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Economists fiddle with theory as world burns

The global economy is seriously ill, and the doctors are debating whether John Maynard Keynes was right to assume that consumption was a function of current income or whether Milton Friedman's intuition that consumption depends on a consumer's sense of her "permanent income" is a better theory.

Andy Mukherjee
CIVILITY has been one of the less-mourned casualties of this financial crisis.
Radically different viewpoints on what will put the world economy back on a stable growth path have split the profession of economics into two warring tribes.
You are either with Paul Krugman, the Princeton University professor who won the 2008 Nobel Memorial Prize in economic sciences for his seminal work on trade theory, and a few like-minded economists of deep Keynesian persuasion. Or you are their enemy. There is no middle ground.
Most people equate Keynesian thinking with government control of the economy. The more modern variant of the economics profession that seeks its inspiration in Adam Smith's invisible hand is equated with private enterprise and free markets.
That is a caricature.
The real difference is that Keynesianism, with its roots in the Great Depression of the 1930s, is concerned with the here-and-now of an economy: When Keynesians see a fire, they want to put it out first and ask questions later.
The non-Keynesians believe that the present is inexorably connected with the future, and unless one can permanently change expectations about the future, tinkering with the present makes no sense. Twitting out a flame in one corner of a burning building merely brings the blaze back in another.
It is one thing for physical sciences to live with sharp differences in opinion. Whether light is particle or wave was hotly debated for four centuries. But Thomas Edison's light bulb did not have to wait for that debate to end.
By contrast, economics is a social science that allocates resources
between members of a society and between today's citizens and future generations. In the absence of a theory that justifies why Peter must be robbed to pay Paul, elected politicians have no basis to enact policy.
Say, United States President Barack Obama, desperate to stimulate the economy, faces a choice. He can spend $1 million to build a road by taxing Warren Buffett, or he can give Buffett a $1 million tax break. Obama should select the course of action that gives a bigger boost to the economy. But do tax cuts have a bigger multiplier effect than government spending?
Sadly, economists cannot agree. Indeed, prominent economists like
John Taylor, who worked in the George W. Bush administration, did not even buy the claim in 2009 by the Obama economics team that a 1% increase in government spending would increase inflation-adjusted US gross domestic product by 1.6% from what it otherwise would be. The effect would be much smaller, he said.
When Obama recently presented a proposal for cutting payroll taxes, Taylor expressed doubts about Moody's Analytics chief economist Mark Zandi's claim that it will create 1.9 million jobs.
"This is the same type of model simulation that predicted the very similar 2009 stimulus package would create millions of jobs, and the same type of simulation that claimed that
that package worked," Taylor noted on his blog last month.
Krugman agrees that the Obama stimulus did not do the job. But in his opinion, it was too small to work.
Nowadays, Krugman, who writes an op-ed column in The New York Times, uses his blog to rain punches on anybody who dares to disagree with Keynesian prescriptions for fighting the economic inferno. As the crisis has deepened, the list of his enemies has grown.
Those at the receiving end of his blows include former Fed chairman Paul Volcker, who recently wrote that the US Federal Reserve was sowing the seeds of future inflation. "Volcker, I am sorry to say, is worrying about re-
fighting the 1970s when we are actually re-fighting the 1930s," Krugman responded.
In the 1970s, the US experienced economic stagnation along with galloping prices. Volcker raised interest rates all the way to 20% to kill inflation.
The other side -- the nonKeynesians — is not taking Krugman's assault lying down. "Paul isn't doing his job. He is supposed to read, explain and criticise things economists write, and preferably real professional writing, not interviews, op-eds and blog posts," said University of Chicago economist John Cochrane.
The US is hurtling towards another recession, Europe is flirting with a sovereign-debt meltdown, China is
slowing and the rest of the world is looking to economists to show the way. And here is what Krugman and Kenneth Rogoff, a former chief economist at the International Monetary Fund, were debating around midAugust on the CNN show Fareed Zakaria GPS:
Krugman: "If we discovered space aliens were planning to attack and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months."
Rogoff: "And we need Orson Welles, is what you are saying."
Krugman: "No, there was a Twilight Zone episode like this..."
The War Of The Worlds, the radio drama about an alien threat that Welles directed and narrated, spooked Americans by its realism. Equally startling is this war of words between economists. It is turning sillier by the day. The debate is now so caught up with settling scores that men with practical ideas stand no chance of being heard. That is dangerous for policy.
The global economy is seriously ill, and the doctors are debating whether John Maynard Keynes was right to assume that consumption was a function of current income or whether Milton Friedman's intuition that consumption depends on a consumer's sense of her "permanent income" is a better theory.
The society at large has to express its disappointment: The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, which is due to be announced on Monday, must be axed. It will not be, but it should.
Anti-intellectualism is an ugly trait. But with their bloodletting, economists have left us with little choice.
© The Straits Times, Singapore. All rights reserved. Printed by arrangement with Asia News Network.