Delivered April 15, 2003, at the Federal Reserve Bank of Dallas to area high school teachers and college professors of economics, and the Dallas Fed’s economic research department staff.

I should like to begin with a very famous quotation from John Maynard Keynes’s book, The General Theory of Employment, Interest and Money:

...the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.

My purpose here today is to examine whether Keynes’s faith in the power of economists to shape policy has any significant empirical support. But before I get to the specifics of history on that point, it might be profitable for us to divide economists into categories, an endeavor that has often been carried out, usually by economists themselves because—as a variation of a well-known joke would put it—there are two groups of economists: those who divide economists into two groups and those who don't. For my purposes in this speech, I am—quite obviously—in the former group.

To begin, I want to look at an essential tension in the field, a sort of paradox, and I will label my categorical antagonists on the opposite sides of this paradox “Friedmans” and “Stiglers,” after two Nobel Prize-winning “Chicago School” colleagues Milton Friedman and George J. Stigler, the latter of whom nonetheless represented significant philosophic, positional differences on this issue, especially during Stigler’s later years.

“Friedmans” wholeheartedly agree with Keynes’s position, at least as enunciated in the quote I just read. They believe that political power lies with elite intellectuals who persuade people to take particular actions—even when those actions need to be explained and even “sold”—to those very people by those same elites, and even when those actions make people worse off generally.

“Stiglers” deny that people are duped into supporting public policies that economists find “inefficient” and/or counter-productive. “Stiglers” want to apply the assumed rationality of individual people to the political sphere just as they apply it in economic theory. Policy, for “Stiglers,” is rational no matter the apparent facts. Voters do understand just what they are voting for, and are getting what they desire regardless of the criticisms offered by the “Friedmans” of the world who are ceaselessly working to convince people to change their minds. “Stiglers” would agree with Oliver Wendell Holmes’s observation on the true purpose of the Supreme Court....“my fellow Americans wish to go to hell, and my job is to see to it that they get there are quickly as possible.”

This is, of course, an old and on-going discussion in our field, and others, and it is unlikely that I—or anyone else—can settle once and for all this lengthy debate. I am myself conflicted because, while I intellectually find myself in great sympathy with the “Stiglers,” I nonetheless believe that the “Friedmans” are mostly right.

Only a person who agrees with the “Friedmans”’ position could love the old H.L. Mencken aphorism that “if (X) is the average level of stupidity of a population, and (Y) the number of voters, then democracy is the theory that (X) times (Y) is less than (X).” Funny, right?

This quite obviously leads to a belief that proper education will somehow change things. As the social rationalist Ludwig von Mises believed, once people were shown by economists that their policies did not produce the results they hoped for, they would change their minds and repeal useless and counter-productive economic regulations. This worldview allows one to observe the real world, and yet remain optimistic. Of course, the definition of an optimist is “one who believes that this is the best of all possible worlds.” We should always remember, however, that pessimists are in whole-hearted agreement!

If the contention of the “Friedmans” is true, then the task becomes explaining how they can be right given their own assumptions about human nature and the rationality of acting individuals. And this is where economics and policy history—rather than the history of economic theory—is of great importance, and can be a useful tool for our inquiry.

What I need to show, if I am to be very convincing about the correctness of the “Friedmans” position, is that economists do in fact control—however indirectly, and with whatever time lags, as Keynes noted—ultimate public policy debate, and ipso facto, the laws and regulations that flow from those debates.

I need to show that economists—and other policy elites—are the small tail that wags the polity dog. I have to refute the oft-heard lament by economists that “no one listens to our brilliant theories and analyses.” On the contrary, my own view is that we economists have influence out-of-proportion with the actual value of our theories and policy recommendations....that our influence, in fact, exceeds our collective wisdom.

That’s probably not a good way to begin a speech while facing an audience of professors of economics, but nonetheless, that’s what I intend to try and demonstrate during this presentation: that we have had, and still do have tremendous influence, and that—just maybe—we ought not to have quite so much. Having said that, I beg for your forgiveness, knowing full well that I shall receive precious little from my economist colleagues!

It is impossible to state when the first economic theory was thought, or spoken; we can trace concerns about efficient resource use back to the ancient Greeks, specifically to the writings of Xenophon in his major work—Oeconomicus—after which our discipline is named.

And certainly, Aristotle’s ideas concerning the proper configuration of households, as well as their relationship to wealth and wealth-getting, qualifies as early—and influential—economic theorizing even though the greatest influence was to come centuries later when the Greeks were rediscovered by Medieval scholastic writers such as Albertus Magnus, Gerald Odonis, Jean Buridan, and Thomas Aquinas. The intellectual disputes over exactly what these writers were recommending for society have been argued for some time, and are far from settled today. Some historians of thought such as Marc Blaug, Robert Ekelund and Robert Hébert—have little respect for their efforts. The old saying that the Scholastics spent their days arguing about “how many angels could sit on the point of a pin” is a simple, dismissive way of dealing with their ideas, most of which were Greek in origin. It didn’t help any that they named their conception of long-run costs of production the “just price,” thus hopelessly infusing ethical considerations—at least, according to their critics—into their economic analyses.

Other historians of thought, e.g., Joseph Schumpeter, and the always iconoclastic Murray N. Rothbard, allow that the Scholastics made sensible arguments, at least no less sensible than Adam Smith’s when it came to long-run cop, though Smith was smart enough not to call this concept a “just” price. Schumpeter is especially generous in his treatment of the Scholastics, and it is a continuing theme throughout his masterpiece History of Economic Analysis.

Any person who has ever claimed to have been “ripped off,” has accepted—even if only implicitly—the idea of a just price, and economists have not been immune from suggesting that actual market prices are somehow often illegitimate. In fact, without such a notion, antitrust laws make absolutely no sense, let alone MC and AC pricing rules for public utilities. (I am assuming, of course, that they do make sense if we accept the notion itself, still a highly debatable proposition.)

For example, the most recent edition of the micro text I am using at University of Texas at Dallas this semester treats the price outcomes in monopolistically competitive markets as somehow “wrong” and “wasteful,” a contention that generations of students have been taught. It is clear that modern economists are more than capable of the same sort of “just price” reasoning that the Scholastics practiced, though of course they claim a scientific basis—rather than an ethical one—for their own beliefs.

What is not arguable is that the Scholastics had a large impact on policy. The first organized school of economic thought—physiocracy—was in fact nothing but a rehash of their doctrines, and yet the writings of Francois Quesnay and others in that French school certainly influenced British political economy through writers such as Adam Smith who fails, in his book The Wealth of Nations, to cite anyone as being his theoretical predecessor other than the physiocrats. This is good in that Richard Cantillion was, like Smith, and well before him, a thorough-going Newtonian on the economy; and the Physiocrats—like the Scholastics who influenced them—were huge admirers and advocates for the idea of natural law, a position that Smith adopted as well. Natural law is, of course, nothing more than the idea that the universe is rationally constructed and behaves according to relationships that are invariate, both in the natural—and social—realms. In other words, things do not occur by accident, but have a “design” that includes both human—and physical—nature. As Francis Bacon observed, “nature, to be commanded, must first be obeyed.” This idea is powerful and even so-called post-moderns embrace it, whether knowingly or not. Modern environmentalism, for example, is based on this intellectual foundation regardless of the fact that many of its adherents do not seem to understand this simple fact.

Smith, who supported natural-law doctrine, was hugely influential in his own time, as he remains in ours. The golden age of British political economy was about real-world policies to an extent that the profession has probably not approached since. This real-world policy appraisal attitude of economic practitioners was summed up well by the very influential teacher and economic writer Edwin Cannan when he wrote: “...when people ask us whether such and such a change will be good or bad, they will find us tiresome if we pretend that we know nothing of good and bad ends in economic matters and can only talk about the cheapness or dearness of different ways of attaining a given end. They will say: “you know perfectly well that what we want from you is to be told whether this proposed change will make us and our children better off...” benefactors endow chairs of economics, audiences listen to economic lectures, purchasers buy economic books, because they think that understanding economics will make people better off. Is it really necessary for us to destroy this demand for economic teaching by alleging that we do not know what the phrase ‘better-off’ means?” (emphasis added).

Given this attitude in British economics, it is not surprising that economists have had a long, profound influence on English public policy, sometimes for good and sometimes, unfortunately, for ill. It was, after all, the view of the Classical School that the world was an orderly place, set in motion by God’s hand, and that human reason could be applied to social problems in the same way that it could be profitably employed in the natural sciences—as a problem-solving device, called “instrumentalism” in modern philosophical epistemology—using: empirical tools without underpinning realistic assumptions. This approach has been often used and still is—for both public good, and sadly, public ill. Due to a very famous article Friedman wrote titled “The Methodology of Positive Economics" in Essays in Positive Economics. Friedman has been called an instrumentalist, although he denies it.

What is undeniable as we read the contemporaneous replies to Friedman’s article, is that the entire profession was caught off-guard by this topic, and their generally weak replies showed a great lack of critical thinking about this issue. So, Friedman carried the day and still stands mostly unrefuted.

The debate over whether ideas move policy or policy leads to rationalizations of it—so prevalent in the work of our friends Friedman and Stigler—has no finer example than British policy in the nineteenth century—the so-called “Victorian” era, ending with the death—not of Queen Victoria in 1901, but with the end of King Edward’s reign in 1910, and the coming storm of WWI.

Did Adam Smith’s ideas, refined by successors such as David Ricardo and John Stuart Mill, create British laissez-faire doctrine, or did Smith simply record the world as he saw it and, in Stigler’s view—simply tell people what he thought they wanted to hear? Did Smith defeat mercantile doctrine, or was it already well on its way out before he wrote about it? “Friedmans” would argue that it was the former, while “Stiglers” would, of course, credit—in a peculiarly Marxist way—events, technologies, etc., driven by forces mostly outside of human control—created a laissez-faire cocoon of accommodating public policies. I cannot definitively answer this question this morning, but I will try and offer some examples that would seem to buttress Friedman’s case.

Even though Smith’s arguments for free trade had been made decades before—and John Locke’s and David Hume’s well before Smith—it was not until 1846 that the “Corn Laws” were repealed in England. And that repeal had more to do with the political efforts of Richard Cobden and Thomas Bright’s "Anti-Corn Law League" than with Smith, especially in light of Smith’s exemption he afforded to the food supply when it came to whatever preaching he did about implementing laissez-faire.

Today, people still look back at the "Anti-Corn Law League" as an organizational-tactical model upon which to base current anti-protectionist initiatives. But in fact, only one prominent classical political economist of that earlier era—David Ricardo—made their repeal a central aspect of his writings. The general appeal of abolition had as much to do with resentment against the land-owning class than it did with theory, although it would be wrong to under-emphasize Ricardo’s efforts in getting these laws repealed, and Britain on her way to almost perfect free-trade policy. He made a difference—he was influential—and his efforts undoubtedly led to a policy change that may well not have occurred anyway.

The repeal of the Corn Laws was but one manifestation of the power of political economy to shape policy in Victorian England. Jeremy Bentham’s “utilitarianism” was all the rage, and public servants found numerous ways to try and implement policies consistent with its principles.

The most influential economists in England during the second half of the 19th century were Nassau Senior, Mill, and Bentham’s last secretary—Sir Edwin Chadwick. Mill and Chadwick especially applied Benthamite views to British policy, and Mill was also a member of Parliament. Senior was a longtime consultant to the government, occupying a prestigious chair in political economy at Oxford University for many years. Against the historical backdrop that represents Britain’s closest adherence to laissez-faire, political economists appeared to drive policy decisions.

What made their success possible were fiscal restrictions placed on the English government by the gold standard, and by Chancellor of the Exchequer, William Gladstone, both of which had the effect—if not the specific intention—of denying to the government sufficient resources with which it might meddle—in any systematic way—in the English economy. Because of these limitations, gold was denounced then every bit as vociferously as it is now. Keynes—who knew better—denounced it as a “barbarous relic.” So many economists today oppose the gold standard that it is probably the right time to reinstate it!

Of course, resources or not, all governments are going to regulate and, during this era, England passed a series of far-reaching laws that abrogated laissez-faire, among them the Factory Acts, the previously mentioned Corn Laws, the Poor Laws and various welfare policies, including even a small amount of income redistribution.

Nassau Senior’s analysis of the Factory Acts was a major precursor to what we today call “public choice” theory. He showed clearly, and with a “lack of compassion” and a “cold-heartedness” that we economists today can only envy from afar—that the Factory Acts were primarily about protection for older, male, higher-paid labor at the expense of children and female workers. So successful were the initial regulations that such relatively cheaper labor was reduced over 50% in just the three years between 1835 and 1838. So successful were the older males in restricting the supply of such labor that they successfully lobbied for—and achieved—an amended, strengthened act in 1844 that placed even more restrictions on potential female competitors.

In retrospect, we can see clearly—thanks mainly to Nassau Senior’s report on these acts—that behind every so-called “reform” lie powerful economic interests, and that every piece of public policy—regardless of the avowed intensions of its supporters (see Thomas Sowell’s examination,in light of F.A. Hayek’s seminal essays during the 30s and 40s on information and knowledge, and brilliant analysis in his Knowledge and Decisions) and he shows that all policy both harms and helps tax money beneficiaries at the expense of others. This is always the case.

This was true of the Poor Laws as well. Mill especially decried the tendency of welfare to discourage work among the poor, citing the need to design assistance so as not to penalize low-wage workers, nor make it attractive for them to forego work in order to receive welfare. Sound familiar? This concern manifested itself—in reality—in the form of work-houses, all of which were run under the act, and all of which were decried, of course, by reform-minded intellectuals and like-minded members of the general public. But Mill remained unmoved, an advocate in his own day of what today we call “welfare reform.”

Such was Mill’s general reputation that, later in his life when he modified his view as to whether the Classical wages fund doctrine was accurate, his change of opinion shook politics in England for some time, and his later views undoubtedly hastened England’s transformation from a quasi-laissez-faire economy into an explicitly quasi-socialist one. For Mill, production ultimately expands to the point that it can be safely redistributed along socialist lines. (It was also not a coincidence that Mill later in life married Harriet Taylor, an avowed socialist.)

Another very influential political economist, and follower of both Bentham and Mill, was Sir Edwin Chadwick. Chadwick was a thoroughgoing utilitarian and his policy ideas reflected that orientation. Chadwick rejected Adam Smith’s idea about a natural harmony between private and public interests and decided that what the government needed to do was create an artificial harmony between those two interests. Avoiding the trap of having to measure inter-personal utility in order to affect a utilitarian solution, he fell into a different sort of trap, and decided that anything that enhanced economic “efficiency” was, ipso facto, in the public’s interest. This should sound familiar to anyone who has read a good deal of output by University of Chicago economists and for good reason; as a welfare criterion, it is not different from what Chicago—especially its law and economics wing—has generally advocated since Ronald Coase arrived there from the University of Virginia in 1960 to take over the editorship of the prestigious Journal of Law and Economics.

For example, faced with a high mortality rate during the transportation of prisoners from Britain to Australia, Chadwick’s solution was pure common sense and a dramatic example of the power of incentives: pay per head on delivery rather than on embarkation, a simple change that cut prisoner mortality by 98%.

Always the dedicated empirical researcher and compiler of statistical reports, Chadwick learned from many prisoner interviews that high probability of capture out-weighed severe retribution in the minds of most criminals; in other words, they acted rationally on expected benefits and costs. Policing was changed to reflect this reality. The police were better paid to reduce their incentive to become corrupt, and Chadwick also implemented judicial reforms to increase the probability of being found guilty once indicted, a calculation almost every professional criminal today knows with remarkable accuracy.

Chadwick applied opportunity-cost considerations to water consumption, and was the first to advocate home delivery as a way of minimizing the total cost of acquisition. This had the happy side benefit of improving sanitation and, hence, the public’s health as well.

Anticipating public-goods arguments, he explicitly laid out a conception that we have come to call the idea of “natural monopoly.” As a thoroughgoing economic centralist, he wanted to create as many public monopolies as possible. He anticipated—and even explicitly outlined—the idea of franchising public services, a practice followed today in many American cities, which is based on a sophisticated understanding of search and information costs that Chadwick learned from gathering market data about—of all things—funeral homes!

It is clear that the movement toward alleged “natural monopoly” public utilities in late 19th century America was one that had digested Chadwick’s many arguments, including even the proposed nationalization of rail lines which in fact came to pass during WWI. The original Interstate Commerce Act (1887) explicitly accepts Chadwick’s contention that railroads are, in fact, natural monopolies. The U.S. federal government later abandoned this idea.

One man, armed with a version of classical-economic doctrine, filled with so many ideas—ideas that led to policies that had such a large impact on his nation—and, indirectly, on our own—and yet how many Americans have ever heard of him? A reasonable guess would be one in ten thousand!

Of course, Chadwick was not the first—nor the last—English economist to dramatically affect policy. No discussion relating to this topic can fail to address the so-called Keynesian revolution. But again, the nagging question returns: did Keynes change policy, or did Keynes merely rationalize policy that was already in place and was quite likely to continue?

In 1936, seven years into the Great Depression, The General Theory of Employment, Interest and Money appeared. It is a difficult read, and that’s why most people—including most economists—don’t bother. Yet, it became an instant classic, well before its theory and policy implications could possibly have been verified—or falsified—by experience. Did Keynes revolutionize economic theory? Or was his work, as a brilliant analysis by Leland Yeager claims, a mere “diversion?” (“The Keynesian Diversion," Economic Inquiry, vol. XI, no. 2, June, 1973). Did governments read the book and decide to meddle in their economies, or were they already meddling and Keynes provided them with intellectual justifications and, hence, with political cover? No one ever got poor engaging in such government suck-up writings. Again, this is not an argument that is likely ever to be settled definitively. But what cannot be denied is that post-WWII policymakers used what they thought were Keynesian ideas, models and concepts when they carried out macroeconomic policy.

The general domination of Keynesian theory—or what passed for it—on macro policy from the end of WWII through the 1960’s is also pretty clearly a fact. So, it’s not surprising that the anti-Keynesian revolution was lurking just off the Keynesians’ radar screens until it found the most appropriate moment to bloom—the 1970s when the H.M.S. Keynes hit an iceberg called “stagflation,” never to be the same again, even after limping back to port. The heyday of alternative macro ideas had arrived and the free for all to replace Keynes was soon in full swing.

Foremost among them was, of course, “monetarism,” propelled into the public’s sleepy consciousness by the irrepressible Milton Friedman—and his students and supporters. Derided as “cranks” by the Keynesians during the 50s and 60s, suddenly there was an explanation for what ailed the economy in the late 70s that clearly traced its intellectual lineage back to Locke and Hume, rather than to Cambridge U.K.

When Paul Volcker and the Federal Reserve decided to implement money supply targeting in late 1979, they were following the monetarist playbook, and the results were as economic theory predicts in such situations: depression—(sorry, that word is just too depressing; I meant to say recession. No, that’s still too depressing. How about “downturn?”) Anyway, price disinflation is not fun and no clearer instance of the link between theory and policy can be found than during the period 1979-83. The greatest fear the Fed has is not inflation but deflation which is why, at a Dallas Fed program honoring Milton Friedman’s 25th Free to Choose Anniversary, every major Fed participant (including Ben Bernanke and Alan Greenspan by television) praised Friedman’s work even as the Fed had not listened to him for decades, and still doesn’t.

Today's Fed uses an old macro model developed by A.W. Phillips—a complete Keynesian follower—and creator of the so-called Phillips Curve that originally examined a century of UK data that suggested there was an positive relationship between total employment and prices, or to turn things around a bit, by taking (1 – TE) for an axis, the relationship changes to an inverse relationship between prices and unemployment. If so, one could, in theory, “purchase” Full Employment by allowing inflation! No major economists dissented and no one argued that we should instead achieve purchasing price stability by allowing more unemployment, although the data suggest that this is true. (What is also true is that money prices don’t vote, but workers do.)

But as is so often true in life, at the moment of its seeming greatest triumph, monetarism was already waning as the macro theory du jour. And to add insult to injury, the Fed quickly returned to its Phillips-Curve-based policy (prediction of the future interest structure based on labor force data that posits a naive relationship between prices and total employment) which must please anti-monetarists such as Nicholas Kaldor who wrote at the height of Thatcherite power in Britain—and no doubt with great Keynesian frustration—a book not so gently titled The Scourge of Monetarism.

Looking back at the macro texts of the 1980’s, the two competing paradigms that really counted were Keynes’s and Friedman’s. But today’s texts have a much wider variety of potential non-Keynesian possibilities, including RBC (real business-cycle) theory, Ratex (Rational Expectations Theory), several varieties of “post-Keynesian,” supply-side, monetarist, and even neo-Austrian approaches. To say that macro is “in flux” is, of course, to express the obvious. But as all policy requires justification, and some policies are just plain terrible, there will doubtless be no shortage of “new” macro ideas in the future.

I think the Keynesian and monetarist episodes clearly demonstrate that the “Friedmans” are onto something when they argue that individual economists can change, not just policy—but the world itself—through the power of their ideas. The twentieth century powerfully supports this contention as it can be viewed as a monumental struggle between the ideas and insights of—with apologies to the multiculturalists who dominate academe these days—two, old, dead, white, male political economists, Adam Smith and Karl Marx.

Of course, it might not have seemed that way, but even recasting the protagonists as, say Keynes and Hayek—as was done in the book by Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The Battle for the World Economy—obscures, but does not change, the fundamental nature of the idea conflict that is personified by Smith and Marx: are you for the market’s “invisible hand,” or Marx’s—and Keynes’s—and yes, even Chadwick’s—central authority, a.k.a. “the State?”

Because really, there is but one central, all-important public policy issue: individual freedom or state control?

So many momentous theoretical debates turn on this issue; so many economists devote themselves to furthering one or the other approach even as they tell others—and sometimes even themselves—that they are completely disinterested “scientists.” But of course, we know that this is not the case most of the time. There are liberal economists, and conservative economists, and libertarian economists, and socialist economists. And it is far from a coincidence that their research findings almost always confirm their a priori political beliefs. Of course, it’s not a coincidence at all, but inevitable, self-choosing by humans.

When economists’ politics remain the same across their entire professional lives, and they claim that reality is best modeled in conformity with their politics, then it is surely the politics that is the driving centerpiece of their beliefs, and not any research evidence or random empirical finding. Remember that Keynesianism swept the profession long before the empirical results were available. So, on what grounds other than politics did one become a Keynesian in, say, 1938?

There are so many names that I have not the time to discuss in detail today, but whose writings profoundly influenced their own times, and often ours. Theorists such as Hume, Ricardo, Malthus, Walras, Wicksell, Clark, Veblen, Kuznets, Knight, Sraffa, Fisher, Coase....the list truly is long and varied, and seems to me to confirm the “Friedmans”’s position that some theory changes reality at least as much as reality drives theory. Indeed, Milton Friedman’s own life is testimony to the truth of the relationship between ideas and policy.

So, after all of this exposition, I suppose I ought—unambiguously—to provide an answer to the question my title raises: Do economists really matter?

I hope that I will not be guilty of self-promotion of my chosen profession if I answer in a strong affirmative voice. Economists not only matter, but I would argue that they sometimes matter too much...they are listened to as carefully when they are wrong as when they are right, and that can be a bad thing.

For every success story, there is also a bad policy that was enacted with the enthusiastic backing of at least some influential economists. In my personal view, the most destructive economist—at least to date—is Marx. The price paid for his writings has been so vast and so terrible that it defies simple categorization. And from whom did Marx learn his economics? Primarily from Smith and Ricardo, whose systems had built into them—unfortunately—a crude version of the erroneous labor theory of value. The rest, as they say, is history.

Or consider Thomas R. Malthus’s An Essay on the Principle of Population, which was wrong when he wrote it and is still wrong today—the “Club of Rome” notwithstanding—but which has driven—and continues to drive—irrational population and environmental policy decisions.

Or the naive faith in Keynesian macro “fine tuning” which drove policy down a one-way street into chronic inflation followed, inevitably, by stagflation. Certainly, it is legitimate to argue about what Keynes “really meant”—and that has been a cottage industry ever since The General Theory’s 1936 publication. But what cannot be denied is Keynes’s own belief that he had discovered the way to maintain permanent prosperity with full employment. It was his followers who invented such things as counter-cyclical policy; for Keynes, the “big rock candy mountain” had arrived and business cycles were to be a thing of the past!

(Here, I cannot resist giving you the following advice. Whenever famous economists start saying—and they will again at some point—that “the business cycle is now dead”—then sell your stocks, my friends—and sell quickly!)

The credulous and, in retrospect absolutely silly, pronouncements of economists are easily documented. John Law’s creative financing of the French government that led to the South Sea Bubble; the disastrous attempt by Britain to return to the gold standard at the wrong parity after WWI; Irving Fisher’s prediction of a long boom two weeks before the 1929 crash; John Kenneth Galbraith’s early-1950 pronouncement that removing price controls in West Germany would destroy their economy—just as the “German Economic Miracle” began to unfold precisely because such controls had been abandoned; Paul Samuelson’s remarkable opinion that the Soviet economy was booming and ready to surpass America’s, written just a few months before the Berlin Wall fell and with it, the entire Potemkin village that was the Soviet economic system....I suppose, to be entirely fair, that I ought to add a mea culpa for the Fed, since it pursued a particularly perverse policy during the late 1920s and early 1930s, a sort of “real bills doctrine,” thereby deepening the severity and duration of the Great Depression.

I could go on, and I am not mentioning these examples as if they are the sole examples of silly predictions, or the advocacy of incorrect policies. That’s something that—to paraphrase Will Rogers—every economist does, only on different subjects. Economists, no less than others, often fall into holes—like Adam Smith did while admiring the stars.

So—yes, economists do matter—a great deal, both when they are right and when they are wrong—and just as Keynes suggested—because they are taken seriously, and the level of understanding of their theories is no bar to their being taken seriously. It really doesn’t matter how complex the advice is as long as it can be sold to voters and politicians in some simple way. An example is Arthur Laffer’s reworking of the fiscal implications of tax revenue collections as a function of incentives rather than tax rates. Nothing new in it, really, and Laffer’s contention is hard to grasp at first sight, but nonetheless it became the foundation of a successful presidential campaign and the generator of one of the largest tax cuts in American history.

The reason probably is that, during hard economic times when the numbers are bad—or conversely, in great times when very good—voters are more likely to embrace alternatives than when things are more normal. All the talk of Social Security privatization seems to have abated dramatically these days even though a well-designed privatization plan is probably a very good, long-term idea. Politically, however, this is not the time that such a change can be accomplished. Social Security itself, recall, is a plan from the depths of the Great Depression. It could never have been implemented in 1928. But by 1935, it was politically unstoppable.

And that leads me to my final point: during times of economic difficulty, economists and voters are more likely to support what we have come to call a “paradigm change.” Some economic historians—notably Mark Blaug—deny that the history of economics can be accurately modeled by paradigm changes, but the history of macro seems—at least to me—to conform fairly well with Thomas Kuhn’s ideas about paradigm change as he expressed them in The Structure of Scientific Revolutions. Periods of “anomaly”—when the prevailing theories seem no longer to explain or predict well—are the times when we get new ideas, or the resurrection and “improvement” of old ideas. Or, as one writer’s cute title put it in his book, New Ideas from Dead Economists: The Introduction to Modern Economic Thought, by Todd G. Buchholz.

For examples of anomaly and change, look at the Industrial Revolution and the way in which it changed markets. Free trade was suddenly the “in” thing, and mercantilism was intellectually destroyed. (Don’t tell that to the always-ubiquitous, anti-trade protesters, of course. They still think it’s 1650 and the workers’ guilds require strengthening!)

Obvious problems with the labor theory of value led, in the late 1870s, to the modifications in classical economics that we now call neoclassicism, which were based on subjective-value theory and the so-called “Marginal Revolution.” The Great Depression caused the casting aside of classical ideas—such as Say’s Law from Jean-Baptiste Say—and paved the way for Keynes. Stagflation had the same effect on the Keynesian revolution, and led to monetarism, supply-side, RBC theory, and Ratex with the “Robert Lucas critique” of macro policy outcomes that are consistent with people knowing the future with a high degree of accuracy, thus suggesting that any policy will fail because market participants will adjust their behavior and counteract the policy.

Each era requires, because of empirical changes, different theoretical explanations—and ours is no different in this regard. (The question of whether things really change or not I will pass over, but a reading of Frederick Lewis Allen’s wonderful study of the 1920s—Only Yesterday—suggests that, as the Greek philosopher Parmenides asserted so very long ago—they don’t).

Which is why, during the 1990s, we heard a lot of talk about the “new economy,” with its slogans such as “distance doesn’t matter,” “profits are irrelevant,” “P/E ratios are useless,” “debt is just a four-letter word,” and so many other mantras that seem, as they always do in retrospect, to have been either wrong, or pushed way too hard. Time will, as usual, give us a final answer. By then, of course, different economists will be advocating a host of new ideas—or dusted off, souped-up old ideas—and the entire cycle will repeat once again.

So, where does that leave us if we want to evaluate the advice that economists are never bashful about tendering? Here are my personal views on that:

  1. TANSTAAFL (“There ain’t no such thing as a free lunch.”);
  2. If it sounds too good to be true, it isn’t true, which leads to the inevitable, sad corollary—“a fool and his money are soon parted”;
  3. Prediction is always best when looking backwards; always ask those making predictions if they have money riding on the truth of their forecasts. Generally, they don’t—and for very good reasons!
  4. If an idea is called “revolutionary,” it was probably first suggested by someone like Plato;
  5. Free markets are not and have never been a utopian solution for all human problems—but then—what major problem has government ever solved, with or without the input of economists?

Thank you for your kind attention.
Suggestions for some interesting reading:

Blaug, Marc. 1980. The Methodology of Economics: Or, How Economists Explain. Cambridge, U.K.: Cambridge University Press.

Boettke, Peter J. 2012. Living Economics: Yesterday, Today, and Tomorrow. Oakland: Independent Institute and Universidad Francisco Marroquin.

Formaini, Robert L. 1990. The Myth of Scientific Public Policy. New Brunswick, N.J.: Transaction Publishers.

Friedman, Milton. 1953. “The Methodology of Positive Economics", in Essays in Positive Economics, 3-16, 30-43. Chicago: University of Chicago Press.

Hutt, William H. 1936. Economists and the Public: A Study of Competition and Opinion. London: Jonathan Cape.

Kuhn, Thomas S. 1962. The Structure of Scientific Revolutions. Chicago: University of Chicago Press.

Schumpeter, Joseph A. 1956. History of Economic Analysis. Oxford, U.K.: Oxford University Press.

Sowell, Thomas. 1980. Knowledge and Decisions. New York: Basic Books.

Stigler, George J. 1985. Memoirs of an Unregulated Economist. Chicago: University of Chicago Press.