“Economists are the forgotten guilty men

Academics – and their mad theories – are to blame for the financial crisis. They too deserve to be hauled into the dock”

So begins Anatole Kaletsky’s essay in The Times for February 5 2009. He is spot on. Economic theory played a direct role in this crisis, by legitimising the deregulation of finance and encouraging the profligate lending of financial institutions. There is much more that is wrong with the theory that dominates academic economics–known as “neoclassical economics”–enough to fill several books. My Debunking Economics : the naked emperor of the social sciences was one such book; in it I tried to explain all the technical flaws in economic theory to a non-mathematical audience.

Even at 350+ pages, it was not long enough. There are many mad notions in economics that I didn’t get time to attack–including for example the madness behind the theory of comparative advantage that supports free trade but completely obscures the process of economic development; the absurdity of the concept of “Pareto Optimality” which is used to block even the most trivial attempts to lessen income inequality. I simply ran out of time and pages.

Anatole’s essay does a great job of pointing out why what might be thought to be obscure academic theoreticians have indirectly done more damage to the capitalist economy than a legion of socialist revolutionaries could ever hope to do. I’ll quote the opening at length here and then recommend that you continue reading the entire post at The Times.

Also, check my “Brickbats” page for comments by Australian neoclassical economists Warwick McKibbin (who sits on the Reserve Bank of Australia board) and Peter Swan, for examples of the sort of nonsense that Kaletsky attacks here.

In the search for the “guilty men” responsible for the near-collapse of the global economy, one obvious group of scapegoats has escaped blame: the economists.

By “economists” I do not mean the talking heads (myself included) employed by the media and financial institutions to “explain”, usually after the event, why share prices or currencies have gone up or down. Nor do I mean the forecasters whose computers churn out scientific-looking numbers about what will happen to growth or inflation, but whose figures are revised so drastically whenever something “unexpected” happens – as it always does – that their forecasts are really nothing more than backward-looking descriptions of recent events.

What I mean by “economists” are the academic theorists who win Nobel prizes, or dream of winning them.

To see why these seemingly obscure academics deserve to be hauled out of their ivory towers and put in the dock of public opinion, consider why the bankers, politicians, accountants and regulators behaved in the egregious ways that they have. It may be true that all bankers are greedy, all politicians venal, all regulators blind and all accountants stupid. But such personal failings do not explain their behaviour in the past few years. After all, bankers do not like losing money and politicians do not like losing power. All these “guilty men” behaved as they did because they thought it made sense.

And why did these greedy bankers and stupid politicians hold beliefs that, in hindsight, seem so ludicrous and self-destructive? Why, for example, did they think it reasonable for a bank with just $1 billion of capital to borrow an extra $99 billion and then buy $100 billion of speculative investments?

The answer was beautifully expressed two generations ago by John Maynard Keynes: “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”