15 years later | World Finance

I wrote my first Econoclast column for this magazine 15 years ago, in the spring of 2010. The economy at the time was recovering from the deepest recession since the 1930s. As I argued in the column, the recession had been blamed on many things, but the real reasons could be traced back to a set of economic myths which have been cultivated and maintained over the last century and a half, ever since economics was invented. These myths include the ideas that markets are stable, self-regulating and efficient; the idea of rational economic man; and even the idea that the economy can be described in terms of mathematical laws.

Today of course things have moved on. For one thing, I see that the number one song in March 2010 (by Kesha) was called ‘Tik Tok’ but it had nothing to do with an app! In the world of economics, though, we still seem to be stuck in the past. Nobel laureate economist Paul Krugman wrote in 2018 that “Neither the financial crisis nor the Great Recession that followed required a rethinking of basic ideas” and most economists seem to agree.

For an update from the front line, I contacted Cahal Moran, who was a co-founder of the Post-Crash Economics Society, a student group set up in 2012. He now runs the YouTube channel Unlearning Economics and is a Visiting Fellow at the London School of Economics. In his opinion, “equilibrium approaches still dominate modelling” although organisations such as the Bank of England “supplement their approaches with more heterodox or historical analysis.”

And while there is more interest today in areas such as behavioural economics or data-driven approaches, an economics education – the famous Econ 101 – is still biased towards the core concepts, or economyths as I called them, of rationality, equilibrium and efficiency. Perhaps though we shouldn’t expect things to change so quickly.

After all, while the field of neoclassical economics has only been around since the late 19th century, the underlying myths go back much further.

Finding the level
The focus of that first 2010 column was the myth of equilibrium, as acted out by ye olde ‘law of supply and demand.’ This imagines markets as consisting of suppliers on one side, and consumers on the other. The propensity of the former to supply the good is represented as a function of price by a line going up, so the dearer the good, the more is produced. The propensity of the consumer to buy the good is represented by a line going down.

The point where these two curves intersect represents the optimal price which gives a stable equilibrium between buyer and seller, and in theory optimises the utility of both buyer and seller. Or, as the neoclassical economist William Stanley Jevons put it in 1871, both parties then “rest in satisfaction and equilibrium, and the degrees of utility have come to their level, as it were.”

The picture is therefore of an economy in a state of happy equilibrium where everything finds its proper level. It was later formalised by Eugene Fama’s efficient market hypothesis – variously described as ‘the best established fact in all social sciences’ and ‘probably the best-tested proposition in all the social sciences’ – which claimed that prices effectively adjust instantaneously to new information.

This view of the markets as stable and optimal would be familiar to any first-year student studying economics in 2010 or equally 2025. But the idea that everything finds its level would have been equally acceptable two millennia earlier.

According to Aristotle, whose word was considered sacrosanct well into the Middle Ages, the universe was made up of the four elements earth, water, air and fire, plus the fifth element, ether, which was reserved for the heavens. Each element had its place, so earth would tend to sink and air would rise.

In a vacuum, each element would find its level instantaneously, which was why ‘nature abhors a vacuum’ (Medieval philosopher: ‘probably the best established fact in natural philosophy’). In neoclassical economics, the perfect vacuum exists, and it is the market. Prices always find their proper level, and dynamics don’t really matter, although they are sometimes included as a kind of friction to slow adjustment, just as in Aristotelian physics.

New information
Now, one would think that an event like the 2007–08 financial crisis would be enough information to shake economics out of its own Aristotelian state of happy equilibrium. As I pointed out in 2010, other fields – such as computational biology – don’t try to model a complex, organic, dynamic, living system by using an equilibrium model. In biology, if a system is at equilibrium, it is dead.

And speaking as an applied mathematician who has worked in diverse areas including engineering, weather forecasting, and drug development, I can report that the approach of modelling such a system as the intersection of two lines, as in the law of supply and demand, is …unusual.

But if there is one other thing that we can learn from the endurance of Aristotelian philosophy, it is that once ideas become established, they can be very hard to get rid of. Let’s just hope this equilibrium doesn’t last another 15 years, let alone 2,000.