The Hindu Business Line : Economics or blind man’s buff?

To the extent I have been able to delve into the past, I see no record of economists having been able to predict looming economic crises with any degree of accuracy. Rather, they get into a frenzy of rationalisations after the event, and even then, are at sea once again when another crisis strikes. You read the accounts of any economic catastrophe of the past — South Sea Bubble, 1929 market crash, South Asian meltdown of 1997or last year’s financial holocaust & #8212; it is the same story.

Economists, among them many Nobel Laureates, were, to use an apt metaphor, running about like chickens with their necks wrung, to find explanations and excuses ex post facto, whereas people at large, looking at their impressive scholastic credentials, expected that they would be the first to sense oncoming trouble and help governments and economic players to head it off.

When some months ago, Queen Elizabeth of Britain, visited the London School of Economics, the assembled academics found themselves in a spot when she pointedly posed the question as to why they failed to predict last year’s crisis. They feverishly scrambled together a response and sent it to her. It was promptly dismissed by the media and the academic community itself as unconvincing and wishy-washy. Some economists had brazenly tried to pass the buck by arguing that it is not just they but every other seemingly perspicacious and experienced group, in the thick of the business of handling financial and economic issues — Wall Street bankers and deal-makers, but banking regulators, mortgage lenders, real estate agents, the Federal Reserve, thinktanks politicians and journalists — were equally oblivious to what was brewing and about to hit them.

Ideological fixation

Indeed, this strenuous bit of self-extenuation apart, some of them had also categorically denied any possibility of a crisis. As a write-up in Knowledge@Wharton puts it, this was because many economists used mathematical models that failed to account for the critical roles that banks and other financial institutions play in the economy since they simply did not believe the banks were important. The same write-up also hits the nail on the head when it attributes the collective failure of top-rung economists to “an ideological fixation with free markets and lack of regulation”, coupled with outmoded and simplistic analytical tools. It says: “Over the past 30 years or so, economics has been dominated by an “academic orthodoxy” which says economic cycles are driven by players in the “real economy” — producers and consumers of goods and services — while banks and other financial institutions have been assigned little importance… In many of the major economics departments, graduate students wouldn’t learn anything about banking in any of the courses.”

Another hard-hitting paper jointly prepared by American and European economists squarely blames the academic economists for being too ignorant of the real world to see the crisis coming. The substance of all this self-pity is that the economists had no idea of the nature of new financial products or the havoc they wrought, and they had no clue to the workings of the increasingly interconnected global financial system.

Business schools have also come in for a rap on the knuckles, and deservedly. The crisis has led to a close scrutiny of the functioning of B-Schools and a revelation of the scanty coverage in their curriculum of the need, nature and scope of regulation and the risks inherent the wide range of financial instruments. In addition to remedying this deficiency, there is need for putting regulators and government officials through special executive education programmes to fill the gaps in their understanding of economic phenomena.

B. S. RAGHAVAN