Middle of the Week Thoughts: what’s the matter with economics? Should we change our point of view to avoid further mistakes?

Yevhen Pentsak (50) 20 August'09

Tags: Yevhen Pentsak, market, risk, investment portfolio, real estate, macroeconomics

A discussion was launched by The Economist in June, 2009 that challenged the wisdom of economic sciences (namely, macroeconomics) as lacking potency to make reliable forecasts. Anyway, no one has been keen enough at predicting the last financial crisis which (regarding the scope of it) is now fairly related to the Great Depression of 1929 in US.

This dismal science – the economics – thus called by a noted historian, Thomas Carlyle in the 19th century (the epithet was later made use of by Nietzsche)– the science that, not too long ago, had been so promising as far as the world’s bright future was concerned … As a matter of fact, the epithet cited was a kind of an answer to Thomas Malthus’s paper on prospective famine that was threatening mankind in view of the coming lack of provisions. Economics, as it is, might explain away any kind of human activity – starting with your personal “advisable course” in conversing with a traffic warden, the instance of on-site tax audit, drug dealers’ game of intrigue, as well as flag football rules. That’s why the Wall Street has always recruited the best of the best of American university graduates to grab the novel tricks like the theory of games, option evaluation techniques etc. Hence, economists became much better trusted than the politicians… The crashes of economic forecasts in the 80-s hurt the reputation of the glorified economic science for good measure. Thus, first seeds of second thought were been planting in minds. I expect that talented youth in Ukraine will soon manage to discern the true value of engineering sciences (as opposed to the above) and avoid being stuffed into economic faculties by their loving parents.

Illustration by John Berkeley for The Economist

Another painful jolt was received by the economic theory from Paul Krugman, a Nobel Prize winner in economics. The latter stated quite recently that all thorough its development over the past 30 years economic science was “spectacularly useless at best, and positively harmful at worst”. Barry Eichengreen, another noted historian of economics poured his fuel on the flame in this discussion, saying that the latter crisis shook the foundations of our economic knowledge. Without any beating about the bush, the journalese-speaking community have come to a comfortable conclusion that, as inefficient as they turned out to be, the economic laws should be substituted with demagogies and gallery play. As long as Adam Smith’s “market invisible hand” presumably had never existed the belligerent political voluntarism should take its place. Considering our case we, in my strong opinion, are hostages of the current government’s and central bank’s policies that will have us financially liable in the long-long time perspective.

That is to say, macroeconomics and economic finances are being blamed of the three sins: they are guilty for the very instance of financial crisis, they’d failed to predict and suppress it, and they haven’t got a littlest idea of how to get out of it.

Presently, both economists and financiers started looking for the principle in the first degree and eventually traced it in person of the market efficiency hypothesis. Patching up the above theory was a matter of honor for the many of outstanding economists. The three grades of the efficiency were developed – weak, semi-strong and strong as regards to the relevant information source that was used for decision making. Joseph Stiglitz and Andrey Shleifer, the coryphaeus of modern economic science, made researches of the irrational behavior of economic entities particularly in the cases when such behavior was in rather poor agreement with the theory. Their voices remained unheard as was the case with the voices of the many. Into the masses the following simple idea should have been grounded instead: real estate prices are destined to be on constant rise, novel financial products (as adjusted for permanent realty and commodity markets’ growth) should be applied. The key points to be remembered were: never have second thoughts as regards purchasing our products, just leverage your intuition reading the sales’ agent’s mind and use special “mantras” to lower your portfolio risk.

Now, that the fundamentals of economic sciences have been leveled to the ground, what are we supposed to –more or less firmly - rely upon? Let’s wait and see it next time…

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