The Problem of Economic Incompetence.

Andrew Smithers
London, 31st October 2017

Inequality, as measured by incomes, has fallen in the UK over the past 20 years. This will probably come as a surprise to many as the debate on inequality has become more strident as the situation has improved. The problem is that incomes have stagnated. Our sense of wellbeing does not just depend on our current standard of living but on the expectation that it will improve. Hopes of a better future for ourselves and our children have been dented and, unless the economy becomes less incompetently managed, these hopes will be abandoned. Populism, which depends upon separating “them” from “us” and promising the unattainable, will then flourish. You can promise “affordable houses for all and no new development”, but you can’t deliver it. People of goodwill would like “higher living standards combined with greater fairness in their distribution”, but this cannot be delivered unless the economy grows faster. Median incomes are likely to fall rather than rise if tax rates are increased to pay for more government financed consumption. Investment will fall if consumption rises, growth will slow further and living standards will decline rather than just stagnate.

Economic incompetence has been demonstrated by the financial crisis, the deep recession which followed and the weakness of the subsequent recovery. The inability to prevent the crisis and then to engender a recovery strong enough to meet voters’ expectations are both intellectual failures. The prominent physicists David Deutsch and Artur Ekert have claimed that physicists are culpable of much bad science. Economics is a science which, even more than physics, is often pursued unscientifically. The financial crisis was one example and the subsequent weak recovery another. The former was due to the widespread acceptance of the myth, known as the Efficient Market Hypothesis, that financial markets were efficient. This was unscientific because in its original “random walk” form, it was testable but failed when tested. With sadly few exceptions, economists were nonetheless reluctant to discard this myth and policy was based on a patched up form of it, which has proved to be nonsense in practice. It was also unscientific in theory because it was untestable and thus fell the wrong side of Karl Popper’s famous demarcation between science and non-science. The policy implications were disastrous. If financial markets were efficient, it followed that assets were always correctly priced and could therefore never rise to excessive and dangerous levels. A similar blindness applied to the dangers of excessive debt levels. The recent financial crisis was, in common with previous ones, the result of excessive debt and overblown asset prices. As this possibility was denied the dangers were ignored by the policymakers, despite the strong warnings of those who showed the hypothesis to be unscientific. The financial crisis has, for the most part, destroyed the myth because events, as so often, convince more readily than argument.

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The Problem of Economic Incompetence