/ Economics

Why Economics has Failed

In 1974, over dinner with senior staff of the Ford administration, economist Arthur Laffer sketched a curve on a cocktail napkin, using it to explain how tax cuts could lead to an increase in tax revenue. Despite facing harsh criticism by leading economists, Laffer’s curve went on to become the intellectual basis for tax cuts by US Presidents such as Reagan and Trump. The appeal was clear. For once, political leaders had economic theory, by a renowned economist no less, that they could use to legitimize popular (and vote-winning) tax cuts. The politicisation of economics is evidence that the “dismal science” does not exist in a vacuum. While much has been said about the theoretical and philosophical aspects of economics (economic models rely on unrealistic assumptions, economists stick too rigidly to certain models, etc.), not enough has been said about its application. This opinion piece seeks to examine the more insidious and systemic factors which hinder the prescriptive and predictive ability of economics.

The Laffer Curve (Photo from the National Museum of American History, American Enterprise Exhibition)

Debate on economic issues is largely influenced by academic economists, owing to their wealth of knowledge and research. However, many of these academics have been revealed to have ties with private sector firms, calling their independence and credibility into question. The award-winning documentary “Inside Job” revealed how major investment firms, such as Goldman Sachs, enlisted researchers from academia to speak in the media and write papers on their behalf in the aftermath of the ‘08 crisis. These firms also tend to have prominent academic economists, who speak out for them, sitting on their board of directors. This is a greater problem in economics than in other disciplines because economics has a more direct and visible bearing on the lives of people. Academic economists speak not only to fellow academics but to laymen, such as politicians and the media. And they do so with an air of authority and impartiality. It is worrying how the organisations they belong to may take advantage of their influence to advance the organisation’s goals.

Academics declare possible conflicts of interest only when they publish their papers. This is a problem because most people don’t read research papers and can’t be expected to know the corporate ties an economist has. The media should report more critically, calling out economists who publicly defend the private sector firms they belong to. It is naive, however, to assume that all news agencies aspire to that level of journalistic integrity. Fox News, which broadcasts to an estimated 71% of US households, has misrepresented facts and accommodated misleading and dangerous views. The onus is on us to source for objective and truthful news sources and constantly question the things we read and see.

There is also a risk of “groupthink” in policy and academic circles. This is driven by both the education system and a natural desire to surround yourself with people who do not think too differently from you. In policy circles, government leaders often bring in aides with similar thinking as them. Many of President Obama’s key economic advisors had Wall Street backgrounds, which is a possible reason for his administration’s lack of substantial reform in key areas such as the regulation of rating agencies.

University economics revolves around more mainstream schools of thought. Graduates then carry those principles with them into their careers. One example is the dogged belief in the efficiency of financial markets that blinded many economists to the emergence of the giant property bubble that caused the ‘08 crisis. The danger lies in economists boxing themselves in their schools of thought. University economics need to be revamped to expose students to more unorthodox theories and instill in them critical thinking skills and skepticism to constantly question what they have been taught.

The US Federal Reserve Jackson Hole Conference in 2005 is a telling moment. Economist Raghuram Rajan presented a paper warning that the financial system was taking on potentially dangerous levels of risk. He was mocked by almost all present, including former Secretary of Treasury Larry Summers who called his warnings “misguided”. In 2008, the financial system collapsed, causing the worst financial crisis since the Great Depression. Rajan is now seen to be prescient. The fact that his warnings were brushed off calls into question the resilience of an institution which easily dismisses contrarian views.

Growing distrust of experts will be increasingly deleterious. Prior to the Brexit Referendum, the Vote Leave Campaign printed advertisements on buses saying that the United Kingdom sends the EU 350 million pounds a week. Many experts were quick to debunk this claim, showing that after calculating the money EU sent back, the net amount paid was less than half of the 350 million quoted. Yet, the 350 million figure caught on and was cited by many voters as a significant reason they voted to leave, revealing how the voices of experts are drowned out in populist and misleading slogans. The credibility of experts has been diminished in the eyes of the public. This is due to many reasons, chief of which are the forces of globalisation which have widened inequality and resulted in many feeling left behind.

(Photo from The Independent)

Economic experts do not always get it right but they are still our best bet when dealing with highly technical economic issues. We ignore them at our own peril. This is perhaps why economic institutions, such as Central Banks, consist of officials who are appointed (not elected) for relatively long terms, in an attempt to insulate them from politics and the court of public opinion. Yet, even this may not be enough if both the people and the state continue to reject expert opinion in favour of virulent populism.

Despite the many criticisms levelled at it, economics is still a tremendous force for good.

In Mexico, the conditional cash-transfer scheme Oportunidades improved outcomes on health and education, quickly becoming a template for anti-poverty programmes in other nations. In Singapore, the ingenious infusion of economic theory into policy, such as our widely admired healthcare system, has produced solid results.

Economic theory will naturally improve as academics develop more refined models and uncover new insights. Improving the application of economics, however, will require concerted effort on our part to ameliorate the systemic faults at play. A more critical media and a revamped education system will go a long way in improving the quality and integrity of academia. Incorporating basic economics and financial knowledge in school curricula can help citizens call out economic drivel, combating ignorant populism. There is still much work to be done.