Benefits of the Bust.

   Anatole Kaletsky, an editor of the Times of London, has a new book, Capitalism 4.0,                 

          and the Wall street Journal printed a brief excerpt on Jun 19^th.  He says that the one benefit of the current economic crisis is that it clearly showed that modern academic economics is nonsense. He begins with a joke:  An economist, a physicist, and a chemist are trapped on a desert island with a can of food but no can opener.  The physicist wants to focus sunlight to burn a hole in the can, the chemist wants to use saltwater to corrode a hole, and the economist says:  “You’re wasting time—let’s just assume a can opener.”

            This joke explains how modern economic theory’s use of unjustified and over-simplified assumptions allowed politicians and regulators to create an imaginary world of market fundamentalist ideology, in which financial stability is automatic, involuntary unemployment is impossible, and omniscient markets would solve all problems if government would stand aside.  Now that the house of cards built on this nonsense has come crashing down, the elegant theories are in well-deserved disrepute.

             The greatest embarrassment was not that none of the academics foresaw the crash—no economist from Smith to Keynes ever claimed to predict the future—but that when the crisis hit, they had no useful advice for what to do about it.  When the politicians and central bankers asked for guidance they were effectively told:  “You are on your own since the situation you have to deal with is impossible—our theories show it cannot exist.”   The problem is not that the elegant theories are incorrect mathematically, but that they assume conditions that seldom exist in the real world.  I’ve said this for thirty years.  And Galbraith was saying it clear back in the 1960s.

            In one of his many books, (I don’t recall which one) Galbraith complained that nearly every scholarly economic publication begins with the phrase:  “assuming normal free market conditions;”   and then the author goes on to build these elaborate  theoretical castles in the air, stacking one complex equation on top of another.  But if you complain that the author has failed establish that such conditions are likely to occur in the real world, they get defensive, and end up just explaining how great it would be--if such conditions did exist.  Galbraith points out that the economics profession has a very precise definition for “normal free market conditions.”    It means having enough buyers and enough sellers so that the removal of the largest seller or the largest buyer would have no measurable effect on supply or price.  So what percentage of your income is spent on such items?  In the 60s, Galbraith estimated it would not be over 15% max.  So why bother construct equations that have no application to most of the economy?