Real Economics, Real Politics

Social Europe

politics, economy and employment & labour

by Leonardo Costa on 24 October 2016

‘Crash and learn: should we change the way we teach economics?’ is the title of the FT article which describes the growing student rebellion in Great Britain against the way economics has been taught in recent decades. Students criticize the unrealistic assumptions of neoclassical economics and its use and abuse of mathematics. They ask for a more pluralistic approach to economics. In a recent working paper, Paul Romer criticized what he calls Post Real Dynamic Stochastic General Equilibrium (DSGE) models used by neoclassical macroeconomists – New Keynesian and New Classical – as they attribute fluctuations in aggregate variables to imaginary causal forces. Times are changing in economics as a result of the 2008 crisis, and for the better. Economists are revisiting theories such as the financial instability hypothesis of Hyman Minsky. Some basic assumptions of neoclassical macroeconomics are being challenged (see the interview given by Olivier Blanchard to the IMF Survey in 2015). We can look at what is happening in the profession – the lively discussion, the changing views on how the economy works, the recovery of old theories, etc. – as something similar to what happened in the Italian Renaissance (Il Quattrocento), when artists revisited the classics (Greek and Roman) to criticize the contemporary art of their time and introduce innovations. In the present discussion on economics, a few economists are revisiting the classics (Adam Smith, David Ricardo, John Stuart Mill et al) to criticize contemporary neoclassical economics and

introduce their own innovations, paving the way for a new dominant approach in economics. For example, the assumption of unlimited consumer wants is behind the general scarcity of resources postulated by neoclassical economics. The general scarcity of resources leads neoclassical economists to focus their analysis on the efficient allocation of resources. Why are consumer wants unlimited? Because neoclassical theory says they are. Whereas for classical economists, production factors such as land (or the environment today) are scarce, but not all factors are scarce. The capital is reproducible. Moreover, consumer wants are not unlimited and there is a social surplus (profits and rents) or a part of production which is not necessary for the reproduction of the existing economic system. The existence of this surplus led classical economists to focus their analysis on its distribution between productive uses (investment) and unproductive uses (luxury consumption). Moreover, neoclassical economists assume that agents pursue a self-interest that is more or less identified with selfishness. However, agents’ self-interest was to Adam Smith limited by the moral principle of sympathy and by law enforcement. Smith’s sympathy is neither selfishness nor altruism. It implies the idea of the impartial spectator; it implies fair play, concern for other human beings, the desire to be loved, and a civilized society. History of economic thought teaches us to look at economic theory as relative, because the dominant economic theories or dominant economic paradigms change throughout history.

The call today then is for the construction of a new economic theoretical framework, more scientific, more plural, with competitive paradigms, abandoning the logical positivism, integrating the views of science of Popper, Kuhn and Lakatos. The call is to have an economic theoretical framework able to analyze the economy as it is, instead of an ideal perfect economy that does not exist. The call is for more realism in economics. The call is, in some way, to recover Aristotle in economic analysis, abandoning the most extreme Platonic ideals of perfection of neoclassical economics.

Of course, there are economists in the profession who do not feel comfortable with all these changes. They do not like competition or theoretical innovations. They prefer to deny reality and/or force it to be consistent with economic theory, rather than build better economic theory to better explain reality. This is There Is No Alternative (TINA) economics. TINA economics led many politicians in Europe to support the so-called expansionary austerity over the past eight years.

Reality shows every day that austerity causes recession instead of expansion, that it does not solve the trade imbalances of the Eurozone, leading the European Union into a dead end, causing the loss of millions of euros and, more critically, affecting the future of a whole generation of young Europeans. But TINA economics only cares about the government deficit and debt. For TINA economics, when reality is not consistent with theory, it is reality that must be constrained until it becomes consistent with the theory, not the other way around. Moreover, the European neoliberal political forces, which are neither new nor liberal, saw in the financial crisis the opportunity to reduce the size of the European welfare state (see here).

TINA economics is not really a scientific theory. It is the neoliberal agenda of the Washington Consensus making use of complex mathematical models as rhetoric to show a scientific appearance. It is Post Real Economics feeding Post Real Politics, with the latter forcing the implementation of Post Real Policies (the fiscal compact) under the supervision of Post Real Institutions (the Eurogroup).