Understanding the Economy
The Financial Crash showed up the weaknesses of mainstream economics and neo-classical models, will it lead to a fundamental shift in the way economics is taught and understood?
What went wrong?
The Queen famously asked economists at the LSE in November 2008, ‘Why did no-one see it coming?’ which even got reported in the Daily Mail: The Queen gives her verdict on global credit crunch not the standard place for reporting on the limitations of economics.
In 2009, a group of economists meeting at the British Academy (PDF) responded to the Queen saying: ‘It is difficult to recall a greater example of wishful thinking combined with hubris’ and that ‘financial and economic models (that) were good at predicting the short-term and small risks, but few were equipped to say what would happen when things went wrong as they have’. The Turner Review in 2009 suggested a key problem was that models didn’t factor in uncertainty and herd behaviour which could lead to irrational results.
More recently Paul Romer, Chief Economist of the World Bank, wrote:
For more than three decades, macroeconomics has gone backwards.
which he attributed to something akin to a cult having taken hold among macro-economists.
The questions about economics are much wider than just macro-economics. The role of money, debt and banking is often ignored or down played, which was a key reason that the significance of banking and private debt in the run-up to the Crash was not recognised.
Micro-economics also struggles to explain real human behaviour as behavioural economics has shown and is unable to explain social norms that underpin such important phenomena as trust. It tends to focus solely on the role of markets while ignoring other institutions and their importance such as values, regulation and organisations. Hence the focus on privatisation, outsourcing, competitive tendering, using incentives which have dominated policy over the last 30 years. This has also fostered the ‘gig economy’ and the financialisation of both economic and social relations which affects all our lives.
In fact, quite a few economists did ‘see it coming’. This included the Bank for International Settlements in its 2005 report, “….it seems increasingly evident that we are today well into the boom phase of a third such cycle, dating from the economic upturn of the mid-1990s. Equity prices were affected first but, after their sharp decline in early 2001, the upward momentum of demand was transferred to the housing market. Indeed, it is not an exaggeration to say that, over the last year or so, the house price phenomenon has achieved global sweep. Most industrial countries are showing symptoms of overheating in the housing market. So too are many emerging market economies, including China and Korea.”
Other economists, who ‘saw it coming’ as Bezemer points out, include Steve Keen and Ann Pettifor, who are both speaking at ‘10 Years After’ events. A number of astute hedge fund managers such as Crispin Odey ‘saw it coming‘.
There had been a long tradition of criticism of the simplistic nature of the assumptions underpinning mainstream economics. Steve Keen published his major work in 2001 well prior to the Crash. This documented in detail the previous criticisms within the mainstream that had been quietly buried and how the mathematics within mainstream economics had failed to keep up with leading-edge mathematics. As the reputation of mainstream is based on its ability to use ‘robust’ maths to make it a science, this raised significant questions.
Behavioural economics was also well established as a subject with the publication of the New Economics Foundation policy-focused report in 2005 commissioned by Henry Leveson-Gower. This was well before the celebrated book ‘Nudge’ in 2008 and the intellectual underpinning can be traced back to Herbert Simon in 1947.
However as most of this critique was well out of the ‘mainstream’ it was ignored, so it could be said the fundamental problem was one of ‘group think’, which excluded anyone with alternative points of view. This is reflected in the famous term TINA, There Is No Alternative.
What happened next?
The British Academicians’ response to the Queen ended by saying ‘The events of the past year have delivered a salutary shock. Whether it will turn out to have been a beneficial one will depend on the candour with which we dissect the lessons and apply them in future’.
As a result, there were a range of discussion, conferences and a the Coyle Group was set up involving eminent practising and academic economists. One of its key recommendations was the need for ‘a more pluralist approach to economics’ which had to start with teaching.
In parallel with this, economics students also began to revolt against the teaching they were getting, as it wasn’t addressing the real world issues the Crash was throwing up. This started in Manchester University and resulted in the formation of the Manchester University Post Crash Economics Society. This movement spread to other universities in the UK and internationally and there are now two international student networks of groups promoting reform of economics teaching – Rethinking Economics and the International Student Initiative for Pluralist Economics (ISIPE).
However there has been very limited change in research and teaching, or in the organisation of economics departments as both pluralist economics academics and the student groups conclude. For instance, the recent book, Econocracy, published research into economic undergraduate examinations in top courses showing that the vast majority of exams tested the ability to regurgitate theories and do multiple choice question rather than testing the ability to critically think, which is key to a pluralist approach.
In terms of teaching, the only major initiative for reform of the curriculum is the CORE project led from University College London. However many do not consider this to be pluralist in its approach to teaching and it certainly does not highlight the different economic methods and their implications. Emeritus Professor Vicky Chick wrote “The CORE curriculum for 1st year students…is an attempt, in my view, to block real change”.
In academia there have also been criticisms that economists have not adequately responded to the failure in economics. Professor Jagjit Chadha, Director of the National Institute of Economic and Social Research (NIESR), a highly respectable research centre dating back to 1938, said in 2017:
Macro-economics has yet to find answers to the questions posed by the financial crisis
However there some positive moves: the Institute for New Economic Thinking [https://www.ineteconomics.org] was established in 2009 in the USA based on a $50 million gift from George Soros, and now has branches in Oxford and Cambridge.
In the UK Government, the economists in general are not trained and do not apply a pluralist economics approach to informing policy as recommended by Ha Joon Chang.
Those not using mainstream methods, some of whom did see the crisis coming, are still on the fringe of the profession in economics departments with lower research scores.
What does the future hold?
The Economic and Social Research Council has funded a new centre called Rebuilding Macro-Economics in the NIESR. This centre claims it is going to ‘revolutionise’ macro-economics. While there are significant questions over its likely success, initial signs are hopeful, particularly in terms of its multi-disciplinary make-up, and inclusion of some non-mainstream economists.
Promoting Economic Pluralism (PEP) has launched an international dialogue on the design of a new international accreditation system for masters courses that take a pluralist approach to economics. PEP believes this will support those economics departments which have fulfilled the Royal Economic Society’s Steering Group’s recommendations and will encourage others to take those steps too.
ISIPE’s website (https://www.exploring-economics.org/en/) explains different economic methods and advertises pluralist courses.
Within policy, there is some promotion and application of new approaches to economics particularly with Andy Haldane, Chief Economist of the Bank of England and the OECD New Approaches to Economic Challenges.
The question remains as to why such limited reform has happened. Max Plank famously said “Science progresses one funeral at a time”, but can we afford for that to happen in today’s fast paced world? Maybe we need radical reform of the University disciplinary system and potentially learn from the experience of Finland where subjects have been replaced by topics as the basis for education, as this article in the Independent noted.