Naive Experts: Economists and the Real World

A review of Robert E. Prasch, How Markets Work: Supply, Demand, and the ‘Real World’ (Edward Elgar: Northhampton, MA, 2009).

It is considered something of a rude question, nevertheless I think it fair to ask why 90% of all economists missed the coming of the current disaster. One doesn’t wish to judge too harshly. After all, everyone makes mistakes, even scientists. And if economic science missed this one, it wouldn’t be fair to use such a mistake to call into question the whole science. None of us would wish to be judged by one mistake. Should we not extend the same courtesy to economic scientists?

The problem, however, is that the same 90% of all economists also missed the last crises, and the one before that as well, and before that, and so on. In fact, their record of being able to diagnose and treat economic problems is about zero. And their prescriptions always seem to be counterproductive: the recommendations to limit government always make it grow, their advice on limiting taxation always makes it more, their prescriptions on growing the economy only leads to the illusory growth of bubbles, etc. Put it this way: If your doctor had this same track record of diagnosing and treating disease, you’d be dead by now.

Obviously, there is some deep problem at the heart of economic science which prevents it from being a useful analytic or prescriptive tool. Let me suggest that the problem lies in the very name of that discipline, which is a new name, only about 100 years old. The study of economic systems is as old as Aristotle, but this study was always considered to be a branch of ethics, and the proper functioning of any economic system was believed to be dependent upon proper ethical arrangements. Adam Smith, for example, was himself a professor of Moral Theology. Through most of the 19th century, the science was known as political economy. As the name implies, an economic system was always viewed as something embedded within—and dependent upon—particular political and social institutions, and could not be studied apart from them. Further, political systems cannot be viewed apart from ethics. It was this connection with ethics that made the new “economists” uneasy. As one wag put it, they suffered from “physics envy,” and wanted to divorce their “science” from any moral considerations, making it solely a matter of pure calculation (as with the neoclassicals) or of pure deduction (the Austrians.) By the start of the 20th century, the term political economy disappeared from common usage and was replaced by the new “science” of economics, a “science” divorced from the moral world.

However, the elimination of ethics could only be accomplished by a ruthless reductionism: man was reduced to an “economic calculator” capable of acting only in self-interest, while all markets were reduced to a single model of supply and demand curves with a single, well-defined equilibrium points. The new homo oeconomicus was conceived as a pure individual with no natural ties and was no more than a collection of unfulfilled desires, always waiting for the entrepreneur to fill them up, while creating new wants. Thus, it is an economics designed for an alien race, built on markets of a single type. But are all men like this new creation, and are all markets like the one they modeled? In other words, does current economic theory bear any relationship to the real world?

These questions are at the heart of Robert Prasch’s book, How Markets Work: Supply, Demand, and the ‘Real World’. This book is comprised of nine brief lectures that challenge the market fundamentalism which has come to dominate the economics profession, whether of the Austrian or more mainstream neoclassical economists. Dr. Prasch first deals with property, contract law, and a theory of exchange, which is the proper place to begin any study of the markets. He concludes that, “[T]he social institution that we term ‘the market’ is a complex construction, based on an evolving system of rights, property law, and contract law,” all of which depend on the political and social environment. Hence,

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