Condivergence: Where did mainstream economics go wrong?

This article first appeared in Forum, The Edge Malaysia Weekly, on January 7, 2019 - January 13, 2019.
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If the economics paradigm that we have used so far is likely to be wrong, where did it go wrong? Specifically, when and how did it go wrong?

When I went to university, economics students had to undergo a course called The History of Economic Thought. This is no longer common in most university economic courses because the economic models used today contain self-evidently universal and timeless principles applicable everywhere. These models assumed that man was rational. They believed in positive economics, meaning that these models are value-free so that economic advice would be objective and politically neutral.

This is a complete con game because there is no such thing as totally objective economic advice. These models contain assumptions that are ideologically biased, except that we were asked to assume that these biases are self-evident truths. The fact that perfect information and markets do not exist is itself a bias, because the use of this assumption assumes you would prefer a perfect market. The question is: perfect or free for whom?

In a real world with huge inequality, free markets and perfect information is biased to those who are already endowed with better information and wealth. In the internet world, there is no natural equality as natural monopolies emerge, like in all large public services.

In the 1960s, the English philosopher of science, Stephen Toulmin (1922-2009), began to question whether “the river of modernity” would always carry us to a better and brighter future since the way science was unfolding seemed to open up more problems and dark issues that we were not equipped to solve. He began to ask what was it in the Modern paradigm that caused us to be blind to such clear and present dangers.

In a thorough review of Western intellectual history, he discovered that up the Renaissance period (14th to 17th century AD), European thinkers were holistic, practical, literary and humanistic. The dividing line between the Renaissance period and the Scientific Revolution is often put at the Thirty Year’s War (1618-1648 AD).

The war was one of the most destructive in history, as it was a religious battle between the Holy Roman Empire’s Catholic states (Spain, France and Italy) versus the Protestant states of Northern Europe — Holland, Prussia, Sweden and England. It ended with the 1648 Treaty of Westphalia, which confirmed the sovereignty of nation states and the separation of state and religion in the West. This basic framework has lasted to the present day.

The Scientific Age is often associated with the French mathematician Renee Descartes (1596-1650 AD) and the Italian astronomer Galileo (1564-1642 AD), both of whom began to express nature in elegant mathematical terms. This tradition reached its apogee at the time of Newton (1642-1726 AD) when he explained the laws of gravity. The beginning of the scientific method greatly helped the Industrial Revolution when mathematical science was applied to technological innovations in maritime and military power, such as navigation, map-making and, later, steam power. Competition within Europe drove innovation and global expansion, which eventually overwhelmed most of the rest of the world.

Toulmin noted that the Scientific Age differed from the Renaissance in four fundamental ways: from oral to written; from particular to universal; from local to general; and from timely to timeless.

First, the import of printing techniques from China in the century enabled ideas to be written down, so they could be debated with much more rigour than oral discussions that were at best qualitative. Second, the use of mathematics pushed thinking away from practical to theoretical, leaning towards general principles rather than particular cases or exceptions. Third, local thinking was always contextual, since diverse contexts lead to diverse ideas. But theory demanded abstract axioms, which then could be tested empirically. So, universal axioms that appeared self-evident became widely used. Fourth, these theories held conclusions that were timeless, so there was no need to study history or context. You could always apply these simple theories everywhere.

These theoretical ideas were very powerful and their simple elegance to explain nature were quickly adopted in social sciences, particularly economics. It was therefore no coincidence that modern economics was founded by Adam Smith’s Wealth of Nations in 1776, the exact year of American Independence and within a few years of the French Revolution. This was a period of idealism, in which even human affairs could be reduced to simple truths, such as equality, freedom, democracy and free trade.

But if you read Adam Smith carefully, it was a treatise for mercantilism, for Great Britain to dominate global trade because free trade was beneficial to the most efficient manufacturer, trader and military power. Indians were led to believe during British rule that India benefited from free trade but more recent history has suggested that the transfer of wealth to Britain and the destruction of indigenous textile and other industries impoverished colonial India.

The ideas embodied in British economic thinking were inherited and built on under Pax Americana, when the US emerged as the global power. Nobel laureate economist Paul Samuelson’s Foundation of Economic Analysis, published in 1947, established mathematics as the elegant explanation of an ideal economy, of course, with the American economy as the implicit model. But not every economy had America’s wealth and institutions.

This is not to say that economic theory has not become more and more diverse, delving deeper into many areas, such as behavioural psychology, climate change, technology, law, institutions and the like. Many young people got into economics because it is fashionable to understand how the economy worked, so that we can become experts and get involved in policy formulation and implementation.

But all theories are simply theories — they will become obsolete or discarded when their predictions proved wrong or there are events and occurrences that the theory cannot explain. The two most important events of the 21st century are the rise of China and the great financial crisis of 2007. Of course, the high priests of economics will say that with hindsight, these events can be explained in conventional economic terms. But it is also a fact that there is absolutely no theory behind quantitative easing. The central bankers simply printed money because the politicians refused to undertake the pain of fiscal adjustment. Similarly, the rise of China cannot be explained in simple model terms.

Similarly, economists have constructed their own silos — pockets of theory that have not borrowed new ideas and approaches from other areas of specialist thinking. It was never wrong to break a complex problem down to its component parts to study more deeply how the parts work, but it is a failure to put all the parts together to see if it all adds up.

Economics can no longer explain to the world if it ignores politics, science, demographics, climate change, social media and technology. The rise of protectionism, populism and social polarisation are political events that have some economic roots, but cannot be explained in simple economic models.

Time to get out of the box and into the real world. Time to think both in convergence and divergence terms simultaneously. This is the challenge of the new era and the New Year!...

Tan Sri Andrew Sheng writes on global issues from an Asian perspective

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