Paul Krugman’s New York Times article, How did economists get it so wrong? (September 6, 2009) was no doubt designed in part as a grenade to be lobbed at economics departments: to arouse anxiety and initiate discussion. In that aim, if no other, it succeeded. Last Friday, the grenade went off at Duke University, as the Center for the History of Political Economy hosted a department wide seminar to discuss the article. The gathering was marked by a general sense of unease and unhappiness: some were annoyed by Krugman’s hypocrisy and tone and some were annoyed with the economics profession. But many, as it turns out, still think that the greatest days of neoclassical economics are ahead of us and were very annoyed with Krugman for suggesting otherwise.
A macroeconomist, an economic historian and a historian of economics introduced the seminar. The macroeconomist, clearly angered, promised not to speak for long, save to tell those assembled that the article demonstrated ignorance and vitriol: most of Krugman’s accusations were not true: macroeconomists were always trying to incorporate money and the financial sector into theory. And as for Krugman’s argument that economists think that the more mathematically beautiful the model the better, nothing, we were told, could be further from the truth. Testing theory against reality is all that matters to this macroeconomist.
The economic historian was less personally offended. Krugman had raised some fair questions. After all economists had not been sufficiently vocal in alerting the world to the unsustainable nature of the past few years and perhaps the emphasis on modeling had produced a certain selective blindness. Finally, the financial sector had clearly not played the role in economists’ models that it should have done. Still, the question remained: what is the ‘real’ problem here for economists? Is this about the reputation of economists, a little bit of hurt pride; or is the economics profession actually part of the problem? After all, the question was posed, how much influence does university economics really have on policy anyway?
Well, of course, I don’t know the answer to this question. But judging from some of the comments from the room, it seems that most economists have a pretty high regard of their profession. Not least of all Krugman himself for, as the panel member representing the history of economics pointed out, Krugman’s tone did not lack in arrogance. For a start Krugman had placed himself above the profession even though he himself is as much implicated in his complaints as anyone else. Moreover, were economists really to blame for the financial crisis: wasn’t the real problem with failed regulation, rather than economic theory?
Now it’s a funny thing. Neoclassical economists working within the mainstream, either general equilibrium-ites or Chicagoans wouldn’t, I suspect, profess much love for Krugman, but they certainly do share his opinion when it comes to the importance of economics. Thus we were told: if only the incentive structures for risk managers had been right, then these managers would have flagged up the risks to their bosses that were, apparently, all too evident in the value-at-risk models. So the problem, it turns out, wasn’t the models (based as they were on only a few years data), but that economist hadn’t ALSO designed the internal management incentive structures. But if you remain unconvinced by this then there was even more hubris to come. It’s only a matter of time, we were told by another attendee, before the neo-classical approach can truly meet its destiny and provide a unified theory of everything (in the economy, just in case you wondered). House values, financial sector leverage and option pricing, just three problems that will in time be solved.
So there you have it. Perhaps those who thought that economists (including Krugman) were overstating their role in causing the crisis were right after all. But, never fear, in the future ‘the general neo-classical theory’ of economics would be there to guarantee that things could never get of control again. Well, that’s a relief. Alternatively of course, some might suggest that the real battle in the room was between relative delusions of grandeur: the delusions of those who think that economists had caused this crisis and those who think that economists will in the future ensure we have no more.
To be fair, there were some dissenting voices in the room. One contributor argued passionately that economics had reached such a level of arrogance that almost no economists were now taught basic skills, like how to read a balance sheet, a skill that would apparently have alerted many to the impending problems at the banks. Another contributor suggested that economics could never be equipped to be able to definitively say when an asset was overvalued. Modern economics after all is based on the idea that value is a function of the buyer’s personal assessment of value and utility. How could economics ever say for sure that someone was overestimating what something was worth to them? Were not questions about inflated asset prices moral and social questions beyond the realm of economics?
Still one suspects these comments fell on deaf ears. As another contributor pointed out, the incentive structures in the profession were all wrong. Such was the structure of modern universities that graduate students were so invested in current ways of thinking that they were always going to be unlikely revolutionaries in the discipline. Economists misunderstanding incentive structures, institutions do play a role after all?? Never! I refuse to believe it!