The 2008 crash clearly demonstrated the failures of a (neo)liberal economic model that claimed to have solved ‘boom and bust’ cycles of growth and recession and found the tools to prevent the onset of longer-term economic depressions. In the wake of this generation-defining failure, Dr Alan Kirman of the École des hautes études en sciences sociales Paris, and Aix Marseille University, argues that the models used by mainstream economists and political leaders to understand what is happening in society are no longer equal to the task. Alan has been someone who has added a breadth of knowledge to the subject. The way in which we think about economics through his work, on how people interact, has increased our understanding of how we reach certain outcomes. His work even uses ants to teach us about collective human actions. Having him contribute to this series is an absolute pleasure.
Ultimately the question for leaders at Davos this week, is how much more proof they need to see before finally jettisoning the governing fictions of current macroeconomic orthodoxy?
- The shocks of 2016 are the realisation of the political consequences of the 2008 crash
- 2008 gave the lie to the reigning liberal idea of society as a neat, closed system capable of seeking and finding its own internal balance
- Current macroeconomic theory appears fundamentally divorced from the political and social realities it claims to understand
- Abandoning the macroeconomists’ dream of a single explanatory model of social behaviour is the only way to move on from the mistakes of the past
Over us all hangs the shadow of 2016, from many points of view a particularly horrible year. This was a year in which old problems surfaced in a new form. There is a consensus that some of the more surprising political developments from 2016 have an economic origin. We saw unexpected things happen in countries where the norm was for each new election to be a movement around a well-defined centre. We witnessed an apparent rejection of certain pillars of economic liberalism, the model on which our society was thought to have converged, at least in “advanced” countries.
In Spain, Greece, and Italy for example populist parties emerged, and in some cases have been elected, the same parties who but which only yesterday would have been considered as extremist. The angry voters who have voted for Brexit, have elected the new American president, and who are supporting populist parties in Europe, are frequently identified as “those who have been left behind” by globalisation and automation. This will no doubt be the subject of much debate at Davos. Yet, as far as globalisation goes there is nothing particularly new here. So why now has this problem come to the surface with such force whereas in the past it was allowed to remain hidden with only sporadic protests?
In part, there has been a technological revolution and the emergence of social networks as a basic provider of information has changed the scene. As individuals focus on one source of regular information, they continue to communicate with those around them, many of whom share their opinions, creating a reinforcement effect and clusters of people with a very specific axe to grind. It is those voices that the Republicans in the U.S. did not hear and that the Front National in France thinks they hear. Anger and fear seem have become the common denominators of the appeal of both.
The strange death of liberal economics?
In an era where the benefits of liberalising markets and unfettered globalization have been systematically advanced, that particular voice, which may be that of many, has not been heard by the “mainstream” politicians. So what was the underlying dogma that the protesting voters no longer seem to believe? Over the last two centuries there has been a growing acceptance of social and political liberalism as the desirable basis for societal organisation. Economics has developed increasingly sophisticated models to justify the contention that individuals left to their own devices will self-organise into a socially desirable state. However, in so doing, it has led us to a view of the economic system that is at odds with what has been happening in many other disciplines, such as statistical physics, ecology and social psychology where it is recognised that complex aggregate behaviour with unexpected upheavals can emerge from the interaction between relatively simple individuals or particles. Such systems do not nicely settle to an “equilibrium” and may, as they evolve, pass through very turbulent periods. As Joe Stiglitz once said, “The invisible hand is invisible because it is not there”.
Our societies and economies cannot be satisfactorily modelled as neat, closed mechanical systems with an automatic tendency to self-equilibrate. Their behaviour is the result of the complicated interaction between all the actors that make them up. As a number of authorities from Herb Simon onwards have pointed out, our efforts to generate comprehensive models of such systems is not feasible for simple logical, mathematical and computational reasons.
The irrelevance of current economic theory?
But this means that the models on which we apparently based our analysis of what was happening in different economies have become more and more detached from reality. Yet, this has not prevented economists from claiming that their work has been useful in solving our major economic problems and their consequences. Who can forget the confident pronouncement of Robert Lucas, Nobel Prize winner and President of the American Economic Association in his Presidential Address in 2003 in which he said: “The central problem of depression-prevention has been solved.” Looking back from 2017 this seems almost quaintly optimistic and is in stark contrast to what a number of economists involved in policy making said later.
Even before the onset of the crisis Greg Mankiw in 2006 who had been chairman of the Council of Economic Advisers said,
“The fact that modern macroeconomic research is not widely used in practical policymaking is prima facie evidence that it is of little use for this purpose. The research may have been successful as a matter of science, but it has not contributed significantly to macroeconomic engineering.”
Jean Claude Trichet the then governor of the European Central Bank said in 2010 that “Macro models failed to predict the crisis and seemed incapable of explaining what was happening to the economy in a convincing manner.”
Paul Romer the new Chief Economist at the World Bank said in 2016,
“The trouble is not so much that macroeconomists say things that are inconsistent with the facts. The real trouble is that other economists do not care that the macroeconomists do not care about the facts.”
The question is then, can we accept that there are two parallel activities in economics, the academics like Boubaki in mathematics thinking only about improving the coherence and generality of their models, and the policy makers and deciders trying to propose concrete measures not founded on modern theory?
Time for a paradigm shift?
Policy makers seem to perceive themselves as having little analytical support from economists with which to face the real problems with which they are confronted. It seems then unreasonable to have academic economists and policy makers working almost independently of each other, in the face of the worsening economic outlook. The situation today is one in which we are faced with an on-going economic crisis which is not only generating its own unstable dynamics but is producing consequences which cause people to act and vote in ways which contribute to increasing that instability. This is the reason that the discussions at Davos have a very different tenor than they did 10 years ago.
At some point, we will have to step away from our pseudo-scientific dream of building a comprehensive model of the economy and accept the fact that the economy is a complex adaptive system in which the aggregate behaviour emerges from the interaction between its components. Because of all the interactions and the complicated feedbacks between the actions of the individuals and the behaviour of the system there will inevitably be “unforeseen consequences” of the actions taken by individuals, firms and governments
Consider the case of the possible impact of Brexit on the British economy and the global economy. Revised forecasts of growth of these economies are now being issued, but when so much depends on the conditions under which the exit is achieved, is it reasonable to make such deterministic forecasts? Given the complexity and interlocking nature of the economies, the political factors that will influence the nature of the separation and the perception and anticipation of the participants (from individuals to governments) of the consequences, how much confidence can we put in forecasts of growth over the next few years?
Some may claim that the complex systems approach is an admission of our incapacity to control or even influence economic outcomes, but this need not be the case. Hayek once argued that there are no economic “laws” just “patterns”. The development of “big data” and the techniques for its analysis may provide us with the tools to recognise such patterns and to react to them.
In 2017 we should accept the fact that we still have a very limited understanding of how the economy works and recognise that the social and political reactions to the evolution of the economy that we are now observing and their feedback have to be included in any analysis of current economic developments. If this means fundamentally changing the framework of economic theory and adopting a more humble stance, so much the better.