Economics and the global crisis

By John Rapley

Three years ago, a paper by two famous economists at US ivy-league universities appeared to provide a scientific basis for the austerity gospel (which I recently criticized in this column). Carmen Reinhart's and Kenneth Rogoff's Growth in a Time of Debt apparently made a striking discovery: that once a country's debt-to-GDP ratio surpassed 90 per cent, growth more or less stopped.

The paper was extensively cited in academic journals and circulated widely in the policy world. Politicians who called for austerity over stimulus used its conclusions to justify their position. At least, they did until two weeks ago. That's when a graduate student at a state university noticed something odd. Digging into the data, he discovered that Reinhart and Rogoff had made a simple spreadsheet error that completely invalidated their claim.

By then, another economist had done a few simple tests which suggested that whatever correlation the two authors had uncovered, they drew an inference about causality which turned out to be wrong. It appeared that high debt resulted from a slowdown in growth, and did not cause it.

messy state of economics

The resultant fallout revealed much about the messy state of economics. When Queen Elizabeth famously asked a bunch of economists at the London School of Economics why the best minds in the best universities had failed to foresee the global economic crisis, it fell to a Nobel Laureate to provide a reply. Robert Lucas famously, or perhaps infamously, wrote that economics did not fail because economic theory predicts that a crisis cannot be predicted. Thanks Bob. The celebrated economist John Kay then noted that "faced with that response, a wise sovereign will seek counsel elsewhere."

And they've been doing just that. Whereas prior to the 2007-2008 financial crisis, everyone sought out the world's top economists to advise them on economic policy, since then, politicians and bureaucrats have been cobbling together pragmatic responses to pressing events. One of the defenses offered in recent days of Reinhart and Rogoff is that their error didn't really matter that much since the paper didn't have a great impact: the politicians who cited it as support for their decisions were going to opt for austerity anyhow.

This point is debatable. But even if we take it at face value, it raises the question as to why anybody would study economics or consult a theorist if their advice is anyhow irrelevant. Looking more closely at the now-notorious paper, it is clear that Reinhart and Rogoff were onto something. At a certain point, and over the long term, chronically heavy indebtedness is bad for growth. But that's something that, as Angela Merkel might say, a Swabian housewife can figure out. It hardly needs a six-figure economist to produce an empirical paper.

criticism

Until the global crisis, the economics profession was beset by hubris, bubbling with the conviction that it was the most scientific of the social sciences. Since then, it's been beset with criticism. The truth is, to a much greater extent than they wish to admit, economists are the prisoners of defunct philosophers, to paraphrase Keynes. Reinhart and Rogoff began with an assumption, one they may well have inherited from the American equivalent to a Swabian housewife (a Midwestern Methodist, perhaps?). Then they built a paper to defend it.

There is nothing intrinsically wrong with this approach, but one shouldn't pretend it's science. It requires a careful probing of the prior assumptions - something economists are virtually trained not to do, on the grounds that they are scientists, not philosophers.

In my years in the policy world, I noticed that an astute politician could manage without good economic advice if he or she had to, but that the best economic advice is little good if the decision-maker lacked judgement. That's not science, that's the art of the possible. And if there is one thing the global crisis taught us, it's that economics would do well to retreat a little from its quixotic quest for scientific status, and go back to being good philosophy.

John Rapley, a political economist at the University of Cambridge, is currently on a visiting professorship at Queen's University in Canada. Email feedback to columns@gleanerjm.com and jr603@cam.ac.uk