By Pavlina R. Tcherneva
Presidential hopeful Mitt Romney boasts support from the scientific community for his supply-side trickle-down economic proposal. It is outlined here, along with the list of economists endorsing the plan.
Several Nobel Prize winners grace the top of the list. Here is a quick look at some of these luminaries and their contributions to some of the most pressing problems of our time.
UNEMPLOYMENT: Robert Lucas
Perhaps no one bears more responsibility for the general apathy among mainstream economists towards the problem of unemployment than Robert Lucas. He is the economist who argued that there was no point in distinguishing between voluntary and involuntary unemployment because agents were ‘perfectly rational’ and the jobless essentially ‘chose’ their condition (1978, 242). (Yes, according to Lucas, even during the Great Depression, 25% of the working population opted for leisure rather than work!) This is not some minor claim, but a signature argument by Lucas and the entire New Classical School of economic thought to which he belongs. This is the school whose second core assumption — that of ‘continuous market clearing’ — together with the ‘rational expectations hypothesis’ has been used to render the condition of involuntary unemployment a virtual impossibility.
Why spend any effort looking for solutions to a problem which has been assumed away?
THE DOWNTURN: Edward Prescott
Edward Prescott is a prominent member of the Real Business Cycle School (a spin-off of the New Classical School), which also embraces the assumptions of continuous market clearing and rational expectations. Prescott and his colleague Kydland shared the Nobel Prize for “their contributions to dynamic macroeconomics”. They are the brainpower behind the most dominant mainstream macroeconomic model—the Dynamic Stochastic General Equilibrium model. Yes, this is the same model that failed to predict the latest crisis and prompted the Queen of England to ask “Why didn’t anyone see it coming?” This same DSGE model has no money, no default, no financial institutions, no debt… in other words, nothing of interest to those who are interested in the real world. Prescott too subscribes to the idea that the unemployed are simply substituting leisure for work during business cycles and that the government shouldn’t do anything about it. Indeed, all that the government safety-nets do is introduce moral hazard (as in, unemployment insurance removes the incentive to look for work). Prescott further maintains that if flood protection were not offered, rational agents would stop living in flood- and hurricane-prone regions.
Surely those troublesome food stamps that go to 47 million Americans disincentivize them from foraging.
THE EUROPEAN MONETARY UNION: Robert Mundell
Robert Mundell is the father of the signature theory (Optimal Currency Areas) that rationalized the design of the European Monetary Union. Under the OCA model, there is no reason for currencies to be connected to nation states. Indeed Mundell claimed that single currency areas would increase economic performance and efficiency. We all know how well this experiment turned out and even the mainstream today recognizes the need for nation states to control their own currencies for the purposes of policy making. The best analysis of the OCA model can be found in Charles Goodhart’s seminal article “The two concepts of money: implications for the analysis of optimal currency areas”, which is a required reading for anyone interested in MMT or wanting to understand why Europe is in such a mess.
FINANCIAL INSTABILITY: Myron Scholes
Myron Scholes (along with his collaborator Robert Merton) shared the Nobel for “developing a new method for valuing derivatives”. This method gave birth to the trading model used by Long Term Capital Management in the 90s. Remember LTCM? The hedge fund that almost brought the financial system to its knees in 1998 were it not for the Fed-orchestrated bailout. 10 years later derivatives trading managed to finish the job and produce a far bigger crisis. Scholes himself was accused by LTCH vs. US of using illegal tax shelters to hide profits from the hedge fund.
No, these are not some obscure economists pushing some obscure ideas. These are the men whose work has defined much of the mainstream economics profession and provided the ‘rationale’ for supply-side, trickle-down economic policy.
These are men whose ideas have stood the test of time and have failed. What can we expect from the economic plan of a man who has their support?
A bonus: Gary Becker
(Though Becker’s contributions do not bear direct relevance to the current crisis, it is emblematic of the warped logic used by many mainstream economists.)
Gary Becker is the economist who developed a pricing model for kidneys and other human organs. Since efficient markets solve all problems—economic or social—monetizing organ donation, in this economist’s view, makes perfect sense. He is better known for his theory on human capital investment. One extension of this work deals with the question of child-rearing. According to Becker, parents choose to have children because they fear that their retirement portfolios are inadequate to support them in their old age…hence, the kids. Some parents opt to have a few “high-quality kids”, while others – many “low quality kids”, depending on the family’s time preference. I am not joking and these are not my words; they are his. This theory has given birth to the “rotten-kid theorem”, which says that because of these financial incentives, parents are “altruistic” even (even?!) towards their spoiled-rotten and selfish kids, because they are essentially trying to maximize their own return. In sum, according to Becker, all social, economic, environmental, health, and other problems can be solved if all human activity is monetized and financial incentives are ‘properly aligned’.
(As I suspect every other rational parent has done, I too have been crunching numbers since I had my daughter 2 months ago. Would she yield the return I’m expecting of her or should I increase my contributions to my retirement portfolio? Ah, where is that perfect information when you need it!?)