Atelier No.0, article 19
Economics: The Politicized
"Science"
Economics: A disinterested profession
or a propaganda parade?
By Edward S.. Herman
Economics has always been
a politicized discipline, its
most prominent members striving to make policy statements as they
propounded their
theoretical doctrines. Adam Smith's Wealth of Nations (1776) was
geared
to demonstrating the negative impact of mercantilist economic policies.
David
Ricardo's Princioles of Political Economy (1817) was merely an
elaboration of a policy aiid propaganda tract he wrote shortly before
entitled
“On the Effects of a High Price of Corn on the Profits of Stock"
(1816).
His "principles" formalized the case for his policy prescription,
that removing tariffs on the import of foodstuffs was essential to
economic
growth.
In his outstanding history of economic thought, The
Meaning and Validity of Economic Theory, Leo Rogin found the Smith
and
Ricardo cases typical and that ma~or theoretical developments have been
in the
service of policy arguments. Rogin showed that the great
economists often
spelled out normative models of an ideal or allegedly "natural"
economy, as with Smith's 'simple system of natural liberty," that
displayed how well the economy would work if certain perversions, like
the
mercantilist restrictions, were removed. Or positive models were
constructed
that described how a particular strategic factor was causing damaging
results
(with N~althus, population growth, encouraged by '~welfare"; with
Ricardo,
the corn laws, that raised money wages, reduced profits, and caused
stagnation;
with Keynes. volatile private investment that called for governmental
offsets).
For Rogin, while economics was scientific in its appeal to facts and
the
requirement of logical consistency, it was inescapably policy based and
policy
driven.
An alternative view was spelled
out in Joseph Schumpeter's History
of Economic Analysis, in which economics was portrayed as a
progressive
science, gradually honing a set of analytical tools and sloughing off
its
ideological baggage. This view contains a germ of truth, and was given
plausibility by the development of mathematical and statistical
techniques of
model building and testing and by the modest early successes of
Keynesian
forecasting of macro-economic behavior. It has diminished in
plausibility,
however, as a result of the failure of forecasting to realize early
optimistic
hopes of improvement and numerous forecasting debacles. Its claims
to be ever
more scientific were also undercut by a resurgence of ideology and
market
accommodation that even mainstream observers have often recognized
and
commented upon.
The Roots of
Politicization
Economics, the supposed
science of the market, has itself
been increasingly integrated into the market system. With the growth in
importance
of macro-stabilization theory and policies from the time of the Great
Depression, governments and business have sought the services of
economists to
help them forecast the effects of policy actions and other
developments. The
growth of government regulation also created a demand for
economists to
advise and testify on regulatory issues. In The Regulatory Game, Bruce
Owen and Ronald Breautigam describe as one important business
strategy the
"coopting of the experts," meaning getting them on the payroll to
advise or neutralizing them by funding their research. AT&T, for
example,
listed corporate payments to 104 social scientists and 215 small
consulting firms, many organized by academics, on its 1978 tax forms.
The corporate community went on the offensive in the 1970s,
trying to transform the intellectual environment to justify
lowering wages and
taxes. Business poured money into a "conservative labyrinth" of think
tanks, funded scores of "free enterprise" chairs, and Sponsored
numerous university lecture series and individual scholars'
research. In the
simile used by Heritage Foundation head Edwin Feulner, the design
was, like
Procter & Gamble's in selling soap, to saturate the intellectual
market
with studies and "expert" opinion supporting the proper policy
conclusions. This was a powerful and conclusion-specific "demand" for
intellectual service.
Competition, financial pressure, the increasing
cost of
computer-based research, and simple self interest pushed many
economists into
the market as private consultants or employees of business, or as
grantees of
the conservative labyrinth's think tanks. The market has worked: the
millions
flowing into the American Enterprise Institute and offered by the Olin
Foundation (among others) found an ample supply of economists willing
to
provide the required intellectual services. The 1992 Nobel Prize winner
in
economics, Gary Becker, spent a lifetime showing that the economic
calculus of
private advantage extends beyond business, even to human behavior in
marital
choice, gambling, commission of crime, drug abuse, etc. Amusingly,
Becker has
never pointed to its highly relevant application to the economics
profession.
The Cold War and continued force
of nationalism have also
helped to politicize economics, with a goodly fraction of the
profession
accepting as givens vast military buildups and market enlarging foreign
policies (including the "pacification" of large segments of the Third
World). Another related factor has been economists' desire to be
"practical,"
which means accepting the institutional status quo and the policy
limits
fixed by those with political powen Many leading economists attached
themselves
to political parties as advisers, the advice then being constrained by
what
political leaders saw as the policy limits. In a world of Increasing
capital
mobility and 'capital market discipline, policy options have
diminished and
the "practical" advice of economists has shriveled with it.
The promise of advancing economic
techniques has also proven
to he a mirage. Techniques rely on models and models depend on
premises, which
may or may not have a close relation to reality. More rapid product
change,
technological innovation, and the globalization of markets have made
the real
world more complex, volatile, and ever changing. Models quickly become
obsolete
and surpnses continually render their premises, structural
relations, and
forecasts off the mark. "Error terms" in forecasting models remain
stubbornly large. Also, models are most workable when they can use
simple
assumptions, like perfect certainty, information, and competition.
Economists
still commonly use such assumptions, partly for reasons of
manageability, but
also because they meet many economists' ideological
preconceptions, and, no
doubt coincidentally, serve well "the market" (i.e., the sponsors of
the Olin Foundation and AEI).
While advances in technique have
not done much for
large-scale economic forecasting, they have helped economists do small
things
better, like modeling and programming ways to take advantage of price
differences
between markets and weighing risk-return differences in complex
environments.
This has helped them create complex financial instruments to serve the
needs of
business and speculators in global capital markets. Such services are
valuable
to banks, broker-age firms, and speculators, and economists rewards in
personal
investment and consulting services have been substantial.
Further complicating the
development of predictive models is
the fact that economists cannot perform replicable experiments,
but instead
must use economic time series as the raw data to test hypotheses, As
William
Brainard and Richard Cooper have observed, "marvelous fits of historic
data can be obtained by models with widely different implications,"
given
the range of choice of variables and flexibility in specification
of time
lags. Unscrupulous practitioners can keep adjusting models and
searching for
amenable data to arrive at preferred conclusions. This has been a
common practice
of Milton Friedman and other members of the Chicago School, as
described
below. It should also be noted that modeling and computer use are
expensive,
which means that well funded economists can use these technical
advances more
lavishly. If their critics are few and poorly funded, they can be
ignored or
overwhelmed by a flood of biased analyses, as Feulner's Proctor &
Gambles
analogy suggested for business-supportive propaganda.
It should be noted that despite
the corruption and
integration into the market of a great many economists, a
substantial number
have remained relatively independent, with critical capacities intact.
There
even emerged a radical fringe large enough to form their own
association (Union
of Radical Political Economists) and other dissident groups and
journals of
institutional and "post-Keynesian" economics. The dominant
institutions keep these economists and schools marginalized and
undervalued, but they exist and may have a
brighter future in a New World Order of growing environmental
problems and
without a plausible and sustaining Soviet Threat.
The Chicago
School
The conservative Chicago School
of economics, with
offshoots at UCLA and the University of Rochester, and
outcroppings elsewhere
in academia and business, steadily increased in influence up to very
recent
years Its monetarist theories partially displaced Keynesian economics in macro
analysis and policy-making in
Western Europe and the U.S. Furthermore, the Chicago School is
concerned not
only with macro-economics, but deals also with labor and
income distribution,
trade, competition and monopoly, and regulatory issues. It is therefore
of
great importance that the Chicago School has been without a peer in the
corrupting influence of ideology and the abuse of traditional
scientific
method.
The Chicago School intellectual
tradition traces back to
Frank Knight and Henry Simon, both professors at the University of
Chicago, who
flourished in the 1920s and 1930s. These men were conservative, but
principled
and iconoclastic. Simon's pamphlet of 1932, "A Positive Pro-gram of
Laissez Faire," actually called for nationalization of monopolies
that
were based on incontrovertible economies of scale, on the grounds of
the evil
of private monopoly and the inefficiency and corruptibility of
regulation of
monopoly.
The post World War II Chicago
School, led by Milton
Friedman and George Stigler, has been more p0litical, rightwing,
and
intellectually opportunistic. On the monopoly issue, for example, in
contrast
with Simon's 1932 position, the post-World War II School's
preoccupation was
to dispute the importance and dam-aging effects of monopoly and to
blame its
existence on government policy. The postwar school is also linked to
U.S. and
IMF policies toward the Third World, in its pioneering service, through
the
"Chicago boys," as advisers to the Pinochet regime of Chile from 1973
onward. This alliance points up the School's notion of "freedom,"
which has little or nothing to do with political or economic
democracy, but is
confined to a special kind of market freedom. As it accepts inequality
of
initial economic position, and the privilege and political influence
built into
corrupt states like Pinochet's (or Reagan's), its economic freedom
is narrow
and class-biased. The Chicago boys have always claimed that economic
freedom is
a necessary condition of political freedom, but their
tolerance of political
non-freedom and state terror in the interest of "economic freedom"
makes their own priorities all to clear.
The Chicago School's attitude
toward labor was displayed in
the Chicago boys complacence over Pinochet's crushing of the
Chilean labor
movement by state terror The School's general tolerance of monopoly on
the
producers side has never been paralleled by softness toward labor
organization
and "labor monopoly." Henry Simon himself became pathologically
fearful
of labor power in his later years, reflected in a famous diatribe
"Reflections
on Syndicalism," and may have contributed to his committing suicide in
1944. Subsequently, the labor specialists of the postwar Chicago
School, most
notably Albert Rees and H. Gregg Lewis, dedicated lifetimes to showing
that
wages were determined by marginal productivity and that labor unions'
pursuit
of higher wages was futile. (Rees, however, did acknowledge the
non-economic
benefits of labor organization in his class lectures.) Chicago School
analyses
stressed the wage-employment tradeoff and the employment costs of wage
increases based on bargaining power (as opposed to those
negotiated individually
and reflecting marginal productivity). They linked collective
bargaining to
inflation, viewing "excessive" wage increases as the pernicious
engine of inflationary spirals. Milton Friedman's concept of a "natural
rate of unemployment" was a valuable t~ in the arsenal of corporate and
political warfare against trade unions-a mystical concept, unprovable,
but
putting the ultimate onus of price level increases on the exercise of
labor
bargaining power.
Milton Friedman. Friedman
was considered an extremist
and something of a nut in the early postwar years. As Friedman has not
changed.
and is now comfortably ensconced at the conservative Hoover
Institution, his
rise to eminence (including receipt of a Nobel prize in economics),
like that
of the Dartmouth Review's Dinesh D'Souza, testifies to a
major change
in the general intellectual-political climate.
Friedman is an ideologue of the
right, whose intellectual
opportunism in pursuit of his political agenda has often been
heavy-handed and
even laughable. The numerous errors and rewritings of history in
Friedman's
large collection of popular writings are spelled out in admirable
detail in
Elton Rayack's Not So Free To Choose. His "minimal
government" ideology has never extended to attacking the
military-industrial complex and imperialist policies; in parallel with
Reaganism
and the demands of the Corporate Community, his assault on government
"pyramid building" was confined to civil functions of government. As
with the other Chicago Boys, totalitarianism in Chile did not upset
Friedman-its triumphs in dismantling the welfare state and
disempowering mass
organizations, even if by the use of torture and murder, made it a
positive
achiever for him.
Friedman's reputation as a
professional economist rests on
his monetarist ideas and historical studies, his analysis of inflation
and the
“natural rate of unemployment," and his theory of the
consumption-income
relationship (the so-called "permanent-income" hypothesis).
These
are modest achievements at best. His monetarist forecasts have proven
to be as
wrong as forecasts can be, and the popularity of monetarism has ebbed
in the
wake of its failures. Friedman's claim that freeing exchange rates
would ease
national balance of payments problems and not destabilize foreign
exchange
markets has also proven to be wildly off the mark. The "natural rate”
of unemployment is an Un-verifiable ideological weapon rather than a
scientific
tool. H's analyses of inflation and the consumption-in come relation
are
ingenious, but neither very original nor anything but partial and
special
cases. They all have the conservative policy implications that
Friedman's
"scientific" writings invariably contain.
Friedman's methodology in
attempting to prove his models have
set a new standard in opportunism, manipulation, and the abuse of
scientific
method. Paul Diesing points out in his valuable article "Hypothesis
Testing and Data Interpretation: The Case of Milton Friedman," that
Friedman "tests" hypotheses by methods that never allow their
refutation. Diesing lists six "tactics" of adjustment employed by
Friedman in connection with testing the permanent income (PI)
hypothesis:
"1. If raw or adjusted data are consistent with PI, he reports them as
confirmation of PI.. .2. If the fit with expectati9ns is
moderate,
he exaggerates the
fit.. .3. If particular data points or groups differ from
the predicted regression, he invents ad hoq explanations for the
divergence..
.4. If a whole set of data disagree with predictions, adjust them
until they
do agree.. .5. If no plausible adjustment suggests itself, reject
the data as
unreliable.. .6. If data adjustment or rejection are not feasible,
express
puzzlement. 'I have not been able to construct any plausible
explanation for
the discrepancy'..."
In a proposed Op Ed column
written in 1990, Elton Rayack,
the author of Not So Free To Choose, pointed out the
interesting fact
that while Friedman's models did well in retrospective fitting to
historic
data, where the Friedman testing methods could be employed, they were
abysmal
in forecasts, where "adjustments" could not be made. Rayack reviewed
11 forecasts of price, interest rate, and output changes made by
Friedman
during the 1980s, as reported in the press. Only one of the 11 was on
the mark,
a not so great batting average of .092; "not enough to earn a plaque in
baseball's Hall of Fame, but evidently quite adequate to qualify
[Friednnan] as
an economic guru." The guru was, however, protected by the
mainstream media;
Rayack's piece was rejected by both the New York Times and Wall
Street Journal. We may conclude that Friedman's truly path
breaking
innovation as an economist has been in the art of what is called
"massaging the data" to arrive at preferred conclusions. This
innovation
has been extended further by other members of the Chicago School.
George Stigler and
and-regulation methodology. A
second major figure of the modern Chicago School, and another Nobel
Prize
winner in economics, was the late George Stigler, a specialist in
economic
theory, industrial organization (monopoly and competition), and
regulation.
His writings on the first two topics tended to show the beauties of
competition
and the relative unimportance and impermanence of monopoly, absent
government
intervention.
Perhaps his greatest mark, however, was made in
developing
and Sponsoring analyses of the inefficiency of government regulation.
In one of
his most famous articles on this subject, "Public Regulation of the
Securities
Markets," published in the University of Chicago School of
Business's Journal
of Business in April 1964, Stigler used an ingenious model of
"before
and after" effects of regulation to demonstrate that the
Securities and
Exchange Commission's (SEC's) requirement of full disclosure in
new securities
issues was of no value. His method was to compile a sample of new
security
issues of certain size and other properties for several years in the
1920s and
a sample in the late 1930s issued under SEC regulation, and computing
what
happened to their prices in the years following issuance. If the SEC
was
effective, and securities buyers were better informed, one would
expect the
post-offering prices to be closer to the initial prices and the
dispersion of
price ratios to be less in the post-SEC period. Stigler 'claimed that
his test
showed no improvement in the post-SEC period.
Professor Irwin Friend and this
writer did a collaborative
analysis of Stigler's study, including a sample review of his original
data as
well as an examination of his reasoning. In our review of his sample
data, we
uncovered 25 errors in his reporting of data, 24 of which were in the
direction
supporting the hypothesis that Stigler was trying to prove, and
sufficiently important
to affect his significance tests, even Though based on only a partial
review of
his data sample. With the corrections, the performance under
regulation, as
measured by average price ratios, was indisputably superior to the
unregulated
performance of the 1920s. In Stigler's own analysis, the dispersion of
price
ratios was also substantially lower in the post-SEC period, but Stigler
"reinterpreted" the test, retrospectively claiming that the lower
dispersion meant that regulation had reduced the willingness of risky
firms to
enter the market (this is Diesing's item 3 in the list given above of
Friedman's methods of "testing'). Ironically, Stigler had written an
earlier article on “The Economics of Information," whose main
theme was
that increased information reduces price dispersion, which he implied
was
beneficial and desirable.
Our showing that Stigler had
doctored the data in a very
serious way, and misread his own results, was published in the Journal
of
Business in October 1964, with an appendix listing the 25 errors
and
showing in a table the large effect on the test results Stigler did not
challenge the criticisms in substance, but proposed using different
data
(Friedman's method 4, in the Diesing list above). This exchange
occurred in
the very year Stigler was made president of the American Economic
Association,
but had no noticeable effect on his reputation. In subsequent years,
Stigler's
Chicago School associates continued to cite his original article as
proving the
ineffectiveness of SEC regulation and full disclosure, which is
comparable to
a physical anthropologist in the 1980s continuing to cite the
Pilttown Man as
a valid member of the evolutionary ladder. But if Piltowns are a
common-place
in the "science" and one operates on principles of a truth above
fact, it is all comprehensible.
Stigler and many of his followers
continued their modeling
of regulation and its effects by the same or related methods. The most
important Stigler follower in this area was Sam Peltzman, who wrote a
Ph.D. thesis
under Stigler's direction in 1965, which purported to show
that the
introduction of federal regulation of bank entry in 1935 caused the
entry of
new banks to drop by 40-50 percent. Peltzman's method was to
specify
several factors that might influence entry rates, most importantly bank
profit
rates, and then explain any decline in entry after 1935 not
attributable to the
chosen factors by a "residual" called "government
regulation." Although branch banking was growing rapidly in this
period,
Peltzman never included new branches in his model. Among the many other
intellectual crimes committed by Peltzman, the model had the
interesting
characteristic that the poorer the explanatory variables, the
better the
result from the Chicago School standpoint (i.e., the larger the effect
of the
residual "government control").
This terrible study was cited as
authoritative in the years
that followed, and was never jebutted, in part because the
formulation and
testing of a rival model requiring data collection back into the 1 920s
would
have been arduous. Peltzman followed up this success with studies of
drug and
auto safety regulation, each demonstrating by means of the new Chicago
School
methodology-using dubious explanatory variables, and leaving
government
regulation as the residual-that government regulation was ineffective.
Several
analysts went to the trouble of showing that Peltzman’s further studies
were
fraudulent, but these studies were still cited as authoritative
demonstrations
that the case for drug and auto safety regulation was dubious. (A good
summary
of Peltnnan and his critics on drugs and auto safety is given in Mark
Green and
Norman Waitzman, Business War on the Law.)
Mergers in the Best of All
Possible Worlds. The
Chicago School was also in the forefront of providing intellectual
rationales
for the merger and takeover boom of the 1980s. Ironically, Stigler had
castigated the turn-of-the-century economists for their
apologetics for the
first great merger movement, defended then as based on "efficiency"
considerations: "One must regretfully record," said Stigler,
"that in this period Ida Tarbell and Henry Demarest Lloyd did more
than
the American Economic Association to foster 4he policy of competition."
But Stigler's pwn progeny greatly outdid the earlier apologists.
An amusing feature of the 1980s
apologias is that the new
wave of mergers, and frequent follow-up "restructuring" by
divestment of company divisions, was explained in part as a consequence
of the
excesses of the conglomerate merger movement of the 1960s, when firms
like ITT,
Ling-Temco-Vought, Gulf & Western, and Litton Industries had
gobbled up
numerous unrelated firms. But at that time, Chicago School
economists
explained those mergers as based on efficiency
considerations. So
efficiency is always the basis of merger movements, even those cleaning
up the
debris of the last one, where we depend on short memories of
our last round
of apologetics.
Chicago School analyses of the
1980s merger boom rested on
the "agency model," the theory of takeovers as an efficient market
instrument, and the use (and abuse) of stock price data to measure
efficiency
effects. In the agency model, managers, while supposedly
agents of
stockholders (owners), are often able to serve their own interests
rather than
those of the owners, because of the large number of owners, proxy
voting, and
managerial influence over choice of directors. Fortunately, the market
has
evolved a corrective take-over mechanism, allowing outsiders to bid for
control
of poorly managed companies over the heads of the managers. (As these
were
poorly run, their stock prices would be low.) Michael Milken was thus a
servant
of the people in providing the financing to those who wanted to bid for
these
undervalued resources in order to put them to better use.
For the Chicago School, if this
takeover mechanism could serve
to enhance efficiency, then it is assumed that it does. But why ignore
the
possibility that the buyers have other motives than efficiency
enhancement?
Perhaps they want to get bigger in an empire-building process or to
loot the
acquired firm (or its workers and their pension funds). Maybe the
market is
working poorly and undervaluing the assets of target firms. Maybe the
bankers
and lawyers are encouraging uneconomic mergers to capitalize on buoyant
and
speculative stock market conditions and to pull down large fees. If
U.S. Steel
Corporation paid twice the prior market price for Marathon Oil in 1981,
while
admitting that it knew nothing about managing an oil company, and
raising the
salaries of the previous Marathon management to keep them on the job,
it is
obvious that the Chicago School "more efficient management" model
was completely irrelevant to explaining that important merger
The Chicago School has also
pioneered in the use of stock
price data to measure the effects of takeovers. The argument is that if
mergers
enhance efficiency, profits will be enlarged and this will be reflected
in
higher stock prices. But this measure is indirect, ignores
non-profit effects
like damage to workers and communities, and could be influenced by
unjustified
investor optimism or investor belief that the merger will increase
market
power, not efficiency. The measure is in the Friedman "natural
rate of
unemployment" mold not only in its obscure relation to that which is
supposedly being measured, but in its amenability to manipulation. Do
we
measure the stock price effect before the merger, at merger time, or
later?
From what base? The Chicago School has regularly focused on price
effects
before, at the moment of, or immediately after a merger transaction,
which
tells us about what investors expect, not about efficiency effects.
A careful study by Ellen
Magenheim and Dennis Mueller
demonstrated that price study results vary widely depending on timing
choices,
and that for many recent mergers the longer the time lag the poorer the
results. In a Chicago School classic on merger effects by Michael
Jensen and
Richard Ruback, which finds mergers pro-efficiency based on stock price
movements before and at the time of mergers, it is eventually conceded
that
several years after the merger the results don't look so
good¾hat there are
"systematic reductions in the stock price of the bidding firms
following
the event [merger]." The authors don't incorporate such findings
into
their conclusions, however; they say it is "unsettling because
they are
inconsistent with market efficiency and suggest that changes in
stock price
during takeovers overestimate the future efficiency gains from
mergers."
In other words, the empirical evidence not conforming to the
preconceived
hypothesis, the authors resort to the Friedman "test" method number
6: "If data adjustment or rejection are not feasible, express
puzzlement," but don't let the incompatible facts interfere with
proper
conclusions.
Nobel Prize
Profession
The Chicago School has
been an extremely prominent recipient
of Nobel Prize awards in economics, increasingly so as its proportion
of total
awards has increased its leverage in the award process. Friedman,
Stigler,
Merton Miller, Ronald Coase, Theodore Schultz, and Gary Becker have
joined
Friedrich von Hayek in a solid, ideological free market phalanx. None
of these
had better qualifications than Joan Robinson and Nicholas Kaldor,
economists
of the left who worked with great distinction within the
mainstream traditions
of economics. Their neglect in favor of Chicago School mediocrities
like Miller
and Becker, and ideologues like Friedman and Von Hayek, testify to a
politicization of the Nobel Prize that reflects well the corruption and
politicization of the profession as a whole.
In 1992 the Union of Concerned
Scientists prepared a World
Scientists Warning on global environmental problems calling for action
by the
world's governments. A majority of living Nobel laureates signed
the
statement, including a number of economists. No member of the Chicago
School
signed. One of the great accomplishments of 1991 Chicago School Nobel
prize
winner, Ronald Coase, which helped him win the award, was a 1960
article on
'The Problem of Social Costs," the gist of which was that the market
could
cope even with externalities. In fact, there would appear to be no
problem the
market cannot solve, at least for those wedded to the proposition in
advance
and willing to make a few little assumptions here and a few little
adjustments
in the data there.