Economics and the Disregard of Reality

An editorial in the WSJ criticizes Tim Geithner for doubling aid to the IADB, calling him “the Obama administration’s first-string hurler, a man who never meets a problem that can’t be solved by throwing more money around.” Critics of the PPIP will probably agree to that categorization.

But the article points to a seminal Cato Journal article written in 1987, on the complete “disregard of reality” that economists sometimes show. Written by Peter Bauer, a leading development economist, it should be required reading for all economists – and indeed social scientists.

Before commenting on this article, it is worth noting that this article was written at a time when foreign aid was very much en vogue. At the time most developing countries had adopted centralized state planning and import substitition policies, often at the behest of economists from America and the UK. In the 1960s, India was a case in point. As noted in this 1992 Cato paper (Foreign Aid and India: Financing the Leviathan State), John P. Lewis – the head of USAID at the time argued:

that India’s planned development was the most feasible and desirable path for a country at an early juncture in the development process and that the decentralized market system was inappropriate, destined to fail, and had only led to the development of Great Britain and the United States because of “special circumstances.”

Bauer’s paper is a good early rebuttal of this view. Bauer argued against many of the popular views at the time, including “that there is by necessity a widening gap between rich and poor countries, and that central economic planning and large-scale capital investment are prerequisites for growth” (see this paper). Criticizing the concept of a vicious circle in development, he said “if the notion of a vicious circle were valid, mankind would still be in the Stone Age at best.”

The Causes of this Disregard

Bauer’s article is revealing in how despite his faith in economics he also held strong reservations on the subject, and particularly on its practice. While an economist himself, he was highly suspicious of the tendency of economists for groupthink and their ability to confuse economics with the natural sciences.

That second comment is particularly telling because economists today seem to fall into the same trap and think their ability to quantify social processes set them apart from other social scientists. Yet, Bauer argued that:

In the course of this shift of approach pertinent differences between the study of nature, especially physics, and economics have not been sufficiently recognized…the use of mathematics is particularly effective because of the language barrier it provides. What we see is an inversion of the Emperor’s New Clothes. Here there are new clothes…But all too often there is no Emporer within.

Implications for Today

Bauer’s observations have implications far beyond foreign aid because policy advocates tend to overlook the obvious, even today. There are two areas in particular where economists, have often neglected this basic test.

First, the current crises has led many economists to herald a new era. Those on the left declare this to be the end of capitalism. As Gordon Brown proclaimed at the G-20 summit, the “Washington Consensus is Over.” Those on the right, however, take it to mean that we have not had enough capitalism – and that we need to re-commit ourselves to free trade, liberalization, and the other tools at the disposal of free-market economists.

Both sides tend to ignore reality. On the left, they ignore that the world is inexorably moving towards greater, not lesser, capitalism simply because the hordes of Indians and Chinese are choosing to trade and consume? And those on the right ignore that countries that had embraced these free-market ideals have suffered the most.

The truth is simply that we have always had a mixed economy. This view, in the Indian context, was underlined most recently by the Indian PM Manmohan Singh (covered very well here). As Amartya Sen said in his article Capitalism Beyond the Crises (excellent recommended reading):

The market economy has depended for its own workings not only on maximizing profits but also on many other activities, such as maintaining public security and supplying public services.

So, if society has depended always on a mix of public and private institutions and players, what is needed is a healthy mix of the two – rather than a substantial reliance on any single one. This is a lesson Indian liberals should do well to remember.

The second area where economists have been particularly vocal these days, at the expense of the obvious, is in espousing the privatization of education in India. They moan regulation that prevents businesses from investing in and profiting from education providers. Implicit in their proposals is the claim that public education cannot work.

Yet, this ignores reality because public education worked in many places, including the entire communist world. This is not to say that the communist system is better. Yet, anyone that suggests public education doesn’t work needs to first explain why, according to the latest UNDP statistics, Cuba has the highest literacy rate in the world (which at 99.8% is 17 ranks above the USA at 99%).


According to O’Grady, Tim Geithner disregarded reality by thinking that the solution to any problem is to “throw more money at it.” This is not true of foreign aid. Nor is it true of free-markets (the PPIP), or education, or healthcare. More money will not solve the problem. Nor will replacing one incomplete system with another.

However, the answers to our problems may not be that elusive. Rather than trying to rethink everything, or change the system we see as failing, we may wish to look at something more obvious but perhaps less sexy. As Amartya Sen says of the “new capitalism” what is needed is “a new understanding of older ideas, such as those of Smith and, nearer our time, of Pigou, many of which have been sadly neglected. What is also needed is a clearheaded perception of how different institutions actually work, and of how a variety of organizations can go beyond short-term solutions to contribute to producing a more decent economic world.”

And above all what is needed is, in Orwell’s words, “the restatement of the obvious.”

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