The Greatest Lesson

The other day on Facebook, a friend of mine wrote:

Kudos to my friend economist Jon Murphy for calling out the instability in the Chinese economy several years ago. Turns out building entire cities that no one is interested in, isn’t sound economic policy.

He is right that I had been calling for instability in China for several years.  But can it really be said I predicted it with any accuracy?  The problem is, if you make a statement long enough, it may eventually come true.  You keep saying a recession is coming, it will eventually come and you will be “right.”  China, just like any real world economy, would eventually face recession and my prediction would have been “right.”

This is the important thing to remember with economics: it is a social science.  It is not a precise measuring and modeling system, no matter how much some people want it to be.  We create models and theories to help understand situations and guide our thinking.  We’ve observed a relationship between price and quantity and call it “Supply and Demand.”  We observe a relationship between production and consumption and call it “trade.”  But, at the end of the day, we are talking about humans.  There is a certain level of randomness involved.  This limits the predictive abilities of the Dismal Science.

No matter what side of the debate you’re on, there will likely be any number on anecdotal data to support one’s point.  For every study showing minimum wage has no effect, I can find one that says it does.  For every study showing free trade causes net harm, I can find one that shows net benefit.  This is why solid reasoning must always triumph and why myself, and so many other free-marketers, are skeptical of arguments (such as minimum wage is good) that attempt to overthrow the current reasoning.  The greatest lesson economics taught me is to ask “does this make sense?”  I fear the increased mathematization of economics is reducing the importance of that question in the minds of many.

To bring this about full circle, my prediction about China was based off of good reasoning (and ABCT), but is the situation in China really a vindication of ABCT and a refutation of Keynes?  I think so, but one could also argue the opposite, that China’s situation is more a reflection of a weak global economy weighing on exports and not malinvestment (which would be a vindication of Keynes and refutation on ABCT).  So, ask yourself: which makes sense?

4 thoughts on “The Greatest Lesson

  1. Jon,

    Apart from the admirable humility demonstrated here, I don’t really agree with how this post is framed.

    All business cycles theories start with the premise that there IS a business cycle and that an economy doesn’t grow indefinitely without some major downturns. So the fact that there is “instability” now in China (or even an uglier crash later) does not vindicate any particular theory.

    To the extent that a particular crash is seen as vindicating a particular theory, the Great Depression did result in a near death experience for Austrian Theory and a dramatic ascendency of Keynesianism. I don’t really want to argue right now about whether the interpretation that the economics profession did take from that was the one they should have taken from it. I want to argue that both Austrian Theory and Keynes had important insights that are far more complimentary than your post here suggests.

    Keynes never denied that a credit bubble can lead to an economic crash. Half the reason he wanted government fiscal policy to be counter-cyclical was so that the budget surpluses he advocated during healthy growth would serve to limit an unhealthy credit expansion. It is true that Keynes never offered much of an explanation for this credit bubble beyond “animal spirits” which was really a bit of hand waving.

    Luckily Hyman Minsky, who is regarded by all as a Keynesian, did just that. In a nutshell, his argument was that “stability is destabilizing” precisely because it tends to reward risky finance. As those who succeed with risky finance prosper, they are celebrated as doing the right thing and emulated by others. So then, people saving for a 20% down payment on a home from 2001-2006 found themselves further from that goal each year while their neighbors who had borrowed to the hilt to buy built equity rapidly. Nothing makes lenders feel comfortable like liquid collateral and real estate got more and more liquid in this period. This is exactly the kind of micro level explanation that normally Austrians love.

    I think Keynes made a mistake calling his book “The General Theory.” It should have been called “The Special Theory of How To Get Out of a Prolonged Depression.” The focus of the book was not on normal economic times. It was about the Depression. Keynes disagreed with the Austrians in that he thought that after a crash and a deflation (which might indeed have been originally caused by a credit bubble) the economy could get stuck in an equilibrium with a lot of unemployment and unused productive capacity. And he thought government could do something useful about that.

    Some of China’s problems result from an unhealthy credit bubble. Some of China’s problems result from a weak world economy. What doesn’t make sense is thinking it has to be one or the other.

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    • Thanks for your thoughtful comment. I don’t think I was very clear about my point. Unlike so many of my other posts, I actually wasn’t trying to do an “us vs. them” argument. I think we’re in agreement that both sides do offer some kind of explanation and that such explanations are equally correct. My point, rather, was that any of us need to be careful claiming victory over any given data point.

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