What Economics Means to Me
by Valerie Bencivenga
I took an economics course my first semester in college and from that point there was no question about what my major would be. I have always found the process of gaining insight from models to be exhilarating. And from the start I was fascinated with macroeconomics and monetary economics.
The questions I have studied mostly concern the contribution of financial markets to growth and economic development. I feel passionately about the importance of economic development in general, and sound financial policies in particular. Over the past twenty years there has been increasing interest in economic development as many economists who began by studying fields such as macro, monetary theory, and industrial organization have turned their attention to the challenges faced by poor countries trying to become rich. Interest within international trade, labor, and public finance goes way back, and new models in these fields have proved useful. Economists' growing interest in economic development is very appropriate. The large majority of the world's population lives in the developing world, and despite the rapid growth of some countries, vast areas of the developing world, even within rapidly growing countries such as China, remain poor. And increasing interdependence among countries makes it all the more important that policy-makers around the world have the economic models they need to formulate sound economic policies--the costs of policy mistakes can ripple around the world, as can benefits that derive from good policy.
Fifteen or twenty years ago, the view that well-developed financial markets and sound financial policy contribute to growth was not very widespread. Now it is generally accepted. The list of episodes providing evidence that weak financial markets hold back growth would be very long but it certainly would include the Mexican peso crisis of 1994-5 and the Asian economic crisis of 1997-8. Across the developing world, countries have scaled back directed credit programs and dismantled economic regimes that repressed financial markets. On a more micro level, recognition has grown that limited access to credit by poor farmers and informal businesses, who usually lack collateral, has hampered growth; the past twenty years have seen big experiments with microfinance and group lending as possible remedies.
What all of these episodes and phenomena point to is the importance of incentives. This is the main lesson of economics. Incentives matter. And you can see this at the macro level as well as the micro level. A poorly regulated banking sector that thinks it will be bailed out by the government has an incentive to undertake excessive exposure to currency risk, and shocks to the economy such as a drop in export earnings can trigger a currency crisis that becomes a banking crisis which in turn becomes a recession. A weak legal system may hold back growth because poor enforcement of contracts and property rights undermines incentives for bank lending in particular and for investment in general. Examples abound of how bad economic policies affect incentives in ways that are adverse to growth.
Economists have a tough job in that there is still much basic research that needs to be done on questions that have policy implications, and as this research proceeds, it certainly may be the case that policies that once were received wisdom need to be re-thought. This has happened before. At one point, protectionist trade policies were thought to be a short-cut to industrialization and high incomes, but experience showed that almost always, countries pursuing "import substitution" for any length of time were left with an array of negative unintended effects (mostly due to bad incentives created by these policies) in addition to the loss of gains from trade. There is still no consensus on whether a floating exchange rate regime or a fixed exchange rate regime is more appropriate for a poor country that is trying to leverage international trade and investment into growth (or maybe they should adopt a "currency board" or "dollarize"). But the well-being of literally billions of people is affected by macro policies with respect to financial markets, exchange rates, and trade, and we don't have the luxury of waiting until we have more complete answers. So study economics! There is so much that needs to be done.