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Economics needs to reflect a post-crisis world
FT Editorial: The dismal science should be grounded in reality to stay relevant
When the global economy crashed in 2008, the list of culprits was long, including dozy regulators, greedy bankers and feckless subprime borrowers. Now the dismal science itself is in the dock, with much soul-searching over why economists failed to predict the financial crisis. One of the outcomes of this debate is that economics students are demanding the reform of a curriculum they think sustains a selfish strain of capitalism and is dominated by abstract mathematics. It looks like the students will get their way. A new curriculum, designed at the University of Oxford, is being tried out. This is good news.
Defenders of the status quo have pushed back, pointing to a rich hinterland of heterodox economics thinkers. Dig deep and you can find plenty of academic treatises on bank runs, unstable credit cycles and irrational markets. That people are selfish and that businesses pursue profit is not the fault of economics but of human nature. Accurately predicting the future is an unrealistic test of any academic discipline, particularly one that encompasses limitless human interactions.
But the fundamental point made by the critics is right. For a subject so engaged with studying worldly behaviour, there is too much timeless abstraction and too little scrutiny of real-world events. The typical economics course starts with the study of how rational agents interact in frictionless markets, producing an outcome that is best for everyone. Only later does it cover those wrinkles and perversities that characterise real economic behaviour, such as anti-competitive practices or unstable financial markets. As students advance, there is a growing bias towards mathematical elegance. When the uglier real world intrudes, it only prompts the question: this is all very well in practice but how does it work in theory?
This theoretical bias left the discipline resistant to challenge at a crucial time. When in 2005 Raghuram Rajan, now governor of the Reserve Bank of India, warned that financial innovation had become a source of instability, his paper was dismissed as “slightly Luddite”. His call for greater prudential supervision of banks was ignored.
Fortunately, the steps needed to bring economics teaching into the real world do not require the invention of anything new or exotic. The curriculum should embrace economic history and pay more attention to unorthodox thinkers such as Joseph Schumpeter, Friedrich Hayek and – yes – evenKarl Marx. Faculties need to restore links with other fields such as psychology and anthropology, whose insights can explain phenomena that economics cannot. Economics professors should make the study of imperfect competition – and of how people act in conditions of uncertainty – the starting point of courses, not an afterthought.
Mathematical models ought to keep their place, so long as their results are not taken too literally. But many of those used in central banks have hitherto ignored the financial sector as a source of instability. Remedying this will add even more complexity. The maths will get harder.
In the aftermath of the financial crisis the popularity of economics courses has surged. Having watched the global economy fall off a cliff, new students will not tolerate anodyne lectures on the wisdom of markets. They demand more pluralism and humility in a subject that has hitherto overvalued purism and certainty. Economics should not be taught as if it were about the discovery of timeless laws. Those who champion the discipline must remember that, at its core, it is about human behaviour, with all the messiness and disorder that this implies.
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