Until the credit crunch and crash of 2008/9, there appeared to be a degree of consensus amongst economists about how economies worked. Agents were generally assumed to be rational and markets generally worked to balance demand and supply at both a micro and a macro level. Although economies were subject to fluctuations associated with the business cycle, these had become relatively mild given the role of central banks in targeting inflation and the general belief that we had seen the end of boom and bust.
True, markets were not perfect. There were problems of monopoly power and externalities. Also information was not perfect. But asymmetries of information were generally felt to be relatively unimportant in the information age with easy access to market data through the internet.
Then it all went wrong. With the exception of a few economists, people were caught unawares by the credit crunch. There was too little understanding of the complexities of securitisation and the leveraged risk in these pyramids of debt built on small foundations. And there was too little regard paid to the potentially destructive power of speculation and herd behaviour.
So how should economists model what has been happening over the past three years? Do we simply need to go back to Keynesian economics, which emphasised the importance of aggregate demand and the ability of economies to settle at a high unemployment equilibrium? Can the persistence of high unemployment in the USA and elsewhere be put down to a lack of demand or is the explanation to be found in hysteresis: the persistence of a problem after the initial cause has disappeared? Can failures of markets be incorporated into standard microeconomics?
Or do we need a new paradigm: one that emphasises the behaviour of economic agents and examines how people act when there are information asymmetries? These are the questions that are examined in the podcast below. It is an interview with Nobel Prize winning economist, Joseph Stiglitz.
Joseph Stiglitz: ‘Building blocks’ of a new economics BBC Today Programme (25/8/10)
Needed: a new economic paradigm Financial Times, Joseph Stiglitz (19/8/10)
Obama should get rid of Geithner, Summers Market Watch, Wall Street Journal, Darrell Delamaide (25/8/10)
This rebel’s heresy is not so earth-shaking Fund Strategy, Daniel Ben-Ami (23/8/10)
- What are Stiglitz’s criticisms of the economics profession in recent years?
- What, according to Stiglitz, should be the features of a new economic paradigm?
- Is such a paradigm new?
- Provide a critique of Stiglitz’s analysis.
- What do you understand by ‘behavioural economics’? Would a greater understanding of human behaviour by economists have helped avert the credit crunch and subsequent recession?
To mark the 20th anniversary of the fall of the Berlin wall, the BBC World Service commissioned a survey across 27 countries to gather people’s views about capitalism and whether it is working well. The findings are striking. Only 11% felt that it is working well. “Most thought regulation and reform of the capitalist system were necessary. There were also sharp divisions around the world on whether the end of the Soviet Union was a good thing.”
The following articles look at the detailed findings of the poll and consider its implications for the functioning and reform of the world economy.
Global poll: Wide dissatisfaction with capitalism 20 years after fall of Berlin Wall BBC Press Office (9/11/09)
Free market flawed, says survey BBC News, James Robbins (9/11/09)
Wide dissatisfaction with capitalism, years after fall of Berlin Wall Dawn.com (Pakistan) (9/11/09)
Capitalism confronted with growing doubts Global Times (China) (11/11/09)
The fall of the Berlin wall – Pt 1 (video), The fall of the Berlin wall – Pt 2 (video), Al Jazeera (on YouTube), Riz Khan (9/11/09)
Column : Why Berlin was a win for all of us Financial Express (India), Lord Desai (Emeritus Professor, London School of Economics) (9/11/09)
The real lesson of 1989 is that nothing is ever settled Guardian, Seumas Milne (12/11/09)
The Wall fell and hope rose – for a while Otago Times (New Zealand), Andrew Rawnsley (10/11/09)
New name for a new economy? BBC News, Stephanomics (13/11/09)
- What are the alternatives to free-market capitalism?
- Do you agree that “however flawed free-market capitalism is, it is still the best of all systems”? Explain your answer.
- In what ways does free-market captialism fail to provide the optimum allocation and distribution of resources?
- What forms can government intervention take to influence markets?
Hayek, through his book the ‘Road to Serfdom’ became one of the founding fathers of the market economic system that we have adopted as the principal method of organising economic activity. However, like all neo-liberal economists, his views and recommendations have come under increasing scrutiny in the current financial crisis.
Faith. Belief. Trust. This economic orthodoxy was built on superstition Guardian (6/10/08)
Dangers of worshipping false god of self-regulating markets Irishtimes.com (3/10/08)
||Write a short paragraph setting out the key arguments in Hayek’s book ‘The Road to Serfdom’.
||Assess the importance of confidence in an economic system. To what extent is a lack of confidence a ‘self-fulfilling prophecy’?
||Discuss the extent to which Hayek’s work influenced the adoption of neo-liberal economic policies.
Adam Smith is the face on the new £20 note. This could be used as an argument that economics has moved into the mainstream, but many people may not be aware of the influence that he has had on modern classical economics. The articles below may help reveal his ongoing economic influence.
What you should know about Adam Smith BBC News Online (13/03/07)
Why Brown reveres the man on the new £20 note Guardian (19/03/06)
||Assess the impact of Adam Smith on classical economic theory.
||Summarise the main works and theories of Adam Smith. (You may find the information in the Biz/ed Virtual Economy on Adam Smith helpful. For a complete list of works of Adam Smith, many online, see website C18 in the hotlinks section of this site.)
||Discuss the extent to which Gordon Brown has been influenced by Adam Smith in his policies.
Recent economic history has led many commentators to believe that a free-market capitalist economy is the only efficient method of allocating resources. The transition of former Eastern Bloc economies has furthered this perception. In the article from the Guardian linked below, Andrew Murray considers this argument and argues that capitalism may not be the be all and end all of economic organisation.
No, capitalism is not the only way to order human affairs Guardian (8/3/07)
||Discuss the arguments for and against using a free-market economy as the principal method of resource allocation.
||Assess the principal reasons for the transition of planned economies to market economies over the past two decades.
||Examine the validity of the arguments raised by Andrew Murray in his article.