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Crisis forces ‘dismal science’ to get real

Teachers argue textbooks are divorced from reality, inconsistent, dull and dangerous

  • Reuters
  • Published: 00:00 July 7, 2012
  • Gulf News

Students walk past Emilio Isgro’s artwork
  • Image Credit: Reuters
  • Students walk past Emilio Isgro’s artwork “Cancellazione del debito pubblico” which hangs on the wall in the lobby of Bocconi University in Milan.

London: As economics teachers struggle to make sense of a post-crisis world, they may have an unlikely army of helpers: ants.

In September 2008, the same month that Lehman Brothers collapsed, the Argentinian ants became the unwitting stars of a German television show that set out to illustrate collective efficiency. To the frustration of the show’s producers, the insects ended up showing how easily rational expectations can go awry.

Students need fewer economic models and more methods to understand the uncertainty

Giovanni Valotti, professor of public management

The ants — Linepithema humile — had a choice between a long route and a short one to get to a pile of food. In theory, their chemical communication and millions of years of evolution should have led them to work out the short route.

They chose the long one, and most kept using it even though some had found the shorter path. “The Germans were furious,” said economics professor Alan Kirman, whose neuroscientist friend and colleague Guy Theraulaz ran the experiments in the south of France.

Kirman, professor emeritus at Aix Marseille University and France’s Ecole des Hautes Etudes en Sciences Sociales, has started to use the footage in a talk he gives about modern economic thinking. The insects were far from efficient, he said, but reached their goal in the end.

“I think the economy is a lot like that.”

There lies a hint of the revolution that is building at the heart of academic economics, particularly in Europe.

As the euro zone crisis deepens, economists in France, Germany and Italy have been forced to turn away from classroom theories and look at the real world — from insects to financial markets, from banks to brain scans — to better understand what’s going on. An increasing number of teachers argue that the textbooks, some by experts who didn’t see the crisis coming, are divorced from reality, inconsistent, dull, and, in a crisis that has gripped the globe for more than four years, even dangerous.

“A crisis is a wonderful opportunity in some sense,” said Kirman. “If it weren’t for the fact that millions of people are suffering as a result, what better time to be an economist, because now you can see what’s going wrong with our theory.”

Robot breakdown

To suggest economies were not generally efficient would, until very recently, have been heresy in many classes.

The modern theoretical framework began to emerge in the 1980s by Nobel Prize winner Robert Lucas, the John Dewey Distinguished Service Professor of Economics at the University of Chicago. Lucas said economic models should be something you could put on a computer and run — “a mechanical artificial world populated by interacting robots.” If it wasn’t in the model, it couldn’t happen. The collapse of the financial system, for example.

Others helped build on this idea. New Keynesians took a slightly different tack, including assumptions about market failure but still resting on the idea people behave rationally.

After the turn of the century, Lucas even suggested economists had cracked one of the profession’s biggest questions. “The central problem of depression-prevention has been solved,” he wrote in 2003.

Four years later, Roger Farmer, a professor of economics at the University of California in Los Angeles, was at a dinner at the Bank of England to celebrate the “Great Moderation”, a term coined to describe an era in which some politicians claimed monetary policy had ended boom and bust. “We had entered a new era of economic prosperity,” he recalled in a paper this February.

That night, British building society Northern Rock went under, heralding the start of Europe’s crisis and a global backlash against economists.

Why didn’t they see it coming, the Queen of England asked on a 2008 visit to the London School of Economics. The Economist magazine wrote of a “dark age of macroeconomics”.

Economists began to ask how the profession had been blind to the fact that its theories were leading people down the wrong path — rather like Kirman’s ants.

That debate continues, charged with political thunder. Diane Coyle, a UK-based economic consultant who is compiling a book on how economics teaching needs to change after the crisis, says it can’t be separated from a backlash in Europe against free market liberalism. But whatever their politics, a significant number of economics teachers in both Europe and the United States think it’s time for a new, more pragmatic approach.

Around one in five respondents to a 2010 survey of economics instructors by the St Gallen university in Switzerland said their profession needed a “major reorientation or new paradigm.” Even those who thought the curriculum was more or less fine said they had started paying more attention to financial markets, banks or speculative bubbles, and included real world context.

Last year Coyle organised a conference on teaching post-crisis economics. Topics ranged from high theory to whether economists could expect to find employment.

Most economists graduating today would not be equipped to read the Financial Times, according to British economist John Kay, who argued they have for too long conflated the abstract and the real.

Cherished beliefs

On a wall in the lobby of the Bocconi University in Milan, the script on an artwork plays on a Christian prayer:

“Et Dimitte Nobis Debita Nostra.” (And forgive us our debts)

Established in 1902, Bocconi was the first university in Italy to grant a degree in economics. Prime Minister Mario Monti was rector there from 1989 to 1994 and dozens of top Italian officials and bankers have attended. It is, in most ways, a cathedral to orthodox economic thinking.

That’s now changing.

“All the macroeconomic paradigms have been put in discussion since the 2007 crisis,” said Stefano Gatti, its Director of Bachelor of Economics and Finance.

Bocconi students use a European edition of a leading textbook by Olivier Blanchard, the IMF’s chief economist. Like the other main volume, by Harvard professor Gregory Mankiw, it has been updated to take in the crisis. But an update may not be enough.

Blanchard, who in August 2008 had declared that “the state of macroeconomics is good”, wrote in a 2011 blog that “our most cherished beliefs” had been brought into question by the crisis.

“The paradigm that the market corrects itself, on which all the traditional economists such as Blanchard and Mankiw base their theories, is on the rocks,” said Gatti. “What the traditional theories do not consider is that the financial market must be regulated. A too-liberalised market creates monsters.”

Both Blanchard and Mankiw declined to comment for this article.

Francesco Saita, dean of Bocconi’s Graduate School and professor of financial markets and institutions, said teachers are bringing newspapers and academic papers into class, and Bocconi has invited leading bankers and economists to address students.

“Students need fewer economic models and more methods to understand the uncertainty,” said Giovanni Valotti, professor of public management.

Alessandro Cofano, a third-year economics student, said questions are constantly raised about why the formulae and graphics published in the manuals cannot be found in real life.

 

 

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