Editorial Note: This is Chapter 8 of Brian Davey’s book Credo, which can be accessed online for free here.

Some of the ridiculous assumptions on which much of mainstream economics is constructed are explored in this chapter – for example the methodology that stresses individual decision- making, the assumption that decision-makers have the information that they need, the assumption of honesty, the default assumption of competition. (TEXT BOX: Labour market competition as an alternative to corporal punishment according to Hayek).

Today’s leading economic textbook writer, Greg Mankiw, has compared non-economists to “mere Muggles”, the ordinary people without magical powers described in the Harry Potter novels. His implication is that economists are “wizards”. (Mankiw, 2008)

Perhaps they are. However, people with magical abilities are not always to be trusted.

The ideas of the economists are important because they frame the way we understand the world, sometimes distracting us from understanding and living in the world in other ways. The economists claim that they describe the world as it is, rather than describing it as it should be, but there is an entire value system implicit in economics. It is implicit in their definition of what it is to be “rational”. Implicitly, economists are making a truth claim about how human beings are, what makes them tick.

Unaware of the criticism of their model of rationality (or ignoring the criticism) it seems reasonable to economists to theorise human beings as if they act in a predictable way by calculating their individual self-interest to maximise their utility and then acting accordingly. This makes possible a deterministic view of human action that allows economists to model markets as fundamentally positive social institutions which can solve virtually all problems.

In actual fact, economists are there as advocates for a particular kind of value system. They are not unlike priests whose job it is to argue that their beliefs should be guiding principles for life.

Some economists are well aware of this. Robert Nelson describes debates about economics as having a “theological character“. He worked as an economist in the US Department of the Interior with responsibility for the upkeep of national parks and landscapes in the USA:

If economists had any influence—which they sometimes did, if rarely decisive—it was seldom as literal “problem solvers”. Rather, the greatest influence of economists came through their defence of a set of values. Much of my own and other efforts of Interior (Ministry) economists were really to persuade others in the department to act in accordance with the economic value system, as compared with other competing priorities and sets of values also represented within the ranks of the department. (Nelson R. H., 2001, p. xiv)

Ridiculous assumptions

In other sciences ideas evolve by testing hypotheses against the facts. In economics what mostly happens is that simple models are created which have this kind of form:

assuming human beings behave in a particular kind of way e.g. as consumers seeking to maximise their level of satisfaction through purchasing

assuming their behaviour takes place in a particular set of conditions e.g. they are fully aware of all their consumption options available with their purchasing power

faced with a particular change in conditions it is possible to state how they will adapt, as well as to quantify this adaptation e.g. faced with a price change they will change how much that they buy by so much

This appears to be an exercise in logic rather like this – All men are mortal, Socrates is a man, therefore Socrates is mortal. The premises of this argument are things asserted to be true which in this case are that “all men are mortal” and that “Socrates is a man”. The conclusion that follows automatically is that Socrates is mortal. This conclusion does not really add any new information to the premises that have been proposed, it only draws out the consequence. In a sense, the conclusion is already contained in the premises.

In an apparently similar way the conclusions of economics follow from the starting points of their modelling analyses. However, the starting points of economic models are not premises asserted to be true but assumptions. These assumptions do not have a truth value status based on evidence but, on first impressions, appear to be plausible. (Bardsley, Cubitt, Loomes, Moat, Starmer, & Sugden, 2010, p. Chtp5)

If many people do not realise that this is a fraud, it is partly because the mathematics, the symbols and the diagrams with which the models are expressed enable economists to distance themselves from ordinary people, rather in the manner that speaking Latin enabled priests to put themselves above the common people.

Consider this proposition:

If Socrates is assumed to be a woman, and if all women are assumed to live forever, then it can be assumed that Socrates will be immortal.

It is obvious what is wrong with this proposition. Nevertheless, the falsity of economic propositions are not always so obvious. This is partly because some of the assumptions have a superficial plausibility and sometimes because the assumptions remain implicit, unstated and unexamined. The most important point here, however, is that there is no evidence for these assumptions. Read any economic textbook and you will find it rich in numerical examples that were made up by the author. They are neither taken from real life nor based on evidence. This is an ideal basis for a self-serving ideology in which this kind of “logic” can prove anything that is wanted according to the starting assumptions. Economics like this is not falsifiable because evidence is implicitly deemed to be unnecessary in the first place.

If you assume no problems at the start of the theory you will conclude that the economic world works without problems. For example, if, as was the case for many years, you assume that there are no problems in getting the information that you need to take economic decisions, then all the uncertainties, the dishonesty, the misinterpretation and the errors that take place in the real world disappear from the theory. The conclusions of models that do not draw on real world evidence are only as accurate as the assumptions they start with – no more and no less. A good deal of textbook economics is a description of what economists assume the world is like.

Even worse, the construction of models based on assumptions enables the imagination of a world akin to the one that Dr Pangloss believes he lives in. He is the character in Voltaire’s satire, Candide, who at every misfortune reassures everyone that all is for the best in the best of all possible worlds. Nothing will go wrong in the world of the mainstream economists because growth, technology, innovation, markets and entrepreneurial zeal together have the mechanisms for fixing all problems for ever. The message is perpetually upbeat and reassuring – which it can be when you construct a model of the world with assumptions that don’t include the problems.

Thus, markets are “efficient” and welfare outcomes are “optimal” when the starting assumptions contain none of the real life issues that would make them otherwise. In order to arrive at these optimal and efficient outcomes what is needed above all is “competition”. This is another very handy conclusion. It enables neoclassical economists to convince themselves and successive generations of students that, as long as the state minimises its involvement in markets, we live in this best of all possible worlds.

Competition is an idea which has many useful ideological functions. Instead of being a place of shambolic chaos, a competitive market is portrayed as having its own kind of order without a single big player – state or monopoly – needing to take all the decisions for overall coherence. With a set of assumptions that portrays this competitive market order as “optimal”, here is an argument that can be used as a default presumption against co-operation; against state regulations; against taxation; against trade union combination in the labour market. Competition is an idea that stands for general “freedom” from interference for powerful economic actors, against any limitation on their rights to act – and therefore for a general understanding of what “freedom” means for everyone else in society too. It can be used by those who are the strongest to prevent support for the weakest, and generally in a self-celebratory way praising “success” as the result of “efficiency”.

But let’s look at some of the most common assumptions that underpin the key idea.

Methodological individualism

To take the first issue – in the textbooks, markets are places where there are lots of actors and, to get a collective picture of what happens, you simply add up the actions of all the separate individuals. Of course, this does not rule out the idea that the separate individuals have previously influenced each other, but that is not what is explored. This is a version of what is called “methodological individualism” and there is no place in it for applying the insights of group psycho-dynamics. This is not because methodological individualists necessarily deny that the “preferences” that form people’s choices can be formed by social, interpersonal or community processes – it is rather because they take the “preferences” that give rise to choices as givens. They see themselves as modelling rational behaviour about what people will do with a pattern of preferences, a certain amount of purchasing power when faced with a set of prices. As economists, they are not concerned to delve further. In that sense, methodological individualism is a choice to ignore why people prefer and choose what they do. It is a choice to ignore and thus a choice to remain ignorant.

It is no wonder that, when criticising their teachers a few years ago, French economics students described neoclassical economics as “autistic”. Autism is a psychiatric disorder where a person is unable to recognise other people as people, as acting subjects. The autistic person is, thus, unable to form meaningful reciprocal relationships. Of course, in their private lives even neoclassical economists recognise that people act in groups in which they interact and have a reciprocal influence on each other – in families, in clubs, in associations, in societies, in crowds. A lot of what happens in markets is driven by crowd psychology. What is “fashion” if not a form of collective psychology? Arrangements made by producers try to influence and steer fashion processes which are only partly under their control.

When I go into supermarkets or department stores at the weekend it is full of families who are taking group decisions about purchasing. At other times, there are mothers who are taking decisions for partners and children. But that is not what most of the theories assume.

Ignoring ignorance – the myth of perfect information vs the thinking of the herd

Let’s look at another assumption. It is only in the last few decades that a new approach of “information economics” has evolved out of the recognition that access to information is crucial to decisions and market outcomes. Many of the textbooks from which today’s elite were taught assumed that markets had all the information that market actors needed. Indeed, some of the more elaborate models that “proved” the superiority of markets to allocate resources assumed that market actors had god like powers because they could make accurate assessments of the future too.

In fact the market is almost always shot through with a lack of information and/or information asymmetry. Perhaps in the world of Adam Smith’s small town butcher, baker and brewer, people could pick up gossip about their suppliers and even know them personally. But how does information work in a global market? How does it work with products made out of hundreds of components made out of hundreds of materials supplied by global supply chains? How does this work with meat products in the freezers of supermarkets? People buy what they think are beef products and are dependent on public health authorities to discover that they have been eating horse meat.

A very powerful reason why people have so much influence on each other lies in the absence of information and the uncertainty in which many economic decisions are taken. When you don’t know, you ask and/or you take your cues from other people.

Margaret Thatcher once famously said that “there is no such thing as society” which is one of those monumentally stupid things that powerful people can say and get away with because they are surrounded by sycophants. A very powerful person like Thatcher could doubt the existence of society because she had little need for the ideas and inluence of other people as she would have known that she was always right. By contrast mere mortals are influenced by others because we live in a world of uncertainty and inadequate information. Allowing ourselves to be in influenced by what others are doing and saying is a rough and ready way of coping with the information that we lack. Thus, we come to be influenced and swayed by social trends.

One cannot possibly understand the mentality of what are called “bubbles” in asset markets and speculation, except through collective psychology. Whether and how much of a commodity, or an asset, is purchased depends powerfully not just on current prices but on what people expect will happen to prices in the future. When they try to figure out what is likely to happen to future market valuations, perhaps the most powerful influence of all is what other people are saying and thinking. Anyone who reads a newspaper like the Financial Times will be struck by the way it is full of reports which convey to the readers what the “market sentiment” is, that is, what others think will happen.

Up to a point, movements in market sentiment are exercises in self-fufillling prophecy. If a rise in price is taken to be indicative of an ongoing trend, which will lead to even higher prices later, then many traders will follow each other and be tempted to buy more now, before prices go higher and possibly also to make money in the “rising market”. Perhaps speculators imagine that they can sell what they buy now on a rising price for an even higher price later. We have already seen how speculation drove up rising grain prices in the famines of India, taking food out of the mouths of the poor even in areas of good harvests.

Honesty and Dishonesty

Other, sharper, market actors seek to play these movements in a devious fashion. This brings us to the third of our assumptions about why competitive markets deliver wonderful outcomes. It assumes that market players are honest when a lot are not. If people are only motivated by individualistically calculated self-interest why should they not resort to fraud and opportunism, to secrecy and misleading accounts of product quality?

This kind of duplicity affects what happens during speculative manias. For example, if you know that the shares of a company are going to lose value because you have insider information that a company or an industry is heading towards a big loss, if you have no commitment to the company or the industry, and if you no scruples, you will want to sell the shares at a high price before the truth gets out. So you might launch a PR campaign to hype the company or industry that you know is heading for a loss. That way you seek to create a rising market in order to offload your otherwise worthless shares on the people who get taken in. The game being played is to let other suckers take the losses.

That happened at the end of the subprime boom where bank traders sold what they referred to privately as “toxic waste” to unsuspecting customers as if these assets were of real value. A similar thing is happening at the time of writing in the gas fracking industry. All over the world, articles are appearing about the incredible potential for gas fracking. Meanwhile, industry insiders are pointing out the rapid depletion of the wells, the number of wells that come up dry and the high cost of drilling. If you believe the former narrative you put up money to enter the industry – and allow the insiders in the know to get out.

So here you have it. If we assume that most actors do not know what it going on and are able to influence each other, along with insiders who do have the best information acting as crooks trying to mislead and defraud other people, this gives us a far better fit for understanding what actually happens in markets. Instead, we have models which assume the reverse and this is what is taught to students.

Perfect competition

To be fair, neoclassical economists do get rather cross when businesses seek to accumulate monopoly power. This is paradoxical because competitive success leads to the weaker companies being driven out and/or taken over by the stronger ones thereby accumulating more monopoly power. Without competition the bracing Darwinist struggle between businesses does not deliver the benefits advertised in the textbooks, such as, cheaper products for all of us. For that reason some capitalist countries have “competition” policies and police against secret agreements between companies that “restrain trade” in favour of higher prices at the consumer’s expense. However, a closer examination of some of these policies often reveals that the intended result is the opposite of the stated one. As already mentioned, the ideology of competition through free trade is intended to clear the field for those companies in those countries that are already in the globally dominant position. It is about preventing competition emerging in the first place and consolidating global dominance. Throughout economic history the ideology of competition has been used to open up markets to the strongest market players and enable them to accumulate further market power. These are the players who will be most influential in political lobbying in the corridors of power. These are the very private sector players who will be influential in university departments of economics.

Text Box– Labour market competition as an alternative to corporal Punishment according to Hayek

Where neoclassical economists can be expected to get indignant is if competition is limited is in the labour market. If workers form trade unions to create for themselves a countervailing power over and against their employer then economists are rarely sympathetic and almost always take the side of employers. Not many infants are born because their parents decided to do their bit to supply the future labour market. However, that does not excuse these infants, when they grow up, from their duty to compete in the labour market for work and take the going price. When there is full employment, this gives employees far too much “market power” for “optimality”. As Hayek puts it in his book The Road to Serfdom, without unemployment, managers lose their ability to discipline workers and take on or lay off workers according to their plans.

“… there should be a place from which workers can be drawn, and when a worker is fired he should vanish from the job and from the payroll. In the absence of a free reservoir discipline cannot be maintained without corporal punishment, as with slave labour.” Quoted in (Smith & Max-Neef, 2011, p. 35)

Note the verb “should”… at the beginning of most textbooks there are usually little homilies that say economists describe the world as it is and not as it should be – but that’s not for Hayek. The labour market needs an alternative for corporal punishment if the workers is to be managed as an input to be used and disposed of as required. Workers are a means to the ends of employers.

At the risk of going off on a tangent, I cannot help but wonder what Hayek would have said about this famous principle from the philosopher Kant:

“Act in such a way that you treat humanity, whether in your own person or in the person of any other, never merely as a means to an end, but always at the same time as an end.” (Kant & (Tr.)Ellington, 1993, p. 30)

I’ve already claimed that human relationships are not the strong point of economists – neoclassical or Austrian. Hayek’s requirement for some kind of discipline derives as a self-fulfilling imperative from the mind-set of employers who use people merely as means, for example, as “factory hands”. If you treat and regard people only as means to your end is it surprising that their commitment to those ends is less than enthusiastic? Why should they feel committed? People do not take well to being used without consideration. It has a cost to their self-esteem, although, if one has no choice, if one is “disciplined” by unemployment, one may have to do it.

When you look at the world using economic concepts you are looking at the world as “snakes in suits” see it. They don’t get this idea that “human resources” are actually people with feelings and emotions. They don’t get the idea that most people are happy to co-operate with each other if they are treated with respect and their feelings acknowledged. This why they need alternatives to corporal punishment to maintain discipline and so they opt for unemployment to “create competition”. (In Britain the snakes are then disconcerted when they get a group of people who become long term unemployed. Rather than resort to corporal punishment for this group they intend to resort to psychological torture – making this group do completely futile time-wasting things for their benefits, like looking for employment when there is none).

Garbage hidden in mathematical formulas

I digress from the topic of unrealistic assumptions made by neoclassical and Austrian economists… If you assume away the real world in your model then the model will deliver a picture of ideal allocation outcomes – on the blackboard. Because the conclusions are arrived at in very sophisticated mathematics “mere Muggles” don’t understand the fraud that the wizards have perpetrated.

What “the mere Muggles” understand… or think they do… is a simplified version of the ideas of the wizards, or parts of these ideas. If the economists are akin to a priesthood who are trained in the theological details, then the mass of the general public are like a congregation who stitch together a vaguer and partial patchwork quilt of ideas from what they read in the newspapers, hear on the news, or perhaps pick up in books or even in introductory courses in economics. The more general “congregation” does not know all the fine details but knows bits that they adapt to their lives and local circumstances. is is what Richard B. Norgaard calls “economism”:

The mix of popular, political and policy mythology as well as practical beliefs that help us understand and rationalise the economy and how we live in it. People share some of those beliefs globally; other beliefs people adapt to fit particular national and regional situation; while yet others serve particular groups, including economists. (Norgaard, 2009, p. 80)

As Norgaard expresses it – a half of the global population is deeply immersed in the global economic system and like fish trying to grasp the nature of water, each of these individuals, playing their specialised roles, seeks to some degree or other to understand the bigger system of which they are a part. As the economy has become the window on which they see the world they use economism as “a set of beliefs constituting a secular religion guiding the remnants of our modern hopes for human progress: material, moral and scientific.” (Norgaard, 2009, p. 79)

John Maynard Keynes was, I believe, saying much the same thing when he wrote that:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist. (Keynes 1936, p. XX)

What I am not saying here is that the priesthoods are supposed to have the correct version while the congregation more often have it wrong because of their simplifications and misunderstandings. It is more complicated than that. The mainstream theory always was “defunct” even in the form that is written out in difficult looking equations. You don’t need to understand the equations to understand that. You just need to examine the foundations of the subject. That said, the priesthood are a little more aware of the nuances in their theories.