The Wealth of Nature. John Michael Greer
Too many fields of study have attempted to skip these preliminaries and fling themselves straight into the creation of complex mathematical formulas, on the presumption that this is what real scientists do. The results have not been good, because there’s a booby trap hidden inside the scientific method: the fact that you can get some fraction of Nature to behave in a certain way under arbitrary conditions in the artificial setting of a laboratory does not mean that Nature behaves that way when left to herself. If all you want to know is what you can force a given fraction of Nature to do, this is well and good, but if you want to understand how the world works, the fact that you can often force Nature to conform to your theory is not exactly helpful. Theories that are not checked against the evidence of observation reliably fail to predict events in the real world.
Economics is particularly vulnerable to the negative impact of premature mathematization because its raw material — the collective choices of human beings making economic decisions — involves so many variables that the only way to control them all is to impose conditions so arbitrary that the results have only the most distant relation to the real world. The logical way out of this trap is to concentrate on the equivalent of natural history, which is economic history: the record of what has actually happened in human societies under different economic conditions. This is exactly what those who predicted the housing crash did: they noted that a set of conditions in the past (a bubble) consistently led to a common result (a crash) and used that knowledge to make accurate predictions about the future.
Yet this is not, on the whole, what successful economists do nowadays. Instead, a great many of them spend their careers generating elaborate theories and quantitative models that are rarely tested against the evidence of economic history. The result is that when those theories are tested against the evidence of today’s economic realities, they fail.
The Nobel laureates whose computer models brought LTCM crashing down in flames, for example, created what amounted to extremely complex hypotheses about economic behavior, and put those hypotheses to a very expensive test, which they failed. If they had taken the time to study economic history first, they might well have noticed that politically unstable countries often default on their debts, that moneymaking schemes involving huge amounts of other people’s money normally implode and that every previous attempt to profit by modeling the market’s vagaries had come to grief when confronted by the sheer cussedness of human beings making decisions about their money. They did not notice these things, and so they and their investors ended up losing astronomical amounts of money.
The inability of economics to produce meaningful predictions has become proverbial even within the profession. Even so mainstream an economic thinker as David A. Moss, a Harvard Business School professor and author of the widely quoted and utterly orthodox A Concise Guide to Macroeconomics, warns:
Unfortunately, some students of macroeconomics are so confident about what they have learned that they refuse to see departures at all, preferring to believe that the economic relationships defined in their textbooks are inviolable rules. This sort of arrogance (or narrow-mindedness) becomes a true hazard to society when it infects macroeconomic policy making. The policy maker who believes he or she knows exactly how the economy will respond to a particular stimulus is a very dangerous policy maker indeed.6
Yet this understates the problem by a significant margin, because a great many of the pronouncements made these days by economists are not merely full of uncertainties; they are quite simply wrong. The quest to turn economics into a quantitative science in advance of the necessary data collection has produced far too many elegant theories that not only fail to model the real world, but consistently make inaccurate predictions. This would be bad enough if these theories were safely locked away in the ivory towers of academe; unfortunately this is far from the case nowadays. Much too often, theories that have no relation to the realities of economic life are used to guide business decisions and government policies, with disastrous results.
The Failure of Markets
The third force driving the economic profession’s blindness to the downside is more complex than the two just discussed, because it deals not with the professional habits of economists but with the fundamental assumptions about the world that underlie economics as practiced today. Perhaps the most important of those is the belief in the infallibility of free markets. The Wealth of Nations popularized the idea that free market exchanges offered a more efficient way of managing economic activity than custom or government regulation. The popularity of Adam Smith’s arguments on this subject has waxed and waned over the years; it may come as no surprise that periods of general prosperity have seen the market’s alleged wisdom proclaimed to the skies, while periods of depression and impoverishment have had the reverse effect.
The economic orthodoxy in place in the Western world since the 1950s, neoclassical economics, has made a nuanced version of Smith’s theory central to its approach to market phenomena. Neoclassical economists argue that, aside from certain exceptions discussed in the technical literature, people make rational decisions to maximize benefits to themselves, and the sum total of these decisions maximizes the benefits to everyone. The concept of market failure is part of the neoclassical vocabulary, and some useful work has been done under the neoclassical umbrella to explain how it is that markets can fail to respond to crucial human needs, as they so often do. Still, as already pointed out, neoclassical economists have consistently failed to foresee the most devastating examples of market failure, the speculative booms and busts that have rocked the global economy to its foundations, or even to recognize them while they were happening.
This is not the only repeated failure that can be chalked up to the discredit of the neoclassical consensus. Social critics have commented, for example, on the ease with which neoclassical economics ignores the interface between economic wealth and power. Even when people rationally seek to maximize benefits to themselves, after all, their options for doing so are very often tightly constrained by economic systems that have been manipulated to maximize the benefits going to someone else.
This is a pervasive problem in most human societies, and it’s worth noting that those societies that survive over the long term tend to be the ones that work out ways to keep too much wealth from piling up uselessly in the hands of those with more power than others. This is why hunter-gatherers have customary rules for sharing out the meat from a large kill, why traditional mores in so many tribal societies force chieftains to maintain their positions of influence by lavish generosity and why those nations that got through the last Great Depression intact did so by imposing sensible checks and balances on concentrated wealth.
By neglecting and even arguing against these necessary redistributive processes, neoclassical economics has helped feed economic disparities, and these in turn have played a major role in driving cycles of boom and bust. It’s not an accident that the most devastating speculative bubbles happen in places and times when the distribution of wealth is unusually lopsided, as it was in America, for example, in the 1920s and the period from 1990 to 2008. When wealth is widely distributed, more of it circulates in the productive economy of wages and consumer purchases; when wealth is concentrated in the hands of a few, more of it moves into the investment economy where the well-to-do keep their wealth, and a buildup of capital in the investment economy is one of the necessary preconditions for a speculative binge.
At the same time, concentrations of wealth can be cashed in for political influence, and political influence can be used to limit the economic choices available to others. Individuals can and do rationally choose to maximize the benefits available to them by exercising influence in this way, and the results impose destructive inefficiencies on the whole economy; the result is one type of market failure. In effect, political manipulation of the economy by the rich for private gain does an end run around normal economic processes by way of the world of politics; what starts in the economic sphere, as a concentration of wealth, and ends there, as a distortion of the economic opportunities available to others, ducks through the political sphere in between.
A similar end run drives speculative bubbles, although here the noneconomic sphere involved is that of crowd psychology rather than politics. Very often, the choices made by participants in a bubble are not rational decisions that weigh costs against benefits. A speculative bubble starts in the economic sphere as a buildup of excessive