Book Review: ‘Seven Bad Ideas’
Few writers have done more than Jeff Madrick to guide American readers through the coils of political economy. His many books — including Why Economies Grow (2002), The Case for Big Government (2009), and Age of Greed (2011)— combine broad historical analysis and specific policy proposals. A stream of essays for TheNew York Review of Books, Harper’s, and other outlets also challenges our reflexive reverence for markets and aversion to government regulation, both of which have dominated economic thinking for decades.
Madrick edits Challenge: The Magazine of Economic Affairs and has directed policy programs at various institutes. (When I was the economics editor at the University of California Press, he also served as my advisor.) Yet his current teaching appointment at Cooper Union is in humanities, not economics. That niche is fitting insofar as Madrick, an elegant writer, targets generally educated readers and situates economic issues in their social, political, and historical contexts. This approach is rare in the United States, where economists write dry scholarly papers for each other and aspire to timeless truths.
We might compare Madrick’s posture to Thomas Piketty’s, whose bestselling Capital in the Twenty-First Century (2014) claimed that economics has yet to overcome “its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.” Piketty’s jab was clearly aimed at mainstream American economists.
There is one great advantage to being an academic economist in France: here, economists are not highly respected in the academic and intellectual world or by political or financial elites. Hence they must put aside their contempt for other disciplines and their absurd claim to greater scientific legitimacy, despite the fact that they know almost nothing about anything.
If Piketty’s tone was feisty, his appeal was for greater intellectual scope, engagement, and humility among economists. On this point, Piketty and Madrick agree.
The global economic meltdown beginning in 2007 strengthened and sharpened Madrick’s critique of the profession. That entirely preventable disaster should have chastened the free-market fundamentalists who have controlled economic policy since the 1980s. Their failure is still very much with us. Last year, U.S. median household income was 8 percent lower than it was in 2007, and the poverty rate was 2 percentage points higher.
Yet remorse is in short supply. Former Federal Reserve chair Alan Greenspan, who touted financial deregulation at every turn, admitted to Congress that he presumed banks would do more to protect their shareholders. Not a word about homeowners, who lost $8 trillion in equity when the housing bubble popped, or the sharp rise in unemployment that followed. In 2010, Obama’s chief economic advisor, Lawrence Summers, claimed that the federal government lacked the authority to regulate markets on behalf of consumers. He made no mention of his own steadfast opposition to regulating the derivatives market, whose collapse helped precipitate the financial crisis.
Such remorselessness isn’t confined to elite policymakers. When Madrick visited the annual conference of American economists in 2009, he found “no one fundamentally changing his or her mind about the value of economics, economists, or their own work. No one questioned their contribution to the current frightening state of affairs, no one humbled by events.” He credited a handful of independent thinkers, including Robert Shiller, George Akerlof, Dean Baker, Nouriel Roubini, and James Crotty. But he found few economists willing to re-examine their basic assumptions in light of new evidence.
Madrick’s new book targets that collective stolidity. It begins with a stark claim: “Economists’ most fundamental ideas contributed centrally to the financial crisis of 2008 and the Great Recession that followed — the worst economic calamity since the Great Depression.” Policymakers didn’t simply fall asleep at the switch or misapply worthy ideas. Rather, an entire generation of economists embraced bad ideas and lost the capacity to criticize them. It is a measure of their insularity, Madrick argues, that the socially corrosive misery they helped create didn’t prompt a fresh review of their most cherished ideas.
The first bad idea is the biggest one of all: the so-called Invisible Hand, which Adam Smith outlined in The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776). In brief, it claims that the pursuit of self-interest in a competitive marketplace allocates resources efficiently and thereby grows the economy. The mechanism for this growth consists of price signals, which guide investment, production, and consumption decisions in the absence of any central authority. Beautiful in its simplicity and power, the Invisible Hand became the foundation of modern laissez-faire economics. Smith’s original idea was less a universal law than a parable about the way markets might work under specific conditions that rarely obtain. For Madrick, the main problem isn’t Smith’s idea so much as its flatfooted reception among today’s economists. Now enshrined in standard textbooks, the Invisible Hand has become what Madrick calls “a source of clean economics in a dirty world.”
Another bad idea is that entire economies, and not only individual markets, are self-regulating. Once again, price signals are the mechanism for this self-correcting equilibrium known as Say’s law. For John Maynard Keynes, the Great Depression refuted this idea by showing that demand could remain low, and unemployment rates high, even when wages, interest rates, and prices were falling. Yet Say’s law made a comeback during the Great Recession, when many economists ignored Keynes’s analysis and called for spending cuts. The federal government resisted that call and implemented a modest Keynesian stimulus that was largely offset by state and local spending cuts. But Britain’s Conservative government implemented austerity policies with disastrous results, leading many prominent economists to withdraw their support for the Conservative program.
Madrick quotes MIT economist and Nobel Prize winner Robert Solow on the appeal of Say’s law. “There has always been a purist streak in economics that wants everything to follow neatly from greed, rationality, and equilibrium,” Solow wrote in 2008. “The theory is neat, learnable, not terribly difficult, but just technical enough to feel like ‘science.’ Moreover, it is practically guaranteed to give laissez-faire type advice, which happens to fit nicely with the general turn to the political right that began in the 1970s.” Those three sentences encapsulate much of what is wrong with the profession today.
Madrick next turns his sights to Milton Friedman, perhaps the most influential economist in the second half of the 20th century. A staunch believer in the wisdom of markets, the University of Chicago professor was also a relentless critic of Social Security, minimum-wage laws, and other measures he regarded as government interference in those markets. Madrick’s main objection to Friedman’s work is his version of American economic history, which downplayed the enormous contributions the U.S. government made to economic growth. Friedman’s popularity also reflects the profession’s penchant for economic theory and modeling. In the absence of any fine-grained historical understanding, Madrick maintains, theory building has become a kind of intellectual narcotic.
Friedman’s student, Eugene Fama, comes in for criticism for his efficient markets theory (EMT), which holds that security prices faithfully reflect the intrinsic value of that security. For Madrick, EMT made useful contributions early on but pushed the notion of rationality too far — so far, in fact, that Fama eventually rejected the very idea that markets could be irrational. “The word ‘bubble’ drives me nuts,” he said in 2007, when the housing bubble burst. Six years later, he told The New York Times, “I don’t even know what a speculative bubble means.” Fama effectively defined that term out of existence by insisting that markets were always efficient and rational. Many observers found more value in Robert Shiller’s work, which showed that speculative bubbles existed and did real damage. As the global economy went over the cliff in 2008, Lawrence Summers said he also consulted the old-school economic histories of Hyman Minsky and Charles Kindleberger, who documented the self-reinforcing nature of financial booms, crashes, and panics.
The split between Fama and Shiller, who shared the Nobel Prize in 2013, points to Madrick’s final bad idea: the notion of economics as a science. Madrick’s poster boy for this position is University of Chicago professor and Nobel Prize winner Robert Lucas. “I came to the position that mathematical analysis is not one of many ways of doing economic theory,” Lucas once said. “It is the only way. Economic theory is mathematical analysis. Everything else is just pictures and talk.” That belief led Lucas to claim “economists are in possession of a body of scientifically tested knowledge enabling them to determine, at any time, what … responses [to economic problems] should be.” Yet according to Madrick, the policy response to the 2008 crash was “an absurdist drama and a masterpiece of forgetting.” He concludes that the urge to make economics a science, or to presume it already is one, is both self-defeating and anti-intellectual.
Seven Bad Ideas isn’t an exhaustively argued treatise but rather a set of snappy essays in the pamphleteering tradition. Several themes emerge from them: an indifference to history, the drive for purity, and a nostalgic attachment to rationality, the great Enlightenment virtue that most modern thinkers view skeptically. Although mainstream economists rarely discuss power and privilege, neither is irrelevant to their professional practices. As Piketty notes, American economists enjoy outsized prestige compared to their counterparts elsewhere. They’re also remarkably attuned to incentives, including their own. Perhaps they can be shamed productively. But until their incentives change, Madrick’s calls for greater intellectual range, depth, and humility are likely to fall on deaf ears.
Peter Richardson is the book review editor at The National Memo. His history of Ramparts magazine, A Bomb in Every Issue, was an Editors’ Choice at The New York Times and a Top Book of 2009 at Mother Jones. In 2013, he received the National Entertainment Journalism Award for Online Criticism. No Simple Highway, his cultural history of the Grateful Dead, is scheduled for January 2015.
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