By William K. Black
February 11, 2017 Bloomington, MN (Part 2 in my Tirole series)
In his letter to the French education minister denouncing French heterodox economists as a “motley crew” of academic failures, Jean Tirole, the 2014 Nobel Laureate in Economics, stated his test for the standard for an economist to be a scientist.
Secondly, like the other great scientific disciplines, modern economic science relies on the continuous questioning of its hypotheses, testing its models against the facts, and abandoning theories that fail the test of reality.
Tirole and his Toulouse school of orthodox economists fail the Tirole test. Their models, policies, and theories, typically “fail the test of reality” – yet they do not abandon the falsified theories. Further, they ignore reality-based scholarly work. Worse, as Tirole admits, the Toulouse school’s failures are typical of orthodox economists. Tirole shows that the foundational errors fall into three categories, and the nature of those errors supports three other underlying errors. Tirole’s admissions also demonstrate the dishonest nature of his and his disciples’ attacks on heterodox economists, as I will explain later in this series of articles.
Tirole’s 2001 article (“Corporate Governance”) contains this remarkable admission.
The economists’ implicit assumption is that employees, suppliers, customers, and other natural stakeholders are protected by very powerful contracts or laws that force controlling investors to perfectly internalize their welfare…. [p. 4]
Tirole admits to three categories of error characteristic of orthodox economics. First, I have repeatedly warned of the danger of orthodox economists making critical assumptions implicitly. Implicit assumptions are deadly for the author and the reader. The author does not have to defend the, often unsupportable, validity of an implicit assumption. The reader does not know that the supposed scientific results of the research are actually dependent on unstated assumptions that may be invalid.
The second category of error is “group think.” Tirole, in this passage and accompanying sentences, makes clear that “economists” share this same assumption. Tirole uses no cheats such as “many” or “Anglo-American” or “conservative.” Indeed, he implies that the assumption is made “implicitly” because ‘everyone knows’ that the shareholders act “perfectly” to “protect” “employees, suppliers, [and] customers.” “Economists” know even though Tirole admits in the next sentence that the “details of the argument have not yet been worked out.” Yes, details, details. Why bother to “work out” the “details” of the “argument” when the entire field of orthodox economists simply assumes implicitly the entire argument? This is a classic example of the dangers of “group think.”
The third category of error is substance. The implicit assumption that investors and laws “perfectly” protect everyone a firm deals with from abuse is utopian and naive. Nothing works remotely “perfectly” against predation, particularly elite predation. Edwin Sutherland stressed this point in his December 27, 1939 presidential address to the American Sociological Society in which he announced the concept of “white-collar crime.” (This was a joint annual meeting with the American Economic Society, which would never happen today.)
The statement of Daniel Drew, a pious old fraud, describes the criminal law with some accuracy:
Law is like a cobweb; it’s made for flies and the smaller kinds of insects, so to speak, but lets the big bumblebees break through. When technicalities of the law stood in my way, I have always been able to brush them aside easy as anything.
Reality falsifies the orthodox “argument” (if you can call a nonsensical implicit assumption an “argument”) continuously. Every adult has personal experience with the falsity. Entire fields such as white-collar criminology falsify the argument. It is common for firms to predate on employees, suppliers, and customers. Two other categories of victims of predation are common and massive in scope and damage but not mentioned in this passage by Tirole.
Tirole was aware of these facts before publishing his 2001 article on corporate governance. The savings and loan debacle was contained in 1994. The dot-com bubble, the largest financial bubble in history, grew through the 1990s and began collapsing in 1999. SEC Chairman Levitt warned repeatedly about the sharp rise in accounting abuses. The housing bubble was rapidly expanding and the appraiser made public their warning of rampant appraisal fraud led by lenders in 2000. Predatory home lending was infamous. Tirole and the orthodox economist persisted in their utopian myths, never “abandoning theories that fail the test of reality.” That means they failed the Tirole test of what it takes to be a scientist.
The officers that control firms use the firms as “weapons” against creditors and shareholders. These forms of fraud cause the massive losses and defaults that drive financial crises and the Great Recession. Orthodox economists implicitly assumed that these frauds and crises were impossible.
In addition to these three direct admissions, the passage I quoted from Tirole suggests three implicit admissions. One, he excluded heterodox economists (and George Akerlof and Joe Stiglitz) from the category “economists.” I have never read an article or book by a heterodox economist who shares the “group think” about firms automatically (much less “perfectly”) protecting the interests of consumers, employees, suppliers, creditors, and shareholders.
Two, Tirole implicitly admits that orthodox economists are mono-disciplinary. No honest orthodox economist could make the implicit utopian assumption Tirole presents if she were aware of the relevant literature in white-collar criminology, sociology, political science, anthropology, accounting, or management.
Three, Tirole’s description strongly supports the inference that ideology is the basis for orthodox economists’ “group think,” utopian myths, refusal to consider heterodox views among economists, mono-disciplinary nature, and embrace of myths that are constantly falsified by reality. The alternative is believing that it is a coincidence that the orthodox myths coincide perfectly with laissez faire and the interests of their patrons – CEOs and the wealthiest investors. Normal economic principles cause us to look for incentives as the principal means of explaining behavior. Tirole’s explicit and implicit assumptions suggest that the incentives push in the same direction – vindicating laissez faire ideology, pleasing research sponsors, getting hired, tenured, and promoted at more elite universities, being treated with respect by elite peers, and published n journals that orthodox economists consider most prestigious. A heterodox economist is a threat not simply because she has different views but because she refuses to play the game and chant the orthodox mantras – even though doing so maximizes her self-interest. She is someone who speaks truth to power – in a discipline that has for centuries slavishly served the powerful.