A Controversial Correspondence

In the July Newsletter Ray Rees’s ‘Letter from Germany’ reported and commented on a recent debate in Germany about the appropriate training for economic policy-makers. As he explains below, these comments sparked further controversy. Ray asks: ‘Does this debate have a resonance outside Germany?’

In my last ‘Letter from Germany’ I reported on a debate among German economists conducted by means of letters to two of Germany’s leading newspapers. I have received quite a lot of comment, not least from economists in Germany itself, and so I thought readers of this Newsletter might be interested in full translations of the letters with some brief comments. Does this debate have a resonance outside Germany?

(1) Rescue Economic Policy in the Universities!
The undersigned 83 professors of economics follow with concern the increasing efforts to suppress the teaching of Economic Policy at the universities. Professorships in Economic Policy are to be diverted from their original purpose or re-designated, and undergraduate programmes in business economics will no longer include lectures on economic policy.

The teaching of Economic Policy deals both normatively and positively with important questions: What should be the goals of economic policy (for example with respect to the share of the public sector, public finances, distribution, stability and suchlike)? What economic policy institutions and economic policy instruments are appropriate to achieve specific economic policy goals? How can it be explained in political economy terms why institutions of economic policy can fail? How can changes in economic policy goals and in the efficiency of economic policy instruments be explained? The systematic analysis of such issues of economic policy without a normative foundation is not possible.

In economic theory the dominant tendency is to derive logical consequences from specified assumptions. The result is already contained in the assumptions. This methodology guarantees formal rigour, but is less than suitable for the analysis of real world economic policy. A good scientific analysis of economic policy is always based on economic theory. However it goes further, in that it pursues the question of the extent to which the theoretically derived conclusions are in reality applicable and implementable. For that it is among other things necessary to have knowledge of the real institutions and of their (incentive-) effects. In the end, only in this way can scientifically well-founded recommendations be made to the decision takers on economic policy.

As a rule, there is a failure of real economic policy not because a decision taker makes a mistake in logic, but rather because they have wrongly estimated the effects of their instruments, or because the wrong incentives have been provided by their economic institutions, or because behaviour patterns of economic subjects prevail that are not consistent with the pure theory. It is the job of Economic Policy to inform us about these connections. Accomplishment in the derivation of logical consequences is sometimes of only limited utility when the task is to understand and judge reality.

In other countries also, increasingly many economists sacrifice the realism of their analysis to the goal of formal logical rigour, and this tendency is also subject to keen public criticism. The United States is no exception. The economists [there] withdraw from reality because the career incentives in their subject are distorted. The prevailing alignment of university teaching and research hardly offers any incentive for young academics to busy themselves with questions of economic policy. For the results of economic policy analysis are frequently controversial and, since they are of an empirical nature, are never capable of being proven with complete certainty. There is no room for public performances of logical virtuosity.

Because the incentives are not right, the economics discipline neglects to make the contribution that it could — and should! -— make to the solution of practical problems of economic policy. But science has a social responsibility. It is kept in being to produce applicable results. Professorships in Economic Policy must therefore remain an indispensable component of economic research and teaching.

Published in the Frankfurter Allgemeine Zeitung, Tuesday 5 May 2009. (Trans. Ray Rees)

(2) Reconstruct German Economics In Line With International Standards!
A call from 188 Professors and Researchers in Economics: The uncompetitive structures in German economics faculties must not be set in stone.

The undersigned 188 professors and researchers in economics follow with concern the efforts of some of our colleagues to argue for a cementing of internationally uncompetitive structures in German economics faculties, and to misdirect the attention of the general public away from the contribution that it is necessary for our discipline to make to the solution of currently pressing problems. In the process of doing so a distorted picture of modern economic research has been presented.

In the appeal ‘Rescue Economic Policy at the Universities’ that appeared in the Frankfurter Allgemeine Zeitung on May 5 of this year, the criticism is expressed that ‘the dominant tendency in economic theory is to derive logical conclusions from selected assumptions [that] are less than appropriate for the analysis of real-world economic policy’. It is further maintained that ‘in other countries economists increasingly sacrifice the realism of their analysis to the goal of formal logical rigour, and withdraw from reality’.

A Distorted Picture of Modern Economics
The conclusion is drawn from this that the subject of economics is ‘increasingly neglecting the contribution that it could make to the solution of practical problems of economic policy’. Therefore, according to the appeal, ‘Chairs in Economic Policy must remain an indispensable part of economic teaching and research’.

With this appeal we oppose this distorted picture of modern economics as pure economic logic. With this appeal we also oppose the further cementing of the unfruitful separation between ‘economic theory’ and ‘economic policy’, which is uncommon internationally.

Instead, we call for a reconstruction and extension of the economics faculties in line with international standards, in order to make it possible for German universities to attain the high quality and comprehensive breadth that would give them a leading position in international research.

[In faculties] where this reconstruction and extension has already begun, it should be strengthened and carried further, and should be supported by academic policymakers as well as by the university administrations.

A clear majority of the fields of specialization in modern economics are in areas of application, concerned both with the theoretical and with the empirical analysis of economic problems and their implications for economic policy. Specialists in theory or in econometrics are just as welcome in these areas as those who combine the two.

The dividing line is not between theory on the one side and policy on the other, but between the main points of emphasis of the respective concrete subject areas. For this reason internationally leading [economics] faculties typically have around three quarters of their professorships in applied areas such as microeconomics, macroeconomics, labour economics, development economics, international trade, industrial economics, experimental economics and public economics.

An important role in these subjects is played by the scientific analysis and understanding of the incentive properties of the instruments and institutions of economic policy, exactly as called for in the May 5 appeal.

By far the largest part of the work published in the leading international journals, such as the American Economic Review, Econometrica, the Journal of Political Economy, the Quarterly Journal of Economics or the Review of Economic Studies is of an applied or empirical nature. Economic policy and the teaching of it are as a result a consistently integrated component of the teaching and research programme in economics. In this way insights into economic policy are methodologically, theoretically and empirically well-founded and their implications can be tested and replicated by others.

Leading Economists as Political Advisors
Economic policy advice is increasingly in the hands of leading academic economists, who have earlier made path-breaking contributions to our subject. Ben Bernanke, Lawrence Summers, Christina Romer and Olivier Blanchard for example have as academics published model-theoretic and quantitative research on economic policy in leading journals and are now key decision takers in American and international economic policy.

In contrast to that, one can scarcely find comparable leading practitioners of our subject in the German government. It is in our view a complete mistake to draw from that the conclusion that the traditional separation of economic policy from economic theory in Germany has paved the way for a central role for economics in the solution of practical problems of economic policy.

Economics is an active, developing subject. The present financial and economic crisis presents new challenges. Building on the leading insights of [economic] science, current research is seeking a deeper understanding of the interactions of the finance, banking and real sectors and the effects of the relevant economic instruments, not least in order to be able to better inform and advise, on a solid scientific basis, practical economic policymakers as well as the general public.

In this, good theory and good empirical work will play an important role, old dogmas on the other hand will not. Those responsible for academic policy decision taking should put economic research in Germany in the state in which it is able to make an internationally significant contribution.

Published in Handelsblatt, Monday 8 June 2009. (Trans. Ray Rees)

Some comments from Ray Rees:

Though the first paragraph of the first letter is formulated in general terms, it is really directed specifically at the economics faculty of the University of Cologne. Faced with a large wave of retirements, the members of this faculty have decided to build up a strong macroeconomics group, by filling six vacant chairs with good, young, internationally-oriented macroeconomists. This involves a break with tradition, since Cologne was for a long time a bastion of so-called ‘ordoliberal economics’, on which more below. A characteristic of this tradition, though not an essential element of the philosophical basis of ordoliberalism, was hostility to mathematical — equated with ‘theoretical’ — economics and an emphasis on policy-advising rather than academic publication as the main activity of professors. This is perhaps why, of the 83 signatories of the letter, an economist outside Germany would recognize probably fewer than a half-dozen of the names. My question: what would be the view taken in the English-speaking countries of a situation in which a group of retired professors, their ex-students, and like-minded professors in other universities make an overt attempt to prevent an economics department reconstructing itself in line with internationally-accepted standards in its discipline?

'Ordoliberalism' takes its name from the journal ORDO (derived from the word Ordnung, meaning ‘order’, in the sense of a social or economic order) and is a form of economic liberalism developed to provide policy recommendations for Germany, particularly in the period of post-war reconstruction of the German economy. It was espoused by Ludwig Erhard, who presided over the Wirtschaftswunder of the 1950’s and 60’s, and provides the intellectual basis for the idea of the ‘social market economy’, an economy that is fundamentally driven by market forces and private ownership, but in which policy-makers also care about social outcomes. It holds that the goal of state economic policy is to create a legal and institutional framework (order) in which competitive markets can achieve prosperity, full employment and growth. It emphasizes the use of strong competition policy to prevent the development of oligopoly and monopoly power, which not only undermines economic performance but also threatens the liberal political order. It also emphasizes that the conduct of monetary policy should be the responsibility of an independent central bank committed to price stability. Other aspects of economic policy should be carried out by similarly specialized institutions with specific, clearly defined responsibilities. The role of the state is to ensure the appropriate institutional framework of law and regulation, but it should not intervene directly in trying to control economic processes. To economists outside Germany, the fact that contributors to the journal ORDO have included Friedrich Hayek, Karl Popper, Peter Bauer, Milton Friedman and James Buchanan should give a clear idea of its intellectual orientation. It also suggests that as an economic philosophy it would find wide acceptance outside Germany. The problem with the intellectual content of the letter, as I see it, is that it fails to understand the methodology of modern economics.

The strength of modern economics, particularly in relation to the other social sciences, is that it proceeds by building, testing and applying models. We perceive the world in terms of models, and progress in economics comes about through the extension of our modelling capability (for example to handle strategic interaction or asymmetric information) and improvements in the relevance of the models to real economic phenomena. This methodology does not strictly require mathematical methods, but of course is hugely facilitated by their use. The authors of the letter, and (older) ordoliberals generally, confuse this methodology with the pure logic of the axiomatic method, to which of course it is closely related, failing to see that the emphasis is on economic content rather than mathematical formalism. They also have no understanding of the role econometrics plays in this process.

Although the first four paragraphs of the letter have these basic weaknesses, I think the letter itself would not have stimulated the responses contained in the second letter if it had stopped there. The last two paragraphs present such a distorted picture of what gets done elsewhere (as a warning to German policy makers — see what will happen here if we don’t preserve our (ordoliberal) chairs in Economic Policy) that such a response was necessary. This isn’t to say that ‘mainstream economics’ is beyond criticism. In particular, my colleague Hans-Werner Sinn, who has probably done more than anyone to bring German economics into the international mainstream, is critical of the neglect of real institutional detail in much of the mainstream work on economic policy, and in this finds a point of agreement with the first letter. Overall, however, I think the second letter makes the correct response and I am happy to be one of the 188 economists who signed it.

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