In our PhD Economics program at Stanford, we learnt nothing about the history of major economic events of the twentieth century. Instead, we were taught the rather arcane and difficult skill of building models. In order to analyse what would happen in an economy, we learnt that you have to construct an artificial economy, populated by rational robots called homo economicus, who behave according to strict mathematical laws. At no point in our studies were we asked to match what happens in our models with any events in the real world; it was assumed that the two always matched. This process of economic modelling permits us to provide exact mathematical answers to a vast range of questions one might ask about the economy. This is undoubtedly a powerful technique, which has earned economics the name “Queen of the Social Sciences”. Our poor cousins in political science, psychology, sociology, geography, and so on, have to study the more complex real world, and cannot offer anything comparable. Nonetheless, the power of mathematical modelling derives from the extremely unrealistic assumption that real world events and human behaviour can be predicted by mathematical formulae. Thus, the precise predictions of economists are often dramatically contradicted by real world outcomes. As Nobel Laureate Paul Krugman remarked after the global financial crisis took economists by surprise: “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”
My own education in economics began many years after graduate school, when I chanced across a copy of Economics and World History: Myths and Paradoxesby Paul Bairoch. Bairoch’s book challenged one of the holy cows of economic theory, that free trade is always a superior policy for all parties. Believing in free trade is a hallmark of economists — a recent survey showed that 90 per cent of economists believe in it, while only 20 per cent of the general public believe that free trade is always optimal. So it came as a shock to me when Bairoch discussed many historical episodes to show that free trade had caused harm to the less developed nations, by preventing development of industries, and also by creating unemployment. Many nations with strong industries had built them up under the umbrella of protection, contrary to free trade principles. This historical evidence was strongly in conflict with the mathematical demonstrations of superiority of free trade that I had learnt in graduate school. In bewilderment, I asked several of my mentors, very senior and respected economists, about this. I was even more surprised by the responses I received. None of them were familiar with the historical evidence, and furthermore, they did not find it relevant. They argued that if protection provided good results, then free trade would have provided even better results. The mathematical proofs were impervious to empirical evidence.
Economists do not study history because it is a record of particular events, while they search for universal scientific laws, which would be equally valid among the Aztecs and the Zulu, in the nineteenth century and in the twenty-first. I realised that the laws of economics hold only in an imaginary world populated by robots, and that to learn real economics, it was necessary to study history, which I had bypassed in graduate school. It was only after many years of detailed historical studies of real world economic events that I came to realise that nearly everything I had been taught in graduate school was wrong.
Recent historical events have shaken the faith of many true believers in free market economics. A landmark 2013 study by Autor, Dorn and Hanson, found that competition from China has destroyed jobs and lowered wages in many US industries, especially manufacturing. Contrary to economic theory, which states that the displaced labourers will find better jobs in different sectors, workers displaced by Chinese competition often went on the government dole. A large group of heterodox economists, students and laymen are becoming increasingly aware of the lack of realism, ideological bias, and lack of concern with poverty and inequality, which are hallmarks of modern economic theory. However, dissent is weak and dis-united, while orthodoxy is firmly entrenched in the halls of power. The task of creating a new economics remains as essential as it is undone.
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