Book review on the new economics

There follows my latest book review for Fund Strategy. It is on Diane Coyle’s The Soulful Science.

Diane Coyle is annoyed. She argues with considerable justification that economics, the subject in which she has immersed herself for her entire adult life, is caricatured by critics. Those who attack the discipline often do so from a position of ignorance. They are unaware of the huge advances economics has made in the past 20 years.

The Soulful Science is Coyle’s attempt to set the record straight. It is essentially an overview of the key developments in economic thought over the past two decades. With a PhD in economics from Harvard she has the theoretical background to understand often arcane debates. And as a former economics journalist she has the ability to translate them into lucid language.

Summarising, what is itself, a summary of a huge range of ideas is a difficult task. But much of the book focuses on the core idea of “rational economic man”. Neo-classical economy theory was based on the idea that humans were utility maximising, unremittingly rational and had access to perfect information. In other words, humans were assumed to be Vulcan – or at least half-Vulcan – like Star Trek’s logical Mr Spock. Coyle explains how each of these core assumptions has come under attack in the new economics.

The idea of utility maximisation is an old one. It assumes that humans are motivated by a desire to maximise their wealth. As a result of this drive, it is argued, society benefits.

Coyle shows how this core assumption has come under attack in recent years. Environmentalists argue that measures such as GDP do not take into account environmental damage to the economy. Some economists, such as America’s Robert Frank and Richard Layard in Britain, argue that rich countries should pursue happiness rather than further affluence. Others, such as Barry Schwartz, have argued that individuals suffer as a result of the vast amount of consumer choice available.

The idea of human rationality has also been called into question. Economists have increasingly drawn on insights from psychology which show that humans often do not behave rationally. This insight has opened up behavioural economics as an important new field of study with behavioural finance as a key sub-branch. In 2002, Daniel Kahneman and Vernon Smith were awarded the Nobel price for research in this area.

Research into the economics of information has also yielded Nobel prizes. In different ways Joseph Stiglitz, George Akerlof and Michael Spence examined the implications of some people having access to better information than others. Their insights have helped governments to create new markets, such as those involved in trading carbon.

While Coyle is right to argue that critics need to be aware of these developments, it does not follow that the discipline is beyond reproach. On the contrary, both the new-style economists and the old-style neo-classical economists share many key assumptions, despite their differences.

The idea of “economic man” illustrates this point. Both accept as a starting point the idea that the economy, and society more generally, is essentially an aggregate of individuals. Different generations of economists differ over the exact character of the individuals involved but all sides tend to be imbued with this individualistic starting point.

In contrast, classical political economy – including the likes of Adam Smith, Karl Marx and David Ricardo – had a much greater sense of the social. It viewed society as more than a collection of individuals – the human world had to be understood in terms of the web of social relations around which life is organised. For example, organising society around the principle of profitability had direct consequences for the operation of laws that govern social interaction.

The current generation of economists use the word “social” a lot, but the sense in which they use it is limited. In contemporary parlance the term “social” refers to interpersonal relations. For example, “social networks” means the personal relationships between individuals. In contrast, “social” in the older sense of the term referred to the set of relations around which production and consumption were organised.

This diminished sense of the social helps to explain why contemporary economics tends to be so ahistorical. Economists can happily make generalisations about the operation of institutions 10 years ago, 1,000 years ago – even 10,000 years ago. They fail to see what is specific to market relations and underestimate the importance of changes over time.

Coyle’s discussion of utility is a perfect example of this lack of sensitivity to historical shifts. The shift away from emphasising utility to one focusing on happiness is not primarily the result of theoretical development by economists. The economists’ discussion reflects a broader disaffection with economic growth and prosperity in society at large. Since the 1970s it has become increasingly common for the benefits of mass affluence to be called into question. This anxiety about popular prosperity then, itself, has to be explained in terms of broader social changes.

From this wider perspective it is clear that Coyle is wrong to portray the emphasis on happiness as more human than the focus on economic growth. On the contrary, the immense benefits of a society based on affluence have made it easier for humans to realise their potential. In contrast, the happiness agenda reduces humans to the level of cows chewing grass in a field. The advocates of happiness would have us pursue individual contentment in the narrowest sense of the term rather than more demanding objectives.

The Soulful Science should be read by anyone who wants a lucid and authoritative introduction to contemporary economic thought. But the limitations of the new economics have themselves to be fully investigated.