The “mainstream-orthodox” economics is the field of economics that is focused on analyzing the optimizing behaviour and the resulting equilibrium of individuals who are assumed to be fully rational and well informed in a static context. It heavily relies on the assumption that individuals are rational and that the invisible hand works efficiently enough to not demand government intervention.
Adam Smith’s theory of non-interference of the government in the economy was proven wrong during the Great Depression, and Keynesian Economics entered the mainstream then. Similarly, orthodox economics which is considered to be mainstream to some extent has become outdated, and demands newer methodologies to establish new theories. This is because orthodox economics has several limitations even though it is widely accepted by most elites within the Economics discipline.
Firstly, and very importantly, the assumptions made in mainstream orthodox Economics are quite unrealistic. The assumption of the rationality of the consumer is one of them. Consumers may not practice utility maximisation due to social constraints. This could be because consumers may be unable to identify the utility/profit-maximising choice points due to the limited availability of information and several other variables, such as carefully targeted advertising. It poses a meaningless assumption and is too general to test.
Secondly, mainstream-orthodox economics has a laissez-faire outlook on the role of government in the working of the economy, i.e., the market should be left alone. Adam Smith theorised that in case of a recession, the market corrects itself and government intervention is universally harmful to the economy. The Great Depression proved this wrong. Paul Krugman wrote,
“Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system.”
Keynes and Hicks argued that the market doesn’t self-correct swiftly in the short run, as prices and wages are sticky and take time to adjust. They claimed that government intervention by using monetary and fiscal policies during a recession is necessary for the revival of the economy.
Thirdly, we shall discuss the impracticality of the multiplier effect. After the Great Depression, Keynesian Economics eventually became a part of mainstream economics. Keynes pointed out that government spending in the economy ultimately prompts more spending in the economy. The initial change in the spending causes a ripple effect in the economy and leads to more total spending and the total amount depends on how much people spend on the new income. This is what Keynes called the marginal propensity to consume, the more people spend, the larger the multiplier effect. In real life, the idea of expansionary fiscal policy becomes tricky. The Multiplier effect is difficult to calculate, as it doesn’t give us a clear answer on knowing how much should the government spend and in which sector.
Another mainstream orthodox concept happens to be that of free trade. Although free-market orthodoxy has its benefits with regards to poverty reduction and increasing living standards in developing countries, it has also created problems. Free market tends to generate winners and losers within a country, thereby potentially causing inequality in developed countries. In addition to this, free markets tend to be very unstable. Keynes had argued that capitalism has periods of boom and bust economic cycles, which would lead to mass unemployment. One of the major downfalls of the free market is the negative externalities that it causes. For example, free markets avoid the negative implications of producing goods at a cheaper cost, which adversely affects the long term stability of the ecosystem. Stan Sorscher, in his article on market failures in 2013 commented:
“If the study of free trade were moved from economics departments in universities to mathematics departments, it would be discredited on logical grounds by the end of the first day… It is worth noting that conventional free trade theory is considered largely irrelevant in business schools, where students learn the realities of how to move capital and production around the world.”
The economists who have different views as compared to orthodox economists are marginalized in the field. They are looked down upon and their opinions are often ridiculed. One such economist with dissimilar views as the orthodox economists was Raghuram Rajan, who was then associated with the University of California. He presented a paper in 2005, about how financial markets were taking on high levels of risk which could be potentially dangerous for the economy, for which he was sidelined in the economics community.
It becomes imperative to acknowledge the American economist- Michael Perelman’s contribution when orthodox economics is critiqued. His book Railroading Economics (2006) is considered as one of the classics where the practices of conventional economics are thoroughly and critically analysed. The Efficient-Market Hypothesis (EMH) failed at recognising the housing bubble which led to the 2008 financial crash and was even accused of inflating the unperceived bubble. According to the EMH, the asset prices are equal to their true economic value, and hence it becomes impossible to outperform the market. EMH, like many other orthodox concepts, also supports unrealistic assumptions like market efficiency and availability of perfect information which ultimately led to a serious blow to its validity after the market crash.
Such limitations have prompted action from economists all around the world. Academicians want economic thoughts other than that of mainstream economics to be taught in parallel, which would help in predicting the future trends of the economy better. Paul Krugman in his book Development, Geography, and Economic Theory (1995) stated that the reason some economic theories are not widely engaged by economists is because they cannot be modelled mathematically. He argued,
“The unwillingness of mainstream economists to think about what they could not formalize, led them to ignore ideas that would’ve turned out to have been very rewarding ones.”
Several theoretical approaches opposed the mainstream-orthodox theory like Austrian economics, Feminist economics, Marxian-radical Economics, post-Keynesian economics etc. This diversity was later grouped as Heterodox Economics. There have been many impressive developments in the field of Heterodox economics, most admirable, in my opinion, being that of the budding field in Neuro economics- a joint effort of economists, psychologists and neuroscientists to examine how economic decision-making actually happens inside the brain, which, at a point was considered impossible. Another major stream that emerged as a result of the financial crisis was the study of Behavioural Economics, to examine and identify the main psychology behind financial decision making, and has so far uncovered many biases prevalent in human nature that prohibits the markets to be efficient and promotes the spread of asymmetric information.
In conclusion, Orthodox Economics doesn’t seem to have the appropriate tools for understanding the workings of modern Economic and social life. The economic models introduced in Orthodox Economics are mere abstractions and happen to be far from an accurate portrayal of reality. From the railroads in the nineteenth century, the Great Depression of 1929, the Savings and Loans scandals of the 1980s, to the housing bubble induced financial crisis of 2008, the market predictions of orthodox economists have been extremely erroneous. Orthodox Economics should be considered as a foundational step to help formulate more advanced and contemporary economic theories which would capture the complexities of the real world in its true sense, and make more accurate predictions of the future, instead of attempting to explain it by making unrealistic assumptions.
1. Stan Sorscher (2013): Opinion | The 4 (or 5) Worst Market Failures in Human History. Retrieved July 7, 2021 from The 4 (or 5) Worst Market Failures in Human History
2. Paul Krugman (2002): How Did Economists Get It So Wrong? Retrieved July 7, 2021 from https://www.nytimes.com/2009/09/06/magazine/06Economic-t.html
3. Krugman, P. (1997). Development, Geography, and Economic Theory. Cambridge: MIT Press, 1997
4. The Investopedia Team (2020): Can Efficient Market Hypothesis Explain Economic Bubbles? Retrieved July 20, 2021 from https://www.investopedia.com/ask/answers/042015/can-efficient-market-hypothesis-explain-economic-bubbles.asp
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