Tuesday, September 22, 2009

Economists and economics

I read two articles recently that lead me to writing this post. One by Paul Krugman who analyzes how most of the economists didn't anticipate the crisis that hit the world last year and another one (in Romanian) who criticize exactly Paul Krugman and Joseph Stiglitz for their omnipresence in mass-media where they impose their "leftist" ideas.

First I should mention that I read both books of the Vienna school economists (like Mises and Hayek) and Stiglitz. The science of economics mainly tries to create models that explain the interactions of people in the context of goods and their value. Apart for the various competing models one big disputed point among economists is how much the state should be involved in economy. The adepts of a liberal ideology claim that we should always let the market free to reach its equilibrium, as the free market is the most efficient way of allocating resources. But the ideal market model has one important assumption: that the agents act rational. And this assumption is not true many times, for example in the recent asset bubble people were driven by an "irrational exuberance" and they kept buying properties at ridiculous prices. One may say that a model is limited by its nature and cannot account for all the complexities of reality, but if a model cannot predict bubbles in various markets that keep appearing and have devastating effects on the economy when they burst then that model is not very useful. On the other hand, if we understand that such bubbles can occur than maybe public policies that act to prevent such evolutions are desirable: for example, counter cyclical monetary policies like raising interest rates when the economy grows strongly.

Moreover, economic theory doesn't question the morality or rationality of our goals. For example, in U.S. under free market conditions it is clear that not all people will have health insurance. The fact that a society may choose to offer health insurance to all its citizens it's not an economic issue, but a moral one. Thus, the fact that the state collects taxes and redistributes money to achieve such a goal should not be seen as an interference with the free market, but as an voluntary action of that society. This particular example of health care was acknowledged even by Hayek in his Constitution of Liberty as a legitimate case where the state might play a role in the economy.

The free market theory says that given certain assumptions an equilibrium state is reached, having the expression of the equilibrium price of a good. However, it is important to notice there can be many possible equilibrium states. Some of them might be more desirable than others (for example having fewer unemployed people, or having universal health insurance, avoiding financial meltdown), so in this case the intervention of the state in the economy is acceptable. The same argument applies when talk about ecology and global warming. Although some say that no intervention is necessary cause the free market will lead us to an equilibrium state, what if this state is one where life is no longer sustainable on Earth? We'd better make sure that the equilibrium state where our environment is heading is one where we can also live around.
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