3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. …

The trouble is that the news from people who watch neo-classical economists at play (including economists of the critical “real world” school) say that in the face of the crisis they are becoming increasingly fundamentalist and ever more detached from the rest of the world – while still being deeply entrenched in policy making.

Several bits of evidence. The commentator Anatole Kaletsky, in the British Prospect magazine, is blunt on the issue:

In general how many academic economists have had something useful to say about the greatest upheaval in 70 years? The truth is even worse than this rhetorical question suggests: not only have economists, as a profession, failed to guide the world out of the crisis, they were also primarily responsible for leading us into it.

Steve Keen, writing in the latest edition of the Real World Economics Review (subscribe or download pdf here), argues that:

Neoclassical economics contributed directly to this crisis by promoting a faith in the innate stability of a market economy, in a manner which in fact increased the tendency to instability of the financial system. .. Simultaneously it distracted economists from the obvious signs of an impending crisis—the asset market bubbles, and above all the rising private debt that was financing them.

The severity of the crisis, he observes, ought to mean that the reform of the economics curriculum ought to be an easy task. But it won’t be. Instead:

• academic neo-classical economists will continue to teach the same courses next academic year as they did last one
• the main academic journals will continue to publish articles extolling aspects of neoclassical theory
• they will interpret the crisis as having been caused by insufficient rigour in applying neo-classical economics in market and policy environments.
• “They will seriously believe that the crisis calls not for the abolition of neoclassical economics, but for its teachings to be more widely known.”.

And more evidence from the British economist Paul Ormerod, writing a column headed ‘Have economists gone mad?‘ in The Atlantic, about the launch of a new American economics journal, Macroeconomics. (He thinks the answer is yes).

The new journal carries an article by one of the world’s leading macro-economists, Michael Woodford, which explains that economists now agree on a synthesis of the general principles of macro-economics. But, as Ormerod point out, it’s as if the financial crisis (which has now been going since August 2007) has never happened. Some of the language he uses is a little technical, but it’s worth sticking with:

The first and most important part of the new synthesis is that “it is now widely agreed that macroeconomic analysis should employ models with coherent intertemporal general equilibrium foundations”. What does this mean in English? It means (a) people and firms act in a rational, coherent manner; (b) they assess coolly and rationally the future consequences of decisions they take now; and (c) the key driving force underlying the economy is a tendency for it to revert to equilibrium. Yes, rub your eyes. The evidence is now so overwhelming that none of these statements are true that it is hard to see how they could even have been written.

[Update 23/04/09: Even Business Week has pitched in – albeit with kid gloves.]

Of course, if this was just a problem for academia it would merely be regrettable. But policy-makers, and their economic models, are now deeply wedded to such equilibrium theory. Which is, of course, one of the reasons that Eric Hobsbawm argued recently that “None of the world’s governments, central banks or international financial institutions know: they are all like a blind man trying to get out of a maze by tapping the walls with different kinds of sticks in the hope of finding the way out. For another, we underestimate how addicted governments and decision-makers still are to the free-market snorts that have made them feel so good for decades.”

Kaletsky extends this point in Prospect by asking why the “rational expectations hypothesis” which underpins neo-classical economics has become so influential. He suggests it’s partly because it happened to fit with the ideological shift in the 1970s:

[One] great merit of rational expectations lay in its key ideological conclusion—that deliberate policies of macroeconomic stimulus by governments and central banks could never reduce unemployment and would merely exacerbate inflation. That government activism was doomed to failure was exactly what politicians, central bankers and business leaders of the Thatcher and Reagan periods wanted to hear. Thus it quickly became established as the official doctrine of the political and economic establishments in America—and from this powerful position it was able to conquer the entire academic world.

As Ormerod points out, there is, in contrast, a whole school of economics which emphasises disequilibrium rather than equilibrium (think of Schumpeter’s theory of “creative destruction”, for example, which has influenced some of ther best writing about the crash. Or Keynes. Or Hayek.) But it has been completely marginalised by the economics establishment.

There’s one obvious analogy here, and that is with Thomas Kuhn’s notion of the ‘paradigm shift’, popularised in The Structure of Scientific Revolutions. Steve Keen discusses this, but comes away depressed. For one thing, even in the face of robust evidence, new scientific theories don’t triumph because they are better; they succeed because the adherents to the old theory die off. And, as Keen notes, “physics is charmed in comparison to economics, since it is inherently an empirical discipline … But in economics, not only will the neoclassical old guard resist change, they could, if economic circumstances stabilise, give rise to a new generation that accepts their interpretation of the crisis.”

Indeed, the response of the neo-classical school of economics to the crisis reminds me of the work which the social psychologist Leon Festinger did on ‘cognitive dissonance’. In his book When Prophecy Fails, Festinger researched a UFO cult which in researching a cult which believed the world was about to end and they would be taken away on a flying saucer. This isn’t a cheap point. Festinger found that members had quit their jobs, left their families, and given away possessions and money. Without wanting to spoil the plot, the world didn’t end and the flying saucer didn’t show up. But the researchers found that the strength of belief in many members of the group was stronger afterwards than it was before – despite the ‘disconfirming evidence’ which should have undermined it. He identified a number of reasons for this – some of which resonate with the present economists’ dissonance:

• The belief must be sufficiently connected to the real world that events can refute it (well, yes)
• The person holding the belief must have committed himself to it (economists spend years of their professional lives honing their mathematical and analytical skills until they are good enough to get an article published in one of the leading neo-classical economics journals)
• The individual believer must have social support. … If the believer is a member of a group of convinced persons who can support one another, the belief may be maintained and the believers may attempt to persuade non-members that the belief is correct.

The systems thinker Donald Schon pointed out thirty years ago that all social systems exhibit ‘dynamic conservatism‘; the more they are pressed, the more they push back. This can be a good thing, as it ensures some resilience and preserves essential funtions. But if fundamental change is required, social systems need to be pushed into crisis. This is a problem of politics, not of competing economic theories.

The whole of the current issue of Real World Economics Review, by the way, is about the impact of the crisis on economics as a discipline.