Now is the time for a revolution in economic...

February 10, 2009

10 February 2009

Now is the time for a revolution in economic thought

The following is excerpted from February 9th edition of the "TimesOnline".

…[The] academic economics has been discredited by recent events. It is now time for what historians of science call a “paradigm shift”. If we want to flatter economists, we could compare this revolution needed to the paradigm shift in physics in 1910 after Einstein discovered relativity and Planck launched quantum mechanics. More realistically, economics today is where astronomy was in the 16th century, when Copernicus and Galileo had proved the heliocentric model, but religious orthodoxy and academic vested interests fought ruthlessly to defend the principle that the sun must revolve around the Earth.

In this article I will outline some of the unorthodox approaches to economics which conventional economists have ignored and which might have helped to avert the present crisis…

Consider the following passage:

“Most economic theorists have been going down the wrong track. When economic models fail, they are seldom thrown away. Rather they are ‘fixed' - amended, qualified, particularised, expanded and complicated.

“Bit by bit, from a bad seed a big but sickly tree is built with glue, nails, screws and scaffolding. Conventional economics assumes the financial system is a linear, continuous, rational machine and these false assumptions are built into the risk models used by many of the world's banks. As a result, the odds of financial ruin in a free global market economy have been grossly underestimated.

By using such methods there is no limit to how bad a bank's losses can get. Its own bankruptcy is the least of the worries; it will default on its obligations to other banks - and so the losses will spread from one inter-linked financial house to another. Only forceful action by regulators to put a firewall round the sickest firms will stop the crisis spreading. But bad news tends to come in flocks and a bank that weathers one crisis may not survive a second or a third.”

This uncannily precise description of the present crisis above was not written by an economist. While some economists had warned for years about global trade imbalances, escalating house prices, of excessive consumer borrowing, none of them remotely foresaw the truly unprecedented feature of the present crisis: the total breakdown of financial markets caused by the unforced blunders by investors and banks. Modern economists were inherently incapable of understanding such a problem because they assumed that investors were “rational” and markets “efficient”.

These assumptions led inevitably to disaster once they were blown apart. The author who came so close to understanding the true causes of the present crisis was not an economist but a mathematician. …

At the other end of the academic spectrum, we find economists treating ideas from sociology, psychology or philosophy with the same derision and disdain.

George Soros is no mathematician like Mandelbrot, but he has repeatedly demonstrated far better understanding of how market economies work than any professional economist by using psychological and philosophical ideas. His books have explained convincingly how false beliefs among investors can create self-reinforcing boom-bust cycles of exactly the kind afflicting the world today….

… [I]nvestors often misinterpret information and markets sometimes send price signals that are dangerously wrong.

What Soros shows, moreover, is that such behaviour should not be regarded as irrational or an aberration. On the contrary, rational investors can find it very profitable to act on false premises - for example that credit will always be available without limit - if these false ide


Topic(s): 
World Economy & Politics
Information Source: 
Canadian News Channel / International News Channel
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