Neo-classical back with a vengeance

Unfortunately Keynes fell out of favour in the 1970s. This had more to do with the economic consequences of mistakes made by politicians than with any fundamental problems with his policy prescriptions. Non-Keynesians saw their chance, and a new and more aggressive form of neo-classical economics took centre stage, this time dressed in the political clothes of neo-liberalism. Not only would its devotees bury their heads in the sand over the issue of private debt, but they would also reassert their belief in Say’s Law. What became known as ‘supply side’ policies quickly became the only tool of economic management — with two consequences. Firstly, the problem of insufficient demand was ignored, introducing the kind of ‘structural’ unemployment which has become a permanent feature in all societies. Secondly, levels of private debt grew dramatically, making inevitable the greatest financial collapse since 1929.

The current financial crisis was sparked by the American sub-prime mortgage explosion and exacerbated by the lack of transparency in financial markets. But for Steve Keen it is the level of private debt in the economy which condemns us to years of reduced demand and high unemployment as individuals and firms struggle to pay back what they owe.

Instead of another Great Depression, this time around Keen predicts a less severe but much more drawn out Great Recession, which could last decades. As he says, “an economic theory that ignores the role of credit and debt in a market economy cannot possibly make sense of the complex, debt-based monetary economy in which we live.” He concludes that “neo-classical economists’ deliberate failure to monitor the dynamics of private debt was the reason why they did not see the crisis coming.”

Classical economics failed to account for technological advances and incorrectly assumed that supply creates its own demand. Keynesian theory fell down in its neglect of natural resources and its failure fully to address the debt issue. But both have much to offer as we try to build a sound economic basis on which to resuscitate our ailing civilization. Neo-classical economics, on the other hand, is deficient in almost every respect. Today’s dominant economic model has nothing to offer — an alarming thought given that eighty-five per cent of economists working today are fully signed-up members of the neo-classical school. The remainder make up a lively mixture of other schools including New Keynesian, Marxian, Evolutionary, Institutional and Austrian. Wikipedia lists another forty variations, most of which have more merit and are more grounded in reality than the currently dominant neo-classical model. There are plenty of alternatives out there.

Academic economists, impressed by advances in scientific method, have turned economics into a value-free science. The world beyond academia is always keen to embrace assertions of certainty, so it has welcomed this ‘modern’ approach to economics without question. But the pursuit of certainty is often the enemy of truth. In his book Animate Earth, Dr Stephan Harding explains that “Descartes taught that any entity could be understood by studying how its component parts worked in isolation — this was his famous reductionist methodology. His belief in mechanistic reductionism was so extreme that he urged his students to ignore the screams of vivisected animals, for such sounds were, after all, nothing more than the creakings and gratings of a complicated machine”. Today this would be unthinkable, except in the practice of economics where a silo mentality delivers models that ignore the suffering of millions, while economists refuse to think beyond their unhelpfully narrow remit.

It’s time to transcend the desire for baseless certainty and swap this imaginary-world economics for a discipline that understands how things work in the real world. This is especially important in respect of the impact of differences in economic and political power in a world of unprecedented population growth. Not so long ago, troublesome tribes or surplus people could be dispatched to faraway places. This is no longer an option. Instead we need an approach that embraces the belief that all people’s lives are of equal worth, and understands that resource and population issues can be solved by reconfiguring the economy and through the judicious use of new technologies.

Many people today are acutely aware of the possibility of the collapse of our civilization and are desperate to see it averted. Many also support the creation of a more just and inclusive global society. Such thinking was the preserve of marginal thinkers even during Keynes’ time. Perhaps we need to take our lead from the people who started it all, and remember that Adam Smith thought of himself not as an economist, but as a moral philosopher.

Excerpt from Four Horsemen: The Survival Manual.

Originally published at