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Economics

No More Mr Nice Guy

In his new book, Steven Keen outlines why the public needs to know that economics is intellectually unsound.

	Debunking Economics

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Why have we handed over the running of the world to economists?

It is hardly because economics has won the intellectual equivalent of a popularity poll or election. In fact, if anything, economics is deeply unpopular, and its unpopularity spans all social spectra. The demonstrations against the IMF and other institutions in Seattle, Washington, Davos, Melbourne and Prague were fundamentally demonstrations against the proposition that the world should be reshaped in accordance with economic theory. Those events were simply the most dramatic of many protests which have frequently cut across the standard Left-Right divide of political debate, uniting the most unlikely of bedfellows against the policy recommendations of economists.

Only parties of the middle - the Democrats and Republicans of America, the Social Democrats or Christian Democrats of Europe, England's Conservative Party and 'New Labour', Australia's Liberal and Labor Parties - espouse the policies of economics. Parties which are more avowedly Left and Right often express economic attitudes which are diametrically opposed to policies of centrist parties, but are remarkably similar to each other - with their similarity derived from a shared disdain for conventional economic thought. However, because centrist parties have almost always been in power, the economic policies they champion have shaped the modern world.

At the level of 'grassroot' politics, in countless disputes around the world, social groups, which normally oppose each other, have also found themselves united by a common opposition to economic policy. Unionists opposing how economics treats labour as a mere commodity have found themselves standing, figuratively or actually, shoulder to shoulder with businessmen chafing against its anti-monopoly dogma. Farmers bemoaning the decline of rural communities have found themselves united with ecologist denying that a dollar value can be placed on nature. Feminists decrying its lack of respect for household labour have found themselves allied with Christians fuming at its portrayal of people as innately hedonistic.

And yet economics has swept all these opponents aside.

Nor is the political success of economics explicable because, though its message may occasionally be unpalatable, its opponents have to concede that it works: that the world has become a clearly better place because of the policies followed by governments that have followed the advice of economists.

The global economy of the early 21st century looks a lot more like the economic textbook ideal than did the world of the 1950s. Barriers to trade have been abolished or dramatically reduced, regulations controlling the flow of capital have been liberalised, currencies are not valued by the market rather than being set by governments; in so many spheres of economic interaction, the government's role has been substantially reduced. All these changes have followed the advice of economists that the unfettered market is the best way to allocate resources, and that well-intentioned interventions which oppose market forces will actually do more harm than good.

With the market so much more in control of the global economy now than fifty years ago, then if economists are right, the world should be a manifestly better place: it should be growing faster, with more stability, and income should go to those who deserve it.

Unfortunately, the world refuses to dance the expected tune. In particular, the final ten years of the 20th century were marked, not by tranquil growth, but by crises: the Japanese economic meltdown, the Long Term Capital Management crisis, the Russian crisis, the Mexican crisis, the Asian crisis, and many more.

Economists are prone to 'point the finger' and blame these crises on particular economic policy failings by the relevant governments - closed capital markets in Japan, fixed exchange rate shenanigans by the Thai government prior to the collapse of the baht, and so on. Yet many non-economists harbour the suspicion that perhaps these crises were in some sense caused by following the advice of economists.

This perspective was recently supported by non other than Joseph Stiglitz, a renowned economist who has had an intimate involvement in public policy via his roles as Chief Economist and Vice-President of the World Bank. Speaking as an insider and an economist, he asserted that these crises were indeed often precipitated by economists.

The most extreme case Stiglitz discusses was the collapse of the Russian economy, as Russia attempted to move from a command economy to a market economy in a timescale measured in days rather than years. While he notes that there was a group of eminent economists, including himself and Kenneth Arrow, who favoured a slow transition with an emphasis upon institutional reform, he says that the day was won by another group

Whose faith in the market was unmatched by an appreciation of the subtleties of its underpinnings. These economists typically had little knowledge of the history or details of the Russian economy and didn't believe they needed any. The great strength, and the ultimate weakness, of the economic doctrines on which they relied is that the doctrines are - or are supposed to be - universal. Institutions, history, or even the distribution of income simply do not matter. Good economists know the universal truths and can look beyond the array of facts and details that obscure these truths. (Stiglitz 2000)

The outcome, as Stiglitz details, was far different from the expectations held by these economists. Rather than enabling Russia to rapidly transmute from moribund socialism to dynamic capitalism,

The rapid privatisation urged upon Moscow by the IMF and the [United States] Treasury Department had allowed a small group of oligarchs to gain control of state assets ... While the government lacked the money to pay pensioners, the oligarchs were sending money obtained by stripping assets and selling the country's precious national resources into Cypriot and Swiss bank accounts. (Stiglitz 2000)

In other words, the end result of the IMF's Russian 'capitalist revolution' was not a vibrant, efficient market economy, but a capitalism of crooks - and a drastically impoverished nation. As Stiglitz observes, "standards of living remain far below what they were at the start of the transition. The nation is beset by enormous inequality, and most Russians, embittered by experience, have lost confidence in the free market." Indeed, this free market experiment may have done more to rehabilitate Karl Marx - and even Joseph Stalin - in the eyes of the average Russian, than anything positive done by Russia's socialist rump.

Stiglitz tells a similar tale of the impact economists had on the Asian crisis, where the IMF's enforcement of austerity seriously worsened a crisis which had been initiated by the international capital markets (Stiglitz 1998 and 2000).

Where I and a significant minority of economists part company with Stiglitz is on the explanation he gives to the question he was often asked, of "how smart - even brilliant - people could have created such bad policies". Part of Stiglit'z answer is that "these smart people were not using smart economics". This book puts the case that even the best, latest version of the type of economics Stiglitz describes as smart is not smart, but fundamentally unsound.

UNSMART ECONOMICS

The belief that economic theory is sound, and that it alone considers 'the big picture', is the major reason why economics has gained such an ascendancy over public policy. Economists, we are told, know what is best for society because economic theory knows how a market economy works, and how it can be made to work better, to everyone's ultimate benefit. Its critics are simply special interest groups, at best misunderstanding the mechanisms of a market economy, at worst pleading their own special case to the detriment of the larger good. If we simply ignore the criticisms, and follow the guidelines of economic policy, ultimately everybody will be better off. The occasional failures of economies to respond as economic theory predicts occur because the relevant policy-makers either applied in theory badly, or were using out-of-date economics.

Bunkum.

If this proposition were true, then economic theory would be clear, unequivocal, unsullied and empirically verified.

It is nothing of the sort.

Though economists have long believed that their theory constitutes "a body of generalisations whose substantial accuracy and importance are open to question only by the ignorant or the perverse" (Robbins 1932), for over a century economists have shown that economic theory is replete with logical inconsistencies, specious assumptions, errant notions, and predictions contrary to empirical data.

These critical economists are neither 'ignorant' of economic theory, nor 'perverse' in their motives. As this book shows, they have a far more profound understanding of economic theory than those economists who refuse to peer too deeply into the foundations of their dogma. Far from being driven by perversity, they hoped to improve economics by eliminating notions which were illogical, internally inconsistent, or irrelevant to the actual economies in which we live.

When their critiques are collated, little if anything of conventional economic theory remains standing.

Virtually every aspect of conventional economic theory is intellectually unsound; virtually every economic policy recommendation is just as likely to do general harm as it is to lead to the general good. Far from holding the intellectual high ground, economics rests on foundations of quicksand. If economics were truly a science, then the dominant school of thought in economics would long ago have disappeared from view.

Instead it has been preserved, not via greater knowledge, as its advocates might believe, but by ignorance. Many economists are simply unaware that the foundations of economics have been disputed, let along that these critiques have motivated prominent economists to profoundly change their views, and to consequently themselves become, to some extent, critics of economic orthodoxy. Names such as Irving Fisher, John Hicks, Paul Samuelson, Robert Solow, Alan Kirman and Joseph Stiglitz are famous within economics because they made major contributions to modern economic theory. Yet to varying degrees, these and other prominent economists have distanced themselves from conventional economics, after coming to believe, for a range of reasons, that the theory harboured fundamental flaws.

Unfortunately, in a classic illustration of the clich� that 'a little knowledge is a dangerous thing', lesser intellects continue to build the economic edifice atop foundations which many of its architects long ago declared suspect.

There are many reasons for this failure of economics to accept fundamental criticism, and to evolve into a different but richer theory. As I discuss later, these include the undeniable complexity of economic phenomena, and the impossibility of conducting crucial experiments to decide between competing theories. But a key reason - the one which motivated me to write this book - is the manner in which economics is taught.

Educated into Ignorance

Most introductory economics textbooks present a sanitised, uncritical rendition of conventional economic theory, and the courses in which these textbooks are use do little to counter this mendacious presentation. Students might learn, for example, that 'externalities' reduce the efficiency of the market mechanism. However, they will not learn that the 'proof' that markets are efficient is itself flawed.

Since this textbook rendition of economics is also profoundly boring, many student do no more than an introductory course in economics, and instead go on to careers in accountancy, finance or management - in which, nonetheless, many continue to harbour the simplistic notions they were taught many years earlier.

The minority which continues on to further academic training is taught the complicated techniques of economic analysis, with little to no discussion of whether these techniques are actually intellectually valid. The enormous critical literature is simply left out of advanced courses, while glaring logical shortcomings are glossed over with specious assumptions. However, most students accept these assumptions because their training leaves them both insufficiently literate and insufficiently numerate.

Modern-day economics students are insufficiently literate because economic education eschews the study of the history of economic thought. Even a passing acquaintance with this literature exposes the reader to critical perspectives on conventional economic theory - but students today receive no such exposure.

They are insufficiently numerate because the material which establishes the intellectual weaknesses of economics is complex. Understanding this literature in its raw form requires an appreciation of some quite difficult areas of mathematics - concepts which require up to two years of undergraduate mathematical training to understand.

Curiously, though economists like to intimidate other social scientists with the mathematical rigour of their discipline, most economists do not have this level of mathematical education.

Instead, most economists learn their mathematics by attending courses in mathematics given by other economists. The argument for this approach - the partially sighted leading the partially sighted - is that generalist mathematics courses don't teach the concepts needed to understand mathematical economies (or the economic version of statistics, known as econometrics). This is quite often true. However, this has the side effect that economics has produced its own peculiar versions of mathematics and statistics, and has persevered with mathematical methods which professional mathematicians have long ago transcended. This dated version of mathematics shields students from new developments in mathematics that, incidentally, undermine much of economic theory.

One example of this is the way economists have reacted to 'chaos theory' (discussed in Chapter 8). Most economists think that chaos theory has had little or no impact - which is generally true in economics, but not all true in most other sciences. This is partially because, to understand chaos theory, you have to understand an area of mathematics know as 'ordinary differential equations'.2. Yet this topic is taught in very few courses on mathematical economics - and where it is taught, it is not covered in sufficient depth. Students may learn some of the basic techniques for handling what are known as 'second-order linear differential equations', but chaos and complexity only begin to manifest themselves in 'third order nonlinear differential equations'.3

Economics students therefore graduate from Masters and PhD programs with an effectively vacuous understanding of economics, no appreciation of the intellectual history of their discipline, and an approach to mathematics which hobbles both their critical understanding of economics, and their ability to appreciate the latest advances in mathematics and other sciences.

A minority of these ill-informed students themselves go on to be academic economists, and then repeat the process. Ignorance is perpetuated.

The attempt to conduct a critical dialogue within the profession of academic economics has therefore failed, not because economics has no flaws, but because - figuratively speaking - conventional economists have no ears. So then, 'No More Mr Nice Guy'. If economists can't be trusted to follow the Queensberry Rules of intellectual debate, then we critics have to step out of the boxing ring and into the streets.

DOES ECONOMICS MATTER?

Economics is often popularly compared to the weather, for two good reasons. Firstly, just as the climate would exist even if there were no intellectual discipline of meteorology, the economy itself would exist whether or not the intellectual pursuit of economics existed. Unlike something that is consciously constructed, such as an aeroplane, the economy is a product of humanity's evolving systems of production and distribution. We don't need economics in the same sense that we need engineering to design planes, etc. Instead, economics shares a fundamental raison d�tre with meteorology, that of attempting to understand a complex system.

Secondly, like weather forecasters, economists frequently get their forecasts of the economic future wrong. But in fact, though weather forecasts are sometimes incorrect, overall meteorologists have an enviable record of accurate prediction - whereas the economic record is tragically bad. Farmers, sailors and ordinary folk who rely on weather forecasts are more often than not beneficiaries of meteorological science. Politicians, businessmen and ordinary folk who rely on economic forecasts are far more often than not misled.

This implies tat it would be possible to just ignore economic - to treat it and its practitioners as we these days treat astrologers: as a source of distraction and amusement rather than as a guide to what the future may bring. Unfortunately, there are two ways in which economics differs from meteorology, which mean that this lazy option is not possible.

Firstly, economics, unlike meteorology, is a social discipline. What we believe about economics therefore has an impact upon human society and the way we relate to one another. Its effects upon interpersonal relations matter.

Secondly, while human activity is clearly having an impact on the earth's climate, no meteorologist in her right mind would suggest that we should modify the physical environment to make the climate work better. But economists, despite the abysmal predictive trace record of their discipline, are forever recommending ways in which the institutional environment should be altered to make the economy work better.

Because politicians and bureaucrats have believed that economic advice is soundly based, this system-altering advice of economists has been taken seriously and acted upon - despite the frequent opposition of many other segments of society. Thus most of Europe has entered a monetary union that consciously restricts the freedom of its member states to undertake expansionary fiscal policies - because economic theory argues that government deficits are bad. Around the world, governments frequently oppose minimum wage laws - because economists argue that such laws increase unemployment. Tariff barriers have been reduced or eliminated - because economics argues that free trade achieves higher social welfare than regulated trade. Indebted Third World governments have been forced to abandon subsidies on basic commodities - because economists argue that these subsidies reduce economic growth by distorting the price mechanism. Russia was rushed into privatisation - because politically influential economists believed that a rapid transition to capitalism was both possible, and preferable to a gradual transition. And the Western world's middle class has been encouraged to entrust its future security to the ups and downs of the stock market - because economists believe that finance markets are inherently 'efficient'.

Economists would contend that these changes have made the world a better place, not because economists have actually verified that the changes have been beneficial, but because the changes have made the real world look more like the hypothetical world of the economic textbook. Since, in economic models, they hypothetical pure market performs better than the mixed economy in which we live, economists are confident that economic reform makes the world a better place. Where problems have occurred, economists normally assert that this was because their advice was not followed properly.

But this confidence in economic reform begs the question - is the hypothetical world of the economic textbook actually a better place than the real world, with all its 'distortions'? This is only possible if the economic theory that describes the economist's ideal world is internally consistent. If the theory is internally inconsistent - if it requires impossible conditions to function - then the economic ideal may actually be an entirely useless guide to how the real world works, let alone to how it might be improved.

Economic reform could produce a manifestly worse system than the one which it alters.

This book presents the wealth of intellectual evidence which proves that economic theory is internally contradictory. These contradictions are so extreme and pervasive that there is little if any chance that reforms guided by this theory will actually improve the economy or society. Though economists have championed economic reform for the quite altruistic reason that they believe these reforms improve social welfare, their recommendations are far more likely to have made the world a worse place, not a better one.

Thus, the economic conditions imposed to achieve monetary union in Europe could enforce a permanent recession upon Europe, and compromise the ability of its governments to counteract any severe downturn in world economic activity. Trade liberalisation could reduce global economic welfare because the rapid opening up of markets could destroy productive capacity. The abolition of price subsidies could retard economic growth by amplifying class conflict in the highly unequal societies of the Third World. Rapid economic change could lead to social breakdown, rather than the development of vibrant market economies. And America's middle class could find its retirement nest eggs eliminated by the collapse of a wildly speculative stock market.

Mainstream economists might deride these statements, but as this book shows, their arguments to the contrary are specious.

The public could still afford to ignore economics if the discipline had the ability to correct its own excesses. But it does not. Despite its record at forecasting, despite the evidence that economic theories are not consistent, and despite negative outcome from 'economic reform', the intellectual discipline of economics shows no tendency to reform itself. Instead, unsound theories continue to be taught to students as if they were incontrovertible. Economics cannot be trusted to reform its own house. Therefore, just as politics is too important to leave to the politicians, economics is too important to leave to the economists.

Excerpt from, Debunking Economics - The Naked Emperor of the Social Sciences' by Steve Keen. Pluto Press 2001

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