The discipline of economics is possibly paying the price for its vaulting popularity, since the end of the Second World War. That popularity was crystallised when the Swedish Central Bank decided to award the Nobel Memorial Prize for Economics in 1969, confirming the pole position of Economics among all the social sciences.
The prize sort of formalised the equation of economics with that of other natural sciences, physics, chemistry and medicine. The Swedish Central Bank clearly said the prize was a recognition of the importance the subject had gained in making a difference to the progress of nations and therefore to peace.
Economists were getting extremely adept at applying the rigour of mathematical methods to real life problems. One of the neatest applications of this was Kenneth Arrow?s impossibility theorem in settling a debate on voter choice in addition to its obvious appeal to welfare economics.
As the subject expanded its scope, a generation of scholars got interested in applying the tools to analyse the movement of Wall Street. Simultaneously companies were also beginning to demand more long term detailed examination of their rivals and growth opportunities from the Wall Street investment banks.
Since the prospect also allowed for rich pickings, a large number of economists swung towards the financial sector, in the 1980s, a period that also coincided with the largest extended run of boom time in the stock markets.
That phase has been neatly captured by Charles D Ellis in the chapter on the use and abuse of research (The Partnership) in his history of the Goldman Sachs. In a telling sentence he talks of a period when the firm sent out highly favourable research reports to clients ?that informal internal e-mails proved were simultaneously being knocked as junk?. The investment bank later went on to pay damages; but so did others.
The junk reports were the product of the conflicting pulls of the interest segments in the bank, driven by the urge to land the best client and deals.
The point of all this is that the present hubris in the business cycle is a culmination of the typical excesses that characterise good times. Whether it is the South Sea Bubble of the 19th century or the Gold Rush shortly thereafter, these are driven by the same factors that drive sound investment ideas too?something that are loosely summed up as animal spirits. There is little evidence in the successive boom and bust that knowledge of economics drove the participants.
The present crisis of course owes its root to the belief among bankers that they could package sub-standard loans as much better products, willing to go on with the belief that the size of the global financial market would ensure the offerings would not clutter it up.
While this was surely facilitated by a set of economics, there are too many books that are being churned out to prove economics as a sort of voodoo science.
John Cassidy in How Markets Fail is one in that line. But unlike many of those, he has taken pains to explain the various theories that have held sway in economics in the last 70 years, to establish his point that free market principle has often won at the cost of more plausible theories.
Cassidy has a strong case in the way economics has come up short in dealing with the impact of climate change on how economic agents should pay for it. But that is not surprising as even other discipline including even climate science is only now beginning to unravel the complexity of the phenomena. Just as mercantilism and later colonialism came up in the textbook after the events occurred, so did a study of depression emerge after the 1930s. It is in fact only in the current phase that the practioners made bold to claim they could check the recurrence of the disaster. The problem in his analysis is that presentation of the results produced by the economists shorn of the assumptions under which they were made makes for an attractive read, but is less than accurate.
Overall Cassidy makes a strong case for giving the free market assumption a burial in favour of government or other interventions. That is something unlikely to be debated now.
