Economists: ‘We need a new paradigm’

5th July 2012

Sara Ledwith and Antonella Ciancio discuss the quiet revolution in economic theory in this piece: "Diane Coyle, a UK-based economic consultant who is compiling a book on how economics teaching needs to change after the crisis, says it can't be separated from a backlash in Europe against free market liberalism. But whatever their politics, a significant number of economics teachers in both Europe and the United States think it's time for a new, more pragmatic approach.

"Around one in five respondents to a 2010 survey of economics instructors by the St Gallen university in Switzerland said their profession needed a "major reorientation or new paradigm." 

Economics has been too abstract, the authors argue. It needs to deliver more pragmatic, real world solutions. There are also flaws in its assumptions: London School of Economics economics professor Charles Goodhart told a conference macroeconomists had been "totally and egregiously hopeless." Their assumption that everyone in an economy can borrow at the same risk-free rate "blows one's mind, the degree of intellectual error." In particular, the assumption that everyone behaves rationally at times of crisis has been horribly exposed.

The response to the piece on the comment boards largely depended on individuals' politics – they either believed that liberalism or excessive intervention was to blame for the failure of the banks. This debate has been seen between economists as well: "Professors Paul Krugman and Richard Layard have launched a manifesto – they are trying to get economists to sign up to their version of what went wrong with the world economy and what we should do about it." 

But to some extent this shows the limitations of economics – it creates conflicting theories that are difficult to prove because it is not always clear what creates shifts in an economy.

Regulation also failed and although there is a lot of banking regulation in the pipeline, more radical solutions are being suggested: John Kay in his blog suggests that investors have to look at the solution in more pragmatic terms. For example, if the banks are operating like casinos, they should be regulated as if they were casinos.

"Casinos attract greedy people with deficient ethics: the fear this engenders frames regulation, the obligations we impose on executives and the culture we expect from operating companies.

"Perhaps banks should operate to standards as high as those of casinos. There are two main arguments for splitting the utility of retail banking from the trading casino. One is to stop croupiers gambling with house money; the other is the incompatibility of trading and banking cultures. The Vickers commission on UK banking reform addressed the first. It is time to turn to the second."

Market theory is also going wrong, largely on the back of government intervention. Markets move higher as more stimulus is put in the system and move lower as its effects wear off. This is a difficult environment in which to invest, but relatively few have found an alternative to equities and bonds. Most are still clinging to the belief that markets will ultimately prove rational over the longer term.

There is an increasing sense that policymakers are working with antiquated systems. These systems are backward-looking and therefore have presented no solutions for the tough new climate.


More on Mindful Money 

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