A couple of weeks ago at a meeting of Nobel Prize laureates in Lindau, a major Bavarian town on the eastern side of Lake Constance, German Chancellor Angela Merkel called on economists to make “more honest” policy advice and admit that mistakes and uncertainties are a regular part of their trade.
That’s not a promising start for economists seeking a louder voice on more economic policy evaluation commissions. The Association for Social Policy, the largest economists’ association representing a majority of German-speaking economists, is holding its annual meeting this year in Hamburg with the motto, “Evidence-based Economic Policy.”
Throughout the meeting, top experts will advocate for an evaluation culture that makes “the evaluation of policy measures a normal routine and provides sufficient funds for it.”
But to convince the skeptical chancellor and her equally skeptical finance minister, Wolfgang Schäuble, the association must find a response to Ms. Merkel’s contention that economists pay too much attention to economically rational criteria and too little to the messy business of politics, where majorities must be organized and responsibilities shouldered.
It’s an old conflict. Even Helmut Kohl, Germany’s chancellor from 1982 to 1998, said, “I want to win elections and not the Ludwig Erhard Prize,” referring to an economics prize awarded annually.
Convincing politicians won’t be easy. The prevailing perception of economists is that they are obstacles. This view is so deeply integrated in the theoretical construct of modern economics that changing it is extremely difficult. It’s no coincidence that this overwhelming perception and its consequences have survived the financial crisis almost unscathed, despite criticism from within their own ranks.
One of the luminaries of the field, the Harvard University macroeconomist Gregory Mankiw, describes it this way in his textbook: “Economic theory is populated by special creatures, sometimes answering to the name homo economicus.” This species maximizes its own self-interests, according to their own firmly defined preferences and independent of their fellow human beings, Mr. Mankiw says.
They are rational and know the probability of everything that can happen in the future. Thus, they assume there is a functioning market for everything, regardless of whether it’s today, tomorrow or the distant future. This way they can envision perfect competition in all markets and a state of equilibrium in the economy.
It becomes difficult, however, when real world markets don’t function in the perfect manner economists embrace. When there is involuntary unemployment, for example, it doesn’t make people happy, but rather oppresses and scares them, yet economists make no provision for these kinds of developments.
The value of a good job and its effect on workers can’t be found in the textbooks used by economists. Instead, their models view unemployed people as happy about having time off, with the only problem a loss in production since the labor market is not making enough manpower available.
This is also reflected in the macroeconomic models dominating professional journals and deeply influencing the economic policies of the central banks and the European Union. There is no room for involuntary unemployment in these models, since there is only a representative budget that chooses its optimal labor supply in hours according to prevailing prices.
Unemployment is only seen as an undesirable underutilization of human resource potential because it is detrimental to growth, but it’s not seen as a personal or social problem.
Unemployment is only seen as an undesirable underutilization of human resource potential because it is detrimental to growth, but it’s not seen as a personal or social problem. Social welfare programs are viewed as interfering with the natural ebb and flow of the economy.
But social security is important to the voting public and that is difficult for economists to understand. Equally important to voters is a just distribution of wealth, however the individual might define it. Economists have little understanding of this because of the interplay of two dogmas of modern economics.
On one hand, “methodological individualism” demands everything be attributed to rational decisions and the utility for individuals. On the other, economists are forbidden to compare the utility for individuals, to add them up or offset them, since the utility isn’t measurable. This makes it virtually impossible to say anything sensible about economic policy measures in which some profit and others are burdened.
Economists have wiggled out of this dilemma with a cheap trick. They simply measure everything in money instead of what it is actually means to an individual, thus making income distribution irrelevant.
Until economists can come to terms with the fact that €100 ($128.8) can make a poor man much happier than a millionaire and that income distribution plays a significant role in the real world, they will continue to have a hard time offering politically relevant advice to the German government.
This article was translated by David Andersen. Jeff Borden also contributed to this story. To contact the author: Haering@handelsblatt.com