David R. Henderson  

Noah Smith on Modern Economics

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Do a YouTube search for "Milton Friedman." Most of the hits will be speeches mixing economic theory with political philosophy. You'll see Friedman talking about the value of greed, for example, or holding forth on socialism versus capitalism. Most entertaining is the series of videos titled "Milton Friedman schools young idealist," in which young, hippie-looking kids stand up and challenge the old man's capitalist values, only to be hit over the head with Econ 101.

As an econ blogger, I get the sense that this is exactly how many Americans still think of economists--as self-appointed defenders of the free market, spinning theories to show that greed is good. Watching those old Milton Friedman videos, I wonder if that picture might have been accurate in the 1960s and 1970s. But some big things have changed in the field of economics, and America should know about them. Three big changes stand out in particular: Econ today is more data-driven, far less politically conservative, and in general much more like engineering than it used to be.

These are the two opening paragraphs of Noah Smith, "Economists used to be the priests of free markets--now they're just a bunch of engineers," Quartz, May 13, 2014.

He's getting at something real. Noah is probably right that the economics profession is more left-wing than it was. But we have to be careful about dates. Noah, and this is understandable given his youth, lumps the 1960s and the 1970s together. Based on his C.V., Noah was probably not alive in either decade and even if he was born in the late 1970s, was obviously not following economics then.

Why do I make such a strong distinction between the 1960s and the 1970s? Because in the 1960s, the dominant view about economists in macro was Keynesianism, the dominant ideology was statism, and the leading economist was the late Paul Samuelson. By the late 1960s, that had started to shift and by the mid-1970s, the shift was well under way. By the late 1970s, the dominant macro view was either monetarism or rational expectations, the free-market deregulators were never dominant but reached their peak influence--think airline and transportation deregulation and elimination of price controls on interest rates that banks could pay on deposits--and the leading economist was Milton Friedman.

So it matters a lot whether we're comparing now with the 1960s or now with the 1970s. With the latter comparison, Noah has a point. With the former, he doesn't.

One more point about the 1960s and even the early 1970s. In the academic year 1971-72, I went to the University of Western Ontario to take advanced undergrad and one grad course in economics, to prepare myself for going on to graduate school in "the States." I had been a math major. Why UWO? Because when I had asked some economics professors at my alma mater, the University of Winnipeg, what was the best school in Canada to get advanced undergrad economics, they had recommended UWO. I was telling this story at breakfast yesterday to two economist friends who were visiting Monterey: Carole Kitti and Stan Horowitz. They had both done their graduate work at the University of Chicago in the late 1960s and early 1970s. When I told them that, Stan said, "That makes sense. The University of Western Ontario had a Chicago leaning."

Stan's comment surprised me. Why? Because it caused me to recall that that was what I had heard back in 1970 but had forgotten. I had forgotten it because when I got there I realized quickly that it wasn't true. There was a small monetarist element. But the dominant macro view was Keynesian. Indeed, I recall that my macro prof, Harry Baumann, in response to some criticisms my fellow student Harry Watson and I were making of his critique of Friedman's consumption function, actually halted the discussion and announced to the class: "These guys [Harry and I] are dangerous." He wasn't kidding. Moreover, as I've written elsewhere, when Gordon Tullock came to our school to present a paper, the faculty did not engage and the buzz around the school the next few days about Tullock's ideas was negative.

The bottom line: the economics department that was thought to be the most Chicago-influenced Canadian department was not very Chicago-influenced.

Now to the rest of Noah's piece. He writes:

When people say "Econ 101," they probably mean a world where free markets work perfectly and government intervention is always bad. But open an actual Econ 101 textbook--say, Greg Mankiw's Principles of Economics--and you'll find a whole host of reasons why markets fail. Economists have always known that "negative externalities" (like pollution), "public goods" (like research), and "incomplete markets" could clog up the plumbing of the free market. But since the 1970s, economists have also explored how information problems like "adverse selection" and "moral hazard" can do the same. Game theory, which has become more and more popular, shows many cases in which even perfectly rational people can reach a bad equilibrium that leaves plenty of "free lunches" uneaten on the table. Behavioral economics has documented a host of ways in which humans might not be rational, and institutional economics has shown how even rational individuals can act stupidly en masse.

Start with his first sentence. I know of no Econ 101 course or its equivalent that talks just about "a world where free markets work perfectly and government intervention is always bad." Zero, none, nada. And adverse selection and moral hazard? Yes, there's more talk of that now, but somehow Noah seems to imply that that those concepts undercut the case for free markets. They don't. The clearest examples we have of adverse selection and moral hazard that really mess things up are those that are created by government regulation. For example, insurance economics scholar Howard Kunruether, not exactly a Chicagoite, along with his co-authors, lays out how adverse selection is not a big problem in health insurance except when government regulation creates it.

Moreover, although Noah is right that behavioral economists have come up with more examples of how markets can fail, they have been incredibly resistant to applying those same tools to government officials, a criticism I make here.

So, although I think the economics profession is more left-wing than it was in the late 1970s, this isn't due so much to an empirical revolution as it is to the profession's hesitance to examine carefully how government actually works.

One last comment: My guess is that for his claim that on YouTube videos, one can find Milton Friedman "talking about the value of greed," Noah had in mind this one. I ask you to watch it for yourself and see if you think Noah Smith has done a fair job of summing up Friedman's point.

Comments and Sharing

CATEGORIES: Economic Philosophy

COMMENTS (18 to date)
Andrew_FL writes:

His title is interesting and telling. When the public face of economics perceived by the people defends free markets, they're priests, but when they attack it, they're engineers.

In point of fact this is backwards. Since at least the time of the Kathedersozialisten, criticism of markets by "economists" has been what has served the social function of the Medieval clergy: as sources of "truth" to provide a rational for the power of the State. Along with intellectuals more generally.

It's probably true that people perceive economists the way he says, but I think it's wrong to suggest it was ever true-at least since Keynes-that economists have generally leaned pro-market. Pro-market minority views became more influential for a time, but I don't think they have been a majority view at any point in the last 60 years, at least.

Of course, I should be clear that I find there to be less than zero value in a view being the "prevailing" or "majority" view, since it has no bearing on whether it is correct or not, and it is much easier than people seem to think for a majority of "smart" people to hold incorrect views. Besides which, to quote Mark Twain: "Whenever you find that you are on the side of the majority, it is time to pause and reflect."

Daniel Kuehn writes:

Andrew FL -
I don't think his point was that economists attack markets today. It's frustrating that that's always the accusation every time a view of economics that doesn't fall in line with conservative or libertarian priors is expressed. And this is precisely what Noah is (rightly) criticizing - the tendency among many people to assume that there is (in his words) "mixing [of] economic theory with political philosophy".

If you are:

1. Calling most economists critics of the market
2. Putting economist in scare quotes in your comment, and
3. Under the impression their purpose is to make rationales for the state

Then it seems like you have precisely the misguided view of how economic science works that Noah is admirably trying to address.

Conor writes:

I think you've misunderstood the first sentence in the second block. Noah isn't saying that econ 101 is dogmatically pro-market, he's saying that that's how the public views it. If I'm reading him right, he would agree with your criticism that no econ 101 class has ever actually been taught that way.

Kevin Erdmann writes:

That Milton Friedman Donahue Show episode is absolutely wonderful from beginning to end. There is no way to legitimately characterize Friedman as the purveyor of simplistic models in that conversation.
In this 10 minute segment, Friedman says that the ICC should free up interstate trucking, and Donahue literally says it would be "chaos", then he goes on to point out, incredulously, that Friedman would even allow Sears and Kmart to merge.


The passage of time has been very friendly to Milton regarding that show. Donahue's facial expressions are priceless.

Ak Mike writes:

Conor, I think you are the one not reading the excerpt correctly. Notice how (1) Smith states in the first paragraph that Friedman uses "Econ 101" against the hippies - obviously Friedman knows what Econ 101 is, so in Smith's view Econ 101 was, way back in that Paleozoic era, dogmatically pro-capitalist. And (2), notice how Smith says in second paragraph that Americans "still" think that economists defend the free market - implying that once upon a time, before they became engineers, that would have been accurate.

So, no, I don't think you're reading him right - I think Smith's words show that he thinks that back in the era of "old man" Friedman, Econ 101 did favor the free markets, although no longer.

Otto Maddox writes:

Of course markets fail but does the government "solution" make things better or worse? This is something that should be addressed in today's Econ 101 courses.

Eric Falkenstein writes:

Noah has swerved leftward since embracing his new blogging/journalist role. I think it simply generates more pageviews, as most people are sympathetic to the idea that markets don't work.

Hayek pointed out that perfect markets are actually a reason why markets are not needed, because if everyone knows the production functions and preferences, a central planner can dominate. It's when there is imperfect information that a competitive market makes things better.

The funny thing is, Stiglitz is famous for a model that shows when there's risk pooling, markets break down. So instead of supporting the ability to price for risk, he supports risk pooling by the government, as they presumably would fix the problem because they are good social planners. That's a leap.

djf writes:

Smith gives away his skewed ideology by describing Friedman as providing justifications for "greed." His desire to put Friedman and other non-Leftist economists in a negative light is transparent. Left unstated is the assumption that government planners and regulators have only pure and selfless motives.

Noah Carl writes:

Check out John Taylor's post 'Market Failure and Government Failure in Leading Economics Texts'.

chipotle writes:

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Jim Rose writes:

great post.

Noah Smith is full of it. Economics was never a priesthood of free markets.

Milton Friedman was a wild man in the wings until late in his life. Hayek had trouble getting up a job after about 1950.

If you mentioned Milton Friedman in a job interview before about 1995 or thereabouts, that was very career limiting.

If you mentioned Hayek's name at a job interview and there was any sign of name recognition, that was evidence that you would been interviewed by well-read people.

A great many economists started out as socialists.

There was great resistance to public choice within the profession, as you noted, and it is still is not well recognised in basic textbooks.

The average economist is a moderate Democrat. That is a shift to the right, not to the left.

Economists are more likely to vote Democratic than Republican by a margin of 5 to 2; and even the Republican-voting economists tended to favour a lot of government intervention.

As for the Austrian School, sorry but that was so small until the late 1990s that they wouldn't need to book ahead to get a table at a restaurant.

Scott Sumner writes:

David, Nice post. I wrote a similar one a few days ago, but haven't posted it yet. I'll put it over at MoneyIllusion. I was at Wisconsin from 1973 to 1977, and they all thought Friedman was a right wing crackpot. Economics was far more liberal in the mid-1970s than during later decades.

David R. Henderson writes:

Thanks, Scott. Also, Jim Rose, I think your data are basically correct.

Joel Aaron Freeman writes:

I just wanted to point out that Adam Smith extensively discussed "adverse selection," "moral hazard," and other misalignments of incentives, although using different terminology.

One particular example I remember was his skepticism of certain joint-stock ventures of that existed in his day, which had some traits in common with modern corporations. In particular, Smith claimed that the acting manager would never be as fastidious and careful as the investors who put their money in the venture. A standard principal-agent problem.

Debate about these issues goes back to the Enlightenment era, not the 1970's.

liberty writes:

I didn't see a "hippie-looking kids stand up and challenge" Friedman in that video. Are you sure it's the right one?

David R. Henderson writes:

I didn't see a "hippie-looking kids stand up and challenge" Friedman in that video. Are you sure it's the right one?
Yes, I am. Read my post more carefully.

Roger McKinney writes:

I have to teach a section on market "failures" but fail to see it. I see leftists putting a burden on the market that it was never intended to carry.

The market is a place for people to exchange goods and services. Making it responsible for all negative externalities (while ignoring the vastly more important positive externalities) on the planet is dishonest.

For example, pollution is a property issue. Protecting property has always been the job of the state. Pollution is a government failure, not a market one.

Slavery was the worst government failure in history. The state, not the market's job is to protect life, liberty and property.

The lemon problem is not market failure, but a failure by economists to consider any time period beyond the very short run as well as failure to look beyond the immediate effects. Any car dealer that consistently cheated customers would quickly fail. It's also the reason most retailers have guarantees, warranties and return policies.

To paraphrase Hayek, engineering is too highly regarded, especially by engineers. Their arrogance convinces them that the state can control most things when in reality it can control very little. And in that attempt to control, it destroys the market along with its enormous positive externalities.

Jacob A. Geller writes:
"I know of no Econ 101 course or its equivalent that talks just about "a world where free markets work perfectly and government intervention is always bad."

All Noah said was that "When people say "Econ 101," they probably mean a world where free markets work perfectly and government intervention is always bad." Which is true. People say "this is Econ 101" when they mean "this is supply and demand," a la a simple supply and demand graph, in which, indeed, government intervention is always bad.

His is a comment on how people use the term "Econ 101," not on the course content of Econ 101 per se.

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