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This article first appeared in Forum, The Edge Malaysia Weekly on December 17, 2018 - December 23, 2018

There is an old Chinese saying that is roughly translated as “it is easier to move mountains than changing one’s mindset”. Since the 2008 financial crisis, the economics profession has been attacked from outside as well as within.

As an example of how ludicrous economic models have become, no less than Lord Mervyn King, former governor of the Bank of England, as well as former Professor of Money and Finance at Oxford and London School of Economics, has claimed that “most people believe that economics is about money. Yet most economists hold conversations in which the word ‘money’ appears hardly at all. Surprisingly, that appears true even of central bankers”.

What he really meant in layman’s terms is that the economic models that financial economists and central bankers use to predict growth, inflation and interest rates rely mostly on real variables, rather than money (which is both a liability and an asset and is often netted out in these models).

As an asset manager who uses financial models, JP Bouchard, writing in Nature magazine (2008), has argued that “economics needs a scientific revolution” because most of the models use axioms, such as rational agents, invisible hand and market efficiency, that actually defy empirical observation. Humans are not always rational, the visible hand of the state clearly changes the invisible hand of the market, and the market is more often inefficient rather than efficient due to monopolies, cartels or simply through market manipulation. In short, by trying to achieve elegant, reductionist models of the economy, economists assumed away all the factors that make the market and the economy very interesting, less predictable and prone to crises.

It was the mathematical elegance of Paul Samuelson’s Foundations of Economic Analysis in 1947 that gave economics much of its mathematical tools and concepts of equilibrium. From then on, economic behaviour could be mathematically modelled with the presumption of predictive power. In attempting to be more a

science than art, humanity and politics were written out through assumptions about rational behaviour. The classical view of political economy became increasingly “positive” economics, namely value-free, politically neutral and scientifically “objective”.

How wrong I was to accept that this was the correct approach to economics. When I arrived at the World Bank in 1989, with the research department dominated by intellectual giants such as Stanley Fischer and Larry Summers, that was the predominant belief — that you should not put politics into economic research.

The World Bank then was still full of idealism, with top academics filling the key positions bringing the unspoken view that the Washington Consensus of free markets was the right way to go. The World Bank was then far more open than the International Monetary Fund, its sister organisation across the street, which had a famous two-gap model on which all policies were predicated. Every developing country economic problem was due to two gaps — the trade gap (current account deficit) and the fiscal gap (government revenue less than expenditure). Hence, the solutions of the basic gaps were to raise interest rates or taxation/cut expenditure.

Intellectually, the existence of two gaps in every country in economic difficulty were irrefutable, but are these two gaps symptoms or causes?

The World Bank was much more intellectually curious because it comprised not just economists who were interested in trade and development, but also engineers, sociologists and former colonial administrators who had worked extensively in South Asia, Africa and Latin America. There was a healthy discussion of distributional issues, and although one did not engage in politics, there was some understanding how politics play into economic decisions.

But this eclectic view began to change organisationally as the bank had a Young Professional (YP) Programme, hiring bright young graduates from the top universities in the West, even though many were from developing countries. As these young economists rose in the ranks, they edged out the non-economists or mid-career professionals like myself, who learnt their ropes on the cutting edge of development, but were not as academically qualified as the YPs. Increasingly, reports had to reference academic papers to give them credibility. Theory became very important, whereas facts from the ground that did not suit theory were treated as anomalies, but which academics called “idiosyncratic”.

When I jokingly told my director, who was one of the brightest of the YPs, that no executive summary can be 45 pages single-space, his trite remark was that there was no problem for him to read at that speed. In other words, these intellectually trained “policy wonks” thought that every problem was an intellectual exercise, whereas many of the policy recommendations, which had to fit the Washington Consensus, began to diverge further and further away from the messy reality at the ground level of development.

This dilemma was mutually reinforcing. You would have thought that at the board level, representatives from the developing countries would present their views that what was recommended may not exactly be right or fit the ground conditions. But as the dominant voice was that of the US and European board members, who had the majority vote and went to the same top universities, these dissenting voices were often drowned or unheard. Other members learnt quickly that if you went along with the majority view, your loans got approved faster.

As I was working on a research project on why banks kept failing in developing countries, it dawned on me that just looking at the technical reasons for failure — such as inadequate capital, too much non-performing loans, even blaming bad bankers — was inadequate. The underlying reasons for bank failure were often political. In Kenya, one of the first countries I visited, the outgoing president had given bank licen-

ces to his political friends. It was not a surprise that these politicians treated the banks like cash machines and ran them to the ground. Arguing for an independent central bank or better-trained regulators was useful to paper over the problems, but as long as the politicians could override the technocrats, the banking problems would not go away.

The World Bank’s strength was that it was technocratic, the creation of former US Defence Secretary Robert McNamara, who took the job as president of the World Bank to salve his conscience in failing to halt the Vietnam War. His mindset was very American — if you put the best and brightest to the task, no problem was unsolvable. This was idealistic and inspirational, but in practice, often wrong.

One of the best books on this subject is the journalist David Halberstam’s book on why the US lost the Vietnam War, The Best and the Brightest (Random House, 1969). This book is an apt reminder why America is also losing the Iraq and Afghanistan wars today. It was a belief that with the best technology, resources and intellectual might, these intractable human problems are solvable.

The intellectual basis of this mindset goes back to the Christian/Judaeic religion that one seeks perfection, and that there is absolute good, without understanding that good often comes with bad.

These absolute concepts exist only in the mind, but in real life, all absolutes become blurred with time. We call such blurring “hybrids”. Innovation often exists from creating hybrids that adapt to new changes. Perfection decays over time through what we commonly call corruption. And out of corruption, revival comes.

The understanding of these follies of concepts and the mind is very Eastern. And it is exactly this complex interaction between the East and West, the convergence and divergence of mind and action, that this series aims to explore.

 

Tan Sri Andrew Sheng writes on global issues from an Asian perspective

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