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Zombie Economics

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Zombie Economics

John Quiggin, an Australian economist, has written a book entitled “Zombie Economics” in which he discusses a number of economic theories that should have been entirely discredited by the recent financial and economic crises. Yet many of these theories live on. Paul Krugman has even noted (December 19 column, New York Times) that not only do many live on, but they also seem to have taken on new prominence.

Krugman stated: “When historians look back at 2008-10, what will puzzle them most, I believe, is the strange triumph of failed ideas. Free-market fundamentalists have been wrong about everything – yet they now dominate the political scene more thoroughly than ever.”

While he goes on to cite a few examples of zombie economic doctrines, he and most other economists miss the most important ones. To relegate the following to the trash bin would shake the very foundations and credibility of economics.

Topping my list of zombie economic theories is the perfect competition paradigm that underlies most economic theories. To begin with, this model is logically flawed. It cannot produce stable outcomes, except in an abstract mathematical framework. Where markets even begin to bear some resemblance to this competitive model, instability and destructive competition characterize the real-world marketplace. Consider financial markets, or the US airline industry post-deregulation in the late 1970s. (Deregulation was based in part on the failed doctrine of contestability.)

Moreover, perfectly competitive markets cannot be innovative or productive. They only can be technologically backward and unproductive. Consider the agricultural sector prior to the late 19th century.

And perfect competition has nothing to do with competition or rivalry. Indeed, there is nothing that resembles what we view as real competition. Introducing the ideas of Michael Porter would make it immediately clear that perfect competition cannot persist, nor should it. Even Krugman’s trade models would fall apart.

Next on my list, and related to the perfect competition paradigm with its concepts of supply and demand, is the assumption (and theories are just a set of assumptions) that markets, especially perfectly competitive ones, adjust automatically and predictably to external shocks. (Interestingly, in market structures other than perfect competition, there are no supply curves.) At a macroeconomic level, this zombie theory would have us believe that the US economy would have recovered from the financial crisis without any government or Federal Reserve intervention.

Maybe, but at what cost? The theory does not address this question. Yet this is the question that matters, for if the “natural” adjustment would take years and result in unemployment rates in the 20% range, then “natural” adjustment is just a fraud.

The critics of government intervention in 2008 and 2009 somehow believe that the world would have been a much better place if none of the intervention had occurred. They can never prove their supposition. But isn’t it better to believe in fairy tales supportive of your political ideology than in reality, which makes a mockery of your ideology? It is very difficult for anyone to admit that her/his life’s work has been a sham.

Finally, the zombie notion of markets as structures unfettered by government rules. Yes, markets can exist without government imposed and enforced rules. But anarchy would prevail and someone, usually the gang with the most firepower and the most sadistic, would set the rules. Organized crime has been doing this for centuries.

Rules are needed for they provide structure to markets and enable the participants to have confidence in playing in these markets. Rules make markets more efficient. But to be effective, the rules have to be enforced; otherwise, we get the financial crisis fiasco where the US Congress put pressure on the regulators to go soft on enforcement.

There are numerous other examples of zombie economic theories – the efficient market hypothesis, purchasing power parity, rational expectations, almost any theory of exchange rates, etc. The examples I have highlighted though should it make it clear that economic theory is in need of a major overhaul.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.


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