Over on Tough Money Love, I left a comment on a post criticizing the actions of economists lately.  Following is a cleaned-up version of my comment.

It is fairly easy to criticize economists for lack of foresight over the past few years.  Relatively few economists saw the housing boom and its ultimate cause and ramifications.  Mark Thornton was one of the people who did, and in a 2004 article decrying the housing bubble, he notes in his penultimate paragraph, “Given the government’s encouragement of lax lending practices, home prices could crash, bankruptcies would increase, and financial companies, including the government-sponsored mortgage companies, might require another taxpayer bailout.”  That sounds rather similar to what did happen 4 years later, and was a significantly better prediction than most economists—especially government economists—came up with.

The problem with government economists isn’t their competence, in the sense that some other group of economists (or laymen) would have done a much better job managing things.  Rather, the problem is in what people–including government economists–expect economists to do.  With this, you get one of two ideas:  either the person who predicts stock market movements (which economists, frankly, cannot do, and most gladly tell people they cannot do) or an Alan Greenspan or Ben Bernanke pulling the strings and coordinating everything so all of our decisions end up working out.  This is FA Hayek’s “fatal conceit” in action:  the idea that some individual or group of individuals has the ability to collect, aggregate, interpret, and disseminate the ridiculously large number of facts necessary for the coordination of human actions.  There are economists who understand the impossibility of this and note that the extent of economic “management” should be the installation of a good, slowly evolving set of generic, abstract rules which limit action at the boundaries (e.g., prevention of theft, potentially setting up welfare for certain groups of individuals, etc.) but not directly written for any particular circumstance or individual/set of individuals.  These economists generally do not end up in government positions because they don’t want to waste their time and they can’t give politicians what they want–intellectual cover to implement their own ideas or pad the wallets of favored constituencies.  Unfortunately, this leaves the economists who do believe in government coordination of markets, or those who believe that they can “guide the economy” in ways favorable to individuals, like Alan Greenspan attempted.  Even more unfortunately, these individuals also work within political constraints, even at the nominally free Federal Reserve (which, of course, is not independent).  This constrains their actions and leads to a tendency for Federal Reserve chairmen to drop interest rates and ride the booms, and that inevitably leads to the busts.

This leads to Mr. Tough Money Love’s question:  “Who should be at the wheel?”  My answer is, nobody should be “at the wheel.”  I would say that, in an ideal world, politicians would be elected to set certain rules that a) pass popular muster and b) are good for long-run growth.  After that point, the legislature should step out of day-to-day dealings of economic entities, and the executive and judiciary should be limited to acting within the general rules.  The entire notion of having “a wheel” to be at is the problem, not the “driver.”  I’d much rather have Ben Bernanke and Hank Paulson/Tim Geithner “at the wheel” than Chris Dodd and Barney Frank or a pair of bureaucrats or regulators, as at least Bernanke and Geithner have an idea of what they’re trying to do (even though they’re doing a rather poor job of elaborating on that idea or being consistent).  The problem, though, is that they can’t do what they’re trying to do–it’s just not possible for anyone.

The entire concept of having a top-down management of the economy—even in a general level, using interest rates to alter “the macroeconomy”—is a fundamental mistake.  Economic coordination is a bottom-up endeavour, as that is where all of the knowledge is.  Most government economists are smart people who are trying their best with the most knowledge they have available to them, but “running an economy” is a fool’s errand.  Unfortunately, this notion is politically stable, as individuals have a very difficult time understanding the idea of a spontaneous order, and that gives politicians and power-seekers an opportunity to set up institutions which control at the expense of true economic coordination, leading to the occasional disaster.  Even more unfortunately, it seems we never learn from this mistake.


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