Ongoing economic problems promise that 2009 will be a tense year for the global economy, and the lives of billions of people will depend on how the year’s events play out.
It thus will be a crucial period for economists, who, by definition, make their living trying to explain such events. The question is whether 2009 will spark a revolution in economic thought.
The ongoing financial debacle is an anomaly to economists. Accepted theory does not pay much attention to bubbles, panics and financial meltdowns. Scan dozens of introductory econ texts and it is hard to find one that devotes more than two pages to the subject. What does appear is likely to be historical, in a box separate from the core material, a section on central banking describing how the Federal Reserve failed in 1929-1933. The word “equilibrium” appears hundreds of times for each time “instability” is used.
Indeed, some theorists, both august Nobel Prize winners and young hotshots, implicitly assume that with rational participants in efficient markets, panics and crashes don’t happen.
The current situation is thus an anomaly in how mainstream economists view the world. The question is whether it is one in the sense that philosopher Thomas Kuhn used in his 1962 book, “The Structure of Scientific Revolutions.”
Kuhn argued that scientific understanding is not generated in a steady process. Instead, there are episodic leaps ahead as someone poses a substantially novel theory that resolves questions that prior theories could not. Kuhn called these “scientific revolutions.” An example might be Copernicus’ observation that the planets revolve around the sun rather than Ptolemy’s assumption that the earth was the center of the universe. Watson and Crick’s discovery of the double-helix structure of DNA was another.
In physics, Newton’s exposition of the laws of motion and gravity was a revolution. These laws explained many natural phenomena that were not understood earlier. With Newton’s insights, physics progressed rapidly in the 18th and 19th centuries.
But in these periods of what Kuhn calls “normal science,” scholars work forward and out from an initial revolutionary breakthrough. They, in turn, discover that the new theory fails to explain everything. There are anomalies that accumulate until the mass of them prove serious gaps in accepted core theories.
These are resolved in another scientific revolution, just as Einstein’s insights on relativity resolved many anomalies that had appeared in two centuries of Newtonian physics.
The fact that Newton’s ideas failed to explain everything did not mean they were useless. You can build a mile-long suspension bridge or send a human to the moon using Newtonian physics. A revolution amplifies and generalizes earlier knowledge, rather than replacing it.
Adam Smith’s 1776 insight that economies often function better without government control upset the prevailing mercantilist doctrine that centralized control was key to greater national wealth.
In 1936, John Maynard Keynes argued that while Smith was correct much of the time, there were other crucial times, such as the Great Depression, in which minimal government left society worse off. To many, this was a scientific revolution.
Revolutions don’t convince everyone. There still is debate within biology about whether a disease-transmitting particle called a “prion” actually exists. And there always have been some within economics who rejected Keynes.
Applying Keynes’ theories through real-world policies certainly did not solve all economic problems. Indeed, Keynesian policies as practiced in the industrialized countries produced the “stagflation” of the 1970s.
One group of Keynes critics, now known as “Rational Expectations” or “New Classical” economists, laid out in exquisite mathematical models why Keynesian policies were doomed and counterproductive. Their enthusiasts deem this a third revolution.
But just as there are few atheists in foxholes, there are few anti-Keynesians in the middle of a full-blown financial panic. A philosophically consistent cadre of free-market fundamentalists still opposes any government action right now, but they are few in number.
Beyond this short-term disagreement, however, economics faces a crisis. The financial debacle of 2007-2009 represents a fundamental failure of the discipline, perhaps the greatest failure ever, including the Great Depression. Bubbles and panics have become increasingly frequent in the last 30 years and harm billions of people.
Yet we do not have mainstream economic theory that, at its core, convincingly explains why bubbles and panics occur. This is an anomaly that can only be resolved with a scientific revolution that inevitably will occur. It may not happen in time to make any difference in our current travail, however.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.