Tuesday, January 05, 2010

The New Yorker on Chicago School of Economics

John Cassidy, in his Jan 11 issue of The New Yorker has a detailed account on the Chicago School of Economics and how it has been the brunt of so much criticism for the credit crisis. Chicago school is associated with -- government intervention is bad except in monetary policy…markets should be allowed to work and left alone because they are self-correcting.

In his article, Cassidy takes on some of the iconic professors and drills down to the point where it appears that in many cases ideology blind-sights reality for many of them. Several professors in Chicago cling to the ideology and when current events don’t match – they will shoehorn any reasoning to sustain the Chicago party line. Cling to almost to the point of being ludicrous. Two examples, that clearly jumps out are that of Fama and Cochrane. While in every forum, lectures, and classes I have attended – I never came across the idea that any one claims that markets are efficient. In fact, that is something that could not be proved – and much of Fama’s work over almost four decades have gone back and forth to tear apart this issue to why we cannot prove markets are efficient. By definition, it is called efficient market hypothesis – not a law or theorem.

In a more general note, I believe the article is a good one. And here’s why:

(1) It talks about that some great ideas in the hands of the uninitiated may get stretched so far that with a combination of right communication headwinds may dilute the subtleties and nuances of the original idea. (Example of Heckman, Lucas is quite pertinent). I find an interesting parallel few years back when revisionist historians, (such as Meghnad Desai) believed that beliefs of Marx were lost in translation over the years to the extent Marx himself does not qualify as a Marxist.

(2) Taking an extreme position is easier than working with nuances and arguments. This is in line with what popular press can grab and run with easily. Nuances and subtleties and exceptions and ifs and buts take more space, discussion, and more importantly understanding. End result, extremes – such as, Chicago believes markets are efficient is what emerges. This is a recipe for formation of a cult where reasoning lapses or converges to support a party line. Whether the belief is in momentary beliefs, Chicago school, Keynesian, etc., does not matter. In this regard, I believe there are people on all sides and their mere existence and the noise they create does not and should not determine the actual beauty and essence of a theory.

(3) Visit to Univ. of Chicago today gives the right perspective what a true learning institution should be. (I say this albeit my own bias). As the article suggests, people as diverse as Fama and Thaler play golf together. Rajan and Posner think differently from Lucas and Cochrane. Posner’s co-blogger Becker openly acknowledges that markets are not efficient. But until we have a better alternative – what else do we have. In summary, what comes out are two key points: Chicago thrives in a constant dynamic of strong ideas. Debate and arguments are a constant part of Chicago and that is what is most respected. On a personal note, it was heartwarming for me to have Rajan as the commencement speaker. If Chicago was loomed into old ideology, I’d expect somebody else.

(4) Arguments have limitations. Fama’s argument soup of joint hypothesis problem which sort of says unless you know the fair value one cannot determine whether the price in incorrect and it presupposes market efficiency. Argument and logical structure has limitations and those limitations are in the language. Who knows the logical structure can break down if we discover another language. (Books on logical fallacy have been written)

(5) Becker’s comment is what comes close to what I personally agree as the most balanced. No one claims the market is efficient. But at the same time, that’s the best bet we have. Even recent examples of China and India prove that believing in market principles, incentives, and less of central planning and government run programs is the road to prosperity.

(6) Posner’s comment to retire Chicago school may be the most sensible thing to do. As a vested personal interest, however, I would rather be a associated with a school whose thinking shapes or forces people to think in a way rather than a proponent of so many things that it makes hardly an impact at an institutional level.

In the words of Booth School of Business Dean Ted Snyder, responding to a question at the “Future of Markets” on why there has not been a unified Chicago response for all the bashing the school is getting in the aftermath of credit crisis, he said, there is no one Chicago thought today. I agree this is what the truth is. In many ways, the term Chicago school has become more of an ideal – a philosophy that has pervaded the thought process not only across the department of economics all over the world, but in our own thinking. To try to find Chicago school within the physical boundaries of University of Chicago is almost like trying to find Marx in London.

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