As economic crises persist around the world, mainstream economic theory has been unable to provide the solutions that will get us back on track, a situation reminiscent of the Great Depression. Paul Krugman and Richard Layard’s recent Manifesto for Economic Sense offers a diagnosis. “The reason is simple,” they write. “We are relying on the same ideas that governed policy in the 1930s.”
The manifesto has garnered support from leading economists around the world, providing the latest manifestation of the obvious problem – that economic theory is not in great shape and is not providing the solutions our societies need to grapple with persistent economic dysfunction. Just as in the 1930s, the market economy is not demonstrating a natural tendency toward full employment when left unattended. Rather, like in the 1930s, developed economies show signs of being in a slump and a low-level liquidity trap, as was described by Keynes and explored in depth in the work of Axel Leijonhufvud.
INET welcomes the invitation this manifesto provides to reopen the debates at the core of economic theory that have too long been neglected. For example, economists who provide insight into radical uncertainty, especially in financial markets, like Hayek, Knight, Keynes, Kindlberger, Minsky, and Soros, have been pushed aside in favor of economic theories that presuppose, but do not prove, equilibrium and stable expectations.
The disastrous consequences of these fragile notions are now abundantly clear, when, for example, they provide false confidence to private-sector actors and government regulators in the financial industry, helping to create a situation where too much risk and too little cushion in the financial system leads to a worldwide economic meltdown.
Likewise, economic theory’s assumption that inequality does not matter has proven disastrous for people and societies around the world. The false belief that “a rising tide lifts all boats” (a bad metaphor given that water naturally tends to rise in a way that is evenly distributed while income does not) no longer makes sense given the vast inequalities that exist even in the world’s wealthiest countries and the political and economic instability this gap has caused.
It is long past time to reopen these debates, and to explore related issues like the role of the state in the economy, climate change, and other collective-action challenges that require some measure of state participation.
All of these issues, regardless of the economics profession’s past religious convictions, should be fair game. The Manifesto for Economic Sense provides an opportunity to engage in these important debates with renewed vigor. This is a very healthy development.
After all, economics and economists are supposed to work in the service of humanity. And only if we begin to address these issues that economic theory has ignored can we hope to avoid repeating the mistakes of the past, with all the damage they caused.