Wednesday, August 31, 2011

the dismal science

finally watched a fantastic movie the other day: inside job, the oscar-winning best documentary of 2010, about the financial system crash that led to our recent great recession.

let's face it, most of the time beating up on economics or economists - even when i do it - feels a bit like kicking some poor old guy collapsed on the street. it's too damn easy, right? there are so many things wrong with economics and with the way it's used.

but economics survives as a discipline in large part because it is, ultimately, really freaking useful. not just the supply and demand, invisible hand type of things. these are just some applications of economic thought that, as they were being developed, were shaped by the personalities and the times of the people who developed them. sometimes these ideas stand the test of time, sometimes they don't. but that's not what economics is.

at it's very core, economics is a framework for understanding decision making, that works best on an individual level. and decision making is all about incentives. that's what was so great about the movie inside job. although in many ways the movie spent a fair bit of time bashing economists - particularly academic economists - they (we?) were redeemed by the presence of a few who never forgot what the discipline is all about: incentives.

markets are not systems that inherently drive themselves towards stability - something that people often forget. it's part of the base theory of economics that, over time, actors acting in their own interest will produce some outcomes that are stable - in the sense that, say, supply and demand will intersect at an appropriate price. but that is only if the incentives are correct and the actors are bit players. in the late 2000s, while most analysts and academics were all blinded by their own bed-sharing interests, a few clear-headed people looked at the system in place and could see where it was headed. could see that the rhetoric defending derivatives markets and other shady, unregulated financial services industry concepts was flawed.

for example, in 2005, raghuram rajan, the chief economist for IMF at the time, delivered a paper that clearly predicted that the crash would happen. he could see that the short-term incentives at play for the agents controlling the system were such that a crash was inevitable - and that, in fact, there was nothing that would stop it from happening.

or nouriel roubini, an economics professor who predicted a crisis as early as 2006, and was disparagingly referred to as 'Dr. Doom' for it. 

or charles morris, who delivered a book about an impending crisis to his publisher in late 2007. published in 2008, the trillion dollar meltdown erred only in underestimating the final cost we'd bear thanks to the financial market shenanigans then occurring.

anyway. a long time ago i had a post in mind bashing micro-economics to follow my earlier macro-economics bashing. it was one of those posts that formed in my head in the middle of the night and was dazzlingly clear and brilliant then that faded away come morning, but nonetheless, it's been sort of sitting on the back burner since then. i've been feeling very grouchy for the past two years about economics - seeing all that was wrong in it, seeing all that is flawed in the fundamentals of it.

oddly enough, watching inside job re-energized me slightly. because, while economics gave us the justification for actions that completely fucked a previously stable system, it also gave us - well, gave some people, anyway - the tools to be able to clearly see where we were headed. it's a powerful field, if we just remember to remove ourselves and our own incentives from our analysis of it. easier said than done, i realize that, but essential, if we want to recapture what's good about economics from what's dismal.

in other news, it would appear that i am the deloach distinguished graduate fellow in economics this coming year. which means, yep, they failed to kick me out of the program, again. oh well. they will surely wise up soon enough and send me packing. until then, it's good to head into the new year feeling slightly warmer towards my chosen field of study.


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