The Next Evolution of Economics

There is no panacea to solve the equation that is global economics

By Aoife Doyle

From the ashes of a deep economic crisis, new economic thinking arises. The Great Depression led to Keynesian macroeconomics – known for its mantra of ‘spending ones’ way out of recession’. The Second World War highlighted the need for a welfare state and a mixed economy – free markets coexisting with government intervention. The 1970s ushered in the rational expectation’s revolution which recognised the power of economic agent’s expectations on the future state of the economy. Hence, the pandemic is provoking economic thought and questioning economic theories for their relevance in a post-pandemic world. Once the dust of the whirlwind COVID-19 pandemic settles, some theories will survive the storm, some will become obsolete, while others will be rethought and re-branded.   

Economists can be seen as the guardians of the economy and play an important role in brokering economic analysis to the British public. Economics is the backbone of society, with policies infiltrating all spheres of life. Just as national economies differ in fiscal and monetary policies – conditioned by time, place and circumstances – so too, economic concepts. Planned economies, such as Cuba, implement economy-wide production plans that designate investment, production, and capital goods allocation. Developed countries’ economies are market-orientated systems in which decisions are guided by price signals created by supply and demand forces. To correctly analyse the current state of an economy and formulate effective policy responses, it is necessary to create a new framework of thought that can link economic movements. As Joan Robinson put it, economic theory is the art of pulling a rabbit out of a hat right after you have stuffed it into the hat in full view of the audience. 

A School of economic thought can be defined as a group of economic thinkers who share a common perspective on the way economics works. The various doctrines differ in their methodologies and the assumptions proposed to describe a particular economic phenomenon. The primary schools of economic thought include; Keynesian, Marxist, Neoclassical, behavioural economics and open economy macroeconomics, to name a few. Each school has had its place in the limelight, popularised by the ability to explain its predecessor’s failure.   

What has come to be referred to as ‘new economics’ cannot be encapsulated as a single theory or a coherent work body. It is best characterised as a research programme that encompasses a broad range of theories, empirical work and methods. New economics is not entirely new; it builds on heterodox traditions (theories that contrast with orthodox schools of economic thought or beyond neoclassical methodologies) in economics. New economics does not accept orthodox theory, which has dominated economics for several decades. Such theory states that humans are entirely rational; they will act on clear thought and reason. Markets are rational optimisers and thus perfectly efficient, so details of institutional design are ignored. Economies are self-correcting equilibrium systems that will find a state that maximises social welfare. Instead, it embodies a new way of thinking to accept human behaviour, imperfect institutions, and complex economic interactions as they are, not what an idealised model says they should be. From the new economics perspective, individuals use both inductive and deductive reasoning – they are subject to errors and capable of learning from such errors. Institutions are imperfect, often inefficient but constantly evolving; details can matter, such as the banking system’s fragility. The economy is a highly dynamic system that can be far from equilibrium, confined in suboptimal states. 

The paradigmatic core of neoclassical economics is regarded as mainstream and dominates economics to the extent that laypeople speak of economics. This school believes that the consumer is ultimately the driver of market forces, price and demand. Neoclassical economics integers the cost-of-production theory from classical economics with the concept of utility maximisation, maximising the satisfaction one receives by consuming goods and services, and marginalism, the change in the value of a product or service with an additional amount of such. The school is concerned about the efficient allocation of limited productive resources and argues that a market equilibrium is the key to an efficient allocation of resources. Therefore, market equilibrium must the primary economic priority of a government. Neoclassical economics argues that ‘greed is good’, a consumer’s first concern is to maximise their satisfaction. Individuals make purchasing decisions based on their evaluations of the worth of a product or service. Unfortunately, from biology to sociology to economics, there is evidence that it simply is not valid. 

In a Neoclassical world, recessions, mass unemployment and financial crashes do not happen, so the global financial crash has done enormous damage to the school to which it has failed to explain. There is a long list of professions that failed to spot the financial crash brewing but none more so than economists who have long asked how they failed to identify and understand the warning signs. Even the Queen asked LSE professors why no one saw it coming. The crisis exposed shortcomings in standard economic theory and gave impetus to new economic thinking. However, in the wake of the crisis, the theoretical debate has been exorbitantly constrained by the mainstream economic theory approach. The public perception of economists resembles those who focus on economic growth and wealth creation. A firm following the neoclassical model can theoretically derive as much value from a consumer as often possible. Neoclassical economics is focused on the transactional aspects of production whilst neglecting labour, the assumption of rational behaviours ignored the vulnerability and irrationality of human nature. A more nuanced development in the neoclassical economic model ought to incorporate human aspects as well. Furthermore, there is an unrealistic overdependence on mathematical models, which have become detached from reality, instigating a failure of these models. The complex models are simply not applicable to describe the real economy, lacking an individual’s interdependence with the economic system. 

All financial crises are not the same. They might share common characteristics in the risk factors from which they stem, the undercurrents unleashed, and the scars they leave behind. Still, each crisis yields unique lessons for future policymakers. There are forcibly emerging themes in policy debates within and between national administrations – regulation of financial services industry, the significance of global leadership, the scope for fiscal stimulus and the threat of economic contagion – a culmination of the lessons ‘learned’ from the experience of financial crises. 

We can expect the coronavirus pandemic, which amounts to the greatest peacetime economic disruption in living memory, to spark a direction of change in what can be considered complementary economic policy. Torsten Bell, CEO of the Resolution Foundation, stated“The UK is poised for a decade of unprecedented economic change”. The pandemic slammed the breaks on ‘normal’ life but has accelerated the pace in change of economic thought. Such economic thought will come from the Economy Inquiry 2030, which is a collaboration between the Resolution Foundation and the Centre for Economic Performance at the London School of Economics (LSE), aiming to set a framework for successfully navigating the challenges and opportunities ahead in the next decade. 

The economic impact of the Covid crisis has exposed the malfunctioning of traditional economic thinking, forcing institutions towards favourable policies that would have previously been anathema to Orthodox understanding. The pandemic is a perfect illustration of the Tragedy of the Commons: each individual is acting in their self-interest and so leading to worse outcomes for the collective. However, Nobel Laureate Elinor Ostrom proposed a solution to such a tragedy. Design principles for the common. The economic ‘we’ replaces ‘me’. 

There is no panacea to solve the equation that is global economics. So, with current policies neither helping core economic growth nor being so easy to implement, economists are calling for a significant rethink on economic policy, both monetary and fiscal. The LSE et al. report will profoundly affect the course of UK economics for the next decade. An emphasis will be placed upon the ‘Green shift’, an energy technology revolution leading to a low-carbon economy, emerging from a stricter and ambitious emissions reduction framework. The current framework for valuing human capital is outdated and insufficient. Covid-19 has added impetus across the field; it is clear that people are organisations’ most significant assets. There is a new paradigm for workforce management. Organisations must implement a framework for measuring and accounting for human capital, enabling companies to monitor and assess the return on their employees’ investments in the same way that they measure financial and intellectual capital. Policymakers must take this crisis as a wake-up call to implement the changes necessary to weather the plunge and prosper in the future.

Book: Joan Robinson (Great Thinkers in Economics), by Geoffery Harcourt (2009), Palgrave Macmillan.

The views expressed in this article are the author’s own and may not reflect the opinions of the St Andrews Economist.

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