Critique of Conventional Economics

{bit.ly/AZcoce} In a previous post on “Economics for the 21st Century“, I explained how the entire framework of conventional economics is broken beyond the possibility of repair. This gives us the opportunity to launch a revolution in the discipline, building it on entirely new foundation. In a sequence of posts, I will now elaborate one-by-one on the five point outline of the talk which were sketched earlier. The first of these is to explain why conventional economics is wrong

Evidence for Failure of Economics: We start by questioning the premise: “IS economics broken?”. The Global Financial Crisis made this obvious to all. The Queen of England went to London School of Economics to ask Why did no one see it coming? The US Congress created a commission to investigate why Economists not only did not warn of the crisis, they actually denied the possibility of a crisis and ridiculed those who gave warnings (see “Building a Science of Economics for the Real World). Quotes Critical of Economics records statements by leading Economists on the failure of economics, such as Krugman’s “The profession as a whole went astray …”. Many economists made a deeper analysis of this failure. See for example Dani Rodrik’s Trouble with Macro, and   Colander et. al.’s The Financial Crisis & the Systematic Failure of Academic Economics. It is not our intention here to survey the massive amounts of evidence against all standard economic theories found in conventional textbooks being taught in universities around the world. More detailed discussions and references are provided via links:  “Empirical evidence against utility theory: A Survey of the Literature” destroys the core theory of consumer behavior, “Understanding the Great Depression” explains why current economic theories based on optimization, equilibrium, and rational expectations, are unable to explain depressions. Hill and Myatt’s The Economics Anti-Textbook systematically debunks all conventional textbook theories.  My post on “An Islamic Approach to Micro” describes a new course which highlights these failures and constructs an alternative theory built on Islamic foundations. NEW: Free online course on A New Approach to Islamic Economics starting on Sunday 5th Feb 2023

Causes for the Failure of Economics: We move on to the important question of “WHY is economics broken?”. How can it be that Ideology masquerading as economic theory is being taught in universities all around the world? A satisfactory answer requires the study of many different dimensions which led to this problem. Corruption of religious leaders, and continuous ruthless and inhumane wars between Catholics and Protestants led a general disenchantment with religion – see ETST 2 Corruption of Catholic Clergy. Europeans started searching for alternatives to religion. This led to the “Emergence of Logical Positivism”, a philosophy which rejects the unseen, and accepts only observables as a sound basis for knowledge. These “Origins of Western Social Sciences” explains why modern economic theory is built around the conception of human beings as robots, without any heart or soul. Taking into account the spiritual dimension of human beings creates radically different foundations for economics; see “Islam’s Gift: An Economy of Spiritual Development.” More specific details of why the methodology of modern economics is seriously mistaken are provided in “Method or Madness” and “How Economic Models Became A Substitute for Reality”. Some fundamental methods for a new methodology can be developed by looking at Polanyi’s Methodology as developed in his classic work on The Great Transformation: the political and economic origins of our times.

Deep Misconceptions about Human Behavior: To understand human behavior, we must start with the question of “What is goal of life?”. This is the most important question for us as individuals, since it governs how should we live, behave – as individuals, families, communities, societies, nations. Western social science attempts to answer all these fundamental questions using REASON alone, without invoking the heart and soul. The rejection of the heart and soul as sources of knowledge occurred due to the trauma of Loss of Faith in the West. Reason cannot provide us with answers to the big questions, such as identity and purpose. For deeper discussion, see “Learn Who You Are!” and “Economic Theory: Purpose of Life”. Loss of higher goals and visions led Albert Camus to state that “Suicide is the only serious philosophical question”. The tragedy of loss of meaning for our existence led nearly every major 19th Century Western Philosopher to a nervous breakdown of some type. In the process of this transformation, which involved the denial of higher goals for life,  “Knowledge” itself was RE-DEFINED. This is signaled by the singular statement “I think, therefore I am” by Descartes, the father of Western philosophy. If we reflect on our own self, our immediately perceived sensations provide a strong evidence for our existence. Descartes, and Western Social Science in general, denies the validity of our experienced reality, and seeks to replace it by reason alone. Denying the validity of our shared experiences, our hearts and and souls, is the reason for the Flawed Foundations of the Social Sciences. In contrast, Islam emphasizes the heart and the spirit of man, and provides us with new foundations for the social sciences, as discussed in “Defining Islamic Economics”.

Flawed Theories about the Purpose of Life: We will briefly discuss some specific defects in modern economic theory which arise from these flawed foundations. To begin with, the denial of God and afterlife has the natural effect of promoting concern with the present life. In economic theory, this concern is crystallized in an axiom which says that all rational human beings have the primary goal of maximizing the pleasure they get from the consumption of goods and services. This axiom is doubly flawed. One flaw is that research shows that long-term happiness comes from social relationships, not from consumption of commodities (see The Coca-Cola Theory of Happiness). Secondly, Islam emphasizes the process by which we obtain wealth, and also regulates our spending. In particular, it prohibits excessive and wasteful consumption. The social harms of conspicuous consumption are recognized even by secular economists (see Chapter 4 of Hill & Myatt Economics Anti-Textbook).

Faulty Methodology: Deeper reasons for the flaws in modern economics as well as the Western social sciences lie in the flawed foundations of the theories of knowledge which developed in the West after the rejection of Christianity – see The Knowledge of Childless Philosophers for a brief introduction. After rejecting religion, the West promoted science as the only source of certain knowledge. This is reflected in the use of the word “science” in social sciences, as opposed to the humanities. Following scientific models, economic theories propose that All individuals in all societies MUST behave according to same mathematical laws, just like the particles of physics. Making all Individual behavior follow the same laws requires ignoring the effects of family, community, culture, and environment. Accordingly, methodological individualism espoused by economic theory treats the community as just a collection of individuals. For an opposing point-of-view, see methodological communitarianism in Polanyi’s Methodology. In addition, the effort to create universal laws, like those of physics, means the economic theories ignore the particular effects of history and geography. Neglect of history and institutions leads to absurd theories, such as the neutrality of money. See The Vital Importance of Understanding International Financial Architecture to understand the crucial role played by World Wars 1 and 2 and the Vietnam war in shaping the nature of money, and the central role of money in an economic system.  

Power/Knowledge Angle: The removal of history and institutions leads to theories which blind economists to the realities of the world around us – see “Method or Madness?” for details. Many economists (see “Quotes Critical of Economics”) have remarked on the stubbornness with which economists hold on to theories flatly contradicted by reality. My post on “Behavioral Versus Neoclassical Economics” shows four predictions of utility theory, all of which are directly contradicted by actual human behavior. This leads to the question of how economists can be so blind to reality? How can sane and rational people believe theories which are so flatly contradicted by evidence? The false philosophical foundations which led to this state of affairs is discussed in “How Economic Models Became Substitutes for Reality”. However, the persistence of false theories, and failure to correct them despite overwhelming evidence to the contrary, requires deeper explanation. Economists refuse to correct false theories because these theories support and justify existing power structures. The economic, political, and social upheavals created by the industrial revolution led to the creation of a small class with large amounts of wealth and power. As noted by many authors, maintenance of power by a small minority requires the willing consent of the vast majority. This consent is manufactured by the spread of false theories which justify the economic system and paint it as just, fair, and efficient. Even though it pretends to be positive, Economic theory is a branch of moral philosophy. One of the key tasks of economics is to justify the highly inequitable distribution of wealth produced by capitalism. This is done via the argument that wages are the marginal product of labor and interest is the marginal product of capital. That is, both factors of production get what they deserve, according to their productivity. There are many ways to counter this argument. A very simple counter comes from noting that this can only hold for a Cobb-Douglass type production function. In a constant proportion production function, both factors jointly produce the output. Thus the entire output is the marginal product of both factors, who cannot both get the full value of the product. For a more detailed discussion of the flaws in the economic theory arguments justifying the exploitation of labor and the wealth of the capitalists, see Chapter 8 of the Hill and Myat Economics Anti-Textbook.

Flaws Resulting from Imitation of Obsolete Physics: Our goal here is not to provide a critique of modern Economic Theory. Rather, we would like to sketch how we can build the foundations for a new kind of economics for the 21^st Century. However, in order to do this, we need to understand the defects, so that we can find suitable replacements. One of these defects is that modern economics is based on concepts borrowed from 19th Century Physics. As Mirowski writes in More Heat Than Light: “the progenitors of neoclassical economic theory boldly copied the reigning physical theories in the 1870s…they copied their models term for term and symbol for symbol, and said so”. The effect of this imitation is the centrality of two principles, Maximization and Equilibrium. Both of these have been abandoned as physics progressed, and both are deeply defective as foundations for economic theory. First, the idea that consumers maximize utility and that firms maximize profits are solidly rejected by overwhelming amounts of empirical evidence. See Karacuka and Zaman for “The Empirical Evidence Against Utility Maximization: A Survey of the Literature” linked in post “Game Theory for Humans with Hearts”. For the stark failure of neoclassical theories of firm behavior, see Chapter 5 of Hill and Myatt Economics Anti-Textbook.   Second, dynamic systems which evolve through time cannot be understood by looking at their equilibria. Rather, as physicists have learnt, it is essential to study the dynamics of disequilibrium, which can be of several different types in relation to the equilibria of the system. A very important consideration in this context is that modern economic theory developed in the pre-computer era and was confined to models which can be solved by paper and pencil. The fanciest and most complex models of economists involve just one agent simply because the computations required for two or more cannot be done manually.