And the backlash grows

The backlash against the "Chicago" or "freshwater" school of economics is gathering steam, and none too soon (it would have been nice if it had happened before I had to learn that crap for my prelims).

Remember, the key things to know about the Chicago School are:

* The Chicago School is a loose term used to describe a group of economists, and their theories, that assume that people are purely rational, have accurate expectations about the future, and use all available information to make their decisions.

* Chicago School economists tend to believe that government is inefficient and that externalities (e.g. pollution) and public goods (e.g. infrastructure) are not very important, even though these conclusions are not included in their theories.

* The ideas of the Chicago School gained popularity in the 80s and 90s, partly as a result of the apparent success of free markets compared to central government planning. Chicago School economists Robert Lucas and Edward Prescott were given Nobel prizes.

* Because Chicago School theories imply that government should not interfere with business, Republican individuals and groups often contribute lots of money and jobs to Chicago School economists.

The financial crisis, which seems to contradict so many Chicago School assumptions and conclusions, has fairly predictably resulted in a backlash against those ideas, though (also predictably) the backlash has been a bit slow to build up. Here's a roundup of some of the rumblings from around the noosphere...


Maxine Udall:

Unfortunately, an entire cottage industry called the economics profession sprang up, firmly anchored on the shores of Lake Michigan, aimed at creating cultural narratives and myths about how “markets” (meaning some abstract aggregation of semi-rational, often ill-informed, but definitely self-interested points of light) would magically “know” and act rationally and with perfect foresight. In many ways, the birth of the cottage industry known as freshwater economics is a testimony to the power of markets. There was and is a lot of money to be made in that cottage industry, especially if one was willing to drink the “business as usual,” “just ignore the man behind the curtain,” “the business of business is business” kool-aid that until recently has characterized Maxine’s profession.

[The fact that Republicans paid Chicago economists to spout B.S. resulted in] the distortion of intellectual curiosity and endeavor. While a course correction, championed by Keynes, Robinson, JK Galbraith and others in the past and now led by such notables as Paul Krugman, Brad Delong, Joe Stiglitz, Mark Thoma and many others is underway, Maxine believes that considerable damage has been done. Not least because most non-economist Americans are unwittingly under the sway of several "defunct economists."...Don’t get Maxine wrong. She is not making a case for central planning. Maxine remains committed to capitalism: free markets when they function well, regulated markets when they don’t.

John Cassidy:

Ever since Milton Friedman, George Stigler, and others founded the Chicago School, in the nineteen-forties and fifties, one of its goals has been to displace Keynesianism, and it had largely succeeded. In the areas of regulation, trade, anti-trust laws, taxes, interest rates, and welfare, Chicago thinking greatly influenced policymaking in the U.S. and many other parts of the world. But in the year after the crash Keynes’s name appeared to be everywhere... In the course of a few days, the writer talked to economists from various branches of the subject. The over-all reaction he encountered put him in mind of what happened to cosmology after the astronomer Edwin Hubble discovered that the universe was expanding, and was much larger than scientists believed. The profession fell into turmoil, with some physicists sticking to existing theories, while others came up with the big-bang theory.

The impact of the financial crisis shouldn’t be underestimated, especially for Chicago-style economics. “Keynes is back,” [judge Richard] Posner [says], “and behavioral finance is on the march.”

Ryan Avent:

[Many economists in Chicago's] department appear to be lost. Casey Mulligan has advocated a "Great Vacation" view of the recession, in which the unwillingness of workers to take jobs has played a significant role in driving up the unemployment rate. John Cochrane is quoted in the New Yorker piece attributing the financial crisis to a speech by President Bush acknowledging that financial markets were in trouble, and not the problems generated by insolvency at the nation's largest banks. It's not very pretty...

Paul Krugman:

Here’s Eugene Fama, insisting that there was no financial crisis, just markets reacting rationally to an economic crisis caused by brain-eating aliens flouridated water something or other — hey, macro isn’t his department. John Cochrane, on the other hand, says that it’s all because George W. Bush gave a scary speech.

What struck me was the fact that Cochrane is still trying the argument-from-authority thing: this was all proved false in the 1970s, nobody serious believes in it, etc.. At this point he knows (although one wonders whether he did originally) that there’s this thing called New Keynesian economics on which a lot of smart people have been working since the mid-1980s. And yes, the models do allow for effective fiscal policy. But Cochrane is still using the Lucas giggles and whispers line.

It’s hard to avoid the sense that Chicago just turned inward on itself circa 1982, and stopped paying attention either to the world or to anyone not of its tribe. And now it finds that the rest of the world is returning the favor.

Also read Justin Fox, David Roberts, and Linda Beale for more on the death of the Chicago School. The good news is that Chicago School theories like "rational expectations" and "efficient markets" look set to join "supply-side economics" as has-been pseudo-theories kept on life support by vested political interests.

The bad news is for the science of economics, which has seen a number of Nobel Prize-winning "discoveries" exposed as claptrap within the short space of thirty years. You never see that happen in physics, chemistry, or medicine. The death of the Chicago School that economists have for far too long used plausibility as the criterion by which theories are evaluated, rather than empirical accuracy or technological usefulness. Despite switching from the English language to the language of math, economics has remained more akin to literature than to natural science. This must change.