Economyths: Ten Ways That Economics Gets It Wrong

Citation

Orrell, D. (2011), "Economyths: Ten Ways That Economics Gets It Wrong", International Journal of Social Economics, Vol. 38 No. 9, pp. 821-822. https://doi.org/10.1108/03068291111157267

Few economists predicted the “great recession” of 2008‐2010; most were as shocked and confused as anyone else. As David Orrell reminds us in Economyths: Ten Ways That Economics Gets It Wrong, the former Chairman of the Federal Reserve Board in the USA, Alan Greenspan (an Economist by professional training), declared in October 2008 that “the whole intellectual edifice” by which he and many other leading American economists had long understood the economic events of the world had “collapsed.” As he added, “those of us who have looked to the self‐interest of lending institutions to protect shareholders' equity (myself especially) are in a state of shocked disbelief.”

The “intellectual edifice” to which Greenspan referred was not a recent development within economics. Indeed, it dated at least back to Adam Smith and the “invisible hand.” For reasons that Greenspan acknowledged he now found difficult to comprehend, the invisible hand had recently failed in the most spectacular fashion since the 1930s.

The 1930s depression precipitated an intellectual crisis within economics that was only resolved by John Maynard Keynes with the publication in 1936 of The General Theory (the title suggesting – Keynes was not known for his modesty – that it was the equivalent for economics of Einstein's general theory of relativity for physics). Keynes's solution was to concede the failure of the invisible hand as far as unemployment, inflation and other macroeconomic variables and thereby open the way for government “scientific management” of aggregate economic outcomes. Keynes, however, left the edifice of micro‐economics largely standing. The workings of supply and demand – not greatly changed from Adam Smith's vision of them – could still be relied upon to determine the socially appropriate levels of production and consumption in specific markets.

The events of 2008‐2010, however, challenged the authority of micro‐economics as well. Over large parts of the American economy, individuals pursuing their own interests had yielded a potentially catastrophic outcome in market sectors, such as housing finance and banking. Only massive government intervention had averted a total disaster for the national economy. Either the cumulative results of individual self‐interest no longer served the social welfare (the invisible hand no longer worked, at least in these critical market sectors) or, equally challenging for mainstream economic thinking, large numbers of leading economic actors had grossly misperceived their own true interest, and to great social detriment.

At a 2011 Washington conference sponsored by the International Monetary Fund, a panel of leading economists thus heard “a fitting eulogy for the economic orthodoxy that once governed the world”, as a reporter for the Washington Post described the scene. The eulogy was delivered by Olivier Blanchard, a current Professor and former Chairman of the Economics Department at MIT, among the most prestigious departments in the world. Blanchard told the panel that until the recent crisis, the mainstream of the profession “had converged on a beautiful construction” to explain the workings of markets but now had to face the fact that “beauty is not synonymous with truth.” As the Washington Post related, Blanchard conceded that “the list of discredited [economic] theories is now long.” Heightening the intellectual crisis now facing the economics profession, it was not clear “whether a new consensus can be salvaged out of the ashes of the old.”

In Economyths: Ten Ways That Economics Gets It Wrong, Orrell hopes to lead us out of this economic wilderness. Given such an ambitious goal, it is not surprising that he falls well short. Orrell does, however, do a good job of developing one central message for any rethinking of the future of economics. According to Economyths: Ten Ways That Economics Gets It Wrong, the standard “neo‐classical” model, dominating mainstream microeconomic thinking for more than 100 years, is fundamentally flawed and must be abandoned. While this is hardly a new idea, it still bears frequent repetition.

Orrell writes of professional economists that they are “physics groupies.” The neo‐classical model was first developed by Stanley Jevons, Leon Walras and other economists of the second half of the nineteenth century. It presented in full mathematical dress the verbal theories of Adam Smith. The goal was to give economics the same scientific status, and the same social prestige, of physics.

The founders of neo‐classical economics were convinced, Orrell writes:

[…] that they needed only to make a simple substitution between physical and economic quantities. In place of atoms, there were individuals or firms, and in place of energy there was [the pursuit of] utility in all its different forms.

As Jevons asserted, it would thereby be possible for economic theory to achieve “a kind of physical astronomy [of the economic world] investigating the mutual perturbations of individuals” in the same manner that Newton investigated the interactions of the sun and the planets in the solar system.

Economics is more complicated than physics, however, more like the weather than the solar system. In order to make the economic theory tractable for the mathematical methods of physics, some very strong assumptions were necessary. Most importantly, economic actors had to be perfectly informed and perfectly rational about everything relevant to their economic decisions – however, altogether implausible this might be. In their desire to emulate physics, Orrell writes, economists:

[…] were really just grabbing ideas from the air and transplanting them into economics without any concern for basic principles, such as [the actual lack of appropriate] units of measurement or the fact that people are not [fully rational calculating] machines.

In developing a theory of the pursuit of maximum utility “as an analogy for energy” in physics, economists ended up with such a high degree of abstraction that the results were of “little use” for understanding most real economic phenomena.

Indeed, neo‐classical economics was virtually a tautology – involving a “circular logic,” as Orrell writes. The fundamental problem faced by any economic system is one of the discovery and utilization of information in an efficient and well‐coordinated way. What types of products will consumers actually demand, what are the best methods of production, what are the lowest cost forms of transportation, what new and better technologies are on the horizon, etc. In a market system, the discovery and use of such information – which must itself be constantly reevaluated for its accuracy – is then driven by a large‐scale and highly decentralized process of constant private trial and error.

Rather than perfect information, it thus might be more appropriate to assume a starting point of perfect ignorance. By assuming, instead that the information problem was already solved (by making the beginning assumption of perfect information possessed by all economic actors), neo‐classical economics in effect assumed its central conclusion – that markets create and use information in an economically optimal fashion. If everyone is perfectly informed and calculates rationally, there is no economic problem left to be solved.

Orrell has studied economics closely, but is trained as a mathematician (he has a PhD from Oxford). When a real mathematician or physicist looks at the supposedly scientific explanations of neo‐classical economics, much like Orrell, they are often appalled. As we are reminded in Economyths: Ten Ways That Economics Gets It Wrong, the leading American mathematician Norbert Wiener once wrote that:

[…] economists have developed the habit of dressing up their rather imprecise ideas in the language of the infinitesimal calculus […] To assign what purports to be precise values to such essentially vague quantities is neither useful nor honest, and any pretense of applying formulae to these loosely defined quantities is a sham and a waste of time.

Neo‐classical economics at its abstract mathematical levels is thus a scientific failure if not an outright fraud. How, then, could it have played such a large part in the thinking of the mainstream economics profession for a century or more, and exerted such a large influence on public policy – at least until the recent economic crisis exposed in such graphic terms its inadequacies?

Orrell offers several explanations. First, neo‐classical economics offered a picture of a perfectly rational world – as Blanchard observed to the IMF panel, its vision appeared “beautiful” to many economists, in sharp contrast to the ugliness of real‐world events in all their rough and tumble disorder. Modern economists are the most recent heirs, Orrell finds, to an important tradition in Western civilization that traces all the way back to the ancient Greeks. The followers of Pythagoras were a “pseudo‐religious cult” who held the belief “that number was the basis for the structure of the universe, and gave each number a special, almost magical significance.”

Plato was borrowing directly from the Pythagoreans when he taught that the abstract forms are the ultimate realities and the events of the world mere imperfect copies. The highest and most important of the forms, moreover, are mathematical – specifically for Plato, they are geometrical. The gods have created the world according to a rational mathematical model, as Platonists have now claimed for more than two millennia – and with neo‐classical economists a particularly important recent claimant. The modern assumption is that progress is occurring in all areas of society; but as neo‐classical economics illustrates, we have not always advanced much beyond the ancient Greeks.

Platonic ideas were the leading Greek influence in shaping Christian theology until the thirteenth century when Thomas Aquinas turned instead to Aristotle. The Aristotelian orthodoxies prevailed until the Protestant Reformation and the scientific revolution. Then, as Kepler, Galileo, Newton and many other practitioners of the scientific method revealed with astonishing success, Plato had actually been correct; the world – or at least the natural world – did follow strictly according to mathematical forms.

In Christian theology, “the creation” is studied to reveal the mind of God. In the Bible, Paul wrote in Romans 1:20 that “ever since the creation of the world His [God's] invisible nature, namely, His eternal power and deity, has been clearly perceived in the things that have been made,” as human beings encounter them in the natural world. As modern science has discovered, God apparently holds mathematical ideas in especially high regard – if not, why would he have made all of the natural order to follow strictly according to mathematical rules. Paul's epistles must now apparently be revised; in many important domains of human experience, God speaks most truthfully to the faithful in the language of mathematics.

Hence, when neo‐classical economists portrayed the economic world of markets as governed by mathematical laws, as Economyths: Ten Ways That Economics Gets It Wrong explains, “the market […] was granted a semi‐divine status.” It was a very old story: the Pythagorean “cult” had similarly regarded numbers as semi‐divine. The neo‐classical model was eventually developed at the highest level of mathematical sophistication by Kenneth Arrow and Gerard Debreu (winners of the Nobel prize in economics in 1972 and 1983, respectively, in part for this accomplishment). Orrell writes that “the Arrow‐Debreu model didn't represent an economy of human beings – it was an economy of gods.” As Orrell further comments, in looking to the efficiency of market processes, “mainstream economists, along with most politicians and media, are almost religiously in favour of economic growth.” In short, depicting the market in strictly mathematical terms may have failed as a matter of a valid scientific understanding of real‐world economic events; as a declaration of theology, however, it was a great success that followed in a long Western tradition dating to Plato (Nelson, 2001).

The religious authority upholding neo‐classical ideas, moreover, made them all the more powerful in society – and thus practically useful to those who could command the services of the economic priesthood. This is the third reason given by Orrell for the large influence and longevity of neo‐classical economics. As Economyths: Ten Ways That Economics Gets It Wrong informs us:

[…] the ruling elite always has a very good argument as to why it should be in charge and have most of the wealth. […] Today, that argument goes by names such as the invisible hand, the efficient market, or mainstream economics,

best seen as theological statements all.

The large benefits of private markets have been known for thousands of years. Aristotle wrote that property rights avoid indefinite squabbling and fighting over the use of resources. As a useful means of trading among the holders of such rights, a market system with money and prices will rather obviously be superior to simple barter. But, full social legitimacy in a society does not derive strictly from such practical usefulness. An economic system blessed by a powerful divinity will have greater staying power. Neo‐classical economics is the latest of these divinities. In portraying a market system governed by mathematical laws – recognized as a main language of God since the scientific revolution – this religious blessing served to ward off Marxist, socialist, Islamist, and many other assaults on the market.

A religious defense of the market, moreover, can itself be practically useful in a non‐religious way. Orrell himself acknowledges the desirability of a market system, declaring that “free markets have many splendid attributes, which must be protected. They are the best way that we have come up with to make a wide variety of economic decisions.” Real markets, however, are turbulent, creating big losers as well as many winners – a process of “creative destruction,” as Joseph Schumpeter wrote. Markets may seem unethical or even morally bankrupt – “un‐Christian” – in their defense of the private pursuit of self‐interest. There have been few times when markets have not been under strong challenge. Orrell fails to mention the practically useful role played by neo‐classical economic religion in defending the market – presenting it as one more reflection of God's mathematical intent for the world.

Economists, in short, are not scientists but, understood more accurately, the high priests of modern society. Like other priesthoods, they have their own religious rituals, symbols and forms of blessing, the pseudo‐scientific “artwork” of neo‐classical economics among the most influential. Also like many other priesthoods, economists speak to each other in a language impenetrable to the average person – now mathematics instead of the Latin of old. The mathematical inscrutability of economic writings not only insulates them from popular comprehension and criticism but gives them a magical aura – as Orrell observes, somewhat in the manner of the Delphic oracles of ancient Greece.

If neo‐classical economics is to be abandoned, it will probably not be for a scientific reason because its religious authority has faded. Environmentalism is perhaps the strongest contemporary religious challenger to the economic mainstream (Nelson, 2010). To the great surprising of many modern observers, older forms of religious belief, such as Christian fundamentalism and Pentacostalism, as well as Islamic and other forms of non‐Christian fundamentalism, have also been staging a comeback.

While Orrell does mention the religious roles played by neo‐classical economics, he does not explore this aspect adequately. Economyths: Ten Ways That Economics Gets It Wrong has other important omissions. Orrell gives little attention to the rise of “institutional economics” since the 1970s, a new economic school which in fact makes many of the same criticisms of neo‐classical economics that he makes. The institutional school has already produced a number of Nobel Prize winners in economics such as Ronald Coase, Oliver Williamson, Douglass North, George Akerlof, Michael Spence, Joseph Stiglitz, and Elinor Ostrom. Orrell is correct, however, that neo‐classical economics continued as the dominant economic voice in the policy making arena into the twenty‐first century. But, there were rapidly growing numbers of economic heretics, converting many of their fellow economists, even if the policy significance of the institutional school to date has been limited (perhaps because, in the end, one religion can only be replaced by another religion).

Economyths: Ten Ways That Economics Gets It Wrong also includes extended discussions of more specific topics, such as the role of women in society, the true sources of human happiness, and environmental policy. Orrell has little new to say in these areas; his treatment is less analytical and more a matter of simple assertion. In the USA, he would fit well within the progressive wing of the contemporary Democratic Party. His arguments would probably be persuasive to many fellow progressives, but less so to others who do not have the same starting point.

On the whole, though, I recommend Economyths: Ten Ways That Economics Gets It Wrong. Whatever its omissions and other failings, much of the book is devoted to making a strong case for one very important finding – the intellectual poverty of neo‐classical economics. Economyths: Ten Ways That Economics Gets It Wrong is also consistently interesting and enjoyable reading – no mean feat for a treatise on economics. A wide audience including many non‐economists could benefit from reading it.