The Rebel Economist Who Blew Up Macroeconomics

  • Paul Romer takes World Bank job after trashing his discipline
  • Outraged fellow economists accuse him of intellectual arson

Paul Romer says he really hadn’t planned to trash macroeconomics as a math-obsessed pseudoscience. Or infuriate countless colleagues. It just sort of happened.

His intention actually had been to write a paper that would celebrate advances in the understanding of what drives economic growth. But when he sat down to write it in the months before taking over as the World Bank’s chief economist, Romer quickly found his heart wasn’t in it. The world economy wasn’t growing much anyway; and the math that many colleagues were using to model it seemed unrealistic. He watched a documentary about the Church of Scientology, and was struck by how groupthink can operate.

Paul Romer

Photographer: Slaven Vlasic/Getty Images

So, Romer said in an interview at the Bank’s Washington headquarters, “I just thought, OK, I’m going to say what I think. I don’t know if I’m the right person, but no one else is going to say it. So I said it.”

The upshot was “The Trouble With Macroeconomics,” a scathing critique that landed among Romer’s peers like a grenade. In a time of febrile politics, with anti-establishment revolts breaking out everywhere, faith in economists was already ebbing: They got blamed for failing to see the Great Recession coming and, later, to suggest effective remedies. Then, along came one of the leading practitioners of his generation, to say that the skeptics were onto something.

Going Backwards

“For more than three decades, macroeconomics has gone backwards,” the paper began. Romer closed out his argument, some 20 pages later, by accusing a cohort of economists of drifting away from science, more interested in preserving reputations than testing their theories against reality, “more committed to friends than facts.” In between, he offers a wicked parody of a modern macro argument: “Assume A, assume B, ... blah blah blah ... and so we have proven that P is true.”

What’s at stake far exceeds hurt feelings in the ivory tower. Central banks and other policy makers use the models that Romer says are flawed. The idea that consumers and businesses always make rational choices pervades mainstream economics. Romer thinks that’s not only wrong, but may lead to the misleading conclusion that government action can’t fix big problems.

That debate goes back at least to John Maynard Keynes, who thought policy makers needed to take bolder action to address the deep shortfall in demand that was prolonging the Great Depression. By the 1970s, Keynes’s ideas were mainstream -- but the policies they spawned had failed to prevent high unemployment and inflation.

Economists trying to understand what went wrong came up with the theories of rational expectations and the “real business cycle” -- the ones Romer dismantles. They argued that Keynesian models didn’t account for the way consumers and businesses recalibrate their behavior to take account of policy shifts.

‘What People Do’

For example, the government can spend more, putting cash in the pockets of consumers. But those same consumers, the theory goes, can see far and true into the future, and won’t be fooled: They’ll figure out that taxes will eventually have to rise to pay for the handouts. So they hang onto their cash in anticipation of that, and the longer-term result is a wash.

The problem with that worldview, says Romer, is that once you rule out policy or people as a catalyst of change, there’s often no convincing alternative: “Everything has to happen because of external shocks.”

That’s why all the hi-tech economic models aren’t much help with a basic but crucial question like: Why has productivity stalled? Romer helped pioneer the idea that human capital and innovation, which can be nurtured by government action, drive growth. He thinks a more empirical approach makes more sense: Economists should be asking “what kind of things influence what people do?” he said. “What actually leads to an improvement in productivity in a factory?”

For economists who actually make policy -- at the Fed, say -- theory may take a back seat.

“One of the important implications of rational expectations is that monetary policy has no effect on economic activity as long as it’s anticipated in advance,” said Benjamin Friedman, a professor of political economy at Harvard. “The Federal Reserve doesn’t believe that.”

Naming Names

Romer agrees that economic models don’t dictate to the top Fed policy makers; but he thinks they still wield undue influence, especially among “cohorts of young people in these research departments who get caught in this kind of groupthink.”

Of course, shocks to the real economy have a way of changing theories about it, as Fed Chair Janet Yellen pointed out last month.

She cited the “new ways of thinking about economic phenomena” that arose from the Great Depression and the stagflation of the 1970s, and said the 2008 financial crisis “might well prove to be a similar sort of turning point.” And Yellen, echoing Romer, pointed to the limitations of the current generation of economic models, saying that by assuming a single “average” household, they failed to capture diverse responses to the financial crisis.

Yellen was relatively diplomatic. One reason Romer has ruffled feathers so badly -- some scholars he cites are refusing to speak to him -- is that he names names. A trio of Nobel prizewinners led economics astray, in his telling: Robert Lucas, Thomas Sargent and Edward Prescott, intellectual architects of rational expectations.

Fix the Car

Lucas and Prescott didn’t respond to requests for comments on Romer’s paper. Sargent did. He said he hadn’t read it, but suggested that Romer may be out of touch with the ways that rational-expectations economists have adapted their models to reflect how people and firms actually behave. Sargent said in an e-mail that Romer himself drew heavily on the school’s insights, back when he was “still doing scientific work in economics 25 or 30 years ago.”

Allies of the three Nobelists have been more outspoken, and many of them point out that Romer -- unlike Keynes in the 1930s -- doesn’t offer a new framework to replace the one he says has failed.

“Burning down the edifice, and saying we’ll figure out what we’ll build on its foundations later, just does not seem like a constructive way to proceed,” said V. V. Chari, an economics professor at the University of Minnesota.

Romer’s heard that line often, and bristles at it: “I’m saying, ‘the car is broken.’ And everyone’s saying, ‘Romer’s a terrible guy, because he couldn’t fix the car’.”

At the World Bank, he may be expected to help fix stuff. The bank’s loans often come with policy recommendations attached, and its research is influential among those studying how poor countries can move up the development ladder. It might turn out to be a bumpy ride at the bank in the coming years, though: It’s not clear how the traditionally U.S.-led lender, with its commitment to channeling rich-country resources toward poorer ones, will adapt to President-elect Donald Trump’s America-first agenda.

‘Like Han Solo’

Reviewing the response to his paper, Romer says his eclectic career may not have endeared him to peers. He interrupted his academic work to found a software company that designs online homework for college students; the firm was sold in 2007.

A year before that, Romer had played a starring role in David Warsh’s history of economic ideas, “Knowledge and the Wealth of Nations.” That book, says Romer, portrayed him as “like Han Solo, and it’s the rebels against the Empire, and I’m the best economist since Keynes. You can imagine how well that went over with my colleagues.”

His name is often raised during Nobel season -- this year, much to his chagrin, by his last academic home. In early October, New York University announced a press conference to congratulate Romer for winning the prize, then apologized for mistakenly posting a document it had prepared just in case he won. Which he didn’t.

Romer said he hopes at least to have set an example, for younger economists, of how scientific inquiry should proceed -- on Enlightenment lines. No authority-figures should command automatic deference, or be placed above criticism, and voices from outside the like-minded group shouldn’t be ignored. He worries that those principles are at risk, well beyond his own field. “I’ve been thinking about progress my whole career. It’s a little bit frightening to think this could all unwind.”

And at the deepest level, he thinks it’s a misunderstanding of science that has sent so many economists down the wrong track. “Essentially, their belief was that math could tell you the deep secrets of the universe,” he said.

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE