How did so many economists miss the impending collapse of the global economic system? Why did politicians so misread the strength of the UK economy?
Ashley Seager, Economics editor of the Guardian commented on December 29th, "Recession is a blow that hits all the harder when the experts fail to see it coming".
He goes on to say,
"Beware the revisionists out there. A lot of people in the City, at the Bank of England and elsewhere are saying that things only really got bad as a result the turmoil in the banking system in September and October, because they did not see the slump coming. 'There is a lot of rewriting of history going on', said a senior Treasury official recently. This is because the Bank of England's Monetary Policy Committee slashed rates by three percentage points between October and this month, a huge monetary easing that saw rates tumble to a 57-year low of 2%, equalling the lowest on record. But the MPC, with the notable exception of external member David Blanchflower (since, alas, resigned), had been slow until the autumn to see how bad the economy was getting.
So if anyone says that it all turned rotten in autumn, ask them how it was that between June and August, before Lehman Brothers collapsed in mid-September, 164,000 people had lost their jobs?
The slump had begun well before September and unemployment started rising at the beginning of the year. Indeed, if you use the definition of recession that the US Bureau of Economic Research does, Britain went into recession in April".
"The majority of City economists got it wrong too, as did the National Institute of Social and Economic Research and the CBI, even though its own surveys were screaming recession throughout the summer.
No wonder they are trying to rewrite history. Many are trying to convince themselves that Blanchflower got it right through luck, but that is just sour grapes and they are not doing themselves any favours".
To compound the felony, Premier Gordon Brown and Chancellor of the Exchequer Alastair Darling were insisting that Britain's economy was more robust than any other in the developed world as recently as mid-summer 2008. This particular piece of self-delusion has been proven very rapidly to be absolutely wrong. Britain's economy is probably the opposite. The supposed British economic 'miracle' was based on a financial sector that was virtually unregulated and indulging in an orgy of irresponsible speculation; a housing market that was unsustainable and a consumer bubble of massive proportions; all fuelled by unprecedented levels of credit and debt. Common sense dictated that an economy that had all the substance of a ball of candyfloss would start to implode once any one of the frail props holding it up collapsed. And, led by the banking sector, all have crumbled at once.
Other economies, such as those of Germany and the Northern European countries, have much more substance than that of the UK because their governments have sought to maintain a balance of technology, manufacturing and industrial services to counter consumer and finance sectors. In the UK, starting with the Thatcher, the more solid sectors were progressively abandoned and the bonus of North Sea oil squandered through tax cutting that fuelled the long consumer boom. Investment in infrastructure and technology went out of the window.
The signs were clear - some saw them - why did the herd miss the point?
There may be several reasons why so many economists got it wrong:
- Many were mazed by ridiculous theories and a body of economic dogma that had no basis in empirical evidence. The market fundamentalist theories of the Austrian School and Reagan and Thatcher's hero, Milton Friedman was not based on firm empirical evidence. So, in effect the whole world has been enslaved by a theory of the free market that has been tragically proven to be fundamentally flawed. It is now absolutely proven that free markets favour the rich and strong and will become corrupted unless strongly harnessed for the good of society
- Economics has become a sort of quasi-mathematical science, dominated by nerds who are hooked on developing elaborate models to explain and predict what is happening and will happen. With a few honourable exceptions, economists signally fail to understand that economics is a social and psychological science that needs to encompass the whole gamut of human behaviours - especially the more irrational and herd-like tendencies of humans en masse. Economists would do well to get their heads out of their computer models and go to observe the behaviour of the human herd. Starting close to home in the financial markets will provide excellent material for observation. The first thing they might do is to study the psychological profile of the financial markets in this site and ponder on what a mighty army of such people, with world-wide reach and power with no restraints might do to the rest of us. (See 'The Personality of the Financial markets', Investment Markets, Fact and Opinion.)
- Economics is regarded as a Profession. Like all professionals, economists are subjected to social pressures from their peers. A tendency therefore is for most economists to swim with the shoal, that way they avoid ridicule, criticism and pressure from their peers. David Blanchflower was a lone voice in the Bank of England Monetary Policy Committee - the rest of the committee failed to notice what was going on around them until too late. And then, of course, many fellow economists then tried to insinuate that he was lucky, not broadly intelligent, a splendid example of collective self-delusion.
The tendency of professionals to worship knowledge that is deep but narrow in scope is probably a major contributor to a sort of tunnel vision that can describe bits of minutiae, whilst losing sight of the big picture. Strategists will tend to be wide in the scope of their perspectives and capable of relating disparate bodies of information to build a broad and dynamic 'picture' of systems of related variables and then predict trends. So, we advocate and laud, broad, even shallow thinking, especially if it constructs big pictures - specialists may be able to fill in the detail later. So in our opinion it is not surprising that one of the more powerful descriptions of the coming economic tsunami was by American historian Robert Brenner (see below). Historians have to manage an understanding of individual and collective human behaviours, identify often faint signals indicating important trends and then relate everything from social anthropology through psychology, sociology and economics to build their interpretations of the tides of human events
- The pressures caused by peer pressures towards conservatism and extreme caution are further exaggerated by the nature of official bureaucracies like the Treasury and the Bank of England. This is to some degree understandable - an unguarded statement from an official will have a disproportionate effect on a world full of impressionable people in the media and financial markets. But the fatal downside of this tendency is that official bodies will tend to follow events rather than predict or anticipate them - and this tendency is vastly exacerbated by the closeness of such bodies to party politicians, who always have a line to spin.
So, what did the 'experts' miss?
First, a smallish body of prominent economists and, more important, powerful and experienced investors have been predicting that the global financial system contained the seeds of its own collapse:
Investor and philanthropist George Soros wrote a book titled "The Crisis of Glabal Capitalism" in 1998.
Here is an excerpt from that book. The truth of his analyses should now have become apparent to even neo-liberal economists
"Financial markets are inherently unstable and there are social needs that cannot be met by giving market forces free rein. Unfortunately these defects are not recognized. Instead there is a widespread belief that markets are self-correcting and a global economy can flourish without any need for a global society. It is claimed that the common interest is best served by allowing everyone to look out for his or her own interests and that attempts to protect the common interest by collective decision making distort the market mechanism. This idea was called laissez faire in the nineteenth century... I have found a better name for it: market fundamentalism.
It is market fundamentalism that has rendered the global capitalist system unsound and unsustainable."
Here is an excerpt from an interesting article by American historian Robert Brenner in the Guardian:
"The bull runs of the 1980's and 1990's and the first half of this decade, with their epoch-making transfer of wealth to the richest 1% of the population, have distracted attention from the actual long-term weakening of advanced capitalist economies. Economic performance in the US, the bulk of Europe and Japan has, by virtually every standard indicator - output, investment, employment and wages - deteriorated, decade by decade, business cycle by business cycle, since the early 1970's.
The early years since the current cycle began in early 2001 have been the worst of all - in the US, growth of GDP and jobs has been the slowest since the end of the 1940's, and real hourly wages for about 80% of the workforce have languished at about their 1979 level.
The decrease in the dynamism of the advanced capitalist economies is rooted in a major drop in profitability , caused by a chronic tendency towards overcapacity in global manufacturing , going back to the !960's. Reduced profitability has, since the 1970's, led to a steady decline in the rate of investment as a proportion of GDP, as well as step-by-step reductions in the growth of the capital stock and of employment. This slowdown of capital accumulation, along with a push by corporations to restore their rates of return by holding down wages, has reduced aggregate demand - a weakness that has long constituted the main barrier to growth in the advanced economies.
Governments, led by the US, have underwritten ever greater volumes of debt, through ever more baroque channels, to subsidise purchasing power. In the 1970's and 1980's they incurred continuously larger deficits to sustain growth.
But since the mid-90's, they have had to resort to more powerful and more risky forms of stimulus to counter the tendency to stagnation, replacing the public deficits of traditional Keynesianism with the private debts and asset inflation of what might be called asset-price Keynesianism - or , with equal accuracy, Bubblenomics."
So, by all means listen to the analyses of economists, but take them with a pinch of salt. But when they move from diagnoses to prognoses, be deeply sceptical if not downright unbelieving.............