In an earlier post, I lamented how economists are no longer dismal and realistic like they used to be, instead today they’re usually overoptimistic.
I blamed this on the new “precise” economics where everything is quantitative and can be calculated to the fifth decimal. Econometrics rule the world, even though it’s still an infant science with a less-than-stellar record of predictions.
Today’s subject is keynesianism. This is the economic ideology named after John Maynard Keynes which says that government should spend more during recessions to make up for the loss in private demand – that is, when consumers and businesses spend less, government should spend more, so that total consumption (and hence employment, growth etc) doesn’t change. The government should “smooth out” the business cycle; save during the booms and spend during recessions.
The idea, on paper, isn’t bad at all. One of the main problems is that governments are really good at spending during recessions, but not so good at saving during booms – there are too many special interests demanding a piece of the cake as soon as the government runs a surplus.
Many keynesians tell me that Keynes founded macroeconomics. While there is certainly some truth to that statement; how exactly does that make him right? Adam Smith founded the whole science of economics, but we don’t regard every word he said as holy.
The truth is that macroeconomics, as of now, is only a protoscience. That is to say, it’s a field where scientific methods are used, but which hasn’t been around for long enough to actually have produced any significant amount of verifiable results and theories. This is because it’s hard to test macroeconomic models and data typically leaves a lot open for interpretation.
I think keynesians are very much like the alchemists of old times. Alchemists, for those of you who didn’t know this, tried to produce gold, mainly focusing their efforts on turning lead into gold (why they didn’t pick something closer to gold, like silver, I don’t know). It’s easy to laugh at this now, but the fact is that the alchemists, in their futile quest to create gold, actually invented and discovered things such as distillation and metallurgy – things that have proved useful in chemistry today. You could go so far as to say that alchemists accidentally founded chemistry.
Similarly, without keynesianism, I’m not sure where economics would have been. They are very much the reason why we started to collect economic data (the government suddenly needed to know everything about growth and unemployment numbers so they knew when they had to intervene) in a larger scope than ever before. This economic data is certainly useful, if not for the reasons Keynes and his followers thought. It’s important for investors to know about growth numbers, in particular for those considering buying bonds or other fixed income instruments. Unemployment numbers are good since they reflect consumer confidence; when unemployment is high, consumer confidence is almost always low. This is good to know if you’re an entrepreneur considering setting up a business. Speaking of consumer confidence, the main reason why we’re measuring that is because of the keynesian idea of “animal spirits” controlling the economy. “Animal spirits” pretty much mean the same thing as gut feeling; if consumers for some irrational reason are feeling a bit down about the future, they’ll spend less, and the economy will go into recession just because of that. Whether they had any reason to feel that way in the first place is irrelevant, it’s a self-fulfilling prophecy.
The sad fact is that government will rarely invest in a science unless they believe they can get something they want out of it. In the case of economics, as long as economists preach that the solution to everything is government spending, the research grants will keep coming. Just like the alchemists received research grants from various noblemen who figured they’d become the richest men on earth if they could come up with a way to turn lead into gold. Inventing distillation was clearly less profitable, it just came as a result. Science for the sake of science is a hard thing to sell to the ruling class – whether they are noblemen or just bureaucrats.
In addition to increasing funding for economic research, keynesians did invent a couple of useful models, like the IS-LM (which is far from perfect, but then which model isn’t). In short, it’s entirely possible to be wrong and yet advance science. The keynesians may have a futile goal, but not everything they do is worthless. I feel this is necessary to point out simply because I’ll be attacking keynesianism quite a bit in my future posts. So I figured I’d be nice today. This post doesn’t have any strong political point really, it’s just a subject I’ve been thinking about a lot lately.
Macroeconomics is very much a protoscience. In 50 years, we’ll probably all laugh at the economic science of today, just like chemists today laugh at alchemists. Although, by the way things are going right now, the US will most likely have defaulted within 50 years, so it’s unclear whether there will be much to laugh at or whether this to us turbulent time will simply be remembered as the calm before the storm.
The big question is; can economics survive even after keynesianism have been disproven? There is no way the US will ever recover the ca 5 trillion dollars that has been added to the deficit since the financial crisis started. Will anyone be interested in funding economic research even after the government realizes it cannot hide behind economics anymore when it wants to grab power from entrepreneurs and consumers? I don’t know, it’s an open question, and I leave it at that.
I think it’s time for alchemistry to make a comeback. We could really use some gold right now.
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