I see, said the blind man: Modern economists understand the world about as well as scientists in the Middle Ages, says Paul Ormerod

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The Independent Online
THE WORLD economy is in crisis. Unemployment in western Europe rises towards the 20 million mark. Vast tracts of the former Soviet empire are on the brink of economic collapse. Japanese companies, faced by the deepest recession since the war, are on the verge of breaking the deep-seated social convention of employment for life.

Orthodox economists, however, are powerless to assist. Economics dominates political debate as never before. The discipline has developed enormously over the past decade, particularly in its mathematical sophistication, yet its understanding of the world is similar to that of the physical sciences in the Middle Ages. Forecasters failed to predict the Japanese recession, the shape of the American recovery, the depth of the German economy's collapse and the turmoil in the European exchange rate mechanism.

Teams of economists have descended on the former Soviet Union, proclaiming not just the virtues, but the absolute necessity of moving to a free-market system as rapidly as possible. Despite governments in the former Soviet bloc doing everything they are told, the economic situation worsens.

Monetarists and Keynesians still argue about how the economy as a whole operates - for example, about the long-term impact of increases in government expenditure. But such tiffs merely conceal a large body of shared beliefs. The old joke that 12 economists in a room could be guaranteed to hold 12 different opinions, and 13 if one of them were Keynes, is becoming less and less true. An intellectual orthodoxy has emerged, based on an idealised, mechanistic view of the world.

Standard textbooks for economics degrees increasingly resemble engineering texts. The subject is not taught as a way of learning about how the world might operate, but as a set of discovered truths as to how the world does operate. But engineering textbooks contain many statements that are known to be true: when formulae for building bridges are applied in practice, bridges generally remain upright. The same does not apply in economics.

Government Treasury or finance departments, central banks and large commercial companies all use what are called 'macro-economic models'. A model may comprise hundreds of equations, each purporting to represent some aspect of economic behaviour, and each connected to other equations in the system. It is supposed to show how a particular government policy will affect the economy as a whole, including factors such as growth of national output, unemployment, interest rates and inflation. It should operate, in other words, rather like a railway signalbox: pull one set of levers and the train goes in one direction, pull another set and it goes in another.

Take, however, the example of VAT. In the summer of 1993, the six leading macro-economic models in Britain were used to assess what would happen if VAT were reduced by one percentage point. All six models agreed on what seems logical: that, initially, average prices would fall. A couple of models thought that average prices would fall at once by 0.6 per cent, another that they would fall by only 0.1 per cent. Even bigger disagreements arose when the models tried to look several years ahead. After four years, two of the models continue to say that prices would fall, and by amounts greater than the initial impact. One model, however, said that by then, prices would not have altered at all. And the other three answered that a reduction in VAT now would lead to higher prices in four years' time.

So a finance minister trying to decide whether he should change VAT, or a managing director trying to understand the consequences for his or her business, would be given quite different answers depending on which model was selected to tackle the question.

Economists cannot even answer quite simple questions about themselves - such as why they are paid so much. In his book Liar's Poker, Michael Lewis, formerly a successful trader on the world capital markets, recalls that his colleagues on a Wall Street training programme were asked precisely this question. A person who had just taken an MBA from the University of Chicago explained: 'It's supply and demand. My sister teaches kids with learning disabilities, and earns much less than I do. If nobody else wanted to teach, she'd make more money.'

The belief that supply and demand determine the price of a commodity - whether it is bananas or people - is fundamental to economics. The higher the demand relative to supply, the higher the price. But, as all the Wall Street trainees were well aware, there had been intense competition to secure places on their programme. It was patently untrue that more people, relative to the places available, wanted to teach children. More than 6,000 people, most of them from economics courses at large American universities, had applied for just 127 places on the Salomon Brothers' training programme. Yet as Lewis remarks: 'Pay cheques at Salomon Brothers spiralled higher in spite of the willingness of others who would do the same job for less.'

To the detached observer, noting the contrast between the actual behaviour of the world and the confidence of orthodox economists to understand and predict it, a number of analogies spring to mind. But the one that is uppermost, and that lingers persistently, is the story of the emperor's new clothes. Or, as people during my North of England childhood used to say, 'there's none so blind as them as can't see'.

It was not always so. The great classical economists, writing in the late 18th and early 19th centuries, tried to understand the dramatic impact on the economy and on society of the Industrial Revolution, using theoretical models for the first time. But they did so with an analysis very firmly rooted in reality. Their overriding concern was to understand the world about them. Further, scholars from a wide range of disciplines were able to contribute. Jeremy Bentham and the Mills, better known as philosophers and political theorists, and the historian Carlyle, for example, were all involved in debates. Economics was not the exclusive preserve of professional economists.

Adam Smith is now seen as the intellectual inspiration of the New Right. The drive to privatise nationalised industries and state functions, and to release free-

market forces, is carried out with fervent invocations of Smith's name. His main economic work, The Wealth of Nations, is intended to demonstrate how the pursuit of enlightened self-interest by individuals and companies can benefit society as a whole. But it is not a piece of abstract theorising. In the best scientific tradition, Smith observed the world and then tried to explain it.

The Wealth of Nations is by no means a pure eulogy for free market forces. Margaret Thatcher's famous declaration that 'there is no such thing as society' would have been completely alien to Smith. In his other great work, The Theory of Moral Sentiments, he argued that there were propensities in human nature which incline us toward society, such as fellow-

feeling and the desire for the approval of others. For Smith, these sentiments exercised a crucial influence on the self-control and restraint of individuals in their behaviour towards others. Such self- control was not, in his view, dependent upon self-seeking calculations - that life would be intolerable if everyone pursued fraud, pillage and murder - but was an integral part of human nature.

The moral climate in which the economy and society function is also an important theme of The Wealth of Nations. The division of labour, though it brought enormous material benefits, rendered many individuals 'not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble or tender sentiment, and consequently of forming any just judgement concerning many even of the ordinary duties of private life'. Smith argued that the state's duty was to ensure that every citizen could exercise intellectual and social 'virtue'.

Today, Smith's followers remember his economics, based on individual self-interest, but not his moral framework. The orthodoxy of modern economics views the economy as something which can be analysed in isolation. It positively extols esoteric irrelevance and gives low esteem to applied work which tests its theories. In other disciplines, a theoretical model is repeatedly tested. The more it is applied successfully, the greater the confidence in the theory and the greater respect in which it is held. And the truly great theoretical thinkers - Archimedes and Isaac Newton, for example - allowed such mundane events as lying in a bath or sitting under an apple tree to inform the development of their theories. Newton's theory of gravity is successful precisely because it can explain such a wide range of events.

In contrast, modern theoretical economists bring to mind Shadwell's 1676 Restoration comedy, The Virtuoso. The Virtuoso is an eminent theorist about anything that moves. And he is held to be the greatest swimmer in the world. But he never actually swims in water. He just lies on a table and follows the movements of a frog, dangled on a string in front of him. Economists are worse: at least the Virtuoso observed the frog - economists, for the most part, observe no reality whatever.

Extracted from the author's 'The Death of Economics', published by Faber & Faber on 20 March, pounds 14.99.