It's strange to think that, while attending a recent conference of some of the most illustrious names in economics and finance, the talk of the 2008 market implosion actually transported me back to eastern Europe in the years before and soon after communism fell.
When listening to the many ways that economic dogma has diverged from economic reality, it began to seem as if capitalism, like communism, was a system that had rotted from within. The conference, held in the iconic setting of Bretton Woods, New Hampshire, was organized by the Institute for New Economic Thinking. INET is backed by billionaire financier and philanthropist George Soros, someone with intimate knowledge of communism and its many corruptions. The message from some at INET seemed to be, if capitalism is to thrive, it needs to be saved from itself and its most ideologically-hardened practitioners.
Among those practitioners are the free market economists at prestigious universities and institutions whose predictions have been so wildly off the mark, and the financial wizards who espouse the ideals of capitalism but have actually twisted and compromised those ideals at trading desks and boardrooms across the world. As they sold the conventional wisdom that a rising tide lifts all boats, the reality is that most of us have been pushed under water by a wave of surging income and wealth inequality.
Princeton economic historian Harold James believes that trust in economic predictions has been broken, and it's not hard to see why. In the free market utopia, markets are supposed to allocate efficiently, self-correct, and bring ever greater prosperity to all, if only regulators would get out of the way of rational financial actors. But just as in that other, now-discredited utopian system (communism), the ideology and the reality had little connection to each other. What we have seen in the disaster of the past few years is that getting out of the way allowed a small fraction of the elite to get very rich by making extremely risky bets. In my view, they used what I call shadow, or unregistered, lobbyists to shape and keep government policies to their liking. And when their luck turned, these "free marketeers" sought and got government help. So much for "getting out of the way." And welcome to the era of moral hazard, a threat which, Soros said, now "looms larger than ever before."
Where exactly have economists gone wrong? A screen that served as a backdrop for one INET session put it well: chalk it up to "arrogance and its ignorance." First there's a faith in the inherent stability and resilience of financial markets, which, of course, is amply discredited by recent history.
Then there's the tyranny of the mathematical models favored by so-called "market fundamentalists." As James points out "....calculations about likely risks.... are terribly.... misleading. If we think there's one-in-a-1000-year chance of something happening, we're inclined to ignore it. But then we find suddenly that these one-in-a-1000-year chances....seem to be happening every 10 minutes...."
Economic models also can't truly account for, as Soros pointed out, the uncertainties that, by definition, cannot be quantified. Nor can they model irrationality. Political economics (a field often derided by mainstream economics) got some of its due at the meeting among those who hope to capture the reality of how market systems actually work. That would mean at least trying to account for the unruly human factors that complicate any predictions and/or policy prescriptions.
There's the ignorance of economists who mistake concepts for reality, according to Berkeley economist and Nobel Laureate George Akerlof. He says the mistake is in treating concepts like the production function or utility function as a thing that is stable without considering the context in which it is applied.
And finally there is the zealous devotion to the idea of broad economic growth creating prosperity for all. This market dogma has driven economic (often deregulatory) policy for decades under both Democrats and Republicans. You could say that it has a sort of parallel in the corporate world where CEO's say that their primary goal is to maximize shareholder value. These ideals might be worthwhile if they actually delivered, but they haven't. As INET speaker University of Massachusetts-Lowell Professor William Lazonick pointed out, CEO's have used stock option manipulations to keep delivering rewards to executives under the guise of "maximizing shareholder value." Average stockholders meanwhile are still reeling from the losses of 2008. This recalls the asset-stripping in Russia that occured after communism fell, with U.S.-sponsored economic "reforms" often providing incentives to those doing the stripping. A crucial patron of those "reforms" was then-Treasury official Larry Summers, who gave a keynote at the conference.
And in terms of the broader economy, the focus on growth has been a boon for power brokers and the already-wealthy, and a bust for nearly everyone else. University of Massachusetts-Boston political scientist Tom Ferguson laid a lot of the blame for income inequality on the fact that regulators can now routinely walk out the door and make sometimes millions as one of the regulated: "in effect it turns government agencies into recruiting agencies for the regulated....there's a point beyond which sheer inequality destroys a [democratic] political system...." U.K. financial regulator Adair Lord Turner also attacked the inequality issue, suggesting the time has come to question whether a singleminded focus on overall growth should shift to goals of stability and crisis prevention.
While Turner struck a reflective tone, one of the most important economic policy players shaping the environment leading up to the financial crash did not. Former Treasury Secretary and avid deregulator Larry Summers said he wasn't convinced financial "innovation" caused the crisis, a convenient narrative for someone who allowed exotic derivatives to grow unchecked under his watch. (And a bit hard to square with what he said last year on PBS when asked if he had any responsibility for the crash. He said that credit default swaps were "the center of the issue now," and this financial innovation "barely existed [during his tenure at Treasury.]")
He also warned against the demonization of mainstream economics by people who "don't do math," and flagged the dangers of overregulating in the wake of a crisis. Summers suggested that a crisis mentality is what led Communists to create a planned economy, which eventually collapsed. To my ear, Summers himself sounded not unlike communist authorities who deflected blame by simply denying having agency or authority, and striking a disinterested, distancing voice. By the way, in that PBS interview, he said the word "mistakes", "error" or "failure" five times, with his finger pointed not at himself but squarely at Wall Street and corporate America. Arrogance and ignorance, meet evasion and avoidance.
Linda Keenan edited this column.
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