John Turner on the Post-2008 Crisis in the Discipline of Economics

4 10 2013

Professor John Turner, who is a financial historian at Queen’s University Belfast, has posted some interesting thoughts about the post-2008 crisis in economics. The 2008 GFC hasn’t exactly discredited mainstream economics, but it has caused people to ask some tough questions about the limitations of this intellectual tradition.

Five years after the collapse of Lehman Brothers, economists are still picking over the corpse of the financial system in an attempt to understand why the financial crisis happened. Some simply blame capitalism. Such a view is naive at best. For others,and I include myself in this camp, there probably wasn’t enough capitalism. In this op-edRoman Frydman and Michael Goldberg, extremely insightful economists, point the finger of blame elsewhere – the discipline of economics. Economists had totally the wrong economic models in their toolkit – they had models which assumed that the economy works in a mechanistic way, much like a complex piece of machinery. This reduces economics to an engineering problem. But at its heart, economics is a social and political science. The real issue for me is not whether economists had the wrong models (they quite obviously did), but why did they have the wrong models.

Read more here.

The film Inside Job is about the complicity of the economics profession in the policies that led to the GFC. The film talks about possible conflicts of interest and advances a sort of theory of disciplinary capture which is analogous to the regulatory capture often associated with the financial sector.  In regulatory capture, the industry being regulated exerts undue influence over the regulatory body, perhaps through revolving door recruitment. In disciplinary capture, key members of an academic discipline are persuaded to advance  a set of arguments that is congruent with the industry’s PR and lobbying campaigns.

Personally, I don’t think that disciplinary capture explains the more fundamental problems in mainstream economics, which go well beyond the few economists with close ties to Wall Street. I think that the problems in the discipline of economics are much deeper and are rooted in the rational actor to which mainstream economists subscribe. As many people have shown, this model does a poor job of accounting for the behaviour of investors in particular historical contexts. Investors and other participants in capital markets are actually more altruistic than the rational actor model suggests. That was certainly the conclusion I reached in an article that was published earlier this year. That article examines the extent to which  political views of turn of the last century British investors influenced the global allocation of British capital. Much of the existing literature on pre-1914 British investment overseas dismisses the possibility that the pattern in Britain’s capital exports was significantly affected by imperial patriotism. This article suggests that imperial sentiment did indeed influence the destination of British capital exports; at least some British investors were willing to accept a lower anticipated rate of return because they valued the psychological satisfaction of investing in territories that happened to be part of the British Empire.