n September 2008, the same month that Lehman
Brothers collapsed, the Argentinian ants became the unwitting stars of a
German television show that set out to illustrate collective
efficiency. To the frustration of the show's producers, the insects
ended up showing how easily rational expectations can go awry.
The
ants - Linepithema humile - had a choice between a long route and a
short one to get to a pile of food. In theory, their chemical
communication and millions of years of evolution should have led them to
work out the short route.
They
chose the long one, and most kept using it even though some had found
the shorter path. "The Germans were furious," said economics professor
Alan Kirman, whose neuroscientist friend and colleague Guy Theraulaz ran
the experiments in the south of France.
Kirman,
professor emeritus at Aix Marseille University and France's Ecole des
Hautes Etudes en Sciences Sociales, has started to use the footage in a
talk he gives about modern economic thinking. The insects were far from
efficient, he said, but reached their goal in the end.
"I think the economy is a lot like that."
There lies a hint of the revolution that is building at the heart of academic economics, particularly in Europe.
As the euro zone crisis deepens, economists in France, Germany
and Italy have been forced to turn away from classroom theories and
look at the real world - from insects to financial markets, from banks
to brain scans - to better understand what's going on. An increasing
number of teachers argue that the textbooks, some by experts who didn't
see the crisis coming, are divorced from reality, inconsistent, dull,
and, in a crisis that has gripped the globe for more than four years,
even dangerous.
"A crisis is a
wonderful opportunity in some sense," said Kirman. "If it weren't for
the fact that millions of people are suffering as a result, what better
time to be an economist, because now you can see what's going wrong with
our theory."
ROBOT BREAKDOWN
To suggest economies were not generally efficient would, until very recently, have been heresy in many classes.
The
modern theoretical framework began to emerge in the 1980s by Nobel
Prize winner Robert Lucas, the John Dewey Distinguished Service
Professor of Economics at the University of Chicago. Lucas said economic
models should be something you could put on a computer and run - "a
mechanical artificial world populated by interacting robots." If it
wasn't in the model, it couldn't happen. The collapse of the financial
system, for example.
Others helped
build on this idea. New Keynesians took a slightly different tack,
including assumptions about market failure but still resting on the idea
people behave rationally.
After
the turn of the century, Lucas even suggested economists had cracked one
of the profession's biggest questions. "The central problem of
depression-prevention has been solved," he wrote in 2003.
Four
years later, Roger Farmer, a professor of economics at the University
of California in Los Angeles, was at a dinner at the Bank of England to
celebrate the "Great Moderation", a term coined to describe an era in
which some politicians claimed monetary policy had ended boom and bust.
"We had entered a new era of economic prosperity," he recalled in a
paper this February.
That night,
British building society Northern Rock went under, heralding the start
of Europe's crisis and a global backlash against economists.
Why
didn't they see it coming, the Queen of England asked on a 2008 visit
to the London School of Economics. "The Economist" magazine wrote of a
"dark age of macroeconomics".
Economists
began to ask how the profession had been blind to the fact that its
theories were leading people down the wrong path - rather like Kirman's
ants.
That debate continues,
charged with political thunder. Diane Coyle, a UK-based economic
consultant who is compiling a book on how economics teaching needs to
change after the crisis, says it can't be separated from a backlash in
Europe against free market liberalism. But whatever their politics, a
significant number of economics teachers in both Europe and the United
States think it's time for a new, more pragmatic approach.
Around
one in five respondents to a 2010 survey of economics instructors by
the St Gallen university in Switzerland said their profession needed a
"major reorientation or new paradigm." Even those who thought the
curriculum was more or less fine said they had started paying more
attention to financial markets, banks or speculative bubbles, and
included real world context.
Last
year Coyle organised a conference on teaching post-crisis economics.
Topics ranged from high theory to whether economists could expect to
find employment.
Most economists
graduating today would not be equipped to read the Financial Times,
according to British economist John Kay, who argued they have for too
long conflated the abstract and the real.
"CHERISHED BELIEFS"
On a wall in the lobby of the Bocconi University in Milan, the script on an artwork plays on a Christian prayer:
"Et Dimitte Nobis Debita Nostra." (And forgive us our debts)
Established in 1902, Bocconi was the first university in Italy
to grant a degree in economics. Prime Minister Mario Monti was rector
there from 1989 to 1994 and dozens of top Italian officials and bankers
have attended. It is, in most ways, a cathedral to orthodox economic
thinking.
That's now changing.
"All
the macroeconomic paradigms have been put in discussion since the 2007
crisis," said Stefano Gatti, its Director of Bachelor of Economics and
Finance.
Bocconi students use a
European edition of a leading textbook by Olivier Blanchard, the IMF's
chief economist. Like the other main volume, by Harvard professor
Gregory Mankiw, it has been updated to take in the crisis. But an update
may not be enough.
Blanchard, who
in August 2008 had declared that "the state of macroeconomics is good",
wrote in a 2011 blog that "our most cherished beliefs" had been brought
into question by the crisis.
"The
paradigm that the market corrects itself, on which all the traditional
economists such as Blanchard and Mankiw base their theories, is on the
rocks," said Gatti. "What the traditional theories do not consider is
that the financial market must be regulated. A too-liberalised market
creates monsters."
Both Blanchard and Mankiw declined to comment for this article.
Francesco
Saita, dean of Bocconi's Graduate School and professor of financial
markets and institutions, said teachers are bringing newspapers and
academic papers into class, and Bocconi has invited leading bankers and
economists to address students.
"Students
need fewer economic models and more methods to understand the
uncertainty," said Giovanni Valotti, professor of public management.
Alessandro
Cofano, a third-year economics student, said questions are constantly
raised about why the formulae and graphics published in the manuals
cannot be found in real life.
"TERRIBLY FLAWED"
The
drive for change is also evident in Germany, where Professor Peter
Bofinger is passionate about the shortcomings of the main texts.
Bofinger is head of monetary policy and international economics at the
University of Wuerzburg and one of five "wise men" who formally advise
Chancellor Angela Merkel.
He also thinks most text books are dangerous.
The
author of a textbook himself, he didn't bother to read the modern
texts, he said. But last year, he did a systematic analysis, and what he
found shocked him.
"To me the most
astonishing thing was that all these textbooks do not find an
analytical explanation of unemployment," he said. "I was really amazed."
Up
to one in four people can't find work in parts of Europe, and the
reality of people who are unemployed without choosing to be is one of
the biggest holes in mainstream theory, for Bofinger and others. In
orthodox teaching, supply and demand in the labour markets should fix
unemployment leaving just those people who choose not to work in the
dole queue.
Bofinger also finds it
incredible that the standard model does not allow for people to behave
in a way that reflects uncertainty about the future. According to the
theory, a Spanish person losing their job today, for instance, would act
as if they knew they would find another job within a year.
In reality, it may take far longer: one of several truths economists say is ignored by the main theory.
"It's
so terribly flawed," said Bofinger. "If students of medicine would
learn such rubbish, you would be afraid to go to your doctor, no?"
THRILL OF THE MIDDLE
Most
economists reject such wholesale criticism. But they do question how
far the conventional approach to modelling has blinded people, Coyle
says. "The gap between the interesting questions or real-world problems
and the workhorse economics being taught to students at all levels has
become a chasm."
Simon Evenett,
professor of international trade and economic development at St Gallen
University, said macroeconomists had ignored the financial system in
most of their models, and the finance guys missed economic linkages.
"That intellectual separation has been the cause of a lot of
misdiagnoses."
London School of
Economics economics professor Charles Goodhart told a conference
macroeconomists had been "totally and egregiously hopeless." Their
assumption that everyone in an economy can borrow at the same risk-free
rate "blows one's mind, the degree of intellectual error."
Kirman
was a theoretician until the mid-1970s and now studies behavioural
economics, a branch of the discipline that began questioning mainstream
theories long before the crisis.
He
and a group of like-minded scientists are working on a project that
focuses on the flaws in big economic theories and in economists'
understanding of financial markets. He has used insect behaviour as the
basis of insights into different economic models.
Kirman
and others think it might be beneficial to look at how individuals
interact and work together in networks. Such thinking is still fringe,
though influential figures such as Jean Claude Trichet, the former
governor of the European Central Bank, and UK central banker Andrew
Haldane, have taken an interest.
Haldane
co-wrote a 2011 study of how the work of ecologists could be used to
understand the risks in the financial system. He has argued that looking
at the way people interact - for instance, by anticipating what others
will do - could provide a more sound basis for prediction than
economists' current models.
Such thinking sits right in between the two main areas of the discipline: macroeconomics and microeconomics.
"When
you teach students nowadays you teach them microeconomics and
macroeconomics - what happens to the individual and what happens on the
aggregate level - and you don't worry about what happens in between the
two because you assume that the aggregate behaves like one individual,"
Kirman said. "What I would argue is that all the interesting stuff
happens in the middle - the interaction between people and the changes
that occur."
Kirman is one of many
who think such ideas will start to change the ‘dismal science'. Others,
including UCLA's Farmer, believe the greater availability of data online
can help reshape economics completely. Digital processing, he believes,
will do for economics what the telescope did for astronomy. "The way we
teach our students will be changed in a fundamental way by the lessons
we learn from the current crisis," he said.
For
Paul Seabright, Professor of Economics at the University of Toulouse,
the crisis has highlighted the way economists have long been hungry for
something more "grounded in the scientific method."
New
tools from psychology and neuroscience can show what really motivates
people, he said. For example, it's well established that people in
financial markets are strongly influenced by their testosterone levels.
"Textbook economic man is only influenced by the returns and the risk."
As
trillions of euros are piled into failing banks, many economists think
their profession needs to get a lot more humble. "We need people whose
idea of the big picture isn't based on some dominating gestalt that
forces the detailed evidence to fit a big frame," said Seabright.
The
Argentinian ants certainly didn't fit the frame. Theraulaz, who
specialises in swarm intelligence, believes they were probably deterred
by strong lights shining onto the shorter path that the film crew wanted
them to take. Then the presence of chemicals on the longer path created
a precedent.
Would they otherwise have chosen the short route? "No," said Theraulaz. "The initial choice is made at random."
