Economics Is Not a Morality Play

Last week’s Oscar winner for Best Adapted Screenplay, "The Big Short," tells the story of how a motley group of investors saw the 2008 financial crisis coming when no one else did. The film’s heroes are bankers with consciences, plucky little guys standing up to the titans of Wall Street. (Two of the characters run their hedge fund out of a garage). They see the contradictions of the housing market—the ghost towns of foreclosed condos, mortgage lenders preying on anyone with a pulse—and, disgusted, place bets against it. When the deluge comes, they profit handsomely. The underlying message is classic Hollywood: Doing the right thing pays off. The big banks, The Big Short contends, were too blinded by their greed to see the crisis coming. Avarice is its own undoing.

But that’s not quite accurate. Betting against the housing market was a financial call, not an ethical stance. By and large, the investors who profited from the financial crisis saw it coming because they understood the economics, not because they were morally any better or worse than their competitors. The film omits John Paulson, the hedge fund manager who made $4 billion betting against the housing market. (Incidentally, some of that money now funds Harvard’s new Paulson School of Engineering and Applied Sciences.) It glosses over the fact that Goldman Sachs—one of the chief targets of the film—predicted the housing bubble as early as 2005, and also shorted mortgage-backed securities.

Turning the story of the few who profited from the financial crisis into a moral parable is giving the tale a dimension it did not have. To borrow a phrase from the economist Paul Krugman, economics is not a morality play. This dictum is not limited to the financial crisis; in general, trying to glean moral lessons from economic ones is misguided.

Krugman originally coined the phrase during the debate over fiscal austerity in 2010. In Europe (and to a lesser extent, the United States), commentators were calling for a return to common-sense fiscal discipline: Stimulus packages should be rolled back and deficits should be cut, lest debt pile up and become unmanageable. On the face of it, this seems ethically sound; countries, just like people, should live within their means. Moreover, these critics argued, countries that prudently built up surpluses for a rainy day, like Germany and the Netherlands, should not be held responsible for supporting profligates like Greece or Spain.

But applying this “common sense” logic to economic management proved disastrous. In depressed economies like Greece, government spending has an amplified effect (in economic jargon, this is to say that the fiscal multiplier is high). Small cuts to spending become disproportionately painful, while increases to spending, even minor ones, can ease a significant amount of pain. There is even significant evidence that by causing so much economic damage, policies of fiscal austerity actually made the debt situation worse for some of these Eurozone countries. In this topsy-turvy economic world, thriftiness was a vice and profligacy a virtue; the normal moral intuitions about paying back your debts did not apply.

Here’s another brief example: Do greater levels of democracy promote economic growth? An influential 1994 paper by economist Robert Barro found that greater levels of political freedom were associated with faster rates of growth—but only to a point. Past a certain threshold of moderate political freedom, Barro found a negative relationship between growth and democracy; in other words, there was a trade-off between levels of political freedom and economic prosperity. Is the takeaway here that we should give up some of our rights in order to achieve a higher growth rate for GDP?

Of course such a trade-off would be absurd. Economic questions and moral concerns do not neatly align; they are orthogonal to each other. In the debate over fiscal austerity, prudence and prodigality were even reversed. As comforting as the David-and-Goliath story of "The Big Short" is, it is ultimately a fable. The traders at Deutsche Bank and Citigroup, who survived the crash, enjoyed no moral high ground over the employees at Lehman Brothers or Bear Sterns, who didn’t.

Telling the story of investors who acted ethically during the crisis but did not make money would make for a braver and perhaps more interesting picture. Pity that that sort of movie would not sell.

Oliver W. Kim ’16, a former Crimson columnist, is an Economics concentrator living in Leverett House.