Economists behaving badly?

Saturday 30 October, 12.15pm until 1.15pm, Lecture Theatre 2 Lunchtime Debates

The financial meltdown in late 2008, and the prolonged economic downturn it triggered, pose a challenge to mainstream economics. The prevailing economic and financial models did not anticipate the financial crash, nor its consequences for the real economy. Many now believe economic concepts associated with the free-market Chicago school, such as ‘rational expectations’ and ‘efficient markets’, encouraged policy errors such as the deregulation of financial markets, and have now been exposed as inherently flawed. In response to the perceived failure of economic theory, an increasing number have argued economics needs incorporate insights from other disciplines, such as psychology, sociology and history. This thinking has even been embraced by UK Chancellor George Osborne, who claims, ‘These disciplines are enabling us to develop a new approach to policymaking, based on empirical evidence about how people really behave’.

The Institute for New Economic Thinking, funded by billionaire George Soros, was launched in Cambridge earlier this year, with the aim of breaking out of the narrow constraints of mainstream economics. A common theme among the alternative ideas emerging from the economists behind INET and others is the notion that economics cannot be a true science because market activity is driven by irrational human behaviour. This underlying irrationality means the future is inherently uncertain and cannot be predicted. Moreover, no economic model can fully grasp the complexity of irrational behaviour. According to this view, the ‘rational economic man’ of conventional economic theory is unrealistic. The turn to behavioural economics and other psychological theories is lauded by many as a return to a more well-rounded understanding of human nature. As behavioural ideas have become more influential they are now informing economic policy. They provide a new rationale for state intervention in the economy: as the market is propelled by unpredictable behaviours, it will inevitably go awry, and thus the state needs to be prepared to intervene and restore stability. Financial reform measures in the UK, US and elsewhere seeks to encourage responsible behaviour on the part of both financial sector players and consumers, and to regulate and punish ‘bad’ behaviours.

Is it true that the financial meltdown represents a failure of free-market economics? Does behavioural economics offer a better explanation for the financial crisis? Do behavioural and other non-traditional ideas provide a more humanistic perspective on economic activity? Will regulatory reforms of the financial sector based on controlling behaviour lessen the chances of another financial meltdown?

Listen to session audio:


James Matthews
management consultant; founding member, NY Salon; writer on economics and business

John Kay
visiting professor, London School of Economics; member, INET Advisory Board; author, The Truth about Markets and Obliquity

Dr Linda Yueh
fellow in economics, St Edmund Hall, University of Oxford; adjunct professor of economics, London Business School; economics editor, Bloomberg TV

Rob Lyons
science and technology director, Academy of Ideas; convenor, IoI Economy Forum

Produced by
James Matthews management consultant; founding member, NY Salon; writer on economics and business
Angus Kennedy convenor, The Academy; author, Being Cultured: in defence of discrimination
Recommended readings
Book Review: Nudge by Richard H Thaler and Cass R Sunstein

Nudge is a book that has been heavily commented on in the national press in recent weeks, not least because of the authors’ influence on the Obama administration – but primarily as the book has reputedly been heavily influential on our own Prime Minister’s thinking

ASK Europe, 7 September 2010

Needed: a new economic paradigm

Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis – or at least it should be.

Joseph Stiglitz, Financial Times, 20 August 2010

Obliquity: Why our goals are best achieved indirectly

Obliquity is the principle that complex goals are best achieved indirectly. This book explains why the happiest people aren’t necessarily those who focus on happiness, and how the most successful cities aren’t planned (look at Paris versus Brasilia). And if a company announces shareholder return as its number one goal, perhaps we should beware: the most profit-orientated companies aren’t usually the most profitable.

John Kay, Profile Books, 18 March 2010

We can make you behave

Davos: Our plan is to embed the insights gleaned from behavioural economics throughout government

George Osborne and Richard Thaler, Guardian, 29 January 2010

Prudence, you no longer rule my world

Deirdre McCloskey once thought economics and rationality were the key to understanding society, but the explanatory power of rhetoric has dented her faith in the dismal science

Deirdre McCloskey, Times Higher Education, 15 January 2010

How Did Economists Get It So Wrong?

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy.

Paul Krugman, New York Times, 2 September 2009

Hope, Greed and Fear: The Psychology behind the Financial Crisis

To explain the current economic crisis, the world of finance has a particular lexicon -- including, for example, credit default swaps, mark-to-market and securitized subprime mortgages. Psychologists, on the other hand, might use very different terms: hope, greed and fear.

Knowledge@Wharton, 15 April 2009

Nudge: Improving Decisions About Health, Wealth and Happiness

Every day we make decisions: about the things that we buy or the meals we eat; about the investments we make or our children’s health and education; even the causes that we champion or the planet itself. Unfortunately, we often choose poorly...

Richard H Thaler & Cass R Sunstein, Penguin, 4 March 2009

The Audacity of Data

Barack Obama's surprisingly non-ideological policy shop.

Noam Scheiber, New Republic, 12 March 2008

Session partners

in association with