Here’s a provocative piece from the Institute for New Economic Thinking declaring that orthodox economics has been dealt a “mortal blow” by the Trump victory. Sanjay Reddy writes:
“Trumpism is a crisis for the most prestigious methods of understanding economic and social life, ennobled and enthroned by the metropolitan academy of the last third of a century. It has caused mainstream ‘social science’ to fall like a deck of cards. It can only save itself through comprehensive reinvention, from the ground up.”
I don’t think it’s controversial to argue that the current populism is the result of dissatisfaction with the state of the world and the economy in particular. I also don’t think it’s controversial to argue that Trump won because he latched onto post-financial crisis economic fear and won votes in the all-important Midwest where he argued that elitist thinking led to globalism and a loss of jobs across the region. Trump persistently stated that free trade and orthodox economic ideas had failed us and that he knew better.¹ If you believe that Trump seized on the current economic malaise and you also believe that orthodox economics contributed to the current economic malaise then it’s not unreasonable to argue that Trump is President-elect because of a repudiation of orthodox economic ideas. But how rational is this idea?
There are too many moving parts in this discussion for me to do it justice, but I would argue that orthodox economics did indeed contribute to the rise of Trump, however, that much of this blame is unfairly placed. Yes, Trump latched onto the post-crisis economic weakness and fear. And yes, orthodox economics contributed to this weak economic environment. However, we should not confuse the idea of “contributing” to the current environment with “causing” the current environment.
There’s little doubt, in my opinion, that orthodox economic ideas contributed to the post-crisis period of discontent. This can be summarized in two ideas:
- Orthodox economics ignored the linkage between the real economy and the financial economy. This failure set the stage for the financial crisis and exacerbated its impact.
- Orthodox economics, being dominated by monetarist influence, had (has?) an excessive faith in the influence of monetary policy. This distracted from other potential policies and resulted in a weaker economy than we would otherwise have.2
It’s well founded that orthodox economic models did not properly account for the financial sector’s integration and impact on the real economy. This led to a liberalization of regulations that put too much faith in the risk management capabilities of bankers and free markets.3 The resulting deregulation and misunderstanding of the operations in the financial economy contributed substantially to the financial crisis and its resulting economic malaise.
Coming out of the financial crisis orthodox economists argued that we were at the “zero lower bound” with regards to monetary policy and that this meant Central Banks needed to implement alternative extraordinary policy measures such as Quantitative Easing. As I’ve repeated ad nauseam over the years, this was a misinterpretation of the credit crisis environment and overestimated the impact that such policies would have. Policies such as QE not only failed to stimulate the economy adequately, but contributed to the paranoia, conspiracy theories and environment of misinformation that have plagued so much commentary in the post-crisis era.
Further, because orthodox economists broadly misunderstood modern banking operations they were excessively concerned about inflation and the potential that QE could cause reserves to leak out of the banking system. This misunderstanding of the money multiplier compounded the problems by further distracting from other policy possibilities such as fiscal policy. This, combined with economic models that excessively emphasize the efficacy of Central Bank operations, led to an environment ripe for fiscal austerity which contributed to our current economic weakness.4
More broadly, orthodox economics has promoted free trade which led to NAFTA and support of the TPP. These trade agreements became key targets of the Trump campaign as he argued that these ideas had directly hurt American jobs by importing jobs overseas. This argument was devastating to orthodox economics as it remains one of the most sacred topics of broad agreement. You could argue that this was the core of the Trump sales pitch and given the Electoral College results in the Midwest it was perhaps the most impactful campaign message.
When you view the Trump victory through this lens it’s easy to argue that orthodox economics contributed to Trump’s win. Then again, referring to it as a “mortal blow” is probably overreach. I agree with Ben Bernanke who said in 2010:
“I think that calls for a radical reworking of the field go too far.”
Yes, orthodox economics probably contributed to the Trump win, but this does not mean orthodox economics caused the Trump win. After all, if you believe, like me, that the credit crisis was essentially a behaviorally driven asset bubble, then it would have occurred with or without deregulation of the financial sector (though this exacerbated its impact). And, if you believe, like me, that much larger emphasis on fiscal policy would have been more impactful than all the monetary policy we got, then we’d probably have higher growth in the post-crisis period, however, a Republican Senate and Congress later in the Obama administration would have still dealt a populist death knell to fiscal stimulus thereby making this a moot point. And lastly, if you disagree with the efficacy of free trade doctrines and its promotion by orthodox economists then you probably find Trump’s message appealing. On the other hand, Trump is ignoring the fact that most of the jobs lost during the last few decades are the result of secular trends in globalism that would have occurred with or without free trade policies.5
So yes, I think you can argue that orthodox economics contributed to the rise of Trump, but I would not say orthodox economics caused the rise of Trump. More importantly, I would not go overboard arguing that orthodox economics is on its death bed. If anything it is in the recovery room learning from these mistakes and pivoting on important matters that will hopefully improve its impact on the world going forward.
¹ – There is little doubt that, when it comes to economic ideas, Trump does not know what he’s talking about, however, given his masterful sales skills he has mastered the art of selling people things they want to hear.
2 – See Eggertsson (2009) as an example of early financial crisis New Keynesian research arguing against the efficacy of fiscal spending.
3 – This was one of the core conclusions of the Financial Crisis Inquiry Commission as well as Ben Bernanke.
4 – New Keynesian models (which could easily be called “New Monetarist” models) excessively rely on theoretical concepts such as the zero lower bound and the natural rate of interest.
5 – The hyperglobalism of the last 30 years is primarily the result of technological changes that have made a big world a very small place as well as the way the US economy has shifted from a manufacturing economy to a services economy. These changes almost certainly would have occurred without or without free trade.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.