How will the financial crisis affect the economics profession?

by on November 3, 2008 at 7:53 am in Economics | Permalink

Paul, a loyal MR reader, asks:

What will be the impacts of the current situation for economics and economists.  It seems clear that we have screwed up.  We don’t even have the excuse that we understood what was going on but no one listened to us; economists have been in powerful positions for a long time, and it is generally agreed that Ben Bernanke is both a powerful and a well respected economist.  Will demand for economics courses fall? (It seems obvious that demand for finance courses and so for finance professors will decline.)  I am not teaching this semester, but I would like to know from those who are:  What do you tell students when they ask what economics had to say about the current mess?  It seems to me that this situation will have profound implications for economics as a scientific and also as an academic discipline and I would like to see a discussion.  Your blog is probably an ideal place for such a discussion.

I believe that demand for economics classes will rise, as it often does in economically troubled times.  Some of this will be "shaman demand" rather than "knowledge demand."  The consulting incomes of finance economists will fall and fewer talented people will go into finance.  Speaking fees will fall since fewer economists will give talks at hedge funds.  The relative status of macroeconomists will rise and the relative status of microeconomists will fall.  Economists will gain in fame and lose in income.  What do you think? 

1 CK November 3, 2008 at 8:12 am

Dating from the publication of “Freakonomics,” economics has had a star turn, “15 minutes of fame,” if you will. Nowadays, any talk of money or assets or securities leaves people with a bad taste in their mouths. Economists, with their images as eminently logical, semi-Spock types who cut to the core of problems, are out of favor. Now it seems like sophistry and false wisdom. The pendulum probably swung to far in favor of economists before, now it’s going to go too far in the other direction.

In other words, the bursting of the world economic bubble will NOT lead to the inflation of a bubble in academic economics.

2 J.K. November 3, 2008 at 8:33 am

“The consulting incomes of finance economists
will fall and fewer talented people will
go into finance. Speaking fees will fall
since fewer economists will give talks at hedge funds. ”

Hmmm… Does this statement violate the fundamental rule of Economics — supply/demand/price?

3 Leonardo Monasterio November 3, 2008 at 8:53 am

Tyler & Alex,

How about the # of page hits of Marginal Revolution during the crisis?

4 odograph November 3, 2008 at 9:05 am

I’m probably representative of a trend. A couple years ago I was reading one or two econ blogs in my mix (including this one). Now they are my top-ten. A huge housing/debt question turned into first a housing and then a credit crisis. Those bumped my energy and environment focus to the back-burner. I’ll probably stick with you (still hoping for Alex’s mea culpa on debt 😉 until that becomes … boring.

5 Andrew Lay November 3, 2008 at 9:09 am

I’m an A-level (16-18 year old) teacher of Economics in the UK, and this year’s intake (which started September) was up by over 20% on last year (actually more like a third, but I’ve shaved some off due to various other factors). Not convinced its entirely crisis-driven, but it seems to be at least some influence, anecdotally.
I’ll get back to you for 2009 intake…

6 Andrew Lay November 3, 2008 at 9:13 am

Should have also added that the numbers of my students who wish to study economics at university is increasing, though harder to get a meaningful number on that as the numbers are small. The importance of knowing/understanding economics seems to be the prime cause.

7 Barkley Rosser November 3, 2008 at 9:28 am

I think the comments look pretty reasonable, although I
do not know about speaking fees for economists at finance
groups. Tyler probably knows that better. However, I
know that I have been swamped with requests to speak to
all kinds of local civic and other groups, badly swamped.
I do happen to be one of those who long said we were
having an unsustainable housing bubble, and that its decline
would cause all kinds of problems. Of course, I also happen
to be the first economist ever to provide a mathematical model
of the most widely observed type of bubble, those that decline
for awhile after their peak and then crash, which is what
happened in the credit/derivatives market (peak, Aug. 2007,
crash, Sept. 17).

Regarding micro and macro, most standard micro assumes rational
agent model, which does not look so hot at the moment. The current
dominant macro model is the DSGE model that assumes a ratex micro
foundation. I have long argued that this is silly, and I see macro
models of various sorts that look in a different direction to be
gaining some increased interest in the near future.

8 spencer November 3, 2008 at 9:55 am

Speaking as an economist/portfolio strategist with some 20 years experience selling my services to portfolio managers, they do not want to hear the truth. I have lost more clients over the years for being right than from being wrong.

If a manager loses the clients money doing what everyone else is doing they probably will keep the client. But if they go out on a limb and lose money they are almost certain to lose their clients. Frequently, just going out on a limb is enough to lose the client even if you are right.

There is tremendous pressure for investment managers, strategists and/or business economists to stick with the consensus even when the consensus is wrong.

9 Amicus November 3, 2008 at 10:47 am

Thesis:

All we can say for certain is that lawyers will “fare” much better than economists (pun intended).

The part where economists … “get blamed” (apart from Greenspan), is just coming up, as part of the “response”, so stay tuned… and ask again in 2 years.

10 dale November 3, 2008 at 11:33 am

Interest in economics will certainly increase (I, too, have been hitting the blogs lately although I never had much interest before). However, we have plenty of micro theories to explain the poor incentives in a situation where the more we mess up, the greater the demand for our talents.

More critically, this should be a time for introspection in the profession. The fact that more people enroll in our courses does not mean we have been successful. The fact that we have been so much in the dark – here I am not underestimating the intelligence of the profession and the contributors to discussions such as these, but I am referring to the complete disagreements on facts without positions converging to some measure of the “truth” – should make us ask some tough questions. Have all the theoretical advances been worth it? Macro, in particular, has become intensely mathematical, perhaps at the expense of real understanding. Keynes now seems a lot closer to understanding the truth of macro cycles than any of these more elegant theories since that time. Perhaps we are trying to answer the wrong questions. We have focused on equilibrium rather than growth; rational behavior rather than actual behavior; technique rather than knowledge.

It is not that all of these efforts have been wrong or wasted. But, the reward structure in academia certainly does not lend itself to understanding anything. It is easier to get published by being overly narrow and overly rigorous and eschewing any real use of psychology, sociology, or ecology. Are we so sure that we have been on the right course?

11 MM November 3, 2008 at 11:41 am

It’s rarely been my experience that people _outside_ the highest levels of business and government actually listen to what economists have to say. They may occupy powerful positions, but in the mainstream they’re nobodies who nobody has ever really placed a lot of stock in – unless they adopt a partisan position, such as Krugman, in which case other partisans will hold them up simply for their academic credentials. But the average man in the street is rarely exposed to real “economics,” and almost INVARIABLY when I do see economic issues discussed, for example, on a cable news program, the talking heads invited to yack with the talking heads is NOT an economist. He’s some sort of business graduate, or a journalist who has ‘covered’ economics, but he is very, very rarely an actual economist, of any sort. This may be a little tangential to the question, but it’s a major pet peeve that I’ve held for a few decades now.

More specifically to the original question, I don’t know why this should discredit economics as field any more than holes in other ‘social’ sciences. And it’s not like there haven’t been many economists who can make the case that they did see this coming (whether they really did, or whether the hows and whys were accurate, is a separate issue), but that no one listened to them. “No one listens” and “economist” are, again in my experience, frequently go hand in hand.

12 Elfin November 3, 2008 at 12:52 pm

I think the bigest hit to economics is our relevance because we are so naive. Most economists were saying that our consumption growth was outstripping our income growth and that this had to end sometime, perhaps badly. I was hoping for a more balanced adjustment with the dollar declining and our exports growing, which was certainly correct from about mid-2006 through mid-2008.

I’m in a business similar to Spencer’s and deal with lots of portfolio managers. The conventional wisdom was that the sophisticated bankers and hedge fund managers had it all under control. It wasn’t easy to question the CW without being called an alarmist. You had to have the data and they weren’t readily revealing it to you (or the regulators for that matter).

How the finance sector is willing to rig the game in their favor and payoff anyone in the way is our biggest miss. Bernanke and Greenspan look foolish in accepting the CW, but so too do politicians like Barney Frank and Chris Dodd as they defended the GSEs. In their defense, there were plausible scenarios that said that the problems were “contained” and the pressure accept was enormous–not just from Wall Street but from the public, too.

We’ve clearly experienced the worst case–higher energy prices, just as fragile financial systems in Europe, and emerging markets that are even more messed up as we are (i.e. no decoupling). My guess is barring some disastrous policy proposals in the next few months, we’ll get through this better than Europe and China.

As far as economic theory goes, I see nothing that has been discredited. We need to improve our understanding of behavioral economics, compensation incentives, and how to regulate finance better, but what’s new? We’ve always had problems trying to get this right, as financial innovation outstrips the regulators ability to comprehend. On the big picture, standard theory said that consumption bubbles had to end at some point and that they are usually painful.

13 dearieme November 3, 2008 at 2:23 pm

“economics as a scientific … discipline”: if it were, there would be no need to make the claim.

14 Sammy November 3, 2008 at 2:38 pm

Possibly of interest, from page 1 of WSJ’s dead tree edition today:

“Behind AIG’s Fall, Risk Models Failed to Pass Real-World Test†

…With regard to this comment somewhere above, I ask all of you to give Nassim Taleb’s THE BLACK SWAN a fair examination. It seems to have a plethora of relevance to this post and what has happened and is happening in general. I’m an undergraduate economics major and currently have lost faith in economists in general (for their hubris as I see it) and in economics to predict anything that matters. I have no clue what I’m going to do once I graduate, but graduate studies is out of the question.

15 MM November 3, 2008 at 3:16 pm

“I’m an undergraduate economics major and currently have lost faith in economists in general (for their hubris as I see it) and in economics to predict anything that matters.”

I find that to be an absolutely mystifying answer. How far in to your economics studies are you that this has convinced you that the field is not worth pursuing?

Should we do away with the econ Nobel as well? Shutter the departments across the country? The field is so broad, so vast, and so varied that I find it absolutely mind-boggling and perhaps telling of our time and the generalized ignorance that pervades our country on the broader subject that it could be “dismissed” in this way.

16 PJ November 3, 2008 at 3:32 pm

In Robert Lucas’s interview with Russell Roberts on econtalk.org he said that the importance of financial effects for explaining business cycles was overrated.

Oops!

But, he also said that just when he thinks he understands macro he finds out later that he didn’t understand a damn thing!

17 GC November 3, 2008 at 10:21 pm

I think economics is not necessarily indicted by the recent financial crisis. It had less to do with failure of models than a failure to regulate smartly and to align incentives correctly, such as with respect to moral hazard.

18 p blank November 4, 2008 at 10:57 am

Econ MA – Industry: Transportation – If you think Las Vegans will spend anything less than $4.5 billion next year on personal travel, then I’m in trouble – if not, I’m fine (but, that’s just me)

19 Jeff November 4, 2008 at 4:57 pm

I’ll let you in on a secret. Most economists, like most other people, don’t actually believe what economic reasoning tells them. You can find economists making excuses for trade restrictions and minimum wages. You can find economists who think that the “credit crunch” is a serious problem, despite the fact that the only real data we have shows that lending to nonfinancial firms continues to grow. You can find economists who are well-acquainted with public choice theories who nonetheless do not oppose national health insurance, the bailout, and other big government programs.

If you understand economics and believe what it tells you, you must be a libertarian. There is no way around it. But most people would rather be popular than correct.

20 Sammy November 5, 2008 at 3:02 pm
21 Craig November 5, 2008 at 11:27 pm

Jeff made a good point that emotions still rule the opinions of economists despite their training. But I would argue they still realize those emotional opinions are wrong at some level.

As for the demand for economics: I think perhaps the demanders are more forgiving than we in the profession are (of ourselves), and often just as curious. So despite our defensiveness sometimes that we don’t “have the answers” people realize the complexity and are willing to learn at least what we DO know. I think the reputation of economics is strong enough that people think we have things to offer. So, as long as we are realistic and humble, we will have an audience and people will take economics. In the world these days, the complexity is such that people know that nobody knows everything. That’s not the expectation, the expectation is that something can be learned from economics. Enrollment will increase.

22 sammy November 6, 2008 at 2:13 pm

Thank you.

23 Mammon November 30, 2008 at 1:01 am

Is it the “economists” or the “politicians” who are now advocating hair of the dog policies as the cure for ten years of loose monetary and fiscal folly?

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