy going for anyone unfamiliar with the history of economics, but nonetheless leaves one with the strong impression that the author knows his subject backwards. He plausibly argues his case, quotes hundreds of studies that make his case and provides comprehensive references and further reading. I wholeheartedly recommend the book for any non-economist, like myself, wanting to delve into contemporary economics. Whether economists would find it appealing may depend on the school of thought to which they are wedded, and their capacity to entertain alternative ways of viewing the world.
This is not meant to be a book review; instead it is an attempt to expose the flawed thinking and the falsities that Joe Hockey inflicted on us in an attempt to discredit the Government’s response to the GFC.
Many of the quotes in this piece are from Zombie Economics, which I gratefully acknowledge.
At the outset Quiggin points out that “If we are to understand the financial crisis, and avoid the kinds of responses that set the stage for a new and bigger crisis in a few years time, we must understand the ideas that got us to this point…They are:
The Great Moderation: the idea that the period beginning in 1985 was one of unparalleled macroeconomic stability.
The Efficient Markets Hypothesis: the idea that the prices generated by financial markets represent the best possible estimate of the value of any investments.
Dynamic Stochastic [random] General Equilibrium: the idea that macroeconomic analysis should not concern itself with economic aggregates like trade balances or debt levels, but should rigorously be derived from microeconomic models of individual behaviour.
Trickle-down economics: the idea that policies that benefit the well-off will ultimately help everybody.
Privatization: the idea that any function now undertaken by government could be done better by private firms."
As it would take as much space as John Quiggin took to debunk these ideas, I will give here but a brief summary.
Regarding the Great Moderation, Quiggin asserts that the GFC has “…invalidated most of the popular explanations…the idea that improvements in monetary policy have been a force for economic stabilization looks rather silly now…If the pretensions of central banks have been shaken, those of financial markets have been utterly discredited. There is now no reason to accept the claim that financial markets provide individuals and households with effective tools for risk management. Rather, the unrestrained growth of financial markets has proved, as on so many occasions, to be a source of instability.” He concludes: “The end of the Great Moderation has forced policymakers to relearn the basic lessons of Keynesian economics. Economies can collapse to a point where only large-scale monetary expansion and fiscal stimulus can revive them. But having revived the economy, can Keynesian policies restore and sustain full employment in a system that is inherently prone to crisis? An answer to this question will require radical new directions in macroeconomics. As I will argue…that means abandonment of more dead and obsolete ideas.”
While I didn’t hear Joe Hockey use the term ‘Great Moderation’ he certainly did strongly criticise the Government’s fiscal stimulus, in the end having to concede that it did provide some benefit, insisting though that it was too big and of course the Coalition would have done it much better.
It may help to here explain the terms micro and macroeconomics. The former applies to individual markets, the latter to the economy as a whole.
Regarding the second idea – the Efficient Markets Hypothesis – Quiggin points out that it “…is the central doctrine of market liberalism [his polite term for the somewhat pejorative term ‘neo-liberalism’], born just as the Keynesian era was drawing to a close.” and continues: “It was finally killed, in terms of intellectual credibility, by the Global Financial Crisis.” He shows that the Hypothesis was beginning to crumble in the 1990s as a number of developing countries experienced severe financial crises, and was finally discredited by the GFC. Even as troubles emerged in 2007 with the ‘subprime mortgage’ crisis, advocates of the Hypothesis still believed that nothing would, or could, go badly wrong, and it was not until Bear Stearns was rescued from bankruptcy in March 2008 that confidence faltered, and with the nationalization of US mortgage agencies Fannie Mae and Freddie Mac in September, followed by the collapse of the investment banking industry and the bankruptcy of Lehmann Brothers, the Bank of America taking over Merrill Lynch, and Goldman Sachs and JP Morgan forced to seek government guarantees, confidence finally collapsed.
The Efficient Markets Hypothesis posited that the markets always know best and outperform public ventures, and so market liberalism led to more investment in the private sector. Quiggin points out that while some private sector take-overs of public utilities have been successful, for example in Finland where private investment in telecommunications led to the rise of firms like Nokia, the results have been mixed. He concludes that experience suggests: “…that a mixed economy will outperform central planning and laissez-faire.” - in other words an economy that includes a mix of public and private investment will do better. The unanswered question is: ‘What is the appropriate mix?’
You will recall that Kevin Rudd challenged the basic precepts of what he termed neo-liberalism in his essay in The Monthly on the GFC, and was roundly criticized for doing so by Joe Hockey, Coalition ministers and economists who still adhered to the Efficient Markets Hypothesis. What would they say now?
Dynamic Stochastic [random] General Equilibrium (DSGE) is a high-sounding name for an idea that succeeded Keynesianism in the late 1960s, with which Milton Friedman was associated. It has many facets and twists and turns that Quiggin explains in his book, but essentially it rests on the belief that macroeconomics derive from microeconomics and as Quiggin puts it: “Complex macroeconomic models can be reduced to simple relationships between one policy instrument (interest rates) and two targets (inflation and growth in GDP). Since there are two target variables, it’s impossible to hit each target exactly, so the models give rise to a trade-off.” Later he says: “By the eve of the Global Financial Crisis, the DSGE approach seemed to have conquered all rivals and to represent the future of macroeconomic theory. The crisis, and the failure of mainstream macroeconomics to offer a successful prediction, useful diagnosis, or coherent responses to the event, shattered the DSGE consensus.”
He says later: “If the micro-foundations approach underlying DSGE is of little use in understanding the macro-economy, where should we turn?” He replies: “…the best answer has been given by George Akerlof and Bob Shiller, in their book ‘Animal Spirits’: ‘In our view, economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations that actually do occur and can be observed’.”
Towards the end of this chapter he canvasses a return to Keynesianism but cautions: “But if a Keynesian policy framework is to be successful, it must be revived. Hopefully, the memory of past disasters will promote a more cautious and cooperative approach in future.”
There is much, much more to DSGE that this very brief account can provide; only by reading Zombie Economics can the complexity of the idea and its many nuances and contradictions be digested and comprehended.
If one can judge from his utterances, albeit couched in the language of politics rather than economics, Joe Hockey would likely be an opponent of a return to a form of Keynesianism. As Shadow Treasurer he needs to thoughtfully consider this option free from any doctrinaire position he may now hold.
The two remaining ideas that have been discredited need little explanation.
Trickle-down economics is an idea that whatever benefits are given to the wealthy, they will filter down to the poorest. Quiggin begins: “As long as there have been rich and poor people, or powerful and powerless people, there have been advocates to explain that it’s better for everyone if things stay that way.” While great economists such as Adam Smith, John Stuart Mills and John Maynard Keynes have supported income re-distribution through progressive taxation, and most economists still do today, there are still some who argue that we should let the rich get richer and wait for the benefits to trickle down to the poor. One could be forgiven for thinking that is what Joe Hockey and the Coalition believe, as they insist on giving tax relief to the wealthy.
Quiggin gives example after example showing the trickle down hypothesis is false, and caps this with a telling graph of household income distribution in the US from 1965 to 2005 that shows that those on the 95th percentile for income steadily improved their position by over fifty percent, while those on the 20th percentile and below were static.
He points out that the biggest challenge of the failure of the Trickle-down Hypothesis is to understand why and how inequality increased so much under market liberalism, and how it can be reversed. Restoring progressivity to the tax system is seen as an obvious move.
Privatization is always better than public provision of services and infrastructure according to some economists, and seems also to be the view of Joe Hockey and his Coalition colleagues. How many times have we heard him say ‘Labour can’t manage anything’, and of course he quotes the HIP and the BER to support his claim. Extrapolating, one assumes he believes that private initiative will always be better than government endeavour, even with a Coalition government.
Government often sees privatization as a way of achieving public works at no cost to itself, or realizing the value of a held asset to balance a budget. Quiggin gives many examples of failed privatization, where governments have had to re-nationalize the enterprise. Other privatizations have worked well. But the mantra that private enterprise will always do better is manifestly wrong.
He concludes by returning to the theme of a mixed economy with the ‘right’ balance of public works and private enterprise.
In his final chapter Quiggin sums up what he believes is needed in twenty-first century economics:
“More on realism, less on rigour
More on equity, less on efficiency
More on humility, less on hubris.”
He concludes: “Every crisis is an opportunity. The Global Financial Crisis gives the economics profession the chance to bury the zombie ideas that led the world into crisis, and to produce a more realistic, humble, and above all socially useful body of thought.” And so say all of us!
I trust this piece has been of some interest to those of you who puzzle about economics and wonder how economists reach their opinions and predictions. You may still be left wondering. It seems to me that the economics profession is encumbered with a plethora of competing ideas, hypotheses, theories and models, many of which seem to be mutually exclusive. There is vigorous and at times heated disagreement among the competing schools of thought. While in one sense passionate debate is essential in any discipline, the conflict of ideas that characterizes economics can leave policy makers up in the air about what to do next, especially when crises occur. They are obliged to select the theories and models that seem most applicable and use them without the certainty of outcome they desperately seek. If only economists could slide out of the procrustean bed in which so many seem to be constrained and look at the whole picture of models and theories with a view to discarding those that have been discredited, and combining the most useful features of the others, we, the victims of economic mismanagement, might, just might, be better off.
But with so many zombie ideas still refusing to die, the prognosis is not promising. Reading Zombie Economics I was reminded of Thomas Kuhn’s 1962 book: The Structure of Scientific Revolutions where he describes how he believes science actually works. Kuhn argues that it is an episodic model in which periods of conceptual continuity are interrupted by periods of revolutionary science. He gives many examples of how a scientific theory (‘paradigm’ is the term he uses) becomes fashionable and is warmly embraced by mainstream scientists, yet as evidence accumulates that cast doubt on it and eventually makes it untenable, too many scientists still tenaciously cling to it, making convoluted attempts to explain away the disparities long beyond when they are overwhelming, until finally the theory is overturned in a ‘revolutionary’ way, what Kuhn called a ‘paradigm shift’, a term he coined. It seems to me that the same phenomenon exists in economics where there are many dominant paradigms to which individual economists and schools of economics cling despite the gathering and finally overwhelming evidence that they are wrong.
At the end of his book, Quiggin quotes Richard Posner, ‘a rare example of a market liberal who has changed his views and embraced Keynesianism’: “Market correctives work very slowly in dealing with academic markets. Professors have tenure. They have lots of graduate students in the pipeline who need to get their PhD’s. They have techniques that they know and are comfortable with. It takes a great deal to drive them out of their accustomed way of doing business.” That just about says it all when we ask why economics zombies continue to lurk, ready for resurrection, ready to wreak destruction on financial systems all over again.
Whatever Joe Hockey believes, he really ought to read John Quiggin’s Zombie Economics from cover to cover. It is a goldmine of systematized information and references that would assist him to make more coherent and logically consistent statements about the economy in the future.
What do you think?
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