Cracks in the German Economic Orthodoxy: Is Economic Theory Detached From Reality?

New economic thinking is creating change in Germany.

The latest evidence is from German business magazine Wirtschaftswoche, which recently published an article arguing that economic theory is detached from reality.

The article suggests that economists had only realized recently that the “homo oeconomicus” paradigm is misleading, when other social sciences such as philosophy and sociology had come to that conclusion long ago. Journalist Dieter Schnaas writes(all quotes translated from German):

“The economists are still hesitating to depart from the classic theory of market harmony – even though Adam Smith (in this regard) has seen Schumpeter put the final nail in his coffin. They still cling to their desire to explain markets according to natural laws, although word should have got round by now that no market has ever been immune to political influence and that people are not entirely predictable, rational beings. At the same time we see Robert Shiller, George Akerlof and Daniel Kahneman being celebrated as innovators in the field for precisely this “finding” and honored with Nobel prizes for the “discovery” of irrationality. Why is this? Because they no longer reduce people to bundles of rationality, but instead to stimulus response machines?

Schnaas continues his criticism of economics by noting seminal thinkers in other disciplines that economics has too long ignored:

“Ultimately the guardians of the temple of individual freedom, of self interest, of the Homo economicus: could it really be that the world of economics has systematically bypassed the relevant literature on sympathy (Adam Smith), pity (Jean-Jacques Rousseau), the division of labor in society (Émile Durkheim) and recognition (G.W.F. Hegel)? Haven’t the economists heard that community, friendship, family and couple relationships have been established since the time of Aristotle as meaningful alternatives to the methodological individualism that continues to dominate their theoretical models?”

It is long past time for economics to include the wisdom of other social science, and Schnaas looks to past economic thinkers who recognized this, including Hayek, for inspiration:

“For Hayek it is clear that ‘truly fertile research requires a very diverse combination of different kinds of knowledge and understanding,’ and that economics is above all a life science that should not only work with formulas, but also make use of herneutic (interpretational) methods. Economics, in Hayek’s view, should not only turn its gaze inward and aim for empirical proof of properties inherent in the system. It should also interpret itself, embed itself in a cultural and historical context. Otherwise it is not a science of people but a science of numbers that disavows its own basic assumption – methodological individualism – by describing people as total quantities, as aggregated bundles of data. Hayek: ‘No one can be a great economist simply by being an economist, and I am even tempted to add that someone who is only an economist can easily become a nuisance, if not a real danger.’”

And finally, Schnaas criticizes equilibrium theories of capitalism and markets:

“Stabilized capitalism is a contradiction in terms. Capitalism is change. Its tense is not the present but the future. Its modes are not cycle and repetition but expansion and transformation. Its money is not accumulated wealth (capital) but created promises (credit). As such, the science of capitalism should also think of itself as an open path of knowledge, as an interface between disciplines, as a constant attempt to build up and tear down one analytical construction after another in a never-ending sequence – just like Joseph Schumpeter always preached. Not one single game, demand, trade cycle or margin utility theory will show us the way into the future, but the capitalist imperative: Always think new ideas into the open!”

Schnaas’s critique of classical economics in a prominent German business magazine shows that the cracks are showing in the old paradigm and that more and more people can see them. These people are now looking to new economic thinking to create more realistic and relevant models of capitalism and markets, models that place real human beings at the center of their analysis, not the cartoonish facsimiles of orthodox economics.