Things economists should admit more often and policymakers should consider

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by Hans Dembowski

Straight talk on economics

I am currently reading Dani Roderik’s latest book “Straight talk on trade”, and I much appreciate what he writes. The Turkish-born economist and Ivy League professor spells out things that sociologists and political scientists understand all too well, but that tend to be disregarded by policymakers.

Rodrik writes on p. 27: “Markets depend on non-market institutions because they are not self-creating, self-regulating, self-stabilising or self-legitimating. Anything that goes beyond a simple exchange among neighbours requires investments in transportation, communications and logistics; enforcement of contracts, provision of information and prevention of cheating; a stable and reliable medium of exchange; arrangements to bring distributional outcomes into conformity with social norms; and so on. Well-functioning, sustainable markets are backed by a wide range institutions that provide critical functions of regulation, redistribution, monetary and fiscal stability, and conflict management.”

These things cannot be said too often. Recent discourse overemphasises the role of markets by belittling the role of the state. The truth is that government institutions and markets complement each other, but do not serve as substitutes for one another. Unfortunately, economists often pretend to reveal universal truths, and policymakers tend to believe that their formulas are more relevant than the insights of other social scientists.

Getting the balance of markets and state institutions right is essential. I fully agree with Rodrik that the viability of capitalism depends on it. On p. 202, he states: “If capitalism is to survive, it must be redesigned to address the multiple challenges of globalisation, inequality (both national and global), rapid technological change, climate change and democratic accountability.” He wants policymakers to address these issues, since markets, left to themselves, cannot provide solutions.

The core questions, according to Rodrik (p. 202f.), are: “How can public policy be more effectively deployed to stimulate green technologies? How can the unequalising forces of technological innovation be harnessed for greater equity and social inclusion? How can globalisation be reformed to enhance both domestic and international equality despite the apparent tension between the two? How can progressives develop a politically winning agenda that overcomes the appeal of populist demagogues?”

I haven’t read enough yet to discuss the solutions Rodrik proposes. I will tell you what I think once I’ve read the relevant chapters. Right now, however, I’d like to share two other arguments made by Rodrik. He writes that history tells us that right-wing populists do not offer solutions, but basically increase the likelihood of conflict, whether at the national or international level. On the other hand, progressive policymakers have delivered solutions in the past and thus made themselves redundant.

The other fundamental message concerns economists’ models. As Rodrik argues, his science does not deliver truths that apply always and everywhere. Economic insights are highly context specific. Scholars design mathematical models that help to analyse settings that are very narrowly defined. The results are very precise, but they are only true to the extent that an empirical situation is actually reflected accurately in the model parameters.

As regular readers of my blog may remember, I have long been deeply uncomfortable with economic modelling. Relevant posts were “Economics is driven by the wrong incentives” and “Economics is just another social science”. I used to argue that economic models are inherently non-empirical. It is correct, that they are to a large extent theoretical mind games. Rodrik is correct to point out, however, that the models are actually quite stringent and can be applied to conditions that fit their parameters.

For good reason, he appeals to his colleagues to make policymakers aware of this point. As he argues correctly, it is a strength of the disciplin to be able to give context-specific advice. If, on the other hand, policymakers fall for the platitudes of market dynamics always being preferable to state action, governance will be inadequate. Rodrik is quite outspoken in this regard (p. 114): “Economics can be tremendously powerful and useful. But at the hands of its practitioners, it often goes wrong – as it did in preparing the grounds for the global financial crisis and pushing for an unsustainable, unhealthy model of globalisation.” I’ll be back with more on his take on globalisation soon.

 

Reference
Dani Rodrik, 2018: Straight talk on trade. Ideas for a sane world economy. Pinceton and Oxford: Pinceton University Press.

 

Correction, Friday 4 May, 9:00 Frankfrut time: The earlier post contained several typos. One distorted the meaning. One of Rodrik's concerns is "the unequalising forces of technological innovation". The earlier phrasing of "equalising forces" was wrong.

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