DANGEROUS CURRENTS, by Lester Thurow; Random, 1983
http://www.amazon.com/exec/obidos/ASIN/0394723686
This book is officially "out of print" but Amazon was able to find one for
me. It's 200 pages poking fun at economists and micro-economic theory by
someone who teaches it. Thurow is brilliant. Here are some samples:
***
I am convinced that accepting the conventional supply-demand model of
the economy is rather like believing that the world is flat, or that
the sun revolves around the earth -- you can make a rigorous case, on
paper, for both propositions, but hard evidence is more than a bit
scarce. Moreover, if you choose to act on either belief, you can get
into a lot of trouble. [p. xvii]
***
...the profession, the discipline of economics, is on its way to
becoming a guild. Members of a guild, as we know, tend to preserve and
advance traditional theories rather than try to develop new ways of
thinking and doing things to solve new problems. The equilibrium
price-auction view of the world is a traditional view with a history as
old as that of economies itself: the individual is asserted to be a
maximizing consumer or producer within free supply-demand markets that
establish an equilibrium price for any kind of goods or service. This is
an economies blessed with an intellectual consistency, and one having
implications that extend far beyond the realm of conventional economic
theory. It is, in short, also a political philosophy, often becoming
something approaching a religion.
Price-auction economics is further blessed because it can assume
mathematical form it can work hand in glove with calculus. Expression in
mathematics imparts to the theory a seeming rigor and internal strength. But
that rigor easily degenerates into scholarly rigor mortis, as mathematical
facility becomes more important to the profession than a substantive
understanding of the economy itself. To express an idea mathematically
gives it the illusion of unassailable truth and also makes it utterly
incomprehensible to anyone untutored in mathematics. Then, too, young
scholars aspiring to the profession are required to demonstrate a technical
virtuosity in math before they are even considered eligible. By analogy,
once the Confucian scholars of ancient China passed a very complicated set
of entrance examinations, they used the same examinations to keep others
out. Both then and now, all honor is reserved for those who can explain
current events in terms of "The Theory," while anyone trying to develop
new theories to explain recent developments is regarded with suspicion
at best. In economics today, "The Theory" has become an ideology rather
than a set of working hypotheses used to understand the behavior of the
economy found in the real world. [pp. xviii-xix]
***
All over the globe, we have recently witnessed a return to religious
fundamentalism. In my view, the return to the equilibrium price-auction
model in economics represents a parallel development -- a desire for
psychological certainty in a world that is, in the last instance,
uncertain. [p. xix ]
***
If you were to ask the average economist what was wrong with his
discipline, he would no doubt tell you that something was really wrong
with macro-economics: the profession has lost its ability to understand
or control the aggregate economic problems of inflation, unemployment,
and low productivity growth. But the same person would probably also say
that micro-economics is fundamentally sound, that the profession fully
understands the behavior of individual economic actors. He would
probably then say that though he wasn't sure exactly how the issues in
macro-economic theory should be resolved, the source of the difficulty
is clear; namely, that macro-economics is not securely grounded in
micro-economic theory -- the equilibrium price -- auction (supply and
demand) view of the world.
The perceptions here are accurate, except for one. Microeconomic theory
is not fundamentally sound, and the real problems in economics are to be
found in a micro-economic theory that is unsatisfactory. Too much of
real individual behavior, as I will try to show in this book, is
unexplained or explained away by the equilibrium price-auction view of
behavior. Macro-problems do exist, but they will not be solved until
some fundamental reform occurs in micro-economic theory. [p. 3]
***
Economists can, for example, always retreat to unobservable variables to
explain unwelcome facts. The price-auction model, for example, calls for
equal wages for those with identical skills, but it is very difficult to
find those predicted homogeneous wage groups. No matter how fine the
background classifications, the job descriptions, and other explanatory
variables, the variance in earnings within each group in the United
States is almost as large as the variance in earnings for the population
as a whole. But economists can claim that unobservable variables are at
work. In this case the most frequently used is the "willingness to take
risks." Seemingly equal workers earn different wages because some are
more willing to take risks than others. But since no one knows how to
measure the "willingness to take risks," this is an explanation that
cannot be definitively proven or refuted. Either one believes it or one
doesn't.
Or it may be said that identical workers are getting different amounts
of psychic income (nonmonetary benefits such as pleasant working
conditions) from their jobs. These nonmonetary benefits lead money
incomes to differ but leave total incomes, money plus psychic,
identical. Here again the explanation may be true, but there is no way
to prove it.
Or the observation can be dismissed as a "market imperfection" --
something that exists but should be eliminated to bring the real economy
into conformity with price-auction theory. Union induced seniority wages
might, for example, be preventing homogeneous wages from developing. The
solution for those who see a "market imperfection" is to eliminate the
problem -- unions. If the economic actors are not doing what they are
supposed to be doing, something is wrong with either the actors or the
market. In short, the theory is always right. [pp. 16-17]
***
So, in general, an economist's prior beliefs about what is true play a
very important role in the way he sees economic evidence. Once their
beliefs are formed, it is difficult to prove any economist's priors
wrong so convincingly that he will change his beliefs about the way the
world works. And because of its seemingly comprehensive answers to all
economic questions, the price-auction model creates a very strong set of
prior beliefs. [p. 18]
***
Economics is like other disciplines in that it attempts to deduce
theories that allow it to describe and predict reality, but it differs
from all other fields because it also has a theory of what "ought" to
be. This explains why economists are always recommending the elimination
of this or that "market imperfection," like the unions mentioned
earlier. In fact, any unpopular regulation is denounced by those not
liking it as a market imperfection. In contrast, no astrophysicist
recommends the elimination of planets (observations) that he does not
like as "market imperfections."
Here the economists' recommendations flow from the peculiar role that
the concept of a free market plays in economic theory. The equilibrium
price-auction model is not just a tool used by economists to describe
and predict events. The particular economic game called free competitive
markets is regarded as the best economic game. It is assumed to produce
the highest possible welfare, and at best, other economic games can only
equal its performance. As a result, economists feel at liberty to
recommend the "free market" to society and to recommend that actual
economic games be made to conform with the free-market game.
Think the academic division between economies departments and business
schools. While economies departments work out ever more sophisticated
versions of the free-market game and watch for market imperfections
imposed by government or monopolies, business schools teach students how
to become better maximizers within the constraints of the flee market.
If economists successfully get their point across in business schools,
they guarantee that at least part of their economic theory -- the existence
of profit maximizing producers -- will come into being. No other discipline
attempts to make the world act as it thinks the world should act. But of
course what Homo sapiens does and what Homo economicus should do are
often quite different. That, however, does not make the basic model
wrong, as it would in every other discipline. It just means that actions
must be taken to bend Homo sapiens into conformity with Homo economicus.
So, instead of adjusting theory to reality, reality is adjusted to
theory.
What this creates, however, is a lot of confusion both among economists
and the public as to whether economists are speaking as predictors or as
prescribers. Suppose some economist says that energy price increases
cannot cause inflation. Is he saying that higher energy prices do not
cause inflation in the real-world economy, or is he saying that higher
energy prices would not cause inflation in a perfectly competitive free
market where any price increase must be balanced with price decreases
somewhere else in the system? The belief that competitive free markets
constitute the best possible economic game also rests on a highly
restrictive set of assumptions. The conclusions are technically correct
only in a static world of fixed tastes and static technology where the
basic economic problem is one of exchange. Every economist knows the
dozens of restrictive assumptions (perfect knowledge, ease of entry,
exogenous independent preferences) that are necessary to "prove" that a
free market is the best possible economic game, but they tend to be
forgotten in the play of events. If tastes are endogenous (created in
the process of conducting economic activities), it is not obvious, for
example, that a free market leads to the highest possible welfare. If
tastes differ depending on what economic game is actually being played,
competitive markets with their opportunities for invidious comparisons
might make people more unhappy with their standard of living than some
other economic game where the "winner" is not the one with the most
goods and services. The perverse preference of envy (my welfare goes
down when your income goes up), for example, destroys the nice utility
maximizing outcome of any free-market economic game where everyone is
supposed to look at his own income and only his own income when judging
his welfare. The economic game played by Homo economicus may or may not
be the best economic game for Homo sapiens, but it is almost always so
advocated by economists. [pp. 22-23]
***
Given a clever economist armed with a concept that can't measure
anything in the real world, any activity can be described and organized
as if it were the outcome of a freemarket maximization process. All
consumption purchases represent utility maximization; all job choices
represent income (psychic plus money) maximization. There is nothing
wrong with formulating models with unknown and in principle unknowable
variables if everyone is clear that the result is merely a descriptive
model that might help us catalogue activities. The capacity to provide
such descriptions, however, does not mean that the model is an economic
model in any of the other four senses. To be that, the model must be
capable of being proved wrong.
Because economists cannot measure nonobservable variables such as
psychic income, they cannot make predictions from a model based upon
them. And if you don't understand how these unobservable variables are
created, you can't understand economic activity in the real world. But
without that, influence or control over the economy is impossible.
Yet economists often talk as if they can do all of these things simply
because they can build a descriptive model.
Economists who hold this view in its most extreme form cling to the
following syllogism: (1) The price-auction market is the most efficient
economic game that man can play. (2) More efficient economic games drive
less efficient economic games out of business. (3) Therefore the real
economic game must be an equilibrium price-auction game. [pp. 23-24]
***
In late 1973 the first OPEC oil shock struck, as oil prices quadrupled
and the general inflation indexes shot up to 11 percent. More important,
gasoline lines appeared. Waiting in line to buy a basic commodity like
gasoline is something that no American had ever experienced. Shock and
irritation were high, but those lines were like the first small heart
attack--an indication of mortality. Maybe the American economy was
growing old and becoming vulnerable. Maybe the American economic dream
of an ever rising standard of living was over. Small may be beautiful,
but if that phrase meant a lower standard of living, then the average
American considered it a nightmare.
The Nixon-Ford Administration responded with oil and gas price controls.
As a vehicle for holding down prices, controls were bound to fail. For
one thing, world prices would have to be paid on that part of
consumption imported from abroad; for another, controls make it too easy
for oil companies to hold oil in the ground or not to look for new
supplies oil until prices rose. When controls did fail, the public's
feeling that the federal government and its economists were incapable of
managing anything efficiently was further reinforced.
What was worse, economists could pose no solution to the energy problem.
Influential professionals, such as Milton Friedman, predicted that the
oil cartel would quickly fall apart. It didn't. Other economists
recommended that prices be allowed to climb to world levels, but that
wasn't a solution to the problem faced by the average American. Higher
prices would force him to change his life style. He might respond to
higher prices with smaller cars and colder houses as economists
predicted, but he liked doing neither and he could vote. No one
considered a forced change in life style a solution.
Once again, falling back on the principle that higher unemployment would
produce lower inflation, monetary authorities tightened the rate of
growth of the money supply in an effort to slow the economy, raise
unemployment, and push inflation out of the economy. This time the
policies produced a credit crunch. For six months in late 1974 and early
1975 the GNP fell at the fastest rate ever recorded. Even the rates of
decline in the Great Depression had been less precipitous -- although of
course longer and deeper. Anxieties quickly shifted from an unacceptable
inflation rate to an unacceptable unemployment rate, and the term
"stagflation" was born.
Stagflation was both a term and an indictment, since economists had
taught that the phenomena -- slow growth, rising unemployment, and
rising inflation -- could not all exist at the same time. Yet they did.
[pp. 34-36]
***
Meanwhile, unemployment cannot exist in an equilibrium price-auction
market. Yet unemployment does exist. Why is it ignored? The answer is
simple. No alternative theory was developed to challenge the price-auction
model's explanation of individual economic behavior. So it was almost
inevitable that the dominant view of the 1920s would reassert itself when
immediate memories of the suffering produced by the Great Depression passed.
Today's measured unemployment is defined away as "voluntary"
unemployment, and therefore not "real" unemployment. [p. 132]
***
According to Reagan economists, social insurance also creates
free-riders: knowing that others will work to provide the resources
necessary to insure you against the hazards of life, you reduce your
work effort and let others carry the load. But when everyone makes what
is individually a rational decision to work less, the result is a
collective irrationality -- an economy with too little work and output.
An extreme form of this contention is advanced by George Gilder, who
argues that both welfare payments and working wives sap male initiative.
"The man's earnings, unlike the woman's, will determine not only his
standard of living but also his possibilities for marriage and
children -- whether he can be a sexual man. The man's work thus finds
its deepest source in love." "Under guaranteed-income plans ...
marriages dissolve not because the rules dictate it but because the
benefit levels destroy the father's key role and authority. He can no
longer feel manly in his own home." "When the wives earn less, the
men tend to work more and are far more likely to reach the pinnacles of
achievement." "Material progress is ineluctably elitists: It makes
the rich richer and increases their numbers, exalting the few
extraordinary men who can produce wealth over the democratic masses who
consume it." [p. 138]
***
According to Reagan's version of supply-side economics, if the economy
is not working, something must be wrong with government's place in the
economy. This has not been proved by empirical analysis but is known so
because a priori it is impossible for an undisturbed free-market
competitive economy to perform badly. If the economy is performing badly,
government, the great distorter in a free-market economy, has to be the
culprit.
Whatever the validity of the supply-side argument, there is no question
that it is a logical product of an equilibrium price-auction view of the
world. The supply-siders merely make explicit what is implicit in that
model. Mainstream economists may say that supply-siders exaggerate the
"truth" to be found in the model, but it is the "truth" nonetheless.
In any case, supply-side economics represents the triumph of literal and
unqualified equilibrium price-auction economics. Supply-siders are to
that model what religious fundamentalists are to biblical
interpretation. No deviations from the revealed truth are possible or
allowed.[pp. 140-141]
***
If Newton and his contemporaries had behaved as the economics profession
is now behaving and had access to the modern computer, it is likely that
the law of gravity would never have been discovered. In Newton's day,
deviant celestial observations were made that did not fit into the
existing epicycle theory of heavenly motion, but each such observation
could be and was explained with an addition of another epicycle to the
system. Given enough epicycles, all patterns were theoretically
explainable. Eventually, however, the computational difficulties forced
Newton to rethink the existing theory to obtain a simpler set of results
based on gravity. But with the modern computer Newton would never have
been forced to look for anything new. The computer would have made short
work of the necessary geometric computations, making a new theoretical
approach seemingly unnecessary.
Like "deviant" celestial motion at the time of Newton, deviant
observations in the labor market keep being reported. But each was and
still can be made consistent with the orthodox theory. Usually some
market imperfection is hypothesized, and as we shall see, each is
posited ad hoc and after the fact. At some point it becomes necessary to
examine the weight of the evidence to see the extent to which the labor
market is or is not working in accordance with the theories of the
equilibrium price-auction model. And if it is not, to develop new
micro-economic approaches. [pp. 184-185]
***
According to the price-auction model, anyone can get a job by knocking
on the door of some employer and offering to work for less than those
already employed. Anyone who has actually looked for work knows this
approach is not viable. [p. 187]
***
Economists often blame unions for economic effects that extend well
beyond the direct effects on their own membership. It is asserted, for
example, that employers have to meet union wages in order to keep unions
out. This may be true, but if so, the economy is not the competitive
economy prescribed by the price-auction model. In a free market,
employers cannot meet union wages to keep unions out. They have to pay
market, not union, wage rates to keep other nonunion employers from
driving them out of business. [p. 193]
