Sunday, August 12, 2012

Paul Krugman shocked to find 'culture of fraud' in economics profession

On his NY Times blog, Nobel prize winning Princeton economics Professor Paul Krugman expresses his shock to find a 'culture of fraud' in the economics profession.

Regular readers know there is nothing shocking about this.

The Queen of England made the point that there is something wrong with the economics profession when she asked how if everything was going so well nobody [in particular, economists] saw the financial crisis coming.  She asked this question at the London School of Economics to economists who claim to understand or at a minimum know something about how the financial system and the economy actually work.

There are two reasons that the economics profession might not have seen the financial crisis coming.

First, maybe economists truly know nothing about how the financial system and the economy actually works.  As a result, economists could not be expected to have seen the financial crisis coming.  However, if this is true, then they also could not be expected to have anything useful to say about how to deal with the financial crisis.

Support for the idea that economists truly know nothing about how the financial system and the economy actually works can be seen in the so-called peer reviewed academic journals in finance and accounting that have approximately zero standards when it comes to publishing articles.  I say this based on the simple fact that articles on informationally insensitive debt have been published.

By definition, all debt is informationally sensitive.  Some debt just requires less effort to assess.

The authors of the papers on informationally insensitive debt argue that demand deposits are an example of informationally insensitive debt.  Every six year old who opens a bank account with their parents knows that demand deposits are informationally sensitive.  Before the six year old hands over their money to the bank they make sure that the government guarantees to get it back.

The fact that a finance or economics peer reviewed journal would not apply something known to a six year old to disqualify an article highlights the lack of academic standards in these journals and supports the notion that economists truly know nothing about how the financial system or economy works.

Second, maybe economics has some useful insights, but maybe many of its current practitioners have become financially and intellectually captured.  It would not be too tough for industry to do this as industry has both the data economists might want to study and money to pay for research.

As explained by Yves Smith in her post on NakedCapitalism,
As much as it’s good to see Krugman call this sort of thing out, it nevertheless raises a basic question: where has he been? He was soft on his colleagues when the movie Inside Job came out, which discussed corruption in academic economics, focusing on Frederic Mishkin, Larry Summers, Laura Tyson, and….Glenn Hubbard:: 
"OK, about the economist-bashing: I thought it was basically fair. There aren’t, I think, all that many cases when economists are literally paid to offer a specific opinion — although Greenspan’s defense of Keating qualifies. But the movie didn’t say there are. What it suggested, instead, was a kind of soft corruption: you get paid a lot of money by the financial industry, you get put on boards, but only if you don’t rock the boat too much. Besides, you hang out with these people, and get assimilated by the financial Borg. I think all of that is very true." 
In other words, the problem is cognitive capture.
Professor Krugman sees this in the scramble by several economists to court the Republican presidential nominee.
The big story of the week among the dismal science set is the Romney campaign’s white paper on economic policy, which represents a concerted effort by three economists — Glenn Hubbard, Greg Mankiw, and John Taylor — to destroy their own reputations. (Yes, there was a fourth author, Kevin Hassett. But the co-author of “Dow 36,000″ doesn’t exactly have a reputation to destroy). 
And when I talk about destroying reputations, I don’t just mean saying things I disagree with. I mean flat-out, undeniable professional malpractice. It’s one thing to make shaky or even demonstrably wrong arguments. It’s something else to cite the work of other economists, claiming that it supports your position, when it does no such thing — and don’t take my word for it, listen to the protests of the cited economists....
Can Hubbard, Mankiw, and Taylor really be that out of it? I don’t think so. They just believe that they can pull one over on the rubes, and pay no professional price. Let’s hope they’re wrong.
I suspect they are not the only economists who have tried this gambit.
Simon Wren-Lewis wonders what could have possessed Mankiw and Taylor to sell their souls this way. I won’t pretend to have a full answer. But surely part of it is simply that they have been caught up in the vortex of the broader Romney campaign .... 
Is it really surprising, then, that the economists who have decided to lend their names to the campaign have been caught up in this culture of fraud?
The actions by these economists are no surprise.  Their upside is a role or voice in policymaking by the Romney administration.  Their downside is they continue in their current roles.

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