Kaletsky on form in todays Times

 

can resist it no longer. Tuesday’s announcement of the biggest jump on record in US consumer confidence was the last straw

	

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I can resist it no longer. Tuesday’s announcement of the biggest jump on record in US consumer confidence was the last straw. So let me say what I’ve had on my mind for nearly two years: if you want to fix a pipe, you call a plumber. If you want to know what’s happening to the economy, you should ask an economist, instead of the mob of rent-a-quote businessmen, stockbrokers and politicians who dominate Britain’s economic debate. 



For most of last year, I bored readers rigid with repetitive articles explaining why a recession was almost impossible, at least in Britain and the US. When I stuck to this prediction after the terrorist attacks of September 11, my mailbox overflowed with derisive and even abusive e-mails from businessmen and stock market investors. I was accused of being a “typical economist”, living complacently in an ivory tower, playing with meaningless statistics which ignored the “real world” of business and finance. I was partly at fault. I wasn’t complacent enough. I should have paid even less attention to industrialists and financiers, who kept insisting that the economy couldn’t possibly recover after the successive blows from the dot-com meltdown, the collapse of capital spending and the layoffs that followed September 11. 



After all, said the captains of industry, unemployment is soaring and corporate investment is collapsing. So how could the economy possibly recover? It did not seem to occur to them that, if this argument were true, recessions would last forever. Economists know, of course, that falling interest rates and rising public deficits can almost always counteract the depressing effects of unemployment. It is only when central banks and governments refuse to pull the monetary and fiscal levers, as they have done recently in Europe and Japan, that a shock such as a stock market collapse or a terrorist attack is likely to produce a full-scale recession. 



Since the inflationary nightmares and ideological shifts of the mid-1970s, economists have been too diffident to tell “hard-headed, practical” businessmen and politicians that they were talking nonsense. But as a result of the successful management of the British and American economies in the past few years, I suspect economics may start to regain its prestige. 



I know all the jokes about economists: If you laid ten economists end to end, they would never reach a conclusion. If you ask two economists any question, you will get four answers. If you cross an economist with a Mafia Godfather, you get an offer you can’t understand. 



But the fact is economists have made an immense contribution to human welfare, especially in the past 50 years. The world has avoided repeating the tragedies of the Great Depression and the subsequent world war, largely because of Keynes’s work on demand management. After 5,000 years of servitude to gold and silver, mankind has learnt to manage paper money without losing control of inflation, thanks partly to Milton Friedman. An orderly global system of free trade has finally been established because nations everywhere have started to understand the theories of David Ricardo about comparative advantage. Above all, humanity is starting to enjoy the fruits of boundless economic creativity, because the world has understood how to unleash the power of Adam Smith’s profit motive, without succumbing to the political instability and social injustice of the untrammelled capitalist system described by Karl Marx. 



Of course economists do not get everything right. In fact, their numerical predictions are almost invariably wrong. But this is also true of meteorologists forecasting weather patterns, physicists trying to understand global warming, historians studying the Roman empire or geologists prospecting for oil. The fact that economics, like any other study of extremely complex systems, can only offer broad-brush guidance, does not mean that the insight of economists can be replaced by guesswork and gut feelings. 



The success of the Federal Reserve Board and the Bank of England in protecting the longest business expansion in human history — in contrast to the stagnation in Europe and Japan, where all the textbook principles of counter-cyclical demand management have been stood on their head — clearly represents the economists’ finest hour. But, other experiences have recently added to my conviction that economics is enjoying a renaissance. 



My first epiphany came last week, when I had the pleasure of judging the Bank of England’s annual schools competition, co-sponsored by The Times. In the final, teams of A-level economics students representing schools ranging from Eton to Blackpool Sixth Form College (the eventual winners), competed to try to second-guess the monthly interest rate decisions made by the Bank’s Monetary Policy Committee. The understanding displayed by these school kids put most industrialist and City analysts to shame. And these students showed a rich appreciation of the role played by monetary policy in defending the US and British economies from the stock market’s “tech wreck” and the terrorist outrage of September 11. 



But the renaissance of economics is not confined to monetary policy and demand management. At the annual conference of the Royal Economic Society (RES), held this week at Warwick University, economists of all kinds displayed a re-engagement with the real world and a practical creativity that seemed forgotten amid the ideological arguments and the fruitless search for mathematical purity of the 1980s. 



I must declare an interest. I am a member of the RES council, but I have for many years been highly sceptical of academic economics. Yet the spirit of academic economics seems to have changed. 



The programme of the RES conference spoke for itself. Sections on work and education, firms and industries and financial markets jostled with empirical assessments of monetary policy, exchange rates and forecasts. In each of these sessions, economists addressed concrete issues and offered clear, informative and often counter-intuitive answers. 



Social mobility diminished, instead of increasing, in Margaret Thatcher’s on-your-bike Britain of the 1980s. Pension fund managers with good track-records did consistently beat the stock market. The Bank of England consistently overestimated inflationary dangers and therefore kept interest rates too high by a small but significant margin. Direct democracy, where voters express choices through referendums, increase the quality of public goods. Frequent flyer programmes damage consumers’ interests. Regulators tend to be more lenient towards utilities the more they are influenced by politicians. These were just a few of the conclusions presented at the RES conference, backed by logical argument and empirical research. Of course all these conclusions can be disputed, as can the findings of any other academic discipline dealing with complex systems. But economics seems to be rediscovering its raison d’être, as a handmaiden of sound public policy and a practical tool for understanding social behaviour. 



If you are still unconvinced about its practical value, you should have a glance at a paper called “The Biggest Auction Ever” in this month’s Economic Journal. Ken Binmore of UCL and Paul Klemperer of Oxford recount the story of the Third Generation (3G) mobile phone auctions, which secured a windfall of £25 billion for the public purse — more than enough to cover the entire cost of rebuilding the nation’s rail network. As this paper shows, the careful application of economic principles to the design of this auction was largely responsible for its success. 



This paper also convincingly refutes the widely held view that the taxpayer’s gain from this auction will result in a consumer loss. The only losers will be stock market investors who were foolish enough to buy phone shares at the peak of the technology bubble — plus the financial analysts who goaded on corporate executives to bid vast sums for the rights to an untested technology of questionable value. Telephone users are unlikely to suffer, for as every economist knows, prices and investment in any market depend on the intensity of competition and on future returns from new technology. 



Like the recession that never happened, the 3G auction was a triumph of good economics over the prejudices of “practical” businessmen and financiers. May there be many more.