Tag Archives: #MiltonFriedman

What skills does a good economist need?

Humility and the willingness to change their minds

Winston Churchill when speaking of Maynard Keynes (the greatest British economist of the 20th century) said that when four economists are gathered together you will get five opinions and two of them will be from Keynes. What this  illustrates is that what the good economist recognises is that economics is dogged by uncertainty. The economy and its host society is so complex that any unexpected change can result in the policy measures undertaken producing contrary results. When Nigel Lawson in his budgets in the 1980s cut taxes he overstimulated a rapidly growing economy. All that extra money from the tax cuts had no outlet except in for investment in the property market, causing a housing boom that ended in a crash in 1990.  Policy recommendations should be made in the spirit of cautious optimism. With the recognition that policies might need to be changed if circumstances change, as there is no certainty in the practice of economics.

When Mrs Thatcher said, ‘that the lady is not for turning’, she made a terrible mistake. Her policy  of using high interest rates to squeeze inflation out of the economy through depressing demand had the unfortunate consequence of driving the exchange rate. This high exchange rate made large sections of British manufacturing industry uncompetitive. The consequence of this was that British manufacturing industry lost 20% of its capacity, which had the long term consequence of Britain developing the largest trade deficit in the developed world. A problem that still persists today.

A capacity for scepticism

There is no ‘economic cure all’ that can solve all problems, although many economists and politicians foolishly believe that there is such a policy. The latest ‘economic cure all’ is Neo-Liberal economics. In the 1970s the post war economic settlement seemed to be falling apart. In 1976 inflation hit the unheard of high of 27% in Britain. A group of economists the Chicago School claimed to have the answer, they diagnosed the problem as being one of excessive government borrowing to finance its spending programmes. This borrowing increased  demand to a level beyond that which the economy could meet and as supply could not be increased prices rose, as consumers entered into bidding war to get these relatively scarce goods and the consequence was rising inflation. This problem was made worse they said by all the restrictions on the market which prevented industry responding to change by increasing supply to meet increased demand. These restrictions were such as the managed exchange rates, trade unions, employment protection laws and health and safety legislation. If government spending was cut and the restrictions to the market were removed, inflation would fall and the economy would grow ending what was a period of ‘stagflation’. What these economists ignored was the massive increase for the world’s oil etc caused by the American participation in the Vietnam war. There was such a massive expenditure of material in this war that it seriously distorted the world economy.  More bombs were dropped in this short war than during the whole of World War II. When Nixon negotiated an end to the Vietnam War that decision did more than any economic policy measure  to end the malfunctioning of the world economy.

Whether its called the monetarist or the Neo-Liberal economic school of economics, it has failed.There have been three world wide recessions since 1990 each one worse than the previous one. Growth remains minimal, the growth in incomes has stalled yet economists (the majority in the universities and those employed by government and international institutions) and politicians refuse to change their policies. They have invested too much prestige in the Neo-Liberal revolution to abandon it now. A little scepticism about the policies of the present would not come amiss. There are plenty of alternative policies that can be used, it’s only stubbornness and ignorance which prevents them being used.

When politicians and economists state ‘that things have changed’ and that we are in a new economic paradigm, it a sign things are  going badly. It’s a weak defence offered for a policy that is failing and for which no better defence can be thought of. It is the wisdom of parrots as politicians repeat this mantra endlessly without understanding that these phrases are completely meaningless.

A good economist will be well versed in literature, in fact English literature should be an essential part of the course of study undertaken by a trainee economist.

Economics has the potential to be the dullest of subjects. I remember that in the second year of my university course all the second year students had to attend a series of lectures given by one of the world’s greatest monetary economists. They were so boring that students did all kinds of things to distract them from the tedium of the lecture. One particular incident sticks in my mind and that was when a group of bored students launched a giant paper plane from the balcony which soared over the lecture hall.

Literature should be an essential part of the course, because a great novel can better than anything else explain the impact of economic and social change on a people. One of my favourite novels is “The White Guard” by Mikhail Bulgakov. This novel details the impact on one Ukrainian family of the Russian civil war. The play on which the novel was based was Stalin’s favourite play, even although he was on the opposite side of the conflict. The reading of such novels will hopefully lead to the development of some sensitivity towards the human condition in the trainee economist  and hopefully led them when qualified and employed by government to hesitate before recommending policies that cause unnecessary economic and social hardship. One cannot impose a test on economists for the possession of those essential qualities that go to make a wel rounded human being, but hopefully immersion in a course of literature will be a good substitute.

Milton Friedman the Chicago economist provides an example of the extreme insensitivity of which economists are capable. General Pinochet launched a coup to overthrow the socialist government of President Allende. The aftermath of the coup involved the torture and killing of many of those people opposed to the coup. Milton Friedman lauded the actions of Pinochet as necessary for the greater good of society, as the imprisonment and killing of these socialists made possible the introduction to Chile of the free market economy. Only a person of extreme insensitivty would applaud the killing of people as the best means to achieve some ultimate end. I tend to agree with Ivan who at the end of the novel “The Brothers Karamazov” asks God why does he permit the death of a child. (when being shipped of the Labour camps of Siberia he witnesses the pain and a suffering of a woman holding her dead baby). Any economist should ask does my policy proposal cause unnecessary suffering and is there a better alternative that will minimise human suffering. Killing may be necessary in fighting a war but never in imposing economic change on a society.

It may also hopefully prevent economics students suffering from too many dull and boring lectures, as the lecturer will have a better grasp of the English language and human nature than would otherwise be the case.

A good economist will be schooled in philosophy

Any economist must recognise that any policy proposal will be flawed or wrong in some measure. J.S.Mill in the 19th century stated that there could be no science of the humanities because human society was so complex. There were so many possible causes of a particular social or economic event and so many possible unintended effects of a policy measure that the one essential requirement of a science could not be fulfilled and it was impossible to have a science it which it was impossible to demonstrate cause and effect. Mills’ words seem to have been forgotten in the twenty-first century. It is believed that computers that can overcome this problem, as they can make calculations involving thousands if not millions of variables. However what politicians and economists at the world’s Treasuries fail to recognise is that the output of the computer findings are only valid if the calculations on which the predictions are based are valid. What politicians fail to recognise and economist ignore, is that the model of the economy used in the computer does not work, there is something missing. Treasury economists have to insert an ‘x’ factor into the calculations,  a reality factor to enable the computer to deliver a realistic prediction. This x factor is little more than an informed guess. This is why the Treasury computer can only make a correct prediction about economic growth after the event when the necessary corrections can be made to the computer model.

Any student of philosophy learns the limits of human knowledge in the first year of their course. It was a shock to this particular student that philosophy provided few of the answers to the questions that he wanted answering. One such question is what is good, Plato tried to answer this question in this question in his book ‘The Republic’ written in 380 BC and it is a question which philosophers ever since have struggled to answer. Now analytic philosophers tend to think it is an unanswerable question and not one contemporary philosophers should waste time on answering. Instead the quests of past philosophers to understand the nature of the good are to be seen to provide a good schooling in the techniques of philosophy but little else.  Students such as myself had instead to look to theology to provide some answers. The point that I am trying to make is that philosophers understand the frailty of human nature and its limitations. A true philosopher can only laugh at the claims of Neo-Liberal economists who claim to understand the workings of the economy, as the evidence from philosophy demonstrates the continued failure of man to have a complete and full knowledge of  human nature let alone human society. The problem with so many economists today is that although they have studied PPE, they compartmentalise the philosophy they learn and think that its findings do not apply to economics.

Diogenes Laertes in his history of the philosophers recalls how visitors to Democritus frequently  found him laughing in his garden. A thing he frequently did when considering the follies of mankind. If the effects of the wrong economic policies were not so disastrous, I would join Democritus in his laughter.

A good economist is aware of the past and does not think today’s events are unique and without parallel in the past and is prepared to recognise the similarities between today’s events and those of the past.

One extreme example springs to mind, both the governments of the Roman Empire and contemporary Britain regard the provision of cheap food for the people as a priority. Rome was able to supply cheap bread to its people through conquering the countries that were the bread baskets of the Mediterranean and then by  supplying low cost labour for the farms in the form of slaves. Contemporary Britain by contrast encourages the production of cheap food through the provision of subsidies to farmers, one estimate is that now 50% of farmers incomes now comes from EU subsidies. Most of this money goes to towards subsidising what is termed industrial farming, which produces large quantities of food at low cost, but in an environmentally damaging manner. Unfortunately there is evidence that British food suppliers are adopting some of the practices of the Romans. Some of migrant workers on Uk farms  adopted in work in slave like conditions.

What the government could learn from Rome is that using low cost labour methods of production discourages investment and innovation in industry. If there are endless supplies of cheap labour employers see no compellilng reason to invest in expensive machinery, if there are endless supplies of cheap labour. Studies of slave labour have demonstrated how slave labour acted as a deterrent to industrial innovation. A government and business class that believes the only solution to problems in the economy is to make labour as cheap as possible have a lot to learn from the slave economies of the past.

While the one lessons that can be learnt from Rome’s history are negative, much that is positive can be learnt from the actions of the government in the 1930s. This government tried to stimulate an economic recovery after the devastating crash that was the Great Depression. The government then recognised the importance of getting new investment into manufacturing industry so as to kickstart a recovery. Recognising that the banks were unwilling to do this, it set up an industrial investment bank which would lend money to manufacturing industry. Today one of the issues that is delaying the recovery is the comparative lack of investment in industry and manufacturing industry in particular. A recent study showed that only 15% of bank loans went to investment in industry most when into speculative trading in property etc.  There is nothing to be lost and much to be gained by setting up a new industrial investment bank and it could be financed through a levy on commercial banks, as happened in the 1930s.

This list of criteria for judging what is a good economist is not intended to be exhaustive but suggestive.

A good lie told well, the secret of managing the economy

  

Image courtesy of randalrauser.com

What every economics student used to learn at university was how difficult it was for leaders to make policy decisions on the economy. The effectiveness of policy measures were uncertain and the time lag in implementing these measures meant that when they came into effect they were often  addressing yesterday’s issues. What we learnt was how difficult it was to understand and manage that highly complex human institution, which is the economy. In one of our seminars it was decided that there were no economics was not a science comparable with physics and that economic  theory was at best a good guess as to how the economy worked. Consequently economics  for the student in the 1960’s was very much a work in progress. It was Churchill who said that if you asked four economists for a solution to a particular pressing economic problem you would get five answers and two of these answers would be from Keynes. (Keynes was the outstanding British economist of his  generation. This humility did no fit well with the demands from politicians for policy solutions, as exemplified in the words of Margaret Thatcher who said she wanted answers not problems. There was a group of economists responded eagerly to such requests and began to supply answers that were not hedged about with caveats about what might possibly make the policy ineffective. 
Economists had to know and there was a school of economists that knew. These new economists where named variously as the Chicago School of Economists, Monetary Economists, Free Market Economists or Neo-Liberal Economists. They took inspiration from the economist Milton Friedman the doyen of the Chicago School, who in turn was inspired by the economist Friedrich Hayek. What this group offered was a solution to the one problem that dogged the Western economies of the 1970 and that was inflation. They offered two solutions to the problem of inflation, they said that inflation could be controlled by controlling the money supply and by supply side economics.  
Monetary economists could supply answers to for example that of inflation, which reached 27% pa in 1976. Politicians could understands that if the money supply increased faster than the supply of goods, more money would be chasing relatively fewer goods and so prices would be pushed up. If money supply was cut inflation would fall and the economy would continue to grow on a smoother trajectory. What they did not want to know was as any non monetarist economist could tell them demonstrated a relationship between increased money supply and inflation is not the same as demonstrating a cause. 
However once politicians began to follow the policies advocated by these new economists, it became obvious that these new economists did not know. Britain was one of the first countries to practice monetary economics as suggested by Milton Friedman. In doing so one huge problem was discovered no Treasury economist was able to define what made up the money in circulation and what was the total money supply. The government came up with five possible measures and from this they selected one as their preferred measure which they called M3. M3 was chosen which was the total of currency in circulation plus bank deposits. They chose this one because it was the easiest to measure, after all the banks regularly published accounts showing their total bank deposits. They then made one huge assumption that all other measures of money supply would change in the same way as their preferred measure. However there was no evidence that all the other possible measures of money supplies the bank identified, would change in the same way as M3. It was a hope that all the unmeasured changes in money supply would follow M3, but the evidence for this was lacking. 
In desperation the Treasury and Bank of England gave up trying to account for changes in money supply and instead adopted a new practice. Admitting they could not count the money in circulation they opened for controlling the demand for money by changing interest rates. They believed that the supply of money was determined by the demand for money, therefore by controlling the latter they would control the first. Ever since the 1980’s changes in interest rates have been the main instrument for controlling the economy. Nobody today every mentions that the central plank of government economic policy is based on a theory for which evidence is lacking, simply because they cannot identify or correctly measure the key determinant, money supply.
Something very similar happened after the great financial crash of 2008/9. There were three deficits that could make recovery difficult the government or public sector debt, the private sector debt and the banking sector debt. The smallest was the government debt amounting in 2009 to about 60% of GDP and the largest was the banking sector deficit of 540% of GDP(as identified in a report by Paul Tucker, Deputy Governor of the Bank of England.) It is obvious that the debt that is in most urgent need of attention was that of the banking sector, yet the government of the day and succeeding ones chose to ignore it and focus instead on the government debt. The latter is the easiest to reduce as all the government had to do was cut its own spending, whereas the more serious bank debt was much harder to tackle. The government would have to take on the big banks and the City of London, very powerful opponents of whose power the government is in awe. Also if the government was serious about reducing bank debt it would negatively impact on the property market, as cutting the debt would be achieved by reducing the loans the banks could make in total. If there was less money available for house purchases, prices would fall. It is a truism of British politics that the easiest way to achieve electoral unpopularity is to preside over a fall in house prices. Consequently Britain remains with Japan one of the most indebted of the developed nations.
While these facts are known amongst the community of economists there is a conspiracy of silence in parliament about the true nature of Britain’s debt problems. There is no leading political figure that wants to be responsible for the painful economic adjustment that would result from putting the bankers house in order. Instead they focus on how they will reduce the least significant of the three debts and the noise of the debate on government debt crowds out any possible alternative debate on the real nature of the debt problem. 
The economic debate as understood by politicians is what matters, as they determine economic policy. The fact that the economic debate is founded on on misinformation and lies is irrelevant. What matters is that the economic lie is the one that every one accepts. In consequence the economic debate is about the wrong debt and the government has pursued the unnecessary austerity programe that impoverishe  an increasing number of people, while turning a blind eye to the excesses of the financial industry. Lies matter because they can be based on simple easily understandable untruths, whereas the truth about the problems of the economy is complex and hard to understand. To admit to truth would deny the politicians the opportunity to offer simple policy solutions that they could sell to the electorate. As the political debate of today is conducted in the simplistic language of the tabloid newspapers the truth about the real nature of Britain’s economic problems will remain concealed. Concealed that is until some major economic crisis forces the political and media classes to recognise the true nature of the problems facing the British economy.