Economics caught in a time warp
Innovation and what it could bring about is being studiously ignored
Mainstream economics hasn’t done well in recent years, failing to predict major shifts
Mainstream economics hasn’t done well in recent years, failing to predict major shifts that have caused significant damage to society. This breakdown sheds light on a more general question: Why have certain fields and activities been unable to benefit sufficiently from innovation?
By analysing household, corporate and government behaviours, economics aims to identify and predict opportunities to enhance social welfare. It highlights the range of inevitable trade-offs, as well as the complexities of group interactions within countries and across borders.
Yet these objectives and enormous promise have not been matched by sufficient progress on the ground.
The field is sometimes called the “dismissal science” (a reference to the quip: If you tell an economist what you need, he or she will tell you how to do without it). And many frustrated insiders have criticised what they see as its domination by “high priests” who are too decoupled from everyday realities, opportunities and problems.
Meanwhile, the reputation of mainstream economists has taken a beating in the last 10 years. The bulk of them failed to predict the 2008 crisis that almost tipped the global economy into a multi-year depression. They also didn’t foresee the aftermath.
Excessive mean-reversion mindset
Most made the mistake of treating the crisis as a cyclical shock and forecast a V-type growth snapback. They were prisoners of an excessive mean-reversion mindset: They acknowledged that growth was taking a huge hit due to severe financial dislocations, but they forecast that economic activity would bounce back strongly and inclusively.
Instead, the experience of advanced economies more closely resembled an ‘L’, in which they got stuck in a “new normal” characterised by a prolonged period of low and insufficiently inclusive growth.
The shortfalls fuelled the politics of anger, along with a heightened mistrust of the establishment, institutions and expert opinion. This, in turn, has diminished the credibility of economics. Meanwhile, many students have complained to me that the mainstream economics they are taught is divorced from real-world relevance. It is only a matter of time before the funding for economic research risks becoming a casualty.
Yet this huge failure has not been the result of ignorance about the limitations of the discipline, nor is it the consequence of a lack of new, disruptive ideas.
Here are some reasons for the erosion of the insights and predictive powers of mainstream economics:
The proliferation of oversimplifying assumptions, including those that sideline many elements of real-world behaviours and interactions, in an effort to make models seem more “scientific”. This leads to overreliance on excessively abstract estimation techniques and approaches.
Insufficient consideration of financial linkages and little allowance, if any, for the possibility that financial dislocations can disrupt the economy.
■ Poor and grudging adoption of important insights from behavioural science, along with excessive hesitation to develop multidisciplinary approaches. An oversimplification of uncertainty and the ways it influences economic interactions.
Technological changes
Overemphasis of equilibrium conditions and mean reversion, a trend that reduces the understanding of transitions, structural changes and tipping points. These shortcomings are amplified by technological changes that alter not only what we do but also how we do it, including accelerating advances in artificial intelligence, big data, machine learning and mobility.
Ironically, economics has not lacked for intellectual advances that can address many of these deficiencies. There has been exciting progress in behavioural economics and finance, as well as in the understanding of the role of market technicals, sudden stops, tipping points, game theory and political influences. Still, too many of the exciting and promising breakthroughs have failed to sufficiently penetrate the mainstream establishment of economics.
The answer to renewing the relevance of economics is creating and nourishing more open mindsets, dealing more explicitly with both conscious and unconscious biases, and creating more of a disruption culture within the field. It is about exposing more “high priests” to the realities of the global economy and financial markets.
It is also about modernising the institutional framework. Too few have embraced the opportunities of multidisciplinary approaches. Many of these problems can be traced back to a basic economic distinction: the difference between invention and innovation. Invention is defined as the discovery of a new exciting idea, product or approach. Innovation means applying that idea through changes in operating models and mindsets.
Too many areas today contain the invention but not the innovation. In too many cases, the flaw has less to do with the need to come up with a brilliant idea, and more a matter of embracing it and adapting accordingly. That requires being curious, openminded, willing to listen and open to experimentation; creating safe zones for candid discussions; and learning from failure.
Economics has persistently failed to address this fundamental problem. The gaps between inventions and innovations have led to too many foregone welfare-enhancing opportunities for individuals, companies, governments and society.