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The Reality-based Economics Community Strikes Back

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An important step in making economic scholarship relevant to the post-crisis world may have been taken last week in Cambridge, UK. A number of economists that do not subscribe to the majority view of how the economy works met to consider what a ‘New Economics’ might look like. While new in several senses, the ‘New Economics’ does not lack deep roots. It is founded in ideas that have taken on new life in the last two years, such as those of John Maynard Keynes from the 1930s and Hyman Minsky from the 1970s. Keynes’s insight was that because the saving of individuals does not automatically translate into investment by firms, government spending may be required to make up for low private sector demand in times of recession. Minsky’s observation was that there is a tendency for firms to optimistically over-borrow in good times to the extent that they become prone to collapse when times turn bad. These insights have become current in the financial media, yet what underpins such ideas and why they must become embedded in our economic thinking, has not.

Modern economics has insisted that the economy as a whole can be studied as a stable outcome of markets that are populated by completely rational and fully-informed individuals. To the extent that this ignores what we know of human knowledge and behaviour, ignores the existence of economic institutions such as firms, banks and governments and ignores the outcomes of actually existing markets, this can be justified by the gnomic utterings of Milton Friedman. In a famous article of 1953 (which even he was subsequently unwilling to defend) he argued that whether the assumptions of any economic model were based on reality was irrelevant, as long as the model made accurate predictions. In fact the very nature of this argument betrays the uselessness of economic predictions. Such models are selected according to how well they fit the facts of the past. If they fit those facts they might be considered further; if not they will be rejected. If enough models, however constructed, are tested, some will pass this test just by chance!

The real value of an economic model is surely in how much we can rely on it for predicting a future that has not yet happened. The only possible basis for this is that the model is built up from what we know about the real world. And what we know about the real world is that it is unstable, deeply uncertain and organised around myriad institutions designed over the years to try and cope with these awkward facts. The ‘New Economics’ recognises these truths, is interested in analysing and improving the institutions and accepts that making economic judgements, predictions and policy, where they are possible at all, need to be based on models that make use of all available data combined with modern computing power.

The sheer number and complexity of the variables the New Economics recognises has the merit of immediately making it less didactic. It is more tolerant of the needs and expressed desires and goals of the individual human beings caught up in the movements of markets and the fortunes of national and global economies. This makes it more disposed towards equality, fairness and economic democracy as basic values, rather than as afterthoughts to an indefinable concept of economic ‘efficiency’.

The contributions at the conference covered these general issues as well as looking at specifics that follow from this approach. For example, we recognise that the involvement of human beings, institutions and the natural world in economic decisions means that the economy is actually a complex, ‘path-dependent’ phenomenon. This means that it doesn’t after a change simply fall back to the ‘equilibrium’ state predicted by standard models. One currently significant lesson of this is that decisions governments make, to spend or not to spend, can have positive or negative effects that last long into the future and far outweigh their immediate fiscal cost or saving. This can be explained by the fact that these decisions are mediated through human beings, institutions and the natural environment.

Other implications include the need for economists to engage with other approaches that study human beings and their institutions apart from monetary transactions; such as in the labour ‘market’ where gender and social conflicts and the psychology of esteem and effort play at least as much a part as demand and supply. The ‘New Economics’ also recognises that the role of money and finance is to allow production and consumption to be separated in location and time. This exponentially increases flexibility and enhances development and growth, but also has huge harmful effects in allowing rapid shifts of demand and in obscuring the social and environmental downsides of modern mass production processes. This strongly supports the idea that money creation and banking must be responsive to human and social purposes rather than under the control of banks and producers whose eyes are on revenue and profit streams. Mainstream whole-economy analysis has little to say on these issues since its models generally don’t include money or banks at all. A stable economy with a pre-ordained future has no need of them.

Currently, academic posts and acceptances by the ‘top’ economics journals tend to go to those embracing the mainstream view and its beautiful (to those so inclined) mathematical models and their brilliantly-extracted but irrelevant solutions. This suggests that we must wait for one of those ‘revolutions’ that the philosopher/historian of science Thomas Kuhn ascribed to Galileo or Einstein. In which case we may be facing many more years of crisis. The hope must be that since economics differs from astronomy and theoretical physics in having tangible consequences for human beings, non-economists will rise up with us and help overthrow the naked queen of the social sciences.

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