As the title of this blog is ‘Unlearning Economics’, I thought I’d start by noting a few of my main objections to economics as taught in schools and universities. Neoclassical theory injects a certain type of framing and a number of hidden assumptions into your head, many of which become second nature, even amongst left leaning economists. They are all, of course, interlinked, and together they can form an incredibly skewed world view.
The framing of issues as governments versus markets
It pains me to see otherwise intelligent critiques of market fundamentalism held back by this framing. The idea that there exists some entity, a ‘market’, which is then passively ‘intervened in’ by government simply makes no sense in the real world. To start, well-defined property rights are necessary for a capitalist economy to function effectively*. But defining property rights is highly complicated – intellectual property, public property, zoning, environmental property rights are all open to debate. Contracts, too, are highly complex; ask anyone trained in law. Fraud is also open to interpretation – predatory lending and ‘looting’ can both be considered types of fraud; some consider FRB and fiat to be fraud. The line between fraud and information asymmetry is blurry to the point of non-existence.
Furthermore, there are many ‘regulations’ that are not commonly considered to be interventionist. Limited liability laws are one, as are immigration restrictions, and laws that protect shareholders and define shares themselves. Where the government levies taxes will also affect the workings of an economy, as will what they choose to accept as payment. I could go on – but my point is clear: from the start, decisions made by the government about the legal system will affect how the economy works. Any line they supposedly cross at some point, that means they are ‘intervening’ and as a consequences the result is now a ‘government failure’, is arbitrary.
I will accept that direct government provision of goods and services makes sense as a government failure, but short of that it’s simply not credible to label some regulation as more interventionist than the last.
In the interests of consistency I have named this after Duncan Foley’s book of the same name, though admittedly it might be unfair to attribute it to Smith, who would surely not endorse what current economists have made of his work.
Adam’s Fallacy refers to the separation of the economic sphere from the political and social spheres, classifying it as one where private self interest is optimal and any ‘interventionist’ action is unnatural. Thus, if we implement a regulation, we are forced to follow the responses of private actors to their logical conclusions, without questioning them along the way.
One of the most persistent example can be seen in the recent crisis. It is often asserted that government guarantees, encouragement of homeownership or regulation x led companies to invent CDOs, CDSs and engage in fraud. The fault is then attributed to the government for getting involved, rather than simply questioning the responses of these actors. This is equivalent to a vandal defending himself by pointing out that ‘someone just left a pile of bricks next to the shop window’. It is a glaring example of begging the question, but one that is completely hidden and, as a consequence, rarely noticed.
The real economy as a deviation from models
You will often see an academic economist say something along the lines of ‘in the real world, we accept that conditions for perfect competition are rarely, if ever, fulfilled’. At first glance, this sounds OK. But imagine if physicists modelled orbits as perfectly circular, and then noted that ‘the conditions for perfectly circular orbits are rarely, if ever, fulfilled’. You’d immediately be inclined to ask: why on earth do you still model orbits as circular?
Yet economists do not question the presence of perfect competition models**. Similar logic is applied to the Arrow-Debreu theorem – economists start from a remarkably unrealistic premise and proceed to ‘tweak’ the model to try to make it resemble the real world (in the case of Arrow-Debreu they are unable to tweak it much before it collapses, which is perhaps a further sign they should abandon it). This is what makes economics so vulnerable to the Theory of the Second Best, which on its own is enough to refute many of the policy prescriptions of the last few decades. Eliminating these unrealistic models as a starting point for analysis is crucial if we want to understand the real economy.
These errors and others like them are the anatomy of what it means to ‘think like an economist’, something many regard with a strange triumphalism, even in the wake of the field’s recent failures. They erect, as Keynes put it, a ‘vast logical superstructure’, ominous and impenetrable to outsiders. This is what allows economists to cut themselves of from criticism and dismiss non-economists as ignorant. The reality is that the economists themselves are mostly ignorant to how the economy works, and many fail to grasp the internal contradictions of their own models.
The economy is a complex, dynamic system whose structures are defined by the government, no matter how small that government is. It is not, at any point, in a particularly special or sacred state, and as such new rules and regulations should not be treated as an unnatural intervention or deviation from an ideal.
*There are a few examples of vaguely anarcho-capitalist societies, but the fact is that the most successful capitalist economies have had states.
**I am aware that most of microeconomics is based around oligopolistic analysis, but this doesn’t change the fact that perfect competition is still taught, and competitive markets are often cited by economists in the public eye as a starting point. Also, defending neoclassical oligopoly models is probably not a great position to be in, something I will cover in due course.