Sunday, 23 August 2009

The failure of 'Economics' and Collective Imagination

Sli Eile: Calls have been made for an inquiry into banking in Ireland. While the proposal is not without some merit I am wary of inquiries - especially when they focus on attention away from the larger context in which banking failed so abysmally. It is a little rich to see economists adding their voices to such an inquiry.

The failure of banking, politics and the economy is clear. But why have economists failed? I don't just mean failure to foretell what would happen. I mean failure to understand properly the nature of economic activity; to learn from history and above all to offer a vision and a set of values to chart a way out of the terrible mess that the world finds itself in? This post explores some possible reasons.

Although trained in the school of positivist economics I have never submitted to its core ideology and premises. Still, political economy fascinates me and so it fascinates more and more people.

Just as CAO points have fallen for civil engineering and property management courses they have risen for business and economics at least in some places. I think that the study of political economy, philosophy and the great thinkers and theories of our time should be encouraged in all second level schools.

Recently, the Queen (of England) asked ‘why didn’t you tell us’ when visiting the London School of Economics. In response, an august group of the great, the good and the mighty (British Academy Forum – The Global Financial Crisis – Why Didn’t Anybody Notice) wrote a letter to the Queen on 22 July last. You can read it (its only 3 pages but its very clear and concise) here.

The letter pulls no punches. I would summarise it in my own words as simply: "People lost sight of the bigger picture".

The ‘bigger picture’ was the way society, politics and economies constitute an organic whole where everything has consequence now, next year and in a 100 years time (you can’t slice off one sector, domain, period or action from another)
The ‘people’ include everyone but especially those at the top – of banking, politics, civil service, media, academia ….. and the economics profession.

Recently, a debate has opened up internationally about the failure of economics as a ‘social science’. In a short article Economists, Economics and the Crisis, Luigi Spaventa tackles the matter.

In an observation that strikes very close to home, he takes economics to task not for failing to see the housing bubble – they did – but for the fact that ‘the financial consequences of bursting this bubble in the brave new world of securitisation were never considered’. The new generation of Dynamic Stochastic General Equilibrium Models so loved by mainstream macro-economists have been described as a ‘costly waste of time’ (Willem Buiter). The problem – over the recent two decades – is that most economists took their eye off the dangers inherent in the financial market ball and were preoccupied with other things. Yes, many did see the bursting of the property bubble. But extremely few saw the potentially devastating connection between what was going on in the FIRE economy (finance, insurance and real estate) and the rest of the world.

In 2008 the game was up and the house of cards came tumbling down (but not the accretion of IOUs in nominal amounts of trillions…)

The idea of failure in the natural world is not new. Paul Ormerod (‘Why most things fail’) claims that 99.9% of all biological species which have ever existed are now extinct. He also asserts that economic theory cannot explain business failure. In the Preface to that book he argues:

"An argument which I first made ten years ago in the Death of Economics is that conventional economics views the economy and society as machines, whose behaviour, no matter how complicated, is ultimately predictable and controllable. But on the contrary, human society is more like a living organism".

The key question posed by Spaventa is whether the ‘tools’ were wrong (mainstream economic theory and modelling) or the economists themselves who were subject to ‘cognitive capture’ (in other words enthralled to their own world view or to their employers). Spaventa quotes Barry Eichengreen (2009) as follows:
It was not that economic theory had nothing to say about the kinds of structural weaknesses and conflicts of interest that paved the way to our current catastrophe the problem [was] a partial and blinkered reading of [the] literature on the part of economists afflicted by a problem of cognitive capture and choosing to stick to mainstream models.
Is there any possibility that many household name Irish economists continue to the miss the wider picture and dangers of deflation as they remain in ‘cognitive capture’ to orthodox thinking?

And what of the media, politicians and policy-makers? To cite Barry Eichengreen again:
The consumers of economic theory …tended to pick and choose those elements of [a] rich literature that best supported their self-serving actions.
I suggest that both were at fault, and especially here in Ireland where the economics gene pool is limited.

In a recent Opinion Leader article in the 18 July issue of the Economist - 'What went wrong with economics?' - the author writes:
….In the wake of the biggest economic calamity in 80 years that reputation [of economics] has taken beating. In the public mind an arrogant profession has been humbled.

Though economists are still at the centre of the policy debate — think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain — their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour.
For Bernanke, Summers and King substitute the names of the first three Irish economists that comes to your mind. And hold those names in your mind for a minute.

I don’t detect much ‘guilt’ and ‘rancour’. In fact I detect huge confidence, ‘told you so’ and an alarming degree of agreement on the big five issues underpinning the Dublin consensus.

Humility is not the first word that springs to mind when examining the role of various actors – including economists – closer to home. However, I note that a discussion has begun recently on

And closer to home, economist Colm McCarthy comes under the spotlight in a satirical piece in the Phoenix Magazine last month. (Ironically, McCarthy is among those called for a commission of inquiry into what went wrong in the local financial world). The article contains the following very telling observation:
Aspiring economists are taught that their involvement with numbers and mathematical models magically and uniquely confers on them a scientific status which practitioners of messier social sciences such as sociology can only envy. This aura of science is, however, purchased at a heavy price. Economists are incredibly squeamish about contact with the real world of the economy. You won’t find economists studying the political process by which taxation decisions are made, asking corporate decision-makers about how prices are actually set, or on factory floors investigating how capital and labour are actually combined to make cars. Instead economists make deductions from abstract models they learned in the classroom and test them against statistics downloaded from the internet. When the models appear confirmed, often after a lot of massaging of the numbers, a publication is produced. When the models are disconfirmed, the study is quietly binned as involving “negative results”........Economists often bring to their deliberations a preconceived preference for the small state.
Is it possible to redeem ‘economics’? The Economist argues that:
But a broader change in mindset is still needed. Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work.
In my view it is going to take much more than that. To start with, ‘economics’ needs to go back to its roots – Political Economy – and make political, institutional and legal structures more explicit in its analysis of complex economies and markets. Second, economics needs to learn much more from other disciplines such as sociology, ethics and philosophy, if only to acknowledge that the rational homo economicus is only 80% true in practice. That 20% makes a mighty difference.

Beginning some time in the 1970s/1980s, economics took a sharp turn to an uncritical view of the markets – championing privitisation, deregulation, flexible labour and product markets and a rolling back of unions, the State in general and the Nation State in particular. It ushered in during the nineties and ‘noughties’ the period of partying – the supposed end of ideology and with it history, socialism and much else. Government was the problem and unfettered Markets were the solution. It is no exaggeration to say that a study of the business cycle had been relegated to the economic history section of the library, while many proclaimed a ‘new economy’ based on continual change and innovation in information technology. The possibility of simultaneous, synchronised and systemic collapse in days rather than years simply never featured in the limited thinking of many macro-economists and financial analysts. The model – based on a particular range of assumptions and empirical observations from recent decades - did not factor in such a possibility.

To summarise, thus far, my claim is that economics and economists both failed because:
* they worked within a set of narrow assumptions and models that reflected their interests (political, economic, personal);
*they saw empirical economic models and associated theories as adequate in explaining economic human behaviour and thus failed to see ‘the bigger picture’ and the inter-connectedness – now more than ever – of natural, social and market environments;
* amidst the fall of one of the biggest tyrannies spawned by the 20th Century Great 'Socialist' Experiment, we had party time in the industrialised capitalist economies with plenty of goods for most people in the audience.

No need to think radically or outside the box went the line when the above signalled the triumph of markets, light-touch regulation and individualised liberalism. ‘It works’! There you have it.

Until the summer of 2008.

But, there was one other factor on which, I think, nearly all of us failed – left, right, centre, economics, political, moral… We lack imagination – collective imagination.
And, so, in concluding their letter to the Queen, the British Academy forum said:
So in summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.
A failure of the collective imagination indeed.

What guarantee is there that the same people working in the same banks, the same Governments, the same university departments and the same offices who failed in ‘collective imagination’ will not fail again? Frankly, I think that only a new generation of leaders from the younger generation can embrace a collective imagination. Recall Einstein – ‘Imagination is more important than knowledge’.

And imagination is more important than assumptions, models, partial equilibria, ideology and interests. I would argue that too many people ‘at the top’ (of State, Church, Corporations, Banks ….) have too much of a vested interest in the current models of thinking and responding.



Brian Woods said...

Very well said. I believe that the economists you speak of live in the Universe of Theoretical and Virtual Certainty. All is true because it just IS! Many statisticians exhibit a similar behavioural phenomenon.

There is however another universe. The Universe of Reality and Uncertainty. This is where the rest of us live.

Funny how very bright academics can be completely beguiled and seduced by numbers. Monorail thinking? I suspect that the phenomenon may be nurtured by the third-level education process itself. Ignorant experts spawning clones of themselves?

Brian P

Anonymous said...

Everything stated here (more eloquently than I could state) rings true as a critique; which we call know is just the starting point.

However, I have one enduring quibble with all these type of analyses. It is the idea that the 'brightest, the intellegensia, or some special group is endowed with all human understanding and that they alone will be responsible for the solutions. They, like the rest of us mere mortals, are just as flawed in their analyses.

Let's democritise both the discourse and the economic models that we prepare as possible solutions. Who knows, from some lowly corner of the internet a lonely voice may illuminate the discourse. At the very least, it's time we gave the voiceless and alphabetless-after-the-surname people a wee say in their future.

Meanwhile, the MSM is duly pronouncing every tidbit of 'green shoot news' it can on a daily basis. What real chance of dynamic discourse - let alone hearing the voice of the plebs?

Paul Sweeney said...

An interesting and thoughtful piece. I think we may have to broaden the term Dublin Consensus. Read John McHale of NUIG's piece in the Irish Times today for more liberal othodoxy. Cut public spending and cut wages and the recovery will be fine, even though he appears to be nuaced on the dangers of deflation. He puts out the same old orthodox but ill informed line on Social parthership and tax cuts. The trade unions agreed to tax reductions for some years from 1987, but in fact were opposed to the tax cuting polices of McCreevy from late 1990s. Even the big big cuts in income taxes (eg the halving of the effective rates for average workers in just 2/3 years) were not sought. The cuts in CGT and corporation taxes and the simultaneous raising of charges and consumption taxes pushed up the overal cost base, which some of us tried to highlight for years, have now become a fashionable target. Its a bit late. We could have addressed this effectively in the boom, if we wanted to, but Govt and most economists did not care to. But to try to reduce the high cost base by simply cutting wages - a central and very political tenet of the Dublin Consensus - demonstrates a certain lack of understanding of how the economy actually works.

Mack said...

It might be more useful to split economics into a few different disciplines. At the core it might be useful to develop Scientific Economics - based around _falsifiable_ hypotheses, that describe the current state of the art with respect to the our best estimation of the laws that govern economic behaviour.

Around that (because applying scientific method here seems incredibly difficult) have various strands of Philosphical and Practical Economics, where you can put your non-falsiable theories and forecasting techniques (but with the clear proviso that this isn't science).

This might aid the credibility of economics in the medium term, and is something like the way psychology is organised today (with the popular, but non-falsifiable ideas of Freud and Jung separated firmly from the main corpus of development which at least attempts to follow scientific method). If economics is already structured this way, then letting people know about it would be a good idea too!

This link might be interesting -

paul sweeney said...

The debate among economists in the US and other countries does not pretend to be objective ie to side with the establishment. Just look at this piece by Paul Krugman in the NYT the other day.
He calls himself and other economists the "progressives." He is partisan, unlike many Irish economists, who either pretend not to be, or genuinely believe that they are "objective". Most seem to take the side of the wealthy and the establisment,whether intentiaonally or not. However, thankfully, it has to be said that some academic economists can be quite critical, when they are so moved.

Slí Eile said...

@Mack I don't accept that any division of economics into falsifiable and non-falsifiable parts is easily done. For one thing there may be an assumption that such distinctions are the equivalent of 'scientific' versus 'a-scientific'. All these terms are loaded and mean slightly different things to different people. I would see a scientific method (which of course can be applied to economics as with other areas of social studies) entailing:
observation and measurement
repetition and experiment
prediction and modelling
On all three counts, the behaviour of individuals and societies do not fit easily into these approaches for a whole set of reasons. I am not saying that it is impossible and useless to attempt some modelling. But, one of the big elephants in the mainstream economics parlour is the nature of class, ethnic, gender differences and power. Many economists/sociologists life Glen Loury or Mark Granovetter have dealt with these issues and 'socio-economists' have made useful contributions. Another issue is the complex emotions and values of individuals - shaped by societies.
Writing in the 1960s, Theodore Schultz said:
Although economists are seldom timid in entering on abstract analysis and are often proud of being impractical, they have not been bold in coming to grips with this form of investment [human capital]. Whenever they come even close, they proceed gingerly as if they were stepping into deep water. No doubt there are reasons for being wary. Deep-seated moral and philosophical issues are ever present.

Mack said...

@Sli Eile

Scientific method is relatively well defined at this point, at least in those disciplines that have been practiscing it for some time. Faslifiability adds robustness, no amount of positive validation can ever prove a theory, a single instance of disprove disproofs it. You can know what is wrong with more certainty than you can ever know what is right. Focusing on that at the core of the discipline would allow economists to build up a common base from which they could communicate with each other and the rest of us. As it is, everyone's views seems to be coloured by the views of some long dead political philospher.

There's nothing wrong with the non-falsifiable base you have. Just because it's not scientific doesn't mean it doesn't have value. Freed from those strictures it explore large and complex domains very quickly. And the rich heritage you have their from Keynes, Marx, Hayek, Schumpeter, Friedman etc. Could certainly form a base for less glamourous scientific endeavour.

Think of it as separating out your scientific, philospical, engineering, forecasting aspects into distinct but inter-related disciplines. That should enable economists to agree a set of fundamental principles, beyond which you can disagree and argue with each other on everything to your hearts content - but still be able to speak to the world as group with some certainty..