Comments on the state of economics

Government Economics Service Conference

In 1931 Keynes remarked of a book by Hayek, ‘It is an extraordinary example of how, starting with a mistake, a remorseless logician can end in Bedlam’. If one thinks this through, it tells one all one needs to know about what’s wrong with economics.

Economics is an axiomatic discipline. It proceeds from a very small number of assumptions – maximisation, stable preference, equilibrium – from which can be deduced a very large number of conclusions. These might be considered simply as heuristics – moves to set the argument going. But undoubtedly most economists see them as foundations of their explanations of real world behaviour.

Underlying these operational assumptions is a super-axiom: perfect knowledge. Agents not only know what they want they know how to get it. Keynes thought of this as the chief ‘mistake’ of classical economics. His own epistemological axiom was ‘uncertainty’. ‘Actually, however’, he wrote, ‘we have, as a rule, only the vaguest idea of any but the most direct consequences of our acts’. This makes wealth ‘a peculiarly unsuitable subject for the methods of the classical political economy’. (xiv,113). From this ‘uncertainty’ postulate, Keynes in turn deduced very large consequences for the stability of investment, and hence for the economy as a whole.

These very abstract considerations have direct consequences for policy. For example, the theoretical tap root of the current deficit reduction programme is ‘Ricardian equivalence’ – the view that all borrowing is deferred taxation. This is a perfect knowledge kind of assumption –what Keynes would have thought of as an initial mistake in reasoning leading to the wrong conclusion for policy.

I’ve been drifting into a criticism of a particular school of economics rather than of economics as such. Yet I would justify this on two grounds. Looking at the history of economics as a whole, it is evident that the perfect information assumption has been much more powerful than its opposite, or opposites. This is because it has seemed the only basis on which to build an axiomatic system. Secondly, discontent with the existing state of economics never gets very far unless the critic can offer an alternative theoretical approach, or an alternative way of doing the subject. Since its inception as a scientific discipline there have been very few paradigm shifts in economics –certainly none comparable to the Copernican revolution which overthrew the Ptolemaic system. Even the Keynesian revolution failed at the level of high theory.

So the best the critic can do today is to offer an alternative way of doing the subject, starting with how it is taught. This is the purpose of INET.

Started in October 2009 with a $50m grant from George Soros, INET or the Institute for New Economic Thinking promotes changes in economic theory and practice through conferences, grants and educational initiatives. The Institute held its inaugural meeting at King’s College, Cambridge, in April of this year. I am on its advisory council and chair a task force to work out a new economics curriculum. A draft of a reformed economics degree programme, suitable for undergraduate teaching, will be presented to the second annual meeting of INET which will be held at Bretton Woods (Mount Washington Hotel) in April. If approved, this will become the official INET curriculum.

An important trigger for British participation in this reform programme was the Queen’s Question, which has achieved almost legendary status. In November 2008, she asked at the London School of Economics why so few economists had foreseen the credit crunch. Tim Besley orchestrated one of the responses.

In the USA, Paul Krugman had already written (NYT 2 September 2009) that ‘this predictive failure was the least of the field’s problems’. More important, he said, was ‘the profession’s blindness to the very possibility of catastrophic failures in a market economy … the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth … economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations … Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong’.

Our lucubrations – in tandem with American colleagues –have produced a draft proposal, the philosophy of which I summarise as follows:

The central idea of our reform is to reconnect the teaching of economics with the workings of the actual economy, and to begin that reconnection at the very beginning — with the undergraduate curriculum.

We agree on the need to infuse the curriculum with historical, philosophical and institutional content. The highly refined model-oriented approach currently dominating graduate teaching is inappropriate for students new to economics. Our aim instead should be to provide students with access to economic discourse at the level of, say, the Financial Times. “Disciplined eclecticism” — a sense of judgment about which tool, among a wide variety of possibilities, is appropriate for the problem at hand — is the defining characteristic of such discourse. This is the appropriate goal of an economic education.

This ambition cannot be achieved with the addition of a course or two on the history of economic thought and economic history to the standard curriculum. The whole curriculum, from the first course to the last, must be suffused with the understanding of the intellectual, historical, and political nexus from which economics emerged. That means a historically and institutionally informed approach to the entire subject. Knowledge of banking and finance is key to understanding how a modern market economy works, and the regulation and interventions which it may require to work well. In order to translate this bold ambition into reality we have taken on the task of devising an ideal curriculum, from the ground up, and of producing concrete educational materials to support its delivery.

So an ideal undergraduate curriculum should aim to introduce breadth in the first year, core competencies in the second, and depth in the third, without choosing between the different schools – new classical, Keynesian, Hayekian, Schumpeterian, etc. ‘Disciplined eclecticism’ or ‘horses for courses’ will be our watchword. By this approach we might hope to mitigate the risk that, starting from a mistake, we end up in Bedlam.