Dr. Volcker, I presume?

Great line today, even if unintentionally funny, in David Pilling's column (subscription required) in the Financial Times. He notes that many are comparing Raghuram Rajan, the new head of the Reserve Bank of India (RBI), with Paul Volcker, inflation hawk, and one time chairperson of the Fed. Rajan has denied the similarities, but as noted by Pilling: "if Mr. Rajan does not want to be seen as Paul Volcker, he has done a pretty good impersonation so far." Not sure that's what India needs with the economy decelerating, but I'll not delve into that right now.

Economic myth and meaning

Earlier this year I had posted on Triplecrisis a critique of the mainstream views of the crisis, pointing out that they were still lagging behind the heterodox discussions and had much to gain from incorporating the insights of progressive economists. One of the surprising things about the readings I did for that post was that Robert Shiller actually was not very prescient about the housing bubble. In the famous paper with Karl Case he argued, as I noted, that: “judging from the historical record, a nationwide drop in real housing prices is unlikely, and the drops in different cities are not likely to be synchronous: some will probably not occur for a number of years. Such a lack of synchrony would blunt the impact on the aggregate economy of the bursting of housing bubbles” [emphasis added].

Now, I'm reading Tom Palley's latest book, The Economic Crisis: Notes from the Underground, and discover that the phenomenon is all too common. He notes (p. ix) that Raghuran Rajan, the ex-chief economist at the IMF, whose paper at Jackson Hole in 2005 was lionized as predicting the limitations of financial innovation in the famous film Inside Job, actually says in his conclusion that he: "believe[s] the changes have, in general, expanded opportunities significantly and have, even on net, made the world tremendously better off. But opportunities can be used for good and for bad" [emphasis added]. Note that if financial innovation has made the world better off, as he concludes, it cannot be that he thinks it has increased risk. However, in the film Rajan said this: "the title of the paper was, essentially: Is Financial Development Making the World Riskier? And the conclusion was, uh, it is." Yep, he should get the Mishkin Prize (awarded after he changed the title of his paper from Stability to Instability).

There are several other interesting cases of oracles that did not predict anything, and of mainstream economists that when they did predict the crisis, they did it for the wrong reasons and got the story and the consequences incorrectly (all bring up more stories from Tom's book in other posts). The essential point that Tom makes, however, is a sociological one, that helps understand the predominance of the mainstream paradigm. The profession suggests that, while predicting the crisis was impossible, a few illuminati within the mainstream did foresee everything, and as a result there is no systemic problem with economics as a science. No need for revolutionary change in the profession.

Levi-Strauss once said that myths are totalitarian stories that eliminate all possibilities of doubt, since they explain everything. In this case, the myth of the lone, foresighted, neoclassical economist preserves the culture of complacency in the profession with the utter irrelevance of mainstream economics.

Who will succeed DSK?

There is a lot of fuss about who should be the next managing director of the IMF. The French have held the position for more than 30 years, and a European has always been at the helm of the IMF. Thus, the voices of protest for a broader representation, more transparency and a democratic process have been raised. Raghuram Rajan, former chief economist at the IMF, has suggested (subscription required) that we need a technical/market economist rather than a politician running the Fund.

“The fund is designed to push tough policies to straighten out countries that have mismanaged finances, not win a popularity contest. When it colludes with politicians to propose politically palatable programs, the IMF fails in its proper role of reforming a country.”

Interestingly enough the idea is that good policies are painful ones. The sadomasochistic vein in mainstream economics runs deep. Rajan means that the IMF is needed to impose fiscal contraction, and it should be independent from politicians, like central banks (I'll leave that for another post). He then suggests that IMF should:

“set up a selection committee of worthies: Larry Summers, Jean Claude Trichet, Ernesto Zedillo, and so on.”

In other words, the independent guys that deregulated financial markets, imposed brutal contraction in the European periphery and commanded over the Mexican Tequila (Zedillo inherited the crisis from Salinas, to a great extent, but shared the neoliberal principles) respectively (among other things). It would be like having Count Dracula in charge of the Red Cross blood donation program.

Further, Mr. Rajan peddles the need for a non-European to head the IMF and cites the usual names (Armínio Fraga, Trevor Manuel, Montek Ahluwalia, Tharman Shanmugaratnam, only missing Agustín Carstens in the lists of developing country’s economists cited for the position). The common denominator is that all of them would maintain policies that are essentially more of the same, and will not push the IMF to revise their adjustment policies. If these are the candidates they might as well appoint a European to do the dirty job!

The question is not so much whether the selection is done by notables (even though one may want less notorious people than the ones in Rajan’s list) or other lesser beings, or even whether the new managing director will come from the colonies (sorry, the developing countries) or Europe. The question is whether the IMF is going to change its ways and understand that pro-growth and employment generating policies should be painful to capital, not labor. We need capital controls and fiscal expansion, to create jobs.