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.