On Election Eve, Economists Struggle to Figure Out a World That’s Unraveled
Both Trump and Biden are winging it when it comes to economic theory—but so are economists, who have yet to get their theoretical house in order.
From the 2008 financial crisis to the COVID-19 shutdown, the world’s best economists have struggled—usually unsuccessfully—to regain the influence over policymakers they once wielded with such abandon. The problem is, most of them don’t have new theories ready that can actually make sense of a globalized world in disarray—and won’t for quite a while.
Once confident in their wisdom as a profession, many economists today admit they are trying desperately to understand the workings of a globalized system they now realize they never really grasped very well. The so-called experts have been continually surprised by the ways in which a tightly knit, fast-paced world economy can produce panics, financial collapses, socially disrupting inequality, a still-mysterious low-interest-rate environment, and, now, a sudden pandemic that has caused continentwide shutdowns. Most of the old models are broken. But there’s little there to replace them.
With the crucial 2020 U.S. presidential election only a day away, that dearth of economic certainty is proving problematic, as politically expedient, populist policies are taking hold in both parties. Economists still wonder how they misread things so badly that Donald Trump could be elected by promising to close borders and start trade wars in a bid to help a devastated middle class. And they wonder how the once neoliberal, free-trading Biden could turn into a quasi-protectionist himself, proposing a $400 billion “Buy American” plan and pledging to renegotiate the Obama administration’s Trans-Pacific Partnership to address American workers’ rights.
For many Americans, the economists have proved to be “false prophets,” as Binyamin Appelbaum called them in his harshly critical 2019 book, The Economists’ Hour.
If politicians everywhere—in Washington, in Tokyo, and all across Europe—are struggling to find the right recipes, they’re not alone.
“Policy cannot wait, and academic knowledge is way behind the needs of policy,” said Andrei Shleifer of Harvard University, one of the most cited economists in the world. “It is moving, but not fast enough. I would say that it is clearly true that the standard New Keynesian model [which has prevailed for decades as a predictor of economic conditions] at this point is unhelpful, and needs to be replaced. People are working on how to replace it.”
But that could take many years, he added. “Progress is pretty slow, and the sluggishness from the old ideas is significant.”
For decades, economists were able to come up with overarching theories that seemed to explain more or less how the economy worked, serving as at least a blueprint for policymakers. John Maynard Keynes developed the field in the middle of the Great Depression, creating a theoretical model that explained why government spending could help boost employment and right a downturn. Decades later, he was sidelined in favor of conservative economists led by Milton Friedman, who preached minimal monetary intervention and small government, especially low taxes and deregulation. By the turn of the century, economists were calling a fairly stable, crisis-free economy the “Great Moderation,” when prudent management of interest rates could tame inflation, boost employment, and ensure steady growth. Then it all blew up in their faces—and the aftershocks keep coming.
“There is probably a bigger gap than there ever was between where mainstream economic theory is and where the policy is,” said the Nobel Prize-winning economist Joseph Stiglitz of Columbia University. “The prevailing wisdom was, before [the crash of] 2008, the economy was always in equilibrium. Except when it wasn’t. That was true for over 100 years, but two events 12 years apart have upset that thinking. … It showed economics was not a science.”
And yet, like physicists in search of a unified theory, economists are still looking for new ways to reinvent their science. “There isn’t a new unified framework yet,” said Adam Posen, the president of the Peterson Institute for International Economics. “I think theory has yet to catch up to policy analysis.”
That disconnect is seen most clearly on Capitol Hill, where lawmakers have been unable to find a replacement for the $2 trillion CARES Act, the big stimulus package launched in the middle of the pandemic-related economic collapse. As a first response to COVID-19, it was a classic Keynesian move, and it seemed to work in avoiding an even worse recession: GDP grew 7.4 percent on a non-annualized basis in the third quarter, the Commerce Department said Thursday, meaning the United States has managed to claw back much of the economic damage done this year.
But Republicans are loath to open the taps again—even pointing to decent third-quarter growth as a reason not to—while Democrats push for more deficit spending, creating an impasse in Congress. Meanwhile, businesses and homeowners are being forced to default on their mortgages, and unemployment claims remain stubbornly high. Part of the problem is outdated economic ideas. Budget deficits clearly matter less than they ever did, because near-zero interest rates make debt more sustainable, and private sector investment is clearly not being crowded out. But Republicans, after overseeing a historic mushrooming of the national debt under Trump, have suddenly decided that deficits are a problem.
The ongoing political battle over a further coronavirus response is “incredibly concerning,” said Wendy Edelberg, a former chief economist at the Congressional Budget Office. “Humans seem to be very slow to adapt to take on new information. And that is frustrating.”
It’s absurd, she said, that in the current environment political concerns about the U.S. debt and deficit should stand in the way of more deficit spending to right the economy. “What we’re seeing in the financial market demand for U.S. Treasurys says we have a different environment, and it would be foolish not to use that information,” said Edelberg, today the director of the Hamilton Project at the Brookings Institution. “We understand a lot better how monetary policy operates when we’re at the zero lower bound, and we should take that on board. It’s frustrating to be stuck in 2005. The world has changed.”
If economists admit that pretty much everyone is winging it, it has been a tough decade. Economists had barely begun to figure out the lessons of the Great Recession that began in 2008-2009, and the anomalous low-interest rate, low-growth period that followed, when they were blindsided by COVID-19’s attack on the sinews of the entire global economy. All that came amid another still unfolding, and still little-understood crisis: the speed at which developing nations like China displaced U.S. jobs this century. The so-called China shock helped fuel the rise of Trumpian populism, xenophobia, protectionism, and it’s one that most trade economists admit they didn’t see coming.
“Globalization is more complicated than we realized it was,” said Karen Dynan, a former Federal Reserve and Treasury official now at Harvard University. “Economists have long recognized that not everyone gets the benefits but there is a net benefit. Then the idea is you can take the benefits and compensate the losers. But in truth we gave only lip service to the losers of globalization. … I think it should make us really humble about our models.”
Or as Edelberg put it, “economists always appreciated that trade increases aggregate output but has really serious distributional consequences,” meaning the economy as a whole might win, but there will definitely be some losers. “Economists for far too long just swept those concerns away, figuring that surely the politicians will figure it out. We said, ‘We’re just going to focus on the aggregate.’ I think that was a mistake.”
That clinical approach shone through when it came to the China shock and the large-scale destruction of manufacturing jobs in the last 20 years. Politicians, consumed with deficit reduction, did next to nothing; Washington spent very little on job retraining and education, while entire communities were devastated, turning some states from blue to red. By the same token, economists and policymakers—eyes fixed on the aggregate—ignored the widening income gap.
But that, too, has big implications for understanding growth—or the lack of it. In a world in which an ever-smaller proportion of people hold most of the wealth, consumption will be suppressed on a long-term basis simply because the rich are less likely to spend, while the growing numbers of poor don’t have the means, even with easy credit, said Christopher Carroll, a leading economist at Johns Hopkins University. Inequality, in other words, is leading to slower global economic growth on a chronic basis.
The new economic reality—which has surged ahead of economists’ ability to model it—explains in large part the ad hoc and often unorthodox economics of Trump’s Republican Party, and the increasing support for once-radical ideas on the left.
Trump, despite or because of an ignorance of economics that Appelbaum notes is “without parallel among modern American presidents,” has single-handedly overturned free-market orthodoxy in the Republican Party. He has made tariffs (taxes on U.S. businesses and consumers) his go-to trade weapon. He has thrown tens of billions of dollars in government subsidies at politically favored sectors. He has made state-managed trade, once the purview of Maoists, the centerpiece of his trade deal with China.
Meanwhile, Democrats are pressing Biden to advance policy ideas like universal college education, universal health care, universal basic income, and a much more progressive tax code. Above all, there is the danger of globalization unraveling and protectionism continuing to creep back, no matter who is elected president.
“I think we could go very much the wrong way,” said David Autor, an economist at the Massachusetts Institute of Technology. Though it was Autor who largely documented the effect of the “China shock” on U.S. workers, he said: “For the United States to disengage from the rest of the world is just a disaster. It creates an enormous opportunity for China, which is building counterpart institutions around the world and forcing some corporations to decide whether they want to hire English-speaking or Chinese-speaking personnel.”
As Fareed Zakaria points out in his new book, Ten Lessons for a Post-Pandemic World, the entire axis of economic thinking is moving leftward as policymakers come to realize, slowly, that “markets are not enough.” He noted that 43 percent of Americans surveyed in 2019 agreed that “some form of socialism would be good for the country,” a nearly 20-point gain from the 1940s, when the United States was actually allied with the Soviet Union.
“There seemed to be a quiet revolution afoot. The country that defined itself by its unapologetic advocacy of capitalism now appeared to be increasingly embracing an ideology that it had fought against for most of the twentieth century. COVID-19 appears to have only accelerated this trend,” Zakaria wrote.
Economists are still working through the masses of new data to create new models: Automatic stabilizers for downturns, greater capital reserves to make the financial sector more resilient, and advocacy of universal health care are all becoming mainstream. Microeconomists like Carroll are working to reconcile the individual decisions of over 7 billion people with big macroeconomic models that are updated at a glacial pace. There’s a new appreciation that old shibboleths, like the relationship between employment and wages, are broken, thanks to a globalization of the labor force and a mismatch in the power of labor and capital.
Being economists—about as contentious an academic field as there is—some disagree strenuously that the field has failed overall. “I think the profession is doing really well in how it’s responded to both crises,” referring to 2008 and COVID-19, said Mark Gertler of New York University. “There was an almost instantaneous stream of research to address the financial crisis and now the COVID crisis.”
Gertler says he believes the current macroeconomic models are sturdier than they were during the last great economic crisis—the stagflation of the 1960s and ’70s. “It’s all a matter of degree. The first [stagflation] crisis created a fundamental change in the way we did macroeconomics,” he said. “The old econometric models fell apart, because they could not explain the simultaneous increase in unemployment and inflation. It blew apart the field.” The solution ultimately came in shoring up microeconomics, which studies the decisions of individuals and companies, bringing more rigor to modeling beliefs and expectations, price settings, and credit constraints.
Still, it’s all a far cry from the days of the Great Moderation before the 2008 crisis. “Mainstream economists thought we had just nailed it in understanding the business cycle,” Dynan said.
“The last two recessions have highlighted the fact that we are still exposed—and even more exposed—to mistakes than we used to be.”