Lawrence Summers and Economic Laws

Friday, 26 February 2010 15:22

Lawrence Summers, ‘Larry’ to his friends, is currently the Director of the National Economic Council for President Obama and thus playing a significant part in the development of American economic policy. He had also been Chief Economist for the World Bank, Secretary of the Treasury in the Clinton Administration and President of Harvard University.

Distinguished though these posts might be, Summers also became notorious on at least two occasions. When he was at the World Bank he wrote a memo for which a member of his staff took the blame. In this he said, ‘I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that. . . I've always thought that under-populated countries in Africa are vastly UNDER-polluted, their air quality is probably vastly inefficiently low compared to Los Angeles or Mexico City.’ At Harvard he explained the under-representation of women ‘in tenured positions in science and engineering at top universities and research institutions’ in terms of what he called, ‘the different availability of aptitude at the high end.’ In short, he believed that women are not as intelligent as men.

Views such as these might suggest that Summers is extremely insensitive, but at least one of his statements shows him to be one of those intelligent men who is also extraordinarily stupid. In 1991 he said, ‘Spread the truth – the laws of economics are like the laws of engineering. One set of laws works everywhere.’

Of course, Summers might have become wiser since he uttered these words. After all, in September 2008 he learned that the markets do not always stabilise themselves as he believed they would. However, when a certain set of beliefs propel a man into a position of wealth, power and influence, he is unlikely to change them.

Summers, it seems, is incapable of distinguishing between inanimate objects and people. I do not mean that he converses with buildings and treats people as chairs, but he cannot distinguish between the nature of inanimate objects and the nature of people. He thinks that, because physicists can derive laws governing what inanimate objects do, economists can derive laws that govern the economic behaviour of people.

When I became an undergraduate studying psychology at Sydney University in 1948, I was required to study the attempts by leading academics to discover the laws governed how we learn. They never did discover such laws, and the whole notion of laws in psychology was quietly dropped. Psychologists were being forced to recognise something about themselves that was very different from inanimate objects.

When a geologist is hacking into a lump of stone, the stone is not thinking, ‘What on earth is this idiot up to?’ When a chemist is pouring a carefully measured amount of an acid on to an equally carefully measured amount of a compound, the compound isn’t deciding whether or not it will behave truthfully, while the acid is bored with whole procedure and decides not to make any effort. But poor psychologists, how their research turns out depends on the goodwill, cooperation and truthfulness of the people they are studying. These attributes depend on, first, how each subject assesses the psychologist, and, second, how each subject interprets what he or she is required to do. Psychologists often decide to avoid all these problems by simply observing what people do. However, simply knowing what people do in a particular situation does not allow you to predict what these people will do in a future situation because you do not know why they did what they did. Two people can do exactly the same thing for totally different reasons.

Inanimate objects do not assess, interpret, value, judge, prioritise, and change their minds. People do this all the time. Assessments, interpretations, values, judgements and priorities arise from the person’s experience, and, since no two people ever have exactly the same experience, no two people ever see anything in exactly the same way.

Economists devoted to finding economic laws argue that they can measure the economic activity of people, derive laws from this, and use these laws to predict what will happen. However, this theory seems not to work in practice. Very few economists predicted the current economic crisis, and there is a marked reluctance among economists to come up with an effective way of ending the crisis. When PM Kevin Rudd decided to give a nice sum of money to all but the well-off Australians in order to get them spending and thus stimulate the economy, he would have known that some of them would spend this money, some would use it to pay off their debts, and some would simply save their windfall. His economic advisers had no way of telling which Australians would do what.

In the early days of psychology, psychologists studied large groups of people because it was believed that that was the only way of doing objective research. However, they they knew that it was impossible to predict from a group study what an individual person will do. It was not until the 1960s that psychologists began to accept that it was possible to do scientifically respectable research where there was only one subject. If you study an individual, and get to know the person really well, so that, say, you knew the meanings the person gave to money, and you knew how the person interpreted himself and his world, you would have a fairly good chance of being able to predict what that person would do if he lost his job, or won the lottery. However, you could not say from this that everyone would behave in the same way that this person did.

There are no laws that govern what people do that operate in the same way as the laws of physics govern what objects do. Individuals assess their situation and decide what to do. Groups of people can discuss their situation and decide what to do. What they do depends on how the interpret their situation. Take, for instance, the British and the Irish governments deciding what to do in September, 2008.

The UK faced a financial crisis that was as bad as, and potentially worse than, the crisis of 1929. Over the boom years Gordon Brown, first a Chancellor and then as Prime Minister, had taken much of the credit for the success of the British economy, but, when he was faced with the evidence of his foolishness, and the stupidity and greed of the bankers, he saw the situation for what it actually was, and acted in accordance with what had been learned from the lessons of the 1929 crash. He interpreted the situation as one where the country needed saving, and where he would do all he could to save it. He did not want to go down in history as the stupid and uncaring leader who led his country to ruin. How different it was in Dublin!

Bertie Ahern when Taoiseach of Ireland believed wholeheartedly in the orthodoxy of the free market in the same way as he believed in the orthodoxy of the Catholic Church. He also believed in cutting income tax, especially to the rich, rewarding his friends, no matter how dishonestly they behaved, not prosecuting old cronies who were engaged in tax evasion and bribing government officials, and showing utter contempt for planning and environmental considerations. His party, the Fianna Fáil, wrote the historian Fintan O’Toole, 'existed as as machine for the gaining and holding of power. It was in general inimical to political ideas that could be spelled out in detail or tested against reality.'

Ahern’s mentor and hero was his predecessor Charles Haughey who, while Taoiseach, acquired some €45 million or 171 his total salary payments as a full-time politician. Ahern close friend was Seanie, that is, Sean Fitzpatrick, Chairman of the Anglo Irish Bank which, over the years of the Ahern government, gave €225 million to its directors in loans, chief among them Fitzpatrick himself.

In the boom years of the 1990s the Irish economy flourished. Many Irish emigrants return home to benefit from the jobs and the money or at least the loans now available. However, nothing lasts forever. On 29 September 2008 Irish banks plummeted on the Irish stock exchange. Anglo Irish shares fell 46 per cent.

The sensible response by the government would have been to nationalise the Anglo Irish Bank. However, doing this would have meant that Ahern and his colleagues were admitting that the way they had interpreted the free market economy as a feast where they and their friends could indulge themselves had failed. Instead they decided that ‘all six major Irish financial institutions, including Anglo Irish, would have their “deposits, loans and obligations” guaranteed 100 per cent by the Irish taxpayer. The government had effectively no idea what those obligations were or how many loans were likely to be repaid. This decision stunned and enraged Ireland’s European partners. . . At least two generations of Irish people would be made to pay for the blind folly and greed of a closed elite.’

The citizens of Britain and of Ireland had their own interpretations of what what was happening in their country. The British reacted in much the way they had always reacted to some major threat. With dogged determination they kept on doing what they could to keep on going. Not that that meant they did not complain. Meanwhile, the Irish reverted to what they had always done when they were faced with economic disaster. They left the country. If they could not leave, they wished they could.

Neither the British and Irish politicians nor the British and the Irish citizens were compelled to behave as they did by any economic law. They simply behaved in accordance with how they had interpreted their situation. Is it not extraordinary that a man regarded as an outstanding economist, a man who continues to have a significant influence on American economic policy, believes that, ‘You can’t repeal the laws of economics. Even if they are inconvenient.’

Doesn’t he know that we can change what we do simply by changing our minds?

Last modified on Tuesday, 17 May 2011 05:10