Friday, October 11, 2013

Aristotelian Economics

            The Italian scientist Galileo Galilei supposedly dropped two metal balls of different weights from the Leaning Tower of Pisa and thus experimentally confirmed the existence of a gravitational constant. 
            Such is the legend, anyway.  An experiment of that sort was actually carried out in 1586 by a Flemish scientist named Simon Stevin who dropped two lead weights from a 10-meter tower.  His results were published, and Galileo may have heard of them; but he had already used other means to determine that different weights fall at the same speed. 
            The famous event at the Tower of Pisa was the work of an Aristotelian professor in 1612 attempting to refute Galileo.  As it happened, the two balls hit almost, but not quite, at the same time, doubtless as a consequence of imprecision in executing the drop.  Nevertheless, the result was touted as proof that Galileo was wrong.  His response was sharp enough to leave a mark:

Aristotle says that a hundred-pound ball falling from a height of one hundred cubits[1] hits the ground before a one-pound ball has fallen one cubit.  I say they arrive at the same time.  You find, on making the test, that the larger ball beats the smaller one by two inches.  Now, behind those two inches you want to hide Aristotle’s ninety-nine cubits and, speaking only of my tiny error, remain silent about his enormous mistake.[2]

            Economics is called the dismal science, and it has more than its fair share of Aristotelian professors.  In the face of repeated failures, they cling to a faulty model — the general equilibrium theory — and ignore the evidence piling up around them.  Every time they are proven wrong, they tweak the numbers and nudge the assumptions and proceed to the next goof.  This wouldn’t be a problem except for the fact that they dominate the policy-making process in Washington, D.C. 
            The general equilibrium theory was proposed by the French economist Leon Walras in 1874.  Kenneth Arrow and Gerard Debreu updated the theory in 1951 and proved mathematically that it was correct if:

            1)  The markets are perfect
                        everyone has the same information
            2)  There is a full set of insurance markets
                        insurance is available against every conceivable risk
            3)  Capital markets are perfect
                        loans are always available at appropriate rates
            4)  And there are no externalities or public goods

             Those are some pretty big ifs.  They are so restrictive that they render meaningless the notion of efficient markets.  For example, pollution is a huge and costly externality that can’t be “assumed away.”  Insurance markets are not complete, loans do dry up, and we have public utilities and roads.  If everyone has the same information, no one can ever gain advantage through innovation or insider trading.  According to the general theory, there can never be any stock market bubbles because prices convey all the relevant information.  If the labor market always clears, there can be no unemployment; or unemployment must be of such short duration that no intervention is needed.

 Conservative economists responded to criticisms of the general model by:
a)  treating them as theoretical niceties — hey, markets are almost perfect                                                                                OR
b)  conceding that markets are inefficient but insisting government is worse

            In other words, they dismissed the contradictions and soldiered on. 
            Subsequent efforts to prop up the theory simply added more questionable arguments.  Milton Friedman of the so-called Chicago school of economists, introduced “monetarism” — the idea that the proper role of the Federal Reserve was to increase monetary aggregates at a fixed rate (the rate of growth of output) and let the market do the rest.  He suggested the Federal Reserve turned the recession of 1930 into the Great Depression by reducing the money supply, which led to currency hoarding, which cut spending, which killed jobs, etc. 
            However, bank failures, not the Federal Reserve, led to currency hoarding and the resulting downward spiral.[3]  There was no federal deposit insurance, and the rate of output was falling.  The Federal Reserve didn’t reduce the money supply; but the Fed didn’t increase it, either.  In a sense, the Fed anticipated the young Friedman’s future theory!  And it didn’t work out very well.  Since then, increasing the money supply has become a standard tool for fighting recessions.[4]
            Friedman’s notion of “free” (as in unregulated) banking was imposed by force in Chile after President Allende was assassinated in 1973: 

Free banking did lead to a burst of economic activity as new banks were opened and credit flowed freely.  But just as it didn’t take long for America’s unregulated banking to bring the American economy to its knees, Chile, too, experienced its deepest downturn in 1982.  It would take Chile more than a quarter of a century to pay back the debts incurred… (Joseph Stiglitz, The Price of Inequality)

            To be sure, other improvements appeared as the general theory became the “classical” theory and then the “neo-classical” theory.  Joseph Schumpeter muscled innovation into the mix with the notion of creative destruction, characterizing markets as dominated by monopolists who are displaced by innovators who become the new monopolists.  In short, he described competition for markets rather than within markets.  But monopolists wouldn’t sit around meekly waiting for innovators to take over.  They would use their clout, especially in the absence of regulations, to deter innovation or steal ideas outright.  The process Schumpeter detailed was anything but efficient.
            One school of thought held that wage structures are too rigid.  From that perspective, unions, minimum wage laws, unemployment compensation, and policies to maintain wage stability are bad because they interfere with “market efficiency.”  That’s why so many on the right blame workers for unemployment.  Teachers are greedy, don’t you know; policemen and firemen are greedy.  Similarly, mortgage scammers blame homebuyers for the mortgage crisis, and throw in an insult to boot — “You should have known better than to trust us.”

            Aristotle is sometimes called the Father of Natural Science; however, he was nothing of the sort.  He claimed women have fewer teeth than men; but although he was married twice, he never asked either Mrs. Aristotle to open her mouth so he could count her teeth.  He used the powers of his mind and reasoned it out.  He held that mice arise spontaneously from damp hay, but he didn’t test that theory.  He reasoned it out. 
            Aristotle died 2335 years ago, and scientists no longer appeal to his authority.  The classical model of equilibrium is slowly being supplanted by a new paradigm of how information affects markets, but adherents of the old theory are very much alive and kicking.  In response to the Crash of 2008, Aristotelian economists pushed the policies of Herbert Hoover!  They extol free markets as long as the markets are rigged in their behalf.  They oppose government intervention until they need to be bailed out.  They reject regulations for the very same reason that muggers don’t like policemen. 

             They’ve reasoned it out.  They’re wrong, but they don’t care because the argument isn’t really about economics anyway.  It’s about who rules.

[1]  Cubit — orig. the length of the arm from the end of the middle finger to the elbow, roughly 20 inches.
[2]  John Gribbin, The Scientists, Random House, New York, 2002, pp. 76-77
[3]  In fact, in 1933, soon-to-be Fed chairman Marriner Eccles told the Senate there was plenty of money to support prices, but it was in the wrong place.  It was concentrated in the financial sector, not dispersed in the hands of consumers.
[4]  Which tells us a great deal about efforts to curtail government spending after the Crash of 2008.  Republicans are actively undermining a recovery — and not because of high-minded adherence to economic verities.  In the spirit of Friedmanism, they see the current crisis as an opportunity to strong-arm the nation into still more ruinous forms of the general equilibrium theory.

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