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The Five Stages of Economic Grief (Stage 3)

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By David Orrell

David Orrell reviews Rodrik D (2015) Economics Rules: The Rights and Wrongs of the Dismal Science, New York: Norton.








In her 1969 book, On Death and Dying, the Swiss psychiatrist Elisabeth Kübler-Ross identified five separate stages or aspects of the grief process. These were denial, anger, bargaining, depression, and acceptance.

The field of economics experienced a traumatic loss during the financial crisis, which left Alan Greenspan in what he called in 2008 testimony “a state of shocked disbelief.” Economists (at least those in the mainstream) are now working their way slowly through the grief progress, as they realise that their treasured economic models not only failed to predict the crisis, but played an active role in creating it.

I have written elsewhere about the first two stages, namely denial and anger. A 2014 article for World Finance magazine asked “Is economics in a state of denial?” (the answer was: yes), while 2015’s “Book burning economists” discussed the anger that some economists were venting on certain critics (e.g. me). The next stage – and the theme of this book review – is “bargaining”. Part of this is bargaining with the future – if we follow certain rules perhaps we can put things right – but another is a kind of retroactive bargaining with the past, saying that the event would not have occurred if only such-and-such had happened.

A case in point is Economics Rules: The Rights and Wrongs of the Dismal Science, by Dani Rodrik of Harvard University, which sets out to explain “why economics sometimes gets it right and sometimes doesn’t.” Rodrik’s conclusion is that mathematical models “are both economics’ strength and its Achilles’ heel.” On the one hand they offer a degree of clarity and consistency which is not possible with purely verbal descriptions. However they are easily misused or taken out of context.

Telling a story

As Rodrik points out, models are best seen as a kind of story. No single model can accurately capture every detail of the economy, but it can illuminate some aspect of the system. The trick is therefore to choose which model is the most suitable for any particular situation. (Or – better – we can use a mix of theories, while keeping in mind what Keynes referred to in his General Theory of Employment, Interest, and Money as “the necessary reserves and qualifications and the adjustments which we shall have to make later on.”) One conclusion is that very large and general models, of the sort often favoured by macroeconomists, are not very useful: “I cannot think of an important economic insight that has come out of such models. In fact, they have often led us astray.”

Rodrik also acknowledges that most economists missed the causes of the financial crisis, with some notable exceptions who were quickly shouted down (such as the IMF’s Raghuram Rajan, who in 2005 told an audience of central bankers including Alan Greenspan and Ben Bernanke that financial innovation had introduced new risks into the financial system, only to be called a “Luddite” by Larry Summers).

According to Rodrik, the reason that the profession did not cover itself in glory before and during the crisis was that leading economists had bought into the dominant efficient market paradigm which saw markets “not only as inherently efficient and stable, but also as self-disciplining.” Regulators just had to get out of the way and the invisible hand would do its job. However, economists use all kinds of models in their work, and “what makes this episode particularly curious is that there were, in fact, plenty of models to help explain what had been going on under the economy’s hood.”

If only they had chosen the right model, perhaps something could have been done! Indeed one such model, which Rodrik does not mention, is that of Hyman Minsky, whose work on financial stability became famous after the crisis, but was all but unknown before it; an assessment published a year after his 1996 death concluded that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.” Curious indeed.

Rodrik also seems a little surprised by claims, from student-based groups such as Manchester University’s Post Crash Economics Society, that economics is overly narrow and lacks pluralism. “How do we understand these complaints,” Rodrik asks, “in light of the patent multiplicity of models within economics?”

A possible reason might be that economists have what he notes is a “guild mentality” which “renders the profession insular and immune to outside criticism.” He observes in a couple of places that “Only card-carrying members of the profession are viewed as legitimate participants in economic debates.” But later he cites the influence of behavioural psychologists and so on to conclude that “the view of economics as an insular, inbred discipline closed to outside influence is more caricature than reality.”

His answer instead is that there is nothing wrong with economics per se, there is just a communication problem. Most economists are poor at presenting their arguments to the public, because they “see themselves as scientists and researchers whose job it is to write academic papers.” Also undergraduate students at Manchester, or Rodrik’s Harvard where students launched their own protest in 2011, obviously don’t get exposed to the full rich diversity of economic thought. Though this still doesn’t quite explain why, as Cambridge University economists Ha-Joon Chang and Jonathan Aldred wrote in 2014, their subject “is the only academic discipline in which a significant and increasing number of students are in an open revolt against the content of their degree courses.”

Good grief

Rodrik concludes his book with “Ten Commandments” – though “bargaining points” might be a better term – for economists, and ten for noneconomists. The latter includes “If you think all economists think alike, attend one of their seminars” and “If you think economists are especially rude to noneconomists, attend one of their seminars” (as if rudeness were a sign of healthy debate). However there is no such exhortation for economists to attend seminars outside their own field; and indeed the book makes little attempt to find out what these complaints from students, heterodox economists, and other non-card carriers actually are.

For example, one of the major criticisms of economic models is that they rarely account for the effects of money, banks, credit, or the financial sector. This omission, which played a hugely important role in the crisis, is beyond curious, it is downright bizarre; but as with other such books to gurgle out of the mainstream there is hardly any mention of money, apart from the observation that phenomena such as bubbles and bank runs have been known about for a long time. Nor does the book come to grips with the interesting questions of why theories of non-conformists such as Minsky were sidelined, or why the field’s core teachings of efficiency, rationality, etc. came to be so perfectly aligned with the PR needs of the financial sector.

Economics Rules offers many useful and valid insights into the nature of economic models, but attempts to rationalise away the problems which confront the field rather than face them squarely. So here is not a commandment, but a gentle suggestion to economists in this difficult time: let’s try to get stage 4 (depression) over with quickly, it’s time for stage 5: acceptance.

Stay tuned.

From: pp.12-13 of World Economics Association Newsletter 6(1), February 2016

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7 responses

  • Marco Saba says:

    Bank money created as deposit is defined as ‘cash’ in current international accounting standards, so it must be accounted for as cash in the same bank cash flow statement – which currently is not.

    (See here: Cash Flow Accounting in Banks— A study of practice, Ásgeir B. Torfason, University of Gothenburg, 2014 )

    By accounting for money created as an inflow in the cash flow accounting you solve most of the current issues:

    1) the surfacing of ‘electronic money seigniorage’ that now is hidden;

    2) banks will never again ‘go under’;

    3) there will be no more unbalances in the inter-central bank clearing systems (in the TARGET2 currently there is an unbalance of 62 billion euro, this is in the Eurosystem);

    4) real profits of bank activity – either central bank and commercial banks – are exposed and can be taxed relaxing the issue of government debt;

    5) by making banks responsible for money creation – by making them ‘accountable’ in accounting terms – the moral hazard is decreased;

    6) the central authority can know how much money is really circulating and best manage the monetary policies;

    7) the macroeconomics models can take into account the money creation side of the economy (actually there is only one open source model that can make right predictions taking in account the money created as an asset for banks – called Minsky – and it is developed by professor Keen from Australia):

  • Dick Burkhart says:

    Great review, David, but I would go further. I say that economics, as an academic discipline, needs a new paradigm.

    First, it must have two aspects: (1) descriptive and (2) normative. For the normative part I nominate three goals: (1) meets the basic needs of all, (2) is sustainable over thousands of years, and (3) is highly egalitarian. Descriptive economics should be able to predict, in a suitable probabilistic or nonlinear chaotic sense, events like the financial crash of 2008 well in advance, with increasing precision in timing, magnitude, and mode as the event approaches. It also should be able to predict long term economic trends, either in terms of probabilities or by the simulation of scenarios, as in the famous Limits-to-Growth studies. Normative economics would (1) argue over the goals and (2) devise controls or guiding principles for economies to achieve those goals in the context of descriptive economics. This is where politics enters big time, in addition to much interdisciplinary work.

    Second, it must cover all human economies from the oldest hunter gatherer tribes to today’s global economy and beyond. This is how you get at the fundamentals, instead of getting stuck in the straight jacket of markets and the like.

    Third, it must be grounded in the natural sciences – physics, chemistry, and biology. The key concept behind the activities and growth or decline of all biological systems is energy, so this must also be the fundamental concept of economics. That is, real world economics is not just a social science.

    Fourth, mathematical models at the broadest level must be based on the nonlinearities and complexities found in historical economies, simple models playing clearly defined subordinate roles, useful for insights into particular situations or for subordinate roles in simulations of more detailed versions of more global models. Today’s climate modeling provides a useful paradigm and is very suggestive of the magnitude of this enterprise and of a multitude of interdisciplinary roles.

    • David Orrell says:

      Dick Burkhart: Agree with your comment though as I wrote in my book Truth or Beauty climate models – which exemplify the mechanistic, unified approach to modelling – may not be the best role model. I would argue that it is better to use a collection of simple models.
      Tom Vischi: I don’t have a good reference, but am busy working on one!

      • Dick Burkhart says:

        David, “a collection of simple models” is pretty much what mainstream economics is today, and that’s the problem. Properly viewed, simple mechanistic models can provide insight into particular circumstances at particular times and locations in history. Instead they become paradigms, such as the “law of supply and demand”, that are used in ideological and political ways far beyond their domains of validity. This is because there is no general theory to constrain them, attempts like micro-economics or equilibrium models having failed spectacularly.

        Non-linear dynamical systems may be formally deterministic, but their behavior can be chaotic, characterized by strange attractors and the like, just like real world economics or weather / climate. For economics, we already know where to start -with the famous limits-to-growth studies of the early 1970s. The techniques of scientific computing show how simpler models, including those of neo-classical theory, may embedded as submodels in the broader non-linear framework so that they are constrained to their regions of validity.

        I’ve participated in this kind of work in aerodynamics, and it has been just as successful in many other areas of applied mathematics and computing. In economics it could be used to develop powerful economic controls or tools by testing them in diverse scenarios after testing the nonlinear dynamical models on all the historical data you could get your hands on. The application of these tools would be continuously updated in real time.

  • Tom Vischi says:

    Thank you for your review, with its nice analogy to the stages of grief — although I think you might be a bit premature or optimistic in suggesting that the economics profession is already moving through those stages.

    You make an interesting point at the end of your review: “Nor does the book come to grips with the interesting questions of why theories of non-conformists such as Minsky were sidelined, or why the field’s core teachings of efficiency, rationality, etc. came to be so perfectly aligned with the PR needs of the financial sector.” Can you suggest some books or articles, perhaps your favorites from among many, that address these questions, especially the latter.

    Recently, business-oriented money has certainly poured into the support of think tanks and research that favor a free market approach, and the entanglements of economists with business and financial interests are now legion. But has mainstream economic thinking and research been strongly influenced by business and financial interests for many years? Or is that a relatively recent phenomenon. And, apart from that, has free market thinking, theorizing, and model building become so dominant at least in part independently of a loyalty to business and financial interests, and because the thinking had its own independent kind of appeal? Probably a mixture of both. As you point out, these are interesting questions, which deserve to be addressed.

  • David Harold Chester says:

    I do not accept that economics, “The Dismal Science”, is in its death throws! Unfortunately and deliberately our science has been deliberately confused and corrupted in the past. But with our modern and more logical ways of thinking, as if the subject was one of engineering instead of from the humanities, can a better path be discerned and followed. Please see my longer comments about the arguments for treating economics as a battle between orthodox and hetro- in the article elsewhere on this website.

  • Peter Swann says:

    David, this is a truly excellent review. I will stay tuned.

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