Harold Meyerson, an op-ed columnist for the Washington Post, this week launched a devastating attack on what he calls “mainstream economists.” Observe:
Has any group of professionals ever been so spectacularly wrong? Pre-Copernican astronomers and cosmologists, I suppose, and for the same reason, really: They had an entire, internally consistent, theoretically rich system that described the universe. They were wrong — the sun and other celestial bodies save the moon didn’t actually revolve around the Earth, as they insisted — but no matter. It was a thing of beauty, their cosmic order. A vast faith was sustained in part by their pseudo-science, a faith from which such free thinkers as Galileo deviated at their own risk.
As it was with the pre- (or anti-) Copernicans, so it is with today’s mainstream economists. Theirs is an elegant system, a thing of beauty in itself…. It just fails to jell with reality. And unlike the pre-Copernicans… their latter-day equivalents in the economic profession pose a clear and present danger to the well-being of damned near everyone.
Meyerson elaborates on the problems with the mainstream:
[It] is not simply that it failed to predict the near-collapse of the world financial system last year. The problem is that it believed such a collapse could not happen, that all risk could be quantified by mathematical models and that these quantifications could help us correctly price just about everything. Out of this belief arose the banks’ practice of securitization, which put a value on all manner of mortgages and enabled buyers to purchase and swap them with the certainty that such transactions reflected an accurate judgment of the value of the properties and the risks associated with them.
Except, they didn’t. So long as economists insisted that they did, however, there really was no need to study such things as bubbles… Under mainstream economic theory, which held that everything was correctly priced, bubbles simply couldn’t exist.
Judging by these excerpts, you might suspect that Meyerson would have some sympathy toward Austrian economics. His characterization of mainstream economics could easily have come from an Austrian. But I admit I left some things out. Alas, Meyerson isn’t an Austrian. Nor has he any sympathy with the free market. In fact, he curiously labels mainstream economists, pejoratively, as “free market” economists, though he conflates two separable, indeed conflicting, things: belief in the virtues of the market and fascination with mathematical modeling. (To speak strictly, Austrian economics is not free-market economics. It is a particular, value-free approach to the discipline. It requires a moral judgment, which no economic theory can supply, to pronounce the market process, as described by the Austrians, good. To be sure, if one values freedom and prosperity, Austrian economics will be attractive and promising, though of course that is not the test of its validity.)
Meyerson reveals his leanings at the top of the column: “‘The worldly philosophers’ was economist Robert Heilbroner’s term for such great economic thinkers as Adam Smith, Karl Marx, John Maynard Keynes and Joseph Schumpeter. Today’s free-market economists, by contrast, aren’t merely not philosophers. They’re not even worldly.”
The mainstream economists he has in mind are those “at least with the purer strain of free-market economics associated with the University of Chicago.” Despite the financial turmoil they still have not learned their lesson, he says. “The quants at the banking houses say that they simply failed to sufficiently factor some risks into their mathematical models. Once they do, their system will be corrected, and banks can resume their campaign to securitize everything (as some banks are already doing by establishing a secondary market in life insurance policies).”
Then he tips his hand fully: “The one economist who has emerged from the current troubles with his reputation not only intact but enhanced is, of course, Keynes.” (That’s too big a topic to address here.)
Uncertainty and Risk
Interestingly from an Austrian perspective, part of what Meyerson likes about Keynes is his grasp “that an uncertainty attends human affairs that transcends quantifiable risk.” Any Austrian can say something similar. Austrians eschew mathematical economics precisely because human action doesn’t fit into equations and the knowledge presumed by mathematical modeling is denied real human beings.
People are not molecules or planets or rats or bloodless calculators reacting to outside forces or instinct. They are entrepreneurial actors who form preferences and plans based on expectations about the uncertain future, none of which can be quantified. Moreover, these factors manifested in action are not fixed and known in advance; people don’t behave according to predetermined utility functions or indifference curves. Plans and preferences emerge when people choose among alternatives in the hustle and bustle of life, and can change unexpectedly and unpredictably as new situations arise (that is, as other people do unanticipated things.) Value preferences are subjective ordinal rankings of utility, or satisfaction, lacking a unit to which cardinal numbers can be attached and manipulated mathematically. Real costs are subjective utilities forgone and thus unobservable to outsiders. There are no constant quantitative laws in human action, according to which, say, doubling the price of commodity guarantees a predictable quantitative response.
In other words, as the preeminent Austrian economist Ludwig von Mises asked, “How can economic action that always consists of preferring and setting aside, that is, of making unequal valuations, be transformed into equal valuations, and the use of equations?”
In short, Austrians — Mises, Hayek, Rothbard, Kirzner, and those who have followed — stand second to none in rejecting scientism, the application of the methods of the physical sciences to the social “sciences.” They have relentlessly critiqued the mainstream’s out-of-touch preoccupation with mathematically describing the Neverland of general equilibrium, while ignoring real-world entrepreneurial action under uncertainty. No wonder Austrian economics has often been dismissed by the mainstream for rejecting the mathematicization that Meyerson properly ridicules.
Unfortunately, Meyerson seems oblivious of the Austrian school. If that were not the case, he would not imply that only the Keynesians are skeptical about neat mathematical models that claim to account for all eventualities. Nor would he identify the free market only with the Chicago school. He’d know that the Austrians were not among those economists who were “spectacularly wrong” as the financial fiasco approached. (It is surely inaccurate to say that all Chicago economists were unconcerned.) And he’d know that many prominent mathematical economists dislike the free market.
Austrians have long opposed the Federal Reserve’s price-distorting power over banking and money, the government’s intervention in the market for housing finance, and the too-big-to-fail doctrine that licenses unjustifiable speculation and rescues failing firms from the consequences of their actions. (That’s the free market?) Therefore, Austrian economists were not surprised by the housing bubble or the miserable aftermath of its bursting. Indeed, they have longed warned of a crash.
Where Are Fannie and Freddie?
Meyerson, unsurprisingly, never mentions the Fed, Fannie Mae and Freddie Mac, or the other agents of intervention that set the economy up for recession and other system-wide failure. To him the culprits are irrational animal spirits, no doubt with a big dollop of greed. Since he is blind to government’s responsibility for the crisis, he can write, “Thus the state must ensure against periodic madness in the markets with regulations and social insurance, because madness is a potential threat in markets just as it is in other human endeavors — because the market is a human endeavor, not reducible to a mathematical construct.”
Since the State is a human endeavor, too, why should we assume that government officials, who are plagued by ignorance, political incentives, and the lack of feedback, are immune to the “psychology” that Meyerson says the mainstream economists leave out of their models? Where is his rebuttal of the mountain of evidence that regulation and social insurance (such as federal deposit insurance) create “madness” through the construction of perverse incentives and moral hazard?
The mathematical economists might have been too busy with their models to notice that in the real world intervention was, and remains, rampant. Meyerson dislikes some of the right things. But his ignorance of Austrian economics keeps him from seeing the full picture. The free market didn’t fail — because there was no free market.