Jeff Madrick - Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World

Also by Jeff Madrick

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The Case for Big Government

Why Economies Grow: The Forces That Shape Prosperity and How to Get Them Working Again

The End of Affluence: The Causes and Consequences of Americas Economic Dilemma

Taking America: How We Got from the First HostileTakeover to Megamergers, Corporate Raiding, and Scandal

This Is a Borzoi Book
Published by Alfred A. Knopf

Copyright 2014 by Jeff Madrick

All rights reserved. Published in the United States by Alfred A. Knopf, a division of Random House LLC, New York, and in Canada by Random House of Canada, Limited, Toronto, Penguin Random House companies.

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Knopf, Borzoi Books, and the colophon are registered trademarks of Random House LLC.

Library of Congress Cataloging-in-Publication Data
Madrick, Jeffrey G.
Seven bad ideas : how mainstream economists have damaged America and the world / Jeff Madrick.
pages cm
ISBN 978-0-307-96118-1 (hardback) ISBN 978-0-307-96119-8 (eBook)
1. United StatesEconomic conditions2009 2. United StatesEconomic policy2009 3. EconomicsUnited States.
4. Financial crisesUnited States. I. Title.
HC106.84.M336 2014 330.973dc23 2014006237

Jacket design by Oliver Munday

v3.1

To economists who do their job well, and to Kim

Economists most fundamental ideas contributed centrally to the financial crisis of 2008 and the Great Recession that followedthe worst economic calamity since the Great Depression. These ideas are so embedded in a way of thinking about the economy that many of the economists who have embraced them for a generation now are unable to criticize themselves seriously and are unaware of how narrowly focused their views of a working economy have become. Over the past thirty years, their way of thinking has in fact time and again damaged America and the worldthe damage outweighing what good has been accomplishedyet we continue to take economists terribly seriously. Their culpability has scarcely been cited. Why?

I am referring to orthodox economists here, by which I mean the large majority of Western-trained academics whose political leanings fall somewhere between the right and the center-left. They would, of course, balk at such a description of their politics; many of them claim they are objective and have no political predilections that affect their economic ideas. They are considered mainstream, and they often teach or were trained at the most prestigious universities, among them Princeton, MIT, Stanford, Harvard, and the more openly conservative University of Chicago, as well as the countless others with similar curricula. I will usually not use the word orthodox when referring to these economists, and when discussing an economist who clearly does not fit into this category, I will make that clear.

Almost no economist predicted the 2008 financial crisis and its wretched aftermath. Even when a handful of economists warned of dangers, only one or two anticipated how devastating the economic consequences would be. Quite the contrary, shortly before the 2008 mortgage market collapse, many of the most respected economists in academia claimed they had mastered the craft of controlling the economy. Robert Lucas, who is on the right politically, said in his 2003 presidential address to the American Economic Association that the central problem of depression prevention has been solved. Olivier Blanchard, a respected left-of-center economist from MIT and the chief economist at the International Monetary Fund, proclaimed as late as 2008the year of the crisisthat the state of [macroeconomics] is good.

Macroeconomics is the study of the national income, or the gross domestic product, and how its growth can be assured. A recession is defined by a significant decline in GDP and a rise in unemployment, and minimizing the occurrence and duration of recessions is a key objective of macroeconomics. Economists thought they had figured out how to do this.

The failure to predict the 2008 crisis is not the only grave mistake economists made. Of far greater concern is that their ideas contributed to or justified much of the financial behavior that caused the crash and the deep recession that followed. These are the harmful ideas that gained credibility in the 1970s and reached the level of doctrine over the succeeding decades, doing harm along the way.

In the mid-2000s, Ben Bernanke, an admired Princeton professor, claimed that the economy had been maintaining an ideal temperaturenot too hot and not too coldsince the early 1980s. National income grew fairly steadily, with little threat of either unstable GDP or unstable inflation, both of which characterized the painful 1970s. (Inflation, a sustained rise in prices, is usually measured as an annual rate of increase.) Recessions, if painful, were short, and recoveries were quick. Like many of his esteemed colleagues, Bernanke, who succeeded Alan Greenspan to become chairman of the Federal Reserve Board in 2006, called the period from the early 1980s to around 2005 the Great Moderation. At the end of 2005, a year before his death, Milton Friedman, the political conservative who was the most influential American economist of the last quarter of the twentieth century, more than agreed. Just when the issuance of risky mortgages was reaching its height, he confidently told the journalist Charlie Rose, The stability of the economy is greater than it has ever been in our history; we really are in remarkably good shape. Its amazing that people go around and write stories about how bad the economy is, how its in trouble.

Friedman was the godfather of the newly prevailing economic theory, which amounted to a laissez-faire revolution among the orthodox, including the moderate left. Governments role in the economy, they said, should be far more limited. Some observers called this hands-off policy the laissez-faire experiment, but experiment implies an open-minded analysis of the costs and benefits of the new approach. It was quite the opposite, as we shall seea closed case presided over by closed minds.

During the period in which Friedman and his colleagues across most of the political spectrum lauded themselves, the economy fared poorly. Until recently, this broad failure almost went unnoticed. Wages in the United States for those the government calls production and nonsupervisory workersmost workersrose only 3 percent since 1979. These wages had been stagnating well before the crisis of 2008. By a slightly different measure, wages for the typical male worker were lower, after inflation, in the 2000s than they were in the early 1970s and, depending on how they are measured, the 1960s as well. Meanwhile, the top 1 percent earned roughly 20 percent of the national income, compared to 10 percent in 1970a level of inequality not seen since the 1920s. African Americans consistently had unemployment rates twice as high as those of whites for thirty years. The lack of decent jobs contributed to a surge in the number of men in prison. In some states, prison costs were the second-highest expenditure after Medicaid.

Economic mobility had stalled, leaving the United States well down the list of rich nations when measuring the ability of its citizens to climb up from the bottom income ranks. Those under twenty-five found it harder to get a job in the 2000s, even before the crash, than in any prolonged period since World War II. The employment of teens hit postWorld War II lows, falling especially sharply after 2000. Women still earned less than men with comparable experience and education. And most tragically, the richest nation in the world had the highest child poverty rate among all wealthy nations.