In 2002, Nobel Laureate Ronald Coase delivered a lecture at the University of Missourie titled “Why Economics Will Change”, wherein he famously said, “it is a striking – and for that matter depressing – feature of economics that it has such a static character. It is still the subject that Adam Smith created.” Coase’s central argument was simple: unlike disciplines of natural sciences such as Physics, Chemistry and Biology, Economics hasn’t changed much. There exists a serious disconnect between abstract economic theory, and real world experiences, simply because over centuries, economists have been obsessed with formalising Adam Smith’s proposition of an invisible hand – at the most redefining its contours and expanding its realm, but sticking to its basic tenets.
The essentials of the subject – demand and supply, utility and profit maximization, marginal costs/marginal revenues – have remained the same.Having studied, fortunately or unfortunately, Economics as my discipline, coupled with my experiences in both the financial sector and now in the civil service, I cite five reasons why Economics not just will change, but must change, followed by why I think it’s already changing, for the better. First, the obsession with Mathematics must go. Economists have often sought to compete with physicists in mathematical rigour and have turned the discipline into a relentless pursuit of mathematical formalism. At the LSE, I recall learning how to express “there is no such thing as a free lunch” as an equation!
The incessant flow of calculus makes it almost impossible to reflect on how those equations translate into the real world. While mathematics often helps in thinking about problems, and in achieving greater analytical and structural clarity, economics is about people, and thus, despite enjoying similar elegance of mathematical models and deductions, it is not physics. It is about complex human interactions that affect the prosperity of a nation and quality of life of its citizens. The problem gets compounded when such models rely on overarching and highly simplistic assumptions and ideal conditions of ceteris paribus.
Second, Economics suffers from an unenviable track record when it comes to addressing the grave economic problems of our times, especially poverty, unemployment and inequality, precisely due to the want of practical applicability of its esoteric theorems. That the insights offered by Economics can be utilized for making an impact on humanity’s ongoing struggle for securing dignity and prosperity draws many to the discipline, and that’s where the disenchantment starts setting in. Approaching the subject as merely a means of thinking, and treating it simply as a “box of tools” without a concrete subject matter, coupled with a lack of interest in doing serious applications-based empirical work, has led to abstract economic theory painfully in disconnect with the real world.
The profession took a serious beating when it failed as a collective to envisage, let alone predict, the financial crisis of 2008, much to the dismay of none other than the Queen! Unsurprisingly, some public surveys rank economists among the leasttrusted professionals. Third, the famed Washington Consensus for long has enjoyed a virtual monopoly over providing the “right” prescriptions for economic growth and development. The essence of the consensus – expanding the role of the market forces and constraining the role of the State – has been considered sacrosanct. However, has this countered the charge levelled against the socialist regimes, that it hadn’t made the poor rich, but had made the rich poor in the name of redistributive justice?
Or will it get stuck with a new charge: that it makes rich richer and poor poorer? There are genuine scepticisms about whether or not economic reforms also benefit the base of the pyramid. While GDP growth makes good headlines, it must transform the lives of people. As a scholar strikingly describes, “benefits of reforms for most seem like what the revolution was for many sceptical leftists: it was always coming and never arriving.” Economists have also underestimated the curse of inequality. From Joseph Stiglitz to Thomas Piketty, there is no dearth of compelling evidence that inequality is increasing. It is in this that the geneses of slogans such as “development with justice” and “reforms with a human face”, which reverberate in Indian politics today, can be traced.
These critical questions demand unambiguous answers, which economics must provide. Fourth, economists stand artificially divided into two antagonistic schools of thought: the Keynesians who focused on the role of aggregate demand in determining economic output, and advocated an active role for the Government and a strong fiscal policy versus the Chicago School, or the monetarists, who focused on the role of money supply, and favoured unhindered economic liberalism and free markets. This “freshwater- saltwater distinction” – freshwater for the University of Chicago, and saltwater for the Keynesians, who were notably based at coastal universities in the US such as Harvard, MIT and Yale – driven by strong ideological moorings, has greatly hindered holistic policy prescriptions for complex economic problems of the modern age, which should rely both on fiscal and monetary policy.
Thankfully, the freshwater-saltwater distinction is becoming increasingly antiquated, as the two schools have incorporated ideas from each other in recent times. New Keynesian economics, for example, has gone ahead to incorporate the insight of rational expectations, without compromising on the traditional Keynesian focus on imperfect competition and sticky wages. Finally, the greatest strength of economics was its supposed ability to inform and shape policy making. However, the credibility quotient is so low on this front that Nobel Laureate Joseph Stiglitz once infamously said: “the World Bank and the IMF are full of third-rate economists from firstrate universities”.
From viewing inequality as a social good that incentivises people to work harder, envisaging the financial sector as an efficient black box that magically turns savings into investment, imagining tax cuts for the wealthy as the magic potion for economic growth, and idolizing trickle-down market-led economics as the cure for poverty, economists have faltered far too often while delivering informed policies for bettering human lives. The search for the holy grail of the equilibrium condition, while underestimating the salience of transitions, tipping points and multiple-equilibria scenarios, has proved to be the discipline’s greatest undoing. Economics, thankfully, has already started changing.
The reason why Abhijit Banerjee and Esther Duflo’s work is considered important is not because it is path-breaking, but because it finally brought to the forefront the immense power of rigorous empirical work and an experimental approach in shaping policy making. Economics doesn’t necessarily have to be all about grand problems and design and bringing microeconomics back into fashion in a macroeconomics- obsessed world will remain Banerjee’s lasting legacy. Similarly, the pioneering work done in the field of New Institutional Economics (NIE) offers possible solutions to the question of why different nations move on to different developmental trajectories.
Though an interdisciplinary science combining law, political science, sociology and organization theory, the roots of this new discipline is economics. While being strikingly different from neoclassical economics, NIE is an attempt to modify the former to incorporate within its framework the theory of institutions. Getting institutions, and not only prices, right is equally — perhaps more– important. Institutions, especially Governance, matters, as they help empower the vast masses through, e.g., well delivered education and health programmes, to participate in the expanding global prosperity, thus rendering it truly inclusive.
Economics, thus, must change, because the world can ill afford status quo. What Lord Keynes wrote in 1936 was true then too, but is even more relevant now: “The ideas of economists and political philosophers…are more powerful than is commonly understood…Practical men, who believe themselves exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
(The writer is an Indian Revenue Service officer of the 2014 batch. He studied Economics at the LSE and worked previously as an investment banker in London. The views expressed are personal)