RWER issue 56: Victor Beker
On the economic crisis and the crisis of economics
Victor A. Beker* [Universidad de Belgrano and Universidad de Buenos Aires, Argentina]
“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.”
Letter to the Queen of England by the British Academy. July 2009
The outburst of the 2008 global economic crisis sparked myriad criticism of mainstream neoclassical economic theory, which is blamed for having not even considered the possibility of the kind of collapse that the subprime mortgage meltdown unleashed.
If we follow Joan Robinson (1972), this was the third main crisis that economic theory has faced. She identified the first one with the great slump of the 1930s and the second one with the 1971 dollar crisis.
The purpose of this paper is threefold. First, to make clear of what economics is guilty; second, to spell out what sort of science economics is, what is legitimate to expect from it and what is not; and, third, to discuss the flaws economics suffers from and how to correct them.
The paper starts with a survey of some of the criticisms which are being made of mainstream economics. In section 2, an analysis is made of the responsibility of economics and economists in the recent financial crisis. In section 3, the main features of economics as a social science are considered. Section 4 reviews the main issues at stake in the discussion between orthodox economic theory and its critics. In Section 5, I discuss the economics research agenda and argue that priorities are misplaced in it. Section 6 has to do with the relationship between orthodox and heterodox economic theories. In Section 7, a list of 15 guidelines for improving the methodological approach as well the contents of economic analysis is sketched out. The main conclusions are found in Section 8.
1. The criticisms against the economics profession
Conspicuous among the critics, Paul Krugman blames the profession for its ¨blindness to the very possibility of catastrophic failures in a market economy.¨ In his view, ¨the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.¨ This led to turning ¨a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets – especially financial markets – that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.¨
For Sachs (2009: 1), ¨sustained and widespread future prosperity will require basic reforms in global macroeconomic governance and in macroeconomic science.¨ He concludes that ¨a new science of macroeconomics must supersede the stale debates of Keynesian and rational expectations theories¨ (Sachs (2009: 3). For this, he recommends to start the new macroeconomics with three issues: climate and energy security, food and nutrition security, and poverty reduction.
Behavorial macroeconomists like George Akerlof and Robert Shiller (2009) put the blame on the rationality assumption of mainstream neoclassical economics. Only “if we thought that people were totally rational, and that they acted almost entirely out of economic motives, we too would believe that government should play little role in the regulation of financial markets, and perhaps even in determining the level of aggregate demand.”
Herbert Gintis (2009) goes further. Although he coincides with Akerlof and Shiller in their criticism of orthodox economic theory, he argues that ¨there is nothing in economic theory that says that rational individuals interacting on markets will produce either stable or socially efficient outcomes.¨ He concludes that there are ¨slim grounds for Akerlof and Shiller to attribute macroeconomic fluctuations wholly to “animal spirits” that would not exist were economic actors “rational.” Gintis vindicates then, as an alternative perspective, the modeling of the market economy as a complex nonlinear system.
For Colander et al. (2009: 2) the financial crisis revealed a ¨systemic failure of the economics profession¨ because the majority of economists ¨failed to warn policy makers about the threatening system crisis and ignored the work of those who did.¨
Direct from the battle front, Willem Buiter, the chief economist of Citigroup and former member of the Monetary Policy Committee of the Bank of England, says that, in his opinion, macroeconomics research programs tended to be motivated by the internal logic, intellectual sunk capital and aesthetic puzzles of established research programs rather than by a powerful desire to understand how the economy works – let alone how the economy works during times of stress and financial instability. So the economics profession was caught unprepared when the crisis struck.
The political scientist Jon Elster (2009) offers what he calls ¨outsider criticism¨ of economic theory. He argues that the problem with economics and other social sciences is ¨excessive ambitions.¨ Economists look for a level of precision and robustness which cannot be warranted in social sciences.
Two conditions are crucial for mainstream neoclassical economics: determinate prediction and rational behavior. If the theory is indeterminate or the agents are irrational no explanation will be forthcoming. Elster explains why more often than not these conditions do not hold. Indeterminacy stems from the difficulty for agents to assess numerical probabilities to the possible outcome of actions. Rationality faces the restriction of agents´ capacities. Economic agents are supposed to make the calculations that occupy many pages of mathematical appendixes in leading journals. Elster discards the ¨as if¨ rationality argument arguing that it is based on the assumption that the economic agent is able to spend absurdly large amounts of time searching for a good rule. He observes that economists make assumptions for the sake of simplicity without telling the reader how many of the conclusions can be expected to hold in the non-simplistic case. His conclusion is that much work in economics and political science is devoid of empirical, aesthetic or mathematical interest. Many articles published by eminent economists, he says, are nothing more than a piece of science fiction. So, according to Elster, lots of economics students waste their time studying useless theories.
Some of these criticisms have a long standing in economics, like the lack of realism of the assumptions or the argument that people do not behave as the theory says they will or should behave.
Although he vindicates behavioral economics as an alternative to neoclassical thought, Elster admits that its drawback is that there are relatively few applications of behavioral economics outside the laboratory. He maintains that a flaw economics suffers from is the belief that social science can only become a science on the model of the natural sciences. However, he remarks that in spite of this belief none of the many mainstream economists who received the Bank of Sweden Prize got it for confirmed empirical predictions. The opposite happens in physics, he adds. For example, string theory is today the dominant paradigm in most physics departments of the major research universities. However, it has not been awarded a single Nobel Prize mainly because it has not yet generated confirmed predictions that are not also consequences of rival theories. Elster´s observation coincides with what Hausman (1992: 222) has called methodological schizophrenia, referring to the fact that in economics methodological pronouncements and practice often do not coincide.
Elster proposes to replace the aim of prediction with that of retrodiction –explaining the past-, which he considers is a perfectly respectable intellectual enterprise. He maintains that the past can be falsified no less than predictions about the future. Elster´s conclusion is that economists should have, instead of excessive ambitions, humble but attainable aspirations.
2. What is economics guilty of?
I would like to thank William J. Baumol, John Barkley Rosser Jr., Thomas Mayer, Ramiro Negrete, Adrián Ravier and several anonymous discussants for comments on an earlier version of this paper. Of course, only I am responsible for the arguments here.
 For a distinction between the concepts of neoclassical, orthodox, heterodox and mainstream economics see Colander et al. (2004).
 How Did Economists Get It So Wrong? New York Times, September 2, 2009.
 Gintis (2009: 4).
 Ibid., p. 5.
 I have already dealt with this argument in Beker (2005: 17). We will come back on this later on.
You may download the whole paper at: http://www.paecon.net/PAEReview/issue56/Beker56.pdf