With Greg Ip, Chief Economics Commentator for the Wall Street Journal
In Defense of the Dismal Science
Steve speaks with Greg Ip, Chief Economics Commentator for the Wall Street Journal, about a recent article he published titled,” In Defense of the Dismal Science,” a somewhat derogatory name given to the science of economics.
Economists Under Attack
Steve kicks off the conversation by asking Greg why he feels economics needs to be defended these days. Greg says he wrote the article because he sees economists getting a lot of criticism across the board. He cites a particularly egregious example of the former Head of the Statistical Agency in Greece, an economist by training, whose alleged sin was to tell the truth about just how big Greece’s debts were six or seven years ago. And that made the resulting austerity and recession worse, causing a lot of folks in Greece to attack him instead of thanking him for getting the real numbers out there. He was prosecuted and sentenced to two years in prison, basically, for crimes linked to the proper execution of his duties.
“In Defense of the Dismal Science” cites another, less egregious, example. In Great Britain last year (2016), a lot of economists (including the Governor of the Bank of England, Mark Carney) warned that voting to leave the European Union could be bad for the British economy. Carney was subsequently attacked for taking a political stand even though he was fulfilling his duties as the head of a central bank, and was ultimately asked to resign.
Greg Ip also speaks of a case right here in the United States where the non-partisan Congressional Budget Office’s (CBO) economists are attacked for unbiased analyses on hot-button topics such as repealing or replacing the Affordable Care Act. President Trump’s Budget Director has attacked the CBO on several occasions for their analyses, and Trump’s staff penned an op-ed saying that anything that comes out of the CBO needs to be treated as fake news!
In general, “In Defense of the Dismal Science” showcases broad skepticism for economists and economic data, and Greg felt it was time to step back and explain what economists do, and what the public should expect.
Greg Ip’s article explains the origins of economics as being rooted in moral philosophy. The first economists, people like David Hume and Adam Smith, were moral philosophers. In the early days, economics was called political economy and people associated with this new discipline were trying to find ways to understand human behavior and how society organized itself without deferring to a higher moral or political authority.
These moral philosophers determined, through force of argument, that when people are left to pursue their own best interests, that in itself is an organizing principle for society that often yields the best outcomes. This was best captured by Adam Smith’s memorable reference to the “invisible hand” of the free market that he spoke of in his 1776 book, The Wealth of Nations.
The Invisible Hand
On Steve’s prompting, Greg explains that “invisible hand” essentially refers to a person, say a baker or butcher, who in pursuit of his own self-interest makes and sells a product at the highest price he can get for it. And the consumer spends his money on things that give him the most satisfaction. Therefore, individuals’ own interests produce social outcomes that are best for everybody. Multiply that a million times, and you have an efficient free market of goods and services.
“In Defense of the Dismal Science” also talks about Comparative Advantage where everyone focuses on things that they do best, as opposed to doing everything—such as the U.S. focusing on grain production and outsourcing tire manufacturing to China, leaving everyone better off.
Quantifying Economic Behavior
In the 1940s, Paul Samuelson used advanced math to present theories and axioms that economists had been using for centuries, to make the discipline more scientific, objective, and predictive.
While mathematical models have helped quite a bit, they’ve also led many astray. For example, a lot of investment banks built entire trading desks based on complicated mathematical systems, and the whole system blew up in 2007. So, mathematical models are somewhat limited, opines Steve, because predicting human behavior is no easy task.
Learn more about economics and its influence on our everyday lives from Greg Ip’s “In Defense of the Dismal Science” article in the Wall Street Journal.
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Steve Pomeranz: A few weeks ago, I was thumbing through the Wall Street Journal and I saw an article entitled, “In Defense of the Dismal Science.” Now the dismal science is a somewhat derogatory name given to the science of economics. Greg Ip is its author, and Greg is the Chief Economics Commentator for the Wall Street Journal, and he joins me today to discuss it.
Hey, welcome to the show, Greg.
Greg Ip: Thanks for having me on the show, Steve.
Steve Pomeranz: So why, in the first place, does economics have to be defended these days?
Greg Ip: Well, I kind of feel it needs to be defended because the economists are getting criticized left, right, and center.
In my article, I cite one particularly egregious example of the former head of the Statistical Agency in Greece. Now even though he’s a statistician, he’s an economist by training, and his alleged sin was to basically tell the truth about just how big Greece’s debts were six or seven years ago.
And that made the resulting austerity and recession worse. So, a lot of folks in Greece, instead of sort of like thanking him for getting the real numbers out there, blame him for the bad stuff that happened after the true size of the debts became known. And so, he was pursued by prosecutors over a number of years.
And even though he was acquitted twice by courts, in at least one case, the charges were reinstated. And in August, he was convicted, sentenced to two years in prison, basically, for crimes linked to the execution of the duties. So, that would be just one example, but we’ve seen less egregious examples much closer to home.
In Britain last year, a lot of economists—including the governor of the Bank of England, Mark Carney—warned that voting to leave the European Union could be bad for the British economy. And a lot of folks, including some members of parliament, said this was a terrible politicization of the bank, that he was saying things that were simply not true and that he should resign.
Steve Pomeranz: Yeah.
Greg Ip: And I guess the most recent example would be right here in the United States. In Washington, we have an agency called the Congressional Budget Office. It’s non-partisan; it’s mostly made up of analysts; a lot of them are economists. Their job is to give Congress the most unbiased analysis they can on the decisions they have to make.
And they have put out a number of reports that said repealing or replacing the Affordable Care Act would significantly increase the number of people without health insurance. President Trump’s budget director has attacked the CBO on several occasions for this analysis. And Trump’s staff penned an op-ed saying that anything that comes out of the CBO on this question needs to be treated as fake news.
So, those are a few of the incidents, but we see this in polls too, broader skepticism for economists and economic data among the broad public. So, that’s why I felt it was time to actually step back and say, “Well, what is it that economists do, and what should the public expect?”
Steve Pomeranz: Yeah, that’s a very good question. First of all, it’s a 200-year-old science. How did it start? How did economics get its first intellectual approach?
Greg Ip: Well, before there was economics, there was moral philosophy. And the first economists, people like David Hume and Adam Smith, were moral philosophers.
And economics, which at the time they actually called political economy, what it had in common was the people who were associated with this new discipline were trying to find ways to understand human behavior and how society organized itself that did not require you to basically defer to some higher moral or political authority.
And what these folks did, was they determined through force of argument that when people are left to pursue their own best interests, that in itself is in some sense an organizing principle for society that yields in many cases the best outcome. Probably the most memorable phraseology to capture this was Adam Smith’s reference to the invisible hand.
Steve Pomeranz: Of the free market.
Greg Ip: Which he talked about, yeah, in The Wealth of Nations in 1776.
Steve Pomeranz: Yeah, what is that invisible hand? What does that mean?
Greg Ip: Well, basically what Smith was saying was the invisible hand is essentially the person, as he put it, the baker or the butcher in pursuit of their own interest makes, they basically sell their product to the person who’s willing to pay the highest price.
The worker puts his effort into perusing that thing that gets him the highest wage. The consumer spends his or her money on the thing that gives him or her the most satisfaction. All these decisions, even though individually driven by individuals’ own interests, produce a social outcome that’s best for everybody.
Steve Pomeranz: Yeah, the idea that a doctor who can take care of her child quite well, decides to actually take care of other people and use that money that she makes to hire a nanny to take care of her child. This has broader implications multiplied millions fold which creates this giant movement, this invisible hand.
Greg Ip: Well, the example you’ve just given is an interesting one, Steve, because in 1817—in fact, we’re celebrating the 200th anniversary of the publication of this book—it was a book by David Ricardo, another great economist, and he established the theory of comparative advantage. And what this theory basically said was that even if you as a country, let’s say the United States, can make tires more efficiently than another country like China, it might actually make sense for you to make something else where you’re even more efficient like growing grain. And then you become an exporter of grain and an importer of tires from China. That’s the theory of comparative advantage. Now, most people have struggled with this theory and cannot understand why the United States would want to trade with poorer countries when we can actually make things more efficiently than those other countries.
The reason quite simply is that there are only so many people in the labor force and so many hours in the day. And you want to spend those people spending those hours doing the thing they’re best at. And then they can sell the things they produce and use that money to buy the other things they don’t produce, and everybody’s better off.
Steve Pomeranz: Well, we seem to be operating in a world that fits that model almost perfectly, even though there’s a movement afoot to try to slow it down, or to put obstacles in front of that. Moving along, though, on the history of economics, Paul Samuelson wrote a book which brought mathematical analysis into the picture.
What happened then?
Greg Ip: So, I think this is important because economics, as I said a few minutes ago, began as this attempt to try and divorce human behavior from moral considerations and put it in more the result of more amoral, sort of drivers. The next step was to quantify these drivers, to quantify things like supply and demand, and wage rates, and the return on capital, and so forth.
That’s what Paul Samuelson did. He comes along in the 1940s and he actually devotes his Ph.D. thesis at the Massachusetts Institute of Technology to using advanced math to basically lay out a lot of the theories and axioms that economists have been using for over a century. And this begins what I would call the mathematical revolution of economics, where more and more of the things that economists try to explore, whether it’s the behavior of interest rates, the behavior of unemployment, supply and demand and monopolistic behavior, that they actually express these in mathematical terms.
And as economists get ever more theory and ever more computing power at their fingertips, the discipline becomes more scientific, more mathematical, or at least it tries to appear more scientific. The economists kind of get this idea that, “Hey, if we just try hard enough, we can be as objective and as predictive as, say, physics.”
Steve Pomeranz: Yeah, let’s get into that a little bit because the mathematical models have helped quite a bit, but they’ve also led so many astray. I’m thinking about the 2007, 2008 recession where a lot of the investment banks built entire trading desks, and the concepts on which they traded on these very complicated mathematical systems and the whole system blew up. And economists weren’t able to forecast that either, and neither was anybody from the Federal Reserve able to do that as well. So, the ability of these mathematical models are somewhat limited, wouldn’t you say?
Greg Ip: Absolutely, and indeed, I think the idea that using more math would give economists greater predictive power was in some sense a chimera.
It was a dream that was never going to be fulfilled. So, economists were able to write more elaborate forecasts, but they’ve never been very accurate. Frankly, if you just look at what the growth rate or the inflation rate was last year and made that your forecast for this year, you’ll probably do better than most economic forecasts.
And what economists have run into time and again is they’re trying to predict the behavior of individuals or groups of individuals or an entire economy is a very different exercise from trying to predict, for example, how a celestial body moves through the skies.
Steve Pomeranz: Yeah.
Greg Ip: Because people are sort of varied. They don’t respond to the same phenomenon the same way among each other, or in the same way over time. They might respond, for example, to a rise in the price of housing by buying fewer houses or they might buy more houses if they think the price is going to go up later.
And it’s also very difficult for economists and financial people to understand how these factors sometimes interact and alter expectations. And that is why economists are almost always surprised by recession. That’s why they’re repeatedly surprised by financial crises.
Steve Pomeranz: My guest is Gregory Ip. He is the chief economics commentator for the Wall Street Journal.
We’re talking about In “Defense of the Dismal Science”. We’ll be back in just a moment with Greg.