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The economic and financial crisis has been a telling
moment for the economics profession, for it has put
many long-standing ideas to the test. If science is
defined by its ability to forecast the future, the
failure of much of the economics profession to see
the crisis coming should be a cause of great
concern.
But there is, in fact, a much greater diversity of
ideas within the economics profession than is often
realised. This year’s Nobel laureates in economics
are two scholars whose life work explored
alternative approaches. Economics has generated a
wealth of ideas, many of which argue that markets
are not necessarily either efficient or stable, or
that the economy, and our society, is not well
described by the standard models of competitive
equilibrium used by a majority of economists.
Behavioural economics, for example, emphasizes that
market participants often act in ways that cannot
easily be reconciled with rationality. Similarly,
modern information economics shows that even if
markets are competitive, they are almost never
efficient when information is imperfect or
asymmetric (some people know something that others
do not, as in the recent financial debacle) – that
is, always.
A long line of research has shown that even using
the models of the so-called “rational expectations”
school of economics, markets might not behave
stably, and that there can be price bubbles. The
crisis has, indeed, provided ample evidence that
investors are far from rational; but the flaws in
the “rational expectations” line of reasoning—hidden
assumptions such as that all investors have the same
information—had been exposed well before the crisis.
Just as the crisis has reinvigorated thinking about
the need for regulation, so it has given new impetus
to the exploration of alternative strands of thought
that would provide better insights into how our
complex economic system functions – and perhaps also
to the search for policies that might avert a
recurrence of the recent calamity.
Fortunately, while some economists were pushing the
idea of self-regulating, fully efficient markets
that always remain at full employment, other
economists and social scientists have been exploring
a variety of different approaches. These include
agent-based models that emphasize the diversity of
circumstances; network models, which focus on the
complex interrelations among firms (such as those
that enable bankruptcy cascades); a fresh look at
the neglected work of Hyman Minsky on financial
crises (which have increased in frequency since
deregulation began three decades ago); and
innovation models, which attempt to explain the
dynamics of growth.
Much of the most exciting work in economics now
underway extends the boundary of economics to
include work by psychologists, political scientists,
and sociologists. We have much to learn, too, from
economic history. For all the fanfare surrounding
financial innovation, this crisis is remarkably
similar to past financial crises, except that the
complexity of new financial products reduced
transparency, aggravating fear about what might
happen should there not be a massive public bailout.
Ideas matter, as much or perhaps even more than
self-interest. Our regulators and elected officials
were politically captured – special interests in the
financial markets gained a great deal from rampant
deregulation and the failure to adapt the regulatory
structure to the new products. But our regulators
and politicians also suffered from intellectual
capture. They need a wider and more robust portfolio
of ideas to draw upon.
That is why the recent announcement by George Soros
at the Central European University in Budapest of
the creation of a well-funded Initiative for New
Economic Thinking (INET) to help support these is so
exciting. Research grants, symposia, conferences,
and a new journal – all will help encourage new
ideas and collaborative efforts to flourish.
INET has been given complete freedom – with respect
to both content and strategy – and one hopes that it
will draw further support from other sources. Its
only commitment is to “new economic thinking,” in
the broadest sense. Last month, Soros assembled a
remarkable group of economic luminaries, from across
the spectrum of the profession — theory to policy,
left to right, young and old, establishment and
counter-establishment — to discuss the need and
prospects for such an initiative, and how it might
best proceed.
For the past three decades, one strand within the
economics profession was constructing models that
assumed that markets worked perfectly. This
assumption overshadowed a wide body of research that
helped explain why markets often work imperfectly –
why, indeed, there are widespread market
failures.
The marketplace for ideas also often works in a way
that is less than ideal. In a world of human
fallibility and imperfect understanding of the
complexity of the economy, INET holds out the
promise of the pursuit of alternative strands of
thought – and thereby at least ameliorating this
costly market imperfection. |
