Economists have been derided for failing to foresee major shifts in the financial landscape and missing clues that pointed to a sudden stock market catastrophe. But now, in the early years of the third millennium, more fundamental questions have been raised about the foundations of the subject — these ones too difficult to dismiss.
First is the fact that its key doctrines, laid down first by John Maynard Keynes and then Milton Friedman, were tried to destruction in the 20th century, often with unhappy results.
Second is a more fundamental failing. Since the subject’s very earliest days, economics has more or less relied on the idea that humans act rationally: that they always act in their own self-interest, and that such actions, in a fully functioning market, will make society better off.
However, this does not explain why people frequently take decisions that are ostensibly not in their own interests. It is in no one’s self-interest to send themselves to an early grave, but despite widespread knowledge about the dangers of lung cancer and obesity, people still smoke and eat fatty foods. Similar arguments have been levied against climate change and man-made pollution.
New disciplines such as behavioral economics have revealed that much of the time people take decisions based not on what would be best for them but on so-called heuristics — rules of thumb from their own experience — or by copying others.
A Pick and Mix Approach
In the light of the realization that people don’t always act rationally, regulators are likely to become more paternalistic in the future. There are, for example, already attempts to regulate the mortgage market more stringently so that it is less easy for consumers to make choices against their best long-term interest.
Economics is evolving from a subject that placed an almost limitless amount of faith in the ability of markets to determine outcomes to one that questions whether markets always come up with the preferred outcome. Rather like the modern novel, which picks and chooses from a variety of different styles instead of limiting itself to one discourse, 21st-century economics will pick and choose widely from Keynesianism, monetarism, rational market theory and behavioral economics to come up with a new fusion.