National Data | Did Immigrant Economists Sink the U.S. Economy?


Most U.S. economists believe globalization is good. The unfettered flow of goods, labor, and intellectual capital across our international borders reduces costs and improves competitiveness of most sectors of the economy.

Or so they claim. But the impact of globalization on the economics profession itself raises serious questions about this point of view.

Foreign students increasingly dominate U.S. doctoral programs in economics. Although the number of doctorates has remained relatively stable over the past 35 years, the fraction of these degrees conferred on foreign students has increased dramatically -from 20.5 percent in 1972 to 72 percent in 2005. While all disciplines have seen increased foreign enrollment, the rise and size of the non-citizen influx into economics is unique—exceeding even that of science and engineering.

The displacement of native born economists is painfully evident in the trend of doctorates awarded since the mid-1980s:

The best and the brightest? Perhaps. Most Ph.D. candidates in economics are Asians—from Japan, Korea, India, and China, and Taiwan. These countries are regarded as having the strongest K-12 and undergraduate education programs outside of the U.S. They usually receive financial aid from the admitting university.

But there is one problem: while the Asians students are whizzes at math, they generally do not speak English well. Had they been high-schoolers, remedial English classes would have been mandatory for most of them.

But instead, university economics departments took the easy way out: they altered the curriculum to accommodate the foreigners!

Gone was the history of economic thought. Gone was the economic history course that exposed students to market failures and the importance of psychological factors—what Keynes dubbed “animal spirits”—to a prosperous economy. In their place: mathematically-oriented courses devoid of any historical content or context.

We have written about the glut of PhD`s in U.S. higher education. Graduate departments routinely exploit their foreign-born enrollees—prolonging their stay as low-wage teaching assistants or researchers.

There are undoubtedly many economics PhDs. in this predicament. But more than any other social science, the economics PH.D. has become the road to riches. Wall Street riches.

In the mid 1980s the financial community discovered it could use mathematics to make money. It started—surprise, surprise—at Goldman Sachs. Robert Rubin, at the time head of the firm`s investment banking division, hired Fischer Black, an economist and academic at the Massachusetts Institute of Technology`s Sloan School of Management. Black was best known as the co-author of the Black-Scholes equation, which measured the risk of complex financial instruments.

Rubin`s put Goldman`s money on Black, wagering that by calculating risks the company could, in effect, eliminate risks both for itself and its customers. All that was needed was enough brainpower to customize the risk equations for the various instruments in Goldman`s portfolio—thing like stock options, warrants, corporate bonds—and even bonds backed by sub-prime mortgages.

A boom time for economics PH.D.s? You bettcha. What Wall Street was really after, a former “rocket scientist” says, was not PhDs, but PSDs: people who were “poor, smart and with a deep desire to get rich”. Asian PH.D.s fit that description perfectly.

At the quant center of the 2008 financial meltdown was one David Li. Born Xiang Lin in China, educated in Canada, Mr. Li was a successful Ph.D. actuary before he published the mathematical equation that propelled him to the position global head of derivatives research at Citigroup. His equation “proved” that the risk of an investment grade mortgage defaulting could be estimated with precision, independently of the risk that other—say, sub-prime mortgages—would default.

For decades banks could only sell their mortgages as part of a diversified portfolio. Li`s breakthrough made that seem very old school. Moody`s incorporated Li`s default equation into its rating methodology for credit default obligations (CDOs.) Ergo, no need for AIG and other insurers of mortgage-backed debt to spread their assets among different instruments if you know the risk of each asset class with precision.

A Wall Street star was born. His reception at a conference shortly after the publication of the default formula is described in a recent profile:

The presentation was a riot of equations, mathematical lemmas, arching curves and matrices of numbers. The questions afterwards were deferential, technical. Li, it seemed, had found the final piece of a risk-management jigsaw that banks had been slowly piecing together since quants arrived on Wall Street.”  [The formula that felled Wall St By Sam Jones, Financial Times, April 24, 2009]

It was, someone who was there recalled, like being at a science fiction convention.

Apologists point out that the traders, not Li and his fellow quants, are the ones who lost billions for Wall Street firms last year. That may be technically true. But when traders sit in front of their computer screens and click the mouse, they are responding to the prompts derived from some complex equation. The almighty equation, devoid of both common sense and a sense of economic history, drove the U.S. financial system over the cliff last year. And immigrant economists played a role.

Edwin S. Rubenstein (email him) is President of ESR Research Economic Consultants in Indianapolis.