Reforming Global Finance

Larry Summers and the Imperialism of Economics

Do economists have the right analytical tools to solve our most pressing problems?

Larry SummersCredit: E.T. Studhalter-World Economic Forum (CC BY-SA 2.0)

Takeaways


  • We are now living in an age when economists such as Lawrence Summers or Ben Bernanke dominate public policy discussions.
  • These high priests routinely sit at the right-hand side of presidents and help explain "the economy" to a benighted public.
  • Most of the important issues that could stymie future world growth and precipitate war remain quintessentially political in nature.
  • Is there a yardstick of good governance in politics analogous to that of "efficient resource allocation" in economics?

There was a time when the cabinet of the U.S. President consisted of lawyers, businessmen, political scientists and economists. Economists, however, were in fact latecomers to the game at the highest echelons of power in Washington.

A key reason for why there were so few economists in the corridors of power prior to World War II was that neither the data nor the theory they needed yet existed. Lawyers dominated policy since the time of President Lincoln, as had gentlemen farmers before that. But this is no longer the case.

We are now living in an age when, in the United States at least, economists such as Martin Feldstein or Lawrence Summers or Ben Bernanke dominate public policy discussions. With their well-honed analytical skills (often lacking in other fields), they sound off with credibility on any number of topics and often have the last word.

These high priests routinely sit at the right-hand side of presidents and prime ministers, dominate cabinet meetings and help explain “the economy” to a benighted public.

During the past few decades, we have witnessed the advent of an “economics imperialism,” in which economists have confidently utilized their analytical prowess to become spokesmen on all sorts of public policy issues — from date rape, to demography, to financial system reform, and to the pursuit of happiness, not to mention the future of the world economy.

Yet there is a paradox here. Despite the appeal of their models, economists have less and less to say about the most important issues of our time. For these issues are primarily political in nature — indeed political and philosophical — rather than economic.

Thus, attacking problems — such as how to prevent the bankruptcy of the welfare state — in a satisfactory manner cannot be achieved with the tools of micro- and macroeconomics. As a result, when economists do discuss such issues as, the results are often superficial and piecemeal. They present the public-at-large with a false sense of certainty.

Strangely enough, the same can be said of the analyses of most political scientists. Their discipline is highly problematic as well, as it never found a “core model” around which to organize the pastiche of insights it offers, interesting as many of these insights are.

For example, consider how little both political scientists and economists have had to say about the central problem confronting most Western governments during the next several decades: How can democratically elected governments be prevented from continuing to mortgage our children’s future?

This problem is rarely even identified in the policy journals or op-ed pages, much less addressed in a serious manner. To be sure, commentators on both the left and the right often complain about the future insolvency of many welfare states, but to complain about a problem is not to analyze it, much less solve it.

Yet there exists an unfortunate and unnecessary imbalance today between res politica and res economica, a distinction apparently introduced by Aristotle. Economics does not and should not rule the roost.

Five key developments help explain the advent of today’s “economics imperialism.” First, the discipline of economics is indeed highly analytical and rigorous, and this imparts credibility to it.

Second, as a scientific endeavor, economics can both describe and explain a wide range of phenomena. Armed with these capabilities, it can also help to forecast the future. Of course, these forecasts are not always accurate and it is easy to laugh at them. Forecasting is difficult in any field, but that does not render it useless, and economic forecasting has become indispensable in today’s society.

Third, the analytics of economics are not mere abstractions, but are transformed into testable models via the linkage between economic theory and econometrics. In an age when the objectivity of analysis is prized, it helps a policymaker to be able to trot out extensive statistical back-up for his case, regardless of how flawed the underlying statistical methodology might be.

Fourth, economics was the first discipline to capture and recognize the all-important concept of “incentives.” When they make decisions, consumers, producers, investors and indeed politicians respond to given incentives.

This point is extremely important. The concept of “incentive structure compatibility” is arguably the most important concept ever set forth in analytical social science, and can be utilized to assess the performance and viability of entire social systems.

Fifth, beginning students of economics are presented with a powerful analytical model that is as compelling to economics as the law of gravity is to physics: the law of supply and demand. Imagine economics without this core model!

No “invisible hand”

Now contrast these selling points of economics with the state of political science today. To begin with, there is no organizing paradigm or “model” of any kind. The field is often described as unrigorous and mushy.

Consider the field of international relations and journals such as Foreign Affairs. Some very good articles appear, representing the considered views of highly knowledgeable people. But the reader looks in vain for clear, rigorous definitions of concepts such as “optimal threats,” “balance of power,” “self-interest” or “rationality.”

There are several different reasons why political science can be viewed as more fundamental than economic science.

First, as growth theorists such as Robert Barro at Harvard have shown, the proper functioning of free market economics is completely dependent upon the assumptions of the rule of law, of non-bribable judges, of sanctity of contract, of transparency and so forth.

That is to say, proper political institutions are a necessary condition for the virtues of a free market system to deliver the outcome society wants, namely an efficient allocation of resources and risk. These basic institutions come first, and we surely need a rigorous discipline to make sense of these political prerequisites of economics.

Second, the ability of a free market capitalist system to deliver the goods requires much more than the basic institutional setup just described. Specifically, whenever issues of “public goods,” “externalities” or “imperfect competition” arise, interest groups that are impacted must determine via multilateral bargaining exactly what gets provided to whom, and who is to pay how much of the bill.

In a more general global context, issues of coping with misaligned currencies, vast trade imbalances and theft of intellectual property rights will only be resolved politically via multilateral bargaining between the impacted interest groups. This is part and parcel of a well-functioning capitalist system.

Alas, there is no “invisible hand” to settle these issues, as there is to determine the daily price of fresh produce in the marketplace.

Third, we are living in a world where the price, quantity and allocation of important commodities like oil were once determined by a free market. But they no longer are. We are now witnessing a dangerous “politicization” of the oil, gas, copper and other markets.

We will see the day when China may well determine the allocation of certain natural resources whose supply they have tied up via long-term bilateral contracts with nations throughout the developing world. Should this occur, then markets per se will no longer allocate resources as they have in the past. This role will have been assumed by bargaining.

Fourth, most of the important issues that could stymie future world growth and precipitate war remain quintessentially political in nature. For starters: Who gets how much water at what price? Who will pay how much for global warming?

How much will tomorrow’s youth be taxed to pay for the elderly? How high a tax bill will they be willing to pay before defaulting upon the debt they inherit? What is their threat strategy? Which nations will be “allowed” to go nuclear? The list goes on.

In short, our future will depend upon the quality of governance. But is there a yardstick of good governance in politics analogous to that of “efficient resource allocation” in economics?

More broadly, is there an organizing paradigm or model that could prove as useful to res politica in the future as the law of supply and demand has proven useful to res economica in the past? That is the task that lies ahead.

Editor’s note: This article is adapted from American Gridlock: Why the Right and Left Are Both Wrong (Wiley) by H. Woody Brock. Published by arrangement with Wiley. Copyright © 2012 by H. Woody Brock.

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About H. Woody Brock

H. Woody Brock is the founder and president of Strategic Economic Decisions, an economic forecasting and consulting firm.

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