In this week’s FT, Gideon Rachman argued that “maybe it is time for an alternative to the brash certainties, peddled by those pseudo-scientists, otherwise known as economists.”
I know, like and respect all three of them, and I think they all make valid points. As someone who studied economics and writes about it, yet has always found some of the central tenets of mainstream macroeconomics unconvincing, I think to a certain extent they are talking at cross purposes.
Gideon’s main critique is of macroeconomics, while Tim’s robust defence is primarily of microeconomics. Gideon points out that economics isn’t physics, and Tim replies that it is more than history. A dispassionate observer might conclude that they both have a point.
Focusing on mainstream macroeconomics, though, I agree with Gideon that a lot of it is bunk.
Neoclassical economics assumes that markets move from one defined equilibrium to another, and assumes away the influence of financial markets altogether. Hence the inability to predict, or even expect, the financial crisis.
Many free-marketeers are attracted to neoclassical economics because they think it “proves” that markets are efficient and that government intervention generally makes matters worse.
In fact, it does no such thing, because if you assume away uncertainty, an all-knowing central planner could allocate resources just as efficiently as free markets.
New Keynesian economics, which grafts a rationale for government intervention on to neoclassical economics, is equally misguided.
It suffers from most of the same flaws that neoclassical economics does. And it isn’t Keynesian at all, since it basically ignores the crucial role of uncertainty.
I think our understanding of macroeconomics should draw on a synthesis of Hayek and Keynes.
While they differed on many things, they both understood that economies are continually in flux, that the future is fundamentally unknowable (not a point on a known probability distribution),and hence that the role of finance and entrepreneurs – both of whom create markets in the future – is crucial.
As I wrote in the conclusion to my new book, Aftershock:
Market economies are not computable machines that shift predictably from one steady state to another, they are dynamic, unfathomably complex organisms that are forever evolving – unsurprisingly, since they are made up of millions of human beings continually interacting with each other. Nor is economic growth a mechanical process oiled by new technologies that appear metronomically as manna from heaven. It is an ongoing voyage of discovery into an unknowable future, fuelled by ingenuity and energy, trialled by enterprising businesses and stimulated by competition within a framework of supportive institutions.