Noah Smith on Modern Economics By David Henderson

Do a YouTube search for “Milton Friedman.” Most of the hits will be speeches mixing economic theory with political philosophy. You’ll see Friedman talking about the value of greed, for example, or holding forth on socialism versus capitalism. Most entertaining is the series of videos titled “Milton Friedman schools young idealist,” in which young, hippie-looking kids stand up and challenge the old man’s capitalist values, only to be hit over the head with Econ 101. As an econ blogger, I get the sense that this is exactly how many Americans still think of economists–as self-appointed defenders of the free market, spinning theories to show that greed is good. Watching those old Milton Friedman videos, I wonder if that picture might have been accurate in the 1960s and 1970s. But some big things have changed in the field of economics, and America should know about them. Three big changes stand out in particular: Econ today is more data-driven, far less politically conservative, and in general much more like engineering than it used to be.

These are the two opening paragraphs of Noah Smith, “Economists used to be the priests of free markets–now they’re just a bunch of engineers,” Quartz, May 13, 2014.

He’s getting at something real. Noah is probably right that the economics profession is more left-wing than it was. But we have to be careful about dates. Noah, and this is understandable given his youth, lumps the 1960s and the 1970s together. Based on his C.V., Noah was probably not alive in either decade and even if he was born in the late 1970s, was obviously not following economics then.

Why do I make such a strong distinction between the 1960s and the 1970s? Because in the 1960s, the dominant view about economists in macro was Keynesianism, the dominant ideology was statism, and the leading economist was the late Paul Samuelson. By the late 1960s, that had started to shift and by the mid-1970s, the shift was well under way. By the late 1970s, the dominant macro view was either monetarism or rational expectations, the free-market deregulators were never dominant but reached their peak influence–think airline and transportation deregulation and elimination of price controls on interest rates that banks could pay on deposits–and the leading economist was Milton Friedman.

So it matters a lot whether we’re comparing now with the 1960s or now with the 1970s. With the latter comparison, Noah has a point. With the former, he doesn’t.

One more point about the 1960s and even the early 1970s. In the academic year 1971-72, I went to the University of Western Ontario to take advanced undergrad and one grad course in economics, to prepare myself for going on to graduate school in “the States.” I had been a math major. Why UWO? Because when I had asked some economics professors at my alma mater, the University of Winnipeg, what was the best school in Canada to get advanced undergrad economics, they had recommended UWO. I was telling this story at breakfast yesterday to two economist friends who were visiting Monterey: Carole Kitti and Stan Horowitz. They had both done their graduate work at the University of Chicago in the late 1960s and early 1970s. When I told them that, Stan said, “That makes sense. The University of Western Ontario had a Chicago leaning.”

Stan’s comment surprised me. Why? Because it caused me to recall that that was what I had heard back in 1970 but had forgotten. I had forgotten it because when I got there I realized quickly that it wasn’t true. There was a small monetarist element. But the dominant macro view was Keynesian. Indeed, I recall that my macro prof, Harry Baumann, in response to some criticisms my fellow student Harry Watson and I were making of his critique of Friedman’s consumption function, actually halted the discussion and announced to the class: “These guys [Harry and I] are dangerous.” He wasn’t kidding. Moreover, as I’ve written elsewhere, when Gordon Tullock came to our school to present a paper, the faculty did not engage and the buzz around the school the next few days about Tullock’s ideas was negative.

The bottom line: the economics department that was thought to be the most Chicago-influenced Canadian department was not very Chicago-influenced.

Now to the rest of Noah’s piece. He writes:

When people say “Econ 101,” they probably mean a world where free markets work perfectly and government intervention is always bad. But open an actual Econ 101 textbook–say, Greg Mankiw’s Principles of Economics–and you’ll find a whole host of reasons why markets fail. Economists have always known that “negative externalities” (like pollution), “public goods” (like research), and “incomplete markets” could clog up the plumbing of the free market. But since the 1970s, economists have also explored how information problems like “adverse selection” and “moral hazard” can do the same. Game theory, which has become more and more popular, shows many cases in which even perfectly rational people can reach a bad equilibrium that leaves plenty of “free lunches” uneaten on the table. Behavioral economics has documented a host of ways in which humans might not be rational, and institutional economics has shown how even rational individuals can act stupidly en masse.

Start with his first sentence. I know of no Econ 101 course or its equivalent that talks just about “a world where free markets work perfectly and government intervention is always bad.” Zero, none, nada. And adverse selection and moral hazard? Yes, there’s more talk of that now, but somehow Noah seems to imply that that those concepts undercut the case for free markets. They don’t. The clearest examples we have of adverse selection and moral hazard that really mess things up are those that are created by government regulation. For example, insurance economics scholar Howard Kunruether, not exactly a Chicagoite, along with his co-authors, lays out how adverse selection is not a big problem in health insurance except when government regulation creates it.

Moreover, although Noah is right that behavioral economists have come up with more examples of how markets can fail, they have been incredibly resistant to applying those same tools to government officials, a criticism I make here.

So, although I think the economics profession is more left-wing than it was in the late 1970s, this isn’t due so much to an empirical revolution as it is to the profession’s hesitance to examine carefully how government actually works.

One last comment: My guess is that for his claim that on YouTube videos, one can find Milton Friedman “talking about the value of greed,” Noah had in mind this one. I ask you to watch it for yourself and see if you think Noah Smith has done a fair job of summing up Friedman’s point.