Robert Samuelson asks a reasonable question in his column today: "what do economists do for a living?" More specifically, how did almost all economists fail to see the coming of the worst downturn since the Great Depression? However, Samuelson reaches the wrong conclusion in saying that the slump originated in finance. The highlights and headlines, like the collapse of Bear Stearns, Lehman, AIG, Fannie and Freddie are certainly in finance. These events get the most attention and headlines, kind of like the explosions from bombs or artillery in war. But, the cause of the war was not the bombs and artillery. The story in this picture was an $8 trillion housing bubble. This hugely distorted the real economy by causing housing construction to expand as a share of GDP by 50 percent above its normal level. The bubble wealth also generated an enormous wave of consumption that pushed the saving rate into negative territory. It was inevitable that this story would end badly, because there is no easy way to replace the loss of $450 billion in annual demand generated from construction and $600-$800 billion of housing bubble wealth driven consumption. It is far too generous to economists to imply that they had to know the details of finance, a specialized area within the profession, to understand the bubble. A knowledge of the basics of intro econ would have been sufficient.
--Dean Baker
