Two cheers for economics

Nothing quite like kicking a man when he is down. In the wake of the financial crisis, the field of economics has taken a deserved beating. The Queen famously asked a committee of distinguished practitioners why they did not manage to predict the collapse. Now the successful entrepreneur and Financial Times columnist Luke Johnson has entered the fray. He calls economics useless and recommends that its acolytes either start their own business or shut up. Despite my own dissatisfaction with much of the blather that comes out of economics departments, I think this is a bit harsh.

Yes, the assumptions of neoclassical economics (perfect rationality, utter omniscience, spectacular self-centredness) are daft. Yes, the field is over-mathematised, divorced from empiricism, and distant from reality. But economics remains, as the great Alfred Marshall defined it, “the study of mankind in the ordinary business of life.” What else can be as important? Its failures should spur us to do better, not to ignore it completely.



Remember, despite the predictive failures of monetarism, the theological nature of real business-cycle theory, the empirical irrelevance of CAPM, and the misplaced optimism of efficient market theory, we actually do know a great deal about how the economy functions. For example, all agree that reducing transportation costs will increase trade, that asymmetrical information favours the seller and the borrower as opposed to the buyer and the lender, and that raising interest rates will tend to slow the economy, strengthen the currency, increase unemployment, and lower asset prices. These are not trivial insights.

William Stanley Jevons, one of the founders of marginalism and so a father of the dominant neoclassical economics, said that he wanted to explain economics through mathematics, the language in which God had written it. This desire is misguided and perhaps has steered economics on the wrong path for the past century.  Our understanding of the economy is more like a cookbook, or perhaps a collection of aphorisms. Economics does need to abandon its fixation on microfoundations and mathematics, and instead to incorporate insights from history, from sociology, from psychology.

Luke Johnson is right to stress the importance of the entrepreneur, but our understanding of how the world works deserves better than anecdotes by triumphant businessmen or abstruse equations based on free-market theology. A certain humility on the part of economists is warranted; that said, we would be fools to toss the insights of economics into the trash heap.