The year 2008 was not only one of history’s biggest financial earthquakes, but also showed the failure of economists to predict the credit crunch, even when the financial forecasts were based on sophisticated mathematical models. The crisis had a number of phases, but the pivotal event was the collapse of Lehman Brothers in september 2008 which sent the crisis into an extremely dangerous phase. It was feared that the global financial system would break down completely, it did not, but the aftershocks of this catastrophe are being felt around till this day.
Before the 2008 global financial crisis, there were signs that the quantitative mathematical models that financiers were highly dependent on were failing to predict the true risks of the economy. For example, In August 2007, events that models predicted that happen only once in 10,000 years happened every day for 3 days as some unexpected market turbulence was stirred by a decline in US house prices. Why did economists fail to foresee this incoming loss? Did the models fail to predict the loss or were they the cause of this crash? These questions have been analyzed and debated but their recognition is long overdue. Now, the most important question is how were so many experts in the financial industry misled and unaware of the dangers? The real problem, which might be highly violating orthodox economic thought, lies in the fundamental assumptions that form the basis of economic theory. The calculations of risks are not the only issue, but the current economic theory cannot deal with our unfair, unstable, and unsustainable economy.
But why even bother to question such an established authority? Rolf Dobelli, a Swiss author and entrepreneur, dedicated a chapter in his million-copy bestseller book ‘The Art of Thinking Clearly’ towards the ‘Authority Bias’. He claims that it is unwise to bow to the authorities like we’re all on a conveyor belt if we don’t challenge them when crises like these give us a solid reason to. He also mentions how there are one million trained economists on the planet, and none of them could accurately predict the timing of the financial crisis in 2008. To quote the author, “Never has a group of experts failed so spectacularly”. Further insights from this chapter reveal that authorities survive through the recognition and constantly find ways to reinforce their status. Therefore, we should do our best to challenge them as authorities might be exerting an influence on our reasoning. The claims made in this article are definitely bold, but, before we further investigate the need for a revolution in economics, it is important that the readers make a mental note of this psychological phenomena.
The 2008 crisis was rather a blessing in disguise. It was an important reality check for economists and experts all around the world as it provides the impetus for us to rethink our approach to economics. As JP Bouchaud mentioned in his paper ‘Economics needs a scientific revolution’ (2021), “the financial crisis highlights the crucial need for a change of mindset in economics and financial engineering, that should move away from dogmatic axioms and focus more on data, orders of magnitudes, and plausible arguments”.
In recent years there have been many calls for economics to reinvent itself, most noticeably from student groups such as the Post-Crash Economics Society, and Rethinking Economics. In 2017, the United Kingdom’s Economic and Social Research Council announced that it was setting up a network of experts from outside economics whose task would be to ‘revolutionize’ the field. It’s not only revolutionary but exciting to see how various fields of study are capable of forming an economic perspective. But progress has been slow and complicated as many would expect. In 2017, the French physicist and hedge-fund manager Jean-Philippe Bouchaud provided an update to the Financial Times: ‘Following the financial crisis, many of us hoped that the economics profession had finally realized that their models were not representative of how the real economy works and that their flawed methods would quickly change. That assumption was wrong.’ He concluded that: ‘If we don’t embrace new methods of modeling the economy, we will be as blind to the next crisis as we were to the last one.’
But the question now is whether history will repeat itself in another sense. In physics, the quantum revolution reshaped the field. Will the financial crash lead to a similar reshaping of economics? After all, mainstream economics is explicitly based on the classical mechanics of the 19th century, with people seen as individual atoms, their behavior guided by deterministic laws. As David Orrell explains in his essay “Economics is quantum”: In physics, the quantum revolution was born when physicists found that at the subatomic level energy was always exchanged in terms of discrete parcels, which they called quanta, from the Latin for ‘how much. Perhaps we need to follow the quantum lead and look at transactions between people. In economics, the equivalent would be exchanges of money — like when you go into a shop, the point at something, and ask: How much? which makes the connection a little clearer.
It is perhaps unsurprising then that consciousness, and the way that we pattern our thoughts, seem to have much in common with quantum physics. One of the hottest areas in economics, especially since the crisis, has been behavioral economics, which was founded in the 1970s by the psychologists Daniel Kahneman and Amos Tversky.
This represents how studies like physics and psychology combined with economics can result in a new kind of economics that will overturn the most basic assumptions of traditional economics, and point the way to a better, fairer, and more sustainable economy. Classical economics is built on strong assumptions that quickly become axioms: the rationality of economic agents, the invisible hand, and market efficiency. Therefore, unlike physicists, economists are not skeptical of these axioms and models. As Robert Nelson argued in his book, Economics as Religion, the marketplace has been deified.
Surely these statements stir up a lot of concerns in mainstream economic thinking. Most economists will argue that economics is far more sophisticated than that, and no one assumes that markets are perfectly stable and investors are perfectly rational. But the risk models used by banks, or the models used to determine government policy are based on these assumptions only with small modifications. These flaws have not gone unnoticed. Heterodox economists, that makeup 10% of economists have been arguing against these assumptions for years.
In reality, A theory is likely to be accepted only if it tells a story that benefits a powerful constituency. Many economists like these just play along with these mistakes in order to get publications and tenure.
According to David Orrell, an applied mathematician, training in economics is actually a liability, and learning only the perspective of an economist is like closing your mind. Ideas that are revitalizing economics come from diverse fields like psychology, network theory, and systems biology which are way beyond the standard economic curriculum. One big area of progress would be how new economists are born, therefore challenging the existing curriculum for economics. An overly formal and dogmatic education in the economic sciences and financial mathematics are part of the problem. Economic curriculums need to include more natural science, as suggested by JP bouchand. He also mentioned how healthy scientific revolutions have not yet taken hold in economics, where ideas have solidified into dogmas that obsess academics as well as decision-makers high up in government agencies and financial institutions. This will be distinctly advantageous as it will allow the new economist to analyze the problems without justifying the previous theories that they’re exposed to early in their career and feel compelled to defend. After all, economics is more than just social science, it’s understanding people, systems, and the nature of the universe.
As Newton once said, modeling the madness of people is more difficult than the motion of planets.
To conclude, Economics, which models itself after 19th-century physics, is clearly due for an update. The revolution in economics happened a century ago. What we need is a recognition of this way of thinking. As Marshall McLuhan wrote in Laws of Media: The New Science (1992): ‘I do not think that philosophers, in general, have yet come to terms with this declaration from quantum physics: the days of the Universe as Mechanism are over.’ Nowhere is that more true than in economics.