Debunking Economics Part 2

The minority which continues on to further academic training is taught the complicated techniques of neocla.s.sical economic a.n.a.lysis, with little to no discussion of whether these techniques are actually intellectually valid. The enormous critical literature is simply left out of advanced courses, while glaring logical shortcomings are glossed over with specious a.s.sumptions. However, most students accept these a.s.sumptions because their training leaves them both insufficiently literate and insufficiently numerate.

Modern-day economics students are insufficiently literate because economic education eschews the study of the history of economic thought. Even a pa.s.sing acquaintance with this literature exposes the reader to critical perspectives on conventional economic theory but students today receive no such exposure. They are insufficiently numerate because the material which establishes the intellectual weaknesses of economics is complex. Understanding this literature in its raw form requires an appreciation of some quite difficult areas of mathematics concepts which require up to two years of undergraduate mathematical training to understand.

Curiously, though economists like to intimidate other social scientists with the mathematical rigor of their discipline, most economists do not have this level of mathematical education.

Instead, most economists learn their mathematics by attending courses in mathematics given by other economists. The argument for this approach the partially sighted leading the partially sighted is that generalist mathematics courses don't teach the concepts needed to understand mathematical economics (or the economic version of statistics, known as econometrics). This is quite often true. However, this has the side effect that economics has produced its own peculiar versions of mathematics and statistics, and has persevered with mathematical methods which professional mathematicians have long ago transcended. This dated version of mathematics shields students from new developments in mathematics that, incidentally, undermine much of economic theory.

One example of this is the way economists have reacted to 'chaos theory' (discussed in Chapter 9). Most economists think that chaos theory has had little or no impact which is generally true in economics, but not at all true in most other sciences. This is partially because, to understand chaos theory, you have to understand an area of mathematics known as 'ordinary differential equations.'9 Yet this topic is taught in very few courses on mathematical economics and where it is taught, it is not covered in sufficient depth. Students may learn some of the basic techniques for handling what are known as 'second-order linear differential equations,' but chaos and complexity begin to manifest themselves only in 'third order nonlinear differential equations.'10 Economics students therefore graduate from master's and PhD programs with an uncritical and unjustified belief that the foundations of economic a.n.a.lysis are sound, no appreciation of the intellectual history of their discipline, and an approach to mathematics which hobbles both their critical understanding of economics, and their ability to appreciate the latest advances in mathematics and other sciences.

A minority of these ill-informed students themselves go on to be academic economists, and then repeat the process. Ignorance is perpetuated.

The attempt to conduct a critical dialogue within the profession of academic economics has therefore failed, not because neocla.s.sical economics has no flaws, but because figuratively speaking neocla.s.sical economists have no ears. As Bernanke's reaction shows, even the global financial crisis wasn't enough to make them listen.

So then, 'No More Mr Nice Guy.' If economists can't be trusted to follow the Queensberry Rules of intellectual debate, then we critics have to step out of the boxing ring and into the streets.

Does economics matter?

Economists have been justly criticized for failing to antic.i.p.ate the financial crisis, but if that had been their only failing, they would be no different to weather forecasters who failed to warn of a destructive storm. They could be at fault for failing to give the warning, but you couldn't blame them for the storm itself. Economics, on the other hand, has direct responsibility for the economic storm we are currently experiencing. This is not to say that capitalism is inherently stable far from it. But the beliefs and actions of economists made this economic crisis far worse than it would have been without their interventions.

First, the naive theories they developed, especially in finance, encouraged reckless behavior in finance by their ex-students. More than a generation of business students were unleashed on the world who believed or at least paid lip-service to the fallacies that finance markets always price financial a.s.sets correctly, and that debt was good.

Secondly, economists also developed many of the tools of the financial trade that Warren Buffett so aptly described as 'weapons of financial ma.s.s destruction.' Options pricing models, 'value at risk' formulas and the like were all based on neocla.s.sical economics, and many were developed by academic economists some of whom received the n.o.bel Prize in Economics for their inventions.

Thirdly, probably their greatest negative contribution to human history was that, as regulators, they allowed the excesses of the finance sector to go on for perhaps two decades longer than would have occurred without their 'rescues.'

Here, pride of place goes to the central bankers especially Alan Greenspan. In Chapter 12, I make the case that were it not for the extreme rescue efforts he initiated in 1987, the stock market crash of that year would have precipitated a serious recession, but one far milder than that we are now experiencing. Instead, that rescue and the many others in the crises that followed the Savings and Loans crisis, the Long Term Capital Management crisis, and finally the DotCom crisis encouraged the speculative excesses of Wall Street to continue. The ultimate result was the subprime crisis, the fallout from which was so big that a further rescue was impossible.

The key indicator here and the key reason that I and the others Bezemer identified as having predicted the crisis could tell that one was coming is the ratio of private debt to national income (known as GDP, which stands for 'gross domestic product'). Every time the US Fed (and its counterparts in the rest of the OECD) rescued the financial sector from its latest folly, that sector continued doing what it is best at: creating debt.

If the Fed hadn't intervened in 1987, this process of escalating debt would probably have ended there, and America would have begun the painful but necessary process of deleveraging from a debt-to-GDP level of 160 percent about 10 percent below the 175 percent level that precipitated the Great Depression and in a milieu of moderate inflation.

Instead, rescued by the Fed, the financial sector lived to lend another day, and went through the veritable nine lives of the cat before the excesses of the Subprime Bubble brought Wall Street to its knees. By then, however, the debt ratio had risen to almost 300 percent of GDP 1.7 times the 1930s level, and even 1.25 times the peak level of 235 percent of GDP achieved in 1932, when rampant deflation and plunging output drove the debt ratio higher even as Americans drastically reduced the nominal level of debt.

2.3 Private debt peaked at 1.7 times the 1930 level in 2009 By delaying the day of reckoning, neocla.s.sical economists thus turned what could have been a 'run of the mill' financial crisis and recession into possibly the greatest capitalism will ever experience. The jury won't be in on the scale of 'The Great Recession' for several decades, but I expect that history will judge it to be more severe than the Great Depression probably not in the depths of the downturn, but almost certainly in its duration and apparent intractability. It could not have got this bad without the a.s.sistance afforded by neocla.s.sical economics.

Revolt.

Bernanke's refusal to countenance that neocla.s.sical economics could be flawed is indicative of the profession as a whole. The vast majority of neocla.s.sical economists have sailed through the financial crisis and the Great Recession with their belief in neocla.s.sical economics intact. If left to their own devices, economists will continue teaching that the economy is fundamentally stable, despite the abounding evidence that they are wrong.

The public could still afford to ignore economics if the discipline had the ability to correct its own excesses. But it does not. Despite its record at forecasting, despite the evidence that economic theories are not consistent, and despite the Great Recession that they have no choice but to admit they failed to foresee, the intellectual discipline of economics shows no tendency to reform itself. Instead, unsound theories continue to be taught to students as if they were incontrovertible. Economics cannot be trusted to reform its own house. Therefore, just as politics is too important to leave to the politicians, economics is too important to leave to the economists. The revolt against neocla.s.sical economics has to go beyond the academic profession itself.

But it seems to make sense ...

One of the great difficulties in convincing believers that neocla.s.sical economics fundamentally misunderstands capitalism is that, at a superficial and individual level, it seems to make so much sense. This is one reason for the success of the plethora of books like The Undercover Economist (Harford 2005) and Freakonomics (Levitt and Dubner 2009) that apply economic thinking to everyday and individual issues: at an individual level, the basic economic concepts of utility-maximizing and profit-maximizing behavior seem sound.

As I explain later, there are flaws with these ideas even at the individual level, but by and large they have more than a grain of wisdom at this level. Since they seem to make sense of the personal dilemmas we face, it is fairly easy to believe that they make sense at the level of society as well.

The reason this does not follow is that most economic phenomena at the social level the level of markets and whole economies rather than individual consumers and producers are 'emergent phenomena': they occur because of our interactions with each other which neocla.s.sical economics cannot describe rather than because of our individual natures, which neocla.s.sical economics seems to describe rather well.

The concept of emergent properties is a complex one, and I don't expect you to accept this argument right away; but as it happens, neocla.s.sical economic theory provides an excellent example of an emergent phenomenon which I cover in Chapter 3 (and at the beginning of Chapter 10). Once you've read that, I think you'll understand why the fact that neocla.s.sical economics seems sensible at the individual level has no bearing on whether it can make sense of capitalism itself.

Sincerity is no defense.

Much well, pretty much all of what I have to say about neocla.s.sical economics will be offensive to neocla.s.sical economists.11 Since this edition is far more likely than its predecessor to actually be read by some neocla.s.sical economists, let me say now that I mean no personal offense. Pardon the cliche, but some of my best friends are neocla.s.sical economists, and I've never for a second doubted the sincerity of most neocla.s.sical economists. Though many in the public believe that neocla.s.sical economists say what they say for personal gain, or to curry favor with the powers that be, the vast majority of neocla.s.sical economists that I have met, or whose work I have read, are undoubtedly sincere in the belief that their work is intended to improve society as a whole, and not merely the situation of the powerful within it.

Unfortunately, as I learnt long ago, sincerity is no defense. A schoolteacher of mine put it this way in a discussion my cla.s.s was having about politics, when one student defended a particular politician with the statement 'Well, at least he's sincere!'

The cla.s.s nodded sagely: yes, whatever we individually thought of this politician, we all had to concede that he was sincere. Our teacher, who normally let cla.s.s discussions proceed unmonitored, suddenly piped up from the back of the room. 'Don't overrate sincerity,' he said. 'The most sincere person you'll ever meet is the maniac chasing you down the street with an ax, trying to chop your head off!'

I never did find out what personal experience led to that epiphany for Brother Gerard, but I've had many opportunities to reflect on its wisdom since: the most dangerous people on the planet are those who sincerely believe something that is false.

So while there is a ma.s.s of criticism of neocla.s.sical economics and of neocla.s.sical economists for believing in it I mean no offense to neocla.s.sical economists as people. But as would-be scientists, their beliefs should not be provably false, as most of neocla.s.sical economics is.

Debunking economics: a user's guide.

Who is this book for? Interest in economics as an intellectual pursuit for its own sake has waned significantly over the last thirty years, and I have often heard academic economists lament this fact especially since falling student enrollments have undermined their job security.

I am not at all amazed by this drop in interest: it is a predictable side effect of the very philosophy of life which neocla.s.sical economists espouse.12 They have told all and sundry that the world would be a better place if we all focused upon our own self-interest, and let the market take care of the common good. Why, then, is it surprising that students have swallowed this spiel, and decided to study subjects which more clearly lead to a well-paid job business management, human resources, computing, etc. rather than to study economics?

In its first incarnation in 2000, this book was directed at this audience, which economists once derided, and whose absence they now lament: people who are interested in 'the common good.' Its message, that the economic mantra ('individuals should pursue their own interests and leave society's overall interests to the market') is wrong, is not new. Many books have made the same point in the past. What is new about this book is that it makes that point using economic theory itself.

In this second edition, I have an additional audience in mind: the professional economist who is honest enough to consider that perhaps the failure of the economics profession at large to antic.i.p.ate the biggest economic event of the last seventy years could be due to deficiencies in the underlying theory itself. There will, I expect, be only a handful of such readers (and on current form, Ben Bernanke and Paul Krugman won't be among them), but if so they will be stunned at how much critical economic literature was omitted in their original education in economics. This book provides a compendium of that literature.13 I can guarantee that mainstream economists will hate the irreverent tone of this book. Nonetheless, I'd ask them to persevere with open but skeptical minds. I hope that exposure to the many published critiques of economics might explain to them why a theory which they accepted too uncritically was so manifestly unable to explain how a market economy actually behaves.

This book should also be useful to budding students of economics, in at least two ways. First, unless they are lucky enough to attend one of the few universities where pluralism rules, they are about to submit to an education in economics that is in reality an indoctrination. This book covers the issues which should form part of an education in economics, but which are omitted by the vast majority of textbooks.

Secondly, they should find that the explanations of economic theory in this book make it easier to pa.s.s exams in economics. I have found that one of the main barriers which new students face in learning economics sufficiently well to be able to pa.s.s exams in it is that they can't reconcile the theory with their own 'gut feelings' about economic issues. Once students realize that they should trust their gut feelings, and treat economic theory as irrelevant to the real economy, then suddenly it becomes much easier to pa.s.s exams. Just treat economics like a game of chess, play the games the exam questions require of you, and you'll pa.s.s easily (just don't mention the inconsistencies in the rules!).

If you are already a somewhat uncomfortable student of economics, but you lack confidence because you are surrounded by peers who can't understand your disquiet, then this book should allay your fears. Normally, the journey from troubled student to informed critic is a difficult and lonely one. I hope to make that journey far less difficult, and less lonely. I hope it also gives you the confidence to confront your teachers if, while an economic crisis continues to rage about them in the real world, they continue teaching theories that argue that such things can't happen.

Similarly, I hope that professional critical economists will find this book a useful introductory compendium to those many critiques of economic theory that are currently scattered through dozens of books and hundreds of journal articles. While the arguments are not presented with the rigor of those formal critiques, the book provides an accessible and understandable introduction to that important and neglected literature. The curious student can be told to use this book as a guide before delving into the more difficult, formal literature.

Because it explains and debunks economic theory from first principles, this book will also be of use to anyone whose career makes them reliant upon the advice of economists. Hopefully it will encourage such people to look more widely for advice in future.

What's in this book? This book has been primarily written for people who are inclined to be critical of economics, but who are intimidated by its apparently impressive intellectual a.r.s.enal. I start from the premise that, though you might be familiar with the conclusions of economic theory, you are unfamiliar with how those conclusions were derived. You therefore don't have to have studied economics previously to be able to read this book.

I have also eschewed the use of mathematical formulas.14 Though I frequently use mathematics in my own research, I'm well aware of the impact that mathematical symbols have on the intelligent lay reader (a Norwegian colleague calls it the MEGO effect: 'My Eyes Glaze Over.') Instead, where some mathematical concept is needed to understand a critique, I present it, as well as is possible, in verbal (and sometimes tabular) form.

Despite the absence of mathematics, this book will still require significant intellectual exertion by the reader. The arguments of economic theory are superficially appealing, as Veblen long ago observed. To understand why they are nonetheless flawed requires thought at a deeper level than just that of surface appearances. I have attempted to make both economic theory and the flaws behind it relatively easy to comprehend, but there will be times when the difficulty of the material defeats my abilities as an expositor.

This problem is amplified by the fact that this book is effectively two books in one.

First, it provides a detailed exposition of the conventional theory, and takes none of the short cuts followed by the vast majority of conventional economic texts. As I noted above, one reason why economic instruction takes short cuts is because the foundations of conventional economics are not only difficult to grasp, but also profoundly boring. Economics should be an exciting, stimulating intellectual challenge, but conventional economics almost goes out of its way to be mundane. Unfortunately, I have to explain conventional economics in detail in order to be able to discuss the critiques of this theory. There are thus sections of this book which are inherently tedious despite my attempts to lighten the discourse. This applies especially to the chapters on the neocla.s.sical theories of consumption (Chapter 3) and production (Chapter 4).

Secondly, this book provides a detailed debunking of conventional theory. This is, I hope, rather more interesting than conventional theory itself though nowhere near as interesting as an exposition of a truly relevant economics would be. But it is quite possible that the exposition of conventional theory which precedes each debunking may persuade you that the conventional economic argument makes sense. Your mind will therefore be tossed first one way and then the other, as you first grind through understanding the foundations of conventional economics, and then attempt to comprehend profound but subtle critiques of the superficially convincing conventional logic.

So, especially if you have never read a book on economic theory, you will undoubtedly find some sections very difficult. You may therefore find it easier to treat this book as a reference work, by reading Part 1 (Chapters 36) carefully, and then turning to the rest when you have some specific economic issue to explore. Alternatively, you can read the chapters in Parts 2 (Chapters 712) and 3 (Chapters 1318) before you attempt the earlier, foundation ones. This is possible because in these later chapters I 'cut economics some slack,' and accept concepts which have in fact been debunked in the earlier chapters. After you've considered the failings of economics in these more interesting applied areas, you could then turn to the flaws in its foundations.

Whichever way you approach it, this book will be a difficult read. But if you are currently a skeptic of economics, and you wish to develop a deeper understanding of why you should be skeptical, I believe the effort will be worth it.

Not left versus right but right versus wrong One possible interpretation of this book certainly one I expect to get from many economists is that it is just a left-wing diatribe against rational economics. This common response to intellectual criticism categorize it and then dismiss it out of hand is one of the great sources of weakness in economics, and indeed much political debate.

It is probably true that the majority of those who criticize conventional economic theory are closer to the left than the right end of the political spectrum though there are many profoundly right-wing critics of conventional economics. Only those occupying the middle of the political spectrum tend to espouse and implement conventional economics.

However, the critiques in this book are not based on politics, but on logic. No political position left, right or middle should be based on foundations which can easily be shown to be illogical. Yet much of conventional economic theory is illogical. Those who occupy the center stage of modern politics should find a firmer foundation for their politics than an illogical economic theory.

The same comment, of course, applies to those at the left-wing end of the political spectrum, who base their support for radical social change on conventional Marxian economics. As I argue in Chapter 17, conventional Marxism is as replete with logical errors as is neocla.s.sical economics, even though Marx himself provides a far better foundation for economic a.n.a.lysis than did Walras or Marshall.

Escher without the panache One thing which sets economics apart from other social sciences, and which makes it hard for non-economists to understand economics, is the extent to which its arguments are presented in the form of diagrams. Even leading economists, who develop their theories using mathematics, will often imagine their models in diagrammatic form.

These diagrams represent models which are supposed to be simplified but nonetheless accurate renditions of aspects of the real-world phenomena of production, distribution, exchange, consumption, and so on. When an economist talks of the economy behaving in a particular fashion, what he really means is that a model of the economy and normally a graphical model has those characteristics.

To learn economics, then, one has to learn how to read diagrams and interpret the models they represent. This applies to critics as much as believers, but the very act of learning the diagrams tends to separate one from the other. Most critical thinkers find the process tedious, and drop out of university courses in economics. Most of those who stay become seduced by the diagrams and models, to the point where they have a hard time distinguishing their models from reality.

The critical thinkers, who could not cope with the diagrammatic representation of economic reality, were fundamentally correct: economic reality cannot be shoehorned into diagrams. Consequently, these diagrams often contain outright fallacies, conveniently disguised by smooth but technically impossible lines and curves.

In other words, rather than being accurate renditions of the economy, the standard economic diagrams are rather like Escher drawings, in which the rules of perspective are used to render scenes which appear genuine but which are clearly impossible in the real, three-dimensional world.

Whereas Escher amused and inspired with his endless staircases, eternal waterfalls and the like, economists believe that their models give meaningful insights into the real world. But they could only do so if the Escher-like a.s.sumptions economists make could apply in reality if, metaphorically speaking, water could flow uphill. Since it cannot, economic models are dangerously misleading when used to determine real-world policy.

Obviously, therefore, I do not wish to encourage you to 'think diagrammatically,' since this mode of thought has helped to confuse economics rather than to inform it. However, to be able to understand where economics has gone wrong, you need to see what has led it astray. I have attempted to explain economic theory without diagrams, but it is still probable that to be able to fully comprehend the fallacies in neocla.s.sical economics, you will need to learn how to read diagrams though not, I hope, to believe them (see 'Where are the diagrams?').

Blow by blow In most chapters, I take a key facet of economics, and first state the theory as it is believed by its adherents. I then point out the flaws in this superficially appealing theory flaws that have been established by economists and, in most instances, published in economic journals. As I show, the effect of each flaw is normally to invalidate the theoretical point completely, yet in virtually every case, economics continues on as if the critique had never been made.

Economics is a moving target, and the outer edges of the theory sometimes bear little resemblance to what is taught at undergraduate level. Except in the case of macroeconomics, I concentrate upon the fare served up to undergraduates, rather than the rarefied extremities of new research mainly because this is the level at which most economists operate, but also because much of the work done at the theoretical 'cutting edge' takes as sound the foundations learnt during undergraduate days. However, for some topics notably macroeconomics the difference between undergraduate and postgraduate economics is so extreme that I cover both topics.

The Great Recession has resulted in a much-expanded treatment of macroeconomics, and also two new chapters that 'break the mold' of the rest of the book by being expositions of my own approach to economics.

Chapter by chapter The book commences with two introductory chapters which hopefully you have just read!: Chapter 1 ('Predicting the "unpredictable"') shows that the 'unpredictable' Great Recession was easily foreseeable almost a decade before it occurred.

Chapter 2 ('No more Mr Nice Guy') gives an overview of the book.

Part 1, 'Foundations,' considers issues which form part of a standard education in economics the theories of demand, supply, and income distribution and shows that these concepts have very rickety foundations. It has four chapters: Chapter 3 ('The calculus of hedonism') reveals that economics has failed to derive a coherent theory of consumer demand from its premise that people are no more than self-interested hedonists. As a result, economic theory can't justify a crucial and seemingly innocuous element of its a.n.a.lysis of markets that demand for a product will fall smoothly as its price rises. Far from being innocuous, this failure cripples neocla.s.sical theory, but neocla.s.sical economists have both ignored this failure, and responded to it in ways that make a mockery of their claims to being scientific.

Chapter 4 ('Size does matter') shows that the economic theory of 'the firm' is logically inconsistent. When the inconsistencies are removed, two of the central mantras of neocla.s.sical economics that 'price is set by supply and demand' and 'equating marginal cost and marginal revenue maximizes profits' are shown to be false. Economic theory also cannot distinguish between compet.i.tive firms and monopolies, despite its manifest preference for small compet.i.tive firms over large ones.

Chapter 5 ('The price of everything and the value of nothing') argues that the theory of supply is also flawed, because the conditions which are needed to make the theory work are unlikely to apply in practice. The concept of diminishing marginal returns, which is essential to the theory, is unlikely to apply in practice, 'supply curves' are likely to be flat, or even downward-sloping, and the dynamic nature of actual economies means that the neocla.s.sical rule for maximizing profit is even more incorrect than it was shown to be in the previous chapter.

Chapter 6 ('To each according to his contribution') looks at the theory of the labor market. The theory essentially argues that wages in a market economy reflect workers' contributions to production. Flaws in the underlying theory imply that wages are not in fact based on merit, and that measures which economists argue would reduce unemployment may in fact increase it.

Part 2, 'Complexities,' considers issues which should be part of an education in economics, but which are either omitted entirely or trivialized in standard economics degrees. It has five chapters: Chapter 7 ('The holy war over capital') complements Chapter 5 by showing that the theory of capital is logically inconsistent. Profit does not reflect capital's contribution to output, and changing the price of capital relative to labor may have 'perverse' impacts on demand for these 'factors of production.'

Chapter 8 ('There is madness in their method') examines methodology and finds that, contrary to what economists tell their students, a.s.sumptions do matter. What's more, the argument that they don't is actually a smokescreen for neocla.s.sical economists and especially journal editors, since they routinely reject papers that don't make the a.s.sumptions they insist upon.

Chapter 9 ('Let's do the Time Warp again') discusses the validity of applying static (timeless) a.n.a.lysis to economics when the economy is clearly dynamic itself. The chapter argues that static economic a.n.a.lysis is invalid when applied to a dynamic economy, so that economic policy derived from static economic reasoning is likely to harm rather than help an actual economy.

Chapter 10 ('Why they didn't see it coming') tracks the development of macroeconomics into its current sorry state, and argues that what has been derided as 'Keynesian' macroeconomics was in fact a travesty of Keynes's views. It explains the otherwise bizarre fact that the people who had the least inkling that a serious economic crisis was imminent in 2007 were the world's most respected economists, while only rebels and outsiders like myself raised the alarm.

Chapter 11 ('The price is not right') deals with the economic theory of a.s.set markets, known as the 'Efficient Markets Hypothesis'. It argues that the conditions needed to ensure what economists call market efficiency which include that investors have identical, accurate expectations of the future, and equal access to unlimited credit cannot possibly apply in the real world. Finance markets cannot be efficient, and finance and debt do affect the real economy.

Chapter 12 ('Misunderstanding the Great Depression and the Great Recession') returns to macroeconomics, and considers the dominant neocla.s.sical explanation of the Great Depression that it was all the fault of the Federal Reserve. The great irony of today's crisis is that the person most responsible for promoting this view is himself now chairman of the Federal Reserve.

Part 3, 'Alternatives,' considers alternative approaches to economics. It has six chapters: Chapter 13 ('Why I did see "It" coming') outlines Hyman Minsky's 'Financial Instability Hypothesis,' and my nonlinear and monetary models of it, which were the reason I antic.i.p.ated this crisis, and why I went public with my warnings in late 2005.

Chapter 14 ('A monetary model of capitalism') shows how a strictly monetary model of capitalism can be built remarkably simply, once all the factors that neocla.s.sical theory ignores are incorporated: time and disequilibrium, and the inst.i.tutional and social structure of capitalism.

Chapter 15 ('Why stock markets crash') presents four non-equilibrium approaches to the a.n.a.lysis of a.s.set markets, all of which indicate that finance destabilizes the real economy.

Chapter 16 ('Don't shoot me, I'm only the piano') examines the role of mathematics in economic theory. It argues that mathematics itself is not to blame for the state of economics today, but instead that bad and inappropriate mathematics by economists has resulted in them persisting with an inappropriate static equilibrium a.n.a.lysis of the economy. The dynamic, non-equilibrium social system that is a market economy should be a.n.a.lyzed with dynamic, non-equilibrium tools.

Chapter 17 ('Nothing to lose but their minds') dissects Marxian economics, arguing that this potential alternative to conventional economics is seriously flawed. However, much of the problem stems from an inadequate understanding of Marx by not just his critics, but also his alleged friends.

Finally, Chapter 18 ('There are alternatives') briefly presents several alternative schools in economics, and shows that viable if somewhat underdeveloped alternative ways to 'think economically' already exist.

There's even more on the Web This book does not begin and end with the chapters just mentioned. It is also intimately linked to one of my two websites, www.debunkingeconomics.com (my other website, www.debtdeflation.com, currently supports my blog on the financial crisis and ultimately will be the online companion to my next book, Finance and Economic Breakdown).

The website complements the book in several ways. First, sections of the argument have been placed on the Web. These are technically necessary, but somewhat tedious, and therefore could distract attention from key issues. These web entries are noted in the text with a comment like 'I've skipped explaining a concept called XX. Check the link More/XX if you want the full version,' which indicates both what has been placed on the Web, and where it is located.

Secondly, more lengthy discussion of some topics has been placed on the Web. For instance, the failure of the conventional theory of market demand means that alternative approaches must be developed. These, and additional critiques of conventional theory, are on the website and referred to under the heading 'But wait, there's more.' The locations of these additional discussions are given by comments like 'These and other issues are discussed on the Web. Follow the links to More/Hedonism.' These sections raise many issues which should be of interest to those critical of conventional economics.

Thirdly, while there are no mathematical formulas used in this book, the logic underlying many of the critiques is mathematical. The mathematically inclined reader can check the original logic by consulting the website. These links are indicated by a parenthetical statement such as '(follow the link Maths/Size/PC_eq_M for the maths).'

Fourthly, some related topics are not covered in the book. One obvious omission is the theory of international trade. The major reason for this omission is that, while sound critiques of international trade theory exist, what I regard as the most obvious and telling critique has not yet been formally developed (I outline this on the website at the link More/Trade, as well as discussing the formal critiques that have been published). Another reason is that the theory of international trade also depends on many basic concepts that are thoroughly debunked in this book.

Pa.s.sing judgment on modern economics This book can be thought of as a critical report card on economics at the beginning of the third millennium. Economic theory, as we know it today, was born in the late nineteenth century in the work of Jevons, Walras, Menger and (somewhat later) Marshall. I have a reasonably high regard for these founders of what has become mainstream economics. They were pioneers in a new way of thinking, and yet, in contrast to their modern disciples, they were often aware of possible limitations of the theory they were trying to construct. They expected their heirs to extend the boundaries of economic a.n.a.lysis, and they expected economics to develop from the precocious but hobbled child to which they gave birth into a vibrant and flexible adult.

Instead, economics today is ridden with internal inconsistencies: an economic model will start with some key proposition, and then contradict that proposition at a later stage. For example, the theory of consumer demand begins with the proposition that each consumer is unique, but then reaches a logical impa.s.se which it sidesteps by a.s.suming that all consumers are identical.

This raises an important general point about scientific theories. Any theory will have some starting point, which can be chosen in any of a number of ways. Newtonian physics, for example, began with the starting point that any object subject to a force (in a vacuum) will accelerate; Einsteinian physics began with the starting point that the speed of light (also in a vacuum) sets an absolute speed limit for any material object.

Clearly the starting point of a theory can be challenged, but the basis of such a critique is normally what we might term 'external consistency.' That is, since the theory is supposed to describe some objective reality, it must be possible to show significant consistency between the predictions of the theory and that objective reality.

Here the degree of proof often comes down to some statistical measure of accuracy. Using the example of physics again, it is obvious that, at the speeds which humans could impart to a physical body during the nineteenth century, the Newtonian vision was extremely accurate.

Internal consistency, on the other hand, requires that everything within the theory must legitimately follow from its starting point. Here, statistical accuracy is not good enough: the fit of the theory with the starting point from which it is derived must be exact. If a theory at some point requires a condition which contradicts its starting point, or any other aspect of itself, then the theory is internally inconsistent and therefore invalid. It is possible to criticize much of economics on the basis that 'reality isn't like that' and this is occasionally done in the subsequent chapters. However, in general I take two allegedly related aspects of economic theory the theory of individual consumption and the theory of the market demand curve, for example and show that to get from one to the other, a clearly contradictory condition must be imposed.

A theory cannot survive with such contradictions or rather, it should not. They are clear signals that something is fundamentally wrong with the starting position of the theory itself, and that real progress involves radically revising or even abandoning that starting point. Even some of the most committed economists have conceded that, if economics is to become less of a religion and more of a science, then the foundations of economics should be torn down and replaced. However, if left to its own devices, there is little doubt that the profession of academic economics would continue to build an apparently grand edifice upon rotten foundations.

The founding fathers of modern economics would, I expect, be surprised to find that a manner of thinking they thought would be transitional has instead become ossified as the only way one can do economics and be respectable. They would, I hope, be horrified to find that the limitations of economic theory have been soundly established, and that most 'respectable' economists nevertheless transgress these limits without conscience, and often without knowledge.

Respectability be d.a.m.ned. Like the populace watching the parade of the emperor, respectability has led us to kowtow to a monarch in fine cloth, when an unindoctrinated child can see that the emperor has no clothes. It's time to expose the nakedness of neocla.s.sical economics.

PART 1 | FOUNDATIONS.