Revolutionary fervour: Does economics need a rethink?

AS THE old joke goes, the questions in economics exams are the same every year; only the answers change. Just 40 years ago, the emergence of stagflation was prompting the monetarists to challenge the disciples of John Maynard Keynes, but after the crisis of 2008 the enthusiasm for Keynesian stimulus was discovered all over again.

In a new book* George Cooper, a fund manager, suggests that the economics profession is itself in a state of crisis. It needs the kind of shift in thinking that Copernicus brought to astronomy, or Charles Darwin to biology, Mr Cooper argues. He cites Thomas Kuhn?s theory of scientific revolutions. First, the existing models are proved wrong by the facts. Second, the experts try to adjust the theory to account for the anomalies, leading to ever-greater complexity. Third, a new theory is put forward that throws away the existing framework. Fourth, the theory is attacked by the experts as being incompatible with the existing model. Finally, younger, more open-minded scientists accept the new theory and it becomes the consensus.

Economics fits the pre-revolutionary template, he argues. It has fractured into many incompatible schools of thought. It has created complex models without noticeably improving the accuracy of its predictions. And many of those models ignore features of the real world.

Neoclassical models, for example, are built on the assumptions that individuals make their own decisions based on self-interest, that they seek to maximise their welfare and that the result is a stable system that tends to equilibrium. Yet as behavioural studies have shown, individuals are not always rational optimisers. Mr Cooper suggests that neoclassical economists treat evidence that humans are not rational as ?problematic, inexplicable and annoying?but also ignorable.?

Instead, he thinks people act as competitors, not maximisers. Usain Bolt does not always try to run the 100 metres in the fastest possible time; he just runs quickly enough to beat his rivals. Some luxury products known as Veblen goods do not obey the laws of supply and demand; as the price rises, demand goes up. That is because competitive humans like to display their social status with such goods. If people are competitors, Mr Cooper argues, it is highly unlikely that the economy will settle into equilibrium, since people will always be attempting to upset the status quo.

The logic of competition helps to explain, in his view, why there was so little economic growth before the Industrial Revolution. This lack of growth is a problem for those who believe that the West?s modern difficulties are caused by excessive government regulation and high taxes; the world before 1700 had minimal government and low taxes.

Before 1700, those in power had little interest in economic growth; they were concerned with maintaining their social position and were suspicious of any disruptive forces. The big change came with the arrival of constitutional liberalism in Britain after the Glorious Revolution of 1688 and in America after 1776. The demise of absolute monarchies allowed the forces of competition to have free rein.

All this leads to what Mr Cooper sees as his crucial insight, akin to William Harvey?s explanation of the circulation of the blood. In a pre-industrial economy, wealth flows up from the bottom of society to the top in the form of taxes and stays there. But in a democratic society, social mobility is more fluid, creating the incentive for capitalists to create wealth. At the same time, progressive taxation means that wealth flows back to the bottom and keeps the circulation flowing. This has been vital to capitalism?s success.

Today?s problems, according to Mr Cooper, are caused by the high debts built up by those lower down the social scale; debt transfers money from poor to rich. What is needed is thus an injection of money at the bottom of the pyramid, via fiscal stimulus, rather than ?quantitative easing?, which pushes up asset prices and benefits the rich.

Whether mainstream economists will take Mr Cooper?s ideas seriously is doubtful; his book has no formulae (and few statistics). Sceptics could also point out that the Asian experience does not suggest democracy is necessary for rapid economic growth. But for those with an open mind his criticisms of the economics profession, and suggestions for new ways forward, will be extremely welcome.

* ?Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a science? (Harriman House)