Special Reports / Do not trust economists!

Do not trust economists!

Tomáš Sedláček in conversation with Łukasz Pawłowski and Marcin Serafin · 8 July 2014
Czech economist and bestselling author talks on the causes of the financial crisis, weaknesses of modern economics and on what vampires and zombies have to do with the free market.

Łukasz Pawłowski: You claim that we came to treat economics as a religion with its own infallible God – the free market – and its own priests who convinced people that they know the Truth. In your view this hubris displayed by economists was one of the causes of the current financial crisis. But you yourself are an economist, why then should I trust your diagnosis?

Tomáš Sedláček: Well, this is exactly my point. You shouldn’t trust us.

ŁP: Even if you say not to trust you?

I try to convince people not to believe in our mythology, to look critically at economic indicators and predictions. Instead of helping you understand the reality, they may impair your judgment since you switch off all other signals you have. Of course, study, read economics, but subjected to other fields of human knowledge.

Marcin Serafin: If, as an economist, you cannot offer us certain knowledge, then what is your job?

I have a 7 year-old son whom I overheard talking to his friends about their parents’ jobs. My son said that his father makes his living by telling fairytales for adults, which is in fact the best description I could think of. Absolutely all economists are like that. All human beings are like that. In your job as a journalist you do hardly anything else – you read stories, you listen to stories, you combine it into your own story. Most predictions of GDP are actually stories. Bank is a story. Poland is a story. And if investors stop believing the Polish story, like they stopped believing the Greek story, they will transfer their money somewhere else.

Author: Ewa Kubat

ŁP: Aren’t you going too far? There is some factual basis for these stories. The United States have more predictable and stronger economy than, let’s say, Russia.

Yes, like in 2007 when America looked unshakable and then its economy crumbled in no time at all.

ŁP: We can make mistakes, but still it is not only about a story. Americans are in fact wealthier than Russians. You cannot deny it.

Of course, every story has some facts. Like in the Little Red Riding Hood, the talking wolf is a fact. In other stories wolves don’t talk, in this they do and nobody questions that.

MS: How then can we distinguish between stories that are more and less true?

It’s like having a debate whether elves are more real than talking wolves. The moment you believe these stories, they become true and real.

MS: And this is how we ended up in the financial mess we are now – because we mistook our myths for reality?

That is definitely one of the crucial elements. For example, we believed that markets are self-regulating, but very often they are not. To me the invisible hand of the market is just wishful thinking, like a prayer. It is very ironic that in economics we are so fascinated with our models that we believe they actually describe reality. In every school children are taught that a model has nothing to do with the reality, it’s just a fictional space. That’s why your previous question doesn’t make much sense to me. We should not ask if models are true or untrue but whether they are useful or not.

ŁP: Useful to whom?

That’s the question! Useful to whom and by what standards. This is the interesting part, not what is closest to truth.

We believed that markets are self-regulating, but very often they are not. To me the invisible hand of the market is just wishful thinking, like a prayer.

Tomáš Sedláček

ŁP: You claim that the story of the free market is just another myth – true as long as we believe in it. But you come from a country where only 25 years ago, just like here in Poland, people fought  not only for political but also economic freedoms. And now you tell them that it was all in vain because free market capitalism is just as good as any other system?

No, no, no. I’ve never said that. I am a huge believer in free markets. But the word “believer” is crucial here. Please don’t make a mistake, my story is as fictional as any other. It is not closer to the Truth. It is, I hope, wider and more inclusive – and that is what makes it different.

MS: What do you want to achieve with it?

I think my narrative is a more useful and less dangerous way of approaching the area of economics.

MS: Some economists, like the late Gary Becker, claim that we can use economics to explain all human behavior: addiction, love, religion. On the other hand, we have authors like Michael Sandel, who say that today we have let economists enter areas such as love and morality, which they should always be kept away from. What’s your position in this debate?

If some of my colleagues claim that, let’s say, religion can be explained economically as a way of maximizing your individual profit, I’m fine with it. Let’s explain it in this manner. But then we must also go the other way. If economists are allowed to discuss religion in economic terms, then we should also be allowed to view economists as a religious group.

MS: Do you think there could be a fruitful conversation between those two perspectives?

This is exactly what I wish for. We believe that all the phenomena in the world can be neatly divided into disciplines – economics here, sociology there, history over there – whereas I think that every issue can be looked at from different perspectives.

ŁP: Which does not change the fact that there are phenomena that can be best explained in the language of economics. If you raise the price of the coffee we are now drinking, we will at some point stop buying it. If you lower the price, we will probably drink more of it. It’s the law of supply and demand which applies to all the people, no matter their religion, social status, language, etc. So in this sense the laws of economics are universal and separate from other areas of life.

I’ll try to prove you wrong. Let’s say I’m willing to buy coffee from you for up to one hundred dollars per kilo and you produce it for one dollar per kilo. There are 99 ways in which we could settle the price, if we disregard the pennies. And there is infinite number of factors which are usually ignored by most economists, yet that can influence the final outcome – my negotiating skills, the level of your English, our previous experiences, the image of my brand, my emotional attitude towards you etc. There is no universal, mathematical formula in which you can put your data and receive an objectively justified price.

ŁP: I agree, but that was not my point. What I am trying to say is that people behave to some extent similarly, because they react to the law of supply and demand. If everything you say was true and there were no universal laws in economics, then we should teach different economics in different countries and there would be no international market at all.

The laws you consider to be automatic are in fact influenced by thousands of factors outside economics.

If economists are allowed to discuss religion in economic terms, then we should also be allowed to view economists as a religious group.

Tomáš Sedláček

ŁP: On the one hand, you think that we should complicate economics by including all the different factors that are not in the calculations right now, but on the other, you say that to avoid crises we should stick to very simple rules: save when we earn and use those savings to stimulate economy when we are in trouble. In the West we allegedly forgot these rules and as a result borrowed and spent extensively. Your critics, however, could say that the Western World would never develop as fast as it did if it wasn’t for liberal economy and financial instruments you criticize: international banking and credit system. And we should keep in mind that the West, even in crisis, is still much wealthier than the rest of the world.

Absolutely. That is why we should improve the system we have, not replace it.

MS: You stop halfway…

Do you see those cars outside the window? Cars are a beautiful and useful invention, but they also cause lots of problems – deaths in accidents, air pollution, even obesity. Does it mean we should get back to horses and carriages? Absolutely not. Let’s make better cars, let’s drive them slower, let’s encourage people to use other means of transport as well. But until we find out a way how to levitate we are stuck with cars. Does it mean I should pretend that there is nothing wrong with them? I am a critic of economics, and lots of people think that I hate it, but does a literature critic hate literature? They love literature, that’s why they are critical of it. And this is exactly my position. I love the field of economics, therefore I am critical of it – I think we can do it better.

MS: How? The economic crisis brought back the notion of uncertainty.

We’ve never departed from uncertainty.

MS: Yes, but now the idea that future is uncertain is again treated seriously by economists. If the future is uncertain…

Even the past is uncertain! Today the GDP of Poland calculated for 2012 will be revised by a significant margin. The statistical office of your respected country, does not know exactly last year’s GDP, and probably the one from two or three years before. This happens all the time. Ironically enough, economics of all humanities believes most in the freedom of individuals, yet at the same time it assures us that human decisions can be predicted. It’s a blatant contradiction – either human beings are free to do what they please, or they are predictable. In my view we cannot anticipate human behavior. That’s not the worst part, though. The worst part is the fact that we live in a situation of fundamental uncertainty, but we behave as if we know what is going to happen.

MS: What is so dangerous about it?

Let’s say you have a sick child and a doctor. If you are lucky, you get a doctor who thinks he knows the causes of the illness and he indeed knows. Then you could have a doctor, who doesn’t know, but he knows that he doesn’t know – in that case he sends your child to another expert. Finally, you could have a doctor who thinks he knows what is happening, but he doesn’t know. This the worst case scenario as your child will be treated for a wrong disease. Pretending that we know something, while we actually know that we don’t know, is not only useless, it’s harmful. This is one of the reasons that encouraged us to make all these risky investments and ultimately lead to the financial crisis. We all believed the economy was going to grow constantly, so why to worry? Our mathematical myths about ourselves turned out  to be untrue.

Author: Maciej Spychał

ŁP: All the economic models are false?

Let me give you an example with which I always tease my colleagues. When you construct a model and you want to be rigorous, then let’s be rigorous all the way. So, if you assume that human beings are rational, assign a probability to that assumption. Let’s say its fifty-fifty, because we don’t know, philosophers have been arguing about that since people learnt how to write. Now, let’s assume that human beings are entirely free to make choices with roughly 80 percent probability. Another assumption is that human behavior can be approximated by mathematical logic. This is also a huge assumption which cannot be fully applied to personal life – we know it from our own experience. In the end, before you start modeling, calculate on what probability level you are moving, and most likely you will find out that it does not exceed a few percent.

ŁP: I don’t think it’s a fair point. You discuss individual behavior, whereas economic models apply to people in general. For example, if the price of coffee in this coffeehouse rises, you may still want to buy it, because you enjoy it and you are willing to pay even twice as much. But on the whole, if we had a thousand people here, the general demand for coffee would decline.

Or not… This has already happened many times – the price of a good increases and the demand increases as well. Even such a simple prediction of how people should react is not always true. I have a colleague, Yoram Bauman, who calls himself the first stand-up economist and makes fun of the holly truths of economics. One of them is that people react to incentives. This is a statement everybody seems to agree on. Yoram looked up the word ‘incentive’ in a dictionary, and it turns out that ‘incentive’ is “something that people react to”. So one of the big wisdoms of economics is that people react to what they react to, but we do not know in what way. This is also true about the maximization theorem, which says that people maximize their utility. I ask immediately, okay but what defines utility?

ŁP: Utility is something that people find useful…

Exactly. People find useful, what they find useful. Or in other words, people do what they do, but there is no way of telling ahead of time. Another basic assumption is that people can order their preferences. In other words this means that people know what they want, which is very doubtful. Talk to psychologists…

ŁP: I am one.

So you should know! There is a science fiction movie “Stalker” by Andrei Tarkovsky which tells a story of the Zone. It is a distant place which, if you reach it, makes all your wishes and desires come true. The main character is a guy whose brother is terminally ill, so he pays a lot of money, goes through lots of dangers, gets to the Zone, makes his wish and comes back only to find out that his brother died the night before and that he won one million rubles in lottery. What does that mean? Did the Zone lie? No, the Zone did what it promised to do. However, it fulfilled not what the main character dared to desire, but what he really desired. The question is, if such a zone existed, would you enter it? Are you so sure that your wishes are really yours?

ŁP: No, I am not sure. You know, there is a drawing by a famous Polish cartoonist, Marek Raczkowski, in which a smirking devil says the viewers – “I wish all your deepest desires come true”.

Precisely. You have it even in fairy tales about the golden fish which grants three wishes. It always ends with people being very happy with who they were before.

I am a critic of economics, and lots of people think that I hate it, but does a literature critic hate literature?

Tomáš Sedláček

MS: Given all you said about how unpredictable people are, what can we expect from economics then?

The major problem of economics is that we generally do not know what to expect from it. The role of economics is not anywhere defined. In my view we should assume that the goal of economics, or the economic system is to allow majority of the people not to worry about food, shelter, about sending their kids to school and being able to lead decent life. In that case – in many countries mission has been accomplished! And don’t expect anything more. Don’t expect justice or equality from economics, because we have never  promised it.

ŁP: Many of the things you say sound reasonable and commonsensical but these are still not the dominant views. Why?

There is this assumption that we freely choose our beliefs, which I question. First of all, you have to have alternative beliefs to choose from.

ŁP: Living in a liberal democracy I can listen to many different people with alternative views and then pick the one I find most convincing.

Yes, but even if you have alternatives… You don’t believe in vampires or zombies, do you?

ŁP: No.

Hardly anybody believes in them. But let’s imagine it’s dark, the moon is shining, you’re going through a graveyard and you hear cracking sounds behind your back. You still do not believe in vampires or zombies but you are scared of them. This is what I have noticed in movies. No one believes in these creatures, but when we watch a movie about them we believe in them in the reality of the movie, because otherwise we wouldn’t watch it. There is always this beautiful joke that filmmakers employ. They create one character, usually a male with a very down-to-earth job – a policemen, detective, lawyer – who does not believe in vampires. You’re sitting there as a viewer and when rational character in the movie says: “No, I don’t believe in vampires”, you start screaming at him: “C’mon, of course they exist! Can’t you see?!”. Obviously you are then screaming at the rational part of yourself. That is how our believes are intertwined with irrational sentiments. It is like falling in love. Sometimes you fall in love with somebody you don’t want to fall in love with. We believe in so many irrational things.

MS: Many pundits claim that at least we do not believe in ideologies anymore and that we entered a postideological age. You say we live in the most ideological times in history. Why?

This goes nicely to the beginning of our discussion about economics being like a religion. Previously people knew what they believed. Today people don’t believe, they know. You don’t consider your beliefs to be beliefs, you consider them knowledge. And that’s where the problem is. You have no reasonable distance from your beliefs.

ŁP: So you say that one hundred years ago people were more reflective about their beliefs than they are right now?

Yes.

MS: Seriously?

Absolutely. And you know, I think economist should be treated as any religious minority, with a right to say whatever they believe and the right to gather, but with some healthy skepticism, just as every religious believer. And that is my point. I am telling stories, which is exactly what everybody else is doing. Those are stories. Let’s use them, let’s enjoy them but let’s not despair and dismantle what we have achieved over the past decades just because one fictional GDP number is not raising as fast as we would like.

Professor Sedláček was a guest of the Big Book Festival held on the 14th and 15th of June 2014 in Warsaw, Poland. “Kultura Liberalna” is grateful to organizers for their help in arranging this interview.