Economists love this statement: if we do A, then B will happen, which leads to C, and that means more jobs and a better economy. I am sure you have heard it in one form or another from presidents and prime ministers in their efforts to sound smart. Economics is a widely revered prediction tool indeed. The government relies on it heavily to predict the effects of tax cuts, new taxes, government spending, and even $700 Billion bailouts. With such prophetic powers you would think economics is the second coming of Nostradamus, or better yet, in the same vein as natural science. However, equipped with the latest and most sophisticated economic models and even more impressive technology, economists failed miserably in sensing the imminent arrival of the Global Financial Crisis in 2008, and they still appear to have no grip on it whatsoever. They have tried. Obama reassuring the public that the US government has taken action to create more jobs is a mainstay on the news and it is bordering on becoming embarrassing because of the lack of results. Despite its conspicuous ineffectiveness, Obama and virtually all world leaders still rely heavily on economics to solve problems of unemployment, poverty, and inequality
Alan Greenspan - Taking full credit for ups, blaming the 'business cycle' for downs
How many tries does economics need? Laissez Faire economics produced the Great Depression, then Keynsian economics was given a chance but ended up in the bewildering Stagflation of the seventies, then supply-side economics claimed to be the savior and set up the devastating stock market crash of the late nineties, then, recently, economic models based on consumption on credit sprang to life engendering a protracted and debilitating GFC that has yet to subside and may signal the beginning of the end of capitalism as we know it. And these are just the grand highlights of many failures of economics to provide a stable economy, one that does not swing capriciously into devastating recessions.
A common explanation for the failure of economic theory is that ‘corporate greed’ and its concomitant power over politics sabotage any attempts by policy makers to put restraining policies in place. It is easy to place the blame on corporate greed but it is as easy to forget that such greed was a result of the economic policies based on neoclassical economics, which claims that individual self-interest leads to global prosperity. If greed does undermine economic policy then it can be inferred that economics is self-destructive and that it acknowledges this fact or it could be that ‘corporate greed’ is just a scapegoat for the complete ineffectiveness of economics. Since economics assumes an intransigent stance of self-importance, it cannot be the former.
‘The business cycle’ has been another convenient way of explaining away the failings of economic theories. It is claimed that all economies go through ups and downs and that it is just natural. That could be true as a law of nature but economics certainly cannot explain it. Furthermore, if economics is and has been so certain about business cycles and so accommodating about it, then why have virtually all movements in economics promised prosperity once and for all and not prosperity for a while and misery for a while? The effects of the business cycle are not incorporated into a single economic theory that has been dominant so far. This underlines the fact that even economists are clueless about the outcomes of their own theories.
The history of application of economic theories to the society of easily forgiving and gullible humans is analogous to that of endless experiments conducted on lab rats until the desired result is eventually achieved. Yet, in this global-scale experiment with very high stakes, the desired result of happiness for all has been elusive after hundreds of years of experimentation and seems out of reach, at least with neoclassical economic theory as a vehicle. While in the mean time, the experiment subjects have been afflicted with fatal poverty, meaningless wars, a destruction of their environments, child labor, monotonous and meaningless work, and broken dreams.
The primary reason that neoclassical economics (what ‘economics’ refers to these days) fails to fulfill its promises of prosperity and happiness for all is that its assumptions about the real world are grossly incomplete and fatally simplistic, which leads to wayward predictions that have very little to do with the real world. One fundamental assumption is that humans are only self-interested. The second fundamental assumption is that humans make rational decisions at all times. These two assumptions form the backbone of neoclassical economic theory. These assumptions are then incorporated into Homo Economicus, or the economic man, and absolutely every economic transaction is deemed to have been conducted by economic man, the completely self-interested and rational individual.
The flaws in the neoclassical assumptions may not be apparent at first glance but when you imagine actual people to be completely self-interested and perfectly rational, the holes in these simple assumptions about human nature appear thick and fast. Humans are not only self-interested but they are also altruistic (a point that was greatly emphasized by Hutcheson, an eighteenth century Scottish philosopher who was ironically the teacher of Adam Smith, who, in turn, is considered the father of modern economics). Furthermore, humans are not perfectly rational when it comes to making decisions. They also base their decisions on emotion and intuition. In fact, it could even be said that almost every decision is a mixture of rational thought, emotions, and intuition, all with different influences depending on the circumstance.
Let us entertain an example just to clarify how the assumptions of economics can lead to an incorrect prediction of a common real-life economic transaction. Suppose John wanted to buy some apples and he went to the local market. Further suppose that there are only two vendors that sell the same kind of apples, the kind that John wants. The first vendor, Kim, sells her apples for $4 per kilo and the second vendor, Ali, sells his apples for $5 per kilo. Now, John, according to economics, would pick the apples for $4 per kilo as a rational economic man. But what if Kim and John hate each other? Most likely, John would not want go to Kim and would instead go to Ali and pick the $5 apples instead of the $4 ones. His willingness to sacrifice $1 for an emotion that he felt cannot be incorporated into economic theory at all.
Going back to the example, supposing that he doesn’t know Kim or Ali, what if Ali was displaying a large picture of his very sick daughter in a hospital bed and printed on the picture was a plea for help? There is a chance that John chooses the $5 apples even though economic theory would clearly predict that he would pick the cheaper apples. Here, the decision made by John would be at least partially altruistic, if not mostly. It would not have been a completely self-interested rational decision. Here again, economic theory goes haywire when humans show altruistic behavior, which is something we see quite often.
These are just simple examples that most people could probably easily relate to. Economics is capable of predicting some transactions, but it is not a reliable tool. It can only be correct when humans are being perfectly rational and completely self-interested but as we know, humans are seldom perfectly rational and they can also be altruistic. When it comes to more complex scenarios with the outcome dependent on millions of transactions or non-transactions, then the failure of economics can be really accentuated. What makes economics even less reliable in complex scenarios is the addition of more assumptions about human behavior.
Let us take an actual incidence as an example. I recently watched a video of US president Obama claiming this (based on advice from his economic advisors, of course): “Congress has just passed a measure where payroll taxes will be reduced, meaning there will be more money in the hands of consumers, who will go out an spend the money, and this will lead to more employment and a better economy.” Very much like the statement at the beginning of this article. Besides the usual assumptions that people are rational and self-interested, there is also an added assumption that people will spend the extra money on consumer goods and services. Based on these assumptions, what follows is that when people spend money this way there will be greater demand and, subsequently, a need for greater supply, which is what creates the new jobs in the economy. Once again, the assumptions are too simplistic to work as intended in the real world.
Let’s say an American receives an extra $100 per month from the tax cuts. Now for Obama’s prediction to work, the individual would instantly go to the shop and do things like buy clothes, dine in restaurants, go to the dry cleaner, buy a few drinks, take a small vacation, and so on. If all Americans did that, there would be more jobs created. The flaw is clearly not in the logic. The logic is very sound indeed. The flaws, once again, are in the assumptions. This can be demonstrated by a very plausible scenario: the individual, instead of spending the money in the way just mentioned, spends it on an electricity bill or a phone bill that was overdue, and in the next month gives the money to his sister to pay her phone bill, and from the next month onwards decides to save it in order to emigrate to a different country because he does not expect to find a job in America soon enough. In this case, there is absolutely no new consumption, and therefore the individual does not directly contribute to the creation of a single job.
Let’s imagine another very common situation in the case of Obama’s tax cuts. Jodie, an American citizen, not being very rational, completely maxed out her $10,000 limit credit card before the recession hit and she is still very deep in debt. All she wants to do is pay off the credit card to relieve her constant stress and she has promised herself that she would never get another credit card again. Moreover, her full-time job has turned into a part-time position and she only earns half the money she used to. Her interest payments are completely out of hand and the amount she is left over after paying for basic things such as rent and food doesn’t even cover half her monthly interest payments. Now, it is easy to imagine that Jodie will put each dollar of the $100 she gets per month from the tax cuts as well as any other money she can save towards the monthly credit card payments. At the rate she is paying, it will take her a few years to pay off her credit card. From this scenario, it is obvious that a person like Jodie will not have any additional consumption for years in regards to the extra money she receives and will not contribute to the creation of any jobs.
As the two scenarios outlined above are commonplace in the real world, especially in America where people are debt-ridden, the economic policy to create jobs, would once again fail because of overly simplistic and flawed assumptions. And this, of course has happened uncountable times before when the government adopts a new economic policy.
In can be established from above that economics is a very unreliable tool to create policies for the world we live in. Even if economics did not exist, the world would not be any worse off. In fact, it would be better off because not only is economics responsible for numerous failed policies and waste of taxpayer money but it has also created greed, corruption, and moral degradation by giving vindication for complete self-interest. If policies are based on assumptions that people will be completely self-interested then that gives them the license to actually be that way. Economics, by claiming that competition is beneficial to mankind has created a world in which competition, and not cooperation, has become the norm. It is well known that competition only breeds envy, cynicism, prejudice, and hatred. Cooperation, on the other hand, would make people a lot more helpful, tolerant, caring, and friendly towards each other.
Neoclassical economics is directly responsible for the horrendous poverty in the world, the pervasive inequality, child labor, destruction of ecosystems and the environment, eradication of thousands of species, meaningless specialized jobs that give people no satisfaction or fulfillment, and millions of broken promises of happiness for people who chased after money.
It is claimed that economics is responsible for great developments such as medicine and technology but what is ignored in that claim is that great scientific breakthroughs came before the advent of neoclassical economics and its offspring, capitalism, and they were already beginning to change lives. Most scientists and pioneers who were responsible for world-changing inventions and discoveries were not motivated by money but rather by a drive to achieve something great or to change the world for the better. It is time to snap out of the illusion that economics is useful and even beneficial to the development of the world, it simply is not.
Ancient Greece ran a great and prosperous civilization without economics and we still look up to and admire what it has left behind. Great thinkers and administrators who lived at the time, such as Xenophon, Plato, and Aristotle, were critical of commercial activity because they believed that the creation of wealth from commercial activity was unnatural. Aristotle thought that only land created natural wealth, in the form of food and other material. Furthermore, he thought that in order to live a good life one must live a life of limited wants and be virtuous.
The administrative policies that were adopted by the city-states of Greece were based on the advice of sophists and philosophers such as those mentioned above, as they were advisors and teachers to the king and these policies were grounded on ethics instead of economics. In fact, the first traces of policymaking based on economic theory only emerged during the mercantilist era in the seventeenth century. In 1668, a bill was introduced into the Parliament of England to lower the maximum rate of interest to 4 percent on the advice of a merchant, Sir Josiah Child, because he believed that countries are ‘richer or poorer in exact proportion to what they pay, and have usually paid, for the interest of money’ (Backhouse, p.80). This marks one of the first instances of economics being used to set national policy. This theory, of course, would later be discredited on the basis that its assumptions were too simplistic and did not take into account the intricacies of the real world. This set into motion a continuous cycle of new policies based on new economic ideas being adopted and then abandoned because they did not work. And that incessant cycle still rolls in the twenty-first century with the same result. How many more centuries before we realize that economics is not reliable and has never been reliable and that it only leads to unwanted circumstances?
The field of ethics, I believe, should replace economics as the main source of policymaking. This change would help alleviate the poverty, inequality, violence, delusion, and frustration that engulfs the current world, which was created by the completely self-interested economic man. Only then, after illusions and barriers have been removed, will there be conditions for the attainment of true happiness for all.
(In the next article I will elaborate on why and how ethics should replace economics as a source of policy-making.)