Thursday, February 12, 2009

How Easy is it to Understand the Economy?

There is no shortage of opinion regarding the current financial crisis. The media is full of people who seem quite certain about what got us to where we are today and/or what will get us out.

For instance, several candidates are put forward as being the cause (or causes) of the current economic hardship:

  • sub-prime loans, or the bundling and sale of sub-prime loans as securities
  • too much, too little, bad or unenforced government regulation
  • tax cuts
  • too much consumer spending and/or debt
  • too much government spending and/or deficit spending
  • low consumer savings
  • bad monetary policy

And several candidates are put forth as what will be the cure (or cures):

  • tax cuts
  • consumer spending
  • government spending
  • better monetary policy
  • bank bailouts or rescues to shore up credit

Whatever the details, those weighing in on the financial crisis are essentially making empirical claims, claims about how the world works. In particular, they're making claims about how people behave in the world. Economics -- the study of meeting wants and needs, and what people do in order to satisfy their wants and needs -- is a social science, which makes it an empirical issue.

We often act and speak as if we know a great deal about the empirical world. But, in fact, gaining knowledge about the empirical world is often difficult, and the rampant disagreement about the causes of and cures for the financial crisis is testament to that.

Despite people's confidence and insistence that they KNOW what caused the financial crisis, and/or that they KNOW how to reverse it, what do they really know for certain? Is it really that obvious what caused the financial crisis, and how to reverse it?

If there is any doubt about how much ignorance there is of the empirical world -- despite our confidence to the contrary -- consider some related events.

The Great Depression

The worldwide economic downturn known as the Great Depression ended decades ago -- in the late 1930s or the 1940s -- and has been the subject of intense study ever since. Despite this, there is still an enormous amount of disagreement regarding what caused it and what ended it.

The 1929 stock market crash, the gold standard, protectionism, bank failures, flawed monetary policy, etc., are all touted as causes by different people. The reasons for the end of the Great Depression are also hotly debated: some say that the New Deal programs offered by President Franklin D. Roosevelt reversed the downturn, while others say that FDR's New Deal prolonged it. It is also often claimed that industrial production stemming from World War II is what ended the Great Depression.

The point is this: even though The Great Depression is a story with an ending -- and not a current, ongoing event -- and even though it has been investigated by various people from various backgrounds over several decades, it is still something of a mystery.

If there's still disagreement over the economics and causality of the Great Depression, which happened 70 years ago -- if THAT is still a topic of dispute -- then how could what's going on NOW be obvious?

The War in Iraq

Another example to consider is the War in Iraq. This is not, of course, primarily an economic event, but -- like economics -- war also involves predictions about how people will behave in the world. And, like today's financial crisis, the War in Iraq is an ongoing current event that has received immense attention and scrutiny.

When invading Iraq in early 2003, President George W. Bush and his administration were sure of several things: that it would be relatively easy to provide security, keep the peace, and administer Iraq after the ouster of Saddam Hussein and his regime; that weapons of mass destruction (WMDs) or ongoing WMD programs would be found; that oil revenue would cover the cost of the U.S. military presence; that a stable democracy could be easily established, etc.

But the U.S. quickly encountered problems in Iraq on a variety of fronts. And the Bush administration frequently refused to admit that they had made errors in their predictions or their understanding of the situation.

Critics excoriated Bush and said he was incapable of admitting mistakes and changing tack. The U.S. presence in Iraq was sharply debated both nationally and internationally, and various solutions from a variety of sources -- for example, Iraq Study Group -- were offered. Many insisted that it was time for the U.S. to pull its forces out of Iraq.

Then, in January 2007, Bush announced a new strategy for the U.S. in Iraq, a strategy which came to be called the "surge". It called for a redeployment of U.S. forces already in Iraq, as well as the addition of thousands more soldiers. Critics denounced the plan, saying that it was more of the same, that it would not work, that it was not in the interests of the U.S., etc. Again, there was intense scrutiny of the new plan.

But the "surge" did not fail. Today, violence in Iraq is down and provincial elections have just been held. Granted, the War in Iraq is still an ongoing event, and the situation could change. But the "surge" was clearly not the failure its critics said it would be. And those critics are now just as reluctant as the Bush administration to admit their mistakes. Currently, there appears to be more interest in talking about the problems in Afghanistan than the successes in Iraq.


Our ignorance of the empirical world -- illustrated by both the Great Depression and the War in Iraq -- is very easy to see. But we tend not to acknowledge it.

Instead, we approach new problems -- for instance, the current financial crisis -- with a boldness and certainty that we haven't earned. We assert strongly that we KNOW this or that about the cause of the crisis and the way to reverse it. And, when someone disagrees with us, we quickly dismiss them rather than trying to slowly and carefully convince them that we're correct. Perhaps this is because, if we DID go through the careful process of trying to prove our that our beliefs about the empirical world are correct, we would find how many embarrassing questions we don't have answers to.

This, naturally, is just a symptom of the already poor standard of debate in the U.S.

I'm not arguing for absolute certainty: often, we have to act without complete knowledge of the situation. But, if we are going to act without having complete knowledge -- and we often have to -- we should at least confess to it, which means not being so dismissive of anyone who disagrees.

After all, of the people who are now so certain of what caused the financial crisis and of how to fix it, how many of them predicted it beforehand? Few, if any.

I'm not saying that those who couldn't predict it are wrong about how to fix it (that would be ad hominem reasoning of the "can't fix your own mistakes" variety). But you'd think that having failed to see it beforehand would prompt a degree of humility about knowing how to fix it.

We don't always know the future. It would be nice if our politicians, pundits, and leaders would be less caustic to those who disagree with their predictions.

-- Civ.

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