Paul Krugman, winner of the 2008 Nobel prize for economics, gave his take on why mainstream economics has gone horribly wrong in an article Sunday’s New York Times magazine.
In broad terms he argues that free market economists got obsessed with beautiful mathematical models that bear little relation to messy reality. He also attacks the assumption that humans can be assumed to act rationally in economic settings. The article concludes:
“So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.”
This is a superficial critique. Few would assume financial markets are perfect. Keynesian economics itself has many flaws. There are many alternative ways to incorporate finance into economics besides his Keynesian approach.
To the key weaknesses of conventional economics – both free market and Keynesian – include the following:
* The overwhelming importance attached to the consumption side of the economy and relative neglect of production.
* A failure to understand the complex character of the link between the financial markets and the real economy.
* A naturalistic method: assuming that economics can be understood in broadly the same terms as natural science.
* Its ahistorical character. A failure to grasp the concrete circumstances in which economic factors emerge. For example, the assumption that contemporary financial crises can be understood in broadly the same terms as tulip mania in the Netherlands in the 17th century.