Monday, March 17, 2008

What Do We Really Know About the Economy?

London-based financial consultant David Roche claims here that there is no way to avoid the looming recession. And it’s going to last a long time. But barring “major policy blunders,” he writes “it won't be a 1930s-style depression.”

Now, there’s some cheery news. Roche provides a number of details about how U.S. and global finances function. He concludes that all of the things that the Fed and other central banks are doing to attempt to stop the disaster simply are incapable of addressing the basic facts of the situation.

Roche may be right. Then again, expert opinions on the economy right now are a dime a dozen.

On a related subject, Nobel Prize winning economist Edmund S. Phelps argues here that many of our current economic woes stem from the assumption that our highly complex economy is basically predictable — an idea that became widely accepted three decades ago. According to this theory, all “the risks in the economy” are “subject to known probabilities … driven by purely random shocks and not by innovations whose uncertain effects cannot be predicted.”

In Phelps’ view this theory is arrogant and wrong-headed. But acceptance of the theory provided the excuse needed for those that were eager to tinker with and manage the economy. Phelps contends that the main constant in an economy as complex and dynamic as ours is uncertainty. He essentially makes the case for humility in dealing with the economy.

In much the same vein, GMU economist Russ Roberts discusses at length here why it is impossible for anyone to empirically determine the specific economic effects of economic events. He starts out discussing a dissatisfying answer he had to give a reporter who wanted to know whether the U.S. had benefited or been harmed by NAFTA.

Roberts replied that it is “absurd to think that in a $14 trillion economy, you could tease out the impact of increased trade with Mexico and Canada and disentangle it from the thousands of other changes going on.” Only those with an agenda, suggests Roberts, could possibly make claims that they know for certain how NAFTA or any other economic event has impacted the U.S. economy.

Roche may be right. We may be in for a long hard slog in the economy. But then again, I’m not so sure that people like him can successfully predict the economic future. I’m not sure anyone can. But I do believe in good old fashioned human ingenuity and entrepreneurial spirit. As long as we don’t hamstring people, they will find ways to make the best of whatever situation presents itself.

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