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Thursday 11 February 2016

Rethinking Economics: Let's Get This Schism Started

Doctors of Doctrine

In the wake of the great crash of 2008 a lot of young people suddenly became interested in finance and signed up for university courses to learn about the detail of what went wrong. Instead, what they got was a load of nonsense dressed up as learning that bore little relation to the real world. Well, what did they expect, they chose to study economics?

Our of this was born the Rethinking Economics movement, an attempt to introduce new ideas and concepts into economic education, to adopt a pluralist approach. The problem with this, well meaning though it is, is that reforming economics is akin to Martin Luther nailing his theses to the door of All Saints' Church in Wittenberg: all it does is create a schism in a religious cult. Economics doesn't need re-thinking, it needs to be put out of its misery.

Pardon My Indulgences

On the 31st October, 1517 it's reported that the theologian Martin Luther kicked off the Protestant Reformation by nailing his 95 Theses to the door of the church in Wittenberg. Luther's beef was over the sale of indulgences by priests; allowing people to reduce their sins in the eyes of God by payment to the Catholic Church. This apparently small act of rebellion was to cause a schism in the Christian church and, fueled by openly available information from Gutenberg's printing presses, was to lead to hundreds of years of brutal atrocities and religious wars. Arguably those conflicts are still ongoing.

With the benefit of hindsight we could argue that the true revolution wasn't happening in Wittenberg but nearly 500 miles east in the Polish town of Fromberk where another priest, Nicolaus Copernicus, was beginning to have funny ideas about whether the Sun really did go round the Earth.  This is a story I've already dealt with in Saving the Appearances (of Standard Finance). As I said there:
In the end the battle over economics is a battle over power. When Martin Luther set in motion the Reformation by nailing his treatises to the cathedral door at Wittenberg he wasn't just challenging the ideas of the established Church but seeking to undermine its power. War followed, because that's what happens when established power centers come under threat; we shouldn't expect any different in economics.” 
So let's get this schism started.

Philosophical Theft

Economics has no deep philosophical roots. Its correctness, or otherwise, can't be tested by scientific study. Like psychology the great ideas in economics are pickpocketed from other, more rigorously fundamental subjects: for instance, Freud developed psychodynamics out of hydrodynamics, the study of sluice gates and water pressure (see: Metaphors of Mind and Money). And it's reflexive: an idea in economics can become true if enough people in a position of influence can insist that the world operates on the basis of some random, usually imaginary, principle.

Consider: the Black-Scholes theorem of option pricing only started working after enough people started using it, as Donald MacKensie and Yuval Millo have shown:
“Option pricing theory—a “crown jewel” of neoclassical economics—succeeded empirically not because it discovered preexisting price patterns but because markets changed in ways that made its assumptions more accurate and because the theory was used in arbitrage."
Or what about the idea that management should have their interests aligned with shareholders? This only became popular after Michael Jensen and William Meckling came up with the idea - and from that point the management of corporations started managing their corporations in a way that maximized the value of their options. Only an economist could be surprised by this.

And the theory that the best and probably only way of deciding whether some project or other is worthy can only be measured by economic means - the so-called process of financialization - has come to dominate the world to a point where it's now the default way of all decisions being made, even those that are clearly more about moral and ethical issues (see: Screwed: Fictional Profits, False Accounting and Financialization). How the hell do you financialize the value of a piece of priceless natural habitat? But we do, nonetheless.

A Fallacy of Analogy

Here's the rub: it's all built on a fallacy. A bloody great gaping hole that goes all the way back to the dawn of economics, back when it fancied itself as the physics of the social sciences. Because, back at the beginning, Leon Walras' economics was based on the First Theory of Thermodynamics, which states that in a closed system everything eventually forms an equilibrium. Equilibrium is the defining quality of neo-classical economics, the state that every right-thinking economic system aspires to.

Beyond this, to make the idea work, Walrus identified the idea that all humans operate in their own best interests to maximize their wealth. When economists vaguely recognized that we do things for other than money the idea of maximization was modified to center on utility - the most vague concept ever to take center stage in a reputable academic theory (see: Utility, the Deus Ex-Machine of Economics).

Worse, the thing about all of this nonsense is that was invented before, and ignored, the Second Law of Thermodynamics which says that in a closed system eventually all energy becomes unusable and the system settles down into a permanent, stable equilibrium. I don't know about you, but as far as I can see the world's economic systems don't look like they're getting any more stable.

Sunny Money

Partly this is because the world is not a closed system as required by the First Law. Even here in rain soaked England we can, sometime in late Spring, dimly discern a large yellow ball in the sky which appears to be emanating heat. The Sun pumps energy into our system, even without accounting for the sunlight stored in fossil fuels. Our economy is not subject to the First Law in any meaningful sense (for a more detailed discussion of this argument see Exit the Walras, Followed by Equilibrium).

You might think that this is simply a historical yarn, of interest but no current relevance. Well, as those disaffected students can tell you, it's not. The ideas of equilibrium and maximization and utility are still alive and well, threaded through modern economics. They're even at the heart of behavioral economics, in the form of Prospect Theory.  

Mystical Orthodoxy

None of this constitutes anything like a scientific subject, there's no evidence that any of this nonsense has any relation to our real economy other than where reflexivity and the tendency of world leaders to follow economic orthodoxy have made it so. This looks less like a science than a religion (see: Religion in EconoLand). And religious views can't be altered from within the same mindset - you can't re-think economics from within. There've been economic schisms before - Keynes versus Friedman for instance - but that's never done anything about the fundamental issue, that the whole discipline is little more than a bunch of high priests incanting mystical rubbish.

The truth of this is revealed every so often when an economic crisis occurs. At this point our economic rune-readers suddenly become revealed as the no-nothings that they really are. They can't predict economic events and they don't know how to react to them - but in a world in which scary events can happen we like to have superstitions to fall back on. That's the real role of economists.

Heretical Heuristics

There are glimmerings of a proper study of financial behavior. Neuroeconomics looks at the impact of financial decisions on the brain. Field experiments take studies out the laboratory to use naturally occurring data to understand how people really behave in real-world economic decisions. There are branches of behavioral economics that have abandoned the ethical black-hole of maximization and equilibrium in favor of heuristical analysis that better fits with the way that we know the brain actually works.

In essence, we have some economists who have abandoned the attempt to save the appearance of modern financial theory and who are taking a good hard look at the evidence, both from economics and from other scientific disciplines. The results will eventually overthrow the religious cults that currently dominate the subject. But priesthoods don't go quietly; they're not about to give up their exalted positions simply because the evidence says they should.

Post-Post-Modern Economics

Expect a fight, and don't expect change from within. Adopting pluralism, having an open mind in this fight, is simply to accept that economics is a branch of post-modernism, in which I can have a dozen competing ideas and they're all right. That can't work: economics needs to be founded in scientific inquiry, not thinking that's so free it's unbound from the laws of physics. 

Economics doesn't need its equivalent of Luther and the Protestant Reformation, it needs Copernicus and the Scientific Revolution. It doesn't need rethinking, it needs replacing.

1 comment:

  1. re: "Walrus identified the idea that all humans operate in their own best interests to maximize their wealth"
    I suspect you have a typo or auto(in)correct in the above sentence. However it could be a reference to Walrus in Through the Looking-Glass. "But he ate as many as he could get," said Tweedledum - referring to the Walrus's attempt to maximize his consumption of oysters.