Every pundit, regardless of their qualifications, has an opinion on who is responsible for the worldwide financial meltdown of 2008 and how to fix the problem. The majority of these fixes involve two elements–more government regulation and the early detection and prevention of “systemic risk”. Each of these assume that there exists a mechanism by which systemic risk can be evaluated by public agencies and that systemic imbalances and overloads can be detected in advance. This is a dream world.
In the recent review of the book The Big Short by Michael Lewis, Brian Carney writes: “Under proposals currently moving through Congress, our financial regulators are supposed to sit down together to identify and head off asset bubbles before they pose a risk to the system. But a bubble becomes a systemic risk only because it is not recognized as such……..it is the rare few who grasp what is truly happening when it is still possible to do something about it…..”
This is the problem with economics as science, of which I have been skeptical since my first encounter with college freshman economics almost fifty years ago. It’s about time we came full circle to this realization that was obvious to the “economists” of the 18th century.
Adam Smith told us that his economic theories were not science, but moral philosophy, and his foundational writing was manifest in The Theory of Moral Sentiments at least as much as in The Wealth of Nations. Likewise other foundational economic theorists such as Friedrich von Hayek. Even John Maynard Keynes recognized the moral implications of economic theory. It was the progressives who were convinced that the laws of science could be easily applied to the social issues, beginning with Herbert Croly, John Dewey, Woodrow Wilson, et al, and extending to the 1960’s intellectuals who espoused such notions as “if we can go to the moon, we can cure poverty”.
The same mentality applies to the static scoring of tax rate cuts and the related resistance to the human behavioral factors embedded in the more accurate dynamic scoring of incentives to investment and growth that result from these cuts. When will we get an apology from the crowd that was so convinced of economic rationality that it could build sophisticated behavioral models with total disregard of the dynamics of human nature? The short answer is never and, in fact, what we’ll get is more of the same.