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Time for a Bad Ideas Bank

The global economic depression plunges economics into a legitimation crisis-not yet noticed by the vast majority of the affected. The current financial crisis involves dogmas that markets function best and correct their own mistakes. Many economists become lost in mathematical models.

By Thomas Fricke

[This article published in: Financial Times of Germany 2/6/2009 is translated from the German on the World Wide Web,  http://www.ftd.de. Thomas Fricke is the chief economist of the FTD. For more, see www.ftd.de/wirtschaftwunder..]

The global economic disaster plunges economics into a legitimation crisis - not yet noticed by the vast majority of the affected. The branch needs a very new generation of economists.

What extraordinary times when professors swagger through German talk shows to teach learning-resistant people economic reason! They lecture indignantly that only this or that needs reform so the economy flourishes. What should be done is really clear.

For a few months, it has become incredibly quiet for swaggering professors. There is a great cynicism about helpless scholars. The world economic crisis has thrown the discipline into a legitimation crisis - without the many impacted seemingly noticing. This is a time for a new beginning as after the Great Depression.


"We are a discipline that seems arrogant without any reason for being arrogant," Harvard economist Dani Rodnik said recently. "In the financial crisis, the economists' claim of being a science has become defunct," Moises Naim, editor-in-chief of the "Foreign Policy" journal, ranted and raved at the World Economic Forum in Davos. Surveys in the population confirm this defunct claim. "Most of us are at a loss," admits Friedrich Schneider, head of the association of German-speaking economists. "We are in a crisis."

The problem is not that no one predicted the Lehman bankruptcy (otherwise it probably would not have happened). The current financial crisis involves dogmas, that markets function best and correct their own mistakes. "This assumption has proven wrong," Nobel Prize winner Edmund Phelps says. "Market fundamentalism was a mistake," declared Ken Rosen of the University of California. No one in Davos 2009 disputed this standard dogma.

According to Nobel Prize winner Joseph Stiglitz, systematic thinking is lacking to many economists today with their specialization in details. Many colleagues become lost in the minutia of mathematical models, Schneider laments. How absurd! The models are supported by hypotheses or years of experience. There is no mathematical formula for what shatters the world in crises. The models only function when the framing conditions are stable, the Bielefeld economic historian Werner Abelshauser ways. Models do not grasp the disastrous effects of insecurity.

What happened in September is missing in standard models, that disaster can arise by letting a bank go bankrupt. Textbooks say this is good so other light-minded banks are not lulled into false security. The idea is that some could be too big and important to fall in view of the threatening collateral damage.

In the textbooks we still read that speculators bet against wild shots and help correct them. On the financial markets the opposite occurs with increasing regularity. Because speculators do not know and seduce people to follow the herd instinct, they reinforce financial bubbles and their far-reaching explosions. The model is shattered.

Critic Naim urges a "bailout for economists." That is a good idea. Perhaps the guild could use a kind of bad bank for bad ideas that takes up toxic theories and animates economists to revise models and methods before they inflict more damage.

After the Depression of the 1930s, there was a great push in innovative economic thinking. At that time the guild that believed in the market was forced to concede that markets could fail. This has marked a whole generation including Karl Schiller who worked out the great infrastructure programs in the 1930s. The Depression also had an enormous influence on young scholars in the US, says the former central banker Alan Blinder. The Depression influenced great economists like Kenneth Galbraith and Paul Samuelson.

"Economists should learn more from history than from abstract models," the financial historian Neal Ferguson counsels. The US is already ahead of us here, Abelshauser says. Obama has appointed the economic historian Christina Romer as a top advisor (unlike the German government that nominated an econometrics expert for its group).


Developing a mechanism for globalization as German politicians did nationally after the war is one of the new challenges. Perhaps a new world currency system, a taboo theme of the old economy, could be one of these challenges. Taking up findings and making them politically concrete would also be new - as in experimental research that explains why people only act partly rationally or in the behavioral economy that analyzes herd conduct. This could help devise anti-cyclical rules that prev3ent disastrous wantonness from arising in good times. Intuition helps more than math!

The ostrich principle seems to dominate among many economists. This drama does not only exist for economics. In the world of non-economists, the pendulum has long shifted from belief in the market to state intervention. The economic framework for this is lacking because a large part of the discipline for decades only preached the powers of the market and repressed alpha- and beta-variables. This has had a disastrous effect similar to 80 years ago.

It is high time for a bad ideas bank that buys up toxic ideas. Perhaps a few continuing education courses in history should be offered. "Otherwise no one will take us seriously," Friedrich Schneider says.

"Missing Links: An Intellectual Bailout," Moises Naim, Foreign Policy, January/February 2009

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