Phrenology is a pseudoscience which reached its highest level of prestige and practice in the 19th century. It is based on the belief that the external morphology of the brain and relative sizes of different sections of the brain are significant in predicting behavior and can be determined by an inspection of the skull. It has a distinguished history, tracing its origins to Aristotle, and an elegant, intricate, and developed supporting theory. It fell from favor not for lack of a distinguished history and elegant theory but for a lack of reproducible, empirical evidence (to be succeeded by other theories, mostly similarly lacking in reproducible, empirical evidence).
In his column in the Washington Post today Robert Samuelson muses over the loss of confidence in economists:
Last week, interest rates on 10-year U.S. Treasury bonds fell to 1.4 percent. This was the lowest on record and less than present or expected inflation (generally 2 percent to 3 percent). On 30-year Treasuries, rates have tumbled to 2.5 percent. The investors piling into Treasuries and driving rates down aren’t buying risky stocks or using their cash to expand businesses. They’re protecting themselves against unknowns. The question is whether the resulting plunge of rates signals something more ominous: renewed recession, deflation or both.
Granted, there are always the standard unknowns of business cycles, new technologies, competitive pressures and shifting government policies. But today’s seem on a scale unprecedented since World War II. Does Europe — one-fifth the world economy — face stagnation or collapse because debt-ridden countries cannot defend the euro? What happens to the weak U.S. recovery if it drops off the “fiscal cliff”: the $500 billion of spending cuts and tax increases (as estimated by the Committee for a Responsible Federal Budget) scheduled for early 2013?
To these daunting uncertainties must be added at least one other that, though less recognized, is perhaps more powerful. It is an intellectual breakdown. There is a loss of faith in economic ideas — and government policies based on them — driven by most economists’ failure to anticipate the financial crisis and many subsequent events.
Economics is not without its useful, commonsensical, practical, predictive side. But it also has plenty of reading the bumps on skulls. Some of its predicted results are replicated again and again. Others, like so many of the prescriptions of Keynesians and neo-Keynesians, have non-existent or such weak empirical support that they can be explained by data collection error or in any number of other ways.
Economics is and will remain a science of human behavior. There’s a critical difference between, say, chemistry or physics, and sciences of human behavior. There is an inherently faith-based component to the latter. If you have built your rocket according to established principles of chemistry, physics, and engineering and calculated its path correctly and fired it correctly it will, in fact, go to the moon whether you believe it will or not. In economics it matters who does it and whether people have confidence in them and whether people believe the things that are done will work.
I think that much of what we’ve seen in our economy over the period of the last twenty or so years can be explained by trade policy. The practice of foreign governments, China’s in particular, taking so much of the proceeds of trade and using it to buy Treasury bonds has caused much of the benefits of trade to accrue to the federal government. The federal government has then spent the money on finance, weaponry and security and military personnel, and healthcare. Should we be surprised that our economy has become disproportionately oriented towards finance, weaponry and security and military personnel, and healthcare?
Right now about half of all federal spending is being financed by selling Treasury bonds and just about 80% of all Treasury bonds are being purchased by the Federal Reserve. Yes, something like $1 trillion per year, about 40% of all federal spending is not a transfer but is in effect being spent into existence. As I understand the theory that should be producing inflation. It does not appear to be. Additionally, I would think it would be producing more growth than it is, significantly more than $1 trillion in additional growth if the Keynesians are correct. Explanations for both would be handy right about now.