Economics and its critics

Hans-Werner Sinn MUNICH – There is much to criticize in economics nowadays. For example, the profession focuses far too little on political issues and far too much on beating students to death with mathematics. But much current criticism of the profession is based on misunderstanding and ignorance. Consider Adam Smith’s concept of the “invisible hand,” which implies that a market equilibrium is efficient if perfect competition prevails and well-defined property rights exist. Contrary to what many critics suppose, mainstream economists do not assume that these ideal conditions are always present. On the contrary, economists tend to use these conditions as a benchmark for analyzing market failures. Like sniffer dogs, they search the economy for such defects and ponder how they can be corrected through intelligent state intervention. In this respect, economists are like doctors, who have to know what a healthy body looks like before they can diagnose disease and prescribe treatment. A good doctor does not intervene arbitrarily in the body’s processes, but only in cases where there is objective proof of a disease and an effective treatment can be prescribed. Environmental regulation addresses a particularly striking example of market failure. Markets are generally efficient if companies’ revenues correctly reflect all the benefits that their output bestows on third parties, while their costs reflect all the harms. In this case, maximizing profit leads to maximizing social welfare. But if production entails environmental damage for which companies do not pay, incentives are distorted; companies may turn a profit, but they function inefficiently in economic terms. So the state “corrects” firms’ incentives by levying fines or issuing bans. Another malady that economists sometimes diagnose might be called “Keynes disease.” If demand is too weak, it can lead to a sharp drop in employment (because wages and prices are rigid in the short term). The disease can be cured with injections of public, debt-financed stimulus – like giving a cardiac patient doses of nitroglycerine to keep his heart going. Contrary to what many think, there is no fundamental bias against this medicine in mainstream economics today. But stimulus cannot be seen as a universal remedy. Many ailments that may afflict an economy are chronic, not acute, and thus call for other types of treatment. Trying Keynesian therapy to resolve, say, the structural problems currently affecting the countries of southern Europe would be like trying to cure a broken leg with heart medicine. Nitroglycerine addresses the risk of circulatory collapse. In economic terms, that is what was needed following the 2008 global financial crisis. But long-term use of such medication can be fatal. Here and elsewhere, ideology causes conceptual confusion. For example, Smith viewed competition as a basic condition of the invisible hand’s operation, because monopolies and oligopolies exploit consumers and restrict production. But only competition among providers of similar products is beneficial. Competition among providers of complementary goods or services is harmful, and can be even worse than a monopoly. (That is why train drivers and pilots, for example, should be forced into monopoly unions that represent all of the other employees of their respective companies.) The market failures that initially give rise to public-sector intervention tend to recur internationally, which means that competition between states is usually not efficient, either. Examples include competition between welfare states to deter economic migrants, the race to the bottom in taxation, and regulatory rivalry in the banking and insurance sectors. Competition, contrary to what many on the right believe, is not always good. Hans-Werner Sinn is Professor of Economics and Public Finance at the University of Munich. Copyright: Project Syndicate,

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Economics and its critics