The European Economic Crisis and the Crisis in Economics (II) (06-08-2013)
In the first part of this essay we have discussed the European economic crisis and stated that the almost complete disappearance of genuine macroeconomics from the educational and research programmes in the North Western world has led to a large-scale cognitive closure among the leading economists. They did not foresee the crisis, while heterodox economists explained in detail the crisis yet to come. In this second part I will show that also the discussion about the necessary reforms suffers from a lack of realistic economic analysis. Institutions are rules of behaviour, applied by persons and organisations. Examples of institutions are habits, routines, customs, and moral and legal rules. According to the neoclassical philosophy institutions are meant to channel behaviour of economic, rational and non-social actors, such that their economic efficiency improves. Rules have the capacity to limit and to enable particular activities. If a legal rule says that discrimination is forbidden, and employers obey this rule, room is created for potentially discriminated people to employ profitable activities. Neoclassical analysis says that the world consists of competitive markets, and discriminative behaviour, by leaving profitable opportunities unused, cannot survive. So anti-discrimination legislation is actually superfluous. But if we assume that actors are also social beings, who are solidary within their own group and are rivalling with members of other groups, anti-discrimination rules might be economically efficient. Governments should only set rules in case of public goods, and there are just a few of this type!
Actual European Economic Institutions
This view on institutions is well-understood by economists – it fits their neoclassical intuition. Actual economic European institutions are not built on a neoclassical view on economy, however. Collective bargaining and social security arrangements, are meant to improve the efficiency of labour markets and of society as a whole. In heterodox economics, economic sociology and behavioural economics the neoclassical paradigm of the economic and rational actor is criticised. Neoclassical economists use an analysis of the economic aspect of human behaviour to explain real life phenomena. But there are two other primary human motivations, which are the social and the psychic motivation. The social motivation concerns the drive to form homogeneous groups and to maximise the status of the own group relative to that of relevant other groups. The psychic motivation concerns the drive to maximise self-respect, by protecting particular interpretations of world and self, right or wrong, for instance. If we combine the three primary motivations in an integrated micro paradigm, and develop a realistic macro paradigm in terms of a historically evolving whole of open subsystems, the analysis of economy and society will be very different from what students are taught at the moment. economics becomes more scientific, and results in better understanding, followed by meaningful and effective action.
With respect to an understanding of the institutional framework of economies, the necessary revolution in economics would lead to a more sophisticated analysis. Then institutions should channel three types of motivation, in such a way that resources are allocated efficiently. Economic, psychic and social goals should be achieved within acceptable restrictions. Progress also means that people become increasingly rational and positive-social. When we interpret institutions as control mechanisms, we can distinguish personal control, social control, economic control and political control. Economies and societies need all these mechanisms to maintain an acceptable degree of reasonability. If persons, especially those who have the power to take important decisions, are out of control – they are irrational – social control might lead to necessary corrections. If personal and social control mechanisms do not function well, economic control mechanisms might work and correct the mistakes, which are made. The problem, however, is that lack of personal and social control might hamper economic control mechanisms. Too much credit to spenders and a fatal expansionary monetary policy is the result. Moreover, if irrational subcultures, in which personal and social control mechanisms are out of order, dominate governance and control agencies, political control turn out to be very ineffective. It seems that the economic crisis is caused by a psychological and cultural trend in our permissive society, in which the various mechanisms of control appear increasingly dysfunctional. It has made the various subsystems more fragile, which means that small negative events, can have far-reaching consequences.
Economic Instabilities in Post-War Europe
After WW II we experienced a long period of stable economic growth. During the sixties left-orientated politicians and macro-sociologists became overoptimistic about the possibility of building a huge welfare state alongside a large market sector. During the seventies we discovered that these expectations were irrational. During the eighties, however, classical-liberal politicians and neoclassical economists became overoptimistic about the possibility of a free-market economy, without any control mechanism. Competition would lead to the survival of economic and rational persons and organisations. Governments were supposed to have the possibility to maintain competition on an acceptable level. Economic sociologists warned for the influence of powerful firms on the government agencies, which should maintain competitiveness. But their discipline have never become part of the obligatory educational programmes of economists. Psychological (behavioural) economists warned for irrational action of persons and organisations. But their contributions have not reached the economic textbooks about markets and market economies. The long period of over-optimism – from the eighties until the financial crisis 2008 – coincide with a strong classical liberal focus on individual freedom. It has led to a dismantling of control mechanisms. The financial world lobbied successfully for deregulation. Leading persons in the business sector became more narcistic and began to take huge risks with respect to mergers and acquisitions, for instance. Subcultures grew, in which persons became increasingly reluctant to be critical towards colleagues – based on a fear to lose their effectiveness, so to speak. Economic control mechanisms became increasingly ineffective. In earlier times many primary banks were socially responsible organisations, serving the interest of their clients. But in the liberal era they tried to maximise their profits by making intransparant products. They lobbied successfully for a relaxed monetary policy – the responsibility of the so-called independent central bank. It made possible for many banks and other organisations, to finance real estate and financial assets by means of bank credit.
Towards a more Scientific and Pluralistic Economics
When we look at the educational programmes we see that economic science is not presented as a rich science with a long tradition of competition and cooperation between different paradigms. The scientific character has eroded, and empirical research without a realistic paradigm and analysis dominates the scene. Economics students should – straight from the beginning – being confronted with a number of essentials, such as an explicit formulation of the neoclassical paradigm, including a careful definition of concepts such as economic, psychic and social (1), neoclassical analysis as the modelling of only one aspect of human behaviour (2), real life economic phenomena result from multi-motivated action(3), serious attention to heterodox economics, and psychology and sociology as far as relevant for economists (4), and a first introduction into philosophy of science – also in a pluralistic way (5). Only in this way it might be possible to reduce prejudice and the continuing rivalry between different schools of thought. To prevent such cognitive closures as we face now might be an important contribution to reduce the severity of the next crisis.
Dr. Piet Keizer
Associate Professor Economic Methodology
Utrecht University School of Economics