Economics: Where to from here?

“orthodox economics had, in the years leading up to the crisis, become more a cult than a science, particularly with the assumption that what exists in competitive markets has to be the best possible outcome, since, if it were not, it could not exist. So, if crises are not predicted, it is because they cannot be: they are the result of unexpected shocks, by assumption”. This is a criticism of the rational expectations school – a criticism with which I fully agree. But this must also be seen as a criticism of the neo-Keynesian school which manipulates  with these “perfections” as if manipulating a recipe, in order to churn out its preferred imperfections. The economy is complex, not amenable to simplistic mathematical analysis, whether of the rational expectations type or neo-Keynesian type. Without understanding institutions and political and historical context, we can’t understand an economy.

“human beings are not rational calculating machines. Their mood and approaches to decision making varies with the circumstances.” This is only partially correct. While humans don’t use rational calculation, their behaviour is best predicted through the assumption that they DO think rationally.

So where should economics go from here?

Well, it should go back to the basics and reset the button. The value-add by economists was astoundingly huge in the first 100 years since Adam Smith’s Wealth of Nations. It increased all the way till Menger came on the scene. Micro-economics, which is largely a deductive discipline, based ENTIRELY on the work of Menger, is still doing fine. But with the advent of Keynes, the “macro-economics” part of economics dropped off like a rock falling off a precipice. The figure below shows what’s happened: