Fundamentalists versus Realists

Senin, 14 Desember 2009 , Posted by JASTIKA at 04.17

Debate among economists. business online, marketing, tips trick, about the $700 billion Paulson plan reveals a deep divide between realists and fundamentalists. If economists and policy makers pay attention to how the tension between these two positions plays out in this particular debate, it will help us know how to deal with it in other areas, including development.

The formal, model-based approach of the fundamentalists has contributed much to progress in economic analysis. At key junctures, it has also made important contributions to policy. The challenge is to maintain an intellectual environment that leaves space for a conversation with realists as well. In complicated policy contexts where models don't yet capture key forces, the realists have much to offer both policy makers and fundamentalist modelers. By giving voice to observations that strike realists as obvious but that are not accepted in conversations dominated by fundamentalists, the report by the Commission on Growth and Development could encourage a richer, more open debate about the policy options for poor countries.
Realists and Fundamentalists business online, marketing, tips trick,

The financial crisis provoked three open letters to policy makers. Fundamentalists opposed the plan (here.) Realists supported the plan (here) or supported more discretionary powers for dealing with the crisis without endorsing any specific plan (here.)

A quick look through the lists of economists who signed the various letters shows that the camps do not separate cleanly along the familiar lines of left-versus-right or active-versus-limited government. The key difference lies in the relative weight each side gives to formal models as opposed to judgment.

Fundamentalists have an unswerving faith in models. Policies should always be derived from the best available model. Data should be filtered through a model. If an observation does not fit within the context of a model, it should be excluded from consideration.
Realists are more conscious of the limits of models and more comfortable with a division of labor between the researcher who improves the models and the clinician who makes policy decisions. They recognize that the power of models comes precisely from a commitment to abstraction that filters out potentially important complexity. They believe that useful evidence can accumulate with direct experience as well as through the research process of testing and refining models. They believe that researchers should consider the possibility that the fault lies with the model when its predictions diverge from clinical judgment and that policies should draw on both sources of evidence.

Many times, the confidence fundamentalists have had in abstract models turned out to be well founded and the objections raised by realists who were more focused on details were misplaced. The fundamentalists were right that an airline industry could still function even if airlines could set their own fares; that people could still talk to each other even if they purchased phone service from different companies. The realists pointed to all the complicated details that arise in such markets, details that simple models could not capture. Fundamentalists, correctly, ignored the detail and pushed prescriptions based on the textbook model of competition.

Other times, the models are missing something that is too important. In the study of macroeconomic fluctuations, real business cycle theorists and their descendants, the dynamic stochastic general equilibrium modelers, are the quintessential fundamentalists. Their models are a useful way to make research progress, but in macroeconomic policy making, the great depression, which these models cannot explain, is a decisive data point warning us that the models are incomplete and have to be supplemented by clinical judgment.
The Financial Crisis

In the current crisis, the astonishing and unexpected consequences of the Lehman Brothers bankruptcy should serve as a similarly decisive data point. On the Thursday and Friday before Lehman filed for protection, I was at a conference on the financial crisis. Everyone there expected them to file on Monday. We repeated for each other all the fundamentalist arguments: "Everyone had been given time to prepare." "The courts handle bankruptcies all the time." None of us expected that putting Lehman through a court managed bankruptcy would be much different from arranging a forced sale of Bear Stearns.
We were all wrong. Within days, AIG was insolvent. Runs were developing on Goldman Sachs, Morgan Stanley, and the entire money market fund industry. Banks had stopped lending to each other in the Fed Fund market. Rates on Treasuries approached zero.

In response, the Treasury, Fed, and market regulators took drastic steps that the fundamentalists would surely have opposed had there been time for debate. Together, the Fed, Treasury, and the SEC arranged an emergency capital injection into AIG, guaranteed all the liabilities of money market funds, banned short sales of stock in financial firms, and injected massive amounts of liquidity into the banking system. Looking back, it appears that they had enough sand bags to hold back the flood and stop the panic, but perhaps just barely enough.
This is not a data point that can be dismissed as an outlier. It is the kind of observation that should make the fundamentalists just a bit less confident in their models and a bit more willing to listen to the realists who are willing to defer to the policy makers on the front lines.

The Commission's Report
As the report implies (read the overview here), there is a fundamentalist model of developing countries. It has an implied policy prescription captured in the familiar phrase "stabilize, liberalize, privatize."

There is an observation that should do for development what the great depression does for business cycle theory and what the panic in the days after the Lehman bankruptcy should do for finance. The report wisely leads with this fact. Some nations have grown for decades at historically unprecedented rates of growth. China is the extreme case in this set, as the largest economy and the one that has grown fastest, so it naturally attracts the most attention. It is not, however, the only one, and they cannot simply be dismissed as outliers.
The fundamentalist models that would justify the "stabilize, liberalize, privatize" prescription don't generate sustained growth at these rates. These models all emphasize accumulation of human and nonhuman capital, and stocks of inputs can't grow fast enough to generate growth at these rates. It could be, as the fundamentalists sometimes suggest, that these very fast growing economies are privatizing fast enough to get big temporary gains from steps like privatization that remove distortions, but in the cases that the commission point to, rapid growth lasts too long for this to be plausible.

Moreover, if we will listen, as the commission has done, policy makers will tell us what they think is going on. To cite one point taken up in the report, inflows of technology by foreign firms are crucial to rapid growth. With appropriate subsidies, countries can encourage this inflow. An exchange rate regime that makes the country an attractive base for manufacturing goods for export may be an important second-best subsidy that can achieve this goal. Directed credit or other forms of industrial policy may do so as well.
These are not deep points. They have been made before. Of course, they immediately suggest the standard point, which the report makes very clearly: good policy requires good governance. Little of this, however, has been taken seriously enough by mainstream fundamentalist academics. In these circles, discussions of industrial policy or structural exchange rate policies are still disreputable (or perhaps dangerous,) so the possibility that effective governance combined with activist policies can lead faster growth than passive policies is not given serious consideration. business online, marketing, tips trick,

By listening to the realists and taking what they say seriously, the report has the potential to change this equilibrium. Realists and fundamentalists will have much work to do before they agree about whether exchange rate policies or explicit forms of industrial policy work can be beneficial for growth, but at least they begin a conversation that is more productive than the "don't ask, don't tell" status quo.