Economics: the top-10 mistakes

Jan 20, 2023
Money climate

Richard Barnes laments the wilful blindness of many elites who go snow skiing while turning a blind eye to the causes of the high country’s dying landscape. Barnes says he mostly agrees with author Jeff Sparrow that the current economic system is to blame. Let me count the ways.

This list of the top-10 errors of mainstream (neoclassical) economics will be controversial because there are way more than 10. But here goes.

  1. It assumes economies can grow forever, either by limitless substitution of materials, or substituting human-made capital for natural capital, or through the agency of limitless human imagination, or through some as-yet unknown mechanism. This amounts to blind faith and has resulted in one of the most dangerous experiments humans have ever devised: ignoring what ecological economists call overshoot. This lack of caution means mainstream economics is radical rather than conservative. Heterodox economists, in the tradition of the late Herman Daly, acknowledge natural limits and pursue quality rather than quantity.
  1. Following from the above, it assumes the natural environment is an ‘externality’ and therefore largely irrelevant to the economic process which focuses on value exchanges between households and firms (of money and labour). In fact the earth’s life-support systems are central to the economic process as there can be no economy without them remaining intact. Mainstream economists are ecology-blind.
  1. It largely ignores the role of energy in the economic process. Energy is the master resource without which nothing can happen. Available energy on an ongoing basis limits the economic process since GDP and energy use are highly correlated. Cheap fossil fuels – and a high energy return on energy invested (ERoEI) – have enabled the extraordinary growth in economies and populations, but that era is rapidly drawing to a close. Future energy availability is highly uncertain, not least because of materials and time constraints, but also lower ERoEI.
  1. It ignores system dynamics, pioneered by Jay Forrester at MIT university from the 1950s and used by the Club of Rome’s Limits to Growth (1972) team. System dynamics allows researchers to model complex feedback loops and time lags in complex systems, rather than using simplistic formulas.
  1. It assumes that the money system grew out of a barter system when no such widespread barter system has been discovered by anthropologists (see for instance David Graeber’s Debt: the first 5,000 years, 2011). Yet they do not correct their assumption. This false barter-money-credit story has important implications for understanding money creation in modern economies and limits to government financing and spending.
  1. Following from the above, it assumes a ‘loanable funds’ model where private banks have limited funds (deposits) to lend and there can be ‘crowding out’ of private borrowers if the government also seeks to borrow this limited supply of funds. In fact private banks create new money (credit money) when they lend rather than lending deposits so they can always lend to any credit-worthy borrower. Central governments with money sovereignty have no need to borrow, but create their own new money when they spend. The difference is that only central governments can create reserves (high-powered money).
  1. It assumes there is a natural rate of unemployment (so-called full employment) that is consistent with price stability: this unemployment rate can vary but might fluctuate from, say, 3% to 8% depending on conditions. If the government tries to lower this natural rate, inflation will result. Too bad if you are one of the ‘naturally’ unemployed. You should try harder and get some training in a game of musical chairs – let some other slob take your place in the unemployment line. In fact the unemployment (and underemployment) rate is a policy choice of the central government and true full employment (1 or 2% unemployment and zero underemployment) is available via a government job guarantee.
  1. It tends to assume some form of Homo economicus, where individuals are ruthless rational actors intent on selfish ends without much care for their fellows, let alone other sentient creatures in the natural world. These rational actors have almost perfect predictive power of future trends in inflation, interest rates, and a host of other variables that, strangely, confound the ‘best’ economic minds. Professional psychologists are not consulted.
  1. It uses these micro foundations to create its macroeconomics. This means it extrapolates from the individual to the many through multiplication without much adjustment for group effects, such as labour unions, political ideologies, cultural variation, the class struggle, and so on. Hence we get Margaret Thatcher’s infamous saying that there is no such thing as society.
  1. It assumes that raising the central bank key interest rate is the best way to lower inflation regardless of the cause of the inflation, as demonstrated in recent months around much of the world. Lenders make a killing and borrowers pay the price. The central bank in Japan has shown in recent years that this thinking is faulty.

Alas we have left out many questionable assumptions, including IS-LM models and Dynamic Stochastic General Equilibrium models that are based around the concept that the economy naturally wants to find some kind of equilibrium, as if governed by natural, scientific laws. Yet ‘the economy’ is a human construct largely devoid of natural laws, save for the laws of thermodynamics that govern the transformation of matter and energy.

These and other errors explain why humanity is in a hot mess, and why only a new economics can save us. See James Galbraith and Steve Keen for further reading.

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