Even setting aside Labour's gratuitous pantomime politics, I have found these days of budget debate frustrating. Arguments are being rehearsed and economists quoted without any regard to the nature of the social science that is economics or where various economists fit into the range of schools of economic thought.
I'll try to explain.
Why economists disagree
Economics is not like the natural sciences because individual people think, choose and act in a system of changing cooperative relationships. We are not inanimate objects buffetted by events, but people. It should be obvious that any study of economics - ie social cooperation - will be informed by a wide range of thinking about the nature of people and society.
Consequently, there are three prevailing theoretical frameworks in economics associated with three cities: Cambridge (Keynes), Chicago (Monetarist) and Vienna (Austrian). There are a few Marxists around too, with their cynical ideas polluting debate.
As I have put on record (1,2), there are real differences between these theoretical frameworks and these differences matter when it comes to public policy. Once you understand the basics of each framework, the political commentary falls into place.
I will spare you a detailed comparative analysis here. If you want it, please see this paper by my Cobden Centre colleagues, Dr Anthony J Evans and Toby Baxendale.
Instead, you may enjoy this brilliant video:
The simple fact is this: Labour politicians are promoting Keynesian ideas with an unwarranted confidence.
Why economists are so often wrong
In 1974, F A Hayek won a Nobel prize in economics for the business cycle theory that he developed with his mentor, Ludwig von Mises, who did not live to share it. He took the opportunity presented by his prize lecture to explain how the economic policies of the time contributed to the twin tragedies of inflation and unemployment. He also explained why economists are so often mistaken:
- Physical scientists can observe and measure the things that drive the sytems they are studying.
- Society, and therefore the economy, is not like a physical system: many of the most important factors cannot be seen or measured.
- Economists and other social scientists, in their attempt to be scientific, ignore what they cannot measure.
- Therefore, many of the most important factors affecting the economy are not considered, while some of those factors which can be measured are deliberately controlled.
- The results are incorrect predictions and policies which positively harm society.
The only function of economic forecasting is to make astrology look respectable.
Contrary to their good intentions, many economists, politicians and commentators are still advocating Keynesian policies which are bound to manufacture unemployment and inflation.
In the general interest of millions, those people must lose the war of ideas.
Where economic thinking goes next
As Kuhn set out, sometimes science makes progress through revolution. This article explains:
The fundamental paradigm, once established, is no longer tested or questioned, and all further research soon becomes minor applications of the paradigm, minor clearing up of loopholes or anomalies that still remain in the basic vision. For years, decades, or longer, scientific research becomes narrow, specialized, and always within the basic paradigmatic framework.
But then, gradually, more and more anomalies pile up; puzzles can no longer be solved by the paradigm. But the scientists do not give up the paradigm; quite the contrary, increasingly desperate attempts are made to modify the particulars of the basic theory so as to fit the unpleasant facts and to preserve the framework provided by the paradigm.
Only when anomalies pile up to such an extent that the paradigm itself is brought into question do we have a "crisis situation" in science. And even here, the paradigm is never simply discarded until it can be replaced by a new, competing paradigm which appears to close the loopholes and liquidate the anomalies.
Do you remember the cover of The Economist of 16 July 2009, which showed a textbook of modern economic theory melting away, and the article which asked, "What went wrong with economics"? The Financial Times asked "What is the point of economists?" on 28 July, 2009. The anomalies had piled up: no one had foreseen the global financial crisis.
Except, however, that a Nobel Prize had been awarded for foreseeing it in 1974. And Jesus Huerta de Soto forecast it, explained it and set out the necessary reforms in his 1998 Spanish-language book, "Money, Bank Credit and Economic Cycles", first published in English in 2006.
In the Foreword to the second English edition, Huerta de Soto writes:
I am happy to present the second English edition of Money, Bank Credit, and Economic Cycles. Its appearance is particularly timely, given that the severe financial crisis and resulting worldwide economic recession I have been forecasting, since the first edition of this book came out ten years ago, are now unleashing their fury.
You can read the rest of the Foreword here. I set out a brief explanation of the thesis in my maiden speech, which The Cobden Centre has annotated here.
A new orthodoxy is emerging in economic thinking. It recognizes that people are social and that social cooperation is dynamic. It recognizes that past assumptions about rationality and perfect markets are flawed. Above all, it it is optimistic about people and their creative energy.
It can explain the cause of the global economic crisis.
Let's move on.
Further reading
Jesse Norman MP sketched his view on the new economic orthodoxy in his maiden speech and you can find his book Compassionate Economics here. I thoroughly recommend them both.
For a light theoretical introduction, please see Eamonn Butler's Ludwig von Mises - a Primer (buy or download).
People with a deep theoretical interest may wish to see:
- Jesus Huerta de Soto, Money, Bank Credit and Economic Cycles (buy, download).
- F A Hayek, Prices and Production (buy, download).
- Roger Koppl’s Big Players and the Economic Theory of Expectations, which is well worth reading in its own right, but which sets out the new orthodoxy in an appendix.
- The Cobden Centre's literature, much of which can be downloaded.
Events
- 30 Jun 2010, book launch, IEA, Westminster: Kevin Dowd, Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System
- 9 Jul 2010, IEA lunchtime event: The crisis and the Austrian theory of the business cycle
- 22 July 2010, IEA evening seminar: Why today’s political class needs Ludwig von Mises
