The best critiques are from within
By Scott Sumner
You would think that the best way to criticize a field of science would be from the outside. After all, those within the field may be blinded by the prevailing orthodoxy, and thus be unable to see the weaknesses in the mainstream models.
Actually, the opposite is true. There are lots of excellent heterodox critiques of economics, but almost all are provided by economists. I presume this is true of other fields as well. If a problem were obvious enough to be spotted by outsiders, chances are it would already be the subject of dispute within the field. An anthropologist named David Graeber provides an excellent example of what goes wrong when you don’t understand the field you are criticizing. Here is the intro to his piece in the New York Review of Books:
There is a growing feeling, among those who have the responsibility of managing large economies, that the discipline of economics is no longer fit for purpose. It is beginning to look like a science designed to solve problems that no longer exist.
A good example is the obsession with inflation. Economists still teach their students that the primary economic role of government—many would insist, its only really proper economic role—is to guarantee price stability. We must be constantly vigilant over the dangers of inflation. For governments to simply print money is therefore inherently sinful. If, however, inflation is kept at bay through the coordinated action of government and central bankers, the market should find its “natural rate of unemployment,” and investors, taking advantage of clear price signals, should be able to ensure healthy growth.
All the economics textbooks that I’m aware of, including those written by free market “ideologues” like me, are full of examples of the various ways that government might play a productive role in the economy, including regulation of monopolies, environmental regulation, intellectual property rights, support for basic research, income redistribution, etc. Most economists are well to the left of me, and probably spend as much or more time on those issues than I do—and when teaching EC101 I spent a lot of time on the case for government involvement in the economy.
Hardly any economists believe that it is sinful for the government to print money. Most agree that the money supply should be adjusted to reflect changes in the demand for money.
It’s not a good sign when you write a very long article telling readers that economics is bunk, which starts off with a series of assertions about economic that are wildly inaccurate. Unfortunately, it gets even worse. For instance, Graeber talks about the reality of “magic money trees” a myth I exposed in my previous post. Then he suggests that little is left of the British welfare state:
It was center-left New Labour that presided over the pre-crash bubble, and voters’ throw-the-bastards-out reaction brought a series of Conservative governments that soon discovered that a rhetoric of austerity—the Churchillian evocation of common sacrifice for the public good—played well with the British public, allowing them to win broad popular acceptance for policies designed to pare down what little remained of the British welfare state and redistribute resources upward, toward the rich.
Actually, government spending in the UK (mostly entitlements) is just under 40% of GDP. As in most countries it is countercyclical, but there is no long-term trend downwards:
Economists, for obvious reasons, can’t be completely oblivious to the role of banks, but they have spent much of the twentieth century arguing about what actually happens when someone applies for a loan.
I’ve spent most of my life studying monetary economics, and I was completely unaware that economists had spent most of the 20th century arguing about what happens when someone applies for a loan:
One school insists that banks transfer existing funds from their reserves, another that they produce new money, but only on the basis of a multiplier effect (so that your car loan can still be seen as ultimately rooted in some retired grandmother’s pension fund).
Here he is conflating two unrelated issues, whether the money multiplier is a useful concept and whether the funds for borrowers come out of saving. The money multiplier is the ratio of the change in the broad money supply (including bank deposits) to the change in the monetary base (cash plus bank reserves.) That’s all. No one thinks it is constant. When people start talking about how economists are “wrong” about the money multiplier, I suggest you stop reading.
Only a minority—mostly heterodox economists, post-Keynesians, and modern money theorists—uphold what is called the “credit creation theory of banking”: that bankers simply wave a magic wand and make the money appear, secure in the confidence that even if they hand a client a credit for $1 million, ultimately the recipient will put it back in the bank again, so that, across the system as a whole, credits and debts will cancel out. Rather than loans being based in deposits, in this view, deposits themselves were the result of loans.
The one thing it never seemed to occur to anyone to do was to get a job at a bank, and find out what actually happens when someone asks to borrow money. In 2014 a German economist named Richard Werner did exactly that, and discovered that, in fact, loan officers do not check their existing funds, reserves, or anything else. They simply create money out of thin air, or, as he preferred to put it, “fairy dust.”
So now we’ve gone from magic money trees to fairy dust. I feel like I’m in a Philip Pullman novel. This is a nice example of what’s called the “fallacy of composition”, the distinction between the individual case and the aggregate. An individual can unilaterally change all sorts of economic variables. If I decide to retire tomorrow, then employment falls, GDP falls, saving declines, etc. But that does not mean that a theory of the determination of aggregate employment, GDP, etc., should try to explain those variables by analyzing changes in the public preference for working. Instead, both left and right wing economists focus on the underlying drivers of employment. Keynesians might emphasize aggregate demand whereas conservative economists might emphasize how government programs and taxes impact incentives. Hardly anyone thinks that employment fell in 2009 because lots of people suddenly wanted more leisure time.
Similarly, an individual banker can make a decision that causes aggregate loans and deposits to be a bit higher than before she made that decision, but this does not mean that bankers determine the aggregate money supply, at least in any meaningful sense. Bankers respond to macroeconomic conditions such as changes in the monetary base, interest rates, capital requirements, reserve requirements, loan regulations, etc.
An auto executive will not consult the data on global oil production when deciding how many cars to build. But if the oil industry were not producing petroleum, then very few cars would be built.
Historically, the feeling that bullion actually is money tends to mark periods of generalized violence, mass slavery, and predatory standing armies
Hmmm . . . does “tends to mark” suggest “causation” or just “correlation”? I ask because I also believe that “bullion actually is money”.
There’s lots more criticism of behavioral assumptions such as self-interest and rationality. Most good economists understand that these are merely approximations of reality, useful for some purposes but not others.