A decade on from the global financial crash: the role of mainstream economics, ideological groupthink and missed opportunities
Professor John Barry looks back at the 2007 financial crash.
“The day the world changed”, was how Adam Applegarth, Northern Rock’s chief executive described the beginning of the Financial Crash on August 9th 2007. This was the day that the bank BNP-Paribas refused to allow withdrawals from its hedge funds, citing a “complete evaporation of liquidity” based on knock-on effects of the sub-prime mortgage crisis in the USA.
However, August 2007 was preceded by HSBC announcing losses in February of that year again linked to the sub-prime crisis in the US property sector while in July 2007, two Bear Stearns-run hedge funds with large holdings of sub-prime mortgages ran into large losses and were forced to dump assets. The trouble spread to major Wall Street firms such as Merrill Lynch, JPMorgan Chase, Citigroup and Goldman Sachs which had loaned the firms money. And contagion ensured…and the rest is history ….
Much attention, not least in the media, on the global financial crisis a decade ago, will focus on greed, lack of adequate financial regulation and the dangerous reality of the financial sector having such a dominant role in advanced capitalist economies, as key elements of the analysis of the causes and consequences of the crash. Here I want to focus on a rather less discussed but crucial part of the story of the great financial crash – mainstream economic theory and its application in practice. Not only did neoclassical economics not foresee the crash, but contributed to it. It did so in two ways.
The first relates to how the dominance of neoclassical economics (one view of the economy and economic policy) ‘crowded out’ and marginalised dissenting economic perspectives. In actively discouraging pluralism in economics, alternative views, perspectives and strategies were excluded, removing possible sources of identifying systemic flaws in the global, financialised economy, and also excluding policy solutions.
The second is about how neoclassical economics gave a false, but politically attractive, sense of intellectual security to theories such as the ‘efficient market hypothesis’, which were the knowledge and ‘evidence’ base underpinning policies of deregulation and buttressed a neoliberal policy ‘direction of travel’ that the market, if left to itself, would deliver economic growth, an efficient allocation of resources, employment and so on.
Ideas matter. And they have real world impacts. And there is perhaps a no more powerful set of ideas than those of neoclassical economics, the dominant school or strain of economics taught in schools, universities, MBA degrees and is the main form of economics used by state policy-makers, political parties, businesses and indeed how the media – and hence the ordinary citizen – understands what the economy is and acts as a guide to making economic decisions and policies. They were the ones who provided the intellectual justification for the transformation of our economy over the past thirty years. They stood idly by as jobs went overseas, demand was sapped by increasingly uneven distributions of income, competition was destroyed by lax attitudes towards antitrust laws, and safeguards were discarded in the financial sector. More than that, many actually praised these events.
As Jamie Moran noted in his overview of the role of neoclassical economics and the economic crisis:
“Unlike other social scientists, mainstream economists consider it a primary aspect of their role to intervene in public policy, and they do so with a degree of unity and self-confidence that other disciplines lack. This unity is internally hierarchical, narrow and exclusionary. To a greater degree than other social sciences, economists tend only to reference their peers (mainstream economists), only seek to publish and reference within a tight core of journals, and do so based on shared commitments regarding what constitutes legitimate economic method and theory expression.”
As such neoclassical economics has elements that can be viewed as ‘academic groupthink’ or a coherent ideology shared amongst a select group of people. While deserving of a much longer analysis (see my own work on this if you’re interested) key here is to understand that ALL forms of economic thinking are forms of ‘political economy’. That is, ALL forms of thinking about what the economy is, what its objectives should be, who or what should manage it, what should be produced and consumed etc. are political and normative. That is, they involved normative value judgements. However, neoclassical economics presents and understands itself as ‘objective, ‘neutral’ and ‘scientific’. And yet it is dripping in normative value commitments, ranging from its assumptions about the human being as endlessly competitive, focusing on consuming and accumulating more and more to assumptions that markets and the price mechanism are more efficient ways to organise the economy than planned or democratised economic practices. As Jim Stanford has noted:
“Neoclassical economics is dedicated to the study of capitalism; in fact, other kinds of economies (that existed in the past, or that may exist in the future) are not even contemplated. Yet the term “capitalism” does not appear in neoclassical economics text books. Instead, economists refer simply to “the economy” – as if there is only one kind of economy, and hence no need to name or deﬁne it. This is wrong, “the economy” is simply where people work to produce the things we need and want. There are different ways to organize that work. Capitalism is just one of them”
Thus, the intellectual debate about neoclassical economics is one that lies partly within the framework of the academic production of knowledge, but is also a debate that goes far beyond the academy. This is also an ideological battle, only part of which occurs within the academy.
A sign of the ideological success of neoclassical economics is that it has, by and large, managed to perform the sleight of hand of replacing “capitalism” with “the economy,” such that whenever we “commonsensically” talk about “the economy” we are in fact, usually, talking about a particular mode of economic organisations, namely capitalism. A category mistake has been made: the confusion and conﬂation of “capitalism” with the “economy.” Think of when an “economist” is called to comment in the media: it is without exception a neoclassical economist who will (generally speaking) talk about (and defend) capitalism. Rarely do we hear non-neoclassical economists in our media, or if we do these are not accorded the label of “economists” but “political commentators,” nicely eliding the fact that those called “economic experts” are also political commentators.
Thus, neoclassical economics supports a particular view of the economy and society, one which, with a few exceptions, is supportive of a capitalist organisation of the economy, private ownership of the means of production, and production for proﬁt; justiﬁes an unequal distribution of income and wealth; promotes free trade, deregulation, and economic globalisation; and above all is committed to promoting orthodox economic growth. By orthodox ‘economic growth’ I mean undiﬀerentiated, monetary/GDP measurements of economic growth as a permanent feature of the economy.
A good illustration of the ‘power of ideas’ is how most politicians, political parties, civil servants, media commentators and indeed ordinary citizens uncritically take economic growth as the main measure of how well an economy is doing, without stopping to think that a) there may be other better measures and objectives and b) GDP measured economic growth does not distinguish between negative events like divorce which leads to an increase in GDP (two houses now are needed, all the goods and services for two houses, greater commuting when co-parenting, etc.).
All of this social and personal distress is viewed as ‘positive’ from an economic growth perspective. On the dangers of a myopic focus on GDP growth, a key tenet of neoclassical economics, we have the words of Robert Kennedy Jr. who noted in 1968:
“…the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit not our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything in short, except that which makes life worthwhile.”
It is important to note that ‘calling out’ these ideological political values underpinning neoclassical economics does not mean that we need to jettison all neoclassical theory and policies. But both the ideological/groupthink character of neoclassical economics, its dominance and false authority in its policy prescriptions does mean we need more pluralism, diversity and creativity in how we think about, teach, research and design policies about the economy. If we value debate, dialogue between different perspectives in our democratic political systems, why do we not extend this democratic debate amongst different perspectives to thinking about designing policies for the economy? What have we (or rather neoclassical economics) to fear from debate and pluralism?
The global financial crisis and its aftermath did lead to some movement towards the reform of the economics profession, including how economics is taught – largely along the lines of calling for greater pluralism in economics and less focus on those studying economics being taught to replicate abstract economic models. These ranged from the high level – British Academy’s letter to the Queen who during a visit to the London School of Economics in November 2008 asked the sensible question: why did economists not see the crisis coming? Or as New York Times columnist and Nobel Prize winning economist, Paul Krugman put it ‘How Did Economists Get It So Wrong?’
The three-page letter that the British Academy wrote to the Queen is telling in terms of mainstream economists and economics not fully accepting their responsibility for the crisis, or seeing in the crisis an overdue opportunity and need for a through reform of economics. In the letter they write
“In summary, your majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”
It goes on to talk about the ‘psychology of denial’ that gripped the financial and political world and notes that arrogant and over-confident ‘financial wizards convinced themselves they had found ways to spread risk throughout the financial markets – ‘wishful thinking combined with hubris’. Yet nowhere do they indicate that perhaps a reason for the crash and reason for not predicting it were the very models, principles, axioms, curriculum and other elements of the intellectual edifice of neoclassical economics itself. No, the blame is not on neoclassical economics and economists but the ‘banksters’.
Other initiatives include the student-led revolt against neoclassical economic curriculum – a movement that called for more pluralism in economics, the hiring of lecturers with a broader outlook, a wider selection of text and more explicitly interdisciplinary programmes between economics and other social sciences. The student manifesto said:
“Change will be difficult – it always is. But it is already happening. Students across the world have already started creating change step by step. We have founded university groups and built networks both nationally and internationally. Change must come from many places. So now we invite you – students, economists, and non-economists – to join us and create the critical mass needed for change”.
Ten years on we are still waiting and neoclassical economics has remained dominant within universities, and also retained its pre-eminence in real world economic policy and decision-making.
This resilience of neoclassical economics should be viewed as deep cause for concern, not least in navigating the turbulent political and economic times ahead. After all, the old adage of ‘If the only tool you have is a hammer, everything is a nail’ is meant as a warning not as a guidebook.