WHAT’S WRONG WITH ECONOMICS?

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 WHAT ’S
WRONG
WITH
ECONOMICS?
A PRIMER FOR THE PERPLEXED

R O B E RT S K I D E L S K Y
YALE UNIVERSIT Y PRESS
NEW HAVEN AND LONDON
iii
Copyright © 2020 Robert Skidelsky

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To students and teachers of economics

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 CONTENTS

List of Figures viii

Preface ix

Chapter 1 Why Methodology? 1

Chapter 2 The Basics: Wants and Means 15
Chapter 3 Economic Growth 30
Chapter 4 Equilibrium 49
Chapter 5 Models and Laws 60
Chapter 6 Economic Psychology 79
Chapter 7 Sociology and Economics 92
Chapter 8 Institutional Economics 110
Chapter 9 Economics and Power 119
Chapter 10 Why Study the History of Economic Thought? 137
Chapter 11 Economic History 149
Chapter 12 Ethics and Economics 161
Chapter 13 Retreat from Omniscience 181
Chapter 14 The Future of Economics 191

Notes 195
Bibliography 202
Index 214

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 FIGURES

Figure 1 Blind Monks Examining an Elephant by Itcho 7

Hanabusa, 1888.
Figure 2 Menger’s Hierarchy of Wants. 21
Figure 3 Competitive Equilibrium. 51
Figure 4 The Method of Modelling. 64
Figure 5 The Bosses of the Senate by Joseph Keppler, 1889, 132
first published in Puck. This version published by
the J. Ottmann Lith. Co.
Figure 6 The Miller Atlas of Brazil, 1519. 139
Figure 7 Raworth’s Doughnut. Redrawn with permission 179
from Kate Raworth.
Figure 8 Different Approaches to Understanding. 188

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 PREFACE

Many students want to study economics to learn how to make the

world better. They soon discover that studying economics is study-
ing what economists do. The question is whether what economists
do is fit for purpose. This book tries to address this question.
The question arises because of the complicity of mainstream
economics in much of what has gone wrong with economic life in
the last thirty years, starting with the dismantling of labour protec-
tions and proceeding, via the explosion of inequality, to the crash
of the global financial system in 2007–2008. Free competition was
‘set loose to run, like a huge untrained monster, its wayward course,
indifferent to the fate of humanity’.1 This quotation from Alfred
Marshall’s Principles of Economics is an apt depiction of what was
allowed to happen in our own times.
Anyone with a historical sense would have realised that the
hubristic attempt to make the world into a frontier- and culture-
free single market would end in tears. But to the dominant ten-
dency in economics, market-led globalisation has been a kind
of coming of age, when humankind, for the first time in history,
shed its irrational resistance to unlimited buying and selling. I was
led to ponder the state of mind of a profession which could offer
such a prospectus and call it progress. Moreover, I became con-
vinced that the tendency to ‘unleash the market’ was inherent
in economics from its earliest times: mainstream economics today
is largely a return to the roots. The more I thought about it the
more I became convinced that the cardinal fault of economics
lies not in specific doctrines, but the methods it uses to reach its
conclusions.

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 PREFACE

What I hope to provide is an insight into the mind of the econo-

mist, into a style of thinking about economic behaviour which is
characteristic of economists. I am not claiming that all economists
think like this. It is a ‘model’ which aims to explain salient features
of the way economists think. What I found in the mind of the
economist is a picture of the human being as a utility maximiser.
To economists, coherent purposes and reliable calculations of the
consequences of action are the magic keys which unlock the secrets
of human behaviour. This conception of homo economicus under-
pins their policy advice: individuals will respond to interventions
in a predictable way. The reason their advice is so often wrong is
that their picture of human motives is incomplete. Quite simply, it
leaves out all the motives for choice and action which fall outside
the calculus of behaviour they have set up. As a consequence it fails
to predict many outcomes accurately.
The main target of my attack is ‘neoclassical’ or ‘marginalist’ or
‘mainstream’ economics (I use the terms interchangeably) because
this has been so dominant in the textbooks and gives a distinctive
flavour to the way all economics is done today. I distinguish it from
‘classical’ economics which was a much broader church than its neo-
classical successor, both in its view of what social matter consists of
and in its view of how knowledge is attained. Neoclassical economics
narrowed the discipline considerably by claiming that only individu-
als really exist – organisations are simply constructions of individu-
als – and that their rationality makes their behaviour predictable.
I call this mainstream, because ever since Lionel Robbins defined the
neoclassical position in a famous essay of 1932, it has been dominant
in the profession. My own critical stance necessarily brings out the
weaknesses rather than strengths of this method: but in view of its
extravagant claims to knowledge, it is the weaknesses not strengths
which need exposing. The great strength of economics lies in its
power of generalisation; its weakness is to generalise from over-
simple premises. It is this flaw which will be the focus of my attack.
Neoclassical economics claims to be more like physics than any
other social science does, able to make ‘hard’ predictions. In its own
estimation, this gives it unique authority. To which one may reply:

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you can put on the uniform of a policeman but that does not give
you the authority of a policeman. The uniform of economics is very
impressive. It is replete with models, equations, regressions, statis-
tics: the claims to authority we associate with science, and whose
absence condemns studies like sociology and politics to the status
of inferior, in other words palpably non-authoritative, musings.
How has economics managed to pull off a feat of authority which
has eluded all the other social sciences? Because it is undoubtedly
the most influential of them, the discipline to which governments
and administrators pay greatest homage.
No small part of the answer, as we shall see, lies in the magic
of numbers. It is the ability to attach numbers to mathematical
symbols which gives economics its unique selling power. It enables
economists to make quantitative predictions. No other social sci-
ence counts and measures its material so energetically. Many
eminent economists have complained of the overuse of maths
in economics, but few have explained clearly that this overuse
is inherent in its restriction of economic behaviour to what can
be measured. No one would have much interest in mathematical
models of the economy unless they could be resolved into quanti-
ties of people and things.
As I tell it, mathematical language must be seen as part of the
art of persuasion, not of demonstration, because economists can-
not demonstrate the truth of what they are saying, only persuade
you to see the world as they do.
An easy, and to some extent valid, attack on the way I depict
neoclassical economics is to say that it is caricature. Some readers
may feel that I distort what goes on in the mind of the economist.
But it is the caricature which rules the textbooks. The method of
stating a hypothesis in a ‘silly’ form (Paul Krugman’s phrase) and
then ‘relaxing the assumptions’ to bring it into closer touch with
reality exerts a gravitational pull towards over-simple reasoning.
And it is the ‘toy’ models which often pass for gospel among finan-
cial journalists, business lobbyists, and politicians. Abstracting
from money in the toy model, and then adding it into the more
complicated model, is a good example of a method which failed to

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understand the crucial role of the financial system as ‘mover and

shaker’ in the events leading up to the crash of 2008. The toy mod-
els exclude the all-pervasive influence of power and uncertainty in
shaping outcomes.
Another criticism would be that my account ignores develop-
ments in the mainstream since the 1980s. The crash of the global
economy in 2008 was undoubtedly a shock, and it led to genuine
soul-searching. ‘Behavioural economics’ has been its main fruit
so far; and beside behavioural economics, there have been hun-
dreds of papers in the specialist journals explaining how cascades,
crashes, and fads can happen. All this is to be welcomed, if only as
a belated discovery of behaviours which have long been obvious to
non-economists. My criticism of these new approaches to realism
is that they start life crippled by the attempt to render them con-
sistent with a method which has as its root the contrary hypoth-
esis of rational calculation. Indeed, in these models, it is impossible
for people not to behave rationally (maximising, optimising) even
though the results may turn out to be far from what they expect. As
Nobel Laureate Thomas Sargent (b.1943), an inexhaustible source
of pithy summary of mainstream positions, puts it: ‘irrationality is a
special case of rationality’.
In my account of how economics is done, I have tried hard to
cite only the best in the field. Many of them are Nobel Laureates.
Equally, it is not out of the mouths of babes and sucklings that
the most incisive attacks on mainstream economics have come, but
from some of the finest minds in the history of economic thought.
This is in no way a textbook, but it refers to matter which is
found in textbooks. It is aimed at students of economics, and writ-
ten in a way intended to catch the interest of economists and non-
economists who wonder where economics is leading us. My aim
is to ask economists to interrogate their implicit premises and, by
bringing them into the light of day, consider how far they really
believe what their models assert. The language is as simple as I can
make it, but the ideas are complicated and often deep. The book is
based on the set of lectures which I was invited to deliver for the
Institute of New Economic Thinking in 2018, in London and New

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York. I have taken advantage of writing the book to repair omis-

sions from the much shorter lectures, and also to reconsider some
of the things I said, following comments and criticisms the lectures
received.
In what way am I qualified to talk about these matters? My first
degree was in history; my Ph.D was in politics. I was always inter-
ested in the economic aspects of history and politics, but when I
decided to write about the great economist John Maynard Keynes, I
quickly realised that it was not enough to have a nodding acquain-
tance with economics. So I studied the subject seriously, wrote three
volumes on Keynes, and ended up with a chair in political economy
in the economics department of Warwick University.
These personal facts have a bearing on what follows, in two
related ways. First, I come to economics with a strong histori-
cal bias – the bias, that is, to see economic doctrines in context.
Secondly, economics not being my first discipline, I came to it as
an outsider, setting myself to learn its methods, habits, and rituals,
rather like an anthropologist studying a tribe, or a migrant trying
to master the customs of his or her host community. I have looked
into the mind of the economist from the outside, and learned a lot
from it. But I speak the language of economics with an accent.
A word needs to be said about the relationship of this book to
‘heterodox economics’, which is also highly critical of the mainstream
approach. According to Geoffrey Hodgson, a leading heterodox
economist, what heterodox economics should aim to do is to estab-
lish a unified discipline which includes but transcends neoclassical
economics, so as to maintain what he calls the ‘cumulative advance’
in economic knowledge. I don’t think we are anywhere near a unified
discipline, or even that a new orthodoxy is desirable.
As I see it, the right development in economics would be towards
what John Kay has called a ‘horses for courses’ approach – that is,
one which relates economic theory to the different situations in
which it needs to be applied. In short, economics should abandon
the attempt to construct a set of universal laws applicable to all sit-
uations and problems. Specifically, it should abandon the attempt
to ‘microfound’ macroeconomics – in other words, to insist that

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all general outcomes need to be explained in terms of the rational

choices of isolated individuals. This leads, for example, to the absurd,
and inhumane, conclusion that mass unemployment is the sum of
individual choices to work less. I prefer the label ‘pluralism’ to ‘hetero-
doxy’. Pluralism involves explicitly taking into account the insights
of other disciplines. In addition to this, I am far from convinced that
there has been a ‘cumulative advance’ in economic knowledge of the
kind Professor Hodgson supposes. The main reason is that, unlike
in most natural sciences, there is no secure method of bringing any
generalising economic proposition to the test.
There are too many fine economists and schools of thought
outside the mainstream tradition to come even close to doing
them justice within this book: ecological economics, feminist eco-
nomics, econophysics, biophysical economics and modern mon-
etary theory is an incomplete list of doctrines that are mostly set
aside here. The only defence against their exclusion is that this
book is not intended as a summary of the alternative schools or
approaches. Excellent works in that vein include John T. Harvey’s
Contending Perspectives in Economics and Rethinking Economics:
An Introduction to Pluralist Economics, an edited volume produced
by members of the student movement Rethinking Economics.2
If the presentation of the book suggests that those outside the
mainstream have the status of mere dissidents to the dominant tra-
dition, that is entirely unintended. The focus of the book is on how
and why mainstream economics has come to be the way it is. In
light of its serious flaws, it might be tempting simply to dismiss the
mainstream out of hand and focus on the construction of alterna-
tives. But if we do not understand the roots of its dominance, we
leave ourselves poorly placed to dislodge it.
The authority of economics derives in no small measure from
its opacity. I want to insist, on the contrary, on the absolute need
for the core ideas in economics (and more generally in the social
sciences) to be transparent, essentially not to be buried in techni-
cal jargon. This is for two reasons. First, it is important that people
should understand what is being claimed about their own behav-
iour. The language of social theory should always be open enough

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to make possible an argument over interpretation between the

observer and the observed. Opacity is a way of disguising power.
Second, the disciplines must be able to talk to each other.
Specialised language is necessary, but is also a form of blindness
– blinding its users to anything being said outside their own the-
oretical enclaves. It is the classic form of exclusion. All the great
economists of the past tried to communicate their insights in
ordinary language: Alfred Marshall famously confined diagrams
to appendices. But today economists normally talk maths to each
other, and few bother to talk or listen to anyone else. In fact the
division of labour has gone even further: the subsets of economists
don’t talk to each other either; and the mainstream never talks to
the ‘heterodox’. This fault of over-specialisation applies to all the
social sciences. They hardly ever read each other’s literature, even
though the literatures deal with the same topics. But the fault of
economists is greater because their language is more impenetrable.
I am grateful to the Institute of New Economic Thinking for
making it possible for me to pursue my interest in reforming the
economics curriculum; and to the many students who encouraged
me on my way. I would also like to thank the following for reading
earlier versions of this manuscript: James Kenneth Galbraith, Rodion
Garshin, Anthony Giddens, Geoffrey Hodgson, Tony Lawson,
Vladimir Masch, and Edward Skidelsky. Their incisive comments on
the draft manuscript have greatly improved both the argument and
its presentation. It is perhaps even more necessary to affirm that the
faults are mine.
A special word of thanks goes to Sam Wheldon-Bayes, a recent
economics graduate, without whose help this book could not have
been written. Sam worked on the book with me for a year alto-
gether, and I owe important arguments and examples to him. Of
his own experience in studying economics at a British university
he writes:

Despite the battering it has taken since the 2008 financial crisis,
both externally and from dissenters within the ranks, economics
retains a privileged position in public life. Neoliberalism, the

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dominant public policy paradigm of our times is, in effect, the

view that essentially all social problems have economic solu-
tions: the market knows best.
Many economists might take issue with the claim that they
have so much influence, arguing that too few politicians pay
them sufficient heed. It is tempting, in the era of Trump and
Brexit, to go along with this view, since the rhetoric of both of
these so-called ‘populist revolts’ might cut against economists’
prescriptions of free trade. However, lurking behind both is a
strain of pro-business market fundamentalism that draws its
intellectual credibility almost entirely from a particular view of
economics, one that bears striking resemblance to the picture
of the subject offered by the standard curriculum: everything
will work out just fine, so long as the government keeps its
nose out.
Many professional economists have substantially more
nuanced views about the role of government in economies, and
argued forcefully against the election of Donald Trump, and in
particular against Britain’s proposed exit from the European
Union. This, however, raises the important question of what
we really mean when we talk of economics. Do we mean the
professional views and research output of economists in
academia, government, and the private sector? Or do we mean
the picture of the subject that students are taught in university
courses?
In other words, is it Econometrica or Economics 101, the
journal or the textbook? In few subjects is the gulf between
what students are taught and what researchers practise as wide
as it is in economics. It is quite possible for capable, hard-
working students to study economics for three years, receive an
excellent mark for their degree and still not really have the
faintest idea of what professional economists do. At that point,
they may go forth into the world and, quite reasonably, label
themselves economists.
So, the protestations that economics has reformed in the
years since the crash are not as convincing as they might be. It

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is not enough that unreadable articles in barely accessible jour-

nals have made some minor modifications to the way they do
things. The core of what the economics profession passes on to
the next generation, the undergraduate curriculum, remains
unchanged. One of the basic premises of academic study is that
each generation should be able to absorb the lessons of their
predecessors and build upon them. In economics, all too often,
the next generation must dismantle the intellectual walls the
previous generation has constructed for them before any
progress can be made.

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 1
WHY METHODOLOGY?

A man is not likely to be a good economist

if he is nothing else.
John Stuart Mill1

The need for economists to think about economics became appar-

ent after the global financial crisis of 2007–2008. Few economists
predicted the crash; more damningly, few envisaged the possibility
that such a collapse could occur, any more than the crash of an
algorithmic system. Students of economics asked: what is the point
of studying economics if it can’t tell you what is going on, or offer
policies to prevent bad things from happening? For what happened
was the worst economic crisis since the Second World War. Terms
to describe it go from the Lesser Depression to the Great Recession.
The roots of this failure do not lie with the incompetence or inat-
tention of individual economists, but deep within the way econom-
ics is done – its methodology. This may sound dry and boring, but
the methods of economists are key to understanding how and why
economics goes wrong. Neoclassical economics has developed a
peculiar method for studying the economy, and the use of any other
method is not regarded as economics. In other words, the subject
matter of economics is defined by the neoclassical method. Models
based on this method allow for only a limited range of possibili-
ties. Events which might occur outside this range are not picked up
on economists’ radar screens. Models which show financial markets
to be efficient – as most of them did – will not give you the col-
lapse of 2008. The spate of papers offering explanations of the crash

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 WHAT’S WRONG WITH ECONOMICS?

came after the crash. We now learn that, with a bit of uncertainty,
‘multiple equilibria’ can be ‘endogenously’ generated. But there was
no ‘uncertainty’ before the crash, only insurable risk. So, this book
aims to discover why the most influential discipline for making
public policy is so often cut off from reality.
Economists usually scorn the study of methodology. ‘Those
who can, do science’, said Paul Samuelson (1915–2009), ‘Those who
can’t, prattle on about methodology.’2 Frank Hahn (1925–2013)
similarly claimed, ‘I want to advise the young to avoid spending
too much time and thought on methodology. As for them learning
philosophy, what next?’3 In other words, these eminent economists
didn’t see the need for students of economics to think about what
they were doing. Their message was not how to think, but what to
think.
If economics were a natural science, this would be good advice.
Natural scientists don’t spend their time agonising about their
methodology. They believe, with good reason, that the methods
they have evolved for understanding physical matter are adequate
for discovering the truth. (In fact, reflections on method have
always intertwined with developments in physics from Descartes
to Einstein. But for all practical purposes, the methodology of the
natural sciences is fixed.) Most economists take the same line.
Their world is peopled with human robots and they aim to estab-
lish ‘laws’ about the behaviour of these machine-like creatures.
A complete set of laws is not yet to hand: but they will catch up with
the natural scientists in the end, perhaps after the neuroscientists
have completed their work on the brain. They are loathe to admit
that the material they study and try to understand does not behave
with the law-like regularity of natural phenomena. Humans are,
uniquely, inventive animals. They are aware of who they are, reflect
on their experiences, set themselves goals, relate to each other and
their environments in complicated ways, puzzle about the morality
of their actions, adapt creatively to new situations. By the exercise
of their minds and imaginations, they modify the future – their
own, and the world’s. Their games cannot be ‘sussed out’. The most
secure laws of economics are tendencies at best.

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 WHY METHOD OLO GY?

Open and closed systems

John Maynard Keynes (1883–1946), one of the greatest economists
of all time, pointed to the inescapable fact of uncertainty:

It is as though the fall of the apple to the ground depended on

the apple’s motives, on whether it is worthwhile falling to the
ground, and whether the ground wanted the apple to fall, and
on mistaken calculations on the part of the apple as to how far
it was from the centre of the earth.4

The implications of this statement are profound. Keynes is

saying that humans are not ‘programmed’ to behave like apples.
Humans are parts of complex systems, whose motions cannot be
explained by the causal laws on which natural science is built.
The difference between natural and human material can be
expressed by saying that a closed system is one in which ‘if X, then
Y’-type statements apply, whereas an open system is one in which
they don’t.5
True enough, there is a lot of variety in a closed system: in a
game of chess, there is a vast number of possible combinations.
But the variety is finite, and in time all optimal moves will have
been made. (Or so it seems: mathematicians claim that chess is so
complicated that potential optimal moves approach the infinite.)
The principle of limited variety is true of the physical world. If you
roll a fair die, there is a ¹⁄₆ chance of each outcome. This ‘truth’ does
not depend on how the die views the situation. But if you say that
a fall in interest rates by X will lead to an increase in investment of
Y amount you are converting an open system into a closed system.
Only if the rest of the economy is frozen by assumption or decree
would a change in X produce a predictable effect on Y.
What economics does is to convert open systems into closed
systems by excluding ‘moves’ which would render the system
unstable. Dictators ‘freeze the frame’ by order: economists do it by
‘modelling’. They model the world as a giant computer network in
which every possible move has been programmed, and anything

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 WHAT’S WRONG WITH ECONOMICS?

‘outside’ the frame excluded by assumption. We will have more

to say about the freezing technique in Chapters 4 and 5. But even
at this point one can assert that their claim to be able to predict
behaviour is greatly exaggerated. Apples do not choose whether
or not to fall to the ground, any more than a hurricane chooses
whether or not to happen every few years. They have no choice; the
task of science is to explain why they behave in the way they do,
not why they choose to do what they do. Economists are seduced
by the thought that, because humans are part of nature, their code
can be cracked just like that of physical objects. But even those
who hold out this hope admit that humans are uniquely compli-
cated. This makes social systems for all practical purposes almost
infinitely complex.
The method of freezing the frame, and including in it only mea-
surable moves, works well enough in the analysis of individual mar-
kets or firms in isolation. But it breaks down when applied to a whole
economy. This reminds us that economics has its roots in micro-
economics – the study of the logic of choice in a single market without
money. Money, the errant or wandering cause, which causes whole
economies to misfire, was added as a separate field of study. In the
standard textbook it is introduced in later chapters as a ‘complicat-
ing’ factor. Keynesian macroeconomics tried to take this complicat-
ing factor into account in explaining economy-wide malfunction.
More recently, economics has reverted back to microeconomics, with
macroeconomics squeezed out by assuming that money can be got to
behave in a non-disturbing way. Microeconomic theory can then be
‘scaled up’ to explain the behaviour of the whole economy. However,
the big questions of the macroeconomy – what causes prosperity or
depression, inflation or deflation, growth or stagnation – cannot be
satisfactorily answered with the tools of microeconomics.
The method of economics
The study of the methodology of economics is the study of the
methods which economists use to gain knowledge, rather than
a study of the knowledge they claim to have acquired. That is to
say, it is not primarily a study of economic doctrines. Rather, the

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 WHY METHOD OLO GY?

proliferation of economic doctrines testifies to the failure of the

established methods to generate knowledge, if by knowledge we
mean true belief. The methods which produce ‘laws’ in physics pro-
duce doctrines in economics. The hypotheses of economists are
largely untestable. In this they resemble religious beliefs. The ques-
tion is not whether economics can be made more like a natural sci-
ence, but whether different methods might enable it to improve its
understanding of human behaviour. The charge is not one of false
reasoning, but of reasoning from over-simple premises.
In today’s classroom, students are fed models: the better the uni-
versity, the more complete their drilling in the conventional mod-
els. The basic model is that of a perfectly competitive economy, in
which prices adjust the preferences of perfectly informed buyers
and sellers to each other. Students must be taught to learn such
models, not question them. The collapse of the financial system in
2008 took nearly all economists by surprise, because such collapses
were ‘outside’ their models.
Economic models are supposed to be closely related to the real
world: once mastered, the model offers reliable knowledge of ‘what
is going on’. But this relationship is not obvious. Economic models
are not like model aeroplanes, which are scaled-down versions of
a real aeroplane. It’s easy to see if you have a bad model aeroplane
– it looks nothing like the real thing. But economic models are not
miniaturised replicas of real things. They typically consist of logi-
cal deductions from axioms (truths treated as self-evident). How
do you know that your economic model has any relation to reality?
That the premises of the argument have not excluded parts of real-
ity important to understanding what might happen? A reply might
be that the model is a caricature which nevertheless contains the
essential features of the real thing. But a caricature is only identi-
fied as such because we have an actual face or body to compare it
with. Economists, like natural scientists, are committed to bringing
their caricatures ‘to the data’, and rejecting those which are discon-
firmed by the data. But I shall argue that no secure tests exist for
many models which claim authority. Economics’ inability to vali-
date its most important hypotheses empirically means that it has

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 WHAT’S WRONG WITH ECONOMICS?

a strong tendency to slide into ideology. The pretence to science

makes invisible the rhetorical character of much of its thinking.
Economists suffer from ‘physics envy’ because they believe that
their material – human beings – being rooted in nature, are only
more complicated versions of natural objects. Like the technolo-
gists, they believe that with enough data and computing power they
can ‘crack the code’ of human behaviour. This quest – and the envy
which inspires it – is misplaced. It drives economists further away
from the ‘real’ world of humans whose behaviour they are trying to
understand. They can get closer to the real world by making use of
the insights of painting, music, and literature, and, in the narrower
sphere of social science, by collaborating with other disciplines
like psychology, sociology, politics, and history. Such cooperation
will broaden economics’ view of what is important and true about
human life, without losing the sharpness of its particular angle of
vision. These studies ought to be part of the education of an econo-
mist because they suggest valid ways of seeing the world which lie
outside the frame of mainstream economics. The demand for plu-
ralism is not a demand for a new theory, but a demand for a wider
vision, from which new theories (plural) may emerge, applicable to
different parts of social life. The historian Eric Hobsbawm looked
forward to a terrain of enquiry on which history, economics, and
sociology could meet. Add psychology and politics and you have
the agenda of this book.
The value of pluralism can be illustrated by the ancient Indian
parable of six blind men trying to identify an elephant. One grabs
the trunk and thinks it is a snake. Another thinks its flank is a wall,
another the tail a rope, another feels an ear is a fan, another still
thinks the legs are tree trunks, and the last reckons the tusk to be
a spear. The point is that, blind, none can see the whole picture;
to do so they must collaborate, share what they have found from
their own vantage points, and piece together the elephant from
their combined insights. Economists must learn to listen: to those
in other disciplines, and to their own dissenters.
The other disciplines do not, of course, speak with single voices,
and it is greatly over-simplifying to talk of a ‘psychological’ or

6
 WHY METHOD OLO GY?

1. Blind Monks Examining an Elephant by Itcho Hanabusa, 1888.

‘sociological’ or ‘historical’ point of view. But they each shed a

distinctive light on the topic of human behaviour, which is my
justification for giving them separate chapters.
So what does the study of economic method involve? Most obvi-
ously, it involves philosophy – thinking about the conditions needed
for making true statements, and how far these conditions apply to
economic propositions. Almost entirely lacking from economics is
any explicit argument pertaining to its epistemological status – its
status as knowledge. Only a total disregard for philosophy enables
economics to claim that it is a positive science, immune from judg-
ments of value.
A key issue is whether logical deduction from tight assumptions
is the best way of ‘getting at the truth’ of the world or whether it is
better to pay more diligent attention to the facts even though this
might mean using a looser logic. As failure to foresee the crash of
2008 testifies, precision can be purchased at the expense of useful-
ness. For the purposes of policy, it is important to ask how far, and
in what areas, the propositions generated by current methods of
doing economics are sufficient pointers to good policy, and where

7
 WHAT’S WRONG WITH ECONOMICS?

they need to be complemented by understandings gleaned from

other ways of studying human behaviour.
Mainstream economics believes social phenomena are best
understood as the summed-up behaviour of individuals, an approach
known as methodological individualism. This method has two charac-
teristics: the only actors or agents recognised on the economists’ social
map are persons (this ‘realistically’ includes households and small
firms, but not organisations or classes), and individual choices and
decisions are independent, that is, specific to those making them. This
twofold claim enables economists to use a simple additive formula to
demonstrate that aggregate outcomes ‘are the result of an enormous
number of discretionary decisions by individual actors’.6 With the
further assumption that individual plans are, on average, fulfilled –
that is, there is no uncertainty – one can derive an aggregate number
simply by adding up the individual plans.
There are two huge flaws in the approach which represents indi-
vidual choices as parallel straight lines. The first is that explanations
in terms of individuals alone omit the relations between them, and
thus the social structure in which choices are made. Individuals are
part of ‘networks’ of choice. So aggregate outcomes of any kind are
the sum of individual choices plus the social structure. The second
flaw is summed up in the phrase ‘the fallacy of composition’. Even if
made independently, individual choices affect each other. We each
decide how much of our income to save. But an increase of $1 in
my saving does not increase total saving by $1, because it reduces
your income by $1, so if everyone else saves the same proportion of
income as before, the total of saving goes down not up. In the words
of songwriter Leonard Cohen, ‘You can add up the parts, you won’t
have the sum’. (For further discussion, see Chapter 7.)
For mainstream economists it is not enough simply to specify
individual persons as the sole choosing units. Their units choose
‘rationally’. They have coherent plans; act purposively to achieve
them; and calculate the most efficient means to get what they want.
Mainstream economics presents to us one human type – Economic
Man or homo economicus, the human calculating machine, con-
tinually calculating how to get the most (‘maximum’) gain he can

8
 WHY METHOD OLO GY?

for the least cost. This calculation is done in prices, everyone and
everything has a price.
These two methodological rules – the concentration on indi-
viduals, and their depiction as calculating machines pure and sim-
ple – are the clue to what goes wrong in mainstream economics.
Economists reduce social structures to economic transactions and
erect one aspect of human behaviour, calculation of costs (‘how
much will it cost me to do X rather than Y?’), into a universal law
of all human behaviour. They are in a quandary when you point to
motives for action like love, devotion, pity, courage, honour, loyalty,
ambition, public service, which on any reasonable interpretation
are not motivated by subjective calculation of gain or outcome. The
codes governing such behaviour may be ‘beyond price’, because it
would be felt shameful to break them. Economists have to say that
such motives appear to be irrational, but may be rational in situa-
tions of limited information. They are forced by the requirements
of their own reasoning to squeeze their explanations of human
behaviour into absurdly narrow channels.
This raises a hugely important question which will run through
this book. Is the unlovely creature homo economicus intended to be
a realistic description of a human, an ideal type, or simply a require-
ment of deductive theory? My own view is that, from the start, phys-
ics envy drove economists to think of the social world as a potentially
perfect machine. This induced them to model human behaviour to
fit the requirements of such a conception. Once economics became
formalised in the twentieth century, the requirements of ‘ideal’ mod-
elling started to dominate theory. Theories needed to be couched in
terms of isolated (deterministic) atoms to facilitate modelling. So, the
possibility that under conditions X the outcome could be any of a
range of outcomes could no longer be allowed. It could be prevented
by specifying that in any conditions X there is a unique optimum
Y, and that human beings (under the compulsion of ‘rationality’)
everywhere seek and find it. However, in the early phase of the dis-
cipline matters were not quite so clear; and the lack of clarity as to
whether economists’ depictions of human nature were intended to
be descriptive or prescriptive has bedevilled the discipline to this day.

9
 WHAT’S WRONG WITH ECONOMICS?

The crudeness of its own psychology cuts the economist’s pic-

ture of the individual off from any serious study of psychology.
Until quite recently, economists dismissed the findings of psy-
chology as of no use to them. ‘Economics’, wrote Lionel Robbins
(1898–1984), ‘is as little dependent on the truth of fashionable psy-
choanalysis as the multiplication table’; he waved away its main
rival, behavioural psychology, as ‘this queer cult’.7
Following the financial crisis, widely attributed to ‘irrational
exuberance’, economists have started to modify their views: behav-
ioural economics is the new vogue. As Andrew Lo says,

the crisis hardened a split among professional economists. On

one side of the divide were the free market economists, who
believe that we are all economically rational adults, governed by
the law of supply and demand. On the other side were the behav-
ioral economists, who believe that we are all irrational animals,
driven by fear and greed like so many other species of mammals.8

What is wrong with behavioural economics is that it dubs irra-

tional any behaviour which does not meet the neoclassical speci-
fication of rationality. It then tries to formalise that behaviour as
rational in the circumstances; for example, it is rational, when faced
with partial information, to ‘follow the crowd’. These concessions to
reality produce incoherence, not progress.
Treating the economy as the sum of individual choices leads to
one of economics’ greatest defects – its failure to understand the
nature of the social world. Economists typically see rational indi-
viduals choosing in isolation; as a result they have paid scant atten-
tion to the ‘sociology of knowledge’ – the part played by society
in structuring the knowledge on which individuals act. They typi-
cally treat social relations as irritating complications to the study
of individual choice, rather than as essential components of the
choosing process. Interactive behaviour can only be brought into
the maximising framework by modelling it as a strategic game, as
in the Prisoner’s Dilemma, in which actors calculate the value of
the payoffs from cheating or cooperating.

10
 WHY METHOD OLO GY?

Sociology is partly responsible for economists’ neglect of it. The

demand for sociology as a science of society may have weakened,
but there is also a problem with the supply. Contemporary soci-
ologists have, by and large, left the economy to the economists,
even though the economists’ image of a world in which the ‘invis-
ible hand’ of the market guarantees social stability is profoundly
opposed to the sociological standpoint. Sociology, writes Wolfgang
Streeck, must rediscover political economy.9
The choice between the individual and the social is not straight-
forward. One strong defence can be offered for methodologi-
cal individualism: it guards against treating individuals simply
as members of groups, deprived of agency. Its weakness is that it
ignores the architecture of choice. Our choices are affected by the
social positions we occupy, our place in society’s power structure,
our reflections on what is good and bad behaviour (‘morals’), and
our state of knowledge, and these choices in turn help restructure
the social world.
In mainstream economics, individual actions typically take
place through voluntary exchange in competitive markets, in
which, by definition, no transactor has power. This means that its
models are blind to the role of power in shaping economic rela-
tions: the mythical power of numbers replaces the actual power
of elites. The power imbalances between workers and bosses, the
influence of money on politics, the role of big business in shaping
beliefs and market behaviour – these are all ‘outside the model’. The
rational agents that economists assume we are would never allow
themselves to be bamboozled by advertising. Political science, the
science which deals with relations based on power, should be part
of the education of every economist, since power structures shape
the structure of choice. Karl Marx understood this better than any-
one, but his writings are outside the standard curriculum.
History offers students of economics another powerful tool to
understand the nature of economic life. All the disciplines have
their histories – the histories of how they were done in the past,
how they came to be what they are today. Like natural scientists,
economists like to claim that the science they do today – the

11
 WHAT’S WRONG WITH ECONOMICS?

economics of the latest textbooks – is better than the science of a

hundred years ago, or even ten years ago. Time, they say, has purged
economics of its mistakes.
However, students will discover that economic theory, far from
progressing like a giant tapeworm towards better knowledge, is rife
with interminable arguments. In the course of this history, no single
school has achieved unchallenged dominance. Classical and neo-
classical economics may be regarded as the main line of advance,
but there are many other schools of thought, including the German
Historical School, Marxism, Institutional Economics, Keynesian
economics, Behavioural Economics, Ecological Economics, and
many others. This pluralism is typical of the social sciences; but it is
rare in the natural sciences. It points to the extreme difficulty of fal-
sifying any theory in economics. After centuries of debate, there is
still no agreed theory of money. A study of the history of econom-
ics is an invitation to join in conversation with some of the greatest
dissenters in the field like Karl Marx and John Maynard Keynes.
Whatever doubts students may have about the way economics is
now done, they will not find themselves alone.
Just as striking as the violent attacks that have been made on
mainstream economics is the fact that its methodology has, by and
large, remained intact. This is because of economics’ undying aspi-
ration to be a hard science. There is an accepted, ‘professional’, way
of doing the subject which exerts a gravitational pull on the way it
is done.
Two eminent philosophers of science, Thomas Kuhn (1922–
1996) and Imre Lakatos (1922–1974), help explain the roots of
methodological persistence. They show that all established sciences
erect virtually impregnable methodological defences to safeguard
themselves from assault. (For further discussion, see Chapter 10.)
These defences include a considerable power of absorbing con-
tradictory thoughts. Economics soaks up heresies, which it turns,
where possible, into maths. Occasionally the defences crumble
altogether, not so much under the weight of disconfirming facts, as
from a changed view of the world. The two candidates for ‘paradigm
shifts’ in economics are the marginalist revolution of the 1870s and

12
 WHY METHOD OLO GY?

the Keynesian revolution of the 1930s. Of these, the marginalist

revolution has proved the most methodologically durable; its meth-
odological persistence, in fact, doomed the Keynesian attempt to
erect an alternative doctrine on neoclassical foundations.
The study of history proper is valuable, because it shows that
economic doctrines, far from being the universal truths they claim
to be, are connected to particular historical conditions and epi-
sodes. The conditions of time and place explain not just why they
arose when and where they did, but why some doctrines swam
while others sank. Influential social theories satisfy ‘needs’ which
arise from outside their own system of thought. Thus the protec-
tionist doctrines of the nineteenth-century German Historical
School answered the desire of late-comers to the capitalist feast to
‘catch up’ successful pioneers like Britain; Marxism tried to explain
the miserable conditions of factory workers in the early Industrial
Revolution; the Keynesian revolution offered a theoretical explana-
tion of the persisting unemployment of the interwar years; twen-
tieth-century development economics took up the argument that
free trade keeps poor countries permanently poor. Today we have
behavioural economics, feminist economics, and other branches.
In all cases, doctrines are partly intended to do political work. It
is important for students to get a sense of which period and place
they are living through, and the power relations of their societies
without swallowing the view that economic doctrines are ‘merely’
reflections of the historical conditions and power structures of the
day. If economics fails to give history its due weight as evidence,
historians are also guilty of self-absorption: with notable excep-
tions like Niall Ferguson and Harold James, they have simply failed
to engage with economic theory, leaving the field to the econome-
tricians.
Because economics is not a natural science, the ‘right’ or ‘wrong’
answer to an economic problem is as much ethical as positive.
Economics is the study of people who make ethical judgments: it
cannot simply be treated as a matter of good or bad logic or arith-
metic. Economists will tell you that moral questions are above their
pay grade – ‘a matter for politics’ – but this is only because they

13
 WHAT’S WRONG WITH ECONOMICS?

have defined their subject in a way that deliberately excludes them.

Yet economists’ values determine what they pay attention to, what
models they use, and what policies they prefer. Ethics can be used
to criticise method.
Except for philosophy (whose job is to sort out everyone else’s
mistakes) all the disciplines have their biases. Psychologists tend
to think of human behaviour as irrational; sociologists, to think of
humans as creatures of groups. Historians tend to see only relations
of power, and students of politics have traditionally followed their
lead. Economics offers a useful corrective to such slanted views.
But it also has much to learn from them. A well-known study
showed that broadly educated people had better judgment about
future economic possibilities than narrow experts.10 Curiosity may
have killed the cat but it leads to better forecasts.
John Maynard Keynes grasped the truth of this when he wrote
that:

The master-economist must possess a rare combination of gifts

. . . He must be mathematician, historian, statesman, philoso-
pher – in some degree. He must understand symbols and speak
in words. He must contemplate the particular in the light of the
general, and touch abstract and concrete in the same flight of
thought. He must study the present in the light of the past for
the purposes of the future. No part of man’s nature or institu-
tions must lie entirely outside his regard.11

An ideal, no doubt; nonetheless, worthy to be put before the mind

of students of economics.

14
 2
THE BASICS: WANTS AND MEANS

I ain’t ever satisfied.

Nat King Cole

Philosophy talks about ends and means. Economics talks about

wants and means. The difference is important. Ends to philoso-
phers are about what is good; to economists ‘ends’ are simply what
people want. What they mainly seem to want is money, or at least
what money can buy. By collapsing ends into wants, economics
cuts itself off from ethics – the study of what is good. It also cuts
itself off from an important part of reality – the fact that humans
have always struggled with moral choices. It also makes the prob-
lem of scarcity insoluble, as we shall see.
Economics was not always as ethically colour-blind as it is now.
Historically, there are two main definitions of the subject. The first
makes it the study of wealth; the second the study of choice. The
first dates from Adam Smith (1723–1790) who called his famous
1776 book An Inquiry into the Nature and Causes of the Wealth
of Nations. In discussing the nature of wealth, Smith set out to
controvert the ‘erroneous opinion’ that wealth consists of money
(gold and silver). Rather, he defined it as the ‘annual produce of
the land and labour of society’.1 Wealth arises from the production
and exchange of ‘useful’ things like provisions, houses, clothes, and
furniture. Wealth is a means to comfort.
Alfred Marshall (1842–1924), writing after a hundred years of
economic growth, opened up a broader vista when he wrote in
his Principles of Economics that economics was the science which

15
 WHAT’S WRONG WITH ECONOMICS?

studies the ‘material requisites of well-being’. Money, he said bluntly,

was a means to an end.2 But he did not define ‘well-being’; and his
notion of requisites is fuzzy. Well-being lends itself to the interpre-
tation of ‘feeling well’, which collapses all too readily into ‘feeling
happy’ – a sad constriction of philosophical usage. And how much
of ‘requisites’ are required for being or feeling well? Traditionally
requisites had to do with the physical upkeep or ‘provisioning’
of the species. People needed money to buy food and ‘comforts’.
But is the internet part of the provisioning? There is nothing very
material about it. Any gross national product (GNP) measure of
‘enoughness’ runs into this problem.
Nevertheless, the older definition in terms of wealth had three
advantages. It isolated for the purpose of study an extremely
important, if not at all times overriding, motive for action.
Secondly, it could measure the inputs and outputs of this activity
by quantity, and thus develop into a causal science. A third attrac-
tion was moral: there was a presumption that the pursuit of wealth
was more benign than other forms of striving, because, unlike the
quest for power, it was inherently cooperative. It could thus be con-
ceived as the benign, or peaceful, form of social competition. The
combination of these advantages go far to explain why economics
eventually established a policy primacy over the other social sci-
ences. Its propositions could be made more exact; and it was more
optimistic.
The view of economics as the study of the causes of wealth and
poverty was superseded by Lionel Robbins in 1932. In his book
The Nature and Significance of Economic Science, Robbins defined
economics as the science which ‘studies human behaviour as a rela-
tionship between ends and scarce means which have alternative
uses’. It was ‘the form [of behaviour] imposed by the influence of
scarcity’.3 Robbins made scarcity the central, and indeed only, topic
of economics, when he pointed out that it was not the materiality
but the scarcity of goods which made them ‘economic’. Every deci-
sion involving choice of means has an economic aspect. People’s
ends are various but ‘life is short, nature is niggardly’.4 Maximising
outputs was essentially a matter of economising inputs. There is

16
 THE BASICS: WANTS AND MEANS

no presumption that people will or should prefer material to non-

material goods; the task of economics is to point out the difference
between efficient and inefficient ways of getting whatever it is that
people want. Economics, that is, is indifferent about ends, but far
from indifferent about means.
The Robbins definition was the culmination of the shift from
‘political economy’ to ‘economics’ – from the idea of economics as
part of the wider study of society to that of a self-sufficient techni-
cal discipline. This went together with a shift from the view of an
economy ‘embedded’ in social institutions to that of a self-regulating
market of calculating individuals. In presenting economics as the
general science of rational choice, applicable to all objects of human
striving, Robbins staked the claim of economics to be the ‘master
social science’, able to penetrate the dark, hitherto un-theorised, cor-
ners of human behaviour with its language of mathematics. This
claim helped to sharpen economic thought, but there was a twofold
price to pay. The first lay in the assumption that all choices are com-
mensurate, that is, that they can be weighed on a common scale,
the scale being money. There are no ‘tragic choices’, only trade-offs.
The second was the elimination of history. The Robbins method
focuses attention on the efficient allocation of given resources at a
point in time. It ignores the question of most concern to the classi-
cal economists, which was how to explain the growth and stagnation
of resources over time. Since the 1960s, Robbins’s has been accepted
as the working definition of economics. Economics is about the
logic of choice. This logic is hard-wired into individuals because of
scarcity.
Of course, in saying that all choices have an economic aspect,
Robbins was not claiming that it was the only aspect. Many aspects
of human life lay outside economic calculation. However, there was
a ‘money-mindedness’ bias in the Robbins conception of rational-
ity, since money was the only standard against which the efficiency
of action might be judged. Almost by default the view developed
that only measurable choices were rational. Robbins’s efficiency
criterion thus opened the way to the economic analysis of non-
market institutions like law and marriage. A string of Nobel prizes

17
 WHAT’S WRONG WITH ECONOMICS?

rewarded the working out of this insight. The Chicago economist

Gary Becker (1930–2014) received this honour for his analysis of
the economics of marriage and crime and punishment. The equa-
tion of rational choice with efficiency, measured in money, is a
classic pars pro toto (a part taken for the whole) error – treating a
specific aspect of human behaviour as a proxy for human behav-
iour in general.
The contrast between the earlier and later definitions of eco-
nomics can be overdrawn. Robbins’s scarcity perspective was
implicit in classical discussions of economic growth. Wealth does
not fall like ripe fruit from a tree; it has to be worked for. Classical
economics was known, not unfairly, as the ‘dismal science’. This was
based on its two most famous ‘laws’: Malthus’s law that popula-
tion would inevitably outstrip food supply; and Ricardo’s law of
diminishing returns. Both ignored the cumulative impact of tech-
nological innovation. Classical economics also taught efficiency in
the use of time: not cashing all the fruits of one’s efforts today but
spacing their enjoyment over a lifetime. Marshall called it ‘waiting’,
economists today know it as ‘saving’.
Economists, it might be said, come to the feast of life like spoil-
sports to a party. They continually remind people of the need for
calculation and efficiency, for working hard and postponing satis-
faction. Even people plentifully supplied with ‘upkeep’ still have to
price their time. Since scarcity of time can never be overcome, the
day when efficiency will no longer be needed will never arrive. To
give the devil her due, economic reasoning is a useful antidote to
politicians who promise today what they know cannot be paid for
tomorrow.
Economists have typically believed that the most efficient
mechanism for achieving coordination of production and con-
sumption decisions is the ‘invisible hand’ of the market. To this
day, this insight remains the single most important contribution of
economics to the economy. Although economic choices are hard,
economic life need not be a zero-sum – winner take all – game. This
is because economics assumes that no voluntary trade will occur
unless both sides see an advantage in doing so.

18
 THE BASICS: WANTS AND MEANS

Wants
The Robbins definition of economics pivots on the tension between
wants and means. Wants may exceed given means; alternatively,
means may fall short of given wants. Both are potential sources of
scarcity, to which ‘economising’ is the right answer.
The word ‘wants’ draws on an earlier association with ‘needs’,
as in the idea of a person ‘wanting’ or ‘lacking’ the means of liveli-
hood. But the idea of ‘wanting something’ has long shed its objec-
tive grounding in ‘needing something’ and has acquired the purely
psychological meaning of wishing for something one hasn’t got.
Contemporary economics, following Robbins, takes wants in this
sense as ‘given’ – that is, not subject to further explanation. He
didn’t say that wants were insatiable, merely that at any point in
time an individual’s wants normally exceed his budget. There is,
nevertheless, a strong implication that wants are insatiable. For
example, in their standard textbook Economics, McConnell, Brue
and Flynn write that ‘For better or worse, most people have vir-
tually unlimited wants’.5 Robbins even conceived it possible that
‘living creatures might exist, whose “ends” are so limited that all
goods for them were “free” goods’.6 The American anthropologist
Marshall Sahlins (b.1930) considered that such was the happy con-
dition in the first hunter-gatherer communities. He called these the
‘original’ affluent societies, able to get what they wanted at very low
cost of effort and time.7 But our own experience – at least ever
since we were expelled from Paradise – has been the reverse of
this. We want – or are induced to want – more than we need, or
can easily get. We suffer from a kind of divine restlessness. We are
always seeking to improve our lot. Economics takes this striving
for improvement as a fact, or datum. It just assumes it is human
nature never to have enough.
This is not enough to make it rational. Rationality is not about
what we want, but how we set about getting it. The main require-
ment of rationality is that one should act consistently towards one’s
goals, whatever they might be. You judge which satisfactions are
more or less important to you, and rank your choices accordingly.

19
 WHAT’S WRONG WITH ECONOMICS?

If you prefer A to B and B to C, it is irrational to prefer C to A.

Inconsistent preferences are taken to be signs of delusion, neurosis,
madness. From the assumption of consistent preferences most of
microeconomics follows: the idea of the substitutability of differ-
ent goods, of the demand for one good in terms of another, of an
equilibrium distribution of goods, of the equilibrium of exchange,
the formation of prices, and so on.
The logic of the argument is plausible enough. Economists
argue that the relentless pressure of wants on scarce resources
forces people to ‘economise’. But we still need to ask whether econo-
mists believe that is how people do behave, or whether they think
this is how they should behave, or whether the postulate of such
behaviour is the only way to make ‘tight’ predictive models. This is
an excellent question for a student to ask her teacher. With math-
ematical models the suspicion is that the last is the most impor-
tant reason. As Robbins noted, the means-ends problem would still
exist if people acted inconsistently; it would just be that no deter-
minate result could be obtained.8
Earlier economists distinguished between needs and wants.
The usual argument was that first we aim to satisfy our physiologi-
cally unmet ‘needs’, then the needs of the imagination take over, in
a progression up the ladder of wants. But economists have rarely
stopped to consider the social origin of ‘wants’ or the economic
implications of the shift from needs to wants.
For Adam Smith, ‘desire of food is limited in every man by the
narrow capacity of the human stomach; but the desire of the con-
veniences and ornaments of building, dress, equipage, and house-
hold furniture, seems to have no limit or certain boundary’.9 The
Austrian economist Carl Menger (1840–1921) recognised that
the different needs of men are not equally important in satisfying
wants, ‘being graduated from the importance of their lives down to
the importance they attribute to a small passing enjoyment’.10
To illustrate his analysis, Menger assigned numerical values to
the different intensities, starting at 10 (highest) through to 0 (no
need), arranged as in the table below. If the need for food is 10 and
for tobacco 6, the consumer will not buy tobacco until his need

20
 THE BASICS: WANTS AND MEANS

I II III IV V VI VII VIII IX

10 9 8 7 6 5 4 3 2
9 8 7 6 5 4 3 2 1
8 7 6 5 4 3 2 1 0
7 6 5 4 3 2 1 0
6 5 4 3 2 1 0
5 4 3 2 1 0
4 3 2 1 0
3 2 1 0
2 1 0
1 0
0

2. Menger’s Hierarchy of Wants.

for food has been satisfied sufficiently. Each increment of satis-

faction is subject to diminishing marginal utility, so the baton is
passed, so to speak, to the next less urgent need. Thus psychologi-
cal, not physiological, needs drive the growth of wealth. Menger’s
table illustrates the principle of how needs of different intensity are
brought into equilibrium. Good I (food, say) is consumed until it
reaches need 9, at which point both goods I and II (shelter, say) are
consumed until they reach need 8 and so on.11
Implicit in both Smith and Menger is the idea of a hierarchy of
wants, starting with the primacy of physical need. For most people,
for most of history, absolute wants – the ‘needs of the stomach’ –
have in fact been by far the most important of their wants, so econ-
omists understandably paid much less attention to the existence of
relative wants – those generated by the existence of other humans.
The American Thorstein Veblen (1857–1929) was the first
economist to attend seriously to the primacy of relative wants in
consumption patterns. No one understood better than Veblen that
the insatiable wants which most economists attributed to human
nature were socially constructed. He originated phrases which have
become household words, such as ‘status symbols’ and ‘conspicuous

21
 WHAT’S WRONG WITH ECONOMICS?

consumption’. We desire a good or service not because of the value

we get from its use, but because of the opportunity its possession
brings to display our superiority to those who cannot command it.12
His work is an exploration of the exploding culture of con-
sumption in nineteenth-century America. Its background was the
rise of a new class of nouveaux riches – ‘robber barons’ – who were
building their gaudy palaces and lifestyles out of the profits of rail-
ways, steel, and oil. Extravagant display was the hallmark of the
new class; a display designed to impress rivals and awe inferiors
with its wealth and power.
Consider an auction of vintage Burgundy wines. The winning
bid may be $50,000 or even $100,000 a magnum or bottle. Does
the winner love Burgundy wine? Not necessarily. Can he or she
tell the difference between a $20,000 glass of it and a $5 glass?
Not necessarily. The winner is telling the other bidders that his
pocket is deeper than theirs. His purchase is an act of conspicuous
consumption.
Veblen’s ironic pen could be turned onto any of society’s cul-
tural institutions; on gender, he writes that ‘the dress of women
goes even farther than that of men in the way of demonstrating the
wearer’s abstinence from productive employment’, which in turn is
useful to signify the status of her husband. The long skirt is espe-
cially valued because ‘it is expensive and hampers the wearer at
every turn and incapacitates her for all useful exertion’.
Veblen argued that ‘the struggle of each to possess more than
his neighbor is inseparable from the institution of private prop-
erty’. It is capitalism which focuses the emulation complex so
completely on material goods. In doing so it reproduces itself, as
people demand more and more, but also bars them from ever fully
succeeding, since dissatisfaction with the present state of being is
the system’s driving force. Veblen saw this ‘emulation complex’ as
wasteful, because it results in expenditure ever ready to absorb any
margin of income that remains after physical wants and comforts
have been provided for. Indeed, ‘a general amelioration cannot
quiet the unrest whose source is the craving of everybody to com-
pare favourably with his neighbour.’

22
 THE BASICS: WANTS AND MEANS

Veblen alerts us to the role of advertising in shaping our wants.

For mainstream economists, advertising is primarily an informa-
tion system that tells consumers about products, old and new. For
Veblen and his intellectual descendants, its role is to stimulate
wants which can never be satisfied.13
Inspired by Veblen’s work, the economist Fred Hirsch (1931–
1978) developed the notion of ‘positional goods’, goods whose chief
function is to position their owner socially or politically. A good is
positional as long as not everyone can have it. As soon as it is gen-
erally available, it loses its value. Some goods like Old Masters are
naturally scarce; others like dwellings with fine views, or degrees
from top universities, can be kept artificially scarce by restriction
on entry. Power is an archetypal positional good. Ownership of
such goods is necessarily a zero-sum game: not everyone can have
power at the same time.14
We are rather a long way from economists’ laudable desire to
ensure enough provisioning for people to lead good lives. Relative
wants build insatiability into human striving and ensure that the
poor are always with us: someone will always be poor relative to
someone else. There is no ‘end’ beyond more and more consumption.
Means
What about the other side of Robbins: ‘scarce means which have
alternative uses’? It is true that we cannot easily conceive of a gen-
eral situation in which there are no costs to an activity. But is it true
that scarcity is as general or acute as economics makes it out to be?
First, one should notice that Robbins closes the circle of scarcity
by including time in his scarcity of means. Life is simply not long
enough to accomplish all that one wants: it is in this deeper sense,
he says, that ‘your economist is a tragedian’. Students are taught that
every activity involves an ‘opportunity cost’, which is a cost not just
of money at a single moment of time, but of time itself: ‘time is
money’. If someone can earn $10 an hour by working, and prefers
to be idle in that time, he has actually ‘spent’ $10. Common sense
suggests that the greater your budget of money (wealth), the more
time you will have to pursue other interests like going to concerts.

23
 WHAT’S WRONG WITH ECONOMICS?

So, with the growth of wealth, the psychological pressure of scar-

city might be expected to recede. In fact, this is not necessarily so:
one now has a choice between different kinds of music; one cannot
listen to them at the same time. Today, information overload helps
keep time scarce. We are constantly being bombarded with choices
we might make which promise more satisfaction than choices we
used to make. Thus the dream of abundance is a delusion: we are
stuck with scarcity of time unless our deaths can be indefinitely
postponed.
Secondly, mainstream economists, following Robbins, take
means, like wants, as data. ‘We assume an initial distribution of
property’, writes Robbins.15 In taking means as given, economists
take the distribution of resources available to satisfy wants off
their agenda. But the problem of scarce resources is caused not
just by the ‘niggardliness’ of nature, which affects everyone, but
the niggardliness of some people’s incomes. If incomes are highly
unequal it will be the wants of the rich which make the first call on
‘scarce’ means. Poverty in today’s world is not due to scarcity but
to inequality. There is enough food to feed an even higher global
population than today. An economics which made the reduction of
poverty and disease a priority would attend to the efficiency of dis-
tribution as well as to the efficiency of production and exchange.
Examples of artificially created scarcity – the scarcity arising
out of particular social and political structures and policies rather
than from natural causes – are legion. War and war preparations
are conspicuous examples of the continuous creation of scar-
city. There is an economic cost to buying a new aircraft carrier as
opposed to paying for a new hospital or school. The more wealth
devoted to military consumption, the less will be available to sat-
isfy civilian needs. Enforced scarcity of this kind was a decisive fea-
ture of communist systems, in which the military sector consumed
up to 30 per cent of national income. This enforced scarcity was
made possible by state ownership of land and capital, and its ability
to allocate labour for its own purposes. Nobel Laureate Amartya
Sen (b.1933) has pointed out that famines in poor countries are as
much the consequence of a politically determined distribution of

24
 THE BASICS: WANTS AND MEANS

food as of natural shortage.16 Eradicable diseases like malaria and

leprosy fail to be eradicated not because nature is niggardly but
because some rulers prefer to spend the money buying arms and
enriching themselves and their families.
Economists may reasonably point out that such artificial scar-
city is produced by bad politics, not by bad economics; and indeed
they have been persistent critics of ‘rent-seeking’ by governments.
However, they have been relatively blind to the ability of big private
corporations to extract rent. Today the biggest rent-extractor is the
cartel of big banks, which controls the means of financing produc-
tion. The method of mainstream economists has blunted criticism
of actual market distributions by setting out to ‘prove’ that in fully
competitive markets consumers are sovereign and all the factors
of production are paid what they produce. These proofs minimise
the extent to which unregulated market distribution is bound to be
skewed in favour of the rich and powerful. By insisting that scar-
city is given by nature, not by institutions, mainstream econom-
ics blunts the edge of efforts to regulate markets and redistribute
income.
It is commonly said that there is a ‘trade-off ’ between efficiency
and equity. Economists can tell you what an efficient distribution of
income is; it is up to politics to secure a just distribution. Neoclassical
economists of left-wing persuasion used to busy themselves with
working out schemes for an ‘optimal’ distribution of income which
satisfied the requirements of both efficiency and justice. But the
propaganda for productive efficiency has latterly become so pow-
erful that interest in moral efficiency has waned. The growth of
inequality, in turn, has produced growing popular disenchantment
with supposedly ‘efficient’ market outcomes. (For a further discus-
sion, see Chapter 13.)
Finally, the assumption of mainstream economists that econo-
mies have a spontaneous tendency to full employment leads them
to ignore the ever-present possibility of crashes and weak recover-
ies. The heavy unemployment, poor growth, and depressed wages
in most of Europe since 2008 is an example of scarcity created by
bad economic policy.

25
 WHAT’S WRONG WITH ECONOMICS?

z
We are now in a position to criticise the way the Robbins definition
sets up the economic problem. We can consider the issue from the
point of both demand and supply. As far as demand is concerned,
three points can be made.
First, and most obviously, the Robbins view expels morality. By
making efficiency God, it fails to ask: what is efficiency for? Robbins
writes: ‘Why the human animal attaches particular values . . . to par-
ticular things is a question we do not discuss.’17 By collapsing ends,
needs, and wants into the single category ‘preferences’, and taking
these as ‘given’ – not subject to further investigation – mainstream
economics precludes itself from questioning the value of wants, of
asking whether what is desired is desirable.
How much ‘wealth’ is needed for ‘well-being’? Economists who
stuck to the older view of their subject were not so shy about con-
sidering this question. John Stuart Mill (1806–1873) believed that
once poverty has been overcome, the need for efficiency would
decline. The economist Marshall, writing in 1890, gave a precise
number for sufficiency. He thought that with $150 a year (about
$10,000 in today’s money), a family ‘has . . . the material condi-
tions of a complete life’.18 Average global per capita income today is
$17,300. If we accept Marshall’s standard, there is no need for fur-
ther economic growth, only redistribution. But, as we have seen, the
notion of ‘materiality’, no longer anchored in food supply, has lost
its clarity; and in a world of ‘relative wants’, there is never enough.
Second, by taking preferences as given, mainstream economics
is debarred from exploring the instruments of persuasion used to
make people want more of one thing rather than another. It takes
consumer sovereignty for granted. It is only interested in the logic
of, and the consequences for, behaviour of people having the wants
they have. It is not interested, that is, in the history and sociology
of wants. Yet, though the acquisitive tendency has always existed,
it became a driving force in economic life only with capitalism. In
the pre-modern world wealth was simply regarded as the means
to the good life; moralists condemned money-making and custom

26
 THE BASICS: WANTS AND MEANS

restricted its scope. ‘Scientific’ economics took the desire for money
to be the main psychological drive of human nature, and empha-
sised its utility for begetting wealth. Ethics was reshaped to accom-
modate the spread of commerce. Greed became the power which
wills evil, but does good.
Mass consumption, the modern form of insatiability, entered
history at a definite time and place, with mass production in the
United States at the start of the last century. Before that the pos-
sibility of mass consumption did not exist. Today it is promoted by
economists, advertisers, and politicians as the democratic form of
happiness. In the words of Andy Warhol, ‘. . . the President drinks
Coke, Liz Taylor drinks Coke, and just think, you can drink Coke,
too. A Coke is a Coke and no amount of money can get you a
better Coke’.
But is giving everyone a Coca-Cola enough? If insatiability is
taken as given, there is clearly no end to scarcity, for there is no
obvious top rung in the ladder of wants. This means that the eco-
nomic problem will always be with us. Paradise never arrives. The
realisation, though, that wants are shaped by culture opens the door
to thinking how they are created – particularly by relentless mar-
keting – and how they might be limited to reduce the constraint
of scarcity. But talk of culture makes the economist, like Goering,
reach for his revolver.
Finally, failing to distinguish between needs and wants allows
mainstream economics to ignore the problem of fluctuations
in demand. In the Robbins view, economies are always supply-
constrained, never demand-constrained. As J.B. Say (1767–1832)
said: ‘supply creates its own demand’, that is, people would not pro-
duce things unless they needed them. This of course makes sense
if one is considering just the needs of the stomach: there is never
enough caviar to go round. But insofar as wants and not needs
direct the larger part of economic activity today, the stability of
economies depends on what goes on in the mind, not the stomach.
Neoclassical economics took over the older mechanistic psychol-
ogy of need without grasping that the shift from needs to wants
undermined the stability of behaviour.

27
 WHAT’S WRONG WITH ECONOMICS?

On the other, supply, side, we have never really shed our anxiety
about sufficiency of means, and with reason. The sanction econom-
ics has given to unlimited wants has brought back the Malthusian
problem, as consumption presses on the planet’s natural resources.
Low entropy energy and materials are dissipated in use and return
as high entropy waste. Our industrial and farming systems release
masses of carbon dioxide, methane, and other gases into the atmo-
sphere, which destabilise the world’s climate, while destroying
the absorptive and recuperative capacities of nature. Put bluntly,
there are too many people, wanting too many things. As Nicholas
Georgescu-Roegen (1906–1994) pointed out, humanity is des-
tined to physical extinction if a growing population continues
to consume at the same rate as it now does. Economics is about
minimising inputs. But because it sets no limit on outputs, the effi-
ciency requirement alone cannot guarantee a sufficiency of natural
resources to satisfy wants.
The neoclassical economist will tell you that the price system
guards against this result. Scarcity is only relative, he says. Price
movements will shift demand for goods which are relatively costly
to produce to those which are relatively cheaper. But this presumes
two things: that there will always be sufficient inputs (energy from
the wind or sun, for example) to satisfy the present scale of pro-
duction and consumption; and that an unimpeded market system
will generate the ‘correct’ prices before disaster strikes. No one not
thoroughly trained in the neoclassical method is likely to believe
either proposition.
To sum up: scarcity is by no means as ‘natural’ a long-run con-
dition as post-Robbins economics makes out. A great deal of it is
artificial, arising not just from the continuous need to stimulate
demand, but from the artificial restriction of supply. Capitalism
creates the demand it requires through advertising; while in many
parts of the world, political control of allocation keeps supply arti-
ficially scarce. By failing to question the sources of demand or the
political obstacles to supply, mainstream economics neuters the
most urgent parts of today’s economic problem.

28
 THE BASICS: WANTS AND MEANS

It would be absurd to claim that the faulty methods of main-

stream economics are responsible for global warming. But by fail-
ing to distinguish between needs and wants, and by taking wants as
‘given’, economics has powerfully reinforced the ethical blindness
which threatens the human species with extinction. Insatiability in
face of climate change is not rationality, but madness.

29
 3
ECONOMIC GROWTH

If theories, like girls, could win beauty contests,

comparative advantage would certainly rate high.
Paul Samuelson, Economics

The only defensible purpose of economics is to help abolish pov-

erty, opening up a more spacious life for humanity. Beyond that
it has no obvious purpose, and should leave the stage to others.
Abolition of poverty was the improvement in the human condi-
tion offered by the first economists. Over the centuries, though,
the means has become the end, so we no longer dare to ask what
economic growth is for, especially in rich countries who already
have more than enough to meet their basic needs.
What has economics contributed to the growth of wealth? It
is the spectacular growth of prosperity, reduction of poverty, and
decline of violence since Adam Smith’s day that is economics’ main
claim to have added value to economic life. By demonstrating that
the striving for wealth, unlike the quest for power, need not be a
zero-sum game, economists set public policy an altogether more
benevolent prospectus.
However, their contribution cannot be considered in isolation.
It came on top of the prior emergence of scientific and market
institutions, legal rules, the ‘spirit of capitalism’, and technological
applications favourable to economic growth.1 This was the plat-
form on which Adam Smith built his ‘science’. The unique contribu-
tion of ‘scientific’ economics was to empower these dynamic forces
with an improved understanding of their place in the scheme of

30
 ECONOMIC GROWTH

improvement, and thus prevent any relapse into bad old habits. It
gave commercial society intellectual and psychological legitimacy.
The question asked by the early economists was: what is the
path to prosperity? The challenge the classical economists Adam
Smith, Ricardo (1772–1823) and Malthus (1776–1834) set them-
selves was to understand how it is that some countries become
rich and others stay poor. The answer they gave – in Smith’s case
based on extensive historical enquiry – was that it depends on their
laws, morals, and institutions. Ruling groups could either retard or
promote invention, stifle or encourage enterprise, restrict or free
up trade. Britain, surging to opulence, and China, stuck in stagna-
tion, were at the opposite corners of Smith’s map. However, the first
economists, imbued with the spirit of the Enlightenment, failed
to understand how institutions, not especially suitable for wealth-
creation, might nevertheless serve other human purposes not less
essential, like maintaining social contentment – a blind spot which
has persisted to this day.
The main policy prescription to emerge from the writings of the
‘English’ economists Smith and Ricardo was free trade. Free trade
increased wealth; restrictions on trade retarded it. The German
economist Friedrich List (1789–1846) asked a narrower question:
how could continental Europe ‘catch up’ with Britain? The answer
he gave was protectionism. Free trade was fine for the already
industrialised; but the industrialising countries needed to protect
their ‘infant industries’ against premature extinction.2 This idea was
taken up by development economics in the 1940s.
The intellectual clash between free trade and protection has
dominated thinking about economic growth. It particularly involves
the part institutions play or should play in the growth story. Adam
Smith and his followers identified the state as an economic monop-
oly, and tended to see producer groups as conspiracies to restrict
trade. Mainstream economics has faithfully reflected this bias ever
since: state economic activity hinders economic growth by block-
ing the mutually beneficial working of markets. For the followers of
List, on the other hand, the state was, or could become, an entrepre-
neur; and they understood that producer groups could be growth

31
 WHAT’S WRONG WITH ECONOMICS?

engines. The role of the state in the growth story is an unsettled

question in economics. There is the question of historical fact: what
role did states play in the growth of wealth? This leads to a further
question. What kind of state is good for growth – democracy or
dictatorship? Are states bound to be corrupt and/or incompetent?
The eighteenth-century classical economists correctly surmised
that the growth of material wealth depends on control of popula-
tion, the ‘accumulation of stock’ (investment), and the ‘widening
of the market’ (trade). They understood that if they were to pros-
per, societies needed to control their fertility, to put aside part of
what they currently produced to invest in future production, and
to trade freely. These were profound insights, on which economics
still largely lives. Where they fell short was in understanding how
societies develop institutions favourable to such activity. To this
day, many, perhaps most, economists take private property rights
as given, and explain the greater wealth of some societies in terms
of their more efficient distribution of property, without showing
much curiosity about why inefficient property distributions per-
sisted for so long, or what functions they played in the life of their
societies.
This chapter traces ‘growth’ economics from the insights of the
classical economists to the emergence of development economics
as a distinct subfield of economics in the second half of the twenti-
eth century, and the gradual dissolution of the developmental per-
spective into the neoclassical Washington Consensus.
Population
If the economist is a tragedian, the Revd Thomas Malthus has a
claim to be considered its tragedian in chief. Before Malthus there
was the allure of a more prosperous future; after him gloom. For
the first fifty years of the nineteenth century, economics was known
as the ‘dismal science’. In An Essay on the Principle of Population
(1798) Malthus set out to refute the utopianism of writers like
Condorcet, Godwin, and Thomas Paine. Excited by the growth of
wealth, the advance of science, and the softening of manners, these
eighteenth-century thinkers argued that there were no natural

32
 ECONOMIC GROWTH

limits to economic progress, and with it, human perfectibility.

Malthus pulled them up short with his famous ratios. Human life,
he proclaimed, is forever poised between ‘population’ and starva-
tion. Population, driven by sexual passion, increases in geometri-
cal ratio (1, 2, 4, 8) while food supply increases only arithmetically
(1, 2, 3, 4), that is, by a constant amount each year.
If every couple has four children, the population is bound to
double each generation. Eventually, population will outstrip the
agricultural production that can support it. The population of
Britain in 1800 was 7 million. So, Malthus reasoned, it would dou-
ble every 25 years, to 14 million in 1825, 28 million in 1850, 56 mil-
lion in 1875, 112 million in 1900 and so on up to nearly 1.8 billion
in the year 2000. Meanwhile, if food supply was enough to feed all
7 million in 1800, it would feed 14 million in 1825, 21 million in
1850, 28 million in 1875 and 35 million in 1900. So, in 100 years,
two-thirds of the population would be starving: a tragic perspective
to be sure. Malthus’s prediction was based on a type of reasoning
which has become standard in economics – logical deduction from
tight priors. His was a ‘model’ with a warning attached.
In the second edition of the Essay (1803), expanded to two vol-
umes, Malthus ransacked history to find empirical support for his
hypothesis. He did, in fact, discern cycles of rapid population growth
followed by large-scale population collapses – the Black Death
of the fourteenth century being the most famous instance – and
offered a causal explanation: any improvement in productivity led
to more population not more wealth, as wage earners took advan-
tage of their prosperity to have more children. Population presses
on food supply: wages fall, and population growth is reversed, with
a fraction of the population, young and old, carried off by disease,
plague, pestilence, and starvation. In this way Nature maintains a
rough long-term equilibrium between wants and means. But this
mechanism prevents wages ever rising above subsistence. Marx
would call this the ‘iron law of wages’. So much for the optimists.
However, Malthus offered a crucial check to the destructive
power of sexual passion: ‘moral restraint’. People should delay their
age of marriage and remain celibate outside marriage. Malthus

33
 WHAT’S WRONG WITH ECONOMICS?

rejected contraception, inside or outside marriage, as a way of

checking population growth. His attitude mixed up theological
and economic arguments in a way which now seems strange. On
the theological side, God, he thought, had planted the sexual pas-
sion in humans not just for purposes of reproduction but to spur
them to moral effort, first to earn enough to marry and then later
to provide for the resultant family. Consequently, reasoning in line
with the tenets of the new economic science, Malthus argued that
contraception (and other ‘vicious’ sexual practices) would reduce
the incentive to work and self-improvement, by blunting the urge
to provide for one’s children.
Thus Malthus emphasised moral efficiency as a requirement of
economic growth. Societies which ‘selected’ an efficient moral code
prospered; societies which wallowed in ‘vice’ stagnated or declined.
In fact, already by the end of Malthus’s third population cycle in
the late seventeenth century, diminishing returns to agriculture
were being offset by productivity gains. In the nineteenth century
a combination of sustained productivity growth and colonisation
swept Malthus’s numbers into the dustbin of failed predictions – at
least as far as the developed world goes. In Europe today the native
birth-rate falls short of the replacement rate. Vice, in the form of
contraception, has rescued it from the Malthusian trap.
However, the Malthusian bogeyman has cast a long shadow. The
best-selling report, Limits to Growth (1972), with strong echoes
of Malthus, predicted that the world’s population would hit 7 bil-
lion by 2000, leading to shortages of grain, oil, gas, aluminium, and
gold.3 Global population is now almost 8 billion, and is expected
to peak at 11 billion, or, in some estimates, 15 billion. Mainstream
economics has largely learned, wrongly, not to think about absolute
resource pressures, but Malthus’s method left a permanent legacy
on economics in other respects. The first was the a priori (literally
‘from the earlier’, and meaning ‘independent of experience’) char-
acter of his economics. His theory was a classic example of deduc-
tive reasoning, the premise of which came to him long before he
tried to verify it empirically, and which was replete with ceteris
paribus defences against disconfirming facts. Second is his use of

34
 ECONOMIC GROWTH

mathematical formulae to give his predictions a precision which

they certainly never merited. Third was his propensity to draw
large inferences directly from ‘the facts of nature’. Finally, he oscil-
lated between the positive and the normative. Like Adam Smith he
was in the growth business; and growth required moral efficiency.
He was a preacher, using science to reinforce his sermons.
Investment
For Adam Smith, the accumulation of ‘stock’ (capital goods) was the
first key driver of growth. The question was how to get the required
investment in capital goods. Ricardo believed that any enquiry
into the process of accumulation had to start with the institutions
governing the division of the product between the three classes of
landlords, businessmen, and workers. If the surplus of production
over consumption was the only source of accumulation, the rate of
growth of prosperity depended on who got the surplus, and this
depended on how much of it went to each of the classes. Landlords
lived off the surplus of producers, which they took as ‘rents’. These
rents were spent unproductively – in building and maintaining
grand houses and lifestyles. Since workers consumed what they
earned, businessmen were the only possible accumulating class,
the only class with the wherewithal and incentive to invest their
profits in improving and expanding their business. Thus economic
growth depended on depriving landlords of their rents, restricting
the ‘wages fund’ to the minimum necessary to sustain the work-
force, and keeping taxes low.4 ‘I shall greatly regret’, Ricardo wrote,
‘that considerations for any particular class, are allowed to check
the progress of the wealth and population of the country.’
Ricardo was a divided soul, torn between an equilibrium theory
which proved that exceptional profits would be competed away,
and his recognition that economic growth was a dynamic process
which required continuous accumulation. He set economics on a
course of class analysis which was eagerly exploited by Karl Marx,
but proved highly embarrassing to his own neoclassical successors.
In effect, Ricardo identified the state with the interests of the land-
lord class, and argued that control of the state should pass to the

35
 WHAT’S WRONG WITH ECONOMICS?

business class. Karl Marx claimed that this is exactly what had hap-
pened: in the new industrial society, the state was the agent of the
capitalist class, a class which used its monopoly control over capital
to exploit the worker, in the same way as the landlord class had pre-
viously used its monopoly of land ownership to ‘exploit’ the other
classes. The difference was that the businessman’s exploitation of
the worker was the source of capital accumulation, and therefore
economic growth, whereas the landlord’s monopoly rent was waste.
So the new exploiting class was also the progressive class.
Marx’s structural method of analysing economic life was iden-
tical to Ricardo’s. As we have already noticed, the neoclassical
economists who followed Ricardo rejected this institutional view
of economic structure: the only actors in their models were indi-
viduals. By this means class power was rendered invisible. The shift
from a structural to an individualist analysis of economic behav-
iour marks a decisive break in economic method, a genuine ‘para-
digm shift’.
Trade
For Adam Smith the division of labour was the second key engine
of growth. Advocacy of the division of labour leads directly to
advocacy of free trade. It carries to a logical conclusion the mes-
sage of the pin factory. Smith explained how the production of pins
can be greatly increased if each pin maker acquires a specialised
aptitude for the production of a part of the pin only. Instead of
one pin maker making ten pins a day, five pin makers might make,
say, 100 pins a day, thus halving the cost per pin in labour time.
This principle of the division of labour into specialised tasks can be
extended to countries and regions. Wealth is increased if countries,
like individuals, specialise in those trades in which they have an
advantage.
Behind the science which Smith and Ricardo brought to the
free trade cause was a crucial political objective: to break the land-
lord stranglehold on the price of food. Free import of food would
reduce its price, simultaneously lowering the costs of production,
augmenting profits and investment, and raising the real wages of

36
 ECONOMIC GROWTH

the working class. The connection between trade, capital accumula-

tion, and economic growth was established at the birth of scientific
economics. It remains the intellectual foundation of globalisation.
However, the free trade doctrine came in two versions.
Adam Smith believed that God had placed people in different
places so they could trade with each other. Trade arises from natu-
ral advantage: you get better quality wine if you import it from the
Mediterranean than if you try to make it in Scotland. The crucial
point to emphasise is that trade based on natural advantage is less
disruptive than trade based on competition for the same product.
Countries produce different things, they don’t compete to pro-
duce the same things. Complementary trade – buying from abroad
needed or desired goods which cannot be produced at home, or
which can only be produced at home at prohibitive cost – minimises
the threat of wage and job competition.
However, to base trade on natural advantage alone is to limit
the division of labour it makes possible. This limitation was over-
come by Ricardo. Ricardo explained that welfare-maximising trade
should not be bound by natural advantage. Rational agents under-
stand that their gains will be greatest if they specialise in those
activities not in which they have a natural advantage, but in which
they are least disadvantaged.
Thus the professor who can both think and type better than
anyone else in town, but who can think better than he can type,
will hire a secretary to do the typing, leaving himself more time for
thinking. Portugal, said Ricardo, should concentrate on producing
wine, leaving cloth production to England, because though it can
produce both wine and cloth cheaper than the English, it can pro-
duce wine at lower cost than cloth. In this way, the gains of both
partners will be maximised.5 The theory of comparative advantage
has been the most influential doctrine in the whole of economics.
It has turned even the most hard-nosed of economists dewy-eyed;
Paul Samuelson described it as ‘beautiful’.
As with the Malthusian population theory, Ricardo’s compar-
ative advantage theory is a classic example of deductive reason-
ing: formalising an intuition, and then deducing its consequences.

37
 WHAT’S WRONG WITH ECONOMICS?

Committed to the long view, Ricardo ignored any disruptive effects

on Portugal in surrendering the production of cloth to England.
Unlike Malthus, Ricardo also disdained any empirical attempt to
show that trade had in practice developed along the lines suggested
by the theory. And to this day, there is no conclusive evidence
that inter-country trade flows have followed the ‘law of compara-
tive advantage’. It comes into that category of economic theorems
which are largely prescriptive.
It is not necessarily good prescription either. Ricardo’s was a
doctrine of static equilibrium: it called on countries to specialise
in what they could do best in the present. This might have made
sense when advantages were in natural endowments, but not in
manufacture. As soon as ‘catch-up’ became the name of the game,
countries looked to exploit dynamic, not static, gains from trade.
This meant developing higher-value industries shielded from pre-
mature competition. Friedrich List claimed that free trade can
be an instrument to entrench existing trade advantages, and, via
these, existing power advantages. Mainstream economists nod to
his ‘infant industry’ argument for Protection but accord it scant
respect. Any transitory benefits protectionism might bring, they
say, are trumped by the corruption and inefficiency attendant on
state interference in trade flows.
The role of the state
Left out of both classical and neoclassical growth stories is the role
the state has played in economic development. As a matter of his-
torical fact, much economic growth has been state-led, not mar-
ket-led, in the sense that a great deal of capital accumulation was
done by the state itself. This was true of all European states in the
nineteenth century; and has been true of Japan, South Korea, and
China more recently. Trade, too, was an instrument of state policy.
As many historians have pointed out, most countries industrialised
under tariff protection, not free trade.6
Why did early economists choose the competitive market and
not the state as galvaniser and coordinator of economic activity?
The most important reason is that they saw the pre-modern state

38
 ECONOMIC GROWTH

as a private monopoly, personified in the monarch who pursued

his own family or dynastic interests at the expense of the pub-
lic good. Adam Smith’s anti-state diatribes were directed against
pre-modern forms of rule. The ruler was the ‘Prince’ who had nei-
ther the knowledge nor integrity to direct the economic affairs
of society. The conclusion seemed to follow that the state’s role
in the economy should be kept as small as possible, by restricting
its sources of revenue and patronage. This anti-statist bias in eco-
nomic thought, briefly disturbed by the Keynesian revolution, has
persisted to this day.
Even in the eighteenth century, the economists were wrong. The
monarchy was already in the course of becoming part of a wider
entity, the state, with a better quality of bureaucracy. In Adam
Smith’s day despots, like Joseph II of Austria, could be ‘enlightened’.
It was the ‘absolute’ monarchies of central and eastern Europe
which spearheaded the drive to modernise their backward societ-
ies, against the strong opposition of nobles, wedded to their tra-
ditional rights and privileges. And by the end of the nineteenth
century, the state was increasingly accountable to voters.
The negative view of the ruler was matched by a positive view
of the market. This was part of the deep-seated eighteenth-century
liberal belief that, in the absence of power, private interests did
ultimately harmonise. A competitive market system made possible
voluntary cooperation in pursuit of prosperity, with only a mini-
mum of regulation.
The view that states do best which govern least persisted, at
least in the Anglo-American mainstream. Even when governments
did start to accumulate capital for economic purposes in the nine-
teenth and twentieth centuries, mainstream theorists were quick to
argue that public investment was bound to be less efficient than
private investment. This was because the state could not direct capi-
tal in line with any choices other than its own. Today’s neoclassical
economists love telling stories of how governments invariably ‘pick
losers’, constructing roads which lead nowhere, towns which no one
wants to live in, and steel mills which use lots of capital and very lit-
tle labour, and whose products cannot be sold for hard currencies.

39
 WHAT’S WRONG WITH ECONOMICS?

The sweeping denunciation of government failure pays no

attention to the character of governance, or the distribution of
power. It assumes that all states are inherently incompetent, if not
also corrupt and predatory. But performance of the pre-modern
state is no guide to what a modern state might achieve. The neo-
classical parody ignores the fact that governments, dedicated to
full employment or growth, have often picked winners. Consider
Toyota, the Japanese automobile manufacturer. Starting as a tiny
textile manufacturer it was propelled to world rank by acts of gov-
ernment: tariffs, exclusion of competitors, and subsidy. In Ha-Joon
Chang’s words: ‘. . . had the Japanese government followed the free-
trade economists back in the early 1960s, there would have been
no Lexus. Toyota today would, at best, be a junior partner to some
western car manufacturer, or worse, have been wiped out. The same
would have been true of the entire Japanese economy.’7
The real story behind Silicon Valley and other dynamic centres
of innovation is not explained by the state getting out of the way,
so that risk-taking venture capitalists and garage investors could
do their thing. From the internet to nanotechnology, most of the
fundamental technological advances of the last half century – on
both basic research and downstream commercialisation – were
funded by government agencies, with private businesses moving
into the game only once the returns were in clear sight. Even mil-
itary spending which is, almost by definition wasteful, can have
growth-creating spinoffs.8
This profound disagreement about the role of the state in eco-
nomic development has run through economics from the start. In
every epoch you find a debate between those (the majority of econ-
omists) who believe laissez-faire desirable, with ‘every departure
from it, unless required by a great good, a certain evil’ and those
who believe that economic development needs the active support,
and often the leadership, of the state.9
Development economics
‘Development economics’ marries two distinct concepts. The first
is economic growth. Economic growth is simply the growth of

40
 ECONOMIC GROWTH

gross national product (GNP), calculated as the total value of all

market transactions in a given period. GNP is a purely quantita-
tive measure. Provided it grows faster than population, it leads to
what is termed an increase in ‘living standards’. Economic develop-
ment is a broader idea, in which economic growth contributes to
the ‘well-being’ or human enrichment of the population.
There is no harm in using the words ‘growth’ and ‘development’
interchangeably, provided one recognises that their requirements
might – and should – diverge after a certain level of ‘provisioning’
has been achieved.
Once economic growth started to be a conscious aim of policy
after the Second World War, growth policy has been through two
different phases of theoretical fashion. First in the field were the
‘big push’ theories of the 1940s and 1950s, designed to turn poor
countries into rich ones in double-quick time. These were based
on a structuralist analysis of the economy, ancestrally derived
from the doctrines of Friedrich List. The alleged failure of the big
push growth policies led, in the 1970s and 1980s, to a swing back
to neoclassical economics, which came to be embodied in the
Washington Consensus.
Structuralism
Development theories can be called structural because they take
as their unit of analysis the structure of the world capitalist system.
They viewed this not as an integrated market peopled by competi-
tive firms but as a binary system with an advanced centre and a
lagging periphery. The dual structure of the economy required a
dual system of economics and economic policy – one suited for
rich countries would not suit poor ones.
Like Adam Smith, development economists saw capital accu-
mulation as a motor of growth, but, unlike Smith, they did not
believe it would come about naturally. The reason was that poor
countries lacked a business class. Therefore it was the state which
needed to mobilise savings (foreign or domestic) and invest them
in manufacturing industries, drawing on ‘unlimited supplies of
labour’ in agriculture.10 The key assumption was the existence of

41
 WHAT’S WRONG WITH ECONOMICS?

increasing returns to scale in manufacturing. The larger the man-

ufacturing sector, the larger the domestic market would be, thus
producing a self-sustaining ‘virtuous circle’ of growth.
Advocates of the big push theory attacked free trade as locking
rich and poor into their pre-existing positions in this global struc-
ture. The Argentinian economist, Raúl Prebisch (1901–1986) argued
in 1959 that the gains from trade are systematically biased against
the poor countries in the periphery. This is because the prices of
primary products, in which poor countries specialised, were set in
competitive markets, whereas the manufactured goods of devel-
oped countries were priced in monopolistic markets. Poor coun-
tries are subject to declining terms of trade, equivalent to transfers
of income from the poor to the rich world. In addition, manufactur-
ing industries have a permanent cost advantage, because technical
change benefits them more than primary producers.11
So Prebisch and his followers demanded that the state insti-
tute policies of import substitution to improve developing coun-
tries’ terms of trade. Under cover of protection, the state would
shift resources out of agriculture, subject to diminishing returns,
and low-productivity services where ‘disguised unemployment’
was rampant, to higher-productivity manufacturing industries,
which enjoyed ‘economies of scale’. This would enable develop-
ing countries to create their own ‘infant industries’, which in time
might become export giants, and so ‘catch up’ with the developed
countries. As Harry Johnson (1923–1977) put it: ‘The notion that
there exist masses of “disguised unemployed” people leads easily
to the idea that “development” involves merely the mobilisation
and transfer of these presumably costless productive resources
into economic activities.’12 In the 1950s and 1960s most of Latin
America, as well as India, pursued policies based on this kind of
analysis.
By the 1970s there was growing doubt that government push
was working. The data for developing countries showed rapid pop-
ulation growth, widening income inequality, and small growth in
industrial employment. Import substitution was also producing
inflation and balance of payments problems. Borrowing abroad

42
 ECONOMIC GROWTH

for infant industries led to the pile-up of debt, which peaked with
the debt crises of the 1970s and 1980s. There was also evidence
that forced growth policies were producing deleterious side effects
ranging from civil wars to the establishment of murderous author-
itarian regimes. Increasing attention was paid to lack of ‘social
capability’. Governments, it turned out, were perfectly capable of
enriching themselves and their families, but not at developing their
countries’ economies. ‘As in the myths which demonstrate the dan-
ger of wresting secrets from the gods, the policy-makers abused
their newly discovered knowledge and applied to excess the magic
formulae that had paid such early dividends.’13
To this disappointment with the big push policies, there were
two reactions. The first was dependencia (‘dependency’) theory, the
Marxist theory of exploitation applied to international economics.
Low-income countries aren’t just up against bad odds, they said,
the game itself is rigged against them. ‘Unequal exchange’ is not a
contingent outcome that can be remedied by state policy within
the world capitalist system, because it is the necessary condition
of capitalist profitability. The prosperity of the core depends on
the poverty of the periphery, with the periphery being required to
provide cheap raw materials, and unskilled labour to keep up the
profits of the core. The villains of the story were the multinational
corporations whose control over global capital enabled them to
extract rents from poor countries.14
A crucial point made by dependencia theorists is that capitalism
at the centre developed on the basis of the home market, whereas
capitalism on the periphery was imposed from outside. Thus the
capitalist economies on the periphery lacked any internal dynamic
of their own. Capitalism in such conditions leads to an ‘enclave’
economy, which not only has no beneficial spillover effects, but
kills off the remaining economy, by diverting resources to ‘artificial’
export activities, substituting luxury imports for home-produced
products, shrinking the tertiary sectors of traditional economies,
and encouraging wasteful modern production techniques.
Dependency theory brings us back to the picture of the econo-
mist as tragedian. Because development of the periphery within

43
 WHAT’S WRONG WITH ECONOMICS?

the capitalist system is cut off, a socialist revolution is the only

path to the conquest of poverty. This will at the same time destroy
capitalism at the centre, by undercutting its sole remaining source
of profit.
Washington Consensus
A more durable reaction to the alleged failure of import-substitution
policies was a drift back to neoclassical economics. It started to
be argued that what was needed was not expensive steel mills and
motor car industries which could not sell their products for hard
currencies, but labour-intensive production based on exploiting the
existing comparative advantage poor countries enjoyed in cheap,
docile labour. Rural labour reserves could be switched into low-cost
manufacturing for exports. The spectacular success of a handful of
East Asian ‘tigers’, like Japan, Taiwan, and South Korea, in break-
ing into world markets gave some evidential backing to the new
approach.
In the 1980s, the Latin American debt crisis and low commod-
ity prices swung the policy discussion to the kind of ‘structural
adjustment’ needed to secure export-led growth. This shift coin-
cided with the global ideological shift to freer markets associated
with Reagan and Thatcher. In the 1990s the growth agenda was
taken over by the so-called Washington Consensus. Significantly,
developing economies became ‘emerging market economies’.
Economists of the International Monetary Fund and World
Bank induced poor countries, as a condition for loans, to ‘liber-
alise’ their financial markets, reduce trade barriers, privatise pub-
lic enterprises, cut down on state spending, and allow production
decisions to be taken in the global marketplace. A related realisa-
tion was that most Third World governments were too incompe-
tent and corrupt to be entrusted with ambitious ‘catch-up’ plans.15
Instead, in line with the New Institutional Economics (see Chapter
8), increasing emphasis was placed on creating enforceable private
property rights, so as to equalise private and social rates of return.
Exploiting comparative advantages became the accepted name
of the game in east and south-east Asia. The new growth engine

44
 ECONOMIC GROWTH

was market integration. Instead of trying to accumulate physical

capital, developing countries should concentrate on exporting
what they could get most for and importing what they had to pay
least for, and using the profits of trade to build up ‘human capital’.
Growth through globalisation is the accepted position today.
So we have three stories of development.16 The free trade the-
ory shows us different cars on the same road with some ahead,
others behind, but assures us that those in the rear will catch up
with those in front by following the free market recipe. The struc-
turalist theory shows some cars stuck in the slow lane, but argues
they can move over to the fast lane by following statist import-
substitution policies. The exploitation theory argues that capital-
ism has consigned most peripheral countries permanently to the
slow lane from which they can only escape by a revolution against
their exploiters.
Structuralist theories still have considerable purchase in Latin
America. What makes them a theoretically dissident strand of
modern economics is that, in contrast to orthodox or neoclassical
economics, they model the world economy as a binary system, bor-
rowing from Marxian class analysis and replacing ‘capitalist’ and
‘worker’ with ‘centre’ and ‘periphery’. The two contrasting methods
of modelling economic life reflect different views of reality.
Both can be criticised for ignoring important aspects of that real-
ity. Structuralists were alert to the distribution of power in the world
economy, but blind to the absence of a competent state to deliver the
results promised by their ‘big push’ policies. Globalisers put their
faith in the ‘invisible hand’ of the market, but paid far too little atten-
tion to the fact that successful marketisation requires entrepreneurs.
Both approaches thus neglected two vital institutional requisites for
economic growth: a strong, relatively uncorrupt state and a com-
mercial middle class. Most of East Asia had these; most of Latin
America and Africa did not; hence the different results.
Who is right?
A flavour of the difference between the structuralist and ortho-
dox views of development is given by the following exchanges in

45
 WHAT’S WRONG WITH ECONOMICS?

2002 between Professor Robert Wade of the London School of

Economics and Martin Wolf, chief economic commentator of the
Financial Times.17 This took place in the heyday of the Washington
Consensus, before the collapse of 2008.
They start with a dispute about the facts. Wade denied that glo-
balisation had lifted hundreds of millions of people out of primary
poverty. World Bank figures showed that the numbers of people
in absolute poverty (with incomes of less than $1 a day) remained
roughly constant in 1987 and 1998 at around 1.2 billion. Since
population had increased, the share of the world’s population in
absolute poverty fell sharply from 28 per cent to 24 per cent; but
the absolute numbers may even have grown. Inequality had been
widening if one compared the average incomes for each country
and treated each one as an equal unit (China=Uganda); it had been
decreasing if each country was weighted by its population. But
the latter result was entirely due to the fast growth of China and
India. While data on income distribution among all the world’s
households was lacking, the falling wage share from 1982 sug-
gested a growth in inequality. Thus globalisation had been nothing
like the poverty and inequality reducing engine the orthodox view
supposed.
To this, Wolf responded that World Bank data showed a decline
of 200 million living in absolute poverty since 1980. This made
nonsense of the claim that poverty reduction had been blighted by
globalisation. Further, a big decline in world-wide inequality had
occurred since it peaked in 1970. So the previous two decades had
seen a decline not just in absolute poverty but also in world-wide
inequality between households. The explanation of both was the
fast growth of China and, to a lesser extent, India.
The debate shifted to the causes of growth. For Wade the main
cause is the diffusion of technical capacity; for Wolf it is multi-
causal, with globalisation as an important ingredient. He pointed
out that the experience of South Korea and Taiwan in the 1950s
showed that countries experience faster growth as they move from
autarchy to trade. But economic success, Wade replied, is not evi-
dence of the benefits of globalisation. China and India had started

46
 ECONOMIC GROWTH

growing before they opened themselves up to trade and foreign

capital.
Wade rejected the prescription that all countries should lib-
eralise to speed up growth. History showed that countries didn’t
liberalise to become rich; they liberalised once they had grown
richer. By forcing premature liberalisation on poor countries, the
Washington Consensus was impeding the growth of their techni-
cal capacity. World Trade Organization (WTO) rules prevented
poor countries from doing things which had previously helped
rich countries nurture their technological learning, like subsidising
their labour-intensive industries, or limiting foreign investment.
Wolf replied that one can’t separate technological innovation
from the context in which it is applied. Among other precondi-
tions, economic growth requires a stable state, security of person
and property, widespread literacy and numeracy, basic health, ade-
quate infrastructure, ability to develop businesses without suffoca-
tion by red tape or corruption, broad acceptance of market forces,
macro stability, and a financial system able to transfer savings to
effective use. In successful countries these emerge in mutually rein-
forcing ways. In Africa few such preconditions exist. Liberalisation
of goods and capital markets won’t fix this, but they are handmaid-
ens of growth.
Wolf conceded that infant-industry promotion, buttressed by
trade restrictions, may ‘occasionally’ accelerate economic growth.
But the record of their use in poor countries is ‘dreadful’. He failed
to see why restraints on policy discretion should be good for rich
countries and bad for poor ones. Poor countries need more not less
protection from bad governments.
A final set of comments related to the reliability of World Bank
data. Wolf wrote: ‘All data on incomes and distribution are ques-
tionable, above all those generated in developing countries. But
contrary to what you [Wade] say, World Bank researchers have cal-
culated the numbers . . . on a consistent basis.’ Wade persisted that
the World Bank had ‘an official view about how to do development
and is subject to arm-twisting by its major share-holders.’ It was
under pressure to fudge its GDP data base, most glaringly in the

47
 WHAT’S WRONG WITH ECONOMICS?

case of China, whose growth, he suspected, was far less stellar than
World Bank numbers showed.
Wolf had the last word:

Economic growth is, almost inevitably, uneven. Some countries,

regions and people do better than others. The result is growing
inequality. To regret that is to regret the growth itself. It is to
hold, in effect, that it is better for everyone . . . to remain equally
poor. [This] seems to me . . . morally indefensible and practi-
cally untenable . . .

z
This debate illustrates very well why economics is not a hard sci-
ence. At issue is correlation versus causation (if two or more events
run in parallel, which, if either, causes the other?), reliability of the
data (how much trust can you put in official statistics?), the ideo-
logical complexion of economic models (is the world economy
best understood as a unitary or binary system?), universal versus
contingent truths (do different economic structures have the same
laws of development?), the role of power (are market transactions
spontaneous or induced?), the type of policy prescription (free
trade or protection?), and last but not least, whether the already
affluent West provides the right model of development for poor
countries to follow. The next two chapters will address the central
question facing the claim of economics to be scientific. Are the
stories we have told just stories? Or can they be subject to scientific
sifting?

48
 4
EQUILIBRIUM

As in the physical sciences, equilibrium is a

central concept in economics.
Edward Lazear, ‘Economic Imperialism’

Equilibrium
Equilibrium is economics’ principle of order. The fact that it is
supposed to be the spontaneous outcome of market transactions
means that alternative systems of maintaining order – those based
on power – can be minimised. Markets will do most of the work
needed to ensure social cooperation. The state can be restricted to
a few political duties – ‘law and order’. Thus the equilibrium of the
market is the traditional answer of economics to the political claim
that societies have to be ‘kept in order’ by the exercise of power.
In technical terms, equilibrium is the concept of a system at
rest. No one has any incentive to change what they are doing.
Economics shares the concept of equilibrium with physics. The
idea is that there exist forces in nature which automatically balance
each other. Any disturbance to the balance will set up an opposing
force to restore it: you swing the pendulum one way, and gravity
pushes it back.
Joseph Schumpeter (1883–1950) described equilibrium as the
‘magna charta’ of exact economics.1 But it poses a severe problem.
How do economists reconcile, even notionally, the idea of a state
of rest with the undoubted dynamism and instability of economic
life? The answer lies in the notion of ‘shocks’. The normal state of

49
 WHAT’S WRONG WITH ECONOMICS?

economic life is one of predictable activity, based on stable expecta-

tions. But the even tenor of economic life is constantly being upset
by shocks: they could be natural, technological, or monetary. In
the prologue of Goethe’s eighteenth-century poetical drama, Faust,
God sends humanity the devil (Mephistopheles) to rouse it from
its somnolence:2

Man’s active nature flagging, seeks too soon the level;

Unqualified repose he learns to crave;
Whence, willingly, the comrade him I gave,
Who works, excites, and must create, as Devil.

In the development of physics, Galileo (1564–1642) glimpsed

the operation of equilibrium in the curved line drawn by the
moon as it circled the earth. Kepler (1571–1630) was then able to
describe accurately the path it took, from which Newton (1643–
1727) explained the curve by the concept of gravity: a field of
force which pulls matter together. No one has ever seen gravity: it
was a hypothesis to explain Kepler’s observation and many others
since. As it was once believed that the planets were held in place by
angels, gravity is a scientific improvement on the angelic host. It is
also a proven hypothesis. With trivial exceptions, gravity holds for
all physical bodies.
Mainstream economists want to make economics as much like
physics as possible. Mechanics came before economics and the first
economists marvelled at the precision and certainty of the laws of
mechanics. So the economic world must be shown to exhibit some-
thing like the laws of physics. Economic equilibrium is secured by
the opposing forces of supply and demand. The elementary supply
and demand diagram shows the quantity of a good which will be
demanded and the quantity supplied at different prices. The price
of something goes up, the quantity sold goes down; its price goes
down, and the quantity sold goes up. If a blight makes tomatoes
scarcer, their price will go up, consumers will buy fewer tomatoes.
If farmers grow too many tomatoes, prices will fall, leading some
farmers to stop growing tomatoes, and some to grow something

50
 EQUILIBRIUM

D S

PQ

Q
3. Competitive Equilibrium. Note: The first diagram students of economics
encounter: P = price, Q = quantity, S = supply curve, D = demand curve,
PQ = equilibrium price. A: excess demand forces P back up to equilibrium level,
B: excess supply forces P down to equilibrium level.

else. Either way the market for tomatoes will find its equilibrium
level, a price level at which no producer willing to accept the going
rate will be left with unsold stock, and no buyer willing to accept
the going rate will have empty shelves.
In Paul Samuelson’s summary: ‘There may have to be an ini-
tial period of trial and error, of oscillation around the right level,
before price finally settles down in balance.’ Thus competitive sup-
ply and demand schedules represent the best response by sellers
and buyers to any disturbance to a pre-existing equilibrium.
The French economist Léon Walras (1834–1910) extended the
notion of equilibrium in a local market to the idea of the general
equilibrium (GE) of a system of markets. He reasoned that if the
whole economy consisted of perfectly competitive markets, supply

51
 WHAT’S WRONG WITH ECONOMICS?

and demand would be simultaneously balanced in all markets, a

balance which can be expressed in a set of simultaneous equations.
In Walrasian GE each market establishes its equilibrium or
market-clearing price through a process Walras called tatonnement
or ‘groping’. At the point of trade all prices in the economy have
been perfectly adjusted to the supply and demand conditions in
each market. It is important to note that all markets in the Walrasian
system are auction markets, in which contracts to buy and sell
are made simultaneously – prices are known to both buyers and
sellers. If prices are uncertain, the existence of equilibrium cannot
be proved, either in one market, or in the market economy as a
whole.3
One little noticed paradox of Walrasian GE is that it abol-
ishes the need for markets! A central planner, with a sufficiently
extensive computer-generated data set on consumer preferences
and producer costs, could just find and implement the equilib-
rium solution. This unfortunate consequence was pointed out
by the Austrian economist Friedrich Hayek (1899–1992). Hayek
guarded against this possibility by famously arguing – in the so-
called ‘socialist calculation debate’ of the 1930s – that information
was diffused through the system of decentralised markets; it was
impossible for even a well-resourced planner to concentrate all the
information arising from market processes at his computer’s finger
tips. It was market transactions which ‘discovered’ the very infor-
mation that Walras assumed all agents had in order to solve his
system of equations.4 Hayek’s argument seems less convincing in
the age of big data and real-time computation.
Although proving the possibility of a general equilibrium may
seem to be nothing more than a playful mathematical exercise, it
seems quite likely that most economists do believe that something
like GE prevails in real life. What Backhouse calls ‘Walrasian for-
malism’ is the bedrock of methodological orthodoxy.5
Self-interest as economics’ gravity equivalent
What is supposed to be the equivalent in economic life of the force
of gravity which keeps the natural world in equilibrium? What is

52
 EQUILIBRIUM

the ‘energy’ that ‘pushes down’ the price of a good in excess supply,
or ‘pushes up’ the price of a good in excess demand? The econo-
mists found the answer in self-interest. An equilibrium is the result
of what purposive, self-interested individuals interacting in mar-
kets achieve through a process of ‘haggling and higgling’.
You will find the germs of this story in Adam Smith. It has, of
course, been refined in the telling. Self-interest remains at the core.
But today self-interest is identified with acting in such a way as to
‘maximise expected utility’. (Some fancy maths will demonstrate
that the requirements for rational behaviour are the same as the
conditions of Walrasian general equilibrium.)
Maximisation (getting the most for least) as a principle of behav-
iour seems so obvious to us today that we find it hard to envisage
a market in which buyers did not try to buy at the lowest price and
sellers did not try to sell at the highest price. Yet this seems to have
been the case in many pre-modern markets, in which the prices of
goods and services were fixed not by the expectation of ‘gaining
on the exchange’, but by custom; and markets were places where
people exchanged goods thought to be of equivalent value, because
they could not produce them themselves. People in such markets
instinctively recognised that they were simultaneously consumers
and producers, buyers and sellers, so that if they spent less, oth-
ers would have less to buy what they produced. Thus the econo-
mist’s idea of intersecting supply and demand curves was alien to
the pre-capitalist mind. That mind conceived of only one curve,
representing the ‘just’ price, and any deviation from it as a sign
of moral disturbance. This, too, was a principle of equilibrium, or
order, with ‘natural prices’ playing the role later assigned to market-
determined prices. But it was entirely static.
Today, the equilibrium achieved by ‘haggling and higgling’
is an approximation to what happens in auction and fresh food
markets and in Arabian souks. However, as a general principle of
market pricing, and particularly in those markets most important
for the working and stability of the modern economy – labour,
commodity, financial markets, and markets for information and
innovation – it is false, because the stationary conditions needed

53
 WHAT’S WRONG WITH ECONOMICS?

for equilibrium are lacking. These markets exhibit momentum and

bandwagon behaviour which cumulatively push prices upwards or
downwards. That is why we get prolonged booms and busts. The
human apple may have a tendency to fall to the ground, but this
tendency is far too weak to be called a law.
Frictions
To explain the sluggish operations of the see-saw, economists have
found it useful to apply the idea of ‘frictions’, another word bor-
rowed from mechanics, which signifies a resistance to the efficient
‘sliding together’ of the parts of the market system. The concept
of frictions does sterling work in protecting the core theory of
equilibrium from attack, by allowing for deviations. When stu-
dents of physics first start to calculate the effects of gravity, they do
so by assuming the object falls in a vacuum. Frictions such as air
resistance can be incorporated into the calculation. So long as the
shapes of the objects remain simple, the frictions do too, and thus
the law of gravitation exhibits high predictability.
But nothing like these conditions exists in economic life. Ideally
Walrasian equilibrium is achieved in a time-free world: it makes
no difference whether you take midday or midnight to be the
zero of time in your calculations. As soon as time is introduced,
which allows processes to work themselves through at different
speeds, the economist is forced to abandon pure Walrasian GE,
and resort to ad hoc explanations for the failure of equilibrium
to establish itself. (We will consider other protective devices in
Chapter 10).
The fundamental impediment to most markets working like
auction or fresh food markets is uncertainty about the future. The
prices of goods in the auction house or grocery store are ‘spot’
prices: prices of goods bought ‘on the spot’ for immediate delivery.
But Walrasian equilibrium requires contracts for future delivery
of goods and services at prices which can only be guessed at.
A great deal of trading in actual markets therefore takes place
at the ‘wrong’, or disequilibrium, prices. This means that equilib-
rium cannot be proved to be the result of a myriad of voluntary

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 EQUILIBRIUM

transactions in markets. Frictions in the social world are much

more severe than those in physics, because they are caused by the
human beings whose behaviour we are trying to explain.
Thus the existence of frictions such as ‘sticky wages’ might
explain persisting unemployment. To the fervent globalist, nations
are frictions to the more perfect integration of markets. When
humans are shown not to possess the properties needed for per-
fect efficiency, they too tend to be regarded as frictions. Humans
are an endless disappointment to economists. They mess up their
equations.
Economic laws, as we have seen, come with health warnings
known as ceteris paribus: the law holds if other things do not
change. In natural science the ceteris paribus limitation is not oner-
ous: it is a reasonable assumption that other things do not change.
In economics this is not true. Where ‘recurring little decisions’ are
all that are involved, economists can estimate demand and supply
functions reasonably accurately.6 But where decisions are unique
and non-recurring the standard models of rational choice, equilib-
rium and so on, break down. Therefore the scope of any economic
law is very much less than the scope of a law in natural science. The
main purpose of this book is to show how much less.
Questions about equilibrium
At this point in the conversation the student should be thinking
of some good questions to put to the economist (or teacher of
economics). First, do economists see equilibrium as a necessary
property of a market system, a benchmark, a logical requirement
for quantitative prediction, or a mathematical ideal: beautiful to
behold but of little practical relevance?
Most mainstream economists would see it as a mixture of the
positive and the normative. They believe in the spontaneous ten-
dency of markets to equilibrium. But they also believe that ‘artifi-
cial’ impediments to this self-adjusting mechanism – like labour
union-controlled wages, over-generous welfare benefits, and erratic
government policies – exist, and should be minimised. However,
some economists have undoubtedly surrendered to the logical and

55
 WHAT’S WRONG WITH ECONOMICS?

aesthetic beauties of the concept of equilibrium. They love it for its

own sake.
Here is a second question. If the pendulum is set in motion by an
impulse (‘shock’), how long does it swing before it stops swinging?
In other words, how long are periods of disequilibrium supposed
to last? Equilibrium will be restored ‘in the long run’. How long is
the long run? Just long enough for equilibrium to be restored! The
assumption in financial markets is that it is almost instantaneous.
As the trader tells it, ‘the long run is what we are going to have for
lunch’. Contrast Keynes’s reminder that, ‘In the long-run we are all
dead’.
Thirdly, does the notion of pendulum swings have any power to
explain the actual movement of prices and output through time? In
other words, is the ‘normal’ condition of the economy one of equi-
librium or disequilibrium? Joan Robinson (1903–1983) stressed
the contradiction between equilibrium and history, between the
swinging of an economy between points of equilibrium, and the
forward movement which time imposes. Time, she argued, is irre-
versible: innovation builds on innovation. Certainly it seems hard
to reconcile the neoclassical equilibrium model, which assumes
‘normal’ returns to scale, from which economies occasionally devi-
ate, with the classical growth perspective, in which the economy is
continually accumulating capital and technology.
z
So what is the status of equilibrium theory today? Duncan Foley
believes in the ‘immense scientific value’ of equilibrium concepts.7
I would argue rather that it has a baleful influence, by encouraging
economists to think that the market system is automatically self-
correcting and therefore not requiring policy intervention.
Formally, equilibrium represents a state of affairs in which
resources are so allocated that market-clearing prices prevail all
round, and no one has any incentive to change their position. This
is an ‘optimum’ equilibrium, in the sense that the economy is at
its production possibility frontier (PPF) and all are satisfied with
‘what they’ve got’. However, within this equilibrium framework,

56
 EQUILIBRIUM

economists toy with several different concepts of equilibrium,

depending on what they want to explain. Static equilibrium is of
the Walrasian kind, relating supply, demand, and price at a single
moment of time. Dynamic equilibrium takes past and expected
future values of the variables into account in explaining the adjust-
ment process. The stationary state is a kind of equilibrium in which
the economy simply reproduces itself. This translates into the idea
of balanced growth, with population and capital increasing at
roughly the same rate and preferences staying constant.8 Partial
equilibrium traces the adjustment of supply to demand in a par-
ticular market in isolation from the rest of the economy.
Joseph Schumpeter contrasted static and dynamic models.
Statics refers to an economy of given, known, and constant external
conditions, such as tastes and technology. This has no resemblance
to modern market economies. In dynamic analysis, external condi-
tions not only change but such change is fundamental to a capital-
ist economy. Entrepreneurs try out innovations which in a process
of creative destruction replace tried methods: ‘increasing destruc-
tion of age-old relationships for the sake of profit’.9 Schumpeter, like
Marx, understood that technological progress is endogenous: it is
impelled by the logic of competitive, profit-maximising capitalism.
Cyclical theories are a long-run type of equilibrium theory. The
capitalist economy experiences waves of innovation, each one of
which eventually exhausts itself like a receding tide. Karl Marx was
an equilibrium theorist in this sense, with the profit rate waxing
and waning with the size of the ‘reserve army of the unemployed’.10
Keynes challenged the idea that an economy is always at, or
tending towards, an optimum equilibrium of the Walrasian kind.
His equilibria need not be optimal, but they are equilibria none the
less. Keynes pointed out that the economy does not correct itself
through relative price adjustments as mainstream equilibrium the-
ory claims. Rather there are uni-directional, economy-wide, move-
ments of output and employment, so that it is ‘quantities not prices’
which adjust, pushing economies to inferior equilibria, in which
all income earned is spent, but some factors of production are left
without any income at all. Uncertainty is key to generating such

57
 WHAT’S WRONG WITH ECONOMICS?

equilibria, with a fall in investment prospects producing a flight to

liquidity rather than a fall in interest rates. There has always been
a debate about whether a Keynesian equilibrium is anything more
than a short-period phenomenon.
Economists in the Keynesian tradition, including Nicholas
Kaldor (1908–1986), Gunnar Myrdal (1899–1987), George Shackle
(1903–1992), Giovanni Dosi (b.1953), as well as many in the
Austrian school, such as Ludwig Lachmann (1906–1990), have
tried to break out of the straitjacket of equilibrium. Innovation
is a fertile field for dynamic analysis. One can’t know in advance
about the effects of innovation because it hasn’t yet happened. New
knowledge builds on prior knowledge so you get an accumulation
of positive feedbacks which push the economy ever further from
equilibrium. Innovation builds ‘first starter advantage’ analysis into
explanations of economic growth.
To sum up: without making unrealistic assumptions about
human behaviour, and without assuming stationary conditions, the
existence of an equilibrium of supply and demand, either in single
markets, or in the system as a whole, cannot be demonstrated. There
is nothing in the ‘market’ akin to the law of gravity. There is no coer-
cive force behind the policeman’s authority. In a famous exercise,
Nobel Laureates Kenneth Arrow (1921–2017) and Gerard Debreu
(1921–2004) specified with great mathematical rigour the condi-
tions under which a market economy could achieve perfect alloca-
tion of resources. These included perfect information, no frictions,
no public goods, consistent preferences, as well as complete com-
petitive markets which include all contingent and future contracts.11
Theirs was a formidable intellectual feat. There are some condi-
tions under which GE is true. But the conditions are too severe
for it to have any general application. The two economists’ health
warnings against GE’s practical usefulness are so muted that it
would surely have been better to have said straight out that GE was
a mental fantasy, despite the great pleasure they derived from the
challenge it presented to their mathematical and logical skills.
How then to explain the continued hold of equilibrium model-
ling? The most important reason, as we have suggested, is physics

58
 EQUILIBRIUM

envy. But the certainty of physics can be achieved only by making

heroic assumptions about human behaviour.
There is also a strong ideological motive. If markets are natu-
rally self-balancing, they don’t need governments to balance them.
Governments, rather, appear in this account as one of the frictions
preventing markets from working optimally. (Unless, that is, one
assumes an omniscient government, which most economists have
been understandably reluctant to do.) Thus the notion of equilib-
rium reinforces the anti-statist thrust of economics.
But there is something deeper than that, which is not unique to
economists. This is the conviction that underneath the messiness
of appearances there exists an underlying order that can be cap-
tured by logic and mathematics: a conviction that goes all the way
back to Plato (c.428–348 bc), and in modern philosophy to René
Descartes (1596–1650). Equilibrium is thus a mental construct to
explain a feature of social life whose explanation is not evident at
first sight, viz. its apparently spontaneous orderliness.
It is undoubtedly true that markets are not violently disorderly.
Even their oscillations exhibit certain patterns and regularities.
Where do these (weak) principles of order come from? For Adam
Smith the world was a providentially ordered cosmos. We no longer
believe the order comes from God, so we invoke reason. We then find
that individual rationality is not enough to guarantee equilibrium in
the face of uncertainty. But there may be an alternative explanation
for the orderliness of markets, to be found not in the rational behav-
iour of ‘maximising’ agents, but in mutually reinforcing social con-
ventions or politically coordinated action. The gravitational forces, so
to speak, are external and not internal to the market.
Thinking about equilibria and disequilibria prompts one to
reflect that if balance exists in economic life it is part of the wider
balance of social life evolved to prevent society itself from explod-
ing. It expresses itself in the tendency of an excess in one direc-
tion to produce a reaction to its opposite. It is in this, but only in
this sense, that the tendency to equilibrium can be thought of as
natural. But this tendency is far too complex to have the precision
required for a prediction of specific events.

59
 5
MODELS AND LAWS

When faced with incomprehensible phenomena the human

mind gives forth hypotheses, the most plausible, convenient
or expedient of which are dressed up into a theory after
which tranquillity may be restored . . . this chaos of jarring
and discordant appearances brought to order, this tumult
of the imagination allayed.
Adam Smith, Essay on Astronomy1

According to Paul Samuelson it is economics’ ability to make

quantitative predictions that makes it ‘the queen of the social sci-
ences’:2 its theories are engines for generating predictions, which
can therefore become the basis of successful policies. The challenge
for economics has always been to ‘model’ economic life in such a
way as to generate reliable predictions. The standard technique is
to isolate a single motive for action, and deduce its consequences
by excluding the influence of other possible motives. This is no
different from the technique of other social sciences: for example,
political science takes love of power to be overriding. What makes
economics ‘queen’ is that its subject matter is what Marshall called
‘measurable motives’ – motives whose strength can be measured
and compared on the single scale of money. No other social sci-
ence has found a way of bringing disparate quantities of stuff into
such precise relationships with each other. As Lionel Robbins put
it: ‘Scientific generalisations, if they pretend to the status of laws,
must be capable of being stated exactly.’3 Furthermore, predic-
tions stated in terms of quantities of money can be properly tested.

60
 MODELS AND LAWS

Hence, economic generalisations are said to be open to improve-

ment in a way that generalisations in other social sciences are not.
Economic generalisation can be falsified; generalisations made by
other social scientists remain matters of opinion.
How do economists seek to establish their so-called laws? There
are two main theories of knowledge in economics (as in all sci-
ences, natural and social): the inductive and the deductive. The
empirical theory sees economics as reliant on induction, testing,
and refutation. The logical theory portrays economics as a system
of logical deduction from axioms – premises ‘known to be true’.
Provided the axioms are correct, the results will follow. The actual
practice of economics is a compromise between these two views.
Logical reasoning is at its heart. But its premises are not entirely
plucked from the air, and it tries to test the validity of its conclu-
sions against real-world outcomes. There is a third view, to which
few economists subscribe, which treats economics as a branch of
rhetoric, engaged not in the science of discovering truth, but the
art of persuading people of the truth of its own utterances, and by
persuasion causing them to behave in a desired way.

Modelling
The answer to the question of how economists seek to establish
their laws is through modelling. Modelling is the act of creating a
simplified theoretical structure to represent real-world events. In
economics, this structure is now overwhelmingly mathematical,
with three parts: input variables, a logical process that links them,
and an output variable.
Economists claim that building a model is like drawing a map:
the object is to leave out cluttering matter, while leaving in place
crucial information. A model that is just as complicated as the
world is of no use at all, just like a 1:1 map. Economic reality –
whatever that is – is too complicated to be directly interrogated;
so it must be simplified to the point of caricature. Critics argue
that this is simply a rhetorical ploy. The open world is ‘modelled’ as
closed, not to simplify reality, but for mathematical convenience.

61
 WHAT’S WRONG WITH ECONOMICS?

The issue is what to include in the map and what to leave out.
What one includes in the map depends on what one wants to do.
If it is to get from one place to another as quickly as possible the
map will highlight coastlines, motorways, express railway con-
nections, and airports. A more leisurely itinerary will require a
map with scenic routes. If the modeller wants to map a social ter-
rain, he might populate the map with individuals, and leave out
firms and classes, or he might include these. All of this, of course,
leaves the modeller, like the map maker, considerable latitude to
choose which features of ‘reality’ to emphasise. There is ample
room for ideology. Neoclassical economics claimed it rediscovered
the individual buried under the institutional lumber of Marxist
theorising.
Models start with hypotheses, which then have to be tested
by experiment, or by some other means if experiment is impos-
sible. This is as true of natural science as of economics. Physics has,
in nature, its own ready-made laboratory, where events regularly
repeat themselves. The social world lacks such stationary features.
The standard economic model is typically a theoretical representa-
tion of a closed system. But to model an open system as though it
were a closed system ‘introduces a damaging rift between ontology
and epistemology – i.e. between the way the social world actually
is, and the way it is represented in economic models. Once in place,
the rift cannot be healed.’4
Economists use many techniques to ‘close’ open systems, of
which the following are the most important. First is ceteris paribus
– working out the consequences of a particular change by ‘freezing’
the other variables specified in the model. David Ricardo’s Essay
on Profits (1815) is an early explicit example of its use: ‘We will . . .
suppose that no improvements take place in agriculture, and that
capital and population advance in the proper proportion . . . that
we may know what peculiar effects are to be ascribed to . . . the
extension of agriculture to the more remote and less fertile land.’
This technique gives you a single starting point leading to a single
destination. A second stratagem is to remove potential distur-
bances from the model entirely by calling them ‘shocks’ – random

62
 MODELS AND LAWS

events ‘exogenous’ to the model. A favourite is a technology ‘shock’.

This preserves the predictive power of the model itself, while
allowing for failure of a change in the input variable to produce the
predicted change in the output: ‘non-linearity’ in maths-speak.
A third stratagem, which we have already noticed, is the concept
of ‘frictions’. This allows for any lags in the adjustment of the dif-
ferent parts of the model to a change in the input variable. It is
closely related to the idea of ‘transitions’ and the short-run/long-
run distinction.
Thus the introduction of machinery may make workers redun-
dant in the short run. But it sets in motion forces which will pre-
serve employment in the long run. Given that economists want
to achieve a high level of model predictability, these are perfectly
legitimate stratagems. But the predictability is too often achieved at
the expense of realism – the models are, in effect, rendered immune
to criticism. With the increasing use of formal mathematical mod-
elling, the zones of exclusion become ever larger. The subject mat-
ter of the enquiry comes to be defined by the requirement of model
tractability.
There are three main views of how to construct economic mod-
els. The first says you must start with ‘realistic’ assumptions or your
models will be merely fanciful. Second, in his influential paper, The
Methodology of Positive Economics, Milton Friedman (1912–2006)
claimed that the important question is not whether the assumptions
of a model are realistic, but whether the model yields good predic-
tions. Any premise will do. If it happens to hit the nail on the head,
one can test for whether this was a coincidence or a causal law. The
third stresses the deduction of conclusions from self-evident axi-
oms. (Malthus’s population theory as described in Chapter 3 is an
example.)
The following questions arise. Are models to be thought of as
descriptive or prescriptive? Do models aim to show how people
behave or get them to behave as the modeller thinks they ought
to behave? The normative or prescriptive purpose of modelling is
hardly ever acknowledged, because economics is supposed to be
‘scientific’ and ‘value-free’.

63
 WHAT’S WRONG WITH ECONOMICS?

The economist Jevons put one view of the task of economics

simply: ‘The investigator begins with the facts and ends with them.’
In his conception, there are three stages in model-building: the
inductive hypothesis, the deduction of a conclusion, the testing of
the conclusion against reality.5
The process may be illustrated as follows. An observation sug-
gests a ‘conjecture’ or ‘hypothesis’ as to why something may be the
case. You then develop a theory which involves establishing a causal
link between your conjecture and other factors called variables. The
deductive stage involves working out the logical consequences of
your hypothesis. You then test the conclusion against reality. Jevons
realised that a deductive argument can do no more than link a set
of premises to a set of conclusions. If the assumptions are unrealis-
tic, the conclusions (predictions of the model) will not hold in the
real world. So in his view the assumptions need to be realistic.
A standard workhouse model in modern macroeconomics
is the Phillips Curve. The statistician A.W. Phillips (1914–1975)

Observe facts of
experience

Frame hypotheses Reason deductively Attempt to verify

about laws governing from hypothesis to deductions so that
those facts expected results results fit reality

Examine results in
Results and Results and
connection with facts
facts conflict facts coincide
in question

Look for disturbing Hypothesis Reasoning

influences abandoned confirmed

4. The Method of Modelling.

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 MODELS AND LAWS

noted (1958) an empirical relationship (‘correlation’) stretching

from 1861 to 1957 between inflation and unemployment.6 This
suggested that governments could ‘trade off ’ a bit more inflation
for a bit less unemployment, and vice versa.
The problem with the original Phillips Curve was the disap-
pearance of the postulated trade-off between inflation and unem-
ployment in the later 1960s. To explain this ‘change in the facts’ a
hypothesis was suggested: rational agents ‘learn from experience’.
They come to realise that the current inflation rate is the rate they
can expect and adjust their wage-bargaining behaviour accordingly.
This resulted in the ‘expectations augmented’ Phillips Curve, which
predicts that over time, government attempts to reduce unemploy-
ment by allowing a bit more inflation lead only to accelerating infla-
tion. Notice that in this model there is no attempt to investigate
changes in institutional facts (in trade union organisation, historic
levels of unemployment, among others) which might explain the
breakdown of the original Phillips Curve: the single postulate of
‘utility maximising behaviour’ does all the work needed.
A close inspection of this procedure points to some of the dif-
ficulties inherent in model construction.

1. What is the status of the ‘facts of experience’? Are they based

on casual observation, observed regularities, interpretations of
the facts, or known a priori? In other words, are they already
‘contaminated’ by prior conceptualisations? – for example, that
human behaviour is rationally calculated?

2. What lies behind the inclusion of some, and the exclusion of

other, possible causal variables? What, in other words, guides
the modeller’s judgments of relevance?

3. What constitutes verification? Results are rarely black and

white, so how dark a grey can we accept? How large a pile of
‘disturbing influences’ is it possible to accumulate before the
theory is more exception than rule, and should be abandoned?
What if the results and facts appear to coincide, but do so only
by chance?

65
 WHAT’S WRONG WITH ECONOMICS?

The facts of the matter

In practice, economists almost never start with the facts; there are
too many. Nor do they normally start with ‘vigilant observation’:
numbers arranged as statistical series from which they try to dis-
cern patterns and suggestive anomalies. They start with a hypoth-
esis and then try to prove it. The hypothesis is not ‘plucked from the
air’. Nor is it based on systematic observation, even though econo-
mists often appeal to the ‘indisputable facts of experience’. Rather,
it is based on the claim to ‘direct acquaintance’ or ‘intuitive’ knowl-
edge of how humans think. Ronald Coase (1910–2013) recalled the
English economist Ely Devons (1913–1967) saying to him, ‘If econo-
mists wished to study the horse, they wouldn’t go and look at horses.
They’d sit in their studies and say to themselves, “What would I do
if I were a horse?” And they would soon discover that they would
maximise their utilities.’7 This joke gives a profound insight into the
economic method. Economists see themselves as forming their the-
ories by looking into the minds of their subjects and seeing how they
think. This is what enables them to make sharp predictions about
their behaviour. ‘Vicarious problem solving,’ writes Nobel Laureate
Thomas Schelling (1921–2016), ‘underlies most microeconomics.’8
So economists’ models may be interpreted as starting with intu-
itions about what goes on in the horse’s mind.9 They claim they are
merely formalising ‘models’ which are already ‘there’. But this may
not give you a good way of understanding behaviour. The chances
are they have put into the mind of the human horse what they want
to find there. So a key question concerns the relationship between
the economists’ hypotheses of human behaviour and how humans
actually behave. Are economists’ models intended as replications or
simplifications of actual behaviour, or are they intended to create
behaviour consistent with the economists’ models – to create self-
fulfilling prophecies, so to speak? It seems pretty obvious that eco-
nomic models are intended to be both descriptive and prescriptive,
wobbling between claims that this is how humans behave in fact,
and this is how they should behave, both converging on a predic-
tive claim.

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 MODELS AND LAWS

Paul Krugman (b.1953) has described the model-building pro-

cess as follows: ‘You make a set of clearly untrue simplifications to
get the system down to something you can handle; those simpli-
fications are dictated partly by guesses about what is important,
partly by the modelling techniques available. And the end result,
if the model is a good one, is an improved insight into why the
vastly more complex real system behaves the way it does.’10 The
argument here is that economists need the untrue simplifications
to get the generalising machinery going. But it can be argued that
heroic (untrue) assumptions should have no place in a discipline
intended to be useful. To start off one’s reasoning with a basic
premise (axiom) that is immune to challenge cannot justify cer-
tain knowledge of a conclusion, unless one (irrationally) accepts
the premise as true.11
Macroeconomic models have tried to get beyond ‘untrue sim-
plification’. The economist Nicholas Kaldor wrote,

The theorist, in my view, should be free to start with a ‘stylized’

view of the facts – i.e. concentrate on broad tendencies, ignoring
individual detail, and proceed on the ‘as if ’ method, i.e. construct
a hypothesis that could account for these ‘stylized’ facts, without
necessarily committing himself on the historical accuracy, or
sufficiency, of the facts or tendencies thus summarized.12

A good hypothesis accounts for the stylised facts. Kaldor’s was

a notable attempt to ground macroeconomic models in ‘vigilant
observation’ rather than ‘inner understanding’ of human nature.
However, an over-enthusiastic reliance on stylised facts may lead
the modeller seriously astray when the facts change.
All economic models have a tight logic, amounting to math-
ematical proof of the conclusion. The name of the game today, as
depicted by Nobel Laureate Robert Lucas (b.1937), is to ‘get logi-
cally consistent mathematical conjectures of various degrees of
complexity’. But economics cannot live by logic alone. To be useful
a logical argument has to be based on true beliefs about something.
Logic can tell you nothing about the real world; it can only tell you

67
 WHAT’S WRONG WITH ECONOMICS?

about itself. Students should be aware of the pitfalls of reasoning

a priori: the argument ‘If all swans are white, and X is a swan; there-
fore X is white’ is valid in logic, but not in fact since not all swans
are white. If the starting point was that ‘most swans are white’, then
one will know more about what colour swans actually are but won’t
be able to make a definite prediction about the colour of the next
one encountered.13
The most important name in the philosophy of testing is the
Austrian philosopher Karl Popper (1902–1994). Popper believed
that what demarcated science from non-science was not whether
theories could be proved but whether they could be falsified.
Popper’s point was not that verification is less powerful than falsi-
fication, but that it is impossible. Scientific laws claim to hold true
universally, and to verify a universal statement is impossible for
finite minds.
However, falsification is also rarely possible. Even in the nat-
ural sciences there can be no conclusive disproof of a theory in
the strict logical sense that Popper wants because it is difficult to
know which of several hypotheses you are falsifying.14 It is always
possible to say that the experimental results are not reliable, or
that the discrepancy between observation and fact will disappear
with the advance of understanding, rather like Cesare Cremoni’s
doubts about whether Galileo’s telescope had been tampered
with.15 Although a lot of scientists still swear by Popper, among
philosophers of science his view has long been rejected. The prob-
lem, as Lakatos pointed out, is that scientists don’t reject theories
the moment they encounter problems; they construct ‘auxiliary
hypotheses’ to account for the disconfirming instance.
Popper believed that his verification principle applied equally
to the natural and social sciences: in fact, he failed to distinguish
between the two. But falsification in economics encounters even
worse problems than in any natural science, because the ubiquity
of the ‘other things staying equal’ condition serves to immunise
an economic theory against the disturbing influence of untoward
events. One can get robust predictions only by waving away the
disturbing causes.

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 MODELS AND LAWS

Testing hypotheses in economics encounters the general prob-

lem of testing faced by all social sciences. First, although one can,
with some difficulty, do experimental work on a small scale, it is
impossible to experiment with whole economies; the second is the
weakness of econometrics, the substitute for experiment.
Economists are mostly debarred from using the experimental
method, typical of applied natural sciences like medicine, to test
their hypotheses. Suppose you invented a new drug which you
expect to lower cholesterol. How would you test for it? In a labora-
tory test you could secure the equivalent of the ‘vacuum’ situation
by ensuring that the two sets of lab rats are subjected to identical
conditions, except that only one group is given the drug. If the out-
come between the two groups is identical this would amount to a
refutation of the hypothesis, calling for a new one. A difference of
outcome would corroborate the hypothesis that the drug lowers
cholesterol. But it would not confirm that it does so in all, or even
most, conditions, because these have been equalised by design. So
no irrefutable ‘law’ has been established, but perhaps a useful indi-
cation, which can be further refined.
The technique of randomised control trials, borrowed from med-
icine, suggests a way round the difficulty of conducting controlled
experiments with rats. In the lab experiment you have taken steps to
ensure identical initial conditions. But you might achieve the same
result by administering tests to individuals selected at random –
that is, those whom you have no reason for thinking are different in
any relevant respect. The trial then proceeds in the same way. Divide
your test subjects into two groups, at random, then administer a
‘treatment’ to only one of the groups, and compare the results.
This method was used to evaluate the famous PROGRESA
scheme in Mexico, which involved providing cash transfers to
households for sending children to school. The finding was that
more education resulted in higher wages. It is unlikely that a trial of
this kind would satisfy a convinced Popperian, but it is fit enough
for purpose.
The randomised evaluation of public policy interventions
works well in fields like public health economics, where one can

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 WHAT’S WRONG WITH ECONOMICS?

plausibly assume equal susceptibility to disease and interventions.

It has been used to develop effective vaccines for treating pneumo-
nia and meningitis in developing countries.16 But it is useless for
testing the effect of interventions in ‘open’ systems, where the con-
stancy of the underlying structures cannot be plausibly assumed.
Each country has its own particularities of geography, climate, cul-
ture and institutions, so would make poor experimental controls.
Even if this were not the case, the sample size would be too small
to draw the types of robust conclusion required.
Econometrics
By far the most prominent testing technique in economics is econo-
metrics. The economist Guy Routh described it as ‘mock empiri-
cism, with statistics subjected to econometric torture until they
admit to effects of which they are innocent’.17 Econometrics is a
kind of statistics, but one in which empirical evidence enters not as
a foundation for the argument, but as a health-check on the conclu-
sion. It is used not to display the facts of the world in statistical form
but to test the statistical significance of the relationships hypothe-
sised by the model. We run a regression to estimate the quantitative
influence of the independent variables on the dependent vari-
able, according to a model specification set out by the researcher.
Typically, this amounts to assuming a linear (straight line) relation-
ship between the independent variables and the dependent variable
(or some transformation of it).
Two problems are commonly raised with econometrics. Firstly,
it is almost impossible to isolate the hypothesis which needs to
be tested from the many other hypotheses which have had to be
assumed in order to make the test possible. This includes the pos-
sibility that there might be a circular relationship, where the vari-
able you have assumed is purely dependent exerts influence on the
independent one, or that important aspects of the relationship are
omitted from the model. This objection highlights the fact that a
correlation (the association in time of two events) tells you nothing
about the causal relationship between them. A celebrated example
of an econometric ‘proof ’ which has failed to escape from the trap

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of circularity is the claim by Alberto Alesina (b.1957) that cutting

government spending in a slump causes economic recovery.18
Secondly, time-series cannot establish the laws which econo-
mists seek. If the time-series is too short, there is not enough data.
If it is long enough, the conditions are not stationary. So something
true at one time may not be true at another. The heterodox econo-
mists are right. All so-called economic laws are dependent on time
and place.
There can also be too few observations. Studies by Harvard
University’s George J. Borjas and others suggest that net immi-
gration lowers the wages of competing domestic labour. Borjas’s
most famous study shows the depressive impact of ‘Marielitos’ –
Cubans who emigrated en masse to Miami in 1980 – on domestic
working-class wages. In reply, others pointed out that there were
sampling issues: the census bureau had recently made an effort to
sample more black males, who tended to have low incomes, and
the sample was too small not to be swayed by this. Borjas in turn
accused his critics of bad faith.19 Far from clarifying the matter,
econometrics had spun everyone around in circles. There are too
many examples of studies whose econometrics were subsequently
discredited, either by spreadsheet mistakes, or cognitive bias.
These problems point to the fundamental weakness of econo-
metric testing: that the conditions needed for its success arise
only in controlled experimental situations. Most econometricians
recognise that these conditions fail to hold strictly but proceed as
if this wasn’t important. They fail to understand that the very act
of writing papers in learned journals using these techniques gives
authority to faulty procedure. Students are told: if everyone does it
this way, it must be right. Economists’ health warnings are like the
small print in a statement of business accounts which no one reads.
Modelling complexity
Following the crash of 2007–2008, there has been a surge of inter-
est in how best to model ‘complex’ systems. This stemmed from
the realisation that the simpler models like the ‘efficient market
hypothesis’ completely failed either to foresee or understand the

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crash. ‘Complexity refers to the density of structural linkages and

interactions between the parts of an interdependent system’.20 In
other words, because there are so many relationships and poten-
tial feedback loops between variables, even small changes have the
potential to produce large knock-on effects. This not only makes
it difficult to understand the system intuitively, but also excludes
traditional modelling techniques which generally require sparse
structural linkages. The chief approaches to understanding com-
plexity are agent-based modelling, network analysis, and system
dynamics.
Agent-based modelling tries to avoid fallacies of composition
that would occur by using the ‘representative agent’ hypothesis,
which assumes that the entire economy can be represented by a
single individual who thinks like everyone else. Instead, it simu-
lates the actions and interactions of a multitude of agents who
may have different characteristics and display adaptive behaviour.
The modeller sets up relationships between the agents and defines
the conditions of their world. The fictional agents are then left
to interact, possibly under a shock or change in conditions of
some kind. The simulated outcomes churned out thus constitute
the results of the model. These outcomes can serve as indicators
of what will happen in the real world without the need for further
interrogation.
Network analysis studies economic networks, which are ‘webs’
whose nodes represent economic agents (individuals, firms, con-
sumers, organisations, industries, countries, etc.) and whose links
depict market interactions. This is useful for studying the rise of
networks in the global supply chain. The most important networks
today are programmed computer networks.
System dynamics, derived from Forrester’s (1971) attempts to
model the world ecosystem, take a similar approach but focus on
links between aggregate variables rather than agents. These can be
economic variables such as GNP or capital stock, but could also
refer to physical quantities such as forested areas or oil stocks,
which has made this technique particularly popular in ecological
economics.

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Although an improvement on mainstream methods, these tech-

niques presuppose the same atomistic ontology in order to gener-
ate their predictions. They must in turn make assumptions about
behaviour and relationships. These may be based upon observa-
tion, intuition, or simply plucked from the air, but must necessarily
be simplified or idealised descriptions of the real world. They will
be internally and logically consistent, but the results largely follow
from the premises: they are not really ‘new knowledge’, and in any
case the ‘art’ of calibrating the model is often what really generates
the results. The chaos of the interacting agents and conditions can
throw up vastly different results even from the same initial condi-
tions, so the best a simulation can do is act as a useful guide to the
range of possible outcomes, and shed light on the dynamics of the
system.
It might be tempting to apply the well-known aphorism ‘gar-
bage in, garbage out’ to economic modelling. Certainly there are
cases where this is true, but it does not apply universally. The pur-
pose of the modelling exercise is key: if precise predictions of real-
world outcomes are desired, models are likely to disappoint, except
in special situations. If they are intended as tools to investigate the
consequences of certain assumptions, clarify thinking, and make
general claims about how events might respond to certain actions,
they are useful.
Platonic modelling
Economists may construct models as ideals, just as a model in
ordinary language can mean not a simplification (as in a model
aeroplane) but an ideal of goodness or beauty: perfect ‘forms’, of
which objects in the everyday world are imperfect copies. Platonic
models are pictures of what reality might be like if it attained to an
ideal state. One can think of them as ‘benchmarks’. To the econo-
mist this means a state of perfect efficiency: the efficiency of a per-
fectly frictionless machine. They have a powerful ally in computer
technology, able to assemble and process masses of data in ‘real
time’. This promises to realise, at no distant date, the economist’s
vision of the human as a perfect calculating machine.

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 WHAT’S WRONG WITH ECONOMICS?

The writings both of neoclassical economists and technologi-

cal utopians reveal the prescriptive nature of their callings. They
are allies in their ambition to ‘make the crooked timber of human-
ity straight’. So economists’ theories are meant to inspire greater
efficiency. There is some evidence that the prescription works. In
a marvellous book, I Spend Therefore I Am, Philip Roscoe (2014)
reports studies which show that students of economics were mark-
edly more calculating than those of other subjects, though whether
it was their calculating nature which drew them to economics,
or economics which made them more calculating, is not clear.
‘Rational expectations’ models are examples of such ideal model-
ling. They assume that economic agents are perfectly rational and
perfect processors of their information. The assumption hides the
hope that in time people will come to behave in the way the ideal
model says they should.
Science versus rhetoric
Deirdre McCloskey is the best-known exponent of the view of eco-
nomics as rhetoric. Coming from a mainstream economics back-
ground, she denies that economics can prove its arguments, because
there is no possibility of falsification. There are no true or false argu-
ments, only persuasive and unpersuasive ones. Maths is neoclassical
economics’ most emphatic metaphor: the economic researcher has
only to produce a correlation, and the statistically unsophisticated
are persuaded he has discovered a cause. Nevertheless, McCloskey
believes that the rhetorical character of neoclassical economics is
socially useful, because it strengthens the case for free markets.21
To say that economics is purely rhetorical is to deny that there
is a reality outside the language of persuasion itself. How does
rhetoric work? It normally starts with an appeal to some thought
or prejudice already in the mind of the audience, like ‘we all know
that . . .’ The rhetorical articulation of this ‘common sense’ makes it
consciously common. This, as we have seen, is precisely the way all
economic arguments start, with the ‘facts of experience’ being the
‘premises’ of the deductive logic. The rhetorical character of this
procedure is disguised by the claim that what ‘we all know’ is true.

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Economics has to assert the truth of its premises to generate its

prized ‘quantitative predictions’. But this is a rhetorical device. The
‘facts of experience’ cannot provide the universal premises neces-
sary to demonstrate the truth of the conclusion. There are too many
contrary facts. This does not make the conclusion utterly false. It
makes the argument incomplete. Rhetoric is the art of incomplete
argument, a ‘heuristic’ device, or story, to point the mind in the
right direction. In this sense all the social sciences are rhetorical.
This simply means that the conditions required to make them uni-
versally true do not hold, or only hold under special conditions.
They are only partially true.
The claim that economics is rhetoric has been heavily influenced
by post-modernism, the movement which has dominated cultural
studies since the 1980s, which claims that all arguments in the
humanities are of the persuasive rather than demonstrative kind.
As Jacques Derrida (1930–2004) put it, ‘there is no outside text’:
there is no reality outside the circle of language. Post-modernist
literary criticism ‘deconstructs’ the ‘text’ by shifting attention from
the truth of what is being asserted to the means by which people
are persuaded of its truth. From this perspective, economic model-
ling is a persuasive undertaking: it does not aim to discover truth,
it tries to persuade people of the truth of its own ‘text’. All reality is
‘socially constructed’.
Philip Mirowski carries the argument further by saying that
natural sciences, too, are built on persuasive utterance. There is a
fundamental gap between our thought and reality which can only
be bridged by metaphor, simile, analogy. Logical proofs are part of
the persuasive machinery.22
There are three valuable implications of this approach. First, it
emphasises that stories or narratives are the ways in which people
try to make sense of complex situations. They assume, that is, that
much social landscape is mysterious, or uncertain. Their ways of
making sense of it should not, therefore, be considered irratio-
nal, but rather reasonable in the circumstances. Second, it points
out that belief in the story rests on confidence in the story-teller.
This is undoubtedly true: knowing that our own predictions are

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worthless, we rely on the testimony of those supposedly better

informed. Third, while the stories are not the engines of prediction
envisaged by Samuelson, they illuminate problems which escape
formal modelling. The question, then, is whether economic model-
ling can improve significantly on story-telling or whether it is part
of the story-telling.
McCloskey is almost unique among methodological critics of
mainstream economics in viewing the overall programme of the
mainstream as a success. Economics may be rhetoric dressed up
as science, but its effects are positive. Quite simply, it tells the right
story. Unlike most of those who think of economics as rhetoric,
McCloskey believes that the market system has ensured progress
and prosperity. The scientific pretensions thus take on a life of their
own; they are not methodological mistakes, but choices of com-
munication strategy which allow economics to be seen to be con-
sistent with the dominant scientific-rational mode of engagement
with the world.
However, the claim that economics is just rhetoric is itself rhe-
torical, because it fails to distinguish between what makes some
arguments persuasive and others unpersuasive. Economists may
tell stories, but these are stories about something. They may be
reflections of folk stories, but where do these stories come from?
The stories we tell each other may not be the complete truth, but
an incomplete argument is not the same as one that is just made up.
It has to have some basis in experience and evidence. Without it,
it would not be persuasive. The point to remember is that eco-
nomics is not the only ‘text’ in the social sciences. There are many
‘truths’ out there about the human condition, of which economics
is just one.
So is economics a science?
Economics is not like a natural science in that it does not, and can-
not, use experimental methods to generate laws. A scientific theory
cannot require the facts to conform to its assumptions, but this is
what economics tries to do. The failures of mainstream economic
theory are not, on the whole, due to the internal inconsistencies of

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its models, but the failure of the models to account for observed
facts. Except in special cases, economics has not advanced beyond
what Rosenberg calls ‘generic’, that is, qualitative, predictions: pre-
dictions of broad tendencies, not of specific events.23
Macroeconomic models have fared particularly badly. The big
Keynesian macro forecasting models broke down in the 1970s,
because the assumed stable relationships between aggregates, like
the consumption function or the relationship between unemploy-
ment and inflation, broke down. Models which start with large
‘stylised facts’ have fallen victim to breaks in trend. For example,
Kaldor’s ‘law’ of a constant wage share in national income fell foul
of globalisation. Verdoorn’s ‘law’ of increasing returns to scale in
manufacturing industry became much less relevant when manufac-
turing ceased to be a major part of production in advanced econo-
mies. The Kuznets Curve, which predicted decreasing inequality
after a period of growth, has broken down, partly because the state
became indifferent to questions of income distribution. Such breaks
in trend – partly at least – reflect changes in behaviour caused by
the discovery of the trend, and the attempt to exploit it for policy
purposes.
It is tempting then to abandon the attempt to map the move-
ment of macroeconomic variables directly, and concentrate on
mapping the supposedly unvarying (maximising) motives of indi-
vidual agents. This, indeed, was the response of the mainstream to
the failure of the Keynesian macroeconomic forecasting models.
Micro-models, it was claimed, would be better forecasters than
macro-models. But this hinged on economists getting human
behaviour right. The failure of the neoclassical financial models to
predict not just the crash of 2008, but even its possibility, suggests
that their account of human psychology was deeply flawed. It was
not just that they got the ‘facts’ of human behaviour wrong; but
that, from the rhetorical point of view, they put much too much
faith in the persuasive power of economic theory to make behav-
iour conform to the assumptions of the model.
The conclusion to which we are drawn is that there are no ‘laws
of economics’ valid at all times and places. At best, theories can

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lead to approximately reliable predictions over such time periods

as other things stay the same. This is true of short periods in par-
ticular markets and in specialised areas such as in health econom-
ics. Macroeconomic forecasts are reliable over very short periods
but not when the parameters are shifting.
One important implication of this is that mathematics plays
an oversized role in modern economics. The role of maths in any
social science is to formalise its logic, and to make specific the rela-
tionships between different variables. But the wholesale formalisa-
tion of economics rests entirely on the premise that the variables of
interest can readily be expressed as mathematical quantities. Many
behavioural facts such as friendship or love of power do not lend
themselves to such treatment. The tight logical relations, therefore,
simply exhibit the theoreticians’ prowess in tight logical reasoning.
As Robert Solow (b.1924) has pointed out, ‘there is enough for
us to do without pretending to a degree of completeness and preci-
sion which we cannot deliver’. The functions of analytic econom-
ics are ‘to organise incomplete knowledge, see connections that
the untrained eye might miss, tell plausible causal stories with the
help of a few basic principles, make rough quantitative judgments
about consequences of economic policy and other events. These
are worth doing, science or not.’24
It’s because economics is not a science that it needs other fields
of study, notably, psychology, sociology, politics, ethics, history to
supply the gaps in its method of understanding reality. We should
not be afraid to say to the economist, ‘There are more things in
heaven and earth, Horatio, than are dreamt of in your philosophy’.
The task is no less than to reclaim economics for the humanities.

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 6
ECONOMIC PSYCHOLOGY

Rational people are people who systematically and

purposefully do the best they can to achieve their
objectives.
Gregory Mankiw, Principles of Economics1

Homo economicus2
To many encountering economics for the first time, the crudeness
of its psychology is disconcerting. The lecturer can barely get past
‘let’s start out by assuming everyone is rational’ before someone
points out that this is quite obviously false. Nor do students take
readily to the idea that they are motivated solely by self-interest,
even if it is said to be enlightened. In this chapter we explore the
economic interpretation of human action, show how far it is from
the truth, and consider why it is so difficult for economists to shake
it off.
Psychology, the study of the human mind, is used by economics
to construct explanations of why market participants behave in the
way they do. Why do these reasons need constructing, when it might
be possible to find out reasons for actions from surveys? The main
reason is that these usually turn out to be too complicated. People
will inevitably end up contradicting each other, and even them-
selves. The standard solution to this dilemma has been to eschew
evidence altogether – to start with assumptions about behaviour
based on the ‘facts of experience’, deduce the logical conclusions
of these assumptions, and present the results as incontrovertible.

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A psychological construct such as utility maximisation ‘allows an

analyst to make predictions in new situations’. Other social sci-
ences, trapped by the non-numerical nature of their subject matter,
can’t do this.3
The fruit of this procedure has been homo economicus, the
human robot or calculating machine. The human robot ‘has the
cognitive capacities of a superhero’: his ‘ability to churn unlim-
ited information and unflinching self-knowledge into instant and
accurate decisions is infallible’.4 Relations with other human robots
are purely instrumental; homo economicus interacts with others,
but is unbound by social ties. His axiomatic character is designed
to ensure the autonomy of economics from history or culture.
If this seems like an unfair characterisation, we need only take
economists at their word. Nobel Laureate Robert Lucas said: ‘My
aim is to construct a mechanical, artificial world, populated by . . .
interacting robots . . . that is capable of exhibiting behaviour the
gross features of which resemble those of the actual world.’5 The
catch is in the claim to capture ‘the gross features’ of the actual world.
Once again we must ask: is this a claim about how humans
actually behave? Is it a prescription of how they should behave?
Or is it a statement of the form ‘if they do behave this way, I can
get my model to work’. In The Economist as Preacher, fellow Nobel
Laureate George Stigler (1911–1991) set out a view of homo eco-
nomicus that was clearly normative: ‘Efficiency in the sense of the
fuller achievement of uncontroversial goals has been the main pre-
scription of normative economics’, because ‘one sets up a perfect
standard to define an imperfect performance’.6
One should always remember that for economists, as for some
other social scientists, humanity has always been ‘work in pro-
gress’. They have seen their task not as describing but improving; as
engineers of the soul not dispassionate students of the mind; their
task being to liberate rationality from the fetters of superstition.
Homo economicus, the rational calculator, would emerge from the
cave of history. So, much of economics must be seen to be about
fabricating the human nature it purports to describe. Nevertheless,
since the stories economists tell of humans are part of the stories

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humans tell about themselves, to some extent humans start behav-

ing in the way economists say they should behave. This is called
progress.
The behaviour of homo economicus
How is homo economicus supposed to behave? Nobel Laureate
Thomas Sargent (b.1943) defines a person as a ‘constrained, inter-
temporal, stochastic optimising problem’.7 The constraint is one
of resources; the optimising takes place over time; and is subject
to random shocks. This leads to the central claim of the rational
expectations school that economists’ models are the formalisation
of models already ‘in the minds’ of persons. Everyone has an incen-
tive to forecast the future. Beliefs about the future (which include
what others are expected to do in the future) affect what people do
today. All agents behave in this forward-looking way. One there-
fore has only to specify the information set possessed by the agent,
and the forecasting ‘problem’ is ‘solved’.
The key to understanding the rational expectations revolu-
tion is that mainstream economists believe they have cracked the
uncertainty problem. Expectations about the future are simply
probability distributions over a sequence of events. Uncertainty
is reduced to probability, and can thus be labelled a special case
of certainty. Economists like Nobel Laureates George Akerlof
(b.1940) and Joseph Stiglitz (b.1943) have pointed to the existence
of ‘asymmetric information’ – situations in which one party to a
transaction has more information than another: a problem rife in
insurance and second-hand car markets.8 But unless such inequali-
ties of information are regarded as inherent, they will be overcome
by computer-generated big data. Provided this is freely available,
all persons will have near-perfect forecasting ability about any
decision they need to make. They will be on an information high-
way linked directly to God.
Homo economicus in action
Here is how the rational basis of criminal activity was revealed to
the economist Gary Becker. One day he was rushed for time. He

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 WHAT’S WRONG WITH ECONOMICS?

had to weigh the cost and benefits of legally parking in an inconve-

nient garage versus in an illegal but convenient spot. After roughly
calculating the probability of getting caught and potential punish-
ment, Becker rationally opted for the crime. Becker surmised that
other criminals make such rational decisions. ‘However, such a
premise went against conventional thought that crime was a result
of mental illness and social oppression’.9
This insight into the criminal mind hardly had to wait on
Becker’s parking problems. It has deep roots in Jeremy Bentham
and the Utilitarians, the thought being that if you raise the cost of
crime and improve policing there will be less of it.10 However, this
insight into the ‘mind of the horse’ cannot be proved statistically. If
we tried to test it we might well find that the crime rate varied with
the number of young males in a population. What they were think-
ing is neither here nor there.
Here are three further examples of homo economicus in action.
The first comes from Becker’s ‘A Theory of Marriage’ (1974). Becker
argued that people marry for the same reason that nations trade:
comparative advantage. Selection of a partner takes place in a
competitive market, and marriages occur only when both part-
ners expect to gain. It’s a very sophisticated theory, constructing
a model of the complementary nature of male and female work,
but ends up treating marriage as little more than a cost-reducing
mechanism. Each partner is assumed to know all the expected pay-
offs from the union over an indefinite future. This is equivalent to
asserting that the marriage market is always in equilibrium, and
thus succumbs to the critique of equilibrium theory in Chapter 4.
To act on the precepts of homo economicus is to renounce love for
the gold one can never be sure of getting.
A second example comes from the work of Jon Steinsson and
Emi Nakamura. Paying someone else to fold your socks, they say, is
a way to maximise your own earnings and those of the sock folder.
Even as penniless graduate students, the two economists borrowed
money to pay people to do their household chores, calculating that
‘spending an extra hour working on a paper was better for their life-
time expected earnings than spending that same hour vacuuming’.11

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Finally, the economists Betsey Stevenson and Justin Wolfers,

pioneers of “lovenomics”, conducted a cost/benefit analysis before
having a child. As Wolfers explains,

The principle of comparative advantage tells us that gains from

trade are largest when your trading partner has skills and
endowments that are quite different from yours. I’m an imprac-
tical bookish Harvard-trained empirical labor economist, while
Betsey is an impractical and bookish Harvard-trained empir-
ical labor economist. When your skills are so similar, the gains
from trade aren’t so large. Except when it comes to bringing up
our baby. There, Betsey has a pair of, um, endowments that
mean that she’s better at inputs. And that means that I’m left to
deal with outputs.

As Stevenson helpfully clarifies, ‘it turns out that fathers can be

pretty good at dealing with diapers’.12
Within the rational expectations framework, these arguments
make a good deal of sense. Assuming, as neoclassical economists
typically do, that what we aim to maximise is our life-time earn-
ings, we must admit that it is irrational to spend time dealing with
matters which cut into our earning power, if we can avoid it. Time
spent on changing nappies is time stolen from inventing, say, new
software (unless nappy changing helps the invention).
Is it rational?
Take our two economists who outsource their house-cleaning. Is
their behaviour really rational? What they are doing is calculating
in terms of money the lifelong consequences of doing one thing
rather than another: writing academic papers to doing house-
work. But they can have only the vaguest idea of what these con-
sequences are. The suspicion must be that the two economists are
simply rationalising their dislike of housework.
Let us take a more winning example than folding socks. Say the
greatest pleasure our economist gets is going to the cinema. But he
calculates that time spent at the movies will reduce the available

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time needed to maximise his earnings as an economist. So he cuts

out, or minimises, going to the movies, that is, he gives up a cer-
tain present benefit to himself for the sake of a doubtful one in the
future. This is not rational because there is no basis for calculat-
ing how much filmgoing he will need to give up to maximise his
income. The prices he attaches to future goods are conventional,
and easily upset by a ‘change in the facts’. It is no use being a conse-
quentialist if you can’t calculate the consequences of your actions.
Economists should spend less time working out the conse-
quences of rational behaviour under conditions of certainty, and
more trying to understand what is reasonable to do in conditions
of uncertainty. This would bring out the rationality and indeed
moral worth of forms of behaviour they are now bound to con-
demn as irrational. They should also take more care to distinguish
situations of imperfect information in which information is con-
tingently incomplete, from situations of uncertainty, in which no
complete information is obtainable under any circumstances.
However, the fundamental objection to homo economicus is
ethical, not epistemic. If, per impossibile, all outcomes could be
assigned probabilities, would there be any objection to thinking of
choice as utility maximisation? The answer is surely yes, because
values cannot be neatly traded off against each other, and therefore
there is no escape from moral choices. We understand the need
for compromise and fine adjustments, but we admire people who
make of their lives ‘songs for singing’.
So, as humans, we should be ready to follow the precepts of
homo economicus when they apply and ignore them when they
don’t. We should certainly not consider this unlovely creature a
general model for behaviour. In many cases it is far better to do
what you want to do, or what you are good at, or what you think is
good, and not waste time on the calculation. We ought more often
to be in the state of mind of not counting the cost at all.
Behavioural economics
Behavioural economics is an attempt by economists to replace the
caricature homo economicus, the human robot, with a more realistic

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actor. As such, it attempts to make use of the insights of psychol-

ogy and neuroscience, hitherto a closed book to the economist.
Behavioural economics does not challenge the idea that behaving
like homo economicus is the best way for individuals to secure their
own well-being. The disagreement comes over the extent to which
this behaviour actually occurs.13 For neoclassical economists, devi-
ations from rationality are assumed to be non-systemic. People
might make errors in estimation, but they overestimate as much
as they underestimate, so it cancels out without altering the over-
all trajectory of the system. Behavioural economics claims to have
uncovered empirically systemic, and therefore predictable, devia-
tions from rationality: situations where individuals consistently
over- or underestimate benefits or costs. They behave like robots
with restricted information.
Behavioural economics came of age in 2002 when the psychol-
ogist Daniel Kahneman (b.1934) got a Nobel prize for the work he
had done with Amos Tversky (1937–1996). It flourishes as a subset
of economics only because the standard behavioural assumptions
of economists have been so thoroughly unrealistic.
Thinking fast and slow
Kahneman and Tversky claimed that we make choices according
to two mental systems, the first intuitive, the second calculating,
which they label fast and slow thinking. Slow thinking is logical;
fast thinking is intuitive, and frequently irrational. They have found
impressive evidence of ‘irrational’ choices – for example, investors’
preference for high-cost actively managed funds which underper-
form zero-cost index funds. Behavioural economists identify the
following ‘systemic’ errors that people make.

1. Survivorship bias
We tend to look only at what was successful. Think of a newspaper
article that claims it can help you imitate Mark Zuckerberg’s morn-
ing routine. The obvious implication is that you too could become a
billionaire if you just wore grey t-shirts and ate the right breakfast,
but this ignores the multitudes of non-billionaires doing just that.

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2. Loss aversion
It is fairly well established that people hate losing something more
than they love gaining it. Dropping a $10 note is more bitter than
finding one is sweet. We are hard-wired, to some extent, to hold on
to what we’ve got. Students given coffee mugs free from the campus
bookstore will not part with them for $6 even though this junk fell
out of the sky, and had they desired them they could have got them
at the nearby store for the price of $6.

3. Prioritising available information

When making decisions, we are likely to weight striking informa-
tion more highly. Shocking, sensational information sticks in our
memories and so plays an outsized role in decision-making. If you
are walking home in the dark, one gruesome news story is far more
‘available’ than all the times you know of people walking home
without trouble.

4. Anchoring
We don’t evaluate things independently of context, and so providing
context can influence a decision. If a shop puts its most expensive
products by the door, everything else seems cheap by comparison.
If something says 50 per cent off, it somehow seems more appeal-
ing than a normal price half as much. People will drive across town
to save $10 on an electronic gadget which costs $50, but not to save
$10 on one which costs $500. Why? $10 is $10. Someone who will
drink wine from his own collection would never dream of buying
the same vintages at current prices of $100 in a market into which
he could easily sell. A much noticed discovery is that the way
choices are framed has an effect on the decision. This is especially
clear in sales pitches. It should be that if something is worth $25 to
you, you buy it, if not, you don’t. But a good ad ‘frames’ the choice
in such a way as to make it seem that you are getting $50 worth of
goods for $25. Quite literally you are being framed! The discovery
that decisions can be manipulated by marketing will seem surpris-
ing only to those who have buried themselves so deep within their
assumptions as to lose sight of reality.

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5. Confirmation bias
This is the most famous. Changing your mind is always annoying.
Much better to just wait until some evidence that confirms your
view comes along! Humans have an amazing ability to rationalise
the decisions they have made out of habit or whim. The inverse to
this is automation bias: thinking that automated instructions must
be correct even when common sense tells you they are wrong. A
bunch of Japanese tourists drove their car into the sea because
their satnav told them they were on a road. Airplane crashes have
happened because pilots trusted their faulty navigation systems
rather than the evidence of their eyes.

6. Sunk cost fallacy

This is a combination of anchoring and loss aversion. People will
keep on ploughing money into a failed investment, because they
can’t face the psychological pain of admitting that it had failed, or
carry on waging a war that they should have abandoned long ago,
because they cannot bring themselves to admit that it was in vain.

7. Hindsight bias
This is central to human thinking and makes the social and eco-
nomic worlds appear much more predictable and less erratic than
they really are. No prominent economist predicted the financial
crisis. Yet almost the next day commentators were rushing in to
explain why it ‘must’ have happened when and how it did. It was the
same with Brexit and the election of Trump. An analogy in everyday
life is when a seemingly happy couple suddenly split up. Everyone
then says, ‘Oh, I always knew there was something wrong there . . .’

These examples upend the central verity of modern econom-

ics, that people always have rational expectations. They often
make choices which they ought to know will leave them worse off.
Advertisers were exploiting this propensity long before economists
started to notice it.
In their book, Phishing for Phools (2015), Nobel Laureates
George Akerlof (b.1940) and Robert Shiller (b.1946) show, with

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many examples both amusing and appalling, that misperception

and deception are rampant in market economies. ‘Phishing’ is a
‘fraud on the internet in order to glean personal information from
individuals’ to get them to do things in the interest of the ‘phisher-
man’ rather than the ‘phools’. The two authors divide ‘phools’ into
two classes – those too emotional to make sensible choices, and
those victimised by misleading information. Modern economics,
say our two economists, should be reoriented to recognise a phish-
ing equilibrium, not a welfare-maximising equilibrium. A defence
of markets that rests on the premise that consumers know what
they are buying won’t work if they don’t know what they are buy-
ing, or are buying things they don’t need. To illustrate his point,
Shiller tested different flavours of cat food – turkey, tuna, lamb, and
duck – and found that the flavours were not that different. As a
reviewer of the book remarked: ‘Few of us would want to replicate
that study. And its empirical validity is undermined by the fact that
Shiller is not a cat.’14
Behavioural economists are especially interested in quirks of
behaviour which seem to defy rational explanation – like lecture
audiences filling up the back seats of the auditorium before the
front seats. Mainstream critics say that the quirks detected by the
behavioural economists cancel each other out, that average behav-
iour ends up much as economists would have predicted, before
behavioural economics started to complicate matters with unnec-
essary puzzles. But the real objection to behavioural economics
concerns not the frequency or infrequency of ‘quirks’, but calling
irrational any behaviour which doesn’t correspond to the neoclas-
sical model of rational choice. Many kinds of human behaviour are
rooted in uncertainty. We cling to our sunk costs because we have
no certain evidence that they are sunk for good: what is civilisation
but a web of sunk costs? We hope for miracles because miracles
sometimes happen.
Another finding of behavioural economics is that imperfect
information, complexity, uncertainty, and limited calculating capac-
ity force agents to use of rules of thumb, or heuristics, rather than

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‘pure’ optimising behaviour. Widespread use of heuristics – short-

cuts – produces systematic behavioural biases. These mean that it
might be both possible and desirable for government to ‘nudge’ (aka
incentivise) people to act more rationally. Nobel Laureate Richard
Thaler (b.1945) and Cass Sunstein (b.1954) argue people might
be ‘nudged’ to eat more healthily by taxing sugar or to save more
by making wage increases conditional on savings commitments.15
How successful this last ‘nudge’ would be is open to question. Saving
for the future implies a belief that money will hold its value, and that
government will honour its commitment to keep savings for retire-
ment tax-free or tax-deferred. In light of well-known facts to the
contrary, consuming more and saving less may be highly ‘efficient’.
A deeper objection to the fashionable ‘nudge’ approach is that
creating incentives for more rational individual behaviour may
decrease the amount of morally efficient behaviour. All organisa-
tions rely on moral commitments, which cannot be specified in
contracts, to achieve efficient results. Companies which introduce
monetary incentives like bonuses to promote efficient effort, often
experience worse ‘bottom lines’ than those that allow greater scope
for natural sociability. Thus the ‘nudge’ cure may easily turn out to
be worse than the disease.16
We may also point to the artificial nature of the experimental
situations economists set up to establish their claims for irratio-
nal behaviour. The experimenters place the subjects of the experi-
ment in atypical situations, assess their answers to trick questions
according to the neoclassical benchmark of rationality, and dis-
cover large amounts of hitherto unsuspected ‘irrationality’. They
ask their subjects to make hypothetical choices like ‘would you
rather toss a coin for a half chance of $1,000 or get a certain $450?’
To settle for $450, the majority choice, is not ‘rational’ in the sense
of maximising expected earnings, but as Lars Pålsson Syll remarks,
‘The important activities of most economic agents do not usually
include throwing dice or spinning roulette-wheels.’17 The effect of
this testing procedure is to draw attention to the irrational ways
people behave rather than to the faulty ways economists model

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their behaviour. Instead of concluding that the subjects are giving

reasonable answers to the tests they have been set, they conclude
that their thinking is delusional.
The most important possibility opened up by behavioural eco-
nomics is that the neoclassical model of rational behaviour based
on fixed preferences, complete contracts, and ample relevant infor-
mation is the wrong one. The way most people behave much of
the time should carry no implication of irrationality, but should
rather be thought of as reasonable behaviour in the circumstances
in which they find themselves. The sin of behavioural economics is
to dub such behaviour irrational.
z
As an account of how human beings behave in general, the model
of homo economicus has been repeatedly disconfirmed by behav-
ioural, cognitive, and other social sciences. We are not always
counting the cost in time or money of what we are doing. Nor
ought we to be. If we are to condense human behaviour down to a
single axiom for the purposes of deduction within a closed system,
the neoclassical principle of rationality is probably the best axiom
to use. The question then is not about rationality, but about the
generality of the axiom.
The neoclassical model of rationality which Kahneman and
Tversky set up as their benchmark might make sense in a small,
closed world with well-defined limits. The coin-toss experiment
is supposed to replicate this – it is either a head or a tail – but it
is irrelevant as a test of rationality in open systems admitting of
many different outcomes.
Behavioural economics has not come up with a decisive alter-
native to homo economicus. In fact it rather misses the point. It
has made some progress in penetrating the working of the mind,
and has come up with some systemic quirks, which economists
had previously assumed they could treat as statistical noise. What
it has signally failed to do is to link the neural networks it posits
to social networks. It looks into our minds and finds some unex-
pected things going on there, but fails to connect what goes on

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in our heads with what goes on in other people’s heads. It leaves

methodological individualism intact.
The next chapter will attempt to shed the loneliness of homo
economicus, to explore how people relate to each other socially,
how society shapes our values, how we shape social institutions
and the social dimensions of economic cooperation.

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 7
SOCIOLOGY AND ECONOMICS

It is not ‘I’ who acts, but the automatic logic of social

systems that work through me as Other. That logic is the
real subject. It is only in the interstices of this logic that
autonomous subjects emerge.
André Gorz, Ecologica1

Can sociology help economics?

Homo economicus – the human calculating machine – is a fiction.
Humans are born into, nurtured within, and protected by groups.
Groups may be regarded as built-in insurance against misfor-
tune and loneliness, the cost humans pay for the curtailment of
individual freedom. Insurance premia are highest in tribal societ-
ies, lowest in the kind of open societies most of us now live in.
Nevertheless, groups always impose some membership costs. If
individuals could calculate exactly the probability of attaining their
desired ends they would not need to live in groups: they would
be exactly as the neoclassical economists describe them. But since
they lack the required information base, homo economicus is not
just a simplified basis for theorising, but, outside special situations,
an impossible one. It presupposes a calculable future which does
not exist.
Economists, of course, understand that humans interact with
each other, just as atoms do. Game theory is the study of how ratio-
nal individuals make choices which depend on the expected choices
of others. But such choices are always autonomous. Sociologists
make a key distinction between interaction and interdependence.

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With interdependence, the parts, whatever they are, depend on

each other, like the parts of a body. They cannot function on their
own. This means that outcomes in many situations cannot be pre-
dicted, unless the relationships between the parts can be specified
accurately, a much more difficult task.
As soon as ‘agency’ (the capacity to act) is introduced as an
explanatory variable, the problem of where the agency is located
becomes crucial. The standard view in economics is that agency is
located only in individuals. So-called ‘collective agents’ like states
or football teams are simply the sum of the individual agents who
compose them. It therefore seems sensible to start the analysis of
how the economy works with the individual, treating the group
merely as a tool of individual purpose. Further, it seems sensible
to treat social outputs as nothing but the sum of individual inputs.
Thus if there is unemployment, we must assume that the unem-
ployed persons prefer leisure to work.
We have already dubbed this approach to social analysis meth-
odological individualism. Adam Smith’s account of how markets
result from the human propensity to ‘truck, barter, and exchange’
is a good example. You start with some simple axiom of individual
behaviour – self-interest, for example – and then deduce the out-
come of the whole economy from this premise. Although sociolo-
gists also try to understand the economy, they start in a completely
different place, with groups rather than individuals. The position of
most sociologists can be broadly called methodological holism. This
asserts that the behaviour of the parts can only be understood in
relation to the whole, the ‘whole’ here standing for the complex of
relationships and institutions which ‘frame’ individual behaviour.
The whole is different from the sum of its parts. We can call it the
‘system’. Most people understand that they are not independent
particles, but part of a system which either helps them or screws
them up. ‘Wholes’, too, have ‘agency’ – they are actors in their own
right.
The attraction of treating individuals as unique actors is easy
to understand. They are the smallest of the social particles with
the capacity for independent action. (Humans, too, are made up

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of parts. But it would be odd to talk of the leg or arm as exer-

cising ‘agency’.) They are also the only actors with moral agency.
Methodological individualists often confuse agency (the power to
act) with moral agency (the power to distinguish between right
and wrong). There is also a moral grandeur in individualism, which
is lost by treating individuals as puppets of groups. We owe most
of our great achievements in art, science, and action to individual
defiance of the group mind.
Nevertheless, the individualist perspective misleads as much
as it illuminates. If agency is the capacity to act, it is not absurd
to talk of collective agency, in the sense that, in many situations,
collectives have a power to act which individuals lack. An army
regiment, a business firm, a trade union is not just a group of con-
tracting individuals. In an important sense it possesses indepen-
dent agency: the power to make things happen.
The sociological claim is twofold: first, that it is perfectly legit-
imate to talk of group action; secondly, that individual action is
framed by the individual’s social position in the group. If either
holds, policies which presuppose that social outcomes are sim-
ply the sum of voluntary individual choices can be seriously mis-
leading. In the first case, it ignores the existence of groups except
as tools of individual purpose; in the second case, it ignores the
power structure within groups. When neoclassical economists talk
of the need for macroeconomics to be properly ‘microfounded’,
they mean that it should be possible to explain patterns of behav-
iour by reference to individual intentions alone, that these patterns
are nothing but the sum of such intentions. For example, GNP is
merely the weighted average of all the individual transactions in
the economy. However, it might make just as much sense to talk
of ‘macro-founding’ microeconomics, that is, showing how indi-
vidual intentions are shaped by individuals’ economic or social
positions. David Ricardo and Karl Marx did just that with their
theories of class interest.
That one’s ‘position’ in society affects one’s choices is obvious
to anyone not thoroughly trained in neoclassical economics. An
anonymous friend of Donald Trump’s told CNN that ‘I always

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thought that once he understood the weight of the office, he would

rise to the occasion. Now I don’t.’ The phrase ‘the weight of the
office’ clearly evokes the idea that the ‘office’ of US president is an
entity separate from its temporary incumbent. There is a two-way
causation. The incumbent’s performance influences the evolution
of the ethics of the office, but the ethics of the office influence the
behaviour of the incumbent.
Any economics can be called sociological which rejects meth-
odological individualism as the general rule. Marxist economics,
Keynesian economics, and some kinds of Institutional Economics,
are all sociological in that they see individuals as inseparable from
wholes, which they influence, but which also influence them. For
neoclassical economists, on the other hand, the causation runs only
one way, from the individual to the institution. Individuals create
institutions as tools for making individual action more efficient.
Firms are viewed as reducing the costs of transactions. The state
is a device to economise on the costs of protection. The church
reduces the costs of transacting with God. In this view, society is
simply the sum of individual transactions. The logic can be further
simplified by treating all individuals as having identical motives.
An institution can then be reduced to the behaviour of just one
individual – the ‘representative agent’.
Sociology offers two routes out of the individualist trap. It offers
a way to understand the structure of economic life apart from indi-
viduals; and it focuses on the value system or ‘culture’ of groups
which shape the behaviour of its members. It claims that humans
are ‘cultural animals’.
If in standard economics the key behavioural abstraction is
rational calculation, in sociology it is the ‘norm’. The first abstracts
from society; the second presupposes it. Of course, Robinson
Crusoes also exhibit ‘normal’ behaviour. Normal in this sense is
simply an abbreviation of individual calculation. However, in soci-
ology ‘the norm’ refers to a code of conduct. In other words, it pre-
supposes a social relationship.
The concept of ‘norms’ in the sociological sense is needed to
explain human behaviour because organisations have rules and

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codes of conduct which shape the motivational structure of their

members. For example, do we really believe that the coal miners’
strike in the United Kingdom in 1984–5, which resulted in the vir-
tual extinction of the coal industry, can be explained by the rational
self-interest of individual miners? Perhaps by a fanciful argument
one could explain the behaviour of individual miners in terms of
rule-utilitarianism. But surely, one does not have to, nor should one
need to, go beyond ideas like ‘loyalty’ and ‘solidarity’. The existence
of group actors means that a lot of neoclassical microeconomics
– the standard textbook teaching of the subject which takes the
utility-maximising individual as the sole independent variable of
the microeconomic model – is plain wrong.
As John Harvey puts it ‘We live, eat, reproduce, grow and die in
packs . . . No individual animal in any . . . species chooses to live with
the others. It is hard-wired into them because it evolved as a sur-
vival mechanism.’ It follows from this that the basic object of study
should be not the individual, but the group, and more especially its
culture. Very roughly, culture is the value system of a group. It is
what we mean when we talk of ‘common sense’, ‘received wisdom’,
or ‘playing by the rules’. It provides formal and informal incentives
to good behaviour, and sanctions bad behaviour. Mostly, though,
cultural conformity is instinctive. Despite outbreaks of rebellious-
ness, ‘it is in our nature. It is part of what makes us human.’2
So why stick to the individual as the unit of analysis? There are
two reasons, one instrumental, the other ethical. Individualism
offers a more efficient basis for modelling than holism or organi-
cism. It is much easier to posit individuals equipped with a single
motive – rational self-interest – than work one’s way to a conclu-
sion through the complexity of social relationships. There is also
an ethical motive for individualism. Most economists think, like
Popper, that holistic models of society are implicitly totalitarian.
Freedom of choice is as much an ethical imperative as a scientific
assumption.
All that a holistic approach claims is that there is system-level
behaviour that cannot be understood at the individual level, and
in particular that the dynamics of the system itself are liable to

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change in unpredictable ways. Economics is the study of ‘closed’

systems, in which particular outcomes can be reliably attributed
to individual actions. Sociology is the study of ‘open’ systems, in
which individuals depend on each other in complex ways. Only in
the broadest sense are their choices ‘predictable’.
The opposition between individualism and holism is delib-
erately set out here in a simplified, undialectical way in order to
bring into focus the nature of the methodological choices which
economists face. Ideally, economics and sociology should comple-
ment each other. The rationality assumption offers the path of ‘least
resistance between ends and means, while sociology is needed to
explain the friction of bias and error which usually gets in the way’.3
Nonetheless, for the most part the two disciplines have made little
progress in appreciating each other’s methodological strengths.
They are self-referential: each views the other through a glass darkly.
The social and the individual
Historically, economics and sociology may be contrasted by their
reactions to the Enlightenment and its consequences. In the pre-
modern world it was understood that economic activity was an
aspect, albeit a very important one, of communal life. In their eco-
nomic lives individuals were glued to groups by customary norms,
expressed through family, village, church, guild, and corporation.
The social order was hierarchical: everyone knew their place in the
scheme of things. The task of the ruler was to generate ‘nourish-
ment’ to all appropriate to their rank, including limits to market
access, price fixing, and controls on consumption. Work should
befit one’s rank. ‘Temporary wealth’ was at best a path to eternal
wealth. It was ‘irrational’ – miserly – to pursue temporary wealth at
the expense of eternal bliss.4 Pre-modern society was not static, but
its fluidity was largely circular, with one dynasty replacing another
in bloody succession at the top, while the mass of serfs, peasants,
townspeople lived their lives in a rhythm interrupted only by natu-
ral catastrophe.
With the Enlightenment, the medieval cosmology broke down.
This movement to ‘light up’ the mind had as its object the release

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of individuals from the social chains that shrouded their lives in

darkness. In the memorable words of Immanuel Kant (1724–1804)
it was ‘man’s emergence from his self-imposed nonage’.5 The con-
vulsions of thought and events freed people from pre-modern rela-
tions of power and dependence to assume an expanding variety of
roles, or ‘identities’ as we now call them. The French revolution-
aries championed people’s political emancipation, the economists
their economic emancipation. This was the double revolution of
the eighteenth century, welcomed by both political and economic
liberals. Progress would bring about a world of elective, not forced,
affinities.
Sociology has a different, and much more sombre, way of under-
standing these events. Its starting point was the ‘absolute reality of
the institutional order . . . bequeathed by history’.6 To the founders
of sociology, what the revolutionaries and economists welcomed
as the liberation of the individual from social fetters appeared as
a wrenching from the protective ties of community. The mater-
ial order was decoupled from the moral order. Sociologists have
typically depicted the breakdown of society as a process of social
atomisation – people losing their functional place in the whole,
and therefore their sense of duty to others.
So both disciplines looked at the social question from opposite
perspectives. Whereas economists defined the central problem of
the age as one of securing the most efficient production and alloca-
tion of scarce material goods, the problem which concerned soci-
ologists was about how a sustainable moral order could be created
out of the disintegrating fragments of religious and communal life.
Economists looked to individual rationality to bring about an age
of growing freedom and plenty; sociologists to the nightmare of
despotic power exercised over, but in the name of, disoriented and
stupefied masses. Sociologists have not been uniformly pessimistic,
since institutions can be viewed either as carriers of progress or
reaction. Conservatives lamented the passing of the hierarchical
order; radicals like Karl Marx accepted the gains of industrialisa-
tion, but argued that what Thomas Carlyle (1795–1881) called the

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‘cash nexus’ must be transcended by new ‘rational’ social bonds.

Sociological liberals emphasised the role of free association. Thus
sociology is not without its ‘improving’, or prescriptive, element.
Nevertheless, the bias and – it could be argued – the weakness of
sociology is its tendency towards conservatism. It could hardly be
otherwise, since its map is cluttered up with immovable presences.7
No one has summed up the continually restless, contradictory
dynamics of the new economic order better than Karl Marx. He
was fascinated by Mary Shelley’s novel Frankenstein: The Modern
Prometheus (1823), the story of the hominoid monster which,
having been designed to serve its master, Victor Frankenstein,
‘went rogue’, turned on its inventor, and wreaked havoc wherever
he went. Marx saw in this a metaphor for capitalism. The bour-
geoisie, he wrote, had created ‘more massive and more colossal
productive forces than have all preceding generations together’. It
had drawn ‘even the most barbarous nations into civilization . . .
created a world after its own image’. But the cost had been hor-
rendous: ‘All fixed, fast-frozen relations, with their train of ancient
and venerable prejudices and opinions, are swept away, all newly
formed ones become antiquated before they can ossify. All that is
solid melts into air, all that is holy is profaned . . .’8 Capitalism, the
‘creature’ Frankenstein created, must be destroyed once it had done
its work.
The comment by Alexis de Tocqueville (1805–1859) on
Manchester, the hub of the new nineteenth-century industrialism,
is similarly double-edged:

From this foul drain the greatest stream of human industry

flows out to fertilise the whole world. From this filthy sewer
pure gold flows. Here humanity attains its most complete
development and its most brutish, here civilisation works its
miracles, and civilised man is turned almost into a savage.9

So sociological enquiry has been, on the one hand, the study of the
forces leading to social breakdown; on the other hand, an analysis
of the new types of association thrown up by the breakdown itself.

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The sociological perspective

The minimum sociological doctrine is that humans are insepara-
bly bound to each other by their biology, experience, and culture.
Further, all sociologists believe in the reality of the institutional
order: institutions exist. The institutional order, though, is not
unchanging, nor is it all of a piece. In pre-modern times the econ-
omy was ‘embedded’ in the moral order, in modern times it has
become separated from it. A further key idea is that different insti-
tutional orders generate different character types. For most of his-
tory social organisation reflected military needs, with the warrior
as its archetype. Homo religiosus was the medieval archetype; homo
economicus emerged with capitalism. All the social sciences have
debated the question of which parts of the institutional order are
to be regarded as primordial, reflecting our biology, accumulated
experience, and innate moral sense, and which parts should be
treated as variable, that is, susceptible to changed beliefs and con-
ditions of existence.
An important ancillary question is: what kind of institution is
the state? The state as we know it is the creation of modern society.
Before that there was the ruler and his family and court. Is the state
to be seen as a private interest? As the executive arm of the capital-
ist class? Or in some way as representing the general interest? The
key question is to whom it is accountable. We will explore this in
more detail in Chapter 9.
To put some flesh on these abstractions, let’s consider three top-
ics which have historically formed the core of sociology: the nature
of community, the spirit of capitalism, and the relationship of the
market to society.

Gemeinschaft and Gesellschaft

Ferdinand Tönnies (1855–1936) distinguished between a com-
munity bound together by affective and customary ties, which he
called Gemeinschaft, and an association of interest, like a business
corporation or a political party, which he called Gesellschaft. In
Gemeinschaft individuals remain united despite separating factors,

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while in Gesellschaft they remain separate despite uniting factors.10

In similar vein, the great sociologist Max Weber (1864–1920), him-
self a professor of economics, distinguished between ‘communal’
and ‘associative’ types of relationship. A relationship is commu-
nal when based on ‘the subjective feeling of the parties that they
belong to each other, that they are implicated in each other’s total
existence’. Examples are a military unit, a labour union, a religious
brotherhood, marriage, and so forth. The relationship is ‘associa-
tive’ when it rests on a ‘rationally motivated adjustment of interest
or a similarly motivated agreement’.11 The associative group is a
community of choice; we ‘elect’ those with whom we want to asso-
ciate, rather than being stuck with them.
The point to emphasise is that sociologists have regarded
Gemeinschaft as typical of the pre-modern type of association and
Gesellschaft as typical of the modern, and have interpreted modern-
ity as a movement from the first to the second. The legal philosopher
Henry Maine (1822–1888) called it the movement from status to
contract. Status is ascribed; but in a contractual association, the rela-
tionship between individuals is based on their choices. The obvious
question is: what constitutes the social glue of the associative form of
relationship? Is the rational adjustment of interest enough?
According to Jürgen Habermas (b.1929), modern citizens
inhabit two separate worlds: the moral-social dimension of domes-
tic, communal, and cultural life and the instrumental relations of
the economy. He called the first the domain of ‘communicative’
rationality, the second of ‘strategic’ rationality, in other words, cal-
culation. Both apply to different sets of circumstances and activi-
ties. The first is indispensable to the moral order; the second to
the material order. Habermas’s fear, as that of many sociologists,
has been the encroachment of strategic rationality on morality.12
The warrant for this was, as we have seen, given by Lionel Robbins
when he argued that all choices have an ‘economic aspect’ (see
above, p. 16). In a world based on contracts, it is no use appealing
to morality, because it will no longer be there.
The issue is: is self-interest enough to establish relations of obli-
gation? Mainstream economists have generally supposed this to be

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the case. Systems of law and regulation have their roots in individ-
ual self-interest: it ‘pays’ to be honest. This picture was powerfully
challenged by Émile Durkheim (1858–1917). In his Professional
Ethics and Civic Morals, Durkheim argued that,

Contract of any type could not be sustained for a moment . . .

unless it was based on conventions, traditions, codes in which
the idea of an authority higher than contract was clearly resi-
dent. The idea of a contract, its very possibility as a relationship
among men . . . comes into existence only in the context of
already sovereign mores.13

No one, for example, would make a money contract without a

belief that money was a trustworthy token of value.
‘Anomie’ was the word Durkheim used to define the social
pathology of a morally uprooted society. He found that the suicide
rate of Protestant countries was higher than in Catholic countries
because family ties were better maintained in Catholic society.14 In
Durkheim’s view, the breakdown of community would lead not to
new instrumental relationships but to further disintegration, gen-
erating an unlimited expansion of state regulation. We encounter
here a recurring motif in the sociological literature: that the spread
of marketisation is paralleled by the expansion of bureaucracy,
trapping the liberal hope of individual liberty in an ‘iron cage of
bondage’. A temporary escape only is offered by ‘charismatic’ lead-
ers, who ‘set new goals and open up new paths for societies ham-
pered by political stagnation and bureaucratic routine’.15
Since Weber’s time, the world of custom has shrunk relative to
the world of ‘business’. Modern life has become increasingly ‘trans-
actional’. The ideology of homo economicus together with digital
technology suck people out of local communities, and even nations,
into a ‘global village’. The student of economics needs to balance
the economist’s enthusiasm for ever-widening markets against the
sociological insight that this can be highly disruptive to settled
ways of life. Without a sociological imagination, we cannot hope to
understand the political revolt of today’s ‘left-behinds’.

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One type of hugely influential institution stands apart from the

binary divide between custom and contract: this is the religious
community, the community of believers. We are tied to church and
religion neither by kinship nor calculation, but rather by a sense of
our own human insignificance, which religious belief is uniquely
able to convert into confidence in the future. Ideology can be seen
as the secular replacement of religious belief. It emerges when cus-
tom starts to be contested. The ideological community is the most
powerful form of association today. And this carries its own obvi-
ous dangers, because it offers completely unwarranted promises of
secular utopia.
The spirit of capitalism
Neoclassical economics assumes an unchanging human nature,
marked by an unlimited desire for gain. This leaves it unable to
explain why this motive for action failed to ignite any significant
growth of wealth for most of human history. It is not enough to
say that it was prevented from expressing itself by inefficient insti-
tutions, because that leaves unexplained the persistence of such
institutions. ‘What needs to be explained’, wrote R.H. Tawney
(1880–1962) in his introduction to Max Weber’s The Protestant
Ethic and the Spirit of Capitalism,

is not the strength of the motive of economic self-interest,

which is the commonplace of all ages, and demands no expla-
nation. It is the change of moral standards which converted a
natural frailty into an ornament of the spirit, and canonised as
the economic virtues habits which in earlier ages had been
condemned as vices.

In The Protestant Ethic and the Spirit of Capitalism, Max Weber

denied that individuals are maximisers by nature. ‘In traditional
society, a man does not “by nature” wish to make more and more
money, but simply to live as he is accustomed to live and to earn
as much as is necessary for that purpose’. The ‘spirit of capitalism’
entered history at a particular time (sixteenth century) and place

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(north-western Europe), and for a particular reason. It was an

unintended consequence of belief in predestination.16
God had divided people into the saved and damned, and there
was nothing they could do to influence His selection. Believers
responded with a redoubling of efforts in order to convince them-
selves – if not the Almighty – that they were among the saved.
Crucially, success in work – accumulation of wealth – was taken
as a ‘sign’ or ‘proof ’ of grace. The worldly asceticism inculcated by
Puritanism was the psychological basis of modern capitalism. In
embracing the accumulation of wealth as a goal, Puritans were
wracked with guilt; personal asceticism or frugality was their way
of coping with this.17
The value of Weber’s brilliant conjecture is twofold: to question
economists’ belief in an unchanging human nature, and to open
our eyes to the link between economics and religion. Economics
can be seen as a form of religious belief: in this case, belief in pro-
gress. ‘If you behave like this, grace will be bestowed on you – at
least in the long run.’ Economists may be likened to a secular
priesthood, fulfilling the ancient priestly function of inducing peo-
ple to live by the book. God is in the model; outside it lie delusion,
madness, evil.
Are markets natural to man?
Following the lead of Adam Smith, mainstream economics has
treated markets as part of the natural order, state power a kind of
mutilation imposed from outside. In contrast, the social anthropol-
ogist Karl Polanyi (1886–1964) distinguished between markets and
the market economy. Markets are natural, but the market economy
is ‘entirely unnatural, in the strictly empirical sense of exceptional’.
What was ‘natural’ were custom and reciprocity. The purpose of
exchange was not to make gains but to strengthen relationships
through gifts; what was to be maximised was social honour, not
money.18 Thus the economy in pre-industrial times was ‘embedded’
in a moral order from which capitalism unleashed it. It followed that
micro price theory is inappropriate and distorting when applied to
non-market relations, as neoclassicals like Gary Becker do.

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Polanyi’s thesis, in a nutshell, is that in pre-modern societ-

ies markets could only exist on the edges of the economy, since
the ‘factors’ of production – labour, land, and capital – were not
marketable. Their transformation into ‘fictitious commodities’, as
much subject to buying and selling as food, clothes, and furniture,
was the result of state power. It was essential to establish ‘national’
economies, so that rulers could mobilise their resources for wars.
The ‘tragedy of the commons’ – the private enclosure of previously
shared land in seventeenth- and eighteenth-century England –
was a notable signpost on the road to creating the first national
market.
However, the attempt to create a ‘market society’ produced a
reaction, as society resisted incorporation into the market econ-
omy. The market economy brought about increasing regulation
by the democratic state to contain its disruptive effects. Thus state
intervention today is not a disruption of the natural order of the
market. Rather, it is an attempt to prevent markets from destroying
the very societies in which they are embedded. Protectionism was
the economic response; social democracy and fascism were alter-
native political responses. All this Polanyi described in his classic,
The Great Transformation (1944). In a single historical sweep he
captures both past economic behaviour and the revolt against lais-
sez-faire in the twentieth century.
Polanyi’s critique of market society rests on his belief in the
dominance of the social over the economic. He represents a major
tradition in sociology which interprets much of modern political
and social history as attempts to protect society from the disrup-
tions of the market. Since its earliest appearance, capitalism has
evoked spontaneous and deliberate social action designed to main-
tain our humanity in the face of its inhumanity. The market ideal
of specialisation alienates people from society and each other.
Through the market, more of our lives are ‘commodified’, crowd-
ing out non-economic values and relations. But human beings are
social animals, with a strong need for identity, companionship,
security, and a sense of worth, so, while accepting the gains market
exchange brings, they devise non-market strategies for protecting

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their human substance against the encroachment of the market. In

political terms, social democracy has been the durable response.
But Polanyi offers no obvious solution, simply a dialectic between
growing market disruption and growing state regulation.
Reconciliation
There seems to be an unbridgeable gulf fixed between sociological
and economic explanations of human behaviour. In methodologi-
cal individualism, explanations are always in terms of individu-
als; in methodological holism, always in terms of collectives. This
amounts to saying either that ‘there is no such thing as society’ (as
indeed Margaret Thatcher did say) or ‘there is no such thing as
free choice’. Both statements are clearly false. The cure for treating
humans as calculating machines is not to turn them into unthink-
ing automatons; rather, we need to understand better the elusive
relationship between the individual and the social.
The philosopher-economist Tony Lawson rejects both the indi-
vidualist and holist positions, arguing that a proper study of society
must focus as much on the organising relations as the individual
people and objects that are organised. He uses the term ‘emergent’
for the social totalities or systems (with independent causal pow-
ers) along with their structures that come into being through the
chaos of human interaction. (Darwin’s theory of natural selection
is an influence.) Any system includes both individual elements and
an organising structure that includes positions that the individual
elements occupy. This organisational structure is fundamental to
a system’s causal powers, so that the latter are seen always to be
irreducible to those of the individual elements involved alone, con-
sidered apart from their being relationally organised.
The body is a system of interdependent parts, in the sense that
each part is defined by its functional role within the whole. As
Aristotle said, a hand is for gripping; thus a hand which cannot
grip, because it is severed from the body, is in a sense no longer
a hand at all.19 Similarly, although the organisational structure of
society is less well-defined than the body, the parts only function
in relation to the structure.

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Lawson argues that the organisational structure of a system

emerges at the same time as the whole. Pre-existing individual
elements become components of the system by slotting into the
organising structures. However, those organised individual ele-
ments are people with some level of agency. They may accept
positional obligations, and thereby have rules, norms, and restric-
tions imposed upon them, with consequences for transgressions.
But this does not mean that the rules are always followed. People
may accept the penalties and seek to adapt, evade, rebel against, or
ignore the impositions. In this respect, social reality is fundamen-
tally open – powerful, but also changeable.20
Given this framework, the question of whether the causa-
tion runs from the lower parts to the totality or vice versa, that
is, whether it is the collection of lower parts or the totality that is
the independent feature, is regarded as posing a false dichotomy.
The system as a whole has causal powers, but these powers can be
exercised only through the participation of individuals within the
system, whether or not these individuals know how their actions
fit into the system; so methodological holism is false. At the same
time, the individuals involved can exercise the causal force they do
only through being relationally organised as system components,
even if rules are sometimes broken; so methodological individual-
ism is false.
Consider, by way of illustration, the relationship between lan-
guage and conversation. To have a conversation, there must first
be a language, some agreed system by which meaning is conveyed.
But languages are not immutable and nor, for the most part, are
they planned. They emerge through the process of uncountable
conversations, as tacit rules come to be understood by partici-
pants. Sounds take on meanings, becoming words and, as contexts
change, the usage of these words can subtly change these meanings
or add new ones.
Another example might come from a team sport like football.
If a goal is scored, it is the team – Arsenal, say – which would then
be winning 1–0, not any individual on the team. But it would be
absurd to say that the team is winning without taking account of

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the participation of the individuals; it’s not as though a team has

feet, and can kick. But neither is an extreme individualist position
appropriate. Eleven individuals running around without reference
to each other would play like a village team from the 1850s, just
taking the ball and running towards goal until someone tackles
them.
Rather, the team is able to score goals because the players are
relationally organised into a formation, with each position carry-
ing certain responsibilities. Forwards and defenders have differ-
ent sets of obligations, and the organisation of the players into a
team allows them to carry them out. Knowing that there will be
a defender to defend allows the attacker to attack. But at the same
time, this structure is not fixed, but interpreted and transformed
by managers and players to take advantage of their own strengths
and the weaknesses of the opposition, and to exploit the element of
surprise. In the 1880s it was virtually unheard of to play more than
two defenders, but nowadays any manager attempting to play just
two at the back would be regarded as incompetent.
In his book on the history of football tactics, Inverting the
Pyramid, Jonathan Wilson writes ‘football is not about players, or at
least not just about players; it is about shape and about space, about
the intelligent deployment of players, and their movement within
that deployment.’ Unlike chess, football is open. Neoclassical eco-
nomics prefers to treat the economy as a game of chess rather than
as a game of football. It reduces complex psychological and social
phenomena to simple behavioural axioms or simple linear math-
ematical models, often without further justification or enquiry.
Football, unlike chess, has a manager, a source of power within
the team whose role it is to define the team’s strategy. Economics
generally assumes that, as in chess, players are totally free to make
their moves. It makes more sense to say that they are free to inter-
pret the manager’s plan within the game, but liable to face sanction
if they deviate too far.
The challenge for the economist then becomes to resist attempt-
ing ever more tortured reductionist accounts which either strip
humans of their agency (as in a crude Marxist account where an

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action can be interpreted solely as an expression of class interest)

or imbue them with unrealistic powers of choice (as in the neoclas-
sical account which completely denies the possibility of involun-
tary unemployment by emphasising the freedom to starve).
Rather than presupposing the direction of causality and per-
forming a revisionist exercise to provide a semi-coherent inter-
pretation of apparently disconfirming facts, such as Becker and
Murphy’s theory of rational addiction, ontological enquiry should
be a normal part of economic practice.21 That is, in attempting
to answer any given problem, economists should think seriously
about the structures and elements involved, and whether or when
reduction to a lower level adds or subtracts from explanatory
power.

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 8
INSTITUTIONAL ECONOMICS

The nature of the firm is not simply a minimizer of

transaction costs, but a kind of protective enclave from the
potentially volatile and sometimes destructive, ravaging
speculation of a competitive market.
Geoffrey Hodgson, Economics and Institutions

Anglo-American thinkers of the Enlightenment had an intense

suspicion of institutions, which they saw as impediments to the
flowering of individual liberty. The economists shared this atti-
tude and perpetuated it. They have been wont to explain the fre-
quent lapses from full employment by the existence of institutional
impediments to fully competitive markets. But this begs the ques-
tion of why institutions exist. Could it not be that many of them
exist to protect society against the market, as Polanyi suggested?
This raises another question. What is the advantage of theorising
as though institutions are absent? The only advantage would seem
be to set up a standard to which institutions should conform. But
to posit, for example, that wages are flexible, when in fact they are
‘sticky’, and that therefore unemployment is at best a fleeting dis-
turbance, builds a false theoretical prospectus.
Institutionalism is economics’ nod to sociology. It took root in
the first decades of the twentieth century when a society which
could have been plausibly understood as one of small firms, indi-
vidual contracts, and small states had morphed into one domi-
nated by big businesses and trade unions, with a parallel growth
in the size of the state and the scope of regulation. Institutional

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economics started out as an attempt to analyse the influence of big

organisations on individual behaviour; it has subsided in a vigor-
ous reaffirmation of market logic against institutional logic.
‘Old’ institutionalism
Institutions are defined as ‘organisations founded for religious, educa-
tional, professional, or social purposes’, or as ‘established laws or prac-
tices’. Economists had been quite vague about how self-interest played
out in different institutional settings. The main interest of the ‘older’
institutionalism was to understand the ways in which institutions
modify the behaviour of their members, just as in the example of the
‘weight of the office’ modifying the behaviour of the US president.
Two prominent examples of this approach were the work of Herbert
Simon (1916–2007) and John Kenneth Galbraith (1908–2006).
Simon’s acute question was the same as Keynes’s: what would
be rational behaviour in a world of uncertainty? Humans lack the
cognitive ability (computing power) to penetrate the future, so they
can exercise only ‘bounded rationality’ when making decisions in
complex, uncertain situations. They will ‘satisfice’, not maximise:
attempt to achieve the best result possible, rather than the best pos-
sible result.
This leads to an explanation of why firms exist. They are ways
of coordinating the activities of different individuals in a ‘satisfic-
ing’ environment. The firm imposes a shared purpose on the indi-
viduals in it through hierarchy and loyalty. Loyalty is described by
Simon as ‘the process whereby the individual substitutes organi-
zational objectives . . . for his own aims as the value-indices which
determine his organizational decisions’.1 Studies have repeatedly
shown that employees internalise the telos (end or purpose) of
the organisation in which they work. By its ability to modify the
motives of its employees, the firm is an economic actor in its own
right.
John Kenneth Galbraith made a further breach in the neoclas-
sical wall by denying consumer sovereignty. He criticised the con-
ventional sequence which starts with consumers to whom firms
respond. His ‘revised sequence’ starts with large firms which design

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new production and technology. They do ‘market research’ to show

what’s possible to sell. They have advertising and consumer finance
divisions to ensure their products can be sold. Big firms internalise
many market activities within themselves. All critical interests in
firms need to be considered, which means that no one’s maximal
interest will be achieved. They need size to gain some control over
uncertainty: hence the increasing concentration of production in
large corporations. Firms do not maximise, they behave in ways to
ensure their survival.2
In such accounts, the organisation or institution exerts an
independent influence on the action of individuals: the caus-
ation does not all run one way. In the words of Geoffrey Hodgson,
‘Individuals are affected by their institutional and cultural situa-
tions’. This does not mean that they are simply ‘creatures of institu-
tions’.3 Institutional economists like Simon and Galbraith study the
grammar of society, not its conversation.
The above two analyses of non-market coordination help
explain the seeming paradox of organisations which exist to serve
the interests of their members imposing codes of behaviour which
seemingly fail to maximise their independent utility functions. It
helps explain the phenomena of military regiments which sacri-
fice themselves in a hopeless cause, of firms which fail to maximise
shareholder value, of trade unions which fight for higher wages
even if it means unemployment. It is true that a map filled with
such agents doesn’t give you a sparse model. The motives of the
organisation lack the hard edge of maximisation, and the outcomes
of its behaviour are thereby indeterminate. But we require not bet-
ter theory, but better understanding.
‘Neoclassical’ institutionalism
With the ‘new’ institutional economics of the 1980s, institution-
alism collapsed back into neoclassical economics. Its main idea
was that individuals form institutions to reduce the ‘transaction’,
especially ‘information’, costs of trading individually in markets.
The neoclassical logic remains intact: individuals create institu-
tions to maximise their utilities. The father of this approach was

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Nobel Laureate Ronald Coase (1910–2013), whose seminal article

on the firm appeared in 1937, in reaction against the then preva-
lent theories of oligopolistic competition. It took the overthrow
of Keynesianism by the new classical economics in the 1970s
and 1980s for his ideas to gain currency. Today they comprise the
orthodox microeconomics of institutions.
Why do firms exist? Coase’s answer is that they exist to reduce
the costs to individuals of doing business separately. His argument
is that people organise production in firms when the transaction
costs of coordinating production through market exchange are
greater than internalising them within the firm. The costs of trans-
acting in markets include discovering relevant prices, negotiating
and writing enforceable contracts, and haggling about the division
of the surplus.4
What gives rise to transaction costs is incomplete information
about relevant prices and the costs of monitoring and enforcing
good performance. It is because production has a time-element
that production transactions are not typically like those which take
place in a fruit and vegetable market, where both buyer and seller
know the prices of all the products. Within the firm, market trans-
actions are replaced by the authority of the manager who directs
the activity of all the productive units. Coase’s theory also neatly
answers the question of what determines a firm’s size. The opti-
mum size of the firm is reached at the point where internalising
an additional cost equals the cost of making the transaction on the
market. Coase’s theorem is a good example of the power of neo-
classical economics to absorb apparently incongruous elements of
analysis. Individuals lack complete information, but by its control
over internal costs, the firm acquires it. So the assumption of profit
maximisation can be retained: in setting up firms owners (share-
holders) cede technical authority to managers to maximise profits
on their behalf. Though somewhat of an intruder on the map of
individual maximisation, the firm fulfils the neoclassical criterion
of rational choice.
The economic historian Douglass North (1920–2015) received
a Nobel prize for using the theory of transaction costs to explain

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the institutional innovations which led to economic growth in the

eighteenth century. The institution ‘is an arrangement between
economic units which defines and specifies the ways by which they
can cooperate and compete’.5 Economic institutions, like products,
are innovated when the gains from the innovation exceed the costs
of innovating. North then goes on to explain how the moderni-
sation of property rights in Britain set it on its growth path, by
making it profitable for ‘improving’ landlords to capture the profits
of their improvements, thus equalising the private and social rates
of return.
While British social historians lament the ‘tragedy of the
commons’ – privatisation through ‘enclosure’ of common lands on
which agricultural workers grazed their sheep and cattle – North
commends it as providing for ‘easier transfer of property and pro-
tection of the peasant’.6 By contrast, in Spain, the Crown failed to
curtail the right of the Mesta (the shepherds’ guild) to drive their
sheep across the land wherever they wanted. ‘A landlord who care-
fully prepared and grew a crop might expect at any moment to
have it eaten or trampled by flocks of migrating sheep.’7 The result
was that England grew and Spain stagnated. What North and
Thomas fail to explain was the persistence of inefficient property
institutions in Spain (and also France and most of Europe) in face
of international competitive pressures, especially those of war. The
question can be put more broadly: since technology is a free good,
why does its diffusion take so much time?
The American economist Mancur Olson (1932–1998) has
argued that even rulers, who originated as ‘roving bandits’ or
mafias, caring only about milking the localities they control and
then moving on, rather like slash-and-burn tribes before the age
of agriculture, develop an ‘encompassing’ interest in the economic
development of their territories when they become ‘stationary’ –
that is, once they have eliminated their rivals. The self-interest of
the stationary bandit is to modernise the economy so as to maxi-
mise his long-run revenue.8 Revolutionary groups in the Middle
East can be theorised as revenue-generating mafias in the ‘pre-
stationary’ phase.

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The explanations of Coase, North, and Olson leave homo eco-

nomicus in the driving seat, innovating institutions to maximise
his efficiency. The causation is one-way: from the individual to the
group. The group has no power to modify individual interest, only
to secure its most efficient expression.
But the new institutionalists have identified a flaw that makes
all institutions precarious as agents of individual purpose: the
principal-agent problem, a form of moral hazard which describes
a mismatch between people’s incentives and responsibilities. The
principal wants to maximise something and the agent is employed
to act on the principal’s behalf. The problem arises from the fact
that the information possessed by the principal and the agent is
unequal, or asymmetric. Often, a principal cannot easily know how
an agent is behaving, either because he cannot directly observe
the agent’s actions, or because the agent (official or manager) has
greater expertise: this may very well be why the agent was employed
in the task to begin with. This leaves agents free to pursue their
own private interests at the expense of the private interests of the
principals. This amounts to saying that the principal has theoretic
agency, but the manager has actual agency.
The new institutional economics has been used to explain the
behavioural characteristics of the state. In the Keynesian age, there
was little theorising about the state: it was viewed as a benevolent
despot, guided by experts. ‘Public choice’ theory has reverted to the
earlier idea of the predatory state, though now decked out in neo-
classical clothes. Far from the ‘weight of office’ shaping the behav-
iour of public officials, it is the private interests of public officials
which shape the behaviour of the office. ‘Public choice’ economists
like Nobel Laureate James M. Buchanan (1919–2013) use the stan-
dard neoclassical methodology to argue that the so-called ‘public
interest’ is ‘nothing but’ the sum of the private interests of public
servants. The ‘office’ has no influence on their behaviour: they are
in the game for private gain.
But what about democracy? Aren’t the private interests of pub-
lic officials constrained by their accountability to voters? Not much,
since politicians (the agents) have much greater knowledge, expertise

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and involvement than the voters (their principals). Political parties

are likened to profit-seeking firms, aiming to sell uncosted products
(policies) to gullible taxpayers. As Buchanan has written, the main
interest of the ‘public choice’ school is in ‘the utility-maximising
behaviour of those who might be called on to supply the public
goods and services demanded by tax-paying voters’.9
In the case of the state, officials are said to maximise their own
utilities and attend to the interest of the voters only after they have
achieved their own required surplus. In the case of the firm, man-
agers attend to the interests of shareholders only after they have
achieved their own private goals. Neoclassical economists have
typically seen self-regulating professions as cartels extracting ‘rents’
from their users.
The principal-agent problem stalks neoclassical economics as
a grim health warning, and with it an unequivocal message: do all
you can to reduce the costs for individuals of transacting directly in
markets. It suggested a rationale for the Thatcher-Reagan privatisa-
tion policies of the 1980s, and the outsourcing of public functions
to private firms. It would be better, so the argument ran, to leave
provision of public goods like legal systems, schools, hospitals,
homes, and transport systems to regulated ‘quasi-markets’ rather
than to government agencies. Even prisons, that classic emblem of
state power, which now incarcerate an increasing proportion of the
population, are leased out to competitive tender.
The insight that agents subvert the goals of principals grossly
underestimates the natural identification of managers, officials,
and employees with the goals of the organisations they serve.
The only solution to the principal-agent problem that neoclassi-
cal economists can suggest is to improve the incentives for agents
not to cheat on their principals. In the aftermath of the financial
crash of 2007–2008, which exposed widespread fraud, the talk
was of the need to ‘align’ bankers’ incentives with honest dealing.
Performance-related pay for teachers is another example. Teachers,
it is said, will not do their best for their pupils unless they are given
special incentives. This depressing view of behaviour assumes that
honesty and duty come at a price.

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The neoclassical distaste for institutions has led some econo-

mists to argue that business and other organisations are a transi-
tional phase in the process of making markets more complete. If
the transaction costs of using markets fall to zero, the cost advan-
tage of firms disappears. What then remains of Coase’s theory?
What is the function of the firm? What indeed is the function of
the state? It can be argued that firms of the old kind are disappear-
ing. Big data and computer technology have lowered information
costs so much that billions of individuals can now transact with
each other directly ‘on line’ without the need for institutional inter-
mediaries. Institutions recede before the invasion of social media
and on-line shopping. ‘All that is solid melts into air’, as Marx put
it. Radical sociologists, like the Brazilian Roberto Unger, believe
that the ‘knowledge economy’ is bound to generate a decentralised
world of small firms wired into global networks.10
However, the new individualist perspective is premature. The
institutions thrown up by digital technology are less visible than
their predecessors, their activities more ‘virtual’, but this does not
mean that they do not exist, or that they are not even larger and
more powerful. The highly visible multinational corporations
which bestrode the world like colossi in the 1970s, and whose exis-
tence and functioning the institutional economists tried to explain,
may no longer exist, but this does not mean that the ‘democracy of
the market’ has taken their place. Their place has been usurped by
new digital platforms like Google, Amazon, Facebook, and Apple,
which establish quasi-monopolies in gathering data on consumer
preferences and tastes, which they can exploit commercially. State
regulation and monitoring expand to control the exploitation of
data for nefarious purposes. Big Brother is (almost) continuously
watching you, but most economists, entranced by their vision of an
individualist trading utopia, have not spotted him.
z
Institutional economics, whether old or new, is a great improve-
ment on the Robinson Crusoe of the pure neoclassical school.
It recognises that individuals face situations which lead them to

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cooperate. These situations can be expressed either in terms of

information ‘costs’ or as an existential problem (uncertainty).
Game theory too recognises that games, particularly repeated ones,
can lead to cooperative equilibria. The players are conditioned by
each other’s behaviour.
Nevertheless, new institutionalism remains generically in the
instrumentalist camp. It perfectly illustrates the imaginative pov-
erty of neoclassical economics under its carapace of technique.
Information is treated as a measurable cost, whereas what causes
people to bond together is not the cost of obtaining information
but the fear of being alone in an uncertain world.

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 9
ECONOMICS AND POWER

Mainstream economists have not only found concepts like

exploitation and power to be useless in explaining
economic phenomena, but they worry about introducing
such emotionally charged words into the analysis.
Joseph Stiglitz, Post Walrasian and
Post Marxian Economics1

Power – how it is acquired, how it is used, its legitimacy – is

the main topic of political science. But it is conspicuous by its
absence from economics. Economics, at least notionally, sets
itself out to study non-coercive relationships: the voluntary bar-
gains of the market. Are the two disciplines, politics and econom-
ics, talking about different areas of life – the political realm shaped
by relations of power, and the economic realm shaped by voluntary
contracts?
Political economy is the traditional attempt to bring the two
together. But as an academic subject it has foundered by its associa-
tion with Marxism; and non-Marxist versions have suffered from
fuzziness about how the power relations and economic relations
are linked together. So the study of political economy has been
marginalised. The two disciplines, politics and economics, pursue
their separate paths, in their familiar silos. In between fall most of
the important questions of public policy.
This chapter is directed at the neglect by economists of the role
power plays in economic relationships. This neglect is deliberate.
By ignoring the extent to which power pervades the economy,

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mainstream economists buttress existing structures of power by

rendering them invisible.
The first challenge for anyone trying to talk about power is to
state exactly what they mean by it. Most simply, it is the ability to
secure compliance with one’s wishes, by punishment or deterrence.
Power is not identical to authority, though the two concepts over-
lap. Authority is established by accepted superiority of character,
brains, experience, or position. This confers a recognised right
to be heeded. The doctor has authority, but not power. Nor is all
power illegitimate. It may be legitimate, in the sense that the right
of some to give orders and the obligation of others to carry them
out is generally accepted. However, it is never fully legitimate. It
carries an implication of some resistance, actual or potential, to
the wishes of the power-holder, which needs to be overcome or
prevented. Nor can all authority be divorced from power, though it
generally is. We talk of the ‘majesty of the law’ as something apart
from, or above, power. But we cannot avoid the suspicion that there
is ‘one law for the rich, another for the poor’.
One of the most influential discussions of power, by Steven
Lukes (b.1941), argues that it must be understood along three
dimensions: blunt power, agenda power, and hegemonic power.
Forms of power
Blunt (or hard) power is the simplest, least controversial, and
almost certainly the most important of these dimensions. It is the
gun to the head, the hand on the throat: the ability to coerce people
into doing what they do not want to do, but what you want them
to do. There are different degrees of coercion, but the basic idea is
the same. If you don’t do what I want, I will make your life either
very short, very painful, or very difficult. Blunt power has been by
far the most prevalent form of power in history, which indeed has
been largely the story of military conflict. Clausewitz defined war
as ‘an act of violence to compel our opponent to fulfil our will’. War
is still important in international relations, though in hybrid forms.
Agenda power, as the name suggests, refers to control over ‘the
agenda’ of politics. It is the ability to keep disturbing ideas out of

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the decision-making process. If an idea does not suit your inter-

ests, you prevent it being discussed. The chair of a meeting sets the
agenda and, with a little guile, can make sure that the meeting is
over before there’s time to discuss an uncomfortable subject. The
media and political parties set the language and tone of public dis-
cussion. They decide which ideas are ‘on the page’ and which are
‘beyond the pale’.
During the Greek bailout crisis, Christine Lagarde, head of the
IMF, famously claimed that there was a need to talk to ‘adults in the
room’, a thinly-veiled allusion to Yanis Varoufakis, then the Greek
finance minister. Varoufakis was portrayed as childish; his pro-
posals for debt relief were ‘off the page’. The revolver-to-the-head
moment came later, when the European Central Bank deliberately
crashed the Greek banking system in the run-up to a referendum.2
In the same way, if major news outlets decline to cover an issue,
and major political parties aren’t minded to press it, eventually
interest in it fizzles out. People might grumble away on the street
or in the pub, but more often than not it comes to nothing. A classic
example of this is immigration.
Of course, the attempt to keep issues ‘off the page’ is not wholly
successful. Despite long-term support from the Daily Mail and
the Daily Telegraph, Brexit was not really ‘on the page’ until David
Cameron and George Osborne thought a referendum would finally
stop the Conservative Party’s perpetual civil war over Europe.
Likewise, Donald Trump was not really ‘on the page’ until he burst
onto it during the Republican primary with a cunning grasp of
the power of social media, a keen sense of TV news’ addiction to
drama, and perhaps a little outside assistance. Division of opinion
is the biggest limit on the ability to exercise agenda power.
Overlapping with agenda power is hegemonic, or ideologi-
cal, power. This is not so much about keeping the wrong ideas off
the page, but filling the page up with one’s own ideas. Ideological
power is invisible, so provokes no resistance. Lukes describes it as
‘power over thought, desires, beliefs and thus preferences’.3 French
sociologists Pierre Bourdieu (1930–2002) and Michel Foucault
(1926–1984) discerned forms of ‘cryptic domination’ that are so

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submerged in our subjectivity and our habits that we cannot really

become conscious of them.4 Propaganda supports both agenda and
hegemonic power; it sways opinion in the short run, and frames
the way people think about things in the long run. Ideological
power is the archetypical ‘soft’ power. You conform from love,
not fear. While the definitions above from Lukes, Bourdieu, and
Foucault differ subtly, what all point to is the idea that our values
and habits of thought can be structured to suit the interests of the
power-holders.
‘Inducements’, in the form of ‘carrots and sticks’, are elements
in the maintenance of all three forms of power. Sticks are obvious
with blunt power, which today is virtually confined to state, mafia,
or terrorist power. But all organisations have developed systems of
inducements (economists call them ‘incentives’) to tie their mem-
bers to the organisation’s aims. Even hegemonic power (which is
largely invisible to those subject to it, acting through their own
agency) has its incentive structure.
The hegemonic conception of power draws heavily on the
Marxist tradition. For Marx, ideology was ‘false consciousness’, an
idea developed by Antonio Gramsci (1891–1937). In Gramsci’s
words, hegemony represents ‘the intellectual and moral leadership’
through which ‘a general direction [is] imposed upon social life
by the dominant fundamental group’.5 The idea of religion as ‘the
opium of the people’ is an example of this thinking: through the
promise of a blissful afterlife in return for toil in this life, workers
are blinded to their true interests on earth. Ideological power can
be seen as a replacement for customary authority, including reli-
gious authority; the ideological community of nation has been the
most potent form of association in the twentieth century.
Gramsci developed the idea of ‘hegemonic power’ to explain
why Marx’s predictions of proletarian revolutions in the industri-
alised countries never happened. The working class had been led
to support the conditions of their own oppression. The immediate
trigger for his revelation was working-class parties in 1914 putting
nation above class in supporting the war. Radical Islamism may
be seen as a contemporary example of hegemonic power: young,

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disaffected men encouraged to throw away their lives for the sake
of eternal bliss.
The hegemonic dimension of power is the haziest. How do we
know it exists if it is invisible? The answer is that, much like gravity,
it is a hypothesis to explain the problem of why people seem to act
against their interests. This assertion of myopia, however, assumes
that the ‘true’ or ‘objective’ interests which are unknown to the per-
son are known to the theorist.
In some cases, involving scientific matters of fact, ‘true’ inter-
ests may be known, and failure to act on them is myopic. In mat-
ters of science – say medicine – we talk about the authority of the
doctor, not his power. If Marxism is regarded, as it has been by
most Marxists, as the ‘true’ science of society, then the failure of
the workers to act as the ‘science’ required them to needs to be
explained. Their behaviour is plainly deluded. This is analogous to
the way economists explain as ‘irrational’ the failure of people to
act in the rational way economists expect them to. But in neither
case are people being offered a true ‘science of society’ in the way it
is possible to develop a true science of nature: at best, a partial, or
incomplete, argument. The charge of irrationality or myopia there-
fore falls to the ground. It is simply not true to say that the ‘work-
ing class’ had no country in 1914. They felt themselves German,
French, British, Russian, Italian. That is why they rallied to their
countries’ cause in war. This was not delusion: it was reality, a real-
ity which a purely class interpretation of history misses.
The legitimacy of power
Study of the forms of power is heavily influenced by one’s view of
the character of the institutions through which it is supposed to
be exercised. Political science recognises three main structures of
power: liberal, Marxist, and Machiavellian.

1. The liberal theory of the state is congruent with, and devel-

oped alongside, the economic theory of the state. State power is
blunt power, but it is strictly limited by the terms of the social
contract which is said to have terminated the ‘state of nature’.

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This subjects state power to the terms of the contract. The state
has rights and obligations; so do its citizens. Provided the state
sticks to the contract, its power is legitimate. Crucial to the
liberal picture was denial of state power over the market. The
state’s power was limited to keeping market actors ‘honest’ –
punishing fraud and preventing monopoly. ‘Sociological’ liberals
like Montesquieu (1689–1755) and Tocqueville emphasised the
role of a constitutional separation of powers and intermediate
institutions as bulwarks against despotic power. Agenda and
hegemonic power are not part of the liberal picture, since liber-
alism denies the state any but coercive power.

2. The Marxist theory of class power reflects its view of history,

not just capitalist history. Social organisation has always been
shaped by a dominant class for its own purposes, whether the
purpose was military glory or booty, with a strong connection
between the two, and both involving exploitation of the
labouring class according to the prevalent mode of production
(slavery, serfdom, ‘wage slavery’). Its basis has always been class
ownership of the means of production. In capitalist society,
class power is wielded by the capitalist class and stems from
their ownership of capital. Mostly this is blunt power: either
workers accept the capitalist-determined wage or they starve to
death. But hegemonic power is not lacking as reinforcement.
Control over the means of production includes control over
the production of ideas. Marx wrote, ‘The ideas of the ruling
class are in any epoch the ruling ideas . . . The ruling ideas are
nothing more than the ideal expression of the dominant mater-
ial relationships that make the one class the ruling one;
therefore the ideas of its dominance’. Class power is per se ille-
gitimate. A revolutionary seizure of power is necessary as a
prelude to abolishing it, by abolishing classes.6

3. The Machiavellian (or cynical) theory of elite power.

For Vilfredo Pareto, economist, sociologist, political scientist,
what Marx envisaged as a social struggle for the control of
power is simply the struggle for power between incumbent and

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opposition elites. ‘The sole appreciable result of most revolu-

tions’, he wrote, ‘has been the replacement of one set of politi-
cians by another set.’ Socialism is a form of false consciousness;
it leads not to the triumph of humanitarianism, but the imposi-
tion of another cage of bondage. ‘Play the sheep and you
will meet the butcher.’7 Elite power, like class power, relies on a
mixture of blunt power and delusion.

How do economists treat power?

Neoclassical economists typically depict the economy as a power-
free zone, with market monopoly as the single recognised excep-
tion. This distinguishes them from Marxists, who treat monopoly
in the market as no more than an extreme case of the monopoly
inherent in all ownership of capital. By modelling markets as com-
petitive, economists help make power invisible.
A monopolist is anyone who buys or sells goods in large enough
quantities to affect their price. The ability to raise prices as you wish
is a form of power; if you are the only provider, then you can easily
say ‘it’s my way or the highway’. Adam Smith recognised the inher-
ent tendency of markets to monopoly. ‘People of the same trade,’
he wrote, ‘seldom meet together, even for merriment and diversion,
but the conversation ends in a conspiracy against the public, or in
some contrivance to raise prices.’8
Smith understood that as soon as some market participants are
monopolists, with power over their own prices, the whole theory of
efficient allocation collapses. If someone has a monopoly on water,
say, then not only does more money go towards the water sup-
plier than is needed to maintain supply, but that supply will itself
be unnecessarily restricted in order to inflate the prices further. In
addition, monopoly in the market greatly increases the power of
political lobbying. If there are many firms in a sector, then the ben-
efits to any one firm of lobbying for more favourable conditions
for the sector go mostly to their competitors, so it doesn’t arise.
A monopolist, however, captures all the benefits.
Economists have no problem in modelling monopoly, which is
simply a market with a single buyer or seller. However, in setting out

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their stall, they choose to minimise its importance in economic life.

Textbooks always start with models of competitive markets, intro-
ducing the theory of monopoly later on. This is because ever since
Smith’s day they have treated monopoly as a blemish or imperfection
on an otherwise desirable state of affairs. The prescriptive, or norma-
tive, character of economic modelling is here clearly on display.
In line with Smith’s attack on monopoly, even governments
that were otherwise committed to laissez-faire have often acted
decisively against blatant monopolies. The most famous example
is the anti-trust Sherman Act in the United States which led to
the break-up of Standard Oil in 1911. Recently this hardline anti-
monopoly approach has been diluted, particularly in the field of
the economics of regulation. Instead of actual competition being
required to undercut monopoly power, the mere threat of it can be
substituted. If a number of assumptions hold, then, even if there
is only one firm in the market, it will be sufficiently worried about
new entrants that it behaves as though it is in a competitive market.
The general proposition is that there can be no market power
if markets are contestable. This is the most powerful argument
for market-led globalisation. Richard Cooper writes: ‘Widespread
economic capacity, in a globally competitive environment, creates
options for all parties; and the presence of alternatives undermines
the capacity of any one player to achieve its preferred ends, except
through good performance in the eyes of its customers’.9 This is a
highly idealised picture of the actual global system in which large
corporations can allocate markets, choose where to invest, and
move money from place to place; and, by using transfer pricing
– buying at inflated prices from their own subsidiaries – pay tax
wherever they want.10 To these abuses of competition, most econo-
mists have one answer: more competition.
A far more common – and complex – form of market power is
oligopoly: a market dominated by a few large firms (cars, oil, tele-
coms, aviation), rather than just one. Each firm knows that any pri-
cing or output decision could provoke a reaction from the others.
A few handshakes would be enough to turn this into a cartel. If they
cooperate, they are equivalent to a monopoly. It doesn’t even have

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to be overt: firms can reach a kind of tacit truce in pricing strategy

for fear of a retaliatory price war. Yet the cartel phenomenon too is
immune from the study of economic power. For one thing it is very
difficult to model: prices are indeterminate. So economists tend to
fall back on saying that sooner or later the cartel will break down
due to the economic incentives to cheat, and producers will end up
playing a competitive strategic game. But price wars like this don’t
seem to happen much in practice: oligopolistic pricing displays a
remarkable stability in many industries.11
Outright monopolies are relatively uncommon in the modern
economy. Far more common is the final form of market power
students learn about: monopolistic competition, first outlined by
Edward Chamberlin (1899–1967) in 1933 and later expanded
upon by Joan Robinson (1903–1983). The idea of this is that while
firms can’t hope to hold an absolute monopoly on what they sell,
they can establish brand monopolies. Nike don’t have a monopoly
on all trainers, but they do have a monopoly on Nike trainers. So,
as long as enough people feel that the ‘swoosh’ is worth paying for,
Nike have a degree of power, a position to defend.
To establish this type of partial monopoly, firms must differen-
tiate their products slightly from their competitors to find some
kind of edge, some ‘unique selling point’, or USP, as the marketers
say. Firms who find a USP can charge a mark-up over the price
that a firm in a perfectly competitive market would charge.12 This
actually starts to appear like a more realistic picture of the modern
economy, but unfortunately is rarely explored in detail beyond the
initial outlining of the theory.
For completeness we should include monopsony power. This
is a situation in which the market is dominated by a single buyer.
A good example of a monopsony is Britain’s National Health Service,
in which the state is the buyer of 90 per cent of medical services.
The result is a consumers’ surplus: the consumers are asked to pay
less for their health than they would be prepared to. Similar situa-
tions can exist for labour. The state holds a high degree of monop-
sony power on, for example, police, teachers, and nurses, as would
any monopoly provider in an industry with specialised labour.

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The hostility to monopoly is a healthy tradition. But in mod-

elling the market system as a self-regulating domain populated
by atomistic ‘agents’, mainstream economics ignores the actual
structure of modern markets in which big firms, digital platforms,
labour unions (sometimes), advertisers, and governments call
most of the shots. Thus most economists minimise the problem of
power in the market system.
The contestability of markets is standard economics’ answer to
Marx’s claim that power is inherent in all wage labour. The reply
is that it would be true if there were only one job to be had; not if
there were a choice of jobs. Even so, quitting has costs. The ques-
tion is, how high do those costs have to be for the wage contract to
count as coercive? The social democratic argument is that it would
be coercive in the absence of measures to balance employers’ power
in the market. This is the justification for labour unions, minimum
wage legislation, and welfare entitlements. Yet the neoclassical nar-
rative has been mainly about how trade unions, minimum wage
laws, and the welfare state ‘price’ employees out of work.
The fact that students are nevertheless taught how prices are
determined in competitive markets before they are introduced to
monopoly or oligopoly pricing strongly suggests that the latter is
viewed as contingent and temporary. The student is additionally
bombarded by qualifications to the existence of market power, assur-
ing them that competition will usually prevail: the cartel will break
down, the threat of an entrant will discipline the incumbent. By
contrast, they are largely encouraged not to think too hard about
the exceptions and qualifications to the existence of competition. The
language of ‘market imperfections’ supports this. Rhetorically, the
default is a perfect market and the rest is just adjusting that template
better to reflect reality. Describing a breakdown in a situation where
a competitive market cannot exist as a ‘market failure’ is like describ-
ing the collapse of a wooden building as a ‘timber failure’: in reality,
the failures belong to the economists and engineers.
The fault is easy to identify, but hard to eradicate, because it
has been with scientific economics from the beginning. The answer
is to start at the other end: to accept that markets in general do

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not, and cannot, satisfy the efficiency conditions required of them,

and identify those particular areas where they do and can. In other
words, to work out a general theory of markets, with efficient mar-
kets as a special case. This, I take it, is what Keynes attempted to do,
and he leaves us with an uncompleted task.
Further, by confining itself to studying and worrying about only
one particular form of economic power – power in the market –
mainstream economics diverts attention from the way in which
power is exercised outside the market to influence the economic
policy of governments and the tastes, preferences, and values of
consumers.
The role of economics in the power system
In the concluding remarks to The General Theory, Keynes famously
wrote that ‘the ideas of economists and political philosophers, both
when they are right and when they are wrong, are more power-
ful than is commonly understood. Indeed the world is ruled by
little else . . . I am sure that the power of vested interests is vastly
exaggerated compared with the gradual encroachment of ideas.’13
Keynes is not just distinguishing between ideas and vested inter-
ests but also asserting the independence of ideas from such inter-
ests. Keynes wouldn’t have denied that ideas are a source of power.
But he would call this disinterested power; more precisely, a source
of authority. The key argument for the independence of econom-
ics from class interests is that economic ideas are the products of
the academy, not of business lobbies. Pure research has long been
recognised as an independent intellectual pursuit; its hallmark,
disinterestedness; its purpose the search for truth. The pecuniary
interest of scholars is not directly involved in either the direction
of their enquiry or its results.
One can further argue, in Keynes’s spirit, that the agenda of eco-
nomics is set by economists, and not by ‘vested interests’. Its leading
ideas are not at the mercy of power in any straightforward way.
Economic theory, as we have argued, exhibits stability through
time, in its concepts, techniques, and language. That is what makes
it difficult to apply to it the idea of a paradigm shift.

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It is true that economic theory is influenced by the conditions

of the times. These produce what John Hicks (1904–1989) called
‘concentrations of attention’. The emergence of persisting unem-
ployment in the 1930s produced the Keynesian revolution; the
inflation in the 1970s produced monetarism. The theoretical inter-
pretation of these facts cannot be linked up to vested interests in
any simple way. But even if we accept (as we must) that ideas are an
independent source of power, does this make them independent of
vested interests?
‘Economics itself (that is the subject as it is taught in universi-
ties and evening classes and pronounced upon in leading articles)’,
wrote Joan Robinson, ‘has always been partly a vehicle for the rul-
ing ideology of each period as well as partly a method of scientific
investigation.’14 The question arises why some ideas produced in
the academy are considered acceptable, and others marginalised.
The world may be ruled by ideas; this does not mean it is ruled by
just any ideas. We still need to ask what gives some economic ideas
‘legs’ and cripples others.
In the natural sciences – physics and chemistry more than
biology – the answer is their superior scientific quality. For this rea-
son,quantum physics replaced classical physics.15 Reality is unchang-
ing, only the theory changes as it improves our understanding
of reality. In social sciences this is much less true. The natural world
does not interfere with one’s observation of it; the social world
does. It is the changeability of the object being studied which
demarcates social sciences from natural sciences. As a result,
propositions in social science do not satisfy the ‘universality crite-
rion’. They can rarely be successfully confirmed or falsified, except
briefly.
This suggests that in economics, much more than in physics,
the profession’s own research agenda partly reflects non-scientific
interests. It is therefore not irrelevant to ask: who finances the insti-
tutions from which economic ideas spring? Who finances the dis-
semination of ideas in popular form – media, think tanks? What
are the incentives facing the producers, disseminators, and popu-
larisers of ideas even in a society in which discussion is ‘free’?

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The financing of economic research is done mainly by the gov-

ernment and business. We may assume, for the sake of argument,
that the government is interested in the public good. It pays for the
production of economic knowledge in order to improve the wel-
fare of the community. It does not directly interfere, or has not till
recently, with the content of research.
This cannot be said about business. Business is Keynes’s classic
‘vested interest’. And a lot of economics is paid for by businesses.
We may point to the huge influence of ‘City economists’ – bank
analysts, financial journalists, and so on – in propagating a crude
version of free-market orthodoxy. And even academic economists
have lucrative sidelines in ‘consultancy’. Economics is more similar
in its funding structure to engineering or pharmacology than to
sociology or history.
Economics is the only social science which has a Nobel prize,
being bracketed together with the hard sciences. This is seen as the
ultimate accolade for a real science. No Nobel prize exists for his-
tory, political theory, or sociology. Yet it is funded by the Swedish
Central Bank, which is no more a neutral technical institution than
any other central bank.16 So we may ask: what is the interest of
business in paying for economic research?
The Marxist charge against bourgeois economics
The Marxists give a clear answer. ‘What else,’ Marx wrote, ‘does the
history of ideas prove, than that intellectual production changes
in proportion as material production is changed?’17 Their charge
is that the power-holders in a capitalist society, through their con-
trol over the media, political, and educational systems, are able to
generate a flow of ideas which induce a pattern of working class
behaviour which suits them, but is contrary to the objective inter-
ests of the working class.
Specifically, these ideas cause workers to accept working
arrangements, wages, debt contracts, lifestyles, and forms of con-
sumption which are contrary to their own interests. Economics,
say Marxists, serves the interests of the capitalist class by disguising
the true nature of things by means of its scientific pretension. This

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5. The Bosses of the Senate by Joseph Keppler, 1889.

causes people to think of it not as connected to ideology or politics

but to something objective like physics or chemistry. It is surely no
coincidence that the policy of central bank independence depends
largely on the acceptance that economics is a science, and thus the
decisions of a central bank are technical, rather than political, in
nature. The idea of a technocratic ruling group, above ‘class’ and
ruling in the interests of the whole society, is strongly challenged
by those in the Marxist tradition. Capitalism and democracy, writes
the German sociologist Wolfgang Streeck, ‘are both individually as
well as in their respective combinations, the outcome of specific
configurations of classes and class interests as evolved in a histori-
cal process, driven not by intelligent design, but by the distribu-
tion of class political capacities.’18 The Keynesian revolution itself
represented a balance of forces between an increasingly organised
working class and a capitalist class on the defensive.19
We have already suggested that the claim of economics to be
a hard science is largely spurious. Most of its propositions can be
neither refuted nor verified. If this is so, economic theory is opin-
ion cloaked in the authority of science. We trust doctors because
they have science behind them, though some theorists of power
such as Michel Foucault have identified the medical system as, in
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part, a tool of social control.20 Economists claim the authority of

doctors without the credentials of medicine.
Nevertheless, the Marxist charge is only partly true. The rela-
tionship between power and ideas is not a simple base-superstruc-
ture one. Not only does economics have its own agenda; practical
people – politicians, businessmen, civil servants – are consumers,
not producers, of ideas. This gives the producers of ideas consid-
erable latitude vis-à-vis their users. The vested interests are in no
position – even were they capable of it – to dictate the precise form
of the intellectual defence offered for their preferences. Thus the
economist’s justification of the free market is likely to be both more
general and also more circumscribed than that offered by the busi-
ness class. For example, economists have almost always opposed
protectionism and monopoly, propositions often heavily supported
by sections of business.
More damaging to the Marxists is that the base on which the
superstructure of ideas is supposed to be erected, is far from being
the monolith of the Marxist imagination. In practice, it is usually
divided into conflicting interests: in economic life, between export-
ers and importers, between creditors and debtors, between finance
and industry. We get the phenomenon, notable in the United
States, of a business class whose ideological hostility to the state is
continually subverted by its reliance on state defence and research
contracts for its prosperity.
A key matter here is how power is divided. How balanced is the
power structure between the state and vested interests, between
contending political and social groups, and between capitalists and
workers? The more even the balance of forces, the less likely one is to
get a single story from economics about the way the economy works.
From roughly the 1920s through to the 1970s the balance of forces
between capital and labour was such as to enable a policy of social
compromise. In the last forty years power has shifted decisively from
the old working class to those with superior birth, wealth, and educa-
tion; and from the old business to the new financial elites.
For these reasons, there is never a 1:1 relationship between an
economic argument and a political argument. This gives economics,

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 WHAT’S WRONG WITH ECONOMICS?

together with the other social sciences, a relative autonomy from

political forces, wherein lies their authority. But the distance, in the
Marxist view, is only relative.
Despite its relative autonomy, there are at least three ways in
which economics serves the interests of business. First, by invest-
ing their interests with the authority of science, economics can
make self-interest seem more enlightened. Practical people like
nothing better than to have their prejudices dressed up in scientific
language. Such language has the power to turn what is really a mat-
ter of opinion into a fact of nature.
The second influence is exerted through its agenda power.
‘Nothing is so important in the defence of the modern corpora-
tion,’ writes John Kenneth Galbraith, ‘as the argument that power
does not exist; that all power is surrendered to the impersonal play
of the market. Nothing is more serviceable than the resultant con-
ditioning of the young to that belief.’21 As he explains,

The rise of the modern corporations has brought a concentra-

tion of economic power which can compete with the modern
state . . . The state seeks in some aspects to regulate the corpora-
tion, while the corporation, steadily becoming more powerful,
makes every effort to avoid such regulation. Where its own
interests are concerned, it even attempts to dominate the state.22

By modelling economic life in terms of individual optimisation in

competitive markets, economics renders any power that is less bla-
tant than outright monopoly completely invisible. For example, an
exploitative wage is any wage that falls below the marginal value of
labour’s product. But under the assumed competitive conditions
labour will receive the value of its marginal product, so exploita-
tion is a pathology, not inherent, as Marx claimed.
Similarly with the mainstream treatment of advertising. For
mainstream economists, decisions on what to buy are made by
rational consumers maximising their utilities in competitive mar-
kets. In this model there is no scope for advertising to alter prefer-
ences. Advertising as an expression of power is rendered invisible by

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arguments to the effect that it merely confirms preferences or pro-

vides consumers with information. Today the unseen influence of
networks of computers known as Cloud storage, owned by virtual
companies like Google and Facebook, on the tastes, ideas, and pur-
chases of their mainly young users, is largely ignored by mainstream
enthusiasts for the market.
Third, economics supports the dominant power system not just
by keeping the role of marketing in shaping consumer choices off
its own research agenda, but by giving ‘scientific’ support to posi-
tive political programmes. The chief example in our own day has
been the alignment of mainstream economics with the political
programme of reducing the role of the state in the economy.
Specific propositions of mainstream economics include the idea
that the market system ensures that business leaders are paid no
more than they are worth, that globalisation benefits even those who
lose their jobs, that government deficits in a slump make things worse
than they would have been, and that finance is merely an intermedi-
ary in the economic system, not an actor in its own right. All these
propositions may be true, or partially true, in special circumstances;
it is their generalisation into universal laws that causes the damage.
Milton Friedman has left a charmingly naive account of the
relation between science and ideology in his own work:

During my whole career, I have considered myself somewhat of

a schizophrenic . . . On the one hand, I was interested in science
qua science, and I have tried – successfully I hope – not to let
my ideological viewpoints contaminate my scientific work. On
the other, I felt deeply concerned with the course of events and
I wanted to influence them so as to enhance human freedom.
Luckily, these two aspects of my interests appeared to me as
perfectly compatible.23

Friedman peers very briefly over the precipice and then hurriedly
withdraws. Yet the whole of his ‘scientific’ work was directed to
demonstrating the futility of government intervention in the econ-
omy. Friedman deserves credit for recognising that there might be

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 WHAT’S WRONG WITH ECONOMICS?

a problem in reconciling science and values. Most economists sim-

ply ignore it.
z
The link between ideology and economics is complex. It is not that
ideology distorts the conclusion of an argument. Rather it invades
the way the argument is set up or ‘modelled’ – the core assumptions
(equilibrium, optimisation), the choice of problem to be studied,
the choice of relevant variables, the selection of data, the choice of
one model rather than another: in short, the research programmes
which economists pursue. In this way economics can display a
strong ideological slant, while sticking to the accepted canons of
scientific enquiry. Its scientific method has served to protect it
from the charge of ideological bias or subservience to power.
Economics has not found a way of modelling power. But it is
worse than that. Neoclassical economics provides the intellectual
backing for the political programme of neoliberalism. Economics
is the cement which binds together what Joe Earle, Cahal Moran,
and Zach Ward-Perkins (founding members of the Post-Crash
Economics Society) call ‘the econocracy’, a network of technocratic
institutions such as central banks, treasuries, large banks, and cor-
porations which have seized control of economies from the nerve-
less hands of government.24 It is for these reasons that the reform
of economics is more than mere academic self-indulgence.
The weakness of economics in handling power is part and par-
cel of the absence of institutions from its map of reality. The only
actors in its map are maximising individuals. A proper econom-
ics would start with institutions – classes, organisations, and social
norms – and then try to show how these shape individual choices.
The objection is that such an approach is impossible to model
mathematically. For mathematical modelling you need tight priors
from which you can deduce precise quantitative conclusions. With
any other approach you fall into – God forbid! – political economy.
To this objection Keynes gave an answer which to me is irrefutable:
in matters of public policy it is better to be approximately right
than precisely wrong.

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 10
WHY STUDY THE HISTORY OF
ECONOMIC THOUGHT?

Economics is more like art and philosophy than science, in

the use it can make of its own history. The history of
science is a fascinating subject . . . but it is not important for
the working scientist in the way the history of economics is
important to the working economist.
John Hicks, ‘Revolutions’ in Economics1

The main reason for studying the history of economic thought

is to question the claim that economic knowledge is cumulative.
Mainstream economics views economics as part of the Ascent of
Man. It believes that all useful economic knowledge from the past
is incorporated in present theories. In fact, economics has been
interminably disputed ever since the start of the ‘science’. The rea-
son, I have suggested, is that its theorems, while often contrary to
common sense, are not refutable.
Yet the claim to cumulation has been there from the beginning.
‘What useful purpose can be served by the study of absurd opin-
ions and doctrines that have long ago been exploded, and deserved
to be?, asked J.B. Say (of Say’s Law fame) in the early 1800s. ‘It is
mere useless pedantry to attempt to revive them. The more perfect
a science becomes the shorter becomes its history . . . Our duty with
regard to errors is not to revive them, but simply to forget them’.2
One wonders whether Say would be flattered or horrified, then, to
learn that his ‘law’ was still being taught to students 200 years on.
Here is Robbins a hundred years after Say: ‘It may safely be
asserted that there is nothing which fits into the old framework

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 WHAT’S WRONG WITH ECONOMICS?

which cannot be more satisfactorily exhibited in the new.’ The only

difference is that ‘at every step we know exactly the limitation and
implication of our knowledge’.3 In our own times, George Stigler
has asked: ‘Does Economics Have a Useful Past?’ and concludes
that it doesn’t: ‘one need not read in the history of economics . . . to
master present economics’.4
Nobel Laureate Paul Krugman gives a more sympathetic view
of the relationship between ‘old’ and ‘new’ economics, by means of
an analogy with the gradual mapping of Africa. Over time maps of
the coastline of Africa got steadily more accurate, but at the cost
of leaving out the details of the (sometimes mythical) interiors.
The improvement in the art of map-making ‘raised the standard
for what was considered valid data’. Something similar happened
to economics:

A rise in the standards of rigor and logic led to a much improved

level of understanding of some things, but also led for a time to
an unwillingness to confront those areas the new technical
rigor could not yet reach. Areas of enquiry that had been filled
in, however imperfectly, became blanks. Only gradually, over
an extended period did these dark regions get re-explored.

In short, ‘a temporary interlude of ignorance may be the price of

progress’.5 Despite the interlude (how long?) of ignorance, the his-
tory of economics is a story of progress. In the end, the territory is
‘re-explored’ with a better map.
Over the last thirty years, nearly all economics departments
have taken Robbins, Stigler, and Krugman at their word by remov-
ing the history of economics from their courses, leaving perhaps a
lecture at the very start of a course to give a brief overview. In this
view, all original formulations have been improved; all ‘errors’ have
been filtered out, leaving nothing but the presently correct state-
ment of the scientific theory. Studying the history of economics is
like rummaging in an attic filled with antique gadgets, a pleasant
enough pastime, but of no practical use. It also invites the suspicion
that the rummager is not competent to do scientific work.

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WHY STUDY THE HISTORY OF ECONOMIC THOUGHT?

6. The Miller Atlas of Brazil, 1519. Note the stylistic depiction of the interior,
compared to the absence of detail in describing the features and settlements
along the coastline. It has been suggested that the map served a political
purpose: its Portuguese creators sought to discourage Spain’s colonial ambitions
by showing Brazil fading into the map’s outer border, implying that circumnavi-
gation around it was impossible.

The question that such accounts beg is whether ‘present eco-

nomics’ is the best economics. The failure of most economists to
foresee the possibility of the collapse of 2008 may be thought a ref-
utation of the affirmative thesis. If so, the student cannot, or should
not, accept on faith that present economics is best. Some past eco-
nomics may be better at explaining problems of present interest.
One might even argue that the stock of knowledge available to
economists has been depreciating. For example, economists in the
past knew more than they do today about banking and finance,
even though they ‘do’ the subject more rigorously.
The fact that an idea formerly grasped without maths is now
stated in maths is not necessarily an argument for progress, because
it ignores the possibility that a great deal of useful knowledge gets
permanently lost in translation. Stigler does give one reason for
studying the history of economics, which is to understand better

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 WHAT’S WRONG WITH ECONOMICS?

how a science evolves, and specifically ‘the relationship between

the intellectual content of a science and the organization and envi-
ronment of the scientist’.6 The study of such relationships might
reveal the secret of persistence without progress, survival without
evolution.
Methodological debates
The history of economics is marked by a profusion of doctrines but
a persistence of method. The one important ‘paradigm shift’ (see
next section for an explanation of ‘paradigm’) was the marginal
revolution – the switch from a cost of production theory of value
to subjective utility in the last quarter of the nineteenth century.
The commitment to this latter method of analysis either emascu-
lated rival doctrines (institutional economics) or expelled them
from economics altogether (Marxism). Persistent sniping from
individual dissidents and dissident schools about the mainstream’s
way of doing economics has been left out of the ‘official’ story of
cumulative progress, and it is this sniping that we shall focus on.
The attacks have been mainly directed against unreal behavioural
assumptions (homo economicus), excessive formalism and abstrac-
tion (including the near-mandatory use of mathematics), claims
to the universal validity of economic laws, and the demand that
macroeconomics be properly ‘micro-founded’ in individual opti-
mising behaviour.
From the birth of scientific economics, dissidents have argued
that too many theories in economics are generalisations made
without proper regard to the facts. That is, they lack an inductive
basis and are derived solely from ‘inner understanding’. Simonde
de Sismondi (1773–1842) wrote that ‘humanity should be on guard
against all generalization of ideas that causes us to lose sight of the
facts’. Richard Jones (1790–1850) had as his motto ‘Look and see’,
as opposed to ‘See and deduce’. Cliffe Leslie (1827–1882) said that
‘instead of investigating actual motives, economists construct a fic-
tional person out of desire for wealth and aversion from labour’.
Henry Sidgwick (1838–1900) criticised the approach which under-
takes to settle all practical problems ‘by simple deduction from

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WHY STUDY THE HISTORY OF ECONOMIC THOUGHT?

one or two general assumptions’. William Beveridge (1879–1963)

called economics a ‘survival of medieval logic’. Economists were
people ‘who earn their living by taking in one another’s definitions
for mangling’.7
What is striking about this is not just the similarity but the per-
sistence of the critiques. Economists have not on the whole been
too worried about the charge of lack of realism. A typical response
has been: the more abstract the theory, the more realistic it will be.
Nobel Laureate Wassily Leontief (1906–1999) attacked the
‘nearly mandatory’ use of maths in economics. ‘Uncritical enthu-
siasm for mathematical formulations’, said Leontief in his 1970
Address to the American Economic Association,

tends often to conceal the ephemeral substantive content of the

argument behind the formidable front of algebraic signs . . . In
no other field of empirical inquiry has so massive and sophisti-
cated a statistical machinery been used with such indifferent
results . . . Most of these [models] are . . . without practical
applications.8

In similar vein, and at the same conference, the British econo-

mist Frank Hahn said: ‘It cannot be denied that there is something
scandalous in the spectacle of so many people refining the analysis
of economic states which they give no reason to suppose ever will,
or have ever come about’.9 Another speaker, Harry Johnson (1923–
1977), noted that ‘the testing of hypotheses’ on which economet-
rics rested ‘is frequently a mere euphemism for obtaining plausible
numbers to provide ceremonial adequacy for a theory chosen and
defended on a priori grounds.’10
Economists with different politics, from different schools, like
Friedman, Coase, Robinson, Krugman, and Stiglitz have com-
plained about excessive maths. It is not just – as some of the more
cynical defenders of today’s orthodoxy have suggested – that dis-
sident students are unwilling to, or incapable of, getting to grips
with the maths. Students who are more than able to cope with the
technical demands of mathematical economics have recoiled from

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 WHAT’S WRONG WITH ECONOMICS?

the barrier maths puts between them and understanding the real
world.
Famous nineteenth-century economists like John Stuart Mill,
insisted that economics must be a broad discipline – a branch of
social philosophy, he called it – if its conclusions are to have any
value, a position echoed by Walter Bagehot (1826–1877), John
Kenneth Galbraith, and many others. The claim that econom-
ics has discovered ‘laws’ of universal validity has been repeatedly
attacked, without making much impression on the discipline. The
nineteenth-century German Historical School introduced the
important, but now neglected, idea that the validity of economic
doctrines depends on circumstances. A ‘law’ valid in one time and
place may be quite invalid in another. This had an important policy
implication: what is good for a nation or society at one time might
be bad for it at another.
One variant of this is the theory of ‘stages’, sometimes called
‘stadial’: that societies pass through successive stages of develop-
ment which generate different kinds of economic system, whose
precepts are justified by the stage they are in. It all depends where
you are in the continuous flow of events. As the ancient Greek phi-
losopher Heraclitus said: ‘You never step into the same river twice’.
The earliest schools of development economics (see Chapter 3)
relied on exactly such a stadial theory, before succumbing to the
universalist perspective. Adam Smith was clear that his economics
was intended to apply only to the last or ‘commercial’ stage of eco-
nomic history. This caveat was forgotten by his followers.
The best economists know that their ‘universal laws’ are subject
to special conditions. But the statement of the law in unqualified
form always makes much more impression on the public mind
than the statement of the qualifications to it. The demand that
macroeconomics be properly ‘micro-founded’ was part of the reac-
tion against Keynesian economics in the 1970s. Keynes based his
economics on the relations between aggregates like saving, invest-
ment, output, and money. His micro-foundations of ‘animal spirits’
and ‘conventions’ were unorthodox. By contrast, the revived neo-
classical tradition claims that macroeconomics should be based on

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WHY STUDY THE HISTORY OF ECONOMIC THOUGHT?

optimisation by firms and individuals. This, as we have seen, rules

out persisting mass unemployment.
This is just a sample of the methodological debates to be found
in the history of economics. Their relevance has not diminished
with time. The criticisms of mainstream economics have been
made by some of the best minds in the discipline, as well as outside
it. Mostly they have been parked into marginal fields, or taken up
by other disciplines.
Piero Sraffa (1898–1983) has explained the strategy of assimila-
tion through neglect and segregation:

From time to time someone is unable any longer to resist the

pressure of his doubts and express them openly; then, in order
to prevent the scandal from spreading, he is promptly silenced,
frequently with some concessions and partial admissions of his
objections, which naturally, the theory had implicitly taken
into account. And so, with the lapse of time, the qualifications,
restrictions and the exceptions have piled up, and have eaten
up, if not all, certainly the greater part of the theory. If their
aggregate effect is not at once apparent, this is because they are
scattered about in footnotes and articles and carefully segre-
gated from one another.11

Paradigms and research programmes

The deep answer to the question of why the persistent sniping of
the dissidents has had so little impact on the mainstream lies in the
extraordinary power of persistence of intellectual paradigms and
research programmes. The most important reason for the persis-
tence of the mainstream methodology is that it is constructed in
such a way that the conclusions deriving from it cannot easily be
falsified (see Chapter 5). On this rock an almost invulnerable set of
defences have been built to protect mainstream economics from its
critics. Thomas Kuhn and Imre Lakatos have described how these
defences work. In their view they are applicable to all sciences, but
economics has benefited especially from these defensive strategies
because of its claim to be like a natural science.

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 WHAT’S WRONG WITH ECONOMICS?

Persistence is partly inevitable in all sciences, as practitioners

must be ‘indoctrinated’ before being allowed to practise, but it also
provides a stable conceptual framework that can be scientifically
useful and, perhaps most significantly, protects the positions of the
established practitioners. The upshot is that once a ‘normal’ way
of doing ‘science’ has been established, it develops strong staying
power, however much its scientific claims are questioned. How
much more is this likely to be the case in economics, when refuta-
tion is almost impossible and vested interests are rampant.
Let’s start with Thomas Kuhn’s explanation of paradigm per-
sistence. A paradigm is a way of doing science which becomes
hard-wired into the psychology and hierarchy of the scientific
community, while simultaneously being open-ended enough on its
own terms to leave all sorts of problems for the defined group of
practitioners to practise their skills on. The paradigm directs the
researcher to the problems to be investigated, and furnishes him or
her with the conceptual tools and experimental methods to inves-
tigate them. This is the ‘normal’ way of doing science, necessary for
any organised enquiry. Significant changes in the science do not
occur within this framework, but instead represent changes in the
framework, what Kuhn calls ‘paradigm shifts’.
The threat to the paradigm comes not from empirical anoma-
lies, which can usually be insulated as ‘puzzles’ to be worked on, but
from changes in world-view, which make the puzzles seem intol-
erable. A mismatch develops between the institutional map of the
science and the problem which needs to be solved. A crisis devel-
ops when more and more practitioners occupy themselves with the
solution of the anomaly, which resists solution by means of the par-
adigm. Ultimately a new paradigm is suggested. This is resisted by
other members of the community but slowly wins them over. The
revolution is completed when a younger generation takes over.12
Two well-known examples in the natural sciences are the
replacement of Ptolemaic astronomy by the Copernican revo-
lution, and the replacement of phlogiston by gas as the agent of
combustion. Has there been anything comparable in economics?
Two candidates for paradigm shifts are the attack on the cost of

144
WHY STUDY THE HISTORY OF ECONOMIC THOUGHT?

production theory of value by subjective utility in the 1870s, and

the assault on Walrasian general equilibrium theory by Keynesian
economics in the 1930s. Both were partial shifts.
The shift to marginalism did not dislodge the central concep-
tion of the self-regulating market, but it did destroy the previous
method of analysing economic life in terms of structures like
classes and organisations. In the second case, although persistent
mass unemployment was regarded by Keynes himself as a refuta-
tion of Walrasian general equilibrium, it came to be accepted by
the orthodoxy as a special case of Walrasian general equilibrium,
one in which wages and prices were sticky. In this form it could be
co-opted into the mainstream. The marginalist revolution had a
more durable effect on the way economics was done than did the
Keynesian revolution.
Lakatos gives a less dramatic account of persistence and change
than Kuhn, by distinguishing between the constant and variable ele-
ments in a ‘research programme’. In such an enterprise the research-
ers will share a common set of basic axioms and assumptions; a set
of accepted working practices for proposing and confirming theor-
ies (the heuristic); finally a ‘protective belt’ (the variable element) in
which empirical research is done. Acknowledgement of ‘frictions’
is a typical strategy of the protective belt to preserve the core doc-
trine of equilibrium. Research programmes eventually degenerate
if there are too many predictive failures in the protective belt.
The function of the protective belt is to prevent premature rejec-
tion of the core, like an organism which develops an immunity to
infection. For example, when Copernicus developed a heliocentric
model of the solar system, people suggested this should mean small
movements in stars could be observed – parallax. They couldn’t be
found, but the theory wasn’t thrown out over this one small error.
These movements were later observed by more powerful tele-
scopes. The protective belt is much more powerful in the social
sciences than in the natural sciences, because of the weakness of
the refutation procedure.13
The debates in orthodox economics have mainly taken place in
the ‘protective belt’, to which economists have consigned puzzles,

145
 WHAT’S WRONG WITH ECONOMICS?

anomalies, and ‘curiosa’ for further work, leaving ‘normal’ science

to proceed unaffected.
Perhaps the most important reason for the lack of theoretical
shifts in economics (or indeed in any social science) is that these
disciplines never developed hard paradigms in the full Kuhnian
sense. Precisely because they are immune from refutation, social
science paradigms have enjoyed greater latitude for assimilation and
co-option. It is not so much that economic theories exist indepen-
dently from each other as that different schools co-exist in a loose
hierarchy, like the diversity of dialects within a single language.
John Bryan Davis (2016) has offered a persuasive account of
the way an economic orthodoxy protects its dominant position.
Traditional ‘reflexive domains’ for judging research quality – the
theory-evidence nexus, the history and philosophy of economics
– are pushed aside. Instead, research quality is assessed through
journal ranking systems. This is highly biased towards the status
quo and reinforces stratification: top journals feature articles by top
academics at top institutions; top academics and institutions are
those who feature heavily in top journals.
Because departmental funding is so dependent on journal
scores, career advancement is often made on the basis of these
rankings – they are not to be taken lightly. It is not that competition
is lacking, but it is confined to those who slavishly accept the para-
digm, as defined by the gatekeepers – the journal editors. In this
self-referential system it is faithful adherence to a preconceived
notion of ‘good economics’ that pushes one ahead. Some of the
most important neoclassical economists today have also criticised
the dominance of journal publications: it depresses quality by hin-
dering basic research, development of innovative theories, and is
often just a rudimentary follow-up of already published theories.
Nobel Laureate Lars Peter Hansen argues that ‘this reliance on
referees leads to a much more conservative strategy. I think it works
against novel papers that cross subfield boundaries and that makes
it all the more challenging. Basically it makes the simplest path
to publication in the top 5 journals to be high quality follow up
papers.’14 The pressure to feature in those prestigious journals also

146
WHY STUDY THE HISTORY OF ECONOMIC THOUGHT?

pushes researchers to write journal articles rather than books. This

constraint on space naturally favours partial accounts, which in
turn promotes the use of ceteris paribus (‘all else equal’) conditions.
Economics shares with social science the existence of profes-
sional standards. This is not true (in general) of the arts. Of asser-
tions or arguments in economics or sociology, it is possible to say
‘you have made a mistake’ in a way not possible, in say, fiction or
painting, where what is conventional can always be challenged or
overridden by ‘creativity’ or ‘originality’. It is the existence of profes-
sional standards which helps explain why social sciences tend to be
stable and resistant to change. But whether these internal standards
are merely internal to the discourse or represent the most useful
way of understanding reality is the point at issue.
Over the years, orthodox economics’ tolerance for diversity has
lessened. It may be that mathematics has so narrowed the scope of
economics that it has at last become a real paradigm. This narrow-
ing is connected with the political supremacy of the United States.
The American school has largely obliterated the other schools:
Marxism, Austrian economics, German economics, Keynesian
economics, Swedish economics. American economics spread with
American power; the decay of that power may finally open up a
field which has seemed increasingly closed.
z
Absent from the training of today’s economists, the dissenters
nevertheless represent an unused, because neglected, arsenal of
tools. The testimony of powerful forebears is particularly valuable.
Current dissenters from established opinion need not feel lonely.
One can recognise oneself in great thinkers of the past. To the
extent that the existing research programme or paradigm in eco-
nomics is coming to be seen as neglecting the problems of most
interest to our own generation (stagnation, inequality, climate
change, automation), the history of the discipline itself becomes a
valuable intellectual tool.
The study of past debates has one great bonus. It is sometimes
claimed that introducing students to too many conflicting ideas

147
 WHAT’S WRONG WITH ECONOMICS?

is going to muddle their heads. Better to thoroughly indoctrinate

them in orthodox thinking before allowing them to dip their toes
in the waters of dissenting ideas. In actual fact, historical debates
have often been conducted in far more accessible language. Debate
and disagreement, far from being off-putting, are really quite com-
pelling. Especially when you can understand what is being said.

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 11
ECONOMIC HISTORY

History doesn’t repeat itself, but it often rhymes.

Mark Twain (attr.)

Great economists like Adam Smith, Karl Marx, and John Maynard
Keynes worked out their theories in the shadow of history, rather
than aiming to perfect a mathematics suitable for conveying truths
independent of history. They understood that states of affairs
deemed permanent do not last for ever, or even for very long, and
with each change in the state of the world comes a change in ideas
about the world. Marshall said ‘Every change in social conditions is
likely to require a new development in economic doctrines.’1
In other words, the value of an economic theory does not
depend on its place on the evolutionary tree, but on its place in
the world. Economics should be a historically grounded social
science. It’s not only economic doctrines, but economic practices
that need to be set in their time and place. In previous times the
economy was not a separate domain but an order embedded in a
complex of institutions and activities designed to ensure the sur-
vival of the population. ‘Scientific economics’ started off as a cri-
tique of the ‘embedded’ economy, but at the same time claimed
that all people at all times were utility maximisers. This enabled
the economists to argue for the existence of universal laws, valid
at all times and in all places. History is a salutary warning against
such effrontery.
There are two main reasons why economists should study the
past. The first is to make economics better; the second is to make

149
 WHAT’S WRONG WITH ECONOMICS?

history better. Although economics has helped a bit with the sec-
ond, my main focus is on the first. If history is the study of the
particular, and economics of the general, the value of history to
economists is to enable them to make their premises more con-
crete and admit their limits. History is an important source of the
facts on which economists rely for their hypotheses.
Yet economic history has been almost entirely removed from
the modern economics curriculum. As William Parker describes it:

The institutional context, the social concepts, the moral zeal

implicit in the training which economists used to be given
through courses in economic history, economic institutions,
and applied fields have been pushed aside, while those fields
have been partially transformed into playgrounds for the imag-
ination of the theorist.2

In short, orthodox economists have stopped listening to history,

treating it rather as a source of numerical data for testing out their
own theories. Equipped as they are with massive data banks, narra-
tive history to economists is simply anecdote: where is the theory?
Economists who turn to history are said to suffer from anecdotage,
to which some may add: if economists are already in possession of
universally valid laws, there is no point in turning to history to help
discover them.
So economists are reluctant to find in history a useful intellec-
tual resource for understanding the human condition. Indeed, their
journey into the past is rather like a colonial expedition. Equipped,
as they think, with their universal models, they can simply apply
them to any topic, past or present, as hypotheses, using such data as
available to test them. The hypotheses are almost always neoclassi-
cal hypotheses. The horse always maximises.
The consequence of this invasion is to empty economic history
of its traditional content. Economic theory corrupts economic
history by foisting on it ahistorical models and inappropriate
testing strategy which merely confirms the model already in the
economist’s mind. ‘Cliometrics’, the application of statistical and

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mathematical techniques to past events, is the corruption of ‘Clio’,

the ancient muse of history.
History as a source of statistics
The standard view is that history provides a field of observations
to test economic hypotheses: a source of empirical evidence for
testing theories, estimating relationships between variables, and
forecasting future trends. A basic tool of economic history is the
time-series, any statistical relationship recorded over a period
of time. For example, Angus Maddison’s historical estimates of
national income, population, growth rates, and so on go back to
ad 1, in certain territories (for the latest edition, see Bolt et al.,
2018). The value of statistics, historical or otherwise, is that they
provide a check on mere assertion. If somebody claims that the
Romans were far richer than people today, Maddison’s study of his-
torical production and translation into modern equivalents pro-
vides conclusive rebuttal.
But one should not be bamboozled. Most of the time-series in
Maddison were constructed long after the event. There were no
national income statistics in 1800, let alone ad 1. So Maddison’s are
estimates based on such statistics as were available then, compiled
for different purposes, and subject to a wide margin of error. They
are useful for swatting away ludicrous assertions, but not for mak-
ing precise comparisons of welfare between, say, ancient Athens
and modern Ethiopia. The same is true of Thomas Piketty’s statis-
tics on economic inequality, and indeed all statistical time-series.3
Time-series analysis is also a core component of econometrics –
the attempt to measure statistically the relationship between two or
more economic variables over time in order to estimate their future
relationship, or to test and validate those in the past. Historical data
join comparative data as a source for econometric studies. There
has been an enormous expansion of the data base for economet-
rics in recent years. Examples include the many attempts to estab-
lish an empirical basis for the quantity theory of money; the long
time-series developed by Simon Kuznets (1901–1985) on national
income and its components to test for the consumption function;

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and E.F. Denison’s use of time-series to estimate relationships of

key inputs (labour, capital, education, efficiency) in the growth
of output.4
But as we have already argued in Chapter 5, econometrics is
vastly oversold as a way of testing theories: in addition to model
specification problems, as soon as you get enough observations,
too much time has passed to assume conditions are stationary. For
example, do high taxes hinder economic growth? The evidence is
inconclusive. Much of economics can never be ‘proved’.
Robert Solow offers a devastating critique of the identification
of economic history with econometrics. Econometrics, he says, is
‘history blind’.

The best and brightest in the profession proceed as if economics

is the physics of society. There is a single universally valid
model. It only needs to be applied. You could drop a modern
economist from a time machine . . . at any time, in any place,
along with his or her personal computer; he or she could set
up in business without even bothering to ask what time and
which place.5

In short, much of the modelling we do depends on assuming that

people in the past had essentially the same values and motives as
we do today.
A good example is from Peter Acton’s recent book, Poiesis:
Manufacturing in Classical Athens (2014), of which Michael
Kulikowski has written:

In case study after case study, Acton describes an Athens very

unlike our post-industrial world, and still less like that of the
19th and 20th centuries. Yet all his case studies are couched in
the language of classical microeconomic theory and a postwar
competitive business and management theory that he spells
out in great detail and with faith in its revealed truths . . . Acton
presents his task reasonably, challenging readers to use classical
microeconomics to ask whether Athenians ‘might still have

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operated in practice according to the same set of fundamental

economic principles that we are familiar with today’, even
though they lacked the language or conceptual framework
within which we articulate those principles. For Acton, there’s
never any question that ‘the same economic laws prevailed
despite the different context’ because the microeconomic
‘framework is timeless’ and because ‘irrespective of conscious
motivation by ancient agents, elementary economic principles
are heuristically effective and a source of important historical
insight.’6

Fine studies of ancient economies, like those of Moses Finlay,

show how remote all this is from good history. The rapacity of the
upper classes, Finlay argues, was dictated by conventional expen-
ditures for political and military careers, not by a ‘maximising’
logic.7 Finlay’s work brings out the fact that human societies are to
a large extent constituted by their ‘social imaginations’. This means
that they cannot be understood in terms radically alien from those
in which they understand themselves. If Ancient Greek craftsmen
didn’t think of themselves as maximising profit, who are we to say
that was what they were ‘really’ doing?
In short, history should not surrender the uniqueness of its own
vision to the econometricians. As Solow writes, in the new eco-
nomic history you find ‘the same integrals, the same regressions,
the same substitution of t-values for thought’ as you do in eco-
nomics proper, but with worse data. Rather than widen the range
of perceptions, the new economic historians and economists sim-
ply feed the same unilluminating stuff back and forth. Courses
in econometrics are inescapably historical, but convey no sense
of history, so we reach a point where ‘economics has nothing to
learn from economic history but the bad habits it has taught to
economic history’.8
Can economics improve history?
But there is another side. Economics has improved history as
well. A famous example is Fogel’s Time on the Cross (1995 [1974]),

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which argued that, in contrast to the claims of nineteenth-century

historians, slavery was economically efficient. It was morally rep-
rehensible, but left to its own devices it could have rumbled on
for much longer. This is an important insight, because it makes
clear that the Civil War was necessary for ending slavery. Nick
Crafts’ work on the late-nineteenth-century British economy
showed – with much more justification that Peter Acton’s on
ancient Athens – that British businessmen were making rational
economic decisions, and not turning themselves into economically
useless gentlemen.9
In a productive division between economics and economic his-
tory, economists should make various kinds of hypotheses based
on stylised facts and economic historians should think about how
and where different models and different kinds of evidence might
apply. Economists should approach history in an enquiring, rather
than a conquering, frame of mind.
‘Cycles’
History shares the inbuilt bias of sociology towards conservatism.
It is a record of what has happened, and there is strong tempta-
tion to say simply ‘What is, is’, and not what might be, still less of
what should be. Reliance on history alone can be a fatal weakness
for a statesman, because the historical imagination finds it very dif-
ficult to accommodate the idea of progress. The weakness of his-
tory as a school for statesmen comes out very clearly in the Treaty
of Versailles in 1919, when the peacemakers fretted about frontiers
and nationalities rather than with the need to reconstruct Europe
economically. The much more durable results achieved after the
Second World War stemmed from putting the economic rehabilita-
tion of the war-shattered economies at the head of the peacemaking
agenda – the task entrusted to the forward-looking economic tech-
nicians who devised the Bretton Woods system and Marshall Aid.
The idea that social and economic life oscillates round some, not
necessarily static, point of equilibrium has been common to both
economists and historians. But they have very different views of
cycles. For economists cycles result from some ‘shock’ to otherwise

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smoothly functioning systems producing cycles of business activ-

ity. An example is the forty-year Kondratieff cycle, produced by a
surge of technological innovation. Fluctuations may be steep as
the economy adjusts to these changes, but they have never been
sufficiently long-lasting to call into question the idea of progress
itself. Cycles as conceived by historians are more like civilisational
cycles. They may be triggered by business crisis, but their origin is
existential, coming from the failure of society’s central institutions.
Abstracting from technology, historians’ cyclical theories have
no built-in notion of progress. Technological progress is exo-
genous and unpredictable. History itself discloses no clear pattern
of improvement: it swings backwards and forwards along famil-
iar pathways. It does not repeat itself exactly, but it rhymes. In the
typical historical cycle, societies are said to swing like pendulums
between alternating phases of vigour and decay, progress and reac-
tion, hedonism and puritanism. Each outward movement pro-
duces a crisis of excess which leads to a reaction. The equilibrium
position is hard to achieve and always unstable. History cannot be
used to predict the future, but it can indicate trends and inevitable
reactions against them. Typically, the cycles are generational, with
children reacting against the beliefs of their parents.
In his Cycles of American History (1986) Arthur Schlesinger
Jr defined a ‘political economy cycle’ as ‘a continuing shift in
national involvement between public purpose and private inter-
est’. Adapting his terms to European usage, the swing he identi-
fied was between ‘liberal’ and ‘collectivist’ epochs. Liberal periods
(when private interests determine policy) succumb to the corrup-
tion of money; collectivist periods (dedicated to ‘public purpose’)
succumb to the corruption of power. The cycle then repeats itself.
This political economy oscillation fits the American historical nar-
rative tolerably well. It also makes sense globally. The era of liberal
economics opened with the publication of Adam Smith’s Wealth of
Nations in 1776. Despite the early intellectual ascendancy of free
trade, it took a major crisis – the potato famine of the early 1840s
– to produce an actual shift in policy: the 1846 repeal of the Corn
Laws that ushered in the free trade era.

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In the 1870s, the pendulum started to swing back to what the

historian A.V. Dicey called the ‘age of collectivism’. The major crisis
that triggered this was the first great global depression, produced
by a collapse in food prices. It was a severe enough shock to pro-
duce a major shift in political economy. This came in two waves.
First, all industrial countries except Britain put up tariffs to protect
employment in agriculture and industry. (Britain relied on mass
emigration to eliminate rural unemployment.) Second, all indus-
trial countries except the United States started schemes of social
insurance to protect their citizens against life’s hazards.
The great depression of 1929–32 produced a second wave of
collectivism, whose virulent form was Nazism, but whose more
enduring legacy was the ‘Keynesian’ use of fiscal and monetary
policy to maintain full employment. Most capitalist countries
nationalised key industries. Roosevelt’s New Deal regulated bank-
ing and the power utilities, and belatedly embarked on the road
of social security. International capital movements were severely
controlled. The liberal instinct was not entirely extinguished, or
else the West would have ended up split between communism and
fascism.
What emerged from the Second World War was the victory
of collectivism in the milder form of social democracy. However,
even before the crisis of collectivism in the 1970s, a swing back to
liberalism had started, as trade, after 1945, was progressively freed
and capital movements liberalised. The rule was free trade abroad
and social democracy at home. The Bretton Woods system, set up
with Keynes’s help in 1944, was the international expression of lib-
eral/social democratic political economy. It aimed to free foreign
trade after the freeze of the 1930s, by providing an environment
that reduced incentives for economic nationalism. At its heart was
a system of fixed exchange rates, subject to agreed adjustment, to
avoid competitive currency depreciation.
The crisis of social democracy unfolded with stagflation and
ungovernability in the 1970s. It broadly fits Schlesinger’s notion of
the ‘corruption of power’. The Keynesian/social democratic policy-
makers succumbed to hubris, an intellectual corruption which

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convinced them that they possessed the knowledge and the tools
to manage and control the economy and society from the top.
This was the malady against which Hayek inveighed in his clas-
sic The Road to Serfdom (1944). The attempt in the 1970s to control
inflation by wage and price controls led directly to a ‘crisis of gov-
ernability’, as trade unions, particularly in Britain, refused to accept
them. Large state subsidies to producer groups, both public and pri-
vate, fed the typical corruptions of behaviour identified by the new
right: rent-seeking, moral hazard, free-riding. Palpable evidence of
government failure obliterated memories of market failure.
The new generation of economists abandoned Keynes and, with
the help of sophisticated mathematics, reinvented the classical eco-
nomics of the self-regulating market. Battered by the inflationary
crises of the 1970s, governments caved in to the ‘inevitability’ of
free market forces. The swing back became world-wide with the
collapse of communism. A conspicuous casualty of the swing
back was the Bretton Woods system that succumbed in the 1970s
to the refusal of the United States to curb its domestic spending.
Currencies were set free to float and controls on international capi-
tal flows were lifted. This heralded a wholesale change of direction
towards globalisation.
This was, in concept, not unattractive. The idea was that the
nation state – which had been responsible for so much organised
violence and wasteful spending – was on its way out, to be replaced
by the global market. The Canadian philosopher, John Ralston
Saul, described the promise of globalisation in a 2004 essay, with
only modest parody:

In the future, economics, not politics or arms, would determine

the course of human events. Freed markets would quickly
establish natural international balances, impervious to the old
boom-and-bust cycles. The growth in international trade, as a
result of lowering barriers, would unleash an economic-social
tide that would raise all ships, whether of our western poor or
of the developing world in general. Prosperous markets would
turn dictatorships into democracies.10

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Today we are living through a crisis of liberalism. The finan-

cial collapse has brought to a head a growing dissatisfaction with
the corruption of money. Neoconservatism has sought to justify
fabulous rewards to a financial plutocracy while median incomes
stagnate or even fall; in the name of efficiency it has promoted
the off-shoring of millions of jobs, the undermining of national
communities, and the rape of nature. Such a system needs to be
fabulously successful to command allegiance. Spectacular failure is
bound to discredit it.
What this kind of history offers students of economics is the
ability to situate themselves and their teaching in the flow of events.
It helps explain why economic narratives, plausible in one epoch,
lose their hold in others. It gives a historical dimension to the idea
of ‘crisis’ which carries one beyond the notion of a ‘shock’ to an
otherwise frictionless system.
‘Stages of development’ – Kicking Away the Ladder
A different kind of historical pattern is revealed by the so-called
‘stages of development’ literature. The standard story of the
West’s economic development is well-known: the Enlightenment
unleashed the twin forces of science and market, giving both tech-
nology and the means to put it to use. But what happens if we start
with the history?
Ha-Joon Chang’s impressive Kicking Away the Ladder (2002)
examines the history of industrialisation and discovers the rather
visible hand of the state at every turn: protecting British mills
from their competitors in France and Belgium, protecting German
industry from the British, protecting new American industries
from their rivals in Europe, protecting Japanese industries from
America and Europe, and so on through the Asian Tigers of Hong
Kong, Singapore, Taiwan, and South Korea and now the meteoric
rise of China.
In each case government was directing and assisting targeted
industries. It was only after each country had successfully indus-
trialised that it perceived free trade and economic liberalisation to
be in its interests. The narrative of their own success changed from

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state-led to market-led development, the visible hand of the state

transformed into the invisible hand of the market.
Such essays in political economy are good examples of start-
ing with historical facts rather than universalist premises. ‘Why
are some countries rich and others poor?’ is a question that main-
stream economists think should have a general answer, but no
general theory will cover all cases. Great economic historians like
David Landes (1924–2013) have emphasised the importance of
cultural specifics, like the invention of spectacles and treatment of
women, in the rise of Europe to economic and military suprem-
acy. Economic history gives us the stories of the British Industrial
Revolution, of German, American, and Japanese catch-up, of the
stagnation and rise of Asia. It offers no general theory of economic
development, but historically rich accounts, which can direct pol-
icy fruitfully to problems in the present.
The neoclassical growth story tells us that a universal precondi-
tion for economic development is a secure set of property rights,
so that owners of land and business can reap private rewards from
socially beneficial improvements and innovations. On this theory,
enclosure of the ‘commons’ in eighteenth-century England led, via
the agricultural revolution, to the Industrial Revolution. Applying
this ‘general theory’ in the 1990s, the first generation of post-
communist reformers in Russia and eastern Europe auctioned off
most state property at a stroke. The results varied with the histories
and resource-profiles of the countries concerned, and the amount
of foreign help they received. But in Russia the results were disas-
trous. The economy collapsed, most of the state property was ‘sto-
len’ by the Soviet managers of the state companies, creating a class
of fabulously wealthy ‘oligarchs’, and autocracy returned as the only
barrier against social disintegration. Economists with a sense of
history warned against ‘shock therapy’, but in the heyday of neolib-
eral economics, no one listened.
z
Since the absorption of modern economics into mainstream intel-
lectual life in the eighteenth century, economics has played a part

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in reshaping the motives and actions of economic agents (includ-

ing governments). Rational economic calculation, which may be
inherent in human beings as they struggle to make ends meet, has
far greater scope for expression than it did in the Middle Ages,
when custom was paramount. So how human beings behaved in
the past is not necessarily a secure guide to how they behave today.
But equally how they behave today is not a secure guide to how
they will behave tomorrow.
History teaches that economies are path-dependent. Their pres-
ent is ‘inherited’ from the past. So understanding a community’s
history can help one estimate its economic possibilities. The pres-
ent and the future are connected to the past by the continuity of
society’s institutions. Economic policy is still different in German-
speaking countries from the Anglo-Saxon world or from that in
Latin America, even though nowadays economic research is widely
connected, globalised, and easily accessible across countries.
It’s not surprising that there has been a revival of Keynesian
economics, as we ask ourselves whether the lessons we learned
from the Great Depression of the 1930s can be fruitfully applied
to the Great Recession of 2008 and after. To argue, as many econo-
mists have recently done, that the path to recovery lies in cutting
government spending, seems a signal case of historical amnesia. As
George Santayana famously wrote, ‘those who cannot remember
the past are condemned to repeat it’.

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 12
ETHICS AND ECONOMICS

The fundamental problem . . . is to find a social system

which is efficient economically and morally.
John Maynard Keynes

‘There are no economic ends, only economical and uneconomical

means for achieving given ends . . . Economics deals with ascer-
tainable facts; ethics with values and obligations. The only way to
associate them is by juxtaposition.’ They are ‘not at the same place
of discourse’.1 With these words Lionel Robbins expelled ethics
from economics. Nobel Laureate George Stigler (1911–1991) had
the same idea when he wrote that economists needed arithmetic,
not ethics, to correct ‘social mistakes’.2
The older generation of economists had puzzled over such
topics as the rationality of ends, the ethics of self-interest, and
the morality of means. However attention to such questions was
increasingly considered a hindrance to proper analytic work.
Alfred Marshall, professor of political economy at Cambridge,
took economics out of the moral sciences curriculum in 1903,
convinced that ‘metaphysics’ was putting good people off studying
economics. Economics, as Robbins said, became concerned purely
with efficiency of means.
For example, there are more and less efficient ways of fighting
a war. Whether the war ought to be fought, and the morality of
the means by which it is fought (for example, the morality of using
torture), are matters on which the economist may have private
views, but they should not tamper with the ‘scientific’ advice he

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tenders. Even if he chooses not to be personally associated with

a war, or the methods of fighting it, this is an ethical judgment
from outside economics. Within the discipline, there is no moral
or immoral behaviour, only efficient and inefficient behaviour. At
best, moral maxims may be serviceable as tools of efficiency: ‘hon-
esty is the best policy’.
Evidently Adam Smith was disturbed by the selfish connota-
tions of self-interest and equipped his agents with the separate
motive of ‘sympathy’, something which his successors dropped,
as complicating the logic of their deductive systems. Marx was
concerned with the justice of distribution. John Stuart Mill raised
the question ‘how much is enough?’ for a good life.3 The Robbins
terrain is stripped of such extraneous ‘moral’ clutter. His econom-
ics presents us with self-interested individuals, denuded of social
ties, but with infinitely varied wants, facing budget constraints
which prevent them satisfying all their wants simultaneously.
Therefore they have to economise. Economics is about the logic of
such economising.
Whether the model is intended to describe how people actu-
ally behave or how they should behave is beside the point here.
Either way no ethics is involved, only arithmetic. If people’s desires
shift from wanting good goods to wanting bad goods this is simply
taken to be a shift in demand schedules. And all economics asks of
means is that they be fit for the purpose intended. The ethical value
of means or purpose is irrelevant to economics.
All of this represented a considerable reversal of earlier think-
ing about the economy. Scientific economics grew, together with
capitalism, out of a collapsing medieval order. At the heart of
medieval thought stood the question of value, of what is worthy
or unworthy of admiration or esteem, more simply, what is good
and what is bad. Economics was part of this enquiry. But it had
one decisive advantage in discussing goods and bads, which is that
the value of material goods could be made commensurable – their
costs and benefits could be precisely stated on the single scale of
money. So questions of value, for this class of goods, were from
the start stated in terms of money prices. Even so, the prices of

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economic goods were supposed to reflect the place of these goods

in the moral order, and were explained by reference to it.
What we find as economics matures is that its moral content is
dropped. Discussion about the relationship of value to price is col-
lapsed into value-free arithmetic. The idea of property as steward-
ship disappears. The morality of means was subsumed in efficiency,
and the morality of ends was outsourced to religion and ethics. The
question today is whether we possess an ethical discourse powerful
enough to overcome the social mistakes of economists.
The just price
Value theory in economics has a joint empirical-moral pedigree.
On the one side, it is an explanation of why things cost what they
do. On the other side, it is a theory of what things should cost: the
just price. This is the price that does justice to the efforts of pro-
ducers and the needs of consumers. It was based on a moral code
designed to prevent people exploiting each other. Just price doc-
trines went back to Aristotle, and were elaborated by the medieval
schoolmen. They were said to have their basis in divine or natural
law. The just price is a measure of a fair transaction.
In pre-modern economic thinking the ‘just price’ was roughly
equated with the ‘customary price’. The customary price was a ready-
reckoner of what societies believed was fair dealing. However, with
the great inflation of the sixteenth and seventeenth centuries, and
the spread of international commerce, market prices became ser-
iously detached from customary prices: which is a way of saying
that the moral economy shrank relative to the business economy.
The labour theory of value was a secular application of just price
doctrine. The classical economists – the French Physiocrats and
Adam Smith and his followers – distinguished productive from
unproductive labour. The labour theory of value was intended to
isolate that part of price which wasn’t value, but represented rent.
Economic rent was a price that had no basis in real cost but was
purely a free lunch for the owners of land and money. The classic
medieval unjust price was usury – taking interest on loans. Why
was it unjust? Because it was seen as making money from money.

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Lending out money for which you had no use cost nothing and was
therefore not entitled to a reward.
Adam Smith and David Ricardo both accepted labour effort as
an explanation of long-run or normal prices, in contradiction to
‘market prices’ which fluctuated round them: that is, they distin-
guished between the ‘natural’ price (the price of labour effort) and
the market price. Smith posed the famous ‘diamond-water para-
dox’: why were diamonds so expensive and water so cheap, when
diamonds were useless and water vital for life? Smith found the
answer in ‘the difficulty and expense of getting them from the mine’,
from which he concluded that ‘what every thing really costs to the
man who wishes to possess it is the toil and trouble of acquiring it’.4
Following Smith, the simple labour theory of value developed
complications. Surely the labour of the capitalist also deserved to
be rewarded? Ricardo incorporated the reward to the capitalist in
the labour theory of value by treating capital as stored-up labour.
Capital comes into existence through the abstinence or ‘saving’ of
the capitalist. The saving of the capitalist adds value to the ‘painful
exertions’ of labour.
In Ricardo’s hands, the labour theory of value became a cost
of production theory. It has one root in the medieval idea of the
‘just’ price. But it also seeks to give a certain moral grandeur to
self-interest by investing it with a particular virtue – the sacrifice
of present for future consumption. Thus profit could be seen as the
just reward for sacrifice.5 Much later came the idea that profit is the
reward for risk-taking, or enterprise.
Karl Marx had a different agenda. He adopted the labour the-
ory of value, not to justify the profits of the capitalist class, but to
remove the capitalist class from the value equation. The capitalist’s
profit has nothing to do with his ‘abstention’ from consumption,
everything to do with his abstention from labour. It arises from the
capitalist being able to extract ‘surplus value’ from the worker. The
worker is paid, say, five hours’ worth of goods for eight hours’ worth
of work. This difference constitutes the capitalist ‘rent’: unearned
income, or in Marxist terms the exploitation of labour. The exploi-
tation is made possible by the capitalist owning all the machines,

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leaving the worker with nothing to sell but his labour power. So it’s
a classic unjust bargain, with the worker having to accept whatever
wage the capitalist offers him, on pain of starvation.6
The problem facing all cost of production theories was that the
prices which goods fetched in rapidly expanding and increasingly
deregulated markets had little relation to the hours of labour spent
in producing them. The long-run, or normal or ‘natural’ price obsti-
nately failed to emerge from the ever-spreading web of exchange
relations. The price system lacked a moral anchor. A theory of value
which couldn’t explain actual price behaviour was rather obviously
deficient, and from the 1870s the cost of production theory was
swept away by a supply and demand theory, in which market prices
were jointly determined by scarcity and consumer demand.
Adam Smith had explained the high price of diamonds by the
expense of getting them from the mines to the market. But, as an
astute critic, Richard Whately pointed out at the time, with a differ-
ent example, pearls don’t fetch a high price because men dive for
them; men dive for them because they fetch a high price.7 Smith
recognised this to some extent, maintaining a double perspective
where scarcity and desire, as well as the cost of production, influ-
enced price.8
The solution to the diamond-water paradox came in two bites
known as the marginalist revolution. The first was the elimination
of any distinction between needs and wants. Both were subsumed
in the idea of subjective utility. Different goods gave people differ-
ent intensities of pleasure; and their prices reflected the degree of
pleasure, or utility, they afforded, and their relative scarcity. In ordi-
nary language, what people pay for something depends on how
much they want it and how scarce it is. People may want some-
thing but it has no price unless it is scarce. Water is normally a free
good: it acquires a price in the desert; air is a free good if one is not
suffocating.
The second step in the marginalist revolution was to say that
prices are determined at the margin. It was Jevons who united the
concept of subjective utility with the differential calculus: it was
not total pleasure that needs to be measured, but the pleasure of

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having a little more. Utility is maximised when the pleasure of hav-

ing a little more is equalised across alternative uses. Jevons pre-
dicted that numerical determination of the laws of utility would
turn economics into a science on a par with the natural sciences.9
Marginalism knocked out the cost of production explanation
of prices. Labour could not be regarded as the source of value,
because the labour spent on producing a commodity was ‘gone and
lost forever’.10 Wages were the effect not the cause of the value of
the product; greater effort could theoretically increase supply, but
would not do so unless the force of desire brought it forth.
Marginalism was a scientific, as well as political, triumph. It
explained (or explained away) many puzzles in the older value
theory, such as the high price of rare paintings – a prime example
of labour ‘gone and lost forever’ – and it knocked away the foun-
dations of Marxist exploitation theory. I leave to one side its own
‘scientific’ problems, such as its inability to measure intensities of
pleasure.11 More serious in the context of our discussion was the
loss of the moral sense of value. Value depends entirely on indi-
vidual anticipations of pleasure from goods in short supply. There
is no appeal beyond the market price. Market prices can only be
unjust if market competition is restricted by monopoly. The nor-
mative goal of mainstream economic policy follows: to make mar-
kets fully competitive.
The theory of subjective value marked a paradigm shift in
method. So long as value was expounded in terms of costs, the sub-
ject matter of economics was seen as something social, and price
phenomena purely a market relationship. Once it was realised that
these market phenomena resulted from individual choice and that
the very social phenomena by which they were explained were the
reflex of individual choice, the social dimension of economics fell
away. Mathematical economics formalised this shift.
Economics could not entirely shed its intellectual legacy. Its
continued commitment to ‘equilibrium’ or ‘natural’ price models of
economic life is unacknowledged homage to its earlier entangle-
ment with the just price theory. The word ‘natural’ still runs through
economics: concepts like the ‘natural’ rate of unemployment, the

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‘natural’ rate of interest, are ghosts of earlier real-cost theories of

value. But ghosts only: value has become whatever you can extract
from the other fellow.
Property as stewardship
That private property is the moral Achilles heel of the capitalist sys-
tem was recognised by Locke nearly 400 years ago. The medieval
doctrine was that wealth must be put to reasonable use. In his Two
Treatises of Government (1764 [1689]), Locke says that everyone
has a natural right to property in his own labour, that is, to such
fruits of the earth as his own labour brings forth. How can this
be reconciled with the fact that most land is owned by a minor-
ity of proprietors? Locke argued that unequal property was the
deserved reward of superior effort. Much later came the flowering
of the utilitarian argument that inequality increases productivity.
This was the core belief of the supply-side economics of Reagan
and Thatcher.
Locke kept alive the connection to older concepts of just prop-
erty holdings, by arguing that owners who left their land or capi-
tal idle should be dispossessed of it, since ‘nothing was made by
God for man to spoil or destroy’.12 To own property was to hold it
in trust for the general good. Good landlords were stewards. Thus
private ownership, if used for the general good, need not abrogate
people’s ‘natural’ right to property in their own labour.
In the Industrial Age workers claimed a ‘right to work’ as an
equivalent to a right to property ownership. Neoclassical econom-
ics evaded this claim by assuming full employment. Sufficiently
flexible labour markets would guarantee everyone who wanted it a
job. Unemployment was assumed to be a choice for leisure, carry-
ing with it no right to income.
Workers also claimed a fair share of the surplus. Marx, as we
have seen, denied this was possible under capitalism. Left-leaning
neoclassical economists like Arthur Pigou (1877–1959) tried to
establish a scientific case for income redistribution. The diminish-
ing marginal utility of money to its possessor, Pigou argued, jus-
tified transferring money from the rich to the poor.13 This effort

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foundered when Robbins pointed out the impossibility of measur-

ing intensities of satisfaction (1938). It became accepted doctrine
that no social welfare function could be derived from interpersonal
comparisons of utility.
While heterodox economists insisted that the absence of a social
welfare function didn’t imply abandoning the goal of redistribu-
tion, mainstream economics simply gave up on the question of
the justice of distribution.14 Instead, proofs were supplied that in a
perfectly competitive market all the factors of production received
their marginal products. That took distribution off the economic,
though not the political, agenda. In fact, the question of distribu-
tion dominated the political agenda for most of the twentieth cen-
tury. It was argued by social democrats that citizenship entailed
state responsibility for ensuring sufficient equality of material
conditions for the exercise of democracy to be meaningful. Today,
neoclassical economists and pessimistic sociologists find common
cause in attacking the welfare state; to the former it undermines the
incentive to work, to the latter it ‘demoralises’ society.
At present the question of the justice of property rights is much
more discussed by philosophers than by economists. For example,
John Rawls’s (1921–2002) principle that inequality is justified to the
extent that it improves the position of the least well-off owes some-
thing to Locke’s idea that property ownership requires a moral jus-
tification. Outside mainstream economics there has been a revival
of interest in the question of the moral responsibilities of own-
ership. Should companies have moral responsibilities in addition
to their legal responsibility to maximise shareholder value? Ideas
of ‘corporate social responsibility’ and ‘stakeholder’ capitalism are
fruits of such discussion, though ‘corporate social responsibility’
is largely big business propaganda. There have been studies show-
ing that firms which take seriously their responsibilities to their
employees, suppliers, and neighbourhoods achieve better ‘bottom
lines’ than companies which attend only to the interests of their
owners and senior managers. But the concept of property as ‘stew-
ardship’ has hardly an echo in mainstream economics, because it
challenges not just the narrow concept of property rights but the

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deeply ingrained idea that markets in land, capital, and labour are,
or can be made, perfectly ‘just’, in the sense of all producers being
paid what their products are worth to the consumer.15
The moral debate is not one-sided. There is of course an effi-
ciency argument for well-specified and legally enforceable prop-
erty rights. Further, the insistence that property must be used for
the public benefit undermines the classical liberal defence of pri-
vate property as a barrier to arbitrary state confiscation. There is
also a liberal argument for the state not interfering in the voluntary
contracts made by employers and workers. Students of economics
should not ignore such arguments. What one asks of them is that
they be conscious of the moral – and political – choices implied by
their analytic choices.
The costs of progress
A third aspect of the disappearance of morality from economics
is found in the disappearance of the idea that progress has serious
costs. Humans have always destroyed to build better, revolutions
and wars being the main examples. Economic change is milder in
method, but no less disruptive in effect. The shift from a static to
dynamic economy in the nineteenth century was accompanied by
furious denunciation of its moral cost, by no one more eloquently
than Marx and Engels in the Communist Manifesto: ‘Constant rev-
olutionising of production, uninterrupted disturbance of all social
conditions, everlasting uncertainty and agitation . . . All fixed, fast
frozen relations are swept away . . . All that is solid melts into air.’
Duncan Foley has written: ‘The moral fallacy of [Adam] Smith’s
position is that it urges us to accept direct and concrete evil in
order that indirect and abstract good may come of it.’16 He raises
a question which shouldn’t be evaded: does the end justify the
means? Mainstream economics accepts that progress has a price,
but nearly all economists will say that the price is worth paying:
the future will be better than the past. If the critic points out the
wrenching costs of continuous adjustment to new conditions, the
economist will invite us to consider how much better most people
live today than they did before the Industrial Revolution.

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In the nineteenth century James Mill put the case in a way that
would not seem out of place now: ‘The free enterprise system has
its hardships, but it is the price we pay for progress and the general
good.’17 His son, John Stuart Mill, unable so confidently to excuse
the sufferings of others, added the proviso that this suffering would
surely be temporary: as wealth advanced, suffering would ease. By
contrast, Herbert Spencer took a tough social Darwinist stance: the
sufferings of the poor were the mechanism through which society
thrived. Only by rewarding the rich and punishing the poor would
it continue do so.
Keynes agreed with the Mills. Capitalism’s psychological main-
spring, love of money, is ethically bad, but it is the means to the good.
By creating abundance it will enable us ‘to live wisely and agreeably
and well’.18 Capitalism was a passing phase, a view Keynes shared
with Marx. Most economists cannot envisage a post-capitalist era,
because they see scarcity as a permanent condition: the Robbins def-
inition sets no limit to human wants. Scarcity continues to demand
arithmetical – not moral – solutions. Further, capitalism has showed
itself superior to communism as a growth engine, because central
planning couldn’t do the necessary social arithmetic – an argument
we owe to Hayek (1937).
Then there was Joseph Schumpeter, whose views could be sum-
marised as ‘never let a recession go to waste’. He was the apostle
of wealth-creation through ‘creative destruction’. Progress was not
a smooth evolutionary process but a chaotic one, in which mori-
bund giants are constantly being replaced by agile upstarts through
a succession of crises. This is a concept that modern-day Silicon
Valley has embraced under the softer label of ‘disruptive innova-
tion’. For Schumpeter creative destruction is the way the capitalist
system works. He would have said that it creates more ‘value’ than it
destroys. The same reply is given by techno-enthusiasts. To be sure,
they say, automation will destroy many existing jobs and ways of
life, but in the long run all will benefit.
The ‘costs of progress’ literature was all about the costs to the
current generation. It was assumed that future generations would
benefit. The thought that future generations would pay the price

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of our profligate pursuit of growth was absent. Only recently has

it started to be recognised that we are benefiting today at the
expense of our children and grandchildren.
You will not find any serious discussion of the moral cost of
progress in standard economic textbooks. The analytic language
itself neutralises the enquiry: the costs of progress are segregated
into a corner called ‘the short run’ or ‘transition’; efficient mar-
kets and technological progress will ensure they are temporary.
Economists with a more generous social imagination have argued
that the ‘compensation principle’ was invented precisely to reduce
the cost of progress. Provided the gainers can compensate the los-
ers, markets will be ‘Pareto efficient’. This assumes, wrongly, that
gains and losses can be measured on a single money scale. It also
abstracts from the problem of the politics needed to bring about
the compensation in practice.
With rare exceptions, all those who concede that economic
progress has a price tag beg the question of what economic growth
is for. Is it to make us or our descendants richer, happier, or better?
And what is the connection between these?
The ‘growth of the cake [became] the object of true
religion’ (Keynes)
The defensible purpose of economics is not to enable people to
satisfy their wants, but to help bring about the end of absolute pov-
erty and disease. Once it has achieved that, it has done its main
work. Philosophers, sociologists, historians, psychologists will have
increasingly more to say as the non-measurable causes of ill-being
and well-being move to the centre of the story. Economists will still
be useful, because scarcities – not generalised scarcity – will still
persist, requiring efficient allocation, especially of time.
This is certainly what Keynes thought. In the ironic summary
quoted above, he claimed that the means – growth of the cake –
had pre-empted the ethical question: what is economic growth for?
The answer which most of us would give, on reflection, is to enable
people to lead better lives. Economists are in tune with popular
feeling in seeing material adequacy as necessary for ‘well-being’.

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But what is ‘well-being’? A subjective state of mind or an objective

state of affairs?
If we follow Lionel Robbins, individuals experience well-being
when their needs are satisfied, as when their stomachs are full.
This can be called an objective state of well-being. But the wants
of the imagination are relative, so one cannot ever say how much
is needed for the state of well-being. Scarcity will always exist.
As long as people want more than they’ve got, economics has no
purpose other than to show them how to get the cake to grow most
efficiently. This is its only religion. Beyond this it has no gospel
to preach.
We can identify three answers to the ‘growth of the cake’ ques-
tion. The first is that the cake just needs to grow without end, since
people are permanently dissatisfied with what they have. This dis-
satisfaction is independent of the level of wealth already achieved,
or of income inequalities. Indeed, the smaller the income gaps
between different sections of the population, the larger the impact
of relative wants is likely to be, as envy will be more rampant, and
competition for status more intense. The impossibility of satisfying
relative wants is the bedrock of the scarcity perspective.
The second, left-wing, position holds the argument that with
greater income equality the cake needs to grow less fast. People
are dissatisfied with the share of the cake they are getting. What
appears as insatiability is really the result of inequality. It is not
so much the growth of the cake as its more equal division that
is needed, though this may well be easier to achieve if the cake is
growing at the same time. In Galbraith’s language, what we need is
less private and more public affluence. Perhaps the economy would
not have to grow so fast if incomes were more equal and public
services improved; perhaps it would not need to grow at all in rich
countries. This introduces an explicit moral argument. It roots the
feeling of dissatisfaction not in individual psychology (e.g. envy)
but in the social demand for fairness.
A third, more recent, argument emphasising the long-term costs
to the planet, and therefore to future generations, of our relentless
pursuit of ‘more and more’, has led to demands for ‘de-growth’.

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However, these are differences within the circle of material ade-

quacy; they do not discuss what the requisites are for. Thus we jus-
tify money spent on education and health as means to well-being,
rather than treating them as part of well-being, and so intrinsically
valuable. Since everyone has their own idea of well-being, econom-
ics must confine itself solely to means, and assume that people are
efficient at converting physical resources into well-being. And so,
economics stops at the frontier of gross national product (GNP) or
GNP per head: we can at least measure that.
There have been fragmentary attempts to get policy to think
beyond the growth of the cake. One inspiration comes from tech-
nical criticisms of what gross national product fails to measure. It is
the sum of the annual market value of all final goods and services.
But it excludes uncosted goods like volunteering, housework, and
child-rearing and includes the costs of fighting crime, pollution,
drug addiction, resource depletion, and so on. Even the father of
national income statistics, Simon Kuznets, argued that ‘the welfare
of a nation can scarcely be inferred from a measure of national
income’.19
Some economists have suggested making ‘happiness’ rather
than GNP the goal of policy. Everyone can agree, surely, that mak-
ing people happier, in the sense of improving their psychologi-
cal well-being, is a laudable goal. This approach draws on surveys
which show that happiness is not equated with quantity of income,
a phenomenon known as the ‘Easterlin Paradox’. The economist
Richard Easterlin (b.1926) found that beyond a certain point,
scales of reported happiness (e.g. 1 to 5) do not grow in line with
the growth of GNP. They move together as income grows up to a
certain point, and then happiness stays fixed as income continues
to rise.20
This suggests that rather than pursuing income growth, policy
should aim for happiness growth. This means enquiring into the
causes which make people happy and unhappy, of which money is
only one.21 Correlating subjective measures of happiness and unhap-
piness with objective conditions is the name of the game. Surveys
show what things make people happier: more time with family and

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friends, satisfying jobs, income security, and so on. Policy should

seek to establish these objective correlates of happiness. It is the
conception of happiness itself that is so feeble. For most researchers
it means nothing more than psychological well-being or a pleasant
sense of mind. Gurus preaching happiness, schools offering hap-
piness courses, proliferate. British prime minister David Cameron,
who took power in the aftermath of the 2008 crash, said he would
measure the ‘well-being’ of the United Kingdom’s citizens every
three months, and ‘hold himself accountable for the success or fail-
ure of his policies by changes in well-being’.22 Little more was heard
of this initiative. It seemed almost obscene to suggest measuring
well-being while the economy was plunging.
At first blush, making happiness a goal of policy is an improve-
ment on crude national income. It promises a way of getting off (or
at least slowing down) the growth treadmill and concentrating on
achieving instead something we can all agree is good.
But there is a terrible trap, even if we leave aside the thorny issue
of how to measure happiness robustly. If happiness is taken to mean
a permanently agreeable state of mind, it might be maximised by a
free distribution of pleasure-enhancing drugs, leaving it to robots
to produce the goods needed for survival, a kind of perpetual dolce
vita or land of lotus eaters. This would be, literally, an ‘opiate of
the people’. Of course, happiness economists do not advocate this,
though significantly the economist Richard Layard (b.1934) does
include the use of both medical and recreational drugs in his hap-
piness agenda.23 They want policy to be directed to the conditions
which make people less miserable, and believe these conditions can
be discovered.
Less misery should certainly be taken seriously as an intermedi-
ate ethical goal, as making it possible for people to lead better lives.
But happiness itself should not be taken as an end to be strived for.
It is a result of living a good life, as the ancient Greeks recognised,
not a separate goal, and is often the result of ‘happenstance’.24
The economist Amartya Sen offers an argument for another set
of measures. Sen, like Marshall, thinks that the aim of policy should
be to increase ‘well-being’. But well-being cannot be understood

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purely through material consumption. Instead, it is made up of

multiple, overlapping ‘capabilities’ that cannot be reduced to each
other, including material welfare, but also non-economic dimen-
sions such as the freedom to make one’s own plan. Consequently,
economic development should be understood as expanding capa-
bilities, and poverty should be understood as a deprivation of
capabilities.25 Making ‘capability’ the goal of policy avoids the trap
of trying to define an ultimate goal. But it raises, and fails to answer,
the question of ‘capability for what?’ Why should we care whether
individuals are capable of being healthy or educated, and so forth?
Surely what matters is that they are actually healthy and educated.
But taking a public stance on what it means to be healthy and edu-
cated would be dictatorial. ‘Capability’ preserves the autonomy of
individual choice.26
Sen realised that an alternative index was needed, so, with
Mahbub ul Haq and others, he produced the Human Development
Index, which includes indicators of a country’s income, education,
and health. Other indices include the OECD’s Better Life Index,
which contains eleven components, the King of Bhutan’s ‘Gross
National Happiness’ goal and the OPHI and UNDP’s multidimen-
sional poverty index.27 The International Labour Organization
(ILO) says that social justice – not growth – should be the goal,
but acknowledges that there is ‘no objective notion of social justice’.
The ecological economist Herman Daly (b.1938) has suggested an
index of ‘sustainable development’, which takes account of environ-
mental degradation and depreciation of natural capital. Developed
in 1989, Daly’s three rules are: 1. Sustainable use of renewable
resources, meaning that the pace of their depletion should not be
faster than the rate at which they can regenerate. 2. Sustainable use
of non-renewable resources, meaning that the pace of their deple-
tion should not exceed the rate at which substitutes can be put in
place. 3. Sustainable rate of pollution and waste, meaning that its
growth should not be faster than the pace at which natural systems
can absorb them, recycle them, or render them harmless.
All such hybrid indices are technically flawed. The first flaw is
trying to measure non-measurables, like judging quality of social

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life by counting up quantity of friends. The second lies in the

attempt to reduce incommensurable quantities to a single number,
thus absolving policy-makers from making ethical choices.
As persuasive as these critiques of GNP are, the enduring fac-
tor in its popularity has been its simplicity: a single number with a
clear meaning. A ‘dashboard’ approach that tries to look at every-
thing can be immensely complicated: how is one supposed to com-
pare an array of statistics on health, education, and so on to see
which country is doing best at a glance?
How can ethics help economics?
The problem of reinserting ethics into economics, of planting
within economic thinking itself an ethical foundation, is that con-
temporary moral theory is on stand-by. Over much of the western
world, religion and custom have collapsed as the glue of a common
morality. Systems of secular ethics are fragments of older religious
beliefs, which lack the authority of divine law. Further, ‘business’
and ‘business calculation’ has become a much more important part
of human activity, with business ‘ethics’ amounting to little more
than the avoidance of fraud. Thus agreement on what constitutes
moral behaviour is undermined from both sides: from the decline
of religion and the spread of business values. As a result, ethics has
become a matter of individual calculation. Individuals disagree on
what is good. To try to revive a common idea of the good life, when
its natural foundations in social life have been so eroded, smacks
of paternalism, or worse, dictatorship. The default position is to
produce and consume ever more material goods. Economics is the
science that enables you to do this most efficiently. We are where
we are.
On all the points at which economics might meet ethics, we
find a weakness in ethics. Contemporary economics and con-
temporary ethics share the same individualist outlook. The main
thrust of the ethical criticism of contemporary capitalism is that
its power structure allows too few people the opportunity for
making good choices. Justice in distribution may be seen as a form
of empowerment. But the choices themselves should be left to

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suitably empowered individuals. Economics and ethics speak the

same language of methodological individualism.
Keynes found a moral basis for economics in the prospect for
the good life which economic (and especially technological) pro-
gress opened up. He had a very clear conception of what the good
life was, and he thought it was grounded in universal moral intu-
itions. But he was referring back to the existence of a moral com-
munity, which in his youth was still taken for granted. Today we
have small moral communities, which pursue their own visions of
the good. But there is no moral consensus about what is good.
The collapse of an ethics of ends has transferred the weight of
contemporary ethical argument to the morality of means, what
we may call procedural ethics. The question of what constitutes a
just distribution of income and life-chances has been vigorously
debated among political philosophers, with the social democrat
John Rawls (see above, p. 168) and the conservative Robert Nozick
(1938–2002) being the most frequently cited. ‘Natural’ rights have
morphed into ‘human’ rights. People have a ‘right’ not to be dis-
criminated against on grounds of race, gender, and age. Reaching
the conclusion by different routes, utilitarian and rights philoso-
phies can agree that harm is bad. Preventing harm is evidently a
minimalist moral programme; we can hope to agree on what is bad
even though we can’t agree on what is good.
Harm prevention builds on the idea that individuals should be
free to pursue their own plans, on condition these do not harm
others. For example, health and safety regulations are designed
to prevent producers of goods and services harming their users;
retailers are expected to provide honest information about their
products; the world-wide web is increasingly subject to regulation
to prevent the spread of harmful, abusive, and hateful material. The
idea of preventing harm has been extended to robots. The first of
three laws of robotics enunciated by biochemist and writer Isaac
Asimov (1920–1992) is that ‘a robot may not injure a human being
or, through inaction, allow a human being to come to harm’.
Two branches of economics, environmental and ecological,
have applied the harm principle to the survival of the human

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 WHAT’S WRONG WITH ECONOMICS?

species. Given the threat posed by man-made climate change, eco-

nomic activity must be made consistent with human survival. This
is an entry point for the revival of the idea of stewardship. The cur-
rent ‘owners’ of the planet have a duty to future owners to preserve
the value of their inheritance. Economists, typically, work out what
this duty will cost them.
One branch, ‘environmental economics’, argues that the envi-
ronment is an important economic resource, and environmen-
tal damage represents a cost that is not borne by those who have
caused it. This creates a problem of moral hazard, where compa-
nies can create pollution and leave others (in this case, future gen-
erations) to deal with the problems. This means that the costs of
polluting the planet must be ‘priced in’ through carbon taxes.
The second, more radical approach is ‘ecological economics’.
This accepts the idea of protecting the environment, but rejects
the claim that all aspects of environmental degradation can be
correctly priced. The important thing is for people to understand
how they fit into the global ecosystem, how economic activities are
damaging this ecosystem, and how they might need to change to
preserve it, a question first posed by the Club of Rome’s classic The
Limits to Growth.28 Georgescu-Roegen went so far as to argue that
the only way of preventing the entropy of the planet was through
policies of ‘de-growth’.
An important development of this line of argument is Kate
Raworth’s (b.1970) ‘doughnut economics’, which challenges eco-
nomics to find a balance between the ‘social foundation’ and ‘eco-
logical ceiling’.29 Economic activity must be set within the bounds
of ecological possibility.
The diagram shows that ecological economics has the same
imprecision in its core idea that we encountered in the economics
of ‘well-being’. What exactly does protecting the ecosystem entail?
It lists a bunch of bad things outside the circle and good things inside
it. While we may hope to measure the value of our own activities in
terms of GNP, there is no accurate way of measuring the impact
of GNP on the ecosystem. ‘Climate change’, which itself poses big
measurement problems, is just one of the nine possible tears in the

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 ETHICS AND ECONOMICS
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7. Raworth’s Doughnut.

ecosystem’s envelope. So ‘doughnut economics’ is a blanket term for

a whole range of worthy goals like ‘gender equality’ and ‘networks’
which have no obvious connection with protecting the ecosystem.
Probably its deepest appeal is to passionate haters of greed and lux-
ury. Whether it is compatible with the western model of political
and economic liberty is moot.30
Yet there is clearly a better ethical argument available, which
is that to live in harmony with nature, and therefore within the
bounds set by it, is part of the good life. This is irrespective of any
measurably deleterious consequences to nature of our bad habits.
But, sadly, such an argument depends on sufficient agreement on
what constitutes the good life, which is lacking. So we fall back on
pseudo-science and the hair shirt to rally support for the cause.31
z
There are two genuine ways of getting ethics back into econom-
ics. The first is to look more deeply into the ‘mind of the horse’
(see p. 81 on ‘Homo economicus in action’). This would show that
although moral variety certainly exists it is less extensive than

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 WHAT’S WRONG WITH ECONOMICS?

is generally supposed. It would reveal broad agreement on what

might be called ‘basic goods’. Health, respect, security, relation-
ships of trust and love are recognised everywhere as part of a good
human life; their absence is regarded everywhere as a misfor-
tune. We have, then, the materials for a universal enquiry into the
meaning of the good life, transcending time and place. We are not
doomed to an endless clash of values, mediated only by the market,
politics, and the law.
A second approach is that of the philosopher Michael Sandel.
His starting point is that public discussion has been emptied of
moral meaning by fear of paternalism. What he offers is not pater-
nalism, but a public debate on the morality of the market. Should
you be able to buy everything or are there some goods ‘beyond
price’? What are the consequences of buying a fast track in a
queue? Of outsourcing wars and prisons to private contractors?
Of offering cash rewards for good exam results? Of converting a
market economy, which is a tool, into a market society in which
money governs access to essential goods, and all social relations are
squeezed into a cash nexus? His hope is that by raising such ques-
tions, we may recover the older idea of a common good.32
The Robbins programme of expelling ethics from econom-
ics so as to make it more ‘scientific’ was always a forlorn hope. It
breaks down on the weakness of economics as a science. Given
the near-impossibility of establishing empirically robust laws of
human behaviour, its ‘scientific core’ has come to consist of logical/
mathematical deductions from tight, unrealistic priors. It cannot
escape what Keynes called ‘introspection’ and ‘judgments of value’;
but it buries them in a logico-deductivist methodology. This makes
large parts of economics useless as a picture of the world, and
therefore seriously misleading as a guide of policy. Nevertheless,
there is reason to doubt whether the moral resources which still
exist in western societies are powerful enough to correct the social
mistakes of economists.

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In the greater part of our concernment, God has afforded

only the Twilight . . . of Probability, suitable, I presume, to
the state of Mediocrity and Probationership He has been
pleased to place us in here.
John Locke, An Essay Concerning
Human Understanding

Mainstream economics gets human behaviour wrong in two ways.

It endows humans with excessive power to calculate; and ascribes
to them an excessive desire to calculate. It ignores, that is, uncer-
tainty and people’s attachment to each other. These failures are
rooted in a method of analysis whose major premise is individual
maximisation. As Keynes well put it, the error of economics lies
not in its logical inconsistency, but in the ‘lack of . . . generality in
its premises’.1 There is a large gap between the account economics
gives of human behaviour and behaviour as it is actually exhibited.
This gap it hopes to close not by broadening its own premises, but
by narrowing what it means to be human to the simple point of
calculation, and empowering calculation by big data and acceler-
ated computing power. The result is a growing disjunction between
what economists think and what many people feel, which expresses
itself in an explosion of social discontent. Mainstream economists
have not looked deeply enough into the ‘mind of the horse’.
In what follows I will try to draw together the book’s two main
threads of argument, those concerned with the epistemology of
economics, and those concerned with its ontology.

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 WHAT’S WRONG WITH ECONOMICS?

Epistemology: risk and uncertainty

The first issue is about how much we do, or can, know about the
future. Economics looks into people’s minds and discovers utility
maximisation. This then becomes the basis of its own theorising.
A much more modest, and accurate, claim would be that people
do the best they can under the circumstances. These circumstances
include uncertainty.
We owe the distinction between risk and uncertainty to both
Frank Knight (1885–1972) and John Maynard Keynes. ‘Risk’ applies
to situations when the chance of a possible event is quantifiable;
‘uncertainty’ implies a lack of any quantifiable knowledge of the
chance. (Equivalently, risk refers to all outcomes that can be insured
against, uncertainty to those which cannot.) Mainstream economists
do not recognise this distinction. They believe that individuals can
accurately calculate the odds of any action turning out one way or the
other. This is because they treat the economy as a closed system, like a
game of draughts. The financial system is explicitly theorised this way
by Chicago economists: the risks of all assets are said to be ‘correctly
priced on average’. The collapse of 2007– 2008 was therefore impossi-
ble. Even economists who reject the full rigour of the Chicago school
are professionally constrained to use the language of risk whenever
they talk about forward-looking choices. People have ‘risk profiles’;
interest rates measure ‘appetite for risk’; government bonds are ‘risk-
free’ (except if they are Greek!), asset prices measure risk aversion
and rational expectation and so on. Yet turn to the financial press,
and we learn that the one thing businesses can’t stand is ‘uncertainty’,
that they are always calling on governments to ‘end uncertainty’ about
this or that. Inflation-targeting was devised to ‘end uncertainty’ about
the future course of prices. What on earth is going on?
The reason why ‘Knightian uncertainty’ has proved more accept-
able to the profession than ‘Keynesian uncertainty’ is that Knight
confined it to ‘disequilibrium’ situations, whereas for Keynes uncer-
tainty determines the nature of the equilibrium itself. In his book
Risk, Uncertainty and Profit (1921), Knight explains profit as a reward
for entrepreneurship, or innovating a new product, and by definition

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there can be no probabilities attached to the success or failure of

an innovation, because an innovation is a new event. So profit is a
reward for a successful venture into the unknown. Such rewards
of enterprise are to be distinguished from the ‘normal’ returns to
capital; profit is a temporary monopoly phenomenon which will be
competed away as the innovation is generally adopted. Economists
are just about prepared to admit uncertainty on those terms. For
Keynes, uncertainty contaminates the investment demand schedule
as a whole, and not just enterprise. There is no ‘normal’ rate of return:
there is simply an expected rate of return, governed by uncertainty.
There are two further reasons for the failure of Keynesian
uncertainty to grip the mainstream. First, Keynes himself called
his discussion of uncertainty in Chapter 13 of the General Theory
a ‘digression’, and standard interpretations of the theory take him
at his word. Second, his fragmentary account failed to distinguish
clearly between those parts of an economic system which could
be considered risky and those which were inescapably uncertain.
This is why post-Keynesian attempts, like those of George Shackle
(1903–1992), Hyman Minsky (1919–1996), and Paul Davidson
(b.1930), to ground economics in epistemological uncertainty have
made so little headway.
However, Keynes bequeathed another ‘general theory’, which
does deserve serious consideration as a foundation for a reformed
economics. This is his theory of probability, offered in his Treatise
on Probability, a neglected masterpiece conceived before Keynes
thought of himself as an economist, in which he expounds what
Rod O’Donnell calls ‘a general theory of rational belief and action’.2
It was not published until 1921, the same year as Knight’s Risk,
Uncertainty and Profit, but the germ of the idea dates back to 1904,
when Keynes was a student at Cambridge University.
Keynes, too, looked into the ‘mind of the horse’, but he didn’t see
maximisation, rather an attempt to behave reasonably under differ-
ent degrees of certainty. His key move was to distinguish rational
belief (or expectation) from true belief. Standard rational expecta-
tion theory identifies the two, because to have a rational expecta-
tion of an event is to have accurate knowledge of its probability.

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 WHAT’S WRONG WITH ECONOMICS?

Keynes claimed it was rational to believe that something would

probably happen on the basis of the evidence supporting it, but
that the evidence might be too sparse to deliver a numerical prob-
ability that it would happen.
Keynes recognised three classes of probability in descending
order of certainty: a small class of cardinal probabilities, a much
larger class of ordinal probabilities, and a third class to which no
probability can be attached.
Cardinal probabilities are ratios, expressed as fractions. They
are either known a priori (mathematically) or as a result of like-
ness to previous events. For example, if one smoker out of ten has
died of lung cancer, the probability of smokers dying from can-
cer is 10 per cent. This second set of numerical probabilities is the
standard domain of risk as recognised by actuaries: for example,
all fire insurance premia are based on the number of houses which
have burnt down in a district over a period of time relative to the
total number of houses in it. At the opposite extreme is uncertainty,
as both Keynes and Knight define it, but which the mainstream
denies: a situation where we have no scientific basis for calculat-
ing a ratio. However, in between lie Keynes’s ‘orders of magnitude’
which are orders of likelihood – ‘more or less likely’ – not exact
ratios: we may say that one probability is greater than another,
without knowing how much greater. He sums up as follows: ‘The
magnitudes of some pairs of probabilities we shall be able to com-
pare numerically, others in respect of more and less only, and oth-
ers not at all.’ Keynes believed that it is in this middle ground of
ordinal ranking that most of our rational choices have to be made.3
In the neoclassical epistemology, by contrast, all probabilities
have numbers. They start off as odds you would give on, say, a horse
winning a race. This requires no knowledge of past performance of
the horse: rationality requires only that your bets should be inter-
nally consistent, such that nobody can construct a ‘Dutch book’
against you.4 Subjective beliefs are transformed into objective prob-
abilities by applying Bayes’ theorem, a rule for updating subjective
probabilities in the face of evidence.5 If one assumes, as hardline
rational expectation theorists do, that agents are fully equipped

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with up-to-date knowledge of the likelihood of any future event,

then they are in a position accurately to price risks.
Keynes’s ‘general theory’ of rationality is a big improvement on
the neoclassical theory. It avoids the trap of calling behaviour ‘irra-
tional’ where it does not conform to the neoclassical standard of
rationality. It offers a way of distinguishing between closed, partly
closed, and open systems. It challenges economics to think about
human behaviour under varying conditions of knowledge, and
not take the easy mathematical route to prediction. In doing so, it
points the way to a unified social science methodology.
Ontology: what exists
The project of improving how to do economics cannot rely on
a return to Keynes. Keynes’s chief failing is an underdeveloped
ontology – one which lacks a genuine sociological or historical
perspective. He recognises that ‘the atomic hypothesis which has
worked so splendidly in physics breaks down in psychics’, and gives
examples like the ‘fallacy of composition’ and the ‘paradox of thrift’.
But he leaves it there.6
So an improved ontology – the study of what exists and of the
basic constitution and nature of social phenomena – should be
the second pillar of a reformed economics. The orthodox map of
reality is peopled only with individuals; to the extent that they are
recognised at all, groups and institutions exist only as instruments,
tools like technology. This ‘methodological individualist’ approach
cuts economics off from understanding a large part of human
behaviour, as a consequence of which it often gives faulty advice.
It fails to understand the hold of religious national and group loy-
alties, attachments, identities – all that Weber calls ‘communal’
associations – and the extent to which these modify its picture
of the maximising individual; it fails to understand the power of
self-understanding and the way social positions shape self-under-
standing; it fails to understand the role of ideas, power, technol-
ogy in shaping choices, including its own; it fails to understand the
historical contingency of some of its universal doctrines; and it is
indifferent to its own history.

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 WHAT’S WRONG WITH ECONOMICS?

A more accurate map of social reality would feature at least three

entities with ‘agency’: individuals, governments, and ‘corporations’,
linked together through an intricate network of relationships. The
meaning of the first two is clear enough: by ‘corporations’ I mean
all those groups intermediate between the individual and the state
which provide valued services to individuals, and to whom indi-
viduals relate: local governments, churches, universities, voluntary
associations, firms, trade unions, banking systems, digital systems,
social movements, and many others. A structure in which public
goods (and bads) are provided by private bodies for reasons of
prestige or duty or profit – as has been the case throughout history
– cannot be fitted into a binary system of state and markets. One
might think of the economy as a ‘mesoeconomic’ system, with the
state administration at the top, the individual at the bottom, and a
variety of intermediate institutions in between; the whole complex
contributing to economic outputs. In the international system, the
national state is itself an intermediate institution between the indi-
vidual and supranational organisations.
The importance of structures is that they affect individual
motives and thus shape individual behaviour. It’s not behaviour
of groups, but behaviour in groups which we should try to under-
stand. Behaviour in groups cannot be understood as the outcome
of individual calculations of self-interest, however hard the New
Institutionalists try. Love, fear, courage, loyalty, greed, treachery, wor-
ship, and many other traits humans regularly display and admire or
condemn can only be understood in a group context.
Proper understanding of both the roots and the logic of collec-
tive action leads us far from the neoclassical path. Cooperation did
not start with the realisation that it could reduce transaction costs.
Economists might say that this is just a precise way of talking about
the costs of individual action. And there are such reasons for cooper-
ation. But these do not lead to any deep understanding of sociability.
The weakness of the neoclassical perception is seen in the stan-
dard account of the origins of trade. In Paul Samuelson’s words:
‘A great debt of gratitude is owed to the first two ape-men who
suddenly perceived that each could be made better off by giving

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up some of one good in exchange for some of another.’7 Most

economists have favoured the bartering savage story because it
leaves out society. The point is, though, that in order to enter into
such transactions you have to be a social animal to start with, as
Durkheim pointed out, though indeed a uniquely inventive one.
Individuals don’t voluntarily choose to be social; they are destined
to be both social and socially inventive. Relative social instability is
thereby built into the human condition. That is why it is impossible
to freeze the frame, except temporarily and locally.
We are left with a conundrum which is hard to resolve. When
economists ‘look into the mind of a horse’ do they really see what is
there, or only the sermons they have already planted in it? In other
words, is economics descriptive or prescriptive? This book suggests
that it is intended to be both. Insofar as it is descriptive it is plainly
inadequate; but is it not possible that description may, over time,
come to resemble prescription? That people may actually behave
more and more as economists tell them they do behave? This would
be an ironic inversion of Bayes’ theorem, with the objective reality
coming increasingly to resemble the subjective bets economists place
on humankind. To transform human nature, not just to describe it,
has always been the dream of social engineers, as today it is that
of the techno-utopians. It is the foundation of the doctrine of
progress. But how far can it, or should it, be pressed, before humans
cease to exist in a recognisable form? And is there something irre-
ducibly human which will resist the ambitions of the engineers
of the soul?
A better map
The two main problems we have identified in this book are related:
insufficient generality of premises (epistemology) and lack of insti-
tutional mapping (ontology). We need a science which is more
modest in its epistemology and richer in its ontology.
The parable of the blind men and the elephant (see above, p. 6)
can be improved by constructing the following grid. On the verti-
cal axis we plot ontology – the theory of what exists; on the hori-
zontal axis, epistemology – the way true beliefs are generated.

187
 WHAT’S WRONG WITH ECONOMICS?

Individualist

Psychology Economics

Deductive
Inductive

History

Sociology Historical
materialism

Politics

Holist
8. Different Approaches to Understanding.

Economics mainly occupies the top right-hand quadrant;

sociology, politics, and history occupy the bottom left-hand one;
psychology, the top left-hand quadrant. This leaves the bottom
right-hand quadrant to historical materialism (Marxism). The
argument of this book is that economics should move in the direc-
tion pointed to by the arrow, with less tight priors and looser deduc-
tion. It should be content, that is, with a logic of partial, rather than
full, predictability.
The further task is to link ontology and epistemology in a
broader understanding, in which the economy is seen not as a spe-
cialised activity, with its own logic of behaviour, but as an aspect of
human life and human striving. Polanyi expressed this idea in the
view of the market economy as an embedded system.
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 RETREAT FROM OMNISCIENCE

The standard objection to broadening the scope of economic

analysis in the way I have suggested is that it will make the sub-
ject too vague to be useful. This is Professor Krugman’s view. He
gives two reasons: first, thinkers, however eloquent, who adopt a
‘discursive, non-mathematical style’ will not be listened to by other
economists; second, that ‘controlled, silly models’ are the only way
to get at useful truths. The first is simply a statement of current
economic fashion; the second deserves more consideration. My
argument is that the ‘controlled, silly models’ destroy old knowl-
edge as much as they create new knowledge. This is because any-
thing which can’t be modelled in tight, silly ways is left out of the
account. One can airily write off the destruction as the price of
progress. But the resulting deficit in understanding may easily pro-
duce bad policy. In Krugman’s own examples, the fact that econo-
mists couldn’t model increasing returns to scale or oligopolistic
competition till the 1970s (can they now?) meant they were stuck
with the ‘silly’ model of the competitive economy.
I doubt if Krugman has realised the full import of saying that
the methodology of economics prevents economists expressing
‘sensible ideas’. His almost casual get-out is that in the long run
these sensible ideas will be captured in ‘fully worked-out models’.8
But how long is the long run? How much useful knowledge is lost
in the short run? And why on earth does he believe that even in the
long run greater rigour will produce greater truth?
In the social sciences, formal modelling is unique to economics.
Psychology, history, sociology, ethics do not rely on ‘controlled, silly
models’ to get a better understanding of human behaviour. They
aim at what Rosenberg has called ‘qualitative’, not ‘quantitative’, pre-
dictions. This is not a sacrifice mainstream economics has been
prepared to make, for it would mean sacrificing its claim to be like
a natural science. This would be fine if economics really were a nat-
ural science, if the policeman, decked out with his fancy equations,
really did have the authority he claimed. But if economics is much
like other social sciences, able to offer qualitative, not quantitative
predictions, the claim that formal modelling is the only way to get
at the truths which matter for economic life is a sign of hubris.

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 WHAT’S WRONG WITH ECONOMICS?

The radical question raised by Tony Lawson (see Chapter 7) is

that if the material studied by economics is the same as the mate-
rial studied by the other social sciences, what reason is there for
the disciplinary divide between economics and the other social
sciences, or indeed what would be the objection to a unified social
science?
One answer is that the material of economics does exhibit
‘closed worlds’, absent from other social sciences, where quanti-
tative predictions are to be had. These closed worlds are like the
world of games, in which the aims are given, the rules are fixed, and
there is only a limited number of moves. They have always existed
and exist today. They are the stuff of microeconomics. But I doubt
if closure is a good general presumption to make of modern eco-
nomic life, especially one dominated by financial institutions. The
question which needs to be asked is: to what worlds does the study
of economics add unique value, to what worlds does it add about
the same amount of value as do other social sciences, and to what
worlds does it add no value at all, and even detract from it?
Finally, we must return to a question central to pre-modern
thought, but pushed aside by ‘scientific’ economics: what is wealth
for? Ethics should be reinserted onto the ground floor of econom-
ics. By taking wants as given, economics offers no critique whatso-
ever of the human hunger for accumulating wealth without limit.
That this might sanction policies which lead to the destruction of
the human species is not something that someone who is just an
economist need concern himself with. But a well-educated econo-
mist will surely have to do better than that.

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THE FUTURE OF ECONOMICS

The political purpose of economics

Economics delivers a great deal, but it promises more than it can
deliver, and, by assuming a certain type of human being – the
rational, forward-looking ‘agent’ – it underestimates the costs of its
promises. This means that its path to re-engineering human behav-
iour is littered with broken societies. The spectre which haunted
the first generation of sociologists, of rudderless masses coalescing
under charismatic leaders promising them back their lost birth-
right, re-emerges.
The question of how to do economics has become particularly
urgent today, because it is linked to the survival of a free society.
Keynes posed the question in the 1930s thus:

The authoritarian state systems of to-day seem to solve the

problem of unemployment at the expense of efficiency and of
freedom. It is certain that the world will not much longer
tolerate the unemployment which is associated . . . with present
day capitalistic individualism. But it may be possible by a right
analysis of the problem to cure the disease while preserving
efficiency and freedom.1

The problem of unemployment now appears in hydra-headed

form – headline unemployment, underemployment, precarious
employment – not all of them easy to define or measure, and is
accompanied (and partly caused) by an ‘arbitrary and inequi-
table distribution of wealth and incomes’.2 As in the 1930s, these

191
 WHAT’S WRONG WITH ECONOMICS?

conditions give rise to dictatorial parties and regimes which prom-

ise to solve economic problems ‘at the expense of efficiency and
freedom’. In addition, there is popular anger at the hollowing out
of community in the name of economic integration. Those whom
President Macron of France described as the ‘left-behinds’ are full
of both economic and social resentment at the elites who presume
to manage affairs in their interest. So, good policy today requires
not just a ‘right analysis’ of the economic problem, but a strong
social imagination. Economics cannot do all this on its own. But
anything it can do to help the economic system work better and
more equitably will ease the strain of social resentment.
Keynes’s attack on the orthodoxy of his day was an attack not
on the competence of economists but on their methodology. This
is the case for a radical rethinking of its methodology today. The
neoclassical economist is a dangerous counsellor for turbulent
times, because he promises things which unmanaged markets
cannot deliver. The conclusions deriving from his closed worlds
are seriously misleading if applied to open worlds, and can lead
to large mistakes in policy. Specifically, the belief that competi-
tive markets spontaneously deliver stability and equity ignores the
need to make the market system stable and equitable by design: a
truth which Keynes understood, but which neoclassical economics
has resolutely ignored.
If economics is to be useful today it will need to modify its belief
in the self-regulating market. That free markets contain a principle
of order was a huge discovery. It meant that economic life could be
set free from state, municipal, communal, and customary direction.
But to maintain that market competition is a self-sufficient ordering
principle is wrong. Markets are embedded in political institutions
and moral beliefs. In today’s world they are inescapably accountable
to voters as well as to market transactors. Market integration across
borders is a not unworthy goal. But it should be pressed only as far
as, and by means which, the conditions of political consent allow.
This is a matter of judgment, not of demonstrative proof. The only
test of good policy should be the Polanyi test: how much disruption
and inequality will societies tolerate for the sake of progress?

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 THE FUTURE OF ECONOMICS

These considerations are relevant to the way economics should

be taught. Economics started as microeconomics – the theory of
relative prices as determined in barter markets. Keynes shifted the
focus to the theory of money, and broadened monetary theory into
macroeconomics. Macroeconomics has now been squeezed out,
and macroeconomic relationships are viewed by the mainstream
as the summed result of rational decisions taken by forward-
looking producers and consumers in competitive markets.
My ideal textbook would reverse the causation. I would start
with the institutions of the macroeconomy and show how they
structure markets and shape individual choices within markets.
This is what a properly sociological economics would do. Central
topics would be the role of the state, the distribution of power,
and the effect of both on the distribution of wealth and income.
There would be no assumptions about individual behaviour except
that individuals act as rationally as they can in the incomplete
conditions of knowledge in which they find themselves. Further,
my textbook would make clear that the only defensible purpose
of economics is to lift humanity out of poverty. Beyond this, the
lessons of economics end, and those of ethics, sociology, history,
and politics take over. The mathematical requirements for this pro-
spectus would be minimal, though proper understanding of the
uses and limitations of statistics is essential. There will always be
a place for clever puzzle-solvers, though they should not be taken
too seriously.
In offering policies to improve the world, economists should
pay much more attention than they have done to the conditions of
political consent. Mainstream thinking on public choice is jejune.
It leads much too quickly to the idea that, pending the invention
of an omniscient computer, everything should be left to the mar-
ket. Future historians, looking back, might well identify finance-led
globalisation as the root cause of the tribulations of the twenty-
first century. To allow the financial system to establish a phantom
global hegemony while leaving political legitimacy to national gov-
ernments was to court economic and political disaster. Economics
was not the cause of these misfortunes, but it was complicit in

193
 WHAT’S WRONG WITH ECONOMICS?

them, because its method, as I have argued, offered no basis for

robust counter-narratives.
Whatever the outcome of our current distempers, it does not
seem that today’s pretentious economics will be of much help. Its
natural trajectory is towards the other social sciences. It will con-
tinue to provide indispensable tools for thinking about the human
condition, but as a co-equal, not as a monarch.

194
 NOTES

Preface
1. Marshall, 1890: 9
2. Harvey, 2016; Fischer et al., 2018
Chapter 1. Why Methodology?
1. Quoted in Robbins, 1935
2. Samuelson, 1992: 240
3. Hahn, 1992
4. Keynes, 2015 [1938]: 281
5. Bhaskar, 1975: 70
6. Christoph M. Schmidt, Chairman of the German Council of Economic
Experts, 2017
7. Robbins, 1935: 84, 86
8. Lo, 2017: 6–7
9. Streeck, 2016: 242–6
10. Tetlock, 2005
11. Keynes, 2015 [1924]: 173–4
Chapter 2. The Basics: Wants and Means
1. Smith, 1904 [1776]: 4
2. Marshall, 1890: 1, 18
3. Robbins, 1935: 15–16
4. Ibid.: 13
5. McConnell, Brue and Flynn, 2009: 8
6. Robbins, 1935: 15
7. Sahlins, 1972
8. Robbins, 1935: 92–3
9. Smith, 1904 [1776]: 165
10. Menger, 2007 [1871]: 125
11. Ibid.: 125–7
12. Veblen, 1899
13. Galbraith, 1969; Packard, 1957
14. Hirsch, 1976; The positional good argument was anticipated by Roy Harrod
(1900–1978) in his idea of ‘oligarchic goods’ and developed by Robert Frank
(b.1945) in his notion of a ‘positional arms race’.
15. Robbins, 1935: 76
16. Sen, 1981

195
 NOTES to pp. 30–67

17. Robbins, 1935: 85

18. Marshall, 1890: 1
Chapter 3. Economic Growth
1. Mokyr, 2016: 5–6
2. List, 1909 [1841]
3. Meadows et al., 1972: 45, 87
4. Ricardo, 1817
5. Ibid.
6. Chang, 2002; Amsden, 1992; Bairoch, 1993
7. Chang, 2008
8. Mazzucato, 2013
9. Mill, 1848: 804–5
10. Rosenstein-Rodan, 1943; Hirschman, 1958; Lewis, 1954
11. Prebisch, 1959
12. Johnson, 1977
13. Hirschman, 1958: 110
14. Frank, 1966
15. Krueger, 1974
16. Smith and Toye, 1979
17. Wolf and Wade, 2002
Chapter 4. Equilibrium
1. Schumpeter, 1954: 968
2. J.W. Goethe, 1808, Faust: Prologue in Heaven (translated by Bayard Taylor)
3. Walras, 1954 [1874]
4. Hayek, 1937
5. Backhouse, 1997: 32
6. Kornai, 2006: 174
7. Foley, 2016
8. Schumpeter, 1954: 963–4
9. Ibid.
10. For the best account of Marx as a cyclical theorist, see Desai, 2002
11. Arrow and Debreu, 1954; for a brief account, see Hahn, 1989
Chapter 5. Models and Laws
1. Quoted in Routh, 1984: 152
2. Samuelson, 1970: 1
3. Robbins, 1935: 66
4. Fleetwood, 2017
5. Jevons, Vol. 2, 1913 [1877]: 509
6. Phillips, 1958
7. Coase, 1999
8. Schelling, 2006 [1978]: 18
9. Paul Samuelson’s more exact, but less playful, variant: ‘In a sense, precisely
because we are ourselves men, we have an advantage over the natural scientist.
He cannot usefully say, “Suppose I were an H2O molecule; what might I do in
such a situation?”. The social scientist often, knowingly or unknowingly,
employs such introspective acts of empathy.’ (Samuelson, 1970: 9).
10. Krugman, 1995
11. For this critique, see Albert, 1976
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 NOTES to pp. 68–98

12. Kaldor, 1961: 177–8

13. In a celebrated book, The Black Swan: The Impact of the Highly Improbable
(2007), Nassim Taleb accused conventional economics of ignoring the possi-
bility of extreme events, which he called black swans. The fact that all swans
were not white has long been known, as in the poet Samuel Taylor Coleridge
imagining joining nineteenth-century British convicts being transported to
Australia: ‘Receive me, Lads! I’ll go with you, Hunt the black swan and
kangaroo.’
14. This is known as the Duhem-Quine theorem, which states that in order to test
empirically an explicit hypothesis such as ‘X is caused by Y’, one must make
additional implicit hypotheses such as ‘this is a valid test of whether X is
caused by Y’, and ‘the testing instruments are accurate’.
15. Popper, 2005[1959]: 65
16. Skoufias et al., 2001
17. Routh, 1984: 154
18. Alesina et al., 2019
19. Borjas, 2017
20. Hodgson, 1997
21. McCloskey, 1983
22. Mirowski, 1989
23. Rosenberg, 1995
24. Solow, 1985
Chapter 6. Economic Psychology
1. Mankiw, 2018: 6
2. There is no gender-neutral equivalent. Nevertheless, with its English transla-
tion ‘Economic Man’, it is too useful to discard.
3. Lazear, 2000
4. Haldar, 2018
5. Lucas, 1988
6. Stigler, 1982: 7,19
7. Sargent, 2015
8. Akerlof, 1970; Stiglitz and Rothschild, 1976
9. Wikipedia, Rational choice theory; Becker, 1968
10. For a classic nineteenth-century utilitarian approach to the problem of crime
prevention, see Henry Sidgwick’s discussion in Elements of Politics (1891),
quoted in Skidelsky, 1993: 7–8.
11. Rampell, 2013
12. Anderson, 2011
13. Angner, 2012
14. Priest, 2016
15. Thaler and Sunstein, 2008
16. Schwartz, 2015: 29
17. Syll, 2018
Chapter 7. Sociology and Economics
1. Gorz, 2010
2. Harvey, 2016
3. Pareto, quoted in Fuller, 2006: 14
4. Samuels et al., 2003
5. Kant, 1784
197
 NOTES to pp. 98–114

6. Nisbet, 1993 [1966]: 13

7. Ibid.: 16
8. Marx and Engels, 2004 [1848]
9. Quoted in Nisbet, 1993 [1966]: 28
10. Tönnies, 1957 [1887]
11. Weber, 1930 [1905]
12. Habermas, 1981a; 1981b
13. Quoted in Nisbet, 1993 [1966]: 90
14. Durkheim, 2006[1897]
15. Eldridge, 1972: 93
16. Weber, 1930 [1905]
17. A follower of Weber, Werner Sombart, substituted Jews for Protestants as
inventors of the spirit of capitalism. It was not Calvinism which made
northern Europe the centre of economic development, but the expulsion of
Jews from Spain and Portugal in the 1490s. See W. Sombart, 1913.
18. Polanyi, 2002 [1944]: 46–7
19. The breakdown of the relationship between the arm and the mind was amus-
ingly portrayed in the film, Dr. Strangelove or How I learned to stop worrying
and love the bomb, in which Dr. Strangelove (played by Peter Sellers) could not
stop his arm shooting up in an involuntary Nazi salute.
20. Lawson, 1997
21. The ‘theory of rational addiction’ claims that ‘addictions, even strong ones,
are usually rational in the sense of involving forward-looking maximization
with stable preferences’ (Becker and Murphy, 1988). In a scathing critique,
Ole Røgeberg suggested that this type of exercise is symptomatic of a wider
problem in economics, writing that ‘these theories show how a loose, unstruc-
tured approach to explaining and justifying a mathematical model allow
one to hide problematic assumptions even when these are central to the
argument made, while providing ad hoc illustrations that trigger feelings
of understanding and insight though neither justifying the assumptions
nor providing an adequate explanation in objectivistic terms.’ (Røgeberg,
2004)
Chapter 8. Insitutional Economics
1. Simon, 1976: 218
2. Galbraith, 1967
3. Hodgson, 2000b, quoted in Hodgson, 2000a
4. Coase, 1937
5. Davis and North, 1971
6. North and Thomas, 1973: 16–17. The thought behind the idea that the enclo-
sure of public land protected the peasant is that it removed the incentive for
some to cheat by ‘over-grazing’.
7. Ibid.: 4
8. There is much more to Olson than this. In his book The Logic of Collective
Action (1971 [1965]), Olson explains the existence of public (or collectively
provided) goods. Certain goods, like street lighting and defence systems, have
to be provided through the tax system, because they have the property that
non-contributors cannot be excluded from using them; therefore they will
refrain from voluntary contribution to them (‘free ride’). In Soviet Russia,
the communist stationary bandit collapsed because it lost control over its

198
 NOTES to pp. 114–44

revenues. In the absence of private property, free-riding became endemic

once the bandit’s coercive power weakened.
9. Buchanan et al., 1978
10. Unger, 2019
Chapter 9. Economics and Power
1. Stiglitz, 1993
2. Varoufakis, 2017
3. Lukes, 2016
4. Hearn, 2012: 20
5. Gramsci, 1971 [1936]: 12
6. Marx and Engels, 2004 [1848]
7. Pareto, 1991 [1920]
8. Smith, 1904 [1776]: 131
9. Cooper, 2003
10. Tugendhat, 1972
11. The ability of cartels to keep prices stable may be an argument for cartels in
an industry like oil, where natural conditions in the industry induce wild
swings in price.
12. Robinson, 1969
13. Keynes, 2015 [1936]: 262
14. Robinson, 1962: 7
15. Cartwright, 1999: 2
16. In actual fact, no Nobel prize exists for economics either; it is properly called
the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred
Nobel. All the other prizes were established by Alfred Nobel’s will in 1895,
while the prize in economics was established by a donation from the Sveriges
Riksbank (Swedish Central Bank).
17. Marx and Engels, 2004 [1848]
18. Streeck, 2016: 190
19. Skidelsky, 2018
20. Foucault, 1973 [1963]
21. Galbraith, 1983: 120
22. Ibid.: 105
23. Friedman, 1993, quoted in Cherrier, 2011
24. Earle et al., 2016
Chapter 10. Why Study the History of Economic Thought?
1. Hicks, 2008
2. Quoted in Gide and Rist, 1948: 10
3. Robbins, 1935: 69
4. Stigler, 1982
5. Krugman, 1995
6. Stigler, 1982
7. All quoted in Routh, 1975: 2–17
8. Leontief, 1970
9. Hahn, 1970
10. Johnson, 2013
11. Sraffa, 1926, quoted in Routh, 1975
12. Kuhn, 1962

199
 NOTES to pp. 145–69

13. Lakatos, 1978

14. Hansen, 2017
Chapter 11. Economic History
1. Marshall, 1890: 31
2. Parker, 1986
3. Piketty, 2014
4. Denison, 1962
5. Solow, 1985
6. Kulikowski, 2014
7. Finlay, 1973: 56
8. Solow, 1985
9. Crafts, 1987
10. Saul, 2004
Chapter 12. Ethics and Economics
1. Robbins, 1938: 148
2. Stigler, 1982: 8
3. Mill, 1848: 754
4. Smith, 1904[1776]: 32
5. Ricardo, 1817: 246
6. Marx, 1887[1867]
7. Whately, 1832
8. Anticipating Veblen, Smith wrote, ‘The merit of the beauty [of diamonds] is
greatly enhanced by their scarcity. With the greater part of rich people, the
chief enjoyment of riches consists in the parade of riches, which in their eye is
never so complete as when they appear to possess those decisive marks of
opulence which nobody can possess but themselves.’ (Smith, 1904 [1776]:
172–3)
9. Jevons, 1987 [1871]: 45
10. Ibid.: 164
11. Though neuroscientists are confident of cracking this problem: ‘[neuroscien-
tists] can measure your emotional reaction to the things you see by simply
monitoring the degree of your microsweating’. (Ramachandran, 2010: 95)
12. Locke, 1764 [1689]: 220
13. Pigou, 1932 [1920]
14. Kaldor, 1939
15. I vividly recall being at a debate in Moscow in the early 2000s between two
Russian businessmen, Kakha Bendukidze and Mikhail Khodorkovsky.
Bendukidze argued that a firm’s duty to society was limited to maximising
shareholder value; Khodorkovsky claimed that it had an additional duty to
society. Bendukidze was simply echoing the view of neoclassical economics
that firms should be seen as giant-sized profit-maximising individuals. This
indeed became the standard doctrine of the 1980s: firms had no social obliga-
tion beyond maximising profits for their owners (shareholders). This over-
threw the older ‘stakeholder’ view of the company expressed by Owen Young,
CEO of General Electric between the wars: ‘The stockholders are confined to
a maximum return equivalent to a risk premium. The remaining profit stays
in the enterprise, is paid out in higher wages, or is passed to the customer.’
(quoted in Plender, 2019)

200
 NOTES to pp. 169–91

16. Foley, 2009

17. Quoted in Galbraith, 1987: 119
18. Keynes, 2015 [1930]: 82
19. Quoted in Chaves, 2003: 336
20. Easterlin, 1974
21. Layard, 2005
22. Quoted in Scull, 2019
23. Layard, 2005
24. For an expanded version of these arguments, see Skidelsky and Skidelsky,
2012: Ch. 4
25. Sen, 1999
26. For an expanded account, see Skidelsky and Skidelsky, 2012: 147–51
27. Alkire et al., 2015
28. Meadows et al., 1972
29. Raworth, 2017
30. See Oreskes and Conway, 2014.
31. For an extended version of this argument, see Skidelsky and Skidelsky, 2012:
Ch. 5
32. Sandel, 2012
Chapter 13. Retreat from Omniscience
1. Keynes, 1964 [1936]: vii
2. O’Donnell, 1989: 3
3. Keynes: 1973 [1921]: 111
4. Suppose you go to a race with three horses, Red, Blue, and Yellow, and a book-
maker offers you the following odds: evens (1–1) on Red, 2–1 on Blue, and
3–1 on Yellow (2–1 means if you win you have your initial stake returned, plus
2 times that). If you place $6 on Red, $4 on Blue, and $3 on Yellow, then you
will win $12 no matter the outcome. But the initial outlay was $6+$4+$3=$13,
so you will make a loss of $1 whatever happens. In this scenario you have
allowed the bookmaker to make a ‘Dutch book’, because you bet on all three
events, but the implied probability of all three adds up to more than 1 (events
with lower odds have higher returns). This is analogous to the practice of
arbitrage in financial markets.
5. Ramsey, 1931 [1926]. Notice that this procedure is identical to Friedman’s rule
for model construction: you can choose any premise you want, the test is the
accuracy of the prediction.
6. Keynes, 1972 [1926]: 262
7. Quoted in Skidelsky, 2018: 24
8. Krugman, 1995
Chapter 14. The Future of Economics
1. Keynes, 2015 [1936]: 260
2. Ibid.: 252

201
 BIBLIOGRAPHY

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213
 INDEX

absolute poverty rates 46 Frankenstein as a metaphor for 99

Acton, Peter 152–3 homo economicus’s evolution 100
advertising 23, 86, 134–5 moral cost of progress 170
agency peripheral economies 43–4
collective agency 93, 94, 186 in sociological thought 103–4
of the individual 93–4 Carlyle, Thomas 98–9
location of 93 Chang, Ha-Joon 40, 158
moral agency 94 Chicago school 18, 182
within social structures 186 class analysis 35–6, 122–3, 124
Akerlof, George 81, 86–7 classical economics
Arrow, Kenneth 58 definition of economics 15–16
auction markets 52 economic growth 32, 38–9
growth/stagnation problem 17
Bayes’ theorem 184, 187 methodology 12
Becker, Gary 18, 81–2, 104 scarcity in 18
behavioural economics cliometrics 150–1
on deviations from rationality 10, closed systems 3, 62, 97, 182
85 Coase, Ronald 113
fallibility of testing procedures collectivism
89–90 collective agency 93, 94, 186
fast and slow thinking 85 liberal/collectivist cycles 155–7
‘nudge’ approach 89 comparative advantage theory 37–8,
overview of xii, 84–5 44–5
systemic errors of human behaviour conspicuous consumption 21–2
85–8, 90–1 consumer sovereignty 25, 26–7,
use of heuristics 88–9 111–12
big push theories 41–3 contracts
Borjas, George J. 71 in general equilibrium theory 52,
Bourdieu, Pierre 121 54, 58
Buchanan, James M. 115, 116 within modern society 101
morality and 89, 101
capital goods 35, 41 the power of the state as 123–4
capitalism regulation of 102
and belief in predestination 104 cost of production theory 164–5
capital as stored-up labour 164
creative destruction of 170 Daly, Herman 175
exploitation of labour 164–5 Debreu, Gerard 58

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 INDEX

decision-making processes liberal/collectivist cycles 155–7

agenda power and 120–1 productive division with economics
in conditions of uncertainty 111 153–4
rationality and 81–2 the study of 149–51, 158–9
systemic errors of human behaviour time-series analysis 151–3
85–8, 90–1 use of econometrics 151–3
dependency (dependencia) theory 43 see also history; history of economic
Derrida, Jacques 75 thought
development economics economics
big push theories of structuralism defined 15–17
41–4 a different approach to 187–90
economic growth in 40–1, 46–7 within the political landscape 191–4
import-substitution policies 42–4, in relation to other social sciences
45 190
liberalisation policies in developing in relation to the laws of physics 50
economies 44, 46–7 as a science 12, 16–17, 76–8, 130–1,
of peripheral economies within 132
capitalism 43–4 teaching of 193
protectionist doctrines 31 see also scientific economics
role of the state 41–2 efficiency
stadial theory 142 efficiency of choice 17–18
Washington Consensus 41, 44–5 moral restraint for economic
Devons, Ely 66 growth 33–4
diamond-water paradox 164, 165 morally efficient behaviour 26, 89,
doughnut economics 178–9 161–2
Durkheim, Emile 102 trade-off with equity 25
emulation complex 22
Easterlin Paradox 173 the Enlightenment 97–8, 110
ecological economics 178–9 environmental economics 178
econometric testing 70–1, 151–3 epistemology
economic growth within a broader understanding of
via accumulation 35, 41 economics 187–90
in classical economics 32, 38–9 in economics 7
in development economics 40–2, insufficient generality of premises
46–7 182–5
division of labour 36 probability in 183–5
free trade doctrine 31, 36–7, 38, 45, in relation to ontology 62, 187–90
155 equilibrium theory
Malthusian population problem contracts in 52, 54, 58
32–5 cyclical theories 57, 154–5
moral efficiency for 33–4 dynamic equilibrium 57
protectionism 31, 38 in economic thought 49, 56–9
role of institutions 31, 105, 114 frictions 54–5
role of the state 31–2, 38–40 in Keynesian economics 57–8
social purpose of 171–6 in the markets 49, 51–2, 53
technological innovation for 47, 57 Marxist thought on 57
Washington Consensus 44–5 optimum equilibrium 56–7
for wealth creation 30–1 partial equilibrium 57
economic history principle of 35, 49–50, 58
for empirical evidence 150, 151–3 in the real world 55–6

215
 INDEX

role of self-interest 52–4 Galbraith, John Kenneth 111–12, 134,

shocks, notion of 49–50, 56 142, 172
static equilibrium 57 game theory 92, 118
supply and demand (competitive Georgescu-Roegen, Nicholas 28
equilibrium) 50–1 German Historical School 12, 13, 142
Walrasian general equilibrium (GE) globalization
51–2, 54, 58, 145 free trade doctrine 37
ethics impact on absolute poverty rates 46
costs of progress 169–71 market-led 126, 157
doughnut economics 178–9 Gramsci, Antonio 122
in economics 13–14, 15, 90, 179–80
ethical objections to homo Habermas, Jürgen 101
economicus 84 Hahn, Frank 2, 141
the harm principle 177–8 Hayek, Friedrich 52, 157
justice of property rights 167–9 heterodox economics xiii, xv, 71, 168
lack of in scientific economics Hicks, John 130, 137
161–3, 180 hierarchies of wants 20–1
methodological individualism Hirsch, Fred 23
176–7 history
procedural ethics 177 biases of 14
value theory 163–7 conservatism of 154
see also morality cycles in 154–8
within a different approach to
fallacy of composition 8 understanding 187–8
financial crisis (2008) of economic doctrines 13
complex system modelling 71–2 within economic study 17
developments in economic thought stages of development thesis 158
since xii, xv–xvii, 1, 10, 116 see also economic history
explanations for 1–2 history of economic thought
failure to foresee 1, 5, 7, 77, 139 methodological debates 140–3
firms paradigm persistence 143–5
as economic actors 111 the study of 11–13, 137–40, 147–8
functions of 113–15, 117 see also economic history
impact of modern technology 117 Hobsbawm, Eric 6
moral responsibilities of 168 Hodgson, Geoffrey xiii, 110, 112
relationship with the consumer holism 93, 96–7, 106
111–12 homo economicus
within social networks 186 ethical objections to 84
transaction cost theory 113–14 fictionality of 92
Fogel, Robert W. 153–4 model of 9, 79–81, 90
Foley, Duncan 56, 169 as a product of capitalism 100
Foucault, Michel 121, 132–3 rational behaviour of x, 81–3
Frankenstein (Shelley) 99
free trade income redistribution/justice of
advent of 155 distribution 167–8
critiques of 42 individuals
economic growth 31, 36–7, 38, 45 agency of 93–4
free trade/protectionism clash 31, behaviour within groups 186
38 constancy of human nature belief
Friedman, Milton 63, 135–6 19, 80–1, 103, 104

216
 INDEX

and the Enlightenment 97–8 Kahneman, Daniel 85

fallacy of composition 8 Kaldor, Nicholas 67
human behaviour within economic Kant, Immanuel 98
models 9–10, 66, 80, 181 Keppler, Joseph 132
institutions’s influence on 111–12 Keynes, John Maynard
methodological individualism 8, 11, ethics in economics 161
93–4, 106, 176–7, 185 moral basis for economics 177
in methodology 8–10 ontology of economics in 185
in neoclassical economics x, on power 129
95, 185 the qualities of an economist 14
in pre-modern society 97 in relation to equilibrium theory
representative agent hypothesis 57–8
72, 95 on the role of economics 191
within social networks 186 theory of probability 183
as sole choosing units 8–9, 10, 17 on uncertainty 3, 182, 183
uncertainty and human behaviour Keynesian economics
3–4, 8, 84, 88, 111, 181 1970s reaction against 77, 142–3,
utility maximisation x, 96, 182 156–7
see also behavioural economics; for employment 156
homo economicus equilibrium 57–8
industrialisation Keynesian revolution 13, 39
free trade in industrialising macroeconomic forecasting models
countries 31, 38 4, 62, 77
Marxist thought on industrial role of the individual 95
societies 13, 36, 98–9, 122 Knight, Frank 182–3
role of the state 158–9 Kondratieff cycle 155
sociological thought on 98–9 Krugman, Paul 67, 138, 189
Institutional Economics 12, 44, 95 Kuhn, Thomas 12, 143, 144
institutionalism Kuznets, Simon 151, 173
neoclassical 112–19
overview of 110–11 labour theory of value 163–4
institutions Lagarde, Christine 121
the church 103 Lakatos, Imre 12, 143, 145
defined 111 laws, economic
digital technology and 117 ceteris paribus warnings 55, 62, 147
influence on the individual 111–12 critiques of 140–2
the institutional order 98, 100 deductive theories 61
non-market coordination 111–12 economic generalizations 60–1
principal-agent problem 115–16 inductive theories 61
public choice theory 115–16 modelling and 61–5
role in economic growth 31, 105, orthodox economics theories 146–7
114 stadial theory 142
self-interest within 111 see also models
the state as 100 Lawson, Tony 106–7, 190
utility maximisation by 112–13 Leontief, Wassily 141
see also firms; states Leslie, Cliffe 140
liberalism
Jevons, William Stanley 64, 165–6 liberal/collectivist cycles 155–7
Johnson, Harry 42 liberal power 123–4
Jones, Richard 140 liberal theory of the state 122–3

217
 INDEX

liberalisation policies in developing Frankenstein as a metaphor for

economies 44, 46–7 capitalism 99
List, Friedrich 31, 38, 41 labour theory of value 164–5
Lo, Andrew 10 the moral cost of progress 169
Locke, John 167, 168, 181 need for social bonds 98–9
Lucas, Robert 67, 80 power relations 11
Lukes, Steven 120–2 in relation to equilibrium theory 57
Marxism
macroeconomic theory on bourgeois economics 131–3
Keynesian macroeconomic on equilibrium theory 57
forecasting 4, 62, 77 hegemonic power concept 122–3
macroeconomic models 67, 77 on industrial society 13, 36, 98–9,
as micro-founded 140, 142–3 122
Maddison, Angus 151 theory of class power 45, 122–3, 124
Maine, Henry 101 theory of exploitation 43
mainstream economics see mass consumption 26–7
neoclassical economics maths
Malthus, Thomas 18, 31, 32–5 mathematical language xi, 35
marginalist revolution x, 12–13, 140, mathematical modelling 60
165–6 role in economics 78, 141–2
market economies 104–5 McCloskey, Deirdre 74, 76
markets means
auction markets 52 choice of means 16
competitive market systems 39 as data 24
consumer sovereignty 25, 26–7, opportunity costs 23
111–12 scarcity of 16, 19, 23
expanded world of business 101–2 scarcity of time and 23–4
general equilibrium (GE) in 49, wealth and 15–16
51–2, 53 means-end problem 15, 19–20, 30
the invisible hand of 18, 159 Menger’s Hierarchy of Wants 20–1
market imperfections 128 methodological holism 93
market maximisation 53 methodological individualism 8, 11,
market-led globalization 126, 157 93–4, 106, 176–7, 185
market/society relationship 104–6 methodology
monopolies in 125–6 classical economics 12
monopolistic competition 127 homo economicus function within 9
monopsony power 127 human nature and 9–10
oligopolies 126–7 the individual in 8–10
origins of trade 186–7 marginal revolution 140
pre-modern markets 53, 97, methodological debates 140–3
104–5 methodological persistence 12–13
role of institutions 110 of neoclassical economics 1
self-regulating markets 192 paradigm persistence 143–5
state intervention in 105, 123 paradigm shifts 12–13, 140
transaction cost theory 116, 117 pluralism within 6–7
uncertainty and 57–8, 59 protective belts in research 145–6
see also trade relationship with sociology 10–11
Marshall, Alfred 15–16, 18, 26, 161 the scientific method 143–4
Marx, Karl the social in 10–11
class analysis 35–6, 94 the study of 2, 4–5

218
 INDEX

subjective value theory 165–6 monopolies 125–6

utility maximisation as 66, 80, 140 morality
microeconomics 4, 94, 193 anomie 102
Mill, John Stuart 26, 142, 170 contracts and 89, 101
Miller Atlas of Brazil 139 just price doctrine 163
models moral agency 94
agent-based modelling 72 moral behaviour 176
complex system modelling 71–3 moral restraint for limiting
econometric testing 70–1, 151–3 population growth 33–4
within economic study 60, 189 morally efficient behaviour 26, 89,
to establish laws 61–5 161–2
establishing the facts 65, 66–7 of ownership 168
fallibility of 76–8 in relation to strategic rationality
falsification of theories 68, 74 101
freezing technique 3–4, 62 see also ethics
frictions 63
human behaviour within 9–10, 66, Nakamura, Emi 82
80, 181 natural resources 28, 34
logic and mathematical proof neoclassical economics
67–8 authority of x–xi, xiv–xv
macroeconomic models 67, 77 the individual and x, 95, 185
Malthusian population problem institutionalism 112–19
32–5, 63 methodology 1
mathematical modelling 60 overview of x–xii
method for 63–5 parody of the state 39–40
of monopolies 125–6 within the political landscape 192
network analysis 72 role of social relationships 186–7
open and closed systems 3–4, 62, New Institutional Economics 44
97, 182 North, Douglass 113–14
Phillips Curve 64–5 Nozick, Robert 177
platonic modelling 73–4
Popper’s verification principle 68 oligopolies 126–7
predictability 60, 63 Olson, Mancur 114
a priori modelling 34, 68 ontology
in relation to reality 5–6 in Keynesian economics 185
rhetoric and 74–6 lack of institutional mapping in
shocks, notion of 62–3 185–7
the study of 5 in relation to epistemology 62,
system dynamics 72 187–90
testing hypotheses 68–71 open systems 3
time-series analysis 151–2 opportunity costs 23
see also homo economicus; laws,
economic paradigm persistence 144–5
money Pareto, Vilfredo 124–5
within economic study 4 Parker, William 150
efficiency of choice and 17–18 Phillips Curve 64–5
as a means to an end 15, 16 philosophy 7, 14, 15
theory of money 12 physics
for well-being 16, 26 concept of gravity 50, 54
see also wealth the laws of physics and economics 50

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Pigou, Arthur 167 Keynes’s theory of probability

pluralism 183–4
as alternative to heterodoxy xiv in neoclassical epistemology 184–5
within economic methodology 6–7 uncertainty as 81
in economic theory 12 production possibility frontier (PPF)
parable of the blind men and the 56
elephant 6, 7, 187 property ownership
Polanyi, Karl 104–6, 110, 188, 192 enclosure of the commons 105, 114,
political economy 15–17, 119, 136, 159
155–6 exploitation of labour 164–5
political science 11, 14 justice of property rights 167–9
Popper, Karl 68, 96 Lockean thought 167, 168
positional goods 23 protectionism 13, 31, 38, 105
post-modernism 75 psychology
power biases of 14
advertising as a form of 134–5 within a different approach to
agenda power 120–1, 134 understanding 187–8
blunt/hard power 120 in economic studies 79–80
defined 120 see also homo economicus
disinterested power 129 public choice theory 115
economic theory and 129–31
in economics 11, 119–20, 125–9, rational expectation theory 183–4, 185
136 rationality
economics/business relationship communicative rationality 101
131–6 decision-making process 81–2
forms of 120–3 deviations from in behavioural
hegemonic/ideological power economics 10, 85
121–4 efficiency of choice 17–18
inducements 122 future conditions of uncertainty 81,
legitimacy of 123–5 83–4
liberal power 123–4 neoclassical model of 85–8, 90
Machiavellian power 122, 124–5 rational behaviour of homo
Marxist critiques of bourgeoise economicus x, 81–3
economics 131–4 rational belief/true belief
Marxist theory of class power 35–6, distinction 183–4
45, 94, 122–3, 124 rational vs irrational human
of monopolies 125–6 behaviour 9–10, 11, 19–20, 79,
monopolistic competition 127 101
monopsony power 127 strategic rationality 101
oligopolies 126–7 Rawls, John 168, 177
as a positional good 23 Raworth, Kate 178–9
relationship with ideas 129, 131–3 religion 103, 122
Prebisch, Raúl 42 representative agent hypothesis 72, 95
pre-modern society research
just price doctrine 163 dominance of orthodox economics
markets in 53, 97, 104–5 in 146–7
sociology on 97, 98, 101 external interests and influences
principal-agent problem 115–16 130–1, 136
probability intellectual independence of
cardinal probabilities 184 129–30

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paradigm persistence 143–5 self-interest

protective belts in 145–6 in equilibrium theory 52–4
rhetoric 74 within institutions 111
Ricardo, David 31, 35–6, 37–8, 62, 94, and relations of obligation 101–2
164 Sen, Amartya 24–5, 174–5
risk Shelley, Mary 99
defined 182 Shiller, Robert 86–7
risk-taking and profit 40, 164, Sidgwick, Henry 140
182–3 Simon, Herbert 111
risk/uncertainty distinction 182–3 Sismondi, Simone de 140
Robbins, Lionel Smith, Adam
definition of economics x, capital goods 35
16–17, 18 definition of economics 15
on economic history 137–8 diamond-water paradox 164, 165
ethics and economics 26, 161, 162 division of labour 36
on psychology 10 era of liberal economics 155
scarcity perspective 16–17, 18, 19, ethics and economics 162
20, 23, 101 free trade doctrine 37, 155
on scientific generalizations 60 on hypotheses 60
the state of well-being 172 on markets 93, 104
Robinson, Joan 56, 130 on monopolies 125, 126
Roscoe, Philip 74 needs and wants 20
Routh, Guy 70 science of economics 30–1
self-interest and equilibrium 53
Samuelson, Paul 2, 37, 51, 60, 186–7 social structures
Sargent, Thomas xii, 81 within economic study 10–11
Say, J.B. 27, 137 human behaviour within 9–10
scarcity lack of in neoclassical economics
artificially created scarcity 24–5, 28 186–7
in classical economics 18 social networks 186
within the definition of economics sociology
16–17 biases of 14
as given by nature 25 capitalism 103–4
and the logic of choice 17 cultural conformity 96
of means 19, 23 within a different approach to
in relation to growth in wealth 24 understanding 187–8
Robbins’s scarcity perspective emergent systems 106–9
16–17, 18, 19, 20, 23, 101 Gemeinschaft and Gesellschaft
of time 23–4 100–1
want–need problem 15, 16, 19–20, group actions 94, 96, 186–7
26–9, 172 individual actions 94–5, 186–7
Schelling, Thomas 66 individualism/holism distinction
Schlesinger Jr, Arthur 155 96–7
Schumpeter, Joseph 49, 57, 170 the institutional order 98, 100
scientific economics interaction/interdependence
in classical economics 27, 30–1, 37, distinction 92–3
162 market/society relationship 104–6
lack of an ethical dimension 161–3, methodological holism 93, 106
180 the nature of community 100–3
markets in 128–9 norms concept 95–6

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post-Enlightenment society 98–100 welfare-maximising trade 37

pre-modern society 97, 98, 101 see also markets
in relation to political economy transaction cost theory 113–14
10–11 Tversky, Amos 85
sociological economics 95
Solow, Robert 78, 152 uncertainty
Sraffa, Piero 143 decision-making in times of 111
stadial theory 142 defined 182
states and human behaviour 3, 8, 84, 88,
anti-monopolist approaches 126 111, 181
class interests of 35–6 Keynesian uncertainty 3, 182–3
expansion of bureaucracy 102 in mainstream economics 181
institutional capacity of 100 and the markets 57–8, 59
justice of distribution function 168 as probability 81
liberal theory of 122–3 risk/uncertainty distinction
market interventions 105, 123 182–3
public choice theory 115–16 unemployment 64–5, 167, 191
role in development economics utility maximisation
41–2 as economic method 66, 80, 140
role in economic growth 31–2, of the individual x, 96, 182
38–40 by institutions 112–13
role in industrialisation 158 in the Phillips Curve 65
within social networks 186 public choice theory and 116
Steinsson, Jon 82 role of advertising 134–5
Stigler, George 80, 138, 139–40, 161 self-interest and 53
Stiglitz, Joseph 81, 119 subjective utility 140, 145, 165–6
Streeck, Wolfgang 132
structuralism 42–4, 45 value theory 163
subjective utility 140, 145, 165–6 Veblen, Thorstein 21–3
sustainable development 175
Wade, Robert 46–8
technology Walras, Leon 51–2, 145
impact on firms 117 want–need problem 26–9
Kondratieff cycle 155 wants
state investment in 40 absolute wants 21
technological innovation for conspicuous consumption 21–2
economic growth 30, 47, 57 emulation complex 22
technology ‘shocks’ 63 ends as 15
Tocqueville, Alexis de 99, 123 finite natural resources 28
Tonnies, Ferdinand 100 hierarchies of wants 20–1
trade as insatiable 19, 21, 26–9, 172
comparative advantage theory 37–8, lack of ethics in scientific
44–5 economics 162
complimentary trade 37 in the marginalist revolution 165
free trade doctrine 36–7, 38, 45, 155 rational choices over 19–20, 101
free trade in industrialising relative wants 21–3
countries 31, 38 role of advertising 23
import-substitution policies 42–4, want–need problem 15, 16, 19–20,
45 26–9
and natural advantage 37 Washington Consensus 44–5

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wealth well-being
creation of 30–1 as goal of social policy 171–3
defined 15 happiness growth 173–4
within the definition of economics indices of 175–6
15, 16 material wealth for 171–2
poverty reduction 30 need for money for 16, 26
in relation to scarcity 24 through capabilities 175
for well-being 26 Wolf, Martin 46–8
Weber, Max 101, 103–4 Wolfers, Justin 82

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