Scott Adams: The unexpected economist

Scott Adams, creator of Dilbert, is best known for his sense of humor. He seems to be developing a sense of social responsibility, too.

Adams' blog is one of my favorite places on the Internet, one of only a handful of pages I try to check every day.

I like his blog because Adams is both funny and smart. He understands that he can exert a certain amount of public influence, but unlike most celebrities, he's smart enough to recognize his own limits. He's also smart enough to expand those limits by gathering data and studying the opinions of others.

Earlier this month, Adams spent his own money on what he calls the Dilbert Survey of Economists, gathering the opinions of over 500 professional economists to see if they could tell us anything useful about McCain's and Obama's economic plans.

They couldn't, really--ask 10 economists to count their own fingers and you're likely to get 11 different answers--but this in itself is good information, because it teaches us that economics is not yet a real science.

On Tuesday, Adams asked the readers of his blog (a valuable if unreliable resource) to help him find a good analysis of the potential consequences of allowing the free market to deal with the recent market meltdown.

Wednesday, in a post titled "The Credit Crunch Explained," Adams identified an article in The New York Times as the best of the responses he received.

Unfortunately, that piece by David Leonhardt was really very bad, and it seems to me that if Adams is going to become as useful to his species as he would like to be, he needs to learn how to recognize bad arguments like this one.

I started to write a comment on his blog, but as it grew longer, I decided to post it here instead. I know that Adams tracks appearances of his name on the Internet (as I do), so I'm pretty sure he'll see this here, and probably pay more attention to it because it's reaching a much larger audience than it would in his blog comments.

Here are some of the danger signs I noticed in the Leonhardt article:

The sob story and the sockpuppet
Leonhardt played to the reader's emotions with a sob story about Meyer Mishkin, a shirtmaker during the Great Depression, whose grandson Frederic Mishkin was until recently a member of the Board of Governors of the Federal Reserve.

Leonhardt used Meyer Mishkin as a sockpuppet for two emotional arguments, opening the article with the assertion that it's wrong to want to punish the "rich scoundrels" of Wall Street, and in closing, that it's also wrong to do nothing.

Leonhardt said something has to be done, but he didn't say what. Of course, if we must act, but we can't punish anyone, about the only thing that's left is to reward someone.

An article of this type is designed to bias or predispose its readers toward a particular course of action that will be communicated to them somewhere else. By not explicitly naming its goals, this type of article avoids triggering negative reactions that might block the desired effect of the piece.

Leonhardt claimed that the Great Depression came about because the government did not respond properly to the stock-market crash of 1929, but the simple fact is that the government DID act, and the government's actions are what made that depression "great." Older readers at least have probable heard of the principal governmental overreaction: the 1930 Smoot-Hawley Tariff Act, which interfered with international trade to the detriment of the U.S. economy.

On the other hand, the government's failure to assist the credit market after 1929, natural factors such as drought, and the actions of various large companies and foreign governments all played a role. Leonhardt could have mentioned these other factors at least briefly, as I just did, but he didn't-- because his purpose was not to inform or to help his readers to reach a logical conclusion. He was seeking an emotional response.

So what Adams needs to learn is that when someone presents only some of the facts, he should assume the writer is avoiding conflicting facts in order to mislead his readers.

How to use the hammer
Now, we got into this mess because of government intervention in the economy, but that doesn't necessarily mean that more intervention is a bad thing. Intervention is usually like using a hammer to repair an engine, but even jet-engine mechanics keep hammers in their toolboxes. They just use them very carefully and delicately.

In fact, at least three major kinds of government intervention led us to this point: first, the government forced banks to make bad housing loans through the Community Reinvestment Act (the last evil legacy of an evil man, Sen. William Proxmire, D-Wis.); second, the Federal Reserve pushed interest rates too low (an attempt to fight inflation, which wasn't entirely wrong-headed, just overdone); and third, the European Union's monetary policies drew much of the liquidity out of U.S. markets. The effect of that latter point was more a matter of timing than causation, really, and one could reasonably say that the U.S. government could have tried to compensate, but that would just have gotten us into a pissing contest with the EU without addressing the other causes that would eventually have led to this kind of collapse anyway.

None of these influences is completely partisan, though the Democratic Party supported the CRA more than the Republicans did (largely a cynical effort to make Republicans look cruel and heartless for not wanting poor people to have houses of their own). The policies of the Fed were maintained by both Republican and Democratic administrations, and were certainly worst under the current Bush administration. The EU's motivations were more nationalistic than a matter of political ideology.

What can we do about the situation now? I can't suggest any particular immediate response because I don't have enough information. In principle, it should be possible for the Federal Reserve and the Treasury to figure out how the economy ought to be operating right now, and apply some careful taps with their big hammers to nudge the economy back on course. But exactly where to tap is way beyond me.

It's clear we need to resolve the liquidity problems, and it seems like that's being done. Some good, profitable businesses absolutely require loans to continue operating. (In the long run, they may prefer to keep more of their own cash on hand rather than relying on short-term loans, but that has its own economic consequences.)

Other good businesses need loans to expand, and entrepreneurs need loans to start new businesses. (Personally, I missed out on an opportunity to make millions of dollars because the company I helped build from 2004 to 2008 couldn't get funding this spring and had to shut down, so I suppose I'm hypersensitive to the needs of entrepreneurs.)

We also need to restore consumer confidence, because when people stop spending money, businesses make less money, which means they have less money to invest in themselves and banks are less willing to loan them more.

A bad situation, but not yet a catastrophe
I don't favor any dramatic steps. This is a bad situation, but it isn't all that bad yet. The net effect on the economy from all of these related banking and insurance problems is in the range of a trillion dollars-- but that's only about 7 percent of our gross domestic product. So this failure is pretty much like a plumber losing $3,000 in Las Vegas. It's painful, but hardly catastrophic. He still has his job, he still has his house and car. Maybe he needs to borrow a thousand bucks from his more prudent brother-in-law to make the next mortgage payment, and he might be eating hamburger instead of steak for a while, but he'll be OK.

I don't mean to oversimplify the situation, but that comparison is numerically reasonable. Macroeconomics is hugely complex because it involves many aspects of human psychology, including politics, and many objective factors, some of which can't really be measured in practice. But at the same time, the fundamental issues of macroeconomics are very simple: how much of the population is doing productive work, how productive are they, what is the net surplus, where is it going, what are people spending money on, where are they investing?

For most of these issues it's pretty easy to see which direction is good.

It's better if more people are working more productively, producing more of a surplus that gets reinvested in ways that expand the economy.

It's better if fewer people are doing non-productive work, which describes most government jobs (that is, both government employees and people who are privately employed for governmental reasons like tax accounting).

It's better to have more economic activity driven by the profit motive in a free market, because in all free transactions, both parties benefit. Nothing truly good ever happens when people act against their own interests (as banks did because of the CRA).

Unfortunately, as long as the government has the Constitutional authority to meddle in the economy, there will always be politicians wielding political sticks and economic carrots. We need a Constitutional amendment that enforces a separation of economy and state just as we currently separate church and state. This would abolish the Federal Reserve and end the government's power to force or entice people to accept short-term harm in pursuit of illusory long-term benefits.

With the government out of the picture we'll also avoid the other key factor contributing to the current mess: the fact that ALL the major banks were operating under the same policies, so the collapse hit all of them at the same time. Less central control means more frequent problems with individual businesses, but fewer problems that affect the whole economy.

There will always be people making bad decisions; one of the great advantages of the free market is that these bad decisions usually have only local effects.

There are still good reasons for government oversight of economic activity. We need the power of government to define common terms in law, certain common standards such as those for workplace safety and environmental protection, enforce contracts, punish fraud, and provide a sort of insurance policy of last resort for people who acted fairly, honestly, and reasonably but still ended up on the wrong side of long odds.

But as long as the economy as a whole can be manipulated by bureaucrats and self-interested businessmen, we're going to have periodic breakdowns like this current one, and that's what we need to stop.