Sometimes I lay awake at night, and ask, ?Where have I gone wrong?? Then a voice says to me, ?This is going to take more than one night.?? That?s from one of last century?s great philosophers Charlie Brown. So where did liberal economics go wrong in the October crisis? Umpteen books have already been written on it and more will be. Guy Sorman?s Economics Does Not Lie: A Defence of the Free Market in a Time of Crisis is a non-apologetic defence of liberal economics, with all its strengths and weaknesses.
It is a brave book. Not just because of its timing, but because it tries to turn cutting-edge academic research readable without watering down the content. There are no catchy generalisations or gimmicky categorisations of economics and economic policies to help the reader sound erudite in office parties. The book is thankfully short on polemics. Instead, Sorman embarks on taking the academic research of the last two decades and the economic experiences of the main developed and emerging countries to argue that with all its imperfections, no other system has reduced poverty and delivered higher growth than free-market policies informed by liberal economics.
Guy Sorman has run the gamut of academic teaching, writing newspaper columns, and advising on public policies (French and Korean governments). He hasn?t yet attempted fiction, but if he did, comparisons with Umberto Eco would be tempting. So, this is not a man who has closeted himself in the relative calm of university life, but has seen the rough and tumble of real world economics. Coming from him, a justification of the relevance and efficacy of liberal economics may mean something.
Back to the book. Given its depth and wide coverage, it is unlikely that the endeavour was initiated after the October crisis as the subtitle suggests. Rather, Sorman confesses quite early that he had planned the book earlier. And, this makes the book?s subtitle an annoying distraction, an afterthought to increase marketability. So any reader looking for a treatise on the current crisis or arm flaying diatribe against the massive government intervention and bailouts will be disappointed. It is there, but not as the central theme.
Ed Prescott (Nobel Prize 2004) and his brand of real-business cycle economics is the newest and perhaps the most sophisticated version of liberal economics, practiced largely in fresh-water universities. The main argument of this version of liberal economics is that the global technological frontier has expanded at 2% annually since the 1950s. If countries did not do anything silly they would grow at least at this rate. So if any economy grows less than 2% it is in virtual crisis, falling constantly behind the global technological frontier. And, almost always, barring wars and epidemics, this is because of bad economic policies and institutions.
A simple enough argument, but the key is to verify its veracity by data. And this is where the real-business cycle economics becomes technically and technologically demanding and loses popular following. And it got hammered by the salt-water universities who pushed market imperfections and informational asymmetries as not only the main cause why economies underperform, but also as something that policies needed to take as given and work around it rather than change it.
In the hands of Sorman, who opens his book with his interpretation of the world of Ed Prescott, this simple liberal economics argument becomes a lucid leitmotif for the next 20 chapters. Having worked under Ed, it was gratifying to see this line of research make it to a more popular forum. For long, mainstream macroeconomists have treated real-business cycle economics much like Boo Radley?the strange guy who lives down the road. But all the credit goes to Sorman to make this transition very readable, avoiding getting embroiled in the technicalities of their arguments.
Sorman paints a global canvas in the book taking the reader through several developed and emerging economy experiences (including the BRICs and Africa) to make his point. India gets a separate chapter; largely a summary of Sorman?s previous book The Genius of India, where India?s License Raj is seen as what Ed would call the ?barrier to riches?.
Sorman then uses the real-business cycle framework to address the financial crisis: economic cycles are the result of technical, financial, organizational, policy innovations. These innovations generate growth, but not all innovations work well. Some are disasters. Citing the work of Jose Scheinkman, Sorman explains that the sub-prime bubble was caused initially by innovations in securitisation that got aggravated by government subsidies for homeowners and rational expectations of investors who ?bet that they could beat the market, at least for one more day.?
Like Ed Prescott, Sorman is critical of the way the US and European governments reacted to the crisis. Letting banks pay for their misdeeds ?could have brought a more severe recession, but a shorter one, followed by a quicker rebound?. And as we have seen unfolding in Europe, the fat lady hasn?t sung as yet. There are still significant headwinds against a sustained global recovery and governments appear to have used their last bullet. Sorman does have kind word or two: these governments have so far resisted giving in to protectionist pressures ?learned from economic science? and the Great Depression.
The book has its flaws. Some would label it overzealous for overstating the influence of liberal economics and the ?scientific? nature of economics in general. Globally neo-Keynesians still rule policymaking and the gap between these two streams is more fundamental and wider than Sorman makes it out to be. But such differences are healthy and shared by any science. Ask the physicists: many of the most respected still think string theory to be voodoo science. But after the reading the book even the most sceptic would at least grudgingly acknowledge that there is some truth to ?The best of all possible economic systems is indeed imperfect.?
?The writer is India chief economist, JP Morgan. Views expressed are that of the writer?s alone