Unlearning Economics - Why Economists Are So Bad At Economic Forecasting

Nate Hagens Discusses with Jon Erickson, Josh Farley, Steve Keen & Kate Raworth

Why are economic forecasts often so wrong when economics plays such a central role in shaping our understanding of the world and the policies that govern it.

In the video below, Nate Hagens discusses the dominant economic theories taught in universities and applied in decision-making with a group of unconventional thinkers. These economists argue that mainstream economic ideas fail to capture the complexities of human behaviour, the importance of energy in the economy, and the true meaning of societal well-being.

“Inexact sciences like economics advance funeral by funeral,” Paul Samuelson

I recommend you watch the video but as it is one hour and forty minutes long, I have summarised the key arguments put forward by these economists and explore the implications of their ideas for our understanding of the economy and our ability to address pressing global challenges.

Questioning the Rational Economic Man

One of the core assumptions of traditional economic theory is the concept of Homo economicus, or the rational economic man. This hypothetical individual is believed to make perfectly rational decisions based on self-interest, always seeking to maximise personal gain. However, Jon Erickson, an economist from the University of Vermont, argues that this view of human behaviour is fundamentally flawed.

Erickson points out that humans are social creatures with a long evolutionary history of cooperation and care for others. Our behaviour is influenced not just by self-interest, but also by our environment, culture and the institutions around us. By ignoring these factors and focusing solely on individual rationality, mainstream economics creates a distorted picture of human decision-making that fails to account for the ways in which people can act in the interest of their friends, families and communities.

“All models are wrong, but some are useful” George Box

Moreover, Erickson argues that the assumption of rational economic man has become a self-fulfilling prophecy. As economic theories based on this idea have gained prominence, they have shaped the way we design institutions and policies, creating a world that rewards self-interested behaviour and discourages cooperation. This, in turn, reinforces the belief that humans are inherently selfish, creating a vicious cycle that further entrenches the flawed assumptions of mainstream economics.

The Energy Blind Spot

Another major shortcoming of conventional economic theory, according to Steve Keen, a prominent critic of mainstream economics, is its failure to properly account for the role of energy in the economy. Keen argues that standard economic models treat energy as just another input, failing to recognise its unique and essential role in enabling all economic activity.

"My dear Kepler, I wish that we might laugh at the remarkable stupidity of the common herd. What do you have to say about the principal philosophers of this academy who are filled with the stubbornness of an asp and do not want to look at either the planets, the moon or the telescope, even though I have freely and deliberately offered them the opportunity a thousand times? Truly, just as the asp stops its ears, so do these philosophers shut their eyes to the light of truth." Galileo Galilei

Keen points to the strong correlation between energy consumption and economic growth, noting that periods of rising energy use are closely tied to periods of economic expansion. He argues that the failure to account for energy has led economists to create models that paint an overly optimistic picture of the economy's ability to grow indefinitely, even in the face of resource constraints and environmental challenges like climate change.

Here is where I disagree with Keen. On one hand he and the other economists are pointing out how group-think has ruined economics whilst on the other failing to question the climate change group think. Nevertheless, he never directly mentions anthropogenic climate change and as none of us can predict the future, we should still listen to these radical thinkers.

Keen says that if economists don't properly account for the role of energy in the economy, they may underestimate the costs of transitioning to a low-carbon future and overestimate the feasibility of continued economic growth in a world of finite resources. Keen argues that we need a new approach to economic modelling that puts energy at the centre, recognising its essential role in powering our economies and the need to transition to sustainable energy sources.

Again, I agree with Keen that we should put energy at the centre of economic models but disagree on the transition to a low-carbon future. At the moment, this would send us back to the dark ages but I am open to the theory that the energy cost to extract energy is rising, so will continue to take on board what he says.

The Limits of Market Efficiency

Josh Farley, another economist from the University of Vermont, challenges the idea that markets are always the most efficient way to allocate resources. While markets can be effective in many situations, Farley argues that they often fail when it comes to essential resources like food, water, and energy.

The problem, according to Farley, is that markets allocate resources based on people's ability to pay, rather than their actual needs. This can lead to situations where the wealthy continue to consume large amounts of resources, while the poor struggle to meet their basic needs. In the case of food, for example, Farley points out that rich countries often waste enormous amounts of food, while millions of people in poor countries go hungry.

Farley argues that in cases like these, market allocation can lead to perverse outcomes that undermine societal well-being. He suggests that alternative approaches, such as rationing based on need rather than wealth or promoting open access to knowledge and resources, may be more effective in ensuring that essential resources are distributed fairly and sustainably.

Redefining Economic Success

Kate Raworth, the creator of Doughnut Economics, takes aim at the way we measure economic success. She argues that the most commonly used metric, Gross Domestic Product (GDP), is a poor gauge of societal well-being, as it fails to account for important factors like income inequality, environmental degradation, and the value of unpaid work.

Raworth proposes a new framework, called Doughnut Economics, which aims to create an economy that meets the needs of all people within the means of the planet. This approach recognises that the economy is embedded within society and the environment, and that economic activity should be designed to promote human well-being and ecological sustainability, rather than simply maximising GDP growth.

Central to the Doughnut Economics framework is the idea of the "social foundation" and the "ecological ceiling." The social foundation represents the minimum standard of living that all people should be able to achieve, including access to food, water, healthcare, education, and other essential resources. The ecological ceiling represents the planetary boundaries that we must stay within to avoid catastrophic environmental damage, biodiversity loss, and pollution.

Raworth argues that the goal of economic policy should be to bring all people above the social foundation while staying within the ecological ceiling. This requires a fundamental shift in our understanding of what the economy is for, moving away from the pursuit of endless growth and towards the creation of a regenerative and distributive economy that works for both people and the planet.

The Path Forward

Changing the way economics is taught and practiced is no easy task, as the mainstream paradigm is deeply entrenched in academia and policy circles. However, the economists in this video argue that change is both necessary and possible.

They point to the growing interest in alternative economic ideas among students, researchers, and policymakers, as well as the urgent need to address pressing global challenges like inequality. By continuing to push the boundaries of economic thinking and engaging with real-world problems, they believe that we can create a new economic paradigm that is more in tune with the realities of human behaviour, the importance of energy, and the need for sustainable and fair development.

Conclusion

The ideas put forward by Jon Erickson, Steve Keen, Josh Farley, and Kate Raworth represent a powerful challenge to the conventional wisdom of mainstream economics. By questioning long-held assumptions about human behaviour, the role of energy, the efficiency of markets, and the meaning of economic success, these thinkers are opening up new possibilities for understanding and shaping our economic future.

As we grapple with the profound challenges of the 21st century it is clear that we need a new economic paradigm that can help us navigate these complex issues. It is clear that current economic thinking does not work and is slow to change because it disproportionately benefits those who are part of that system.

The alternative perspectives offered by these economists provide a valuable starting point, encouraging us to question the status quo, embrace new ways of thinking, and work towards an economy that truly serves the needs of both people and the planet.