One intriguing subplot of the economic crisis is the failure of most economists to predict it. Here we have the most spectacular economic and financial crisis in decades — possibly since the Great Depression — and the one group that spends most of its waking hours analyzing the economy basically missed it. Oh, a few economists can legitimately claim some foresight. But they are a handful. Most were as surprised as the rest of us.
Why? This is a compelling question without, as yet, a compelling answer. Indeed, so far as I can tell, economists have not engaged in rigorous self-criticism to explain their lapse. Weve had some casual theories and some partisan recriminations: “Free-market ideology” is a standard scapegoat on the assumption that most economists are “free-market ideologues.” But that’s not true. In any case, the crisis surprised liberal and conservative economists, Republicans and Democrats alike. . . .
The crisis originated in financial markets the markets for stocks, bonds and many complex securities, and yet finance occupies a peripheral position in mainstream economics. It’s studied by a subset of economists, and financial markets — their ups, downs and side effects — are not considered big sources of economic expansions and slumps. Economists tend to focus directly on the spending of consumers, businesses and government. It was also widely assumed that deposit insurance and the existence of the Federal Reserve would prevent financial panics.
Well, if you de-emphasize financial markets and financial markets are decisive, you’re out to lunch. . . .
Overshadowing the misunderstanding of finance is a larger mistake: ignoring history. By and large, most economists dont care much about history. Introductory college textbooks spend little, if any, time exploring business cycles of the 19th century. The emphasis is on “principles of economics” the title of many basic texts, as if most endure forever. Economists focused on constructing elegant, mathematical models. “For years theorists held the intellectual high ground,” writes economic historian Barry Eichengreen of the University of California at Berkeley. They were “the high-prestige members of the profession.”
History is messy and constantly changing. . . . It flows from institutions, technologies, laws, cultural and religious values, governments, popular beliefs, and much more. Model-building and theorizing can sometimes simplify the real world in ways that provide insights. But often, the models assumptions depart so radically from reality that the conclusions become useless. Someone who studies history becomes humble in the face of the ceaseless changes and capricious mixing of motives.
I would add that this failure shows the limits of the “social sciences.” The scholarly study of human beings–psychology, sociology, anthropology, economics–likes to claim to be scientific, with economics with all of its mathematics supposedly the most scientific of all. But each of these fields puts forth multitudes of contrary explanations and contradictory theories, with hardly any agreement within the disciplines. They are supposedly empirical, but they miss what would seem to be obvious observations all the time, and their models keep failing to have predictive value. The social sciences are thus quite unlike the physical sciences. This is because human subjects, unlike chemicals and physical objects and other life forms, do not hold still. Human beings, with their freedom, volition, and spiritual complexity, resist reductionistic explanations. (Nothing against the social sciences, which have their value and their interesting observations, except to say that they have their limits.)
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