Month: February 2014

The Value of Flawed Theories…

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As part of my research on eclecticism and pluralism in economics I am discussing the relevance of eclecticism in economic pedagogy, i.e. how should we teach economics in the future. In regard to this I came across Chris House’s blog post about the usefulness of real business cycle theory (RBC).

RBC has been criticised in the economic literature quite a lot. Gregory Mankiw for example wrote in a paper in the late 80’s that RBC has no persuasive power due to a lack of empirical evidence of its major claims and will therefore disappear at one point.

However, Chris House argues that there is still some value in RBC, despite its flaws, and therefore we should continue to teach to students . First of all, it has a historic value, i.e. the important role it played in the development of macroeconomics in the past. Secondly, it allows students to learn the ‘language’ of mainstream economics. RBC is embedded in a dynamic stochastic general equilibrium framework (DSGE) and by teaching it, students will learn the basics needed in mainstream economics. The third point is the most interesting one, an epistemological argument that claims even if RBC is wrong; it helps us to understand why it is wrong.

I think that is quite an interesting point, because it allows us to think about falsified theories and their epistemological value. Especially as teachers we should not dismiss falsified theories completely. After all, they can serve us as tool to teach students knowledge. At this point, I shall not jump into the discussion on what knowledge actually is. Every failed theory is not only an important part in giving the reason why it failed but also reflects the general controversies and historic, cultural and social environments surrounding and inspiring scholars and their discipline.

Based on this, I hope to develop the concept of, as I call it, pedagogical eclecticism in economics. Under eclecticism, I generally understand a philosophical leitmotif of unprejudiced but critical endorsement of the established contents in research traditions. That may sound a bit complicated but it is quite simple once you read it twice, or three times. In economic pedagogy, this leitmotif translates itself into a teaching style that accepts and teaches the otherwise unaccepted. Not because it provides reliable knowledge about the research object, i.e. the economy in my case, but it gives us an understanding of the subject itself. Such a self-awareness is, in my opinion, necessary for a better comprehension of economics and will help students to gain a critical understanding of the subject they study.

What an inside job…

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So yesterday my faculty screened the documentary Inside Job for our students, who were partly lured to come with pizza and soft drinks too. The movie 2010 Inside Job was directed by Charles H. Ferguson, and narrated by Matt Damon, and is about the financial crisis of 2007/2008. It tells the story about the financial crisis in five parts, starting with an historical abstract of how we got there and finishing with where we are now. With this story-telling, it connects the neo-liberal deregulation of financial markets beginning the 1870’s and the housing boom in the US in the late 1990’s and early 2000’s with the development of complex financial instruments by major players in the then deregulated financial industry. The instruments the film focuses on, and explains, are the collateralised debt obligations and  credit default swap. Additionally, the film mentions the role of the three big rating agencies S&P, Moody’s and Fitch and also looks on the impact of the deregulation of the financial system in Iceland. 

I must say that I very much liked the documentary because it is very entertaining and well made. However, there are some aspects I didn’t like. First of all, the conclusion of this movie is somewhat dissatisfying. You leave this movie with the feeling that a handful of bad people in control are responsible for the situation we are now in. By doing so, this movie unintentionally moves close to, and might invite, antisemitic conspiracy theorists. I came across these kind of people quite often in discussion about the financial crisis and its origins and it is quite common to find the opinion that these few bad people are in fact Jews with a Zionist plan of world domination. The movie, at no point, makes such allegations but I know people who used this focus on a few bad people as starting point for their conspiracy theories. Also, some hero’s are presented who did foresee the crisis and tried to warn the world about the problem. This is a classical black and white dichotomy, I think they could have made an emphasis on how many different people talked about problems in the economy and the financial system, from Keynes over Minsky to Keen and many more. In addition, the movie uses a few tricks we know from Michael Moore in order to become, in Christopher Hitchens’ words, an “exercise in facile crowd-pleasing”. An example of this tactic is, when one of the interviewees says that the majority of academic economists do not make millions. The movie tries to proof otherwise by listing a handful of economists who are both academics and working/consulting in financial institutions or the government, including their income, thus showing the audience that this was a lie. Yet, these people are among the elite of academics, most of them in high positions in elite universities and other institutions in the US. The suggestion is, that academic economists make more money and have close connections to interests groups in the financial sector. Although this is true for the five or six people shown, it does not refute the claim that the majority of academic economists are not rich and have no or loose ties with the financial sector. I bet a more detailed analysis would have shown the reality of well-paid but not super rich academic economist working in normal universities in the US and around the world.

The same “crowd-pleasing” creeps in when the conclusion suggests that the problem is caused by a handful of bad, greedy, drug addicted people. I am not arguing against the claim that the financial industry is greedy or that drugs and prostitutes are part of the daily routine, even without the movie The Wolf of Wall Street I knew from sources about such things. However, the focus on the handful of people might tempt people to conclude that the problem can be solved by simply removing these people from power. As a result, the movie misses to outline deeper systemic problems of capitalism itself. There is an awful lot of literature about the systemic risk of capitalism, not only from Marx, which, by mentioning, could have shown how much more complex the financial crisis actually was. For example, the beginning of the deregulation in the 1970’s and 1980’s under Ronald Reagan finds its origin in a interesting development in economic theory. The critique of Keynes and the rise of the Chicago School under Milton Friedman are only part of it. Well, I guess the economists inside of me is getting upset…

Anyway, other aspects about the financial crisis have been briefly mentioned and could have deserved more attention. The actions of the Clinton administration during the time he balanced the budget for example, not only the fact that Alan Greenspan was against regulations. Not only deregulation but also a lot of cheap money from the FED played important role. The Bush housing initiative could have been outlined a bit more, even after the crisis home ownership remained at 65.4% in 2012 while, for instance, European nations like France, Germany or Denmark are between 57.8% and 41% in the same year. The relationship between the housing bubble and the dotcom bubble could be explained in more detail, as for instance Jared Bernstein did.

And finally, I think it would have been interesting to get more information about the political situation in the US, not only complaints about the composition of Obama’s cabinet, basically a handful of economic advisers who were involved in the crisis are not trying to solve it. For instance, the democrats had a majority in both the Senate (ca. 59/41) and the House of Representatives (ca. 255/179) in the first two years of the Obama administration. However, the 2009 stimulus pack was passed with almost no agreement by the Republicans, also some Democrats voted against it. The question must be asked whether a regulation act on the financial industry would have been passed in case Obama’s advisers had suggested it.  I am not an expert on US politics, so this would have been interesting to me to see the political dimensions behind the crisis. This would have brought us to what the crisis really is, or as many others see it, not only a crisis of the misbehaviour of a group of people but as a crisis of a capitalist system with a neoliberal political ideology. The film does give a glimpse on this by suggesting that the economic discipline itself is affected but then it returns to the allegations against individuals. It is unfortunate, however the movie gives interesting insights into a crisis and its legacy that affects all of us. A true must watch, despite the points I criticised =)

What we now need, is a similar take on the crisis in the EU.