Are you smarter than a fifth grader? The ways that neoclassical economics obscures common sense

True story: I went to one of the most progressive colleges in the U.S. Friends who knew of my intense interest in politics thought that I would not enjoy microeconomics but that I would love macroeconomics. As it turns out I had a brilliant microeconomics professor and it was one of the best classes I ever took. But my experience of macroeconomics was another matter entirely.

Midway through the semester, after explaining the money supply, fractional reserve banking, and the role of the Fed, the professor spent most of one class on the "Chilean Economic Miracle." He talked about deregulation and privatization and 8% growth rates in the GDP. As he concluded his lecture I realized, with astonishment, that he was not ever going to mention the military brutality that went along with the Chicago School Economic Program. Look, if this was the University of Chicago Economics Department, I might have understood, embarrassed as they might be at the number of people murdered in the name of their theories. But this was one of the most liberal colleges in the country and yet, the thousands of people murdered under Pinochet in Chile were going to get no mention in this class.

I was alarmed and looked around the classroom to see if anyone else was similarly distressed by the sleight of hand that had just happened in front of us. But all of the other students were dutifully taking notes. So I slowly raised my hand, interrupting the professor as he blissfully moved on to another topic.

I don't remember exactly what I said but it was something along the lines of:

"Um, aren't you missing something? The economic growth that you are talking about happened under a military dictatorship. Pinochet murdered thousands of union members, rounded up people and tortured them in soccer stadiums, threw nuns out of helicopters, operated death squads throughout the regime. Don't you think it's a problem that the Chilean Economic Miracle that you are talking about was implemented by a fascist government? Doesn't that invalidate the economic growth that happened, if it had to happen under a military dictatorship?"

At the time, I was taking a class in modern Chilean literature, reading first-hand accounts of what it was like to live under the Pinochet government. Clearly my economics professor was not reading the same books.

The professor, clearly taken aback by my rather sharp criticism of his lecture proceeded to talk about the Pinochet government and the Pinochet/University of Chicago economic program as if they were two separate, unrelated things. He acknowledged that the Pinochet government was brutal, but said the military repression was not the cause of the economic growth. Rather, Chile, in spite of the military government, had implemented an economic program that would work regardless of who was in power.

His argument seemed disingenuous at best. A year before, I had traveled in Central America and seen what U.S. economic and military power did to people on the ground in these countries. And the U.S. had just concluded the first Persian Gulf, an unbelievably cynical corporatist war straight out of 3 Days of the Condor.

So, at the risk to my grade and to the horror of the econ majors in the room, I took another pass at explaining the problem with his argument. "If the Nazi's had had 8% economic growth, would you give an entire lecture on the economic growth in Germany without mentioning the rest of the Nazi program?" (lol. *sigh* I was much more brazen in those days).

The Professor, now clearly unhappy with me, explained that while the Pinochet government was surely brutal, they did not rise to the same level (of horror) as the Nazis; and that Chile under Pinochet and Nazi Germany were different examples. It is true that I probably erred in including the Nazi example (people get all woozily the moment anyone mentions Nazis -- any hope of reaching a new understanding pretty much goes out the window after that). But the point remains that if a nation has to use death squads and military dictatorship to implement their economic program -- it invalidates everything that happens afterward. You can't claim credit for increasing GDP if said increase in GDP required the murder of thousands of your fellow citizens in order to achieve that growth.

My point is this: I'm sure the economics professor was a great guy. In fact one of my friends thought this professor was the best in the whole college. I'm sure at a summertime bbq this professor would tend the grill and greet the guests and tell great stories. But his academic training had made him LESS smart than he would have been through common sense and living in the world.

That's always my question with various disciplines -- do they make people smarter, more able to see and understand the world around them? Because sadly, it seems to me that a lot of disciplines make people less smart -- dogma has a way of making things perfect on paper and yet, over time, rather unhelpful in the world.

Take the Buddhist story of the faithful monk who meditated so long that he developed gangrene in his legs but kept meditating to show his faithfulness to a discipline that devalues the physical world in favor of the spiritual world. (Now maybe the story is apocryphal, but it certainly illustrates a certain mindset of those who keep pressing on even when evidence suggests one should stop.) I'm sure the monk was a great guy, but his dogma had made him less smart than he would have been through just common sense and living in the world.

It seems to me that religion, neoclassical economics, and scientific disciplines that downplay the importance of emotions and human experience all make their practitioners less smart than they would have been on their own, left to their own devices.

Which brings me to my next example. The March 1, 2010 edition of The New Yorker has a long profile on Paul Krugman (again it appears free right now but if you want to read it, do it soon before they move it behind their subscription pay wall). It's definitely worth a read. Paul Krugman is brilliant. He's one of the smartest economists in the world and a winner of the Noble Prize in economics. He's also a progressive and one of the most important public voices in the country challenging neoclassical orthodoxy and conservative policies that don't make sense. But what really jumped out at me about the article, were Paul Krugman's blind-spots -- the areas in which economics as a discipline had made him less smart than he might have been through just common sense and experience in the world. I want to quote several sections at length:

Krugman’s tribe was academic economists, and insofar as he paid any attention to people outside that tribe, his enemy was stupid pseudo-economists who didn't understand what they were talking about but who, with attention-grabbing titles and simplistic ideas, persuaded lots of powerful people to listen to them. He called these types “policy entrepreneurs”—a term that, by differentiating them from the academic economists he respected, was meant to be horribly biting. He was driven mad by Lester Thurow and Robert Reich in particular, both of whom had written books touting a theory that he believed to be nonsense: that America was competing in a global marketplace with other countries in much the same way that corporations competed with one another. In fact, Krugman argued, in a series of contemptuous articles in Foreign Affairs and elsewhere, countries were not at all like corporations. While another country’s success might injure our pride, it would not likely injure our wallets. Quite the opposite: it would be more likely to provide us with a bigger market for our products and send our consumers cheaper, better-made goods to buy. A trade surplus might be a sign of weakness, a trade deficit a sign of strength. And, anyway, a nation’s standard of living was determined almost entirely by its productivity—trade was just not that important.

When Krugman first began writing articles for popular publications, in the mid-nineties, Bill Clinton was in office, and Krugman thought of the left and the right as more or less equal in power. Thus, there was no pressing need for him to take sides—he would shoot down idiocy wherever it presented itself, which was, in his opinion, all over the place. He thought of himself as a liberal, but he was a liberal economist, which wasn’t quite the same thing as a regular liberal. Until the late nineties, when he became absorbed by what was going wrong with Japan, he believed that monetary policy, rather than government spending, was all that was needed to avoid recessions: he agreed with Milton Friedman that if only the Fed had done its job better the Great Depression would never have happened. He thought that people who wanted to boycott Nike and other companies that ran sweatshops abroad were sentimental and stupid. Yes, of course, those foreign workers weren't earning American wages and didn't have American protections, but working in a sweatshop was still much better than their alternatives—that’s why they chose to work there. Moreover, sweatshops really weren't the threat to American workers that the left claimed they were. “A back-of-the-envelope calculation . . . suggests that capital flows to the Third World since 1990 . . . have reduced real wages in the advanced world by about 0.15%,” he wrote in 1994. That was not nothing, but it certainly wasn't anything to get paranoid about. The world needed more sweatshops, not fewer. Free trade was good for everyone. He felt that there was a market hatred on the left that was as dogmatic and irrational as government hatred on the right. --The New Yorker

Take any fifth grader in the U.S. and explain the situation to him or her as follows: there is a factory that makes running shoes that pays their workers $18 an hour. Now another factory opens up and instead of paying their workers $18 an hour -- they pay their workers less than $1 an hour -- and the shoes are about the same quality. What will happen to the workers at the first factory?

I would wager that the average fifth grader will be able to figure out that all of the workers at the first factory will lose their jobs. Furthermore, if one continues the example and says that "the worker from the first factory is now looking for work, what are his/her wages likely to be at the next job?" the average fifth grader will be able to figure out that the wages for the worker are likely to be significantly less at the next job than in his/her former job.

But if you put that average fifth grader through a Ph.D. program in economics that only looks at neoclassical economics models, voila, that person might now conclude that "A back-of-the-envelope calculation suggests that capital flows to the Third World since 1990 have reduced real wages in the advanced world by about 0.15%." Neoclassical economic dogma actually made a really smart guy less smart than an average fifth grader.

An entire generation of American workers (those with only a high school diploma who worked in manufacturing) has had their economic aspirations crushed by U.S. free trade policies based on these incorrect models of how the global economy works. And yet, because these workers didn't neatly fit into the economists' models, they weren't factored into policy.

The extent of the corruption in corporate America, was also missed by Krugman until recently:

Certainly until the Enron scandal, Krugman had no sense that there was any kind of problem in American corporate governance. (He consulted briefly for Enron before he went to the Times.) Occasionally, he received letters from people claiming that corporations were cooking the books, but he thought this sounded so implausible that he dismissed them. “I believed that the market was enforcing,” he says. “I believed in the S.E.C. I just never really thought about it. It seemed like a pretty sunny world in 1999, and, for all of my cynicism, I shared a lot of that. The extent of corporate fraud, the financial malfeasance, the sheer viciousness of the political scene—those are all things that, ten years ago, I didn't see.” --The New Yorker

Look, I don't want to cap on Paul Krugman. He's one of the finest thinkers in our country. And unlike many neoclassical economists, he's willing to admit when he is wrong and shine a light on the limitations of the thinking that characterized his earlier career. But it is a striking illustration of just how primitive economics remains as a field at this point that such glaring errors show up in the writings of one of our finest economists.

And the reason these errors show up is that economics as a discipline has placed priority on mathematical models over experience.

Again, as in his trade theory, it was not so much his idea that was significant as the translation of the idea into mathematical language. “I explained this basic idea”—of economic geography—“to a non-economist friend,” Krugman wrote, “who replied in some dismay, ‘Isn't that pretty obvious?’ And of course it is.” Yet, because it had not been well modelled, the idea had been disregarded by economists for years. Krugman began to realize that in the previous few decades economic knowledge that had not been translated into models had been effectively lost, because economists didn't know what to do with it. --The New Yorker

Krugman makes this point eloquently in an article in the New York Times Sunday Magazine titled, "How Did Economists Get it So Wrong?" His short answer: economists mistook (mathematical) beauty for truth.

This is not a small matter. Economists have enormous influence over policy. Quite literally, life and death policy matters are being decided based not on the facts but on how pretty the economic model looks.

I will have much more discussion on this topic in a future post when I review Yves Smith's extraordinary book, "Econned: How unenlightened self interest undermined democracy and corrupted capitalism." I'm just two chapters in but it is amazing -- the best book I've read since Shock Doctrine.