Economics is an endeavor where progress can seem very slow. In the hard sciences (physics, chemistry, biology, and the like), experiments and data can settle debates once and for all. But in economics and finance, theories often persist for decades, even as empirical evidence against them accumulates year after year. This frustrating “life after death” of economic theories has inspired at least one economist to write an entire book on the phenomenon.
The problem in economics and finance is that we deal with human beings who change their behavior all the time, so there is always an excuse to explain why a particular theory failed in practice: “If the price of butter in Poland had not increased, the value. would have outgrown the growth” and so on.
Another critical factor is that many business and finance professionals learned about these topics in college and have not kept their knowledge up to date with the changing consensus among researchers. That’s why arguments about how printing money leads to inflation and similar nonsense still attract an audience.
One of my goals with these posts is to give investors a refresher course on the latest research so they don’t make the same mistakes as other people. That doesn’t mean we don’t make mistakes. After all, knowledge is constantly changing and what may be “true” today may be naive and wrong tomorrow.
But even in economics and finance, knowledge shouldn’t go around in circles. We do not abandon one theory for another only to return to the old debunked model later. We discard a theory or perspective because the evidence is incomplete or incorrect and move on to a better description and model of the world. We don’t have to go back to a description of the world that we know is wrong and the reasons why it is wrong.
The Economists’ Consensus: Says the Survey?
That’s why I was eager to see the results of a study I participated in by Doris Geide-Stevenson and Alvaro La Parra Perez. This survey of American Economic Association (AEA) members has been conducted every 10 years since 1990 and tracks how the consensus among economists has evolved on key issues and how it hasn’t. It’s also a great barometer of where the consensus lies in the first place.
In 2020, the survey looked into 46 topics and found some areas where there is broad agreement:
- Tariffs and quotas tend to reduce welfare.
- Income distribution in the United States should be more equitable.
- Immigration generally has a positive economic impact on the US economy.
- The long-term benefits of higher fossil fuel taxes outweigh the short-term economic costs.
- Universal health insurance coverage will increase economic well-being in the United States.
And then the survey identified areas where there was little agreement:
- The economic benefits of an expanding world population outweigh the economic costs.
- The level of government spending relative to GDP in the United States should be reduced.
- Macro models based on a “representative rational agent” give generally useful and reasonably accurate predictions.
- The reduction of the tax rate on income from capital gains would encourage investment and favor economic growth.
Some of these questions reflect a changing consensus among researchers. Take, for example, the question of whether a growing world population is a net positive. In 2000, 63.5% of economists disagreed versus 36.5% who agreed or largely agreed. By 2020, the balance had reversed: only 42.4% disagreed and 57.6% agreed.
Deficits don’t really matter
And although many professionals believe that “a large trade deficit has an adverse effect on the economy”, the view of economists has changed. In 1990, two out of three agreed with this statement. Today, two out of three reject it. Large trade deficits are nothing to fear.
The consensus on public deficits has also changed, even if conservative politicians have not yet been won over. In 1990, 42.2% of economists said the government deficit should be reduced, while 38.6% said deficit reduction was not necessary. Today, government deficits are higher than they were in 1990, but 57.3% of economists don’t think they should be reduced, compared to 23% who say they should be.
The percentage of economists who believe the more general statement, “A large budget deficit has an adverse impact on the economy,” fell from 39.5% in 1990 to 19.7% today, while the share who did not agree increased from 14.1% to 38.6%.
We’re all Keynesians (again)
And finally, my favorite: “Business cycle management should be left to the Federal Reserve; activist tax policies should be avoided.”
In 1990, at the end of the Reagan and Thatcher revolutions, 71.6% of economists agreed or largely agreed with this statement. Today, 66.6% disagree and see a clear role for fiscal policy in managing the economy. The phrase “We’re all Keynesians now” came back into prominence after the Global Financial Crisis (GFC).
In terms of the research consensus, that seems to be what happened. The question is: what are we to make of this Keynesian revival? Was the Keynesian view right all along? Or will it be bad again?
We’ll just have to wait and see what the consensus is in 10 years.
For more information from Joachim Klement, CFA, don’t miss out Risk profile and tolerance i 7 mistakes every investor makes (and how to avoid them) and subscribe to his regular comment a Klement on investment.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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