The Economic Crisis and the State of Economics

By Rob Killick

The Institute for New Economic Thinking, funded by billionaire George Soros, held its first Conference in early April 2010. Just in case we were not already aware of its intellectual underpinnings, the event took place at Kings College, Cambridge, where Keynes developed his General Theory. Sessions took place in the Keynes Lecture Theatre, whilst many participants and speakers were neo-Keynesians.

Much of the substance of the discussion is prefigured in a new book of essays, The Economic Crisis and the State of Economics, edited by leading Keynesian Robert Skidelsky. Although written last year in response to the recession, its themes have now become central to the range of economists lined up in Soros’ new Institute. The three main themes to emerge are: first, the future is uncertain and cannot be predicted; secondly, no economic model can be trusted to work; and thirdly, economics cannot be a science, because it is driven by often irrational human behaviours. A fourth, although often tacit conclusion, is that the state has to be prepared to intervene to make up for the inadequacies of the market.

The main target of these essays is the Efficient Market Hypothesis (EMH), associated with the Chicago school of economists, who proffer the view that markets operate efficiently. State intervention can only damage the market mechanism by distorting market rationality. The general view expressed in this book is that the financial crisis has destroyed both the practical and intellectual basis for the EMH. However, the peculiar aspect of this debate is that, although it’s true that the EMH has been popular amongst some economists in the past, this has had little to do with the real world outside of academia. In the real world, the 20th century saw ever increasing state involvement in the economy at every level. The free market, outside of state control, subsidy, and regulation, in reality is a myth.

In that sense, the EMH is a straw man for the Keynesians to tilt at. If you have any doubt about the irrelevance of the EMH in the real world, then look at how the world’s leaders responded to the financial crisis. Governments everywhere stepped in with massive subsidies to keep the financial system afloat. Would leaders, who were supposedly ideologically wedded to the principles of the free market, have acted in such a concerted way to bail out the markets?

So, if the demolition job on the EMH is of little value, is there any interest in what the Keynesians are saying? Yes, because what they are trying to do is suggest rationality is impossible in the economic sphere. John Kay, in his essay, Knowledge in Economics, says that, ‘the test of an economic theory is whether it is useful rather than whether it is true.’ (p.91)

Paul Davidson, in Risk and Uncertainty, says that believers in the EMH, and indeed anybody who accepts the views of the classical economists Smith and Ricardo, are guilty of thinking that ‘the future is merely probabilistically risky but not uncertain.’ (p20) Davidson argues the future is not predictable; therefore, planning is pointless. All governments can do is be prepared to step in when things go wrong, which they inevitably will.

The Keynesians are expressing in this abandonment of rationality the viewpoint of those who feel the world is out of control. Paradoxically, there is a rational aspect to this viewpoint. The global market is indeed out of control, but only in the sense that markets always are and always have been.

Markets are the antithesis of rational planning. It is only after production has taken place, money spent, and resources used up that you take the product to market and find out if there’s a buyer. Enormous effort and time is wasted on products which turn out to have no buyer, leading to waste, bankruptcy, and redundancy. That is how the market regulates the economy: through destruction. It is because of the essential irrational nature of markets that the state has emerged over a long period to regulate and support the economy, and limit the damage done to society as a whole when markets cease to function effectively.

The challenge facing us all, especially in the aftermath of the global recession, is to work out what a more rational economic world would look like and how it would operate. After all, most production is essentially rational, in that it is about the meeting of human needs in one sphere or another—and requires conscious activity in order to be effective.

The key element missing, which the Keynesians recognise, is the absence of enough information about what is happening in the economy to enable people to make rational decisions. Yet, this is not a problem of economics, but of politics. How can we organise an economy in which people are sufficiently engaged in—and have control over—the consequences of investment decisions and their outcomes? This would be a good subject for the Institute for New Economic Thinking to consider.

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Written under a Creative Commons License, with edits: https://creativecommons.org/licenses/by/1.0/

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