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Importance of being Krugman

October 20, 2008 10:37 IST

I read Paul Krugman's now much-reproduced column 'Gordon Does Good' in the online New York Times on the morning of October 13.

A few hours later, I spoke to a colleague in Bonn and told her about Brown being the unlikely hero (she is British, so I thought she should know) according to the Princeton professor and distinguished NYT columnist, Paul Krugman, who was likely to get a Nobel in the near future. The Stockholm announcement of the Nobel Memorial Prize must have been getting ready at that time.

Krugman's opening statement, "Has Gordon Brown, the British prime minister, saved the world financial system?" was akin to elevating the usually dour Dirk Bogarde to the league of superstars like Peter O'Toole, but nevertheless correct, as bourses all over the globe reacted buoyantly to the expanded and co-ordinated Brown plan later in the day, reversing the fearsome trends of the week past.

So while a distinguished economist was honoured for being realistic and understandable as well as on the nose in the current crisis, another, of a far more modest variety half a world away, was for once accurate in his prediction!  Rather novel and rare coincidences in the world of economists!

The prize committee cited Krugman's work on trade theories and also mentioned his role as an opinion maker.  For the world at large, however, it is the latter role that distinguishes him from most of his fellow laureates of late.

Consider his summary of the current crisis: "The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further."

In just 70 easily understandable words, he has identified the root cause of the problem, which makes it possible to chalk out the outline of a possible remedy.

In contrast, Joseph Stiglitz, who won the prize in 2001, has meandered about unbridled greed and overenthusiastic deregulation causing the present crisis, in the November issue of Vanity Fair, now available on the net.

He may be right, but these issues were very much present when the Dow was at its peak of 14,000 last year and as a responsible and respected economist, he could have sounded the warning bell then.

Such analysis does not lead to a clear course of action either.

Stiglitz is not the only Nobel laureate in being late or not being able at all to see the coming crisis. The works of most of them in the last decade contain economic theories galore based on set theories, probability models, lie algebras, and ever more complex and abstract tools to analyse human behaviour, which they don't seem to understand.

The emerging models give a false sense of accuracy, which is then mistaken for their being correct predictors.  It may be an oversimplification, but not entirely untrue, to say that most of their fellow recipients would be hard put to understand what they have done. 

Good economists can always explain the past in seventeen different ways but cannot predict the future, leave alone offer correctives, in any plausible manner. Only the Israeli economist, the much maligned Dr Doom, Nouriel Roubini, has been predicting the meltdown and most of its consequences for two years running.

The very same IMF economists who are now warning us of the currency system being on the brink very nearly laughed him out of court (an effort led, unfortunately, by the so-called mathematical-model geniuses of Indian origin).  If budget forecasts of deficits, growth rates, etc (which are supposed to be the forte of economists who prepare them) have ever come true, they are exceptions to the rule.

If one were to scan the contemporary economic commentary of the 1930s, similar confusion would be found.  Then as now, most economists had not a clue to what was happening or what should be done, until Keynes came up with his seminal work.

Every bright new economic theory, however, is replaced by one which says its diametric opposite in a few years.  So the Chicago School represented by Milton Friedman dominated economic thinking in the last decades of the twentieth century.

Now it is the turn of this school and its last apostle, Alan Greenspan, called the Oracle by a legion of his votaries, to be sharply criticised.  He had said in 2004, "Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient."

In a long analytical piece on the Greenspan legacy in The New York Times on October 9, Peter S Goodman wrote, "Economists from across the ideological spectrum have criticised his decision to let the nation's real estate market continue to boom with cheap credit, courtesy of low interest rates, rather than snuffing out price increases with higher rates. Others have criticised Mr Greenspan for not disciplining institutions that lent indiscriminately."

The Brown plan must surely please the ghost of Lord Keynes!

Krugman's genius lies in translating his ideas into clear, simple terms, and never losing his focus on what needs to done in common interest.  His criticism of the Bush administration may have become the talking point, but his analyses of the health care and education systems and remedies for them would be perhaps the more outstanding components of the economic policy of a future Democratic administration.

"Paul's great strength is to take something very simple and make something new and very profound," says Maurice Obstfeld, his co-author of a text on international economics.  Paul Samuelson, the godfather of all modern economists, says, "Krugman is the only columnist in the United States who has had it right on almost every count from the beginning."

Even though this year's Nobels have come in for some criticism, in one field at least, the committee seems to have got it absolutely right.

Shreekant Sambrani
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