TCA Srinivasa-Raghavan: Mirror, mirror on the wall?

LINE & LENGTH

If you can't get it right after 16 attempts, how can you say your method works?

Back in 1970, when Amartya Sen was still teaching at the Delhi School of Economics, one of the subjects assigned to him was mathematical logic. On a rainy winter day, wishing to explain statement calculus, he wrote on the board: "The Delhi School of Economics is a ghastly pink building."

The rest of the afternoon was spent most enjoyably discussing whether pink was a ghastly colour, or if the building was ghastly because it was pink or whether being pink was fine but the shade was ghastly. The discussion, as with everything economists discuss, was inconclusive.

I am reminded of this incident because the June issue of the Economists' Voice, an e-journal brought out by the University of California Berkeley Press, has an article by Laurence J Kotlikoff entitled "Are Economists Smarter" (than sociologists?).

He starts off saying: "The final straw that forced my friend Larry Summers to resign as President of Harvard may have been his alleged suggestion that economists are smarter than sociologists ... I had always thought economists were better looking than sociologists, but smarter?"

This came as news to me. Economists better-looking than sociologists? Certainly not in the Delhi School of Economics, which boasts of a department of sociology as well. Both faculty-wise and students-wise, it was and continues to be a no-contest. The socio-types, as they were known, won hands down in the looks department.

Kotlikoff says economists are not smart at all, and the reason he gives is that his brother refused to study economics and studied English instead, and eventually, however, ending up as a vet. But then he went to get a Ph D in physiology. Now he is engaged in genetic research with massive grants. This, says Kotlikoff, shows who was smarter, he or his brother.

He once asked his brother if they had located the smartness gene yet. "We have," his brother Mike said. "And there's an easy test for it. Anyone who thinks he's smarter doesn't have it." That, if I may venture to suggest, applies especially to economists.

Kotlikoff has made his point in a way that economists are likely to dismiss saying "he was just trying to be funny." But I suspect not. When older brothers admire their younger siblings""and Kotlikoff admires not just his brother Mike, but also his sister Barbara, who started off as a paralegal but now runs a large corporation""it suggests an element of seriousness.

But psychology aside""into which also economists are now dabbling so that they can discard the foundation on which their discipline is built, namely, rational human behaviour""how smart are economists really? For example, after raising interest rates as many 16 times, they still can't get demand to decline. What does that do to their theories about the inverse relationship between price and quantity? How many more rate changes are required before demand finally succumbs? Indeed, will such rate changes work at all?

I want to pose a question in this context to the really smart economists: "Is it possible for a reverse liquidity trap to come into being?" In a Keynesian liquidity trap, investment does not revive even when interest rates fall to zero because people expect nothing to be gained from it.

Could we now have a reverse of this phenomenon? Even if not exactly the reverse, because interest rates cannot rise to infinity, is it possible that central banks can go on raising rates but not have much impact on inflation? I am beginning to suspect so.

This aspect of globalisation, that is, its impact on aggregate demand and its rendering central banks or monetary policy ineffective, has not been analysed by economists, who, in any case, are slow to change their views. But I think this is exactly where we are now because a fundamental change has occurred.

After a very long time, nearly 120 years or so, both labour and capital are in excess supply globally and therefore cheap. Over-heating, inflation and bank collapses used to be commonplace back in the second half of the 19th century, before central banks got into the bailing-out business.

The result now is the same as then: both manufactures and services have become cheap. Capital is almost completely mobile and labour, though not as mobile it was then, is delivering services in a disembodied way, that is, via satellites, which is why American wages have been stagnant for the last five years. The Europeans are fighting this but at a cost that will be their undoing.

The only limiting factor is the supply of physical resources. What is happening now is different from the previous periods, when, in the final analysis, it was the supply of currency, namely, gold and, to a lesser extent, silver (that is credit and confidence in it) that eventually determined the levels of activity. Add to this the emergence of nation states as major players in the international financial markets and you get a situation that resembles nothing that has gone before, even the much-touted previous phase of globalisation.

But the world is not going to revert to metal-backed currencies. So one consequence will be asset and commodity price inflation, which is what we are seeing now. The question therefore is: if the mover changes, how should the shaker respond? Or, when facts rearrange themselves, how should theory respond?

If economists are indeed smarter, they should tell us, and soon.