What have we learned from the GFC?

Had the pleasure to listen to John Quiggin at yesterday's Australian Economics Society seminar on "What have we learned from the Global Financial Crisis?"

By we he meant the economics profession and policy makers.

The core of the talk was basically a quick - and very good - summary of his book Zombie Economics The thesis is that there is a group of economic ideas that emerged from the failure of Keynesian economics to deal with the crisis of the 1970s (oil shock stagflation) that refuse to die. Instead, despite evidence that should kill them once and for all, they continue to roam the planet like zombies.

He collectively refers to the set of ideas as "market liberalism". There are five core ideas that he dissects;

1. The idea that the period starting with the 1980s was a "great moderation" that would see the end of the business cycle.
2. The efficient market hypothesis, that you can't use historical data to predict asset price moves because the price already includes all the available information. That is financial markets are the best possible guide to the value of assets.
3. Dynamic Stochastic General Equilibrium modeling and the inherent assumption that the economy never deviates far from equilibrium.
4. Trickle down economics and the idea that a focus on efficiency will guarantee that everyone is ultimately better off, even if equity diverges.
5. Privatisation and the belief that all economic activity is better performed in the private sector - even natural monopolies.

After he explained all of these theories, why they should be dead and how they are still emerging, in his talk he went on to cover a few bits about the economic profession that didn't make the book - and that I'm not going to do justice to here. The first was that we need to factor more of the learning of behavioural economics into microeconomic theory - less homo econimus in the theory. The second was a twin recognition of the problem of assuming markets at or near equilibrium and of the need for policy to focus on risk management.

Both the book and the lecture concluded with three statements of what is needed in economics;
1. More on realism, less on rigor
2. More on equity, less on efficiency
3. More on humility, less on hubris

The ultimate question here is whether we are just seeing the need for a few "tweaks" in neo-classical economics or the need for a fundamental revolution.

This raises the question of exactly what is "neo-classical" economics?

I referred to a great paper by Arnsperger and Varoufakis on this in discussing digital economy policy. That listed the three axioms of neo-classicism as;

1. Methodological individualism.
2. Methodological instrumentalism.
3. Methodological equilibriation.

At heart Quiggin is really endorsing not just the need to walk away from market liberalism as a philosophy, but to revise these axioms.

I take a wide view that behavioural economics, institutional economics and complexity economics are all manifestations of a "realist" economics that confronts axioms 1 and 3 with the reality that the "preferences" that determine agent choices are socially constructed by the interaction with other agents - particularly so with network effects - and that as a consequence the "system" is not only never at equilibrium but is more likely than not to have multiple not singular equilibria.

The neo-classicists themselves will point to all the ways that they might piecewise incorporate elements of a widely defined institutionalism, an excellent article by Philip Mirowski showed how this attempt ultimately fails.

That article ended with a nice piece that reads;

To attempt to portray all history as the end result of purposive constrained maximization is to make the same error as was made by early biologists who touted Darwinian evolution proved that man was the peak of the evolutionary process. Biologists now teach that there is never a peak or a maximum in evolution, which is merely a process of incomplete adaptation to circumstances that are shifting, partly as a result of past adaptations. As Victor Goldberg has wrtitten in the context of his study of contracts, "the results stemming from the establishment of new institutions or modifications in existing ones are seldom known precisely and are often widely divergent from the original expectations."

As I noted Quiggin's "we" was both academics and policy makers. The challenge of convincing academics is hard enough, but at least they should understand the theory. The problem with policy makers is that they have started to incant market theory and competition policy without any understanding.

This was a point eloquently put by Evan Jones at last year's Contesting Markets Symposium..

I think I have covered it is some of the concepts I outlined in my first submission to the Convergence Review wherein I argued for a better view of "competition policy".

I think the simplest way to describe it is that Quiggin critiques Trickle Down theory, which argued that a focus on efficiency improves life for all. The way "efficiency" is now used it has become the policy objective itself. Market Liberalism as a theory said you don't need to worry about equity because efficiency improves everyone's lot, modern policy theory doesn't even get that far.

Novae Meridianae Demetae Dexter delenda est