Causes of the Crisis

Critical Review has started a new blog “Causes of the Crisis” featuring contributors to the journal's stellar issue on the topic. The papers in CRs special issue add up to the best and most comprehensive autopsy of the financial collapse available anywhere. The blog looks terrific too. Some excerpts…
David Colander:

Using models within economics or within any other social science, is especially treacherous. That’s because social science involves a higher degree of complexity than the natural sciences. The reason why social science is so complex is that the basic unit in social science, which economists call agents, are strategic, whereas the basic unit of the natural sciences are not. Economics can be thought of the physics with strategic atoms, who keep trying to foil any efforts to understand them and bring them under control. Strategic agents complicate modeling enormously; they make it impossible to have a perfect model since they increase the number of calculations one would have to make in order to solve the model beyond the calculations the fastest computer one can hypothesize could process in a finite amount of time.
This recognition that the economy is complex is not a new discovery. Earlier economists, such as John Stuart Mill, recognized the economy’s complexity and were very modest in their claims about the usefulness of their models. They carefully presented their models as aids to a broader informed common sense. They built this modesty into their policy advice and told policy makers that the most we can expect from models is half-truths. To make sure that they did not claim too much for their scientific models, they divided the field of economics into two branches—one a scientific branch, which worked on formal models, and the other political economy, which was the branch of economics that addressed policy. Political economy was seen as an art which did not have the backing of science, but instead relied on the insights from models developed in the scientific branch supplemented by educated common sense to guide policy prescriptions.
In the early 1900s that two-part division broke down, and economists became a bit less modest in their claims for models, and more aggressive in their application of models directly to policy questions. The two branches were merged, and the result was a tragedy for both the science of economics and for the applied policy branch of economics.

Vernon Smith:

Hayek made a similar charge [to Krugman's in his long NYT piece] in his Nobel Lecture of December 11, 1974, The Pretence of Knowledge:

… the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

Although Hayek saw the problem as stemming from an inappropriate “scientistic” attitude, he explicitly wanted “…to avoid giving the impression that I generally reject the mathematical method in economics.” Rather, his main message was that

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible…The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Economic scientists have precious little understanding of this rule governed complex order, and how to keep it on its demonstrated long term path of growth and human betterment without suffering too irreparably from the kind of unpredictable reverses that we are now mired in. Less pretence and a commitment to learn from the new data being generated as I write, will be both humbling and informative, after the inevitable human political impulse to blame one's long standing political adversaries has run its course.

I look forward to posts from the other contributors.

Author: Will Wilkinson

Vice President for Research at the Niskanen Center

8 thoughts

  1. Warren Buffett has interesting things to say about corporate philanthropy.
    A recent survey reported that about 50% of major American
    companies match charitable contributions made by directors
    (sometimes by a factor of three to one). In effect, these
    representatives of the owners direct funds to their favorite
    charities, and never consult the owners as to their charitable
    preferences. (I wonder how they would feel if the process were
    reversed and shareholders could invade the directors’ pockets for
    charities favored by the shareholders.) When A takes money from B
    to give to C and A is a legislator, the process is called
    taxation. But when A is an officer or director of a corporation,
    it is called philanthropy. We continue to believe that
    contributions, aside from those with quite clear direct benefits
    to the company, should reflect the charitable preferences of
    owners rather than those of officers and directors.
    Berkshire’s practice in respect to discretionary philanthropy
    – as contrasted to its policies regarding contributions that are
    clearly related to the company’s business activities – differs
    significantly from that of other publicly-held corporations.
    There, most corporate contributions are made pursuant to the wishes
    of the CEO (who often will be responding to social pressures),
    employees (through matching gifts), or directors (through matching
    gifts or requests they make of the CEO).
    At Berkshire, we believe that the company’s money is the
    owners’ money, just as it would be in a closely-held corporation,
    partnership, or sole proprietorship. Therefore, if funds are to be
    given to causes unrelated to Berkshire’s business activities, it is
    the charities favored by our owners that should receive them.
    We’ve yet to find a CEO who believes he should personally fund the
    charities favored by his shareholders. Why, then, should they foot
    the bill for his picks?
    Let me add that our program is easy to administer. Last fall,
    for two months, we borrowed one person from National Indemnity to
    help us implement the instructions that came from our 7,500
    registered shareholders. I’d guess that the average corporate
    program in which employee gifts are matched incurs far greater
    administrative costs. Indeed, our entire corporate overhead is
    less than half the size of our charitable contributions. (Charlie,
    however, insists that I tell you that $1.4 million of our $4.9 million overhead is
    attributable to our corporate jet, The Indefensible.)
    Below is a list showing the largest categories to which our
    shareholders have steered their contributions.
    (a) 347 churches and synagogues received 569 gifts
    (b) 283 colleges and universities received 670 gifts
    (c) 244 K-12 schools (about two-thirds secular, one-
    third religious) received 525 gifts
    (d) 288 institutions dedicated to art, culture or the
    humanities received 447 gifts
    (e) 180 religious social-service organizations (split
    about equally between Christian and Jewish) received
    411 gifts
    (f) 445 secular social-service organizations (about 40%
    youth-related) received 759 gifts
    (g) 153 hospitals received 261 gifts
    (h) 186 health-related organizations (American Heart
    Association, American Cancer Society, etc.) received
    320 gifts
    Three things about this list seem particularly interesting to
    me. First, to some degree it indicates what people choose to give
    money to when they are acting of their own accord, free of pressure
    from solicitors or emotional appeals from charities. Second, the
    contributions programs of publicly-held companies almost never
    allow gifts to churches and synagogues, yet clearly these
    institutions are what many shareholders would like to support.
    Third, the gifts made by our shareholders display conflicting
    philosophies: 130 gifts were directed to organizations that
    believe in making abortions readily available for women and 30
    gifts were directed to organizations (other than churches) that
    discourage or are opposed to abortion.
    Last year I told you that I was thinking of raising the amount
    that Berkshire shareholders can give under our designated-
    contributions program and asked for your comments. We received a
    few well-written letters opposing the entire idea, on the grounds
    that it was our job to run the business and not our job to force
    shareholders into making charitable gifts. Most of the
    shareholders responding, however, noted the tax efficiency of the
    plan and urged us to increase the designated amount. Several
    shareholders who have given stock to their children or
    grandchildren told me that they consider the program a particularly
    good way to get youngsters thinking at an early age about the
    subject of giving. These people, in other words, perceive the
    program to be an educational, as well as philanthropic, tool. The
    bottom line is that we did raise the amount in 1993, from $8 per
    share to $10.

  2. That seems like a pretty vague proposition. You could probably win by conceding most of the points the other side is thinking will be the most controversial (e.g., that businesses ought sometimes to engage in philanthropy), and limit the discussion to a narrower set of ideas.

  3. For a libertarian pro-CSR approach, see Roderick Long’s “Stakeholder Theory for Libertarians: A Rothbardian Defense of Corporate Social Responsibility.” [.doc]
    Also see John Hasnas’ “The Social Responsibility of Corporations and How to Make It Work for You,” [.pdf] 44 The Freeman 332 (1994) and “The Normative Theories of Business Ethics: A Guide for the Perplexed,” 8 Business Ethics Quarterly 19 (1998) For a .pdf version of that last article, go here.
    My sympathies for having a debate partner with the last name “Crook,” given the proposition and the current economic climate.

  4. For a constitutional economics approach:
    “Corporate social responsibility and the ‘game of catallaxy’: the perspective of constitutional economics”, by Viktor Vanberg.
    Abstract The paper examines the issue of corporate social responsibility (CSR) from the perspective of constitutional economics, focusing on the distinction between a political community’s constitutional choice of the rules of the “market game,” and the market players’ sub-constitutional choice of strategies within these rules. Three versions of CSR-demands are identified and discussed, a “soft,” a “hard”, and a “radical” version. The soft version is concerned with the issue of how “socially responsible” corporations ought to play the market game within existing rules. The hard version is about how the rules of the market ought to be changed in order to induce “socially responsible” corporate behavior. And the radical version questions the compatibility of CSR and the logic of the market game, calling in effect for adopting some alternative economic regime.

  5. Will you tell us after your reading which one do you think is the best one of the articles proposed in the comments?

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