What’s wrong with economics? Part 4: What has to change?

There have been frequent calls for a new approach to economics in the press. For this purpose, George Soros founded the “Institute for New Economic Thinking” (INET). I personally do not see this as a solution. Nobody knows what “new thinking in economics” should be like. In addition, “old thinking in economics” also yielded a lot of good results. If you go to the INET website, you will come across a familiar problem. It is dominated by a small circle of researchers from elite English-speaking universities, and its texts recycle topics that have been treated time and time again. George Soros’ new thinking is in fact the same as old thinking, but it comes in a new packaging. And this is no solution to the problems.

Edward Fullbrook, Director of the World Economics Association and prominent critic of established economics, already urged the economic sciences to start applying diverse methods, like in modern physics, a long time ago. Physics does not expect its theories to deal with views of the world, but to explain very concrete problems. And, at the same time, it is accepted that a specific approach is not appropriate for dealing with other matters. At first glance, Fullbrook’s suggestion seems to be a logical step, yet it is tricky. Orientation towards the natural sciences could be a double-edged sword. Natural scientists also battle for recognition, striving to publish articles in top journals, but with different consequences. They do not recycle the same contents in a different packaging. Instead, an increasing number of scandals have come to light regarding rigged or incomprehensible research results. It could well be that the diversity of methods strongly favours abuse in the field of research.

To renew economics, the ideology urgently needs to be taken out of it and its antiquated structures need to be broken up. Economists have to learn that when they have ideas that they believe to be right that these cannot apply to all circumstances. And it would also be helpful if they refrained from behaving like the reincarnation of Nostradamus or stubborn do-gooders when they appear in the media. They need to stick to the role of the respectable researcher.

In addition, they should abandon the ideal of recycling mainstream notions. If recognition is only achieved in science by publishing in established journals, then it goes without saying that new ideas will fall by the wayside.

Above all, economics need to learn that non-economists can have good ideas about the economy; they need to be open to suggestions from other social sciences or from business. These days we often forget that many of the “founding fathers” of modern economics were from other scientific disciplines or from business or had close contact with economic reality. Adam Smith was a moral philosopher, David Ricardo a stock exchange speculator and John Maynard Keynes worked parallel as a fund manager. Because they approached economic matters with an open mind,, they were able to question prevailing dogmas and advance science.

The sponsors of science – i.e. the education policy-makers, foundations and other sources of research funds – should think twice about what they are actually financing. And both they and the economists should ask themselves the question: What is the real purpose of economics? The textbooks tell us that it is about understanding how to achieve an optimum allocation of resources. Adam Smith already found out that free markets are the most efficient form of economic activity under certain conditions. Nevertheless, research has not yet succeeded in explaining how markets – as the sites of economic activity – function.

Some 240 years after Adam Smith presented his model of the “invisible hand”, economists still do not completely understand the mechanism behind this model. Moreover, does it really describe markets with heterogeneous products and information asymmetries? What drives markets in reality? How are prices determined? If we are not able to completely understand how markets function, we will certainly have difficulties when markets fail. It makes it impossible to analyse the problem meaningfully and to show what can be done to improve the situation. The financial crisis has again demonstrated how the complete lack of understanding of the real-world markets has marginalised economics.

Decades ago Friedrich von Hayek recognised that the “central issue” is the problem of coordinating knowledge: “How can the combination of fragments of knowledge existing in different minds bring about results which, if they were to be brought about deliberately, would require a knowledge on the part of the directing mind which no single mind can possess?” *) Von Hayek’s opinion that the uninfluenced market economy could somehow fix everything seems too simplistic in today’s times of globalisation, moral hazard and deliberate creation of information asymmetries. Yet what solution could also apply to a complex world?

Only new findings about how consumers, businessmen and investors handle their knowledge or lack of knowledge in the future can help us to avoid misguided decisions, which could lead us to the next major crisis. Areas such as empirical social research, behavioural psychology, physics and evolutionary biology could make valuable contributions to economics.

While there are definitely some economists currently conducting research in many interesting areas, they have only little chance of being recognised. But perhaps this will change. Then there might even be a slight chance that economics regains its former splendour as a profession for outstanding thinkers.

*) in his book: “Individualismus und wirtschaftliche Ordnung”; Salzburg (1937)

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