We Can’t Learn About Economics

fundamentals_economics

Despite spending the last several days reading up on Treasury Secretary Geithner’s plan to buy bad bank assests, I now feel only marginally better prepared to judge whether this is a good idea or not. Of course, no one is asking me, but I still think it’s a big problem that I can’t evaluate this plan, because the fact that we live in a democracy means that citizens need to be able to understand what their government is doing. 

Now, I am no economist and I have no idea how to run a bank — much less all the banks. However, I am smart, interested, and I’ve done my homework, including previously reading a first year economics textbook (covering both micro- and macro-economics) and several other interesting books (1,2,3) on how markets work or don’t. In short I have been the model of a concerned citizen, and I still have no idea what is going on. This is partially because the situation is very complex, but it is also because there is no way a private citizen can get access to the data that would clarify matters — large banks will barely share their balance sheets with the government, much less me.

This is a problem. It means that the government, financial, and academic communities have not paid nearly enough attention both to basic economics education, and to transparency in real-world business. It is therefore impossible for anyone else to check their assumptions and restrain their huge power. Lest this sounds like unhelpful complaining, I promise to make a concrete suggestion for improvement by the end of this post.

I find it useful to compare the question of bank bailouts to climate change. Like the worldwide recession, climate change presents a policy problem of global scope that needs to be handled right the first time. And like the global economy, climate change is a ridiculously complex problem, depending on the long-term interplay of hundreds of variables interacting through physical laws that most people have never head of. Because I was once a physicist, I can appreciate the basic science involved, and I can even make credible sense of specialist papers in the field. However, I don’t have to: the most cursory investigation of the topic quickly leads to the IPCC reports, a series of massively collaborative international summaries of current knowledge. There is no such authoritative primer for the economic crisis.

The best I have been able to find is Baseline Scenario’s Financial Crisis for Beginners, a collection of articles and interviews on various aspects of the problem. On the Geithner plan in particular, I have also found Brad DeLong’s FAQ to be quite helpful. Unfortunately, his (good) opinion of the plan is not universal: noted (and Nobel-winning) economist Paul Krugman disagrees. There’s a lively debate in the New York Times editorial pages today, and so it goes…

The core of the plan is this: the US Treasury will provide loans to allow investors to buy up bad bank assets — mortgages that might not be repaid, that sort of thing — as a long term speculative investment. This will, in theory, make the troubled banks more solvent, which should encourage them to start lending again. The potential problem is this: the loans will be “non-recourse“, which means that investors don’t have to repay the loans if these assets really are worth little or nothing. It amounts to the government insuring financiers to take more risk — for free.

This galls me, but it actually makes sense if you believe that the root of the current problem is that everyone is scared to take risk, and thus businesses can’t get loans, etc., which is the well-reasoned position of yet another prominent economist. It doesn’t make sense if you believe that some of these bad assets are just that: worthless debt that will never be repaid, such as mortgages to people who couldn’t afford them in the first place. In this view, the pre-crash boom was just a pyramid scheme that finally collapsed.

Which view is right? I have no idea. Neither, it seems, does anyone else. The major papers seem more interested in covering the politics of who said what (see, e.g. this from the NYT) than getting deep into the complexities of what is actually going on. This isn’t helpful; it’s little more than celebrity gossip, yapping about what the stars are doing. It’s akin to talk-show pundits arguing about climate change — which, sadly, also happens frequently.

So where is the IPCC report for the financial crisis?  Where is the graph that shows that lending has collapsed? Where is the excruciatingly careful analysis of the relationship between credit and unemployment? What percentage of which assets at which banks are now considered to be bad? I know these things must exist — I surely hope they do — but I do not have the time, expertise, or connections to track everything down. Thus I want a careful overview, but I also want the citations, because requiring that claims be documented is a really good way of keeping people intellectually honest. Lacking this, what reason do I  have to believe anything that anyone is saying?

One of the clearer, more careful resources I’ve found is the Congressional Research Service report “Causes of the Financial Crisis.” Ironically, this document, like all CRS reports, was not meant for members of the general public, and it had to be leaked to the fabulous OpenCRS.com for us to get at it. And in this summary I find the most refreshingly honest sentence:

While some may insist that there is a single cause, and thus a simple remedy, the sheer number of causal factors that have been identified tends to suggest that the current financial situation is not yet understood in its full complexity. 

If we are at all serious about democracy, then public education about complex topics must be a specific goal. This is a goal that goes hand-in-hand with greater transparency, because it is not possible to make convincing arguments about data that is secret. We need to be treated like adults, not children: the level of economic discourse in the current press is scarcely high-school level, complete with whispered secrets and gossip about who is popular. At best, the major players in this game — the US government and financial institutions — have been negligent in educating the public on the functioning and dys-functioning of the economy; at worst they are playing politics to protect their power and money. Nor have academia or well-informed bloggers stepped in to fill the vacuum.

Again, what is needed is a meticulously documented argument as to 1) what happened and 2) what can be expected to fix it. The truth may be that we simply don’t know what happened or what will happen next — but even if this is so, I want to know why those in charge believe what they believe. Lacking such a detailed, evidence-based narrative, it is simply not possible to be an informed citizen. The worst part is, I’m not sure that our professional legislators currently understand any more than I do. Transparency and good education benefit us all.

3 thoughts on “We Can’t Learn About Economics”

  1. Jonathan,

    Great article, and thanks for the compliment.

    You ask who is right about the bad assets. I think the answer shows one difference between the economic crisis and climate change. Whether or not bad assets will remain bad or will recover is unknowable right now. First, for the ordinary reason: the value of those assets will depend on the overall state of the economy in the future, which is itself unknowable. Second, there is an endogeneity problem: the future state of the economy depends in part on people’s current beliefs about those assets. If people were very optimistic about the assets, they would stop worrying about banks, housing prices would recover, people would consume more, the economy would recover, and the assets in question would recover. If the opposite, the opposite.

    Now, there might be an analogy to climate change here. I think it is pretty well established by the IPCC that climate change is occurring and, more or less, why. But I believe (I only know this on the level of NYT articles, so maybe I’m wrong) that there is less agreement about the evolution of temperatures in the future, and how it would be affected by various policies or changes in emission levels. That’s because we don’t understand how the various systems involved will interact with each other, creating positive or negative feedback loops. I think the future state of the economy is similar, at a very high level of generalization.

    But, you might ask, why can’t we at least get an account of how we got here that is comparable to our understanding of global warming? I’m not sure. But one hypothesis (besides the possibility that economists are just not as smart as physicists, which is probably true, at least in the traditional sense) is that economic systems are actually more complex than physical systems. The economy is affected by the decisions of 6 billion individuals, and some exogenous shocks like natural disasters, and we don’t fully understand how even one of those individuals behaves. I don’t even know how to compare this to the natural world, which might be far more complex, so I’ll stop there.

    James

  2. Hi James, thanks for your comment.

    Surely you are correct that the global economy is much, much more complex than the global climate. Physicists have it easy: their fundamental objects of study are all particles which can be described by very few parameters. Economists, on the other hand, have to contend with people — billions of them. So I do not mean to imply that economics itself should be as clear or as detailed as climate science, but rather that the educational material and available information should be every bit as good.

    If we truly don’t have the ability to predict what will happen, I wish the limits of our forecasting ability would be discussed more clearly and more often. Meanwhile, action must be taken, and I’ll credit the powers that be with having reasons for their choices. However, I can’t seem to find the chain of justification that leads them to believe that what they are doing is the right thing. Instead I find a lot of ideology and many qualitative remarks, and very little in the way of detailed econometric reports, solid historical studies, or careful argument from known principles. This is my complaint.

    With a messy, complex, unpredictable problem like fixing the global economy, epistemology is critical; one must have very good reasons for one’s beliefs. In a democracy, it’s equally important to put serious effort into communicating those reasons.

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