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Paul Romer’s second critique of economics

Summary:
I like Paul Romer, and found some merit in his earlier critique of the “mathiness” of modern economics. But I was disappointed with his recent critique of economics (part of a book review), which appeared in Foreign Policy. David Henderson has identified one problem—Romer’s desire to expel economists who he sees as biased. (Romer’s comments on this issue are a bit hard to interpret, but that’s hardly much of a defense.) Here I’d like to focus on the core of his piece, what he sees as being wrong with modern economics. The essay begins with a discussion of the recent fall in life expectancy in the US. Then Romer gets to the core of his argument, that economists became increasingly involved in policy-making in the latter part of the 20th century (a defensible claim),

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I like Paul Romer, and found some merit in his earlier critique of the “mathiness” of modern economics. But I was disappointed with his recent critique of economics (part of a book review), which appeared in Foreign Policy.

David Henderson has identified one problem—Romer’s desire to expel economists who he sees as biased. (Romer’s comments on this issue are a bit hard to interpret, but that’s hardly much of a defense.) Here I’d like to focus on the core of his piece, what he sees as being wrong with modern economics.

The essay begins with a discussion of the recent fall in life expectancy in the US. Then Romer gets to the core of his argument, that economists became increasingly involved in policy-making in the latter part of the 20th century (a defensible claim), and that they often promoted a policy of deregulation (also a defensible claim.) This deregulation is blamed for all sorts of ills, but no persuasive evidence is provided in the essay.

Next there’s a weird digression on the Brexit fight. Romer points out (correctly) that the UK public stood up to the so-called “experts” in the economics profession and opted to leave the EU. He seems to admire their spunk. But what does Romer actually think about Brexit, which was sold as a way of getting out from under EU regulations? We don’t know.  Obviously if the experts supported staying in the EU, this example doesn’t fit neatly into the hypothesis that experts have been forcing deregulation on the public.  So why did Romer add this paragraph?

Next there is an anecdote from 1970:

In 1970, William McChesney Martin, Jr., then chair of the Federal Reserve’s Board of Governors, could still explain to a visitor that although economists asked good questions, they worked from the basement because “they don’t know their own limitations, and they have a far greater sense of confidence in their analyses than I have found to be warranted.”

During the 1960s and 1970s, while economists were relegated to the basement, the Fed was making a mess of our monetary system, producing the Great Inflation and a highly unstable business cycle.  Economists were later brought in to clean up the mess. Since 1983, there have been 3 recessions and inflation has stayed low and stable.  There were 9 recessions from the beginning of 1945 to 1982, and inflation was wildly unstable.  So what does Romer’s example prove?

Then Romer devotes 6 entire paragraphs (in a short essay that is only 33 paragraphs long) to auto safety regulation, particularly the use of the “value of life” concept in determining which safety improvements to require.  There’s a rather meandering discussion of a safety regulation that would have prevented Jane Mansfield from being decapitated in an auto accident, but in the end no firm conclusions are reached, other than this:

In Appelbaum’s account, this arrangement seems to have worked out surprisingly well in setting standards for automobile safety. Economists in the mold of Schelling and Viscusi seem to have channeled as best they could the moral beliefs of the median voter. When regulators first rejected Mansfield bars, in 1974, they put the value of a life at $200,000, but in response to pressure from voters demanding fewer traffic fatalities, economists and regulators gradually adjusted that number upward. Eventually, as the estimated value of the human lives lost to car accidents began to exceed the cost of installing Mansfield bars, regulators made the bars mandatory, and voters got the outcome they wanted.

We are now almost half way through a short essay that the reader is led to imagine will tell us how a blind faith in deregulation has shortened our lives, and the first major example, taking up nearly 20% of the entire essay, is an example of regulations working pretty much as they should, albeit perhaps with a slight delay.  Finally he gets to the meat of the argument:

The trouble arose when the stakes were higher—when the potential gains or losses extended into the tens of billions or hundreds of billions of dollars, as they do in decisions about regulating the financial sector, preventing dominant firms from stifling competition, or stopping a pharmaceutical firm from getting people addicted to painkillers. In such circumstances, it is all too easy for a firm that has a lot riding on the outcome to arrange for a pliant pretend economist to assume the role of the philosopher-king—someone willing to protect the firm’s reckless behavior from government interference and to do so with a veneer of objectivity and scientific expertise.

The rest of the essay does indeed focus on arguments claiming that deregulation in pharmaceuticals and finance led to big problems.  Unfortunately, the arguments are vague and unpersuasive.  He begins by blaming drug deregulation for the soaring rate of opioid deaths, which recently reduced life expectancy in the US.  But how was this caused by “deregulation”?  The worst of the opioid crisis occurred after the government tightened regulations on drugs like Oxycontin, and people switched to (highly regulated!) alternatives like heroin and fentanyl.  It was actually regulations forcing these drugs into the underground economy where there are no quality controls that prevented people from getting safe doses of those alternatives, and overdose deaths soared as a result.

But let’s say I’m wrong, and that the approval of Oxycontin was the core mistake here.  What does that decision have to do with “deregulation”?  After all the FDA does regulate drugs like Oxycontin.  Here’s Romer:

Imagine making the following proposal in the 1950s: Give for-profit firms the freedom to develop highly addictive painkillers and to promote them via sophisticated, aggressive, and very effective marketing campaigns targeted at doctors. Had one made this pitch to the bankers, the lawyers, and the hog farmer on the Board of Governors of the Federal Reserve back then, they would have rejected it outright. If pressed to justify their decision, they surely would not have been able to offer a cost-benefit analysis to back up their reasoning, nor would they have felt any need to. To know that it is morally wrong to let a company make a profit by killing people would have been enough.

Unless I’m missing the point, this seems like a very weak argument.  First, in the 1950s there weren’t even restrictions on cigarette use.  People were more tolerant of risk back then.  Second, the whole argument for “regulation” is that average people can’t make intelligent decisions on what drugs to buy, and thus we need experts at the FDA to determine what’s appropriate.  And yet Romer contemplates asking the Board of Governors at the Fed what they think of Oxycontin.  What does this example show?  Why would the Fed regulate drugs?  Maybe Romer merely meant that if you ask average people with no expertise in health care, like Fed officials, they’d see the obvious foolishness of approving Oxycontin.  But then why not use average people in the example, why Fed officials?  I don’t get it.

I don’t think that it’s even true that Oxycontin was obviously a foolish drug to approve. If it was, why did the FDA approve it?  More importantly, if Romer’s correct then he’s actually making an argument for getting rid of the FDA and letting average people decide what is safe.  Maybe we could have a referendum on whether to approve Oxycontin, instead of having the decision made by the “experts”, by the “philosopher kings” at the FDA.  Romer is engaging in a sort of populism here, which doesn’t seem entirely sincere to me.  Regulation of drugs is inherently paternalistic, it’s elitist. But that’s what Romer wants, isn’t it?

He also doesn’t explain why if Oxycontin should never have been approved, the FDA did not see what was (he thinks) obvious to ordinary people.  And what exactly is the argument here—that painkillers should not be sold?  What about cancer victims in extreme pain?  Or is the argument that it should not have been widely prescribed?  But that’s a failing of the medical profession, not economists promoting “deregulation”. (I use scare quotes, because the health care industry has most certainly not been deregulated.)  We could punish doctors who overprescribe Oxycontin, but that regulation has produced horrible side effects.  So what’s the plan?

To summarize, it seems weird to blame “deregulation” for problems in a highly regulated industry, which might have been caused by regulators who often refuse to approve new drugs making a bad choice in a particular case (Romer’s view) and might have been caused by the regulations themselves, which pushed people into even more dangerous drugs (my view.)

The DEA is one of the most evil organizations in American history, presiding over a war on drugs that has put 400,000 Americans in prison and resulted in countless deaths. Foreign countries like Mexico have been destabilized, and murder rates have skyrocketed.  The DEA is also a major abuser of the human rights of American citizens, stealing their money and breaking into their homes and shooting innocent people. But Romer discusses the DEA as if it’s a force for good:

And when the Drug Enforcement Administration finally tried to limit the distribution of these painkillers, pharmaceutical companies launched a massive lobbying effort in favor of a bill in Congress that would strip the DEA of the power to freeze suspicious narcotics shipments by drug companies. It is a safe bet that these lobbyists made their arguments to Congress in the language of growth, incentives, and the danger of innovation-killing regulations. The push succeeded, and the DEA lost one of its most powerful tools for saving lives.

And then there’s this:

Of course, during earlier eras, regulators allowed many industries to profit massively from products known to be harmful; Big Tobacco is the most obvious example.

Is Romer actually saying that cigarettes should be banned?  How did prohibition of alcohol work?  How about the prohibition of pot, cocaine and heroin?  If you are going to argue against deregulation, pointing to the set of regulations called the war on drugs is absolutely the last place you want to go.

Then Romer mentions Greenspan’s support for deregulation of finance, which he later regretted.  But actual experts on regulation of financial regulations (and Greenspan is most certainly not an expert) understood that FDIC, too-big-to-fail, the GSEs and other regulations were creating moral hazard, leading to way too much risking taking in the financial sector.  Numerous free market economists (including me) pointed this out.  After the banking crisis of the 1980s (almost entirely created by FDIC and FSLIC), there was an increase in regulation.  I argued (correctly) that we had not solved the problem and that it was only a matter of time until it happened again.  Of course Dodd-Frank also failed to address this issue.  Regulations encourage risk-taking.  True deregulation would reform FDIC so that banks didn’t use insured deposits to make risky loans.

Then there’s an example of some unethical behavior at Goldman Sachs, which seems to have nothing to do with economists promoting deregulation.  It’s sort of thing you normally get in a left wing essay—anything bad that happened in a country called “capitalist” shows the evils of capitalism.  I don’t think Romer accepts the left wing critique of capitalism, but he is using their sloppy arguments in parts of this essay.  Financial firms also engage in unethical behavior in regulated systems.  Even worse, the activity Goldman Sachs engaged in was “regulated”.  They had to pay a massive fine for violating these regulations.  Regulation can never stop all unethical behavior; at best it can punish this behavior.  And that’s what happened here.  The system worked; bad behavior was punished.

Not surprisingly, there is no discussion of how monetary policy created the Great Recession.  But even economists who disagree with Romer suffer from the same blind spot on monetary policy.  More importantly, there’s no evidence that deregulation played a significant role in the crisis.  Actual examples that people occasional cite, such as repeal of Glass-Steagall, did not have any significant impact on the crisis.

Here’s Romer’s conclusion:

The alternative is to make honesty and humility prerequisites for membership in the community of economists. The easy part is to challenge the pretenders. The hard part is to say no when government officials look to economists for an answer to a normative question. Scientific authority never conveys moral authority. No economist has a privileged insight into questions of right and wrong, and none deserves a special say in fundamental decisions about how society should operate. Economists who argue otherwise and exert undue influence in public debates about right and wrong should be exposed for what they are: frauds.

Economists like Deirdre McCloskey have pointed out that most economists have a simplistic and almost cartoonish view of ethical issues in economics.  Economists talk about “positive” and “normative” issues with little understanding of the difficult philosophical issues involved in defining these terms.  It sounds nice to say that economists should stick to positive issues and stay out of normative issues.  But what does that even mean?

Romer is famous for advocating charter cities (similar to Hong Kong), which are free of burdensome regulations (consider the irony). I am pretty confident that if Romer were forced to explain why economists advocating deregulation are engaged in “normative economics” and economists advocating charter cities are engaging in “positive economics”, he would have a difficult time drawing a meaningful distinction.  McCloskey would have a field day with this essay.

Romer’s a great economist, but I think he got out of his area of expertise in this essay.  Of course you could say the same about my rebuttal.  But if even a non-expert like me sees obvious flaws, imagine how an expert on deregulation or normative economics would react to Romer’s essay.

Paul Romer’s second critique of economics

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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