Debunking Economics.

Steve Keen.

About the author.

Steve Keen is professor of economics and finance at the University of Western Sydney. Steve predicted the financial crisis as long ago as December 2005, and warned back in 1995 that a period of apparent stability could merely be 'the calm before the storm'. His leading role as one of the tiny minority of economists to both foresee the crisis and warn of it was recognized by his peers when he received the Revere Award from the Real-World Economics Review for being the economist who most cogently warned of the crisis, and whose work is most likely to prevent future crises.

PREFACE TO THE SECOND EDITION.

Debunking Economics was far from the first book to argue that neocla.s.sical economics was fundamentally unsound. If cogent criticism alone could have brought this pseudo-science down, it would have fallen as long ago as 1898, when Thorstein Veblen penned 'Why is economics not an evolutionary science?' (Veblen 1898). Yet in 1999, when I began writing Debunking Economics, neocla.s.sical economics was more dominant than it had ever been.

My reason for adding to this litany of thus far unsuccessful attempts to cause a long-overdue scientific revolution in economics was the belief that a prerequisite for success was just around the corner. As I noted in my concluding chapter, I felt that a serious economic crisis was approaching, and that when this crisis. .h.i.t, fundamental change in economic theory would be possible: I am not wishing an economic crisis upon the modern world instead, I think one has been well and truly put in train by the c.u.mulative processes described in chapters 10 and 11 [on finance]. If that crisis eventuates one which neocla.s.sical economic theory argues is not possible then economics will once again come under close and critical scrutiny. (Debunking Economics, 1st edn, p. 312) When I finished Debunking Economics, I hoped to be able to start work on a book with the working t.i.tle of Finance and Economic Breakdown, which would have provided a comprehensive theory of the forces that would cause this crisis. Instead, the reaction from neocla.s.sical economists to Chapter 4 of Debunking Economics 'Size does matter', on the neocla.s.sical model of compet.i.tion was so vehement that I spent much of the next four years developing the arguments in that chapter in response to their attacks.

Finally, in December 2005, I returned to writing Finance and Economic Breakdown (for Edward Elgar Publishers). Almost immediately, unforeseen circ.u.mstances intervened once more, when I was asked to be an expert witness in a predatory lending case. One look at the exponential growth in the debt-to-GDP ratios for Australia and the USA convinced me that a truly huge crisis was imminent.

I decided that raising the public alarm was more important than writing an academic treatise on the topic, so I reluctantly delayed the book once more and turned to the media and the Internet instead. I published a monthly report on debt, starting in November 2006 (Keen 2006), became sufficiently well known in the media to be described as a 'media tart' by some Australian critics, established the blog Debt.w.a.tch (www.debtdeflation.com/blogs), which now has over 10,000 registered users and attracts about 50,000 unique readers each month (with about 25,000 of those being Australian, and most of the rest coming from America and the UK), and in what pa.s.sed for spare time, worked to complete a model of debt deflation to inform my public comments.

The economic crisis began with a vengeance in September 2007. Unemployment in the USA doubled in the next year, while a 5 percent rate of inflation rapidly gave way to 2 percent deflation.

The complete failure of neocla.s.sical economics to antic.i.p.ate the crisis also meant, as I expected, that economic theory and economists are under public attack as never before. Their defense has been to argue that 'no one could have seen this coming.' They have taken refuge in the phrase that this crisis was a 'Black Swan,' using Na.s.sim Taleb's phrase completely out of context (Taleb 2007), and ignoring the fact that I and many other non-neocla.s.sical economists did in fact see this coming.

I therefore decided that, for both positive and negative reasons, a new edition of Debunking Economics was needed.

The negative reason is that there is no better time to attack a fallacious theory than after it has made a spectacularly wrong prediction. By arguing that the macroeconomy had entered a permanent 'Great Moderation' (the phrase Ben Bernanke popularized to describe the apparent reduction in economic volatility and falls in unemployment and inflation between 1975 and 2007), neocla.s.sical economics couldn't have been more wrong about the immediate economic future. Now is the time to show that, not only was this crisis eminently foreseeable, but also neocla.s.sical economists were about the only ones who were ill equipped to see it coming. The main positive reason is that, with the public and policymakers much more amenable to alternative ways of thinking about economics, now is the time to provide a brief and accessible look at an alternative, realistic model of the economy.

There have also been some important developments in economics since the first edition notably the growth of econophysics, and the concession by finance academics that the Efficient Markets Hypothesis has been empirically disproven (Fama and French 2004).

Several new chapters have been added on the dynamics of debt-based money, and the continuing economic crisis currently called the Great Recession in America (and the 'Global Financial Crisis' in my home country, Australia), but which I fully expect to be renamed the Second Great Depression by future economic historians. These new chapters 'break the mold' for the rest of the book, in that they are not critiques of the neocla.s.sical theory of financial instability and economic crises because there simply is no such theory. Instead they set out, in an introductory way, the non-neocla.s.sical theories of debt deflation and endogenous money that I have played a role in developing (Keen 2008, 2009a, 2009b, 2010), and the model of financial instability that I will cover in detail in Finance and Economic Breakdown.

I have also edited a number of chapters where there have been significant theoretical developments since the first edition. By far the most important development here has been a substantial deepening of the critique of the theory of the firm in 'Size does matter.' There is also substantially more information on why the theory of demand is false in 'The calculus of hedonism' and 'The price of everything and the value of nothing,' and a record of the recanting of the Efficient Markets Hypothesis by its major advocates Fama and French in the addendum to 'The price is not right.'

Lastly, a book that was in its first incarnation almost exclusively about microeconomics now covers microeconomics and macroeconomics in roughly equal measure.

The one glaring omission is the absence of any discussion of international trade theory. The reason for this is that, while the flaws in the theory of comparative advantage are, to me, both huge and obvious, a detailed critique of the mathematical logic has not yet been done, and nor is there a viable alternative. That is a task that I may tackle after Finance and Economic Breakdown is completed, but not before.

Looking back.

The reception of the first edition was both gratifying and predictable. The gratifying side was the public reception: sales far exceeded the norm for this cla.s.s of book, it continued to sell well a decade after it was first published, and the critical response from the public was almost universally positive.

The predictable side was the reaction from neocla.s.sical economists. They disparaged the book in much the way they have treated all critics as Keynes once remarked, he expected his work to be treated as being both 'quite wrong and nothing new.' My critique received the same treatment, and as well neocla.s.sicals were incensed by my critique of the theory of the firm.

Their rejoinders to that critique led me to develop it far beyond the version first published in 2001, and in ways that I thought would be very difficult to convey without mathematics, but which in fact I found quite easy to explain in the addendum to 'Size does matter.' However, for a detailed treatment mathematics is still necessary, so for those who can cope with the odd or rather frequent! equation, the most accessible papers are in the journals (Keen 2003, 2004; Keen and Standish 2006, 2010) and book chapters (Keen 2005, 2009a). The paper in the free online journal The Real-World Economic Review is the most easily accessed of these (www.paecon.net/PAEReview/issue53/KeenStandish53.pdf), while my chapter in the book A Handbook for Heterodox Economics Education (edited by Jack Reardon and published by Routledge), 'A pluralist approach to microeconomics,' covers the critique of the Marshallian model of the firm in a manner that should be useful to academics and schoolteachers.

Looking forward.

I knew when I wrote the first edition of Debunking Economics that its real aim the elimination of neocla.s.sical economics and its replacement by an empirically based, dynamic approach to economics could not be achieved until a serious economic crisis called into question the Panglossian view of market economies that neocla.s.sical economics promulgates. That crisis is well and truly with us, and the public has turned on economists as I had hoped it would. Unfortunately, the economics profession is also reacting as I expected by pretending that nothing is wrong.

As I write these words I have just returned from the 2011 American Economic a.s.sociation (AEA) annual conference, where close to 10,000 mainly US and overwhelmingly neocla.s.sical economists meet every year to present and hear 'the latest' in the profession. Though there were quite a few sessions devoted to the Great Recession and what its implications are for economic theory (mainly organized by non-neocla.s.sical a.s.sociations within the AEA, such as the Union for Radical Political Economics), the majority of the profession continues to believe, as Ben Bernanke put it some months beforehand, that 'the recent financial crisis was more a failure of economic engineering and economic management than of what I have called economic science' (Bernanke 2010).

Bernanke's belief could not be farther from the truth: as a means to understand the behavior of a complex market economy, the so-called science of economics is a melange of myths that make the ancient Ptolemaic earth-centric view of the solar system look positively sophisticated in comparison. What his opinion reveals is his inability to think about the economy in any way other than the neocla.s.sical one in which he has been trained an inability he shares with most of his colleagues.

If we leave the development of economics to economists themselves, then it is highly likely that the intellectual revolution that economics desperately needs will never occur after all, they resisted change so successfully after the Great Depression that the version of neocla.s.sical economics that reigns today is far more extreme than that which Keynes railed against seven decades ago. I concluded the first edition with the observation that economics is too important to leave to the economists. That remains the case today.

If change is going to come, it will be from the young, who have not yet been indoctrinated into a neocla.s.sical way of thinking, and from those from other professions like physics, engineering and biology, who will be emboldened by the crisis to step onto the turf of economics and take the field over from the economists. It is to those real engines of change in economics that this book is dedicated.

PREFACE TO THE FIRST EDITION.

In the preface to the General Theory, Keynes commented that its writing had involved a long process of escape from 'habitual modes of thought and expression.' He implored his audience of professional economists to likewise escape the confines of conventional economic thought, and observed that 'The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds' (Keynes 1936).

This statement was unfortunately prophetic. Keynes's own escape was incomplete, and the residue of traditional thought the General Theory contained obscured many of its most innovative aspects. Faced with a melange of the new and unfamiliar with the old and familiar, the bulk of his audience found it easier to interpret his new ideas as no more than embellishments to the old. The Keynesian Revolution died, slowly but surely, as economists reconstructed the 'habitual modes of thought and expression' around the inconvenient intrusions Keynes had made into economic dogma. Economics failed to make the escape which Keynes had implored it to do, and as time went on, 'modern' economics began to resemble more and more closely the 'old ideas' which Keynes had hoped economics would abandon.

I was initially educated in this resurgent tradition known as the Keynesian-Neocla.s.sical synthesis some thirty years ago. The catalyst for my escape from this dogma was extremely simple: my first-year microeconomics lecturer pointed out a simple but glaring flaw in the application of conventional theory.

The economic theory of markets argues that combinations of any sort, whether by workers into unions or manufacturers into monopolies, reduce social welfare. The theory therefore leads to the conclusion that the world would be better off without monopolies and unions. If we were rid of both, then the economic theory of income distribution argues that, effectively, people's incomes would be determined solely by their contribution to society. The world would be both efficient and fair.

But what if you have both monopolies and unions? Will getting rid of just one make the world a better place?

The answer is categorically no. If you abolish just unions, then according to 'conservative' economic theory, workers will be exploited: they will get substantially less than their contribution to society (equally, if you abolish just monopolies, then workers will exploit companies). If you have one, then you are better off having the other too, and a single step towards the economist's nirvana takes you not closer to heaven but towards h.e.l.l.1 I was struck by how fragile the outwardly impregnable theory of economics was. What seemed self-evident at a superficial level that social welfare would rise if unions or monopolies were abolished became problematic, and even contradictory, at a deeper level.

Had I come across that fragility in my Honors or postgraduate education, which is when students of economics normally learn of such things, I would quite possibly have been willing to gloss over it, as most economists do. Instead, because I learnt it 'out of sequence,' I was immediately suspicious of the simplistic statements of economic principle. If the pivotal concepts of compet.i.tion and income distribution could be so easily overturned, what else was rotten in the House of Economics?

That skepticism initiated a gradual process of discovery, which made me realize that what I had initially thought was an education in economics was in fact little better than an indoctrination. More than a decade before I became an undergraduate, a major theoretical battle had broken out over the validity of economic theory. Yet none of this turned up in the standard undergraduate or honors curriculum unless it was raised by some dissident instructor. There were also entire schools of thought which were ant.i.thetical to conventional economics, which again were ignored unless there was a dissident on the staff.

Thirty years after starting my skeptic's intellectual tour, I am completely free of the 'habitual modes of thought and expression' which so troubled Keynes. There are many non-orthodox economists like me, who are all trying to contribute to a new, deeper approach to economics.

But still the world's universities churn out economists who believe, for example, that the world would be a better place if we could just get rid of unions, or monopolies.

Worse still, over the last thirty years, politicians and bureaucrats the world over have come to regard economic theory as the sole source of wisdom about the manner in which a modern society should be governed. The world has been remade in the economist's image.

This ascendancy of economic theory has not made the world a better place. Instead, it has made an already troubled society worse: more unequal, more unstable, and less 'efficient.'

Why has economics persisted with a theory which has been comprehensively shown to be unsound? Why, despite the destructive impact of economic policies, does economics continue to be the toolkit which politicians and bureaucrats apply to almost all social and economic issues?

The answer lies in the way economics is taught in the world's universities.

When I became an academic economist, I realized that very few of my colleagues had any knowledge of the turbulent streams in economics. Most were simply dismissive of any attempt to criticize orthodox thinking, and equally dismissive of any of their peers who showed tendencies towards unconventional thought.

This was not because these conventional economists were anti-intellectual far from it. Even though conventional economics is flawed, it still takes intellectual muscle to master its principles as you will soon discover. Yet still economists refused to consider any criticisms of economic theory, even when they emanated from other economists, and met rigorous intellectual standards.

Nor were they ill intentioned most of them sincerely believed that, if only people followed the principles of economic theory, the world would be a better place. For a group of people who espoused a philosophy of individualistic hedonism, they were remarkably altruistic in their commitment to what they saw as the common good. Yet the policies they promoted often seem to non-economists to damage the fabric of human society, rather than to enhance it.

They also rejected out of hand any suggestion that they were ideologically motivated. They were scientists, not political activists. They recommended market solutions, not because they were personally pro-capitalist, but because economic theory proved that the market was the best mechanism by which to determine economic issues. Yet virtually everything they recommended at least appeared to favor rich over poor, capitalist over worker, privileged over dispossessed.

I came to the conclusion that the reason they displayed such anti-intellectual, apparently socially destructive, and apparently ideological behavior lay deeper than any superficial personal pathologies. Instead, the way in which they had been educated had given them the behavioral traits of zealots rather than of dispa.s.sionate intellectuals.

As anyone who has tried to banter with an advocate of some esoteric religion knows, there is no point trying to debate fundamental beliefs with a zealot. After many similar experiences with economists, I abandoned any delusion that I might be able to persuade committed economists to see reason (though there has been the odd exception to this rule). Instead, I prefer to spend my time developing an alternative approach to economics, while persuading others not to fall for the superficially persuasive but fundamentally flawed arguments of conventional theory.

Hence this book, which is aimed at a broader audience than Keynes's target of his fellow economists. Instead, my primary target market is those people who feel that they have been effectively silenced by economists. One of the many reasons why economists have succeeded in taking over social policy is that they have claimed the high intellectual ground against anyone who opposed their recommendations. The object of this book is to show that this claim is spurious.

Though I am the sole author, and thus responsible for all its errors and omissions, I cannot claim sole credit for what is good in it. In particular, I owe an enormous debt to the pioneers of critical thinking in economics.

Pre-eminent amongst these is Piero Sraffa a name which is known to almost no non-economists, and very few economists. There are many others whose names turn up in subsequent pages Blatt, Garengani, Goodwin, Kalecki, Kaldor, Keynes, Minsky, Veblen, to name a few. But none has had quite the impact of Sraffa.

I owe a more personal debt to those few teachers who were, as I am now, dissidents in a sea of believers. Pre-eminent here is Frank Stilwell the first-year lecturer who, many years ago, introduced me to the first of many flaws in conventional economics. I also gratefully acknowledge the influence which Ted Wheelwright's panoptic knowledge of the many currents in economic thought had upon my intellectual development. My colleagues in HETSA, the History of Economic Thought Society of Australia, have also enriched my appreciation of the many 'roads not taken' by mainstream economics.

Colleagues around the world have provided feedback on the arguments presented here. None can be held liable for what follows, but all influenced it, either directly, in debate, or by providing a forum in which heterodox views could flourish. My thanks go to Trond Andresen, George Argyrous, Tony Aspromorgous, Joanne Averill, Aldo Balardini, Bill Barnett, James d.i.c.k, Marchessa Dy, Geoff Fishburn, John Gelles, Ric Holt, Julio Huato, Alan Isaac, James Juniper, Gert Kohler, John Legge, Jerry Levy, Henry Liu, Basil Moore, Marc-Andre Pigeon, Clifford Poirot, Jason Potts, Barkley Rosser, Gunnar Toma.s.son, Sean Toohey, Robert Vienneau, Graham White, and Karl Widerquist, for reading and commenting upon drafts of this book. I would especially like to thank Karl Widerquist for detailed suggestions on content and the flow of arguments, John Legge for a.s.sistance with the proofs of some propositions, Alan Isaac for providing a testing foil to many propositions in the early chapters, and Geoff Fishburn for many years of intelligent and critical discussion of economic theory.

Joyce Hitchings provided valuable feedback on how to make the book's arguments and counter-arguments more accessible to readers with no prior training in economics.

I have also received great encouragement and feedback from my publishers Tony Moore of Pluto Press, and Robert Molteno of Zed Books. My editor, Michael Wall, did a sterling job of making the final product more concise and accessible than the original ma.n.u.script.

Sabbatical leave granted by the University of Western Sydney gave me the time away from the everyday demands of an academic life needed to complete a book. The Jerome Levy Inst.i.tute of Bard College, New York, and the Norwegian University of Science and Technology in Trondheim, Norway, kindly accommodated me while the finishing touches were applied to the ma.n.u.script.

And so to battle.

1 | PREDICTING THE 'UNPREDICTABLE'

A major motivation for writing the first edition of this book was my feeling in 2000 that a serious economic crisis was imminent, and that it was therefore an apt time to explain to the wider, non-academic community how economic theory was not merely inherently flawed, but had helped cause the calamity I expected. At the time, I thought that the bursting of the DotCom Bubble would mark the beginning of the crisis though I was cautious in saying so, because my work in modeling Minsky's Financial Instability Hypothesis (Keen 1995) had confirmed one aspect of his theory, the capacity of government spending to prevent a debt crisis that would have occurred in a pure credit economy.

Statements that a crisis may occur were edited out of this edition, because the crisis has occurred after the Subprime Bubble, which was in the background during the DotCom Bubble, finally burst as well.1 But these pre-crisis statements remain important, because they indicate that, without the blinkers that neocla.s.sical economic theory puts over the eyes of economists, the crisis now known as the Great Recession was not an unpredictable 'Black Swan' event, but an almost blindingly obvious certainty. The only question mark was over when it would occur, not if.

This brief chapter therefore provides excerpts from the first edition on the likelihood of a crisis as seen from the vantage point of non-neocla.s.sical economics and in particular, Minsky's 'Financial Instability Hypothesis' in 2000 and early 2001. I hope these pre-crisis observations persuade you to reject the 'n.o.body could have seen this coming' smokescreen. Rather than being a 'Black Swan', the Great Recession was a 'White Swan' made invisible to neocla.s.sical economists because their theory makes them ignore the key factors that caused it: debt, disequilibrium, and time.

The destabilizing effect of neocla.s.sical economics The belief that a capitalist economy is inherently stabilizing is also one for which inhabitants of market economies may pay dearly in the future. As they were initially during the Great Depression, economists today may be the main force preventing the introduction of countervailing measures to any future economic slump. Economics may make our recessions deeper, longer and more intractable, when the public is ent.i.tled to expect economics to have precisely the opposite effect.

Fortunately for economists, the macroeconomy at least in the United States appeared to be functioning fairly well at the end of the year 2000. It is thus possible for economists to believe and preach almost anything, because they can bask in the entirely coincidental fact that the macroeconomy appears healthy.

However, this accidental success may not last long if the pressures which have been clearly growing in the financial side of the economy finally erupt (Keen 2001a: 213).

Possibility of debt deflation in the USA.

If a crisis does occur after the Internet Bubble finally bursts, then it could occur in a milieu of low inflation (unless oil price pressures lead to an inflationary spiral). Firms are likely to react to this crisis by dropping their margins in an attempt to move stock, or to hang on to market share at the expense of their compet.i.tors. This behavior could well turn low inflation into deflation.

The possibility therefore exists that America could once again be afflicted with a debt deflation though its severity could be attenuated by the inevitable increase in government spending that such a crisis would trigger. America could well join j.a.pan on the list of the global economy's 'walking wounded' mired in a debt-induced recession, with static or falling prices and a seemingly intractable burden of private debt (ibid.: 254).

The likelihood of a j.a.panese outcome for America after the crash.

Only time will tell whether the bursting of the Internet Bubble will lead to as dire an outcome as the Great Depression. Certainly, on many indicators, the 1990s bubble has left its septuagenarian relative in the shade. The price to earnings ratio peaked at over one and a half times the level set in 1929, the private and corporate debt to output ratio is possibly three times what it was prior to the Great Crash, and prices, though rising in some sectors, are generally quiescent. On all these fronts, Fisher's debt-deflation theory of great depressions seems a feasible outcome.

On the other hand, Minsky argued that 'Big Government' could stabilize an unstable economy, by providing firms with cash flow from which their debt commitments could be financed despite a collapse in private spending. Certainly, the US government of 2000 is 'big' when compared to its 1920s counterpart, and its automatic and policy interventions will probably attenuate any economic crash to something far milder than the Great Depression. What appears more likely for post-Internet America is a drawn-out recession like that experienced by j.a.pan since its Bubble Economy collapsed in 1990 (ibid.: 2567).

The impact of the Maastricht Treaty on Europe during a crisis.

Macroeconomics is economic policy par excellence, but economic theory itself has virtually reached the position that there should be no macroeconomic policy. The clearest evidence of this is the Maastricht Treaty, which made restricting budget deficits to no more than 3 percent of GDP a condition for membership of the European Union. While some fudging has been allowed to make membership possible in the first place, when an economic crisis eventually strikes, Europe's governments may be compelled to impose austerity upon economies which will be in desperate need of a stimulus (ibid.: 21213).

The Efficient Markets Hypothesis encouraging debt-financed speculation.

[According to the Efficient Markets Hypothesis] The trading profile of the stock market should therefore be like that of an almost extinct volcano. Instead, even back in the 1960s when this [Sharpe] paper was written, the stock market behaved like a very active volcano. It has become even more so since, and in 1987 it did a reasonable, though short-lived, impression of Krakatau. In 2000, we saw 25 percent movements in a week. October 2000 lived up to the justified reputation of that month during bull markets; heaven only knows how severe the volatility will be when the bubble finally bursts (ibid.: 232).

What can I say? By promulgating the efficient markets hypothesis, which is predicated on each investor having the foresight of Nostradamus, economic theory has encouraged the world to play a dangerous game of stock market speculation. When that game comes unstuck, America in particular will most likely find itself as badly hobbled by debt as j.a.pan has been for the past decade. This speculative flame may have ignited anyway, but there is little doubt that economists have played the role of petrol throwers rather than firemen. When crisis strikes, conventional economists will be the last people on the planet who can be expected to provide sage advice on how to return to prosperity unless, as often happens in such circ.u.mstances, they drop their theoretical dogmas in favor of common sense.

When the Great Crash of 1929 led to the Great Depression of the 1930s, many of the erstwhile heroes of the finance sector found themselves in the dock. It is unlikely that any particular economists will find themselves so arraigned, but there is little doubt that economic theory has been complicit in encouraging America's investing public to once again delude itself into a crisis (ibid.: 256).

Deregulation and crisis.

Deregulation of the financial sector was not the sole cause of the financial instability of the past twenty years. But it has certainly contributed to its severity, by removing some of the limited constraints to cyclical behavior which exist in a regulated system.

These deregulations were mooted as 'reforms' by their proponents, but they were in reality retrograde steps, which have set our financial system up for a real crisis. I can only hope that, if the crisis is serious enough, then genuine reform to the finance sector will be contemplated. Reform, of course, cannot make capitalism stable; but it can remove the elements of our corporate system which contribute most strongly to instability.

The major inst.i.tutional culprit has to be the finance sector itself, and in particular the elements of the stock market which lead to it behaving more like a casino than a place of reasoned calculation [...]

Surely, when the Internet Bubble really bursts, it will be time to admit that one fundamental excess of the market as currently organized is its ability to allow sky-high valuations to develop (ibid.: 2556).

The history of crises causing and not causing paradigm shifts in economics This is far from the first book to attack the validity of economics, and it is unlikely to be the last. As Kirman commented, economic theory has seen off many attacks, not because it has been strong enough to withstand them, but because it has been strong enough to ignore them.

Part of that strength has come from the irrelevance of economics. You don't need an accurate theory of economics to build an economy in the same sense that you need an accurate theory of propulsion to build a rocket. The market economy began its evolution long before the term 'economics' was ever coined, and it will doubtless continue to evolve regardless of whether the dominant economic theory is valid. Therefore, so long as the economy itself has some underlying strength, it is a moot point as to whether any challenge to economic orthodoxy will succeed.

However, while to some extent irrelevant, economics is not 'mostly harmless'. The false confidence it has engendered in the stability of the market economy has encouraged policy-makers to dismantle some of the inst.i.tutions which initially evolved to try to keep its instability within limits. 'Economic reform,' undertaken in the belief that it will make society function better, has instead made modern capitalism a poorer social system: more unequal, more fragile, more unstable. And in some instances, as in Russia, a naive faith in economic theory has led to outcomes which, had they been inflicted by weapons rather than by policy, would have led their perpetrators to the International Court of Justice.

But even such a large-scale failure as Russia seems to have little impact upon the development of economic theory. For economics to change, it appears that things have to 'go wrong' on a global scale, in ways which the prevailing theory believed was impossible. There have been two such periods this century.

The first and most severe was the Great Depression, and in that calamity, Keynes turned economic theory upside down. However, Keynes's insights were rapidly emasculated, as Chapter 9 showed. 'Keynesian economics' became dominant, but it certainly was not the economics of Keynes.

The second was the 'stagflationary crisis' the coincidence of low growth, rising unemployment and high inflation during the 1970s. That crisis led to the final overthrow of the emasculated creature that Keynesian economics had become, and its replacement by an economic orthodoxy which was even more virile than that against which Keynes had railed.