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Economic Science and Economic Reality

Last week, Rethinking Economics NL published an outstanding analysis of the state of economics education in the Netherlands today. It starts out by explaining how economics has gone from a science whose focus, domain and methods are defined or at least informed by its subject matter to a science whose subject matter is wholly defined by its method of analysis.

To see the difference, it may well be worth quoting the UvA webpage on the nature of economics: ‘Economists are specialised in analyzing trade-offs. At the heart of this field is the notion of scarcity of means (commodities, time) in relation to unlimited needs. This forces subjects to make choices as to how to use their means. ‘ So there you have it: economics is useful only in situations where trade-offs engendered by ‘a scarcity of means in relation to unlimited needs’ are the most essential determinant of an agent’s economic behavior as it shapes human institutions (such as markets).

This definition excludes many phenomena that lay people would consider of economic interest, crises prominent among them. After all, when you are in a crisis, unemployment soars and capital lies idle. So both capital and  labor time are abundant rather than scarce at such times. Of course one can rephrase this in terms of scarcity of aggregate demand and scarcity of jobs. Such a linguistic trick however, merely begs the question as to how such things could become scarce in the face of an abundant supply of labor, capital and money (created by quantitative easing) and abundant desire to consume.

Something other than scarcity is clearly gumming up the works. Economists that define their field along the lines quoted above, however, will never find out. Moreover, if they try to, they are engaging in extra-scientific speculation. After all, theories that distance themselves from the idea of trade-offs engendered by scarcity fall outside the realm of economics as the UvA (and the mainstream generally) defines it.  No wonder then that ‘the collective imagination of many bright people’ failed to predict the financial crisis or properly understand it. Economists’ definition of their subject matter forbids them to engage with the causes of crises and if they do engage with them, their tools make it impossible for them to make any leeway in their understanding (see also here). So, if you signed up for a study in economics hoping it would help you understand the pickle we have found ourselves in since 2008, you are very likely to be disappointed.

Interestingly enough, Rethinking Economics presents evidence that suggests economists are implicitly aware of the limited scope of their methods. Van Dalen et al (2015) have asked economists to rank both the qualities of the ideal academic economist and the ideal professional economist. The profiles that emerge could hardly be more different. Only 7% of economists for instance say that for the professional economist does not need profound knowledge of the (Dutch) economy. A whopping (and shocking) 34% of economists however, feels such knowledge is irrelevant for academics.

So it appears there is a wide rift between the skills required for professionals advising e.g. economic policies and those developing economic theory. Such a rift implies that economic theory is not developed to illuminate economic phenomena. For if it were, the academic economist would need to be knowledgeable about the economy.  ‘Nothing is as practical as a good theory’ the maxim goes. Economists, then, either deny this or they secretly believe their theories aren’t any good, but are afraid to admit it (hell, you are out of a job if you do – oops, there goes mine).

This explains why some economists voice the sentiment that ‘economics is very useful as a form of employment for economists’ (Galbraith). Phrased like this, economics is a mostly harmless waste of time and talent for nerds that otherwise would probably be more usefully employed. The harmless part only holds, however, if economists refrain from applying their tools to problems they are unsuitable for. Alternatively, they could add extensive disclaimers to their advice. (Something like: ‘Warning! This advice is based on mainstream economic theory. It is therefore only valid in situations of scarcity. Furthermore, many of the models used, assume that everyone is exactly the same. The chances that this analysis has any bearing on economic reality in times of crisis are therefore small to non-existent. Use at your own risk.’) Economists would also be harmless if policy makers refused to take over their advice on the grounds that it stems from ‘a caricature that’s so silly [they do not] want to get close to it’ (Meyer 2010).

In practice however,  economists do offer advice on unemployment, crises and what not and such advice is often accepted without question. A lot of this advice is not rooted in the inherent scarcity properties of the problem at hand. Instead, it unwittingly creates scarcity in effective demand while trying to remedy the scarcity of jobs. For instance, the response to the crisis is driving down wages, social security and government spending (austerity). Although the lower wages may increase labor demand, they hurt effective demand and thus profit and investment opportunities at the same time. Adding government austerity to the mix only exacerbates the situation. So lowering wages and engaging in austerity measures amounts to adding insult to injury for those least responsible for, but suffering most from, the financial crisis. The net macro-economic effect is quite ambiguous, though. Such measures, then, effectively amount to swapping one type of scarcity for another. Yet, if we take the whole economy into account, scarcity cannot actually be the root cause of the problem, let alone solve it.

For this, we need a different kind of economics (for instance, a Keynesian one). Economics is only a tool and tools have to be used with skill, precision and judgement. Physicians that dogmatically use the same tool no matter what the patient’s ailment is, will most likely kill the patient. Similarly, economists who define the scope of their field with reference to their tools, should not apply their expertise to economic phenomena that lie outside that scope. Economists that do, are positively dangerous.


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