Month: October 2023

That is the topic of my latest Bloomberg column, here is one excerpt:

Another episode frequently cited as evidence against economists is the Great Recession of 2007-2009. Economists did make some mistakes on that one — but they are not the ones you usually hear about.

When real estate prices started to slow down and then fall, many economists declared there was a real estate bubble. The theory quickly developed that the market crash was due to a real estate bubble bursting, followed by a sharp fall in aggregate demand, followed by a decline in employment and output.

The last part of that explanation is correct. In retrospect, however, it is not clear that the housing prices of 2006-2007 represented a bubble. By today’s metrics those prices appear prescient, if slightly premature. The market was suddenly realizing that a lot of real estate assets were going to be worth much more — and the recent evolution of real estate valuations seems to have confirmed that judgment.

In 2009, however — and following a lot of foreclosures and the emergence of troubled banks — the market was far from ready to accept that the high real estate prices had been justified. The market was too skeptical when it should have been less panicked. A lot of economists got this wrong too, along with many pundits. All of this made the resulting panic worse because the talk was so pessimistic about real estate valuations. Instead, the real problem was that the market had lost faith in a set of high real estate prices that has since been largely validated. Maybe not in Las Vegas and Orlando, but for the nation as a whole, most of all on the coasts.

Economists should have been less quick to judge what is or is not a bubble. The real-estate-bubble explanation appeared to be correct in the short run, but economists should have been more modest about their ability to second-guess the market. The good news is that, with hindsight, we can piece together what happened. Policymakers and market participants made a series of overlapping mistakes related to monetary policy, the shadow banking system and panic about real estate.

There is a good picture of trends in real estate prices at the link, or ungated here.

One feature of my new generative book GOAT: Who is the Greatest Economist of All Time and Why Does It Matter? is that almost all of the major contenders (save Hayek) considered India and wrote about India.  I compare and contrast the different treatments, as this is one test of how good an economist you are: can you make sense of a very new and different environment?

From the text, written by me, here is Milton Friedman on India:

Let’s consider Milton Friedman’s 1955 memo written to the government of India, based upon his first trip there. No one ever has suggested that Friedman was an expert on India, or even an expert on developing nations, a topic that barely came up in his published research (he does discuss Hong Kong and the other Asian tigers in some of his more popular writings).

Friedman starts the memo by noting that a five percent rate of economic growth should be possible for India, reflecting of course his interest in economic progress. That was during a time when Indian growth rates were more in the range of two percent, and the prevailing approach was to refer to “the Hindu rate of growth” in a pessimistic manner. Friedman also suggests that Indian growth will be “catch-up growth,” drawing upon the “technical and scientific knowledge” of the world. Early on in the memo, Friedman also argues for a moderately expansionary monetary policy, much better education and training, and better infrastructure.

So far Friedman is on track.

He presents further specifics when confronting other views. For instance, he argued that the prevailing development literature put too much emphasis on aggregate investment and the capital to output ratio. Friedman worried about the possibility of malinvestment, and that the Indian government would favor “heavy industry…and handicrafts” too much, at the expense of small and medium-size enterprises.  Furthermore, he saw that India should focus more on human capital.

Friedman also insists that the Indian government should not excessively expand the public sector. He criticized “nationalization and detailed state control over economic activity,” hardly a surprising view from Milton Friedman. You might see this point as overlooking the possibility of East Asian-style industrial policy, but Indian government interventions, during this period and afterwards, did turn out relatively badly, and furthermore the East Asian successes were hardly apparent or even existing at the time. So Friedman’s analysis may be imperfect in hindsight, but overall it was defensible. Nonetheless Friedman could have raised the importance of an economy having sectors with increasing returns, learning effects, and higher growth potential, but he did not. Most of all, he was appropriately critical of the efforts of the Indian government to protect inefficient industries, and he attacked licensing requirements and the general stifling of progress through excess regulation and favoritism.

Friedman also called for India to have money supply growth of 4 to 6 percent a year, and he placed special stress on this recommendation. My view is a little different, having observed that South Korea often had high double-digit inflation during its economic miracle, but still this was sound enough advice, even if he overly prioritized the point.

On the tax side, Friedman called for a broader tax base for India with a greater scope for direct income taxation. Excise taxes, in turn, should be cut back. These recommendations also have held up well, and furthermore they belie the view of Friedman as a mindless tax cutter.

In his notes on Indian economic planning, Friedman expressed concern that the distribution of income in India was widening rather than narrowing. He also takes pains to rebut the view that India is culturally or religiously unsuited for economic growth, and he blames poor Indian economic policy for India’s poverty, not the Indian people. To the current reader, this sharp distinction between culture and ideas about policy may sound naïve, especially since Friedman complains about both corruption and the fondness of Indian intellectuals for socialist ideology. Do those two factors truly have nothing to do with the culture of a country or region? In any case Friedman saw the very great potential in India.

He also criticized India’s system of foreign exchange allocation and called for a freeing up of capital markets and exchange rates. Arguably the verdict on this recommendation is still out, as India still controls capital flows and thus its exchange rate to some extent. Some defenders of this policy will argue it is why India has avoided a major financial crisis, namely that international capital flows in and out of the country never have been so volatile. Again, while I tend to agree with Friedman here (there is evidence that foreign capital significantly boosts Indian productivity), I would acknowledge this as a possible point of criticism. At the very least it is not obvious that Friedman was correct in this segment of his recommendations.

Finally, Friedman closes the memo by noting he has focused so much on monetary and financial affairs because that is his area of expertise. He also notes a few times that he is no expert on the economic affairs of India.

In sum, this memo is not perfect…but it basically hits the mark, has held up well, and Milton Friedman passes the test of giving good policy advice into a broadly unfamiliar situation.

You will find the endnotes in the core text.  Of course Smith, Malthus, Mill, and Keynes also dealt with India, with varying degrees of success.  The import of India for the history of political economy remains a wee bit underrated.