Politics & Policy

Lies, Damned Lies, and Economics

There is a science of economics. Unfortunately, many economists don't practice it.

Shortly after he was elected, President Obama said, “The truth is that promoting science . . . is about ensuring that facts and evidence are never twisted or obscured by politics or ideology.” Obama’s remark was a veiled shot at his predecessor and at Republicans in general. Democrats often use the term “anti-science” as a rhetorical weapon against people who have ethical reasons for opposing embryonic-stem-cell research or who voice prudential concerns about energy rationing. When it comes to economics, however, many Democrats brazenly ignore scientific evidence that calls into question the wisdom of their preferred policies. They get away with it because most people don’t think of economics as a “science” the way they do biology or astronomy. In his new book, Economics Does Not Lie: A Defense of the Free Market in a Time of Crisis, French economist Guy Sorman says it’s time for that to change.

Economics Does Not Lie is not as argumentative as its subtitle might lead you to think. It has the feel of a book that was embarked upon before the crisis hit, as if Sorman set out to write a sober-minded survey of economics as a science and got caught in a raging storm. The book doesn’t read like a polemical counterattack on capitalism’s crisis-minded critics, but it does serve as a defense of free markets because that is the direction in which the science of economics as explicated by Sorman points. No other system has proven as effective at reducing poverty and delivering growth as “free-market capitalism, informed by classical liberal economic theory,” and reports of the death of this system are greatly exaggerated.

Step by step, Sorman takes us through the major discoveries that led to this conclusion: the work of Edward Prescott and others demonstrating that excessive taxation slows economic growth; of Avner Greif on the importance of courts and other institutions that enable markets to function; of Friedman and Lucas on the pernicious effects of inflation; and of Jagdish Baghwati on the benefits of trade. Always Sorman’s focus is on work that is based on empirical observations and testable hypotheses — economics as a science.

The scope of the book is global, as it must be, for some of the strongest scientific evidence in favor of free-market capitalism is to be found in developing countries. The governments of India, China, Brazil, and other countries have reduced crushing poverty by opening their borders to foreign investment and relinquishing control over the economy. Sorman adds value to this familiar discussion by elevating less familiar economists like Xavier Sala-i-Martin — whose work has drawn important connections between commercial globalization and poverty reduction — and distinguishing them from well-known figures like Jeffrey Sachs, who is often seen alongside U2’s Bono arguing that what Africa really needs is more foreign aid. Of Sala-i-Martin and Sachs, both of whom teach at Columbia, Sorman writes, “In competing to attract students, donors, and other professors, universities seek not only pure researchers but also scholars who attract media attention.”

Sorman addresses the financial crisis in the developed world simply and clearly by explaining how steady growth and cyclical downturns are interconnected:

Economic cycles are the result of innovation. Innovations — whether technical, financial, or managerial — generate growth, but not all innovations are successful. . . . It would be nice to escape economic cycles, but there is no way to have growth without innovation, innovation without risk, or risk without economic cycles. Cycles and downturns are thus not the enemies of economic progress; the enemy of human development is bad economic policies.

Later in the book, Sorman explores the logic of speculative bubbles, citing the work of Princeton’s Jose Scheinkman. Sorman writes that bubbles begin with “something real, some discovery or innovation.” In the case of the housing bubble, the innovation was securitization, or the ability to package bundles of individual debts into bonds that would provide reliable rates of return. Government policies such as easy credit and subsidies for homeowners inflated the bubble, as did the rational expectations of participants who “bet that they could beat the market, at least for one more day.”

The collapse of a bubble is usually followed by the temptation to regulate, but regulations rarely prevent the next bubble — innovation moves too fast. Nor should we wish for innovation-killing regulations. As Sorman points out, securitization brought benefits as well as hazards, and it will survive the subprime bubble just as the Internet survived the collapse of tech stocks.

Sorman is critical of the way the U.S. and European governments reacted to the crisis. Saving some banks and not others, he writes, created a level of uncertainty that could potentially lead to long-term stagnation. Letting banks go bankrupt and clear their bad debts — the free-market approach — “could have brought a more severe recession, but a shorter one, followed by a quicker rebound.” He praises these governments’ performance in one respect: Their reluctance (so far) to give in to protectionist pressures demonstrates that they have “learned from economic science” and avoided the “beggar thy neighbor” policies that unquestionably deepened the Depression.

The only flaw in Sorman’s presentation is that he overstates at times the degree to which economists have reached a consensus. “[T]he new scientific consensus among economists holds Roosevelt’s policies responsible for the length of the crisis of 1930,” he writes. Would that it were so. The neo-Keynesians still credit Roosevelt with rescuing the country from the Depression, and they form a more powerful and well-respected bloc within the field of economics than similarly wrong-headed cabals in other sciences. More importantly, the Democratic party’s adherence to their ideas is much stronger than, say, the Bush administration’s mild endorsement of Intelligent Design. Thus President Obama’s neo-Keynesian stimulus package will needlessly add $800 billion to the national debt, whereas President Bush’s support for ID had no manifest consequences.

Sorman admits that the short-term benefits of fiscal stimulus are “hotly debated,” but he implies that there is a consensus on the long-term costs: inflation, higher interest rates, and wasted resources. In fact, the economists who pushed for the first stimulus package (and at least one Nobel laureate is pushing for another) have downplayed these consequences. Relax, they say: Policymakers have the tools to stave off hyperinflation or scale back massive indebtedness. They disingenuously fail to note that these tools (tight monetary controls, big tax increases, and deep spending cuts) are like the shiny new ratchet set your mechanically disinclined dad got for Father’s Day in 1998: rarely used.

Economics does not lie; on this point, Sorman is correct. But we must contend with the fact that economists sometimes do.

Stephen Spruiell is an NRO staff reporter.

 

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