Is economics to blame for the mess in Washington, D.C.? Is it the reason why we can’t seem to get along with one another anymore? Does economics have any value now, or has it been done in by its own unrealistic assumptions?
Two writers recently raised these questions. One pointed to an economic event that should have been controlled but wasn’t; and the other believes that economics has been blindsided by reality and rendered obsolete by other behavioral sciences.
The first writer, Michael Tomasky, recently published an essay on “The Real Legacy of the 1970s.” In it, he claims that the severe inflation that capped the economic expansion of the 1960s changed America in very fundamental ways.
To demonstrate just how fundamental the changes were he makes a comparison to the Great Depression of the 1930s. At that time, he writes, the economic losses brought people closer together. Friends, relatives and neighbors formed tighter bonds in adversity and helped each other cope with job losses and other economic setbacks. By contrast, in his view, the inflation of the 1970s drove us apart as inflation destroyed our savings and to avoid being left behind we had to become competitors in a heartless market.
It is a logical idea, and attractive for that reason, even though it paints an unappealing portrait of our society. A closer look, though, reveals some questionable assumptions.
One of the assumptions is that economic adversity promotes social ties. The images of Depression-era rent parties, neighbors donating money, food and household goods to laid-off workers owe more to Hollywood movies than reality. Closer to the reality of economic adversity was and is its portrayal in the blues song “Nobody Knows You When You’re Down And Out,” and in a line from Woody Guthrie’s folk song, “If You Ain’t Got The Do Re Mi.”
Another important but questionable assumption is that it was the inflation of the 1970s that drove people to a “casino mentality.” In fact, the road to this mentality had been paved in the 1920s and its stock market millionaires. It persists today not only with our tech millionaires and billionaires but also state-sponsored lotteries, sports gambling and online gambling knocking at the door.
There is no doubt that inflation, even at modest levels, erodes savings and sends people in search of safe places to earn more than traditional bank savings accounts.
It seems more likely that the restructuring of savings was due to a very old human nature issue: the tendency to allow greed to obscure risk. And, in this case, increased numbers of people searching for higher savings returns created a self-fulfilling prophecy by kicking the demand for stocks upward. The stock price increases, of course, only reinforced the greed and further obscured the risk.
The second writer, Fareed Zakaria, also poses an interesting question. His recent essay published in “Foreign Policy” magazine posed this question: “The End of Economics?” in which he argues that, “Human beings are rarely rational— so it’s time we all stopped pretending they are.”
The assumptions of economic theory have been a punching bag for critics and humorists for well over a hundred years. Thorstein Veblen mocked the “economic man” concept in economics, for example, as a “lightning-fast calculator of pleasure and pain.”
Zakaria is a critic of economics, certainly, but it is not clear what his principal reason is. He believes, for example, that economics was dealt a devastating blow by its failure to predict the financial crash of 2008. As the only proof of this, though, he cites only writings that appeared right after the crash itself — when people were still reeling and hardly in a position to put things into perspective.
More significantly, he fails to reveal any information that would support his point about rationality. As far as we know, people didn’t act irrationally and create the financial crisis. Instead, investors were encouraged to let their greed obscure the risks. Part of that encouragement, in fact, came from government agencies and large banks which would normally act as anchors for risk-evaluation decisions. But that is a very different thing from acting irrationally.
Zakaria’s essay offers behavioral economics as a replacement for current economic theory, citing the excellent work of Nobel laureate Daniel Kahneman and others in that area, to demonstrate that individuals do not always make rational decisions.
Behavioral economics is still in its infancy, though, and is no position to take on the responsibilities of guiding today’s economies through today’s hazards.
At bottom, both essays miss their targets. Inflation didn’t cause today’s polarized society, and economics is not collapsing because individuals sometimes, or even often, act irrationally. But both essayists gave us some things to think seriously about. That can’t hurt.