Economics by humans, for aliens

Thus, it is no surprise that the overwhelming majority of economists on planet Earth — former Princeton colleague Ben Bernanke apparently among them — have been as surprised by the train wreck now hurling toward our economy as has been the laity. Nor is it surprising that earth-bound economists are at a loss regarding how to avoid the train wreck, they being so unschooled in earthly matters.

Turn to the media, where economists now pronounce on the calamity.

Here is N. Gregory Mankiw ’80 — Princeton undergraduate, Ph.D. from MIT, professor of economics at Harvard, chair of former president George W. Bush’s Council of Economic Advisors — assuring the public that as a stimulus for the economy, tax cuts are better than added government spending, the latter thought by him to be wasteful.

And there is Joseph Stiglitz — Amherst undergraduate, Ph.D. from MIT, Nobel Laureate in economics, professor of economics at a series of top universities (Princeton included) — telling us that tax cuts will not work in the current situation and only added government spending will.

Listen to the rest of the profession, and you have a veritable Tower of Babel. Which is why you might as well listen to Ali Velshi on CNN. He has a degree in religious studies from Queens University in Canada and makes just as much sense — and more — as formally trained economists.

The profession’s failure to perceive the coming train wreck and speak in unison on proper remedies does not deny the profession’s brilliance. Rather, blinded by the clever, stylized theories of human behavior they have concocted, economists would not recognize an economic train wreck driven by human irrationality unless the train hit them. (Luckily for Princeton, its Nobel Laureate, Wilson School professor Paul Krugman, is one notable exception.)

Princeton psychology professor Daniel Kahneman — who earned the Nobel Prize in economics for his and late colleague Amos Tversky’s trenchant critique of the economists’ behavioral theories — had long warned the profession about the perils of its simplistic assumptions. Richard Thaler, pioneer in the still nascent profession of “behavioral economics,” calls the extraterrestrial creatures at the core of these stylized models “Econs,” as distinct from “Humans.” Alas, economists find it difficult to embrace the behavior of Humans within their mathematical models. So instead they have prepared themselves and their students for the more elegant life among the Econs.

The problem begins with the simplistic introductory textbooks used in ECO 100: Introduction to Microeconomics. The content in these texts has not much changed since Paul Samuelson first published his classic introductory textbook in economics in the 1950s. Indeed, all modern introductory microeconomics texts are merely slight mutations from Samuelson’s original opus, albeit accompanied now by sundry electronic bells and whistles probably not much used by students.

Mankiw’s text, “Microeconomics,” wildly popular in high schools and on Princeton’s campus, is a prime exhibit of the genre. Start with Chapter 21 to behold the profession’s model of consumer choice. Though it describes utterly rational Mr. Spock to a “T,” it does not prepare students to consider the utterly myopic and chaotic style of life-cycle planning — if the word “planning” may be used in this connection — of the typical American household.

The theory of the firm in this text is still based, as in Adam Smith’s time more than two centuries ago, on the model of an owner-operated firm producing one single, simple product such as bagels or ice cream or the mythical “widget,” the latter a product that has all of the attributes economists need to produce neat Vulcan models. Not a hint here about modern corporation finance, or of the fact that so much profit in recent years was booked by firms called “banks” by the sale of products that the firms themselves did not understand, or of the fact that many of these banks had become gambling casinos, or that an allegedly sophisticated economy such as ours could collapse on something as unimaginable (to economists) as the utterly debauched subprime-mortgage market.

Unless students are ceaselessly warned about the misguided assumptions about human behavior in these texts — as I routinely do with a series of written commentaries when I teach ECO 100 — they come away from such a course indoctrinated with the general idea that, with a few exceptions, private markets are self-regulating and efficient, that private enterprise is inherently more efficient than is public enterprise and that government interference in private markets triggers inefficient distortions in private markets. And all this without ever being properly warned that the economist’s use of “efficiency,” far from being scientific, masks instead a rather dubious ethical doctrine that non-economists need not share.

Certainly no one studying these texts would ever imagine that the chief executives of the world’s financial sector would in unison drive their firms over a cliff like lemmings, arguably harming the world economy more than bin Laden and his band of terrorists ever could hope to do.

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And no student would ever suspect that the economics profession would be as unprepared and helpless to deal with that calamity as the profession has shown itself to be.

Let us hope that the medical profession does better, should we ever be hit by a pandemic.

Uwe E. Reinhardt is the James Madison Professor of Political Economy and a professor in the Wilson School. He can be reached at reinhard@princeton.edu.