As I’ve written previously, central bankers received a lot of criticism over the last year or two as the global economy has stubbornly refused to recover from the Great Recession at anywhere near the rate of past post-recession growth cycles.
Economics has come under fire along with other “establishment” institutions that are perceived as uncaring and out of touch. The criticism grew more intense—and more effective in the past year as Brexit and then the Trump victory occurred.
These events have proved that the masses and concerns are real people and not just faceless numbers dwelling inside someone’s model.
Economics is like string theory
While I was putting the finishing touches on another rant on this very subject last September, contrarian NYU economist (and now World Bank chief economist) Paul Romer published what professors like to call a “seminal paper,” titled “The Trouble With Macroeconomics.”
For more than three decades, macroeconomics has gone backwards. The treatment of identification now is no more credible than in the early 1970s but escapes challenge because it is so much more opaque. Macroeconomic theorists dismiss mere facts by feigning an obtuse ignorance about such simple assertions as “tight monetary policy can cause a recession.” Their models attribute fluctuations in aggregate variables to imaginary causal forces that are not influenced by the action that any person takes.
Romer then makes a very interesting comparison between what he calls “post-real” economics and string theory, which is a branch of physics. Like macroeconomics, string theory deals with vast systems jam-packed with unknown variables and incomplete data.
The conjecture suggested by the parallel is that developments in both string theory and post-real macroeconomics illustrate a general failure mode of a scientific field that relies on mathematical theory. The conditions for failure are present when a few talented researchers come to be respected for genuine contributions on the cutting edge of mathematical modeling. Admiration evolves into deference to these leaders. Deference leads to effort along the specific lines that the leaders recommend. Because guidance from authority can align the efforts of many researchers, conformity to the facts is no longer needed as a coordinating device. As a result, if facts disconfirm the officially sanctioned theoretical vision, they are subordinated. Eventually, evidence stops being relevant. Progress in the field is judged by the purity of its mathematical theories, as determined by the authorities.
Physics is unquestionably a science. But is macroeconomics a science? I’ve never thought so.
The economy is not an incentive but an information system
I think that to have any hope of correctly analyzing the economy, we are going to have to continue trying to understand the complexity of natural systems—because that’s exactly what the economy is.
The basis for creating policy should be to foster dynamic, growth-oriented complexity in the form of entrepreneurial activity. To understand that activity and promote it, we need to marry information theory with the new field of complexity economics.
Let’s look at information theory first. It may have been best explained by my friend George Gilder in his must-read book Knowledge and Power.
Information theory, at its root, is about distinguishing signal from noise.
In the world of economics, an entrepreneur has to distinguish amidst the market noise a signal that a particular good or service is needed. But if some force—a government or a central banks, for instance—distorts or corrupts the transmission of the signal by adding noise to the system, the entrepreneur may have difficulty interpreting the signal and may potentially respond to the wrong message.
“The economy is not chiefly an incentive system,” George asserts, “it is an information system.”
Economists and the governments they work for often appear to prefer a deterministic, no-surprises (and too-big-to-fail) economy, but that way lies economic stagnation.
Knowledge is centrifugal: it’s dispersed in people’s heads, and that has never been more true than in the Age of the Internet. And it is this universal distribution of knowledge, which feeds back to the economy through the creative insights and entrepreneurial efforts of people worldwide, that constitutes our chief hope for economic growth in the era opening up before us—where the limits of monetary manipulation and material extraction are becoming painfully apparent.
The writing is on the wall
Either we reinvent ourselves and our global economy, or the noise that is obviously building in the system will overwhelm the creation and transmission of knowledge, and the great human quest for the democratization of wealth will fail.
John Mauldin is the chairman of Mauldin Economics, which publishes a growing number of investing resources, including both free and paid publications aimed at helping investors do better in today's challenging economy. Mauldin uncovers the truth behind, and beyond, the financial headlines.
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