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Irrational economics

As a primer in general economics theory, as a history of 20th century economics studies and evolution, and as an insider’s commentary on a professional circle that seems a blend of brilliance and ego in almost equal measure, Paul Krugman’s article in the Sunday Times Magazine several weekends ago, How Did Economists Get It So Wrong?, is very worthwhile reading.  The article is long, and touches on a wide variety of subjects, so any attempt to summarize would not do justice. But one aspect in particular caught my attention: the very distinct, active, and vocal party system within schools of economics, and the enormous influence of these academic parties on affairs of enormous global import.

Krugman describes these two main parties as the “saltwater” and “freshwater” schools respectively. The “saltwater” party consists of academia along the oceanic coasts – Harvard, MIT, Princeton, Berkeley, and others – and is a descendant of John Maynard Keynes several generations removed. The “freshwater” party includes the inland universities, most notably the University of Chicago, and more or less follows from the foundation of Milton Friedman. Where the “saltwater” school leans in the direction of an activist fiscal policy approach, particularly at times of economic crisis, the “freshwater” party favors the pure and free market, with occasional and good-natured guidance of monetary policy to ease the way. The “saltwater” folks do not trust the free market left to its own devices. The “freshwater” school does not trust government intervention. This is all an oversimplification, but in essence the debate is one of left vs. right.
It is clear from Krugman’s overview that the “saltwater” school feels a sense of vindication in the wake of a global economic collapse that, by many accounts, was triggered by a free market gone wrong. The argument is that markets are not necessarily rational, that financial behavior has been irrational throughout the history of capital markets, and that a buffering, protecting, supervising mechanism is necessary to shield us from our own nature. The counter to this case, which Krugman does not really get into (thus betraying his own leaning), is that this protective mechanism is itself managed by human beings, who, like anybody anywhere, may themselves be prone to irrational behavior. If nothing else, Krugman’s article demonstrates the human and non-robotic and not always scientific nature of even those who stand firmly at the pinnacle of logic, mathematics, and objective reasoning: the economists themselves. How then, are we supposed to trust that more fragile group, the politicians?
But to take the argument even one step further, and returning to the other side of the coin, it seems that the market itself, free and full of enthusiastic participants as it is, could be described as disproportionately influenced by the so-called “smart money”, “big money”, “large institutional capital”, which has become more concentrated and consolidated in the recent past. Is it then really a question of Keynes vs. Friedman, salt- vs. freshwater, left vs. right, intervention vs. free market? Or is the economic debate more truly one between dominant forces: a public and a private sector respectively represented by strong central authorities? The idea of a “rational free market” is likely to suffer either way. And economics, as a science, is likely to migrate into the realm of literature, as observed.

Disclosure: No positions.