‘Why did nobody notice it?’ is the question Queen Elizabeth II famously asked Economics Professors about the credit crisis which led to the 2008 Recession. It was obvious to many people that the practice of extending sub-prime loans to poor households in the USA was getting out of control. The fact that banks were leveraging these loans to acquire more debt should have alerted regulators to the danger of a run on the banks. Yet nothing was done until it was almost too late. This failure to notice that credit was over-extended, raise any alarm, let alone to act, is the ultimate condemnation of economics as an academic discipline.
It went wrong in the nineteenth century when it was shown mathematically that if firstly, there is full and fair competition, secondly buyers have access to the full information on available purchase options, and thirdly buyers always choose the cheapest purchase that satisfies their requirements, then it is possible to reach a state of equilibrium in which costs and prices are minimised. From then on, they assumed that purchase decisions were made in this way and that the proof explained the undoubted success of the market mechanism. This encouraged economists to believe that economics is a mathematical discipline. That, as in science, there are laws that relate all the economic variables. In essence that the economy is a giant clockwork machine in which once the inputs are known the results can be predicted.
The reality is that humans don’t make rational decisions based solely on price; for instance brands play a big role. This is because people never truly know the quality of goods they are buying, hence a supplier’s reputation is a critical factor in purchase decisions.
Also, there is never full and fair competition. Companies strive to establish unique selling points for which they can extract a price premium. This is crucial. If the lowest price seller always won out, there would be little profit remaining for future investment. Full competition is also impossible because it takes time and money to establish a company’s reputation. Hence it is difficult for firms to freely enter or exit a market and as a result a small number of firms often dominate a market sector.
Stability is one thing markets never achieve. There is always dynamism. Raw materials can be in short supply. Transport links break down. New products are brought to market. Companies fail and competitors merge. The economy is the result of a complicated interaction between people, companies and states. There is no automatic link between demand and supply, prices and volumes, investment and interest rates, unemployment and wages. All links are nuanced, complicated and dynamically integrated with external factors. The idea that scientific laws exist linking these variables is pure fantasy. Yet these ‘laws’ continue to be taught in degree courses. Economists still act as if they are true. The discipline needs to be reset as what it really is a ‘social’ not a ‘real’ science.
For more background read https://www.theguardian.com/commentisfree/2019/aug/03/economics-global-economy-climate-crisis
