TCS Daily

Economists Mugged by Reality

By Arnold Kling - October 25, 2005 12:00 AM

"During President Bush's first five years in office total real discretionary spending went up by 36.5 percent... Rather than attack this cancerous growth, Republicans have fed it, doling out prescription drugs to seniors, hurricane relief and bridges-to-nowhere with equal glee."
-- Kevin Hassett

Fellow TCS columnist Kevin Hassett was also a speaker at a conference on economic theory and public policy held at Swarthmore College on October 21-22 in honor of the late professor Bernie Saffran. The conference provided a vivid illustration of how political reality impacts -- or fails to impact -- the thinking of economists.


The first question at the conference, posed to a panel by organizer Mark Kuperberg, was, "Does studying economics make you more conservative?" The panelists (who did not include Hassett) completely dismissed that notion. Peter Diamond, Albert Fishlow, Alan Krueger, Jeff Frankel, Alice Rivlin, Joseph Stiglitz, and Sidney Winter remain committed to their left-leaning views.


Five years ago, liberal economists were arguing against the Bush tax cuts, and conservative economists were arguing in favor of them. The big concern of economists on all sides was the looming increase in entitlements due to demographics and growth in health care spending. (Oddly enough, one economist who appeared to ignore the entitlement issue was Alan Greenspan, who in 2001 argued that without tax cuts the government might accumulate such large surpluses that the national debt would be retired. At the Saffran conference, Stiglitz properly excoriated Greenspan for stooping to such nonsense.) We thought that an increase in national saving would be helpful. Liberal economists thought that high tax revenues would allow the government to run a surplus, thereby increasing saving. Conservatives thought that saving was more likely to increase if income was returned to the private sector.


The two viewpoints might be summarized as follows:


Conservatives: Cutting taxes will help reduce the size of government.


Liberals: Big government is not really so bad.


In the face of overwhelming evidence over the past five years, conservatives like Hassett and me have to admit that we were wrong. Cutting taxes did not help to reduce the size of government.


On the other hand, in the face of what I think is overwhelming evidence that much government spending is misguided and serves only narrow interests, I don't find liberal economists willing to admit that they were wrong. They refuse to be mugged by reality.


Krueger mentioned the phenomenon of "confirmatory bias," in which people who believe a proposition tend to interpret reality to serve their prior beliefs. For example, as a Cardinal fan, I believe that the videotape of the play at second base where Yadier Molina was called out clearly shows that Molina was safe. An Astro fan would look at the same tape and say that it proves that Molina was clearly tagged out by Adam Everett. Krueger warned that economists may be subject to the same sort of bias, which would lead conservatives to become more conservative and liberals to become more liberal.


At Swarthmore, I was a liberal. However, Bernie Saffran's philosophy (I'm willing to be wrong) was to resist confirmatory bias. Over time, mugged by what I see as the reality of political economy, I became libertarian.


Market Imperfections and Political Imperfections


Nobel Laureate Stiglitz confirmed that he is what I call a Stiglitzian. He snorted at the notion of laissez-faire, deriding the assumptions under which markets achieve optimal outcomes as laughably impossible. The implication is that anyone who opposes government intervention is under the spell of a discredited faith.


If Stiglitz looks at the market process and sees flaws everywhere, then I cannot disagree. However, the mugged-by-reality view also sees flaws in the political process. In fact, in response to moderator Kuperberg's request to name instances in which economic theory influenced policy favorably as well as instances in which policymakers ignored economic theory to the country's detriment, the panelists found it much easier to list examples of the latter.


For example, someone in the audience brought up the topic of farm subsidies. Rivlin said that in all of the battles against farm subsidies, she could recall having been able to eliminate only two -- one for honey and one for mohair. All of the rest were untouchable. Stiglitz pointed out that the "freedom-to-farm" act was supposed to phase out farm subsidies -- the act provided a large one-time subsidy that was supposed to ease the transition out of farming. Instead, it became a permanent hike in the level of farm subsidies.


Several panelists discussed their experience in the Clinton Administration, including the way that economists were frozen out of the process for coming up with a health care proposal. They described how the Council of Economic advisers came under pressure from the White House to minimize the estimates of the cost of compliance with the Kyoto protocol. For the economists, the challenge was to formulate their testimony cleverly in order to satisfy their political bosses while maintaining their integrity.


Overall, I came away with confirmation of my bias that honest economic analysis is highly unwelcome in Washington. At best, good economic policy can be arrived at by stealth -- using a rationale that has little or nothing to do with the true merits. For instance, panelists pointed out that the Clinton Administration turned to auctions for allocating spectrum as a way of helping the deficit numbers, not as a way of achieving greater efficiency. Frankel said that when he happened to run into Clinton-era FCC Chairman Reed Hundt years later, Hundt seemed completely unaware that economists had been in the forefront of the idea of spectrum auctions.


As another example, Robert Rubin was able to sell fiscal discipline during the Clinton Administration by saying that lower Budget deficits reduce interest rates. This effect is small, and it is not the primary reason that economists favor lower deficits. Lower deficits now will reduce the future debt burden, which is economists' main concern, particularly in view of those looming entitlement spending increases.


The Political Climate


Outside the context of the panels, Rivlin and Hassett offered insights into the current political climate. Rivlin suggested that we may be learning about the benefits of divided government. When the parties divide control of Congress and the White House, they recognize the inevitability of compromise. With one-party control, the minority party is too bitter to compromise and the majority party is too arrogant to compromise.


Hassett pointed out that the dynamics in both parties lead to an overstatement of the magnitude of the Bush tax cuts and an understatement of the Bush spending increases. As Hassett put it, Bush partisans want to remind mainstream Republicans about the tax cuts and try to get them to overlook the spending increases. Meanwhile, the Democrats have no desire to criticize spending, but they are eager to criticize tax cuts. The bottom line is that everyone wants to make more noise about the tax cuts than about the spending increases.


"My Priors Shifted"


Of the left-leaning panelists, only Frankel attended Swarthmore and therefore reaped the benefit of studying under Bernie Saffran. The other panelists might have answered Kuperberg's opening question differently had they studied economics under Bernie Saffran. Saffran did not indoctrinate his students as conservatives. However, he did impart to his students a willingness to change your mind. In a follow-up email the morning after the conference, referring to the more technical papers (which I sketch here) rather than the panel discussions, Frankel wrote, "the program Saturday was one of the most interesting, informative and entertaining set of papers and discussants' comments I have heard in a long time...I did have my priors shifted importantly on a variety of major policy questions."


"My priors shifted" is econ-speak for "I changed my mind." Bernie gave us that skill -- to respond when you have been mugged by reality.



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