Crisis in Economics?

To the unforgettable memory of László Antal

CRISIS IN ECONOMICS?

Studies in European Political Economy

by László Csaba

ISBN 978 963 05 9101 0

First edition in English language, 2009

© László Csaba, 2009

© Akadémiai Kiadó, Budapest, 2009

Published by Akadémiai Kiadó

Member of Wolters Kluwer Group

P.O. Box 245, H-1519 Budapest, Hungary

www.akademiaikiado.hu

All rights reserved. No part of this book may be reproduced by any means or transmitted or translated into machine language without the written permission of the publisher.

Part One

PURE THEORY

I. INTRODUCTION: WHY EUROPEAN POLITICAL ECONOMY IN AN AMERICANIZED DISCIPLINE?

The financial meltdown of 2007–2009 has produced a series of claims inside and outside the economics professions maintaining that the currently available toolkit of the profession is next to no use. Calls for creating a brand new version of analyzing economic matters and discontinuing the tradition of the past 150 years of analytical social sciences can be heard at every corner and read in every paper. Therefore, we find it timely and legitimate to ask some of the fundamental questions about economics as a discipline, its methodology, relevance and applicability on subjects of the real world. In doing so, we first have to ask how we got there and where we are now.

The evolution of economic science has taken a resolute turn since the late 1970. This is reflected, inter alia, in the unprecedented geographical concentration of Nobel Prizes in Economics, having been awarded in about 95 per cent to scholars who have spent all, or at least most, of their productive years in the United States of America.[1] This cannot be taken as historically given, neither as a consequence of the enhanced financing and technological conditions of research, economies of scale and scope, which is the case in the natural sciences.

One of the most influential authors, Alan Blinder (1999), also highlights the growing Americanization and equates it with professionalization. For him, this is a synonym for the extensive – or perhaps often exclusive – use of econometric and mathematical techniques, which are considered sine qua non features of scientific analysis. The quality of their mastery is, at least in the mainstream form, decisive over its publishability, respectability and, indeed, its seriousness. In terms of language, sophistication, presentation and even issue areas, it has demonstrably narrowed the field in geographicaly terms. This cannot be overshadowed by the increasing presence of authors of previously less appreciated background, such as Chinese, Spanish Indian or Greek origin, as they tend to work, or be organically integrated to, the research networks of the big US schools.

Others, most notably József Móczár (2008: 18–24, 286) in his broad summary of mathematical economics, attribute this development to the economies of scale and scope of the academic market in the United States, which reflects the generally competitive economic arrangements of the country. While we shall try to get into the nitty-gritty of both sweeping claims, it still remains puzzling that of a total disciplinary history of around 250 years, the past ten per cent of the track should have produced such an all-encompassing change in terms of geography, genre, focus, interest, methodology and the potential circle of authors who may aspire to be taken seriously and recognized as school molding personalities.

This book, in its first part, is an attempt to provide at least a partial and preliminary answer to this first puzzle. It also tries to address and remedy some of the ramifications of this development in terms of subject matter, methodology, social relevance as well as applicability.

Reasons for a Copernican Change

One of the side effects of this all-encompassing change is the uncontested rule of English as the singular means of communication and academic interchange. Thereby Anglo-American publishers, journals and universities have taken the lead, not only in terms of setting the standards, but also in shaping tastes, values, approaches and even the choice of subject matter. A mere glimpse into the flagships journals of the economics profession, such as the American Economic Review, the Quarterly Journal of Economics or the Journal of Political Economy, may convince anybody in doubt about the validity of our claim.[2] It is particularly obvious that empirical issues, which may be relevant or fashionable in the US economy and society – be that gender, race, local elections, China or the subprime crisis – stand a disproportionately better chance in obtaining space and attention than other per se equally interesting and important topics, which may matter more for other sections of the globe but are less interesting for Americans. The latter include a number of traditional issues in European studies, such as the history, development and the intricacies of the operation of the single currency without a political union, or the still troubled lot of the economies that have (re)-emerged from the doldrums of communism.

Insightful analyses (e.g., Simonovits 2005) have called attention to the very large dose of subjectivity and open favoritism in the selection process of the most highly esteemed journals of the economics profession. But even more broadly, other sources on the uses and misuses of scientometrics warn us about the limitations of the quantitative methods currently in vogue in evaluating scientific achievements.

The role of prejudice and other components usually considered to be outside the scope of academic inquiry is shown to be at work even in such seemingly policy neutral areas – or value-free fields, if you wish – as medicine or regional studies (Braun ed. 2007). As the papers in the volume show, the most sophisticated Hirsch indices of several Hungarian physicists, for example, considerably exceed the indices of physicists decorated with a Nobel Prize. The same is the case in medicine. Self-references as well as foregoing the allocation of partial weights to multi-author pieces (currently ubiquitous in the natural sciences) result in inflated impact assessments and non-comparability across disciplines and time periods. As the authors warn, and not only on the base of the above-cited extreme examples, one should be circumspect in making use of quantitative indicators and even positively suspicious of the proliferating listing of schools and individuals, even though allegedly entirely merit-based.[3] Therefore, it might make sense to investigate components of merit, of trying to return to the classical standards, also in use across the natural sciences. This entails merits such as originality, lasting value and lasting citation,[4] in short peer assessment, which is perhaps more complex but more reliable than the currently fashionable rankings.

Our endeavor should thus cover both the fields and methods of the economics discipline, as well as the outcomes of the analyses, in the broad sense. As a second puzzle, we shall address at least some of above concerns and show why and how it matters to economics, in terms of research area and academic performance assessment alike. Both have undergone Copernican changes without having been preceded by broad and consensual understanding, as was the case in arts or natural sciences.

A third factor of concern might be the increasing drift between the self-interpretation of the guild of academic economists, increasingly under the control of technicist orthodoxy, on the one hand, and the challenges of social, political and market expectations, on the other. E. Roy Weintraub (2002) of Duke University has gone perhaps the farthest in describing the mathematicization of economics, which has become established practice everywhere over the past quarter of the 20th century, and which means much more than the instrumental use of mathematical, statistical and econometric techniques of various sorts. What he criticizes is the tendency to take mathematics as an independent structure, determining the questions and thus the answers as well for the entire profession. For this reason, while the coevolution of academic economics and at least some trends in mathematics is rather straightforward, the relation to any of the many real world issues has become rather coincidental.[5] True, this coevolution has rarely included feedbacks from economics to mathematics, with the potential exception of financial economics in general and risk assessment in particular.

Alan Blinder (op. cit.) is quite straightforward in claiming that the economics of the past two decades has produced relatively little of what he terms ‘useful knowledge’. Being a practitioner – as former member of the Council of Economic Advisors and also active member of the governing board of the FED – and also a prolific writer on policy relevant issues of various sorts, he might be particularly well placed to make this comment. In the view of several representatives of the mainstream, such as Gary Becker and Robert Solow, to be cited in the next chapter, economics has entirely lost its separate subject matter and has evolved into methodology, more precisely a specific brand of modeling. Advances that have been made in the area of quantitative analyses, modeling and forecasting have, notwithstanding the frequent claims to the contrary, contributed little to the management and the efficient solution of various societal, corporate, financial, environmental and redistributory problems. The latter have been multiplying over the past few decades, rather than fading away as the naive modernization theories of the 1950s and 1960s would have had it in East and West alike. The cumulative unresolved challenges have been calling for novel solutions for such traditional economic issues as the financial tremors, the stagnation of the universalist European welfare state, global poverty, the resource curse, the spread of macroeconomic populism and its ramifications or the stagnation of European integration at the time of globalization and the information and communications technology revolution (ICT).

Fourth, as an interesting, though by no means unforeseeable by-produc of the standardization, over-technicization and Americanization of economics education, also at the PhD level, is that a certain mismatch has emerged between the aspirations and abilities of successful postgraduates, on the one hand, and the needs and priorities of the labor market, on the other. People coming from the top schools have difficulties in being integrated in their local academic and societal environment, which is a phenomenon not constrained to transformed societies. Analyzing this issue through a series of methods including surveys of the graduates, David Colander (2008) has found that the internal evolution of PhD training has created a mismatch by eroding some of the traditional pluses of the traditionally much broader European approach to postgraduate education, while disregarding some of the rather fundamental differences in the institutional setup of European and American labor markets, academic and non-academic alike.

Applications of the Americanized Theory in and on Europe

Fifth, although in Central Europe accession to the European Union has contributed to solving some major problems that have been bequeathed by the cold war and the collapse of the Soviet Empire, it has clearly fallen short of triggering a series of structural reforms which could have laid the foundations for lasting financial solidity and sustainable development in the broad sense, i.e., more than mere quantitative growth. At the time of writing, it seems that both major development issues have remained unattended as yet.[6]

Sixth, the European Union itself has been emerging, even though quite slowly, from its self-created political and institutional stagnation. The latter has evolved with the derailment of the project of political deepening launched at the Constitutional Convention of Laeken back in 2003. With its relatively smooth ratification in 23 out of 27 member states by September 2008, the overall paralysis and the climate of deep mutual distrust seems to be over. The Irish veto of the Reform Treaty in June 2008 somewhat slowed this process but by no means reversed it – a claim we shall substantiate in a separate chapter. This new opportunity can be seen as the carrot for reformers while the challenges emanating from globalization in general and the conclusion of the Doha developmental round in the WTO in particular, will create the much needed stick (Sally 2008). The interaction of the two is likely to galvanize changes and thus help to institute some of the overdue reforms, rethink enlargement as well as alternative neighborhood policy options. The need to remain active in Turkey, the Western Balkans, Ukraine and the new independent states, as well as in the Mediterranean remains a top priority for the EU and for its common foreign, security, trade and financial policy. The formation of the Euro-Mediterranean Union in July 2008 is a clear indication of the centrality of these issues for strategy- and policy-making alike.

As the fifth and sixth issue areas to a large extent overlap, it might be legitimate and even necessary for us to devote some time and space, as a seventh issue area, for covering the common ground. Was the process of eastward enlargement delayed or rather premature, and has it been, on balance, a success or a failure? What should we think, with the benefit of hindsight, about ‘transition strategies’ that have culminated in EU accession in some cases, but led to being left out in the cold in others? How efficient has social engineering – materializing in constitutional development and leveraged institution building during the accession process – been in terms of transplanting and internalizing EU values and procedures in post-communist societies?

Do New Theories Emerge from the Applications?

Finally, as eighth, the question arises whether we can draw any more general theoretical lessons from the diverse regional experiences in Central and Eastern Europe over the past two decades for broader global economic analysis. Such lessons might, inter alia, relate to the roles of public policy, path dependence, the role of spontaneity versus constructed projects/policy plans, the role of the social acceptance of economic concepts, the pluses and minuses of institutional shortcuts or the role of fiscal responsibility in bringing about lasting growth and development in historically backward or medium developed economies.

Even the mere listing of our eight major puzzles and possible angles of analysis should make it clear that this is not (even meant to be) a conventional economics book, confined to refinement of technical analyses. Its scope and approach, while firmly anchored in the standard economic paradigm, overstretch pure economic approaches and complement these with a series of insights from the natural and social sciences. We aim to endogenize public choices, institutions, policy options and social feedback, in line with decades-old traditions in the new political economy and the political economy of policy reforms.[7] We thus join the institutionally informed standard economic analyses and apply these to a variety of European topics, thus presenting-unique European perspectives and European concerns. We hope to contribute, even if modestly, to the ongoing change in emphasis in the global economics profession. Meanwhile, we also wish to remain relevant to students of sociology, political science, international relations and even to analysts working for the business community. This position is in line with the traditions of European economic thinking, from Adam Smith through John Maynard Keynes, Friedrich August von Hayek, Walter Eucken and János Kornai.

When discussing systemic change, both in the “post-communist” context and in the analysis of the EU, we enter into the field of new political economy, where political processes, institutions and public choices in the broadest possible sense are being endogenized. As we stick to the standard economic paradigm and its means of analysis, we do not join the research project of those (e.g., Chang 2002) who interpret the inclusion of institutional analysis as an alternative, rather than a complement, to modern economic approaches. Their line of thought constitutes, at the end of the day, a return of pre-modern approaches such as the German historical school, where the economy was seen as a mere subsection of a much broader superstructure, dominated by culture and power considerations as well as morals and geographic factors. By contrast, we join the current academic majority in treating the economy as a subject on its own right, following the logic of its own, thus being liable to analytical investigations by means developed over the past 150 years or so. Thus, while being distinct to the ‘institutional void’ of technicist orthodoxy, we also reject – on theoretical and methodological grounds to be elaborated in the next chapter – any reintegration attempts of the competing ‘old institutionalist’ streams, including the culturalist school, strongly represented in the area studies and international relations literature.

Our study of institutions follows the mainstream economic logic and aims at creating a productive feedback to it, rather than at undermining or fundamentally revising its basic insights. These usually reflect broad and generalizable considerations that are formulated at a much higher level of abstraction.[8] They represent the common thread over and above the individual observation (and case study level, overcoming coincidental and other ad hoc factors). What we hope to provide by the current analysis is two sorts of insights:

a) policy applications on particular fields that normally lie outside the focus of mainstream analysis; and

b) generalizable insights that may verify or falsify theoretical claims that were established in the mainstream literature.

Both endeavors may prove productive and open-ended. Time will tell whether a Kuhnian paradigm shift, or a mere – rather conventional – incremental change, which incorporates institutionally and historically informed approaches in the mainstream, will take place in the coming decades. What seems to be beyond doubt is that neither a return to story-telling narratives in the name of cultural and historical peculiarities, nor timeless, rigid, mechanic frame void of history, institutions and human beings, nor the customary disregard of advances in the natural sciences, in quest for methodological rigor developed particularly by the new classical and new Keynesian schools, is sustainable and productive[9] in the long run.

For us, the eight major issue areas seem to form an integrated topic with mutual interrelationships and mutually reinforcing consequences. However, we also accept that their diversity does not yet allow forming a tight structure that would be required of a proper conventional monograph. While every effort is made to ensure the dovetailing of various chapters, the outcome, by necessity, can only be partial. Some chapters are, due to the complexity of the subject, somewhat longer than others, which would be inadmissible even in a graduate level textbook. This is reflected in retaining the word Studies in the subtitle. In turn, most of the individual chapters might well be read and used separately, also for reading lists for various graduate level and PhD courses. On occasions, the digressions are mostly confined to the numerous footnotes, which reflect the controversies of fine print, as well as complementary, rather than fundamental pieces of information. These can be omitted, at least in the first overall reading to capture the major line of the argument. Also, with the passage of time, while using the text in classroom, current commentary and most recent statistics can and should complement the arguments introduced in the main body of the text.

Acknowledgements

I have presented previous versions of each chapter to several academic audiences and received critical comments, which I attempted to address and integrate in the final version of the text. Those contributing particularly to individual chapters are mentioned by name at the respective places. As far as the entire project is concerned, my special thanks are due to my four most diligent commentators providing regular and very critical feedback: Dr. hab. Dóra Győrffy, Assistant Professor at the Department of Economics, University of Debrecen, as well as Prof. Julius Horvath, Chair of the Economics Department, the Central European University, and József Móczár, Professor of Mathematical Economics at Corvinus University of Budapest as well as my defending PhD student Deniz B. McDonald who commented on various versions in terms of structure, substance and presentation.

The book could not have been conceived without the generous support of two of my schools, the Central European University and the Corvinus University of Budapest, both having granted me a year of sabbatical leave starting in September 2007. The then Head of the Department of International Relations and European Studies, Associate Professor Béla Greskovits and the long time Chair of the Department of Comparative Economics, Professor Balázs Hámori, President of the Hungarian Association for New Institutional Economics, both deserve my special thanks. Active members of the Committee on Economics of the Hungarian Academy of Sciences, an academic body I was honored to chair for two cycles in 2002–2008, have helped, through continuous exchanges and criticism to formulate and finalize many of my ideas.

Last but not at all least, the continuous support of my family must be appreciated. The love and devotion of my wife, Csia (Gabi), as well as of our son, Zoltán, and our daughter, Orsi (Hedgehog), have been a fountain of lasting inspiration during this challenging period of academic and public life.

Budapest–Debrecen, 30 September, 2008.

László Csaba

REFERENCES

1. ASLUND, A. (2008): Russia’s Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed? Washington, D.C.: Peterson Institute for International Economics.

2. BLINDER, A. (1999): Economics becomes a science – or does it? In: BEARN, A. ed.: Useful Knowledge. Philadelphia: American Philosophical Society. Available online on the author’s website: http://www.princeton.edu/~blinder/articles.htm. Accessed on 19 April, 2008.

3. BRAUN, T. ed. (2007): The Impact Factor of Scientific and Scholarly Journals. Its Use and Misuse in Research Evaluation. Budapest: Akadémiai Kiadó.

4. CHANG, H.-J. (2002): Breaking the mould: An institutionalist political economy alternative to the neo-classical theory of the market and the state. Cambridge Journal of Economics, vol. 26. no. 5. pp. 539–559.

5. COLANDER, D. (2008): The making of a global European economist. Kyklos, vol. 61. no. 2. pp. 215–231.

6. MÓCZÁR, J. (2008): Fejezetek a modern közgazdaság-tudományból (Chapters of contemporary economics). Budapest: Akadémiai Kiadó.

7. NAVRATIL, Á. (1927/2008): Régi igazságok és új felismerések a közgazdaságtanban (Old truths and new insights in economics) – Text of the inaugural lecture to the HAS, delivered in 1927, reprinted in the similarly entitled posthumous collection of his papers, edited and introduced by Márta HILD. Budapest: Aula Kiadó, pp. 207–241.

8. SALLY, R. (2008): Trade Policy, New Century. London: Institute of Economic Affairs.

9. SIMONOVITS, A. (2005): Selection by publication in economics. Acta Oeconomica, vol. 55. no. 2. pp. 255–269.

10. TÖRÖK, Á. (2006): Az európai felsőoktatás versenyképessége és a lisszaboni célkitűzések. Mennyire hihetünk a nemzetközi egyetemi rangsoroknak? (Competitiveness of European higher education and the Lisbon Agenda. How credible are university rankings?) Közgazdasági Szemle, vol. 53. no. 4. pp. 310–329.

11. WEINTRAUB, E. R. (2002): How Economics Became a Mathematical Science? Cambridge and New York: Cambridge University Press.

12. WILLIAMSON, O. E. (2000): The new institutional economics: Taking stock, looking ahead. Journal of Economic Literature, vol. 38. no. 3. pp. 595–613.

[1] Nobel Prizes, either in economics, literature, peace building or in the natural sciences, certainly never constitute an undisputable standard, the final say of history. Still less in economics, an area in search of its identity and thus riddled with intellectual intolerance and animosities. Relying on a series of formal and independent appreciation of an impartial body, however, may help us find impartiality and thus strike a balance among competing – often mutually exclusive – interpretations.

[2] Tellingly, the German quality business paper, Handelsblatt in its July 2008 ranking of institutions and individuals, relies on the lists of the Tinbergen Institute in Holland and adds to it the contributions to the Journal of the European Economic Association. One may wonder why the editors opted for the TI against the previously used similar list made by the Kiel Institute of World Economics. This choice was never explained, although it clearly influences certain outcomes. While we share the editors’ enthusiasm for the influential colleagues editing the JEEA, tellingly published by the MIT Press in the USA, we must note that this journal is currently merely in its sixth volume. For this reason, it has yet to prove if it will join, say the Quarterly Journal of Economics, or other leading academic forums, in carrying the most frequently cited articles in the profession. Likewise, we still have to see if it will graduate to publishing the printed version of the Nobel Lectures, let alone carrying any of the papers that deserve – usually with a delay of three to five decades – this decoration. Incidentally, all the three most recent Nobel lectures were printed in The American Economic Review (vol. 98. no. 3, May 2008). The alternative could have been The Journal of Political Economy, currently in its 116th volume. In short, the option chosen by a major opinion molder as a point of orientation for employers is a rather arbitrary option, disregarding the minimum of scientometric professionalism. Since selection criteria to a large degree predetermine the outcomes, this is not an innocent error – generally, more funding follows the rankings (as in many bureaucratic procedures including competitive bidding at governmental and international agencies as well as foundations). For a similar assessment of the ever more fashionable ranking of universities with a science appeal, see the critical assessment of Ádám Török (2006).

[3] These listings are by no means innocent. They orientate good students as well as research funding in a number of areas just because of their science appeal.

[4] Contrary to frequent journalistic claims, citation, in a sufficiently long period of time, does not follow fashions and personal relations, if for no other reasons, because of the changing nature of both. Thus, while it is a true observation that extreme positions arouse considerable interest and reflection, still those ebb out with the inevitable marginalization of the extremist position.

[5] According to József Móczár (2008: 233): “Economic historians have offered a multitude of proofs that by nowadays there emerged such an abstract version of academic economics, which bears no relation whatsoever to empirically observable facts of the economy, but meanwhile it has become unintelligible in its twists and turns in mathematics”. In a way, his entire monograph may be taken as supportive of this quote.

[6] In our analysis, we shall abstract from the trends that have evolved in the New Independent States, as these seem to fit better to developmental studies. On their core, Russia, a recent survey by Anders Aslund (2008), might serve as a point of reference.

[7] Certainly, comparative economic systems’ research, the Austrian school and German institutionalism, especially Ordnungstheorie, much of it originating in the 1890s and revived by the 1920s’ and 1930s’ debates on socialist calculation and the study of state-managed economies all count among the intellectual roots of this line of thought.

[8] This is the well-known argument of Oliver Williamson (2000) explaining that institutions act at a different level of abstraction and analysis than the study of elementary facts, the focus of neo-classical analysis. This differentiation was widely known in the Hungarian economics of the interwar period, and formed the backbone of the economic concept of the leading academic economist of the time, Ákos Navratil (1927/2008: 214).

[9] Productive, in this sense, means the same as in the natural sciences, i.e., coming to previously not known (original) insights, finding new methods and being able to test those empirically. Moreover, in a best case scenario the entire exercise yields results that help to improve practical problems, in our case of economic nature, yielding a better quality life for individuals, communities and humankind in a sustainable fashion.

II. CRISIS IN ECONOMICS?[1]

“God put macroeconomists on earth not to propose and test elegant theories, but to solve practical problems.”

Gregory Mankiw (2006: 29)

This chapter discusses four main issue areas. First, through reverse problematization it addresses the disconnect between global economic issues and modern economic theory that has evolved around a definite and reductionist methodology, based on assumptions that no longer hold in light of the new insights in the natural sciences. Second, it tries to develop an understanding of how and why methodological exclusionism in the mainstream has emerged. Third, it attempts to forecast if a Kuhnian paradigm shift is in the making through the gradual revitalization of historically and institutionally informed analyses. Finally fourth, wether a moderate and co-operative approach and the ensuing methodological pluralism could be suggested, basically following the nightposts of Nobel winners in economics,[2] complemented with the output of the leading journals of the profession. Being a leader implies first tradition, second being the forum for the publication of the most frequently cited contributions to economics, third, being the forum of publishing the ideas of school molding personalities over the past five to seven decades, when contemporary economics has emerged. In checking our propositions, the two journals of the American Economic Association, specifically devoted to covering the entire field and orienting end-users, i.e., the Journal of Economic Literature and the even more end-user oriented and thus educational Journal of Economic Perspectives serve as our points of reference.

In this overview, we attempt the impossible. Namely, to provide a survey of how economics with its peculiar methodology of analysis and a focus on modeling emerged. We also try to answer the intriguing question, haunting the discipline over the past 150 years or so, namely if, and to what degree analytical methods that have been developed in and for the natural sciences are apt for application in a different field. In answering the second question, we need to address some of the fundamental issues of the philosophy of science, such as the uses and misuses of reductionism and equilibrium analysis. We also try to describe the rather fundamental changes that have emerged in the natural sciences since the onset of neo-classical analysis. Our basic endeavor is an attempt to re-play the match between the methodology of economics and the natural sciences.

Introduction

With the triumphant march of formalized economics in the second half of the twentieth century, one of the most controversial topics in the social sciences has become the meaning of interdisciplinarity. In economics, the ambition of postwar decades, originating in the works of Léon Walras, William Stanley Jevons, and later Alfred Marshall, but molded primarily by Paul Samuelson and his disciples, has been to match physics in terms of exactness. The major idea has been to be able to “put numbers on variables” and establish quantitative relationships among those variables. A mere glimpse on the output of major journals of the field, from The Journal of Political Economy to The Economic Journal, allows anybody to observe this trend. This would by no means be a cause for concern, if other established criteria of sciences, such as the primacy and originality of the insight, testing theoretical propositions on empirical grounds, or the applicability/wider social relevance of any finding, would not be entirely or frequently missing. For instance, few would doubt that in pharmaceutical chemistry the success of a new molecule can be judged on its ability to cure illnesses that could not be cured before, or to cure an illness with less side effects and lower costs than before. Similar feedbacks are usually being rejected out of hand in the case of a large part of the output produced in top-ranked journals.[3]

In terms of academic promotion, especially in major universities, the breakthrough has been perhaps even more straightforward, while very few articles that deserve the name political economy in any sense, have been brought by the Journal of Political Economy over the past quarter of a century. The quibble of American students qualifying economics as “advanced math in disguise” is perhaps true. In recent times, even wilder advances are being made, further narrowing the field. In the latter line, several PhDs, especially in Chicago, are produced in the current decade as “computational economics” relying exclusively on ever more sophisticated computer techniques as their major feature. This seems to be the trend-setter in terms of academic appreciation, publishing in top journals, and academic promotion alike.[4]

The Emergence of the Methodological Bias

It would be difficult to dispute the finding of the broad survey by William Baumol (2000) that the quest for rigor in economics has clearly become dominant over the traditional quest for social relevance. Academic economics, as it has evolved in the past few decades, is generally deeply suspicious of any policy applications. The mood of many departments is openly hostile to business practice (as distinct from microeconomics), let alone the other “soft” social sciences. In a number of ways, economics seems to have lost its interest in time and the historic context (Hodgson 2001). Some go as far as declaring economics as a mere methodology devoid of a peculiar subject of its own. The forefighter of this approach – termed sometimes as economic imperialism – has undoubtedly been Gary Becker, who was awarded the Nobel Prize “for having extended the domain of microeconomic analysis to a wide range of human behavior and interaction, including non-market behavior such as discrimination against minorities, crime, education and fertility”.[5]

Explaining his point, Becker (1992: 1) goes out of his way in stressing that “unlike Marxian analysis, the economic approach I refer to does not assume that individuals are motivated solely by selfishness or gain. It is a method of analysis, not an assumption about particular motivations. The analysis assumes that individuals maximize their welfare as they conceive it” (emphasis in the original – L. Cs.). In short, this is the extension of the microeconomic approach and its arsenal of analysis to all walks of life. Similarly, other formative personalities have also characterized the mainstream as the manifestation of the modeling approach, applied to any aspect of economic life (Solow 1997). In this respect, the 2005 conference volume of the National Bureau of Economic Research, published in a book format by MIT Press (Frankel and Pissarides eds. 2007) may, but not necessarily does, show the beginning of a new trend, with real world related issues, such as the labor market or the EMU, coming back to the main stage of formal macroeconomic analyses. Also in the new political economy studies, such as those of Alesina, Rodrik or Acemoglu (the 2007 winner of the Prize of the American Economic Association, AEA), we do find the use of econometric techniques. But in the majority of the mainstream journals, the nuances of modeling techniques and the way the issue is being formulated still matters far more for acceptance for publication than any substantive question, be that of social or business relevance, implications for other disciplines or simply novelty of insights.

Gary Becker (1976), who is currently a holder of a joint appointment to the Department of Economics and the Department of Sociology in the University of Chicago, also complains bitterly in his autobiography[6] that his focus on reality-related issues and his instrumental use of math had been seen for decades by his peers in the AEA as falling beyond the limits of the profession – true more before than after his Nobel Prize in 1992. But as so often, the mainstream proved to be flexible enough to incorporate what seemed revolutionary or deviant, even positively hostile to it at a certain point. In reality, according to the self-evaluation of Becker (1991), his major oeuvre is the application of the modeling approach offering microeconomic foundations for the understanding of choices in the intimate sphere of human beings – phenomena which are normally viewed as being the farthest from wealth-maximizing, at least in normative terms. Whether or not we think his insights are well grounded in empirical psychology and other testable fields of natural sciences, what was once called “economic imperialism” (Lazear 2000) – i.e., the approach developed by Becker – has undoubtedly revolutionized thinking in many social sciences in the 1980s and 1990s and also extended the scope on which economic journals regularly publish articles – a point richly documented in the cited article and also later in this chapter.

In a way, this line of development may qualify as the adolescence of a relatively young academic discipline. The parallel to human development is rather obvious. This stage is characterized by the distancing of the new individuals from their origins, from their previously natural environment. From this angle, the sometimes excessive emphasis on methodological rigor is, in the long run, perhaps an inevitable in-between station on the road to cooperation, based on more self-confidence. It is illuminating in this respect to delineate two concepts: may be or put in (Colander et al. 2003: 490–493).

The first is a sociologically determined category of the individuals and departments that dominate the profession at any given point of time, and therefore exhibit – perhaps inevitably – a considerable degree of diversity in terms of acceptable views and approaches. By contrast, the second is an intellectual category, which is a static representation of a dynamic and constantly changing profession. The first is often represented by the second, although more in textbooks than in the profession in toto. Still, as the above cited overview notes, it is exactly the methodological hard core of technical/mainstream economics which tends to resist the challenges offered by ecological, experimental, behavioral, psychological and evolutionary approaches as well as advances in statistics, which highlight the limitations of empirical proof through classical methods.

What may induce us to think that the future of economic analysis is likely to witness a return to the broad church of the social sciences, while also sustaining its self-declared aim, the classical Walrasian agenda of being “just like the natural sciences”? For the time being, most mainstream departments would hesitate at best to accept the label of being, a constituent of the social sciences. This can be partly explained by the different analytical framework and the methodological flexibility, which is accepted by many departments in other fields such as international relations or sociology. However, the major explanatory variable is not the spread of post-modernist, post-structuralist, non-rationalist schools in the latter disciplines, but rather the self-selection in the field of global economics as we shall illustrate below.

But how has the profession gotten to this stage? To sum up briefly the extensive summaries cited in this piece, a number of factors may be mentioned. Let us note that the pre-eminence of the current technicist orthodoxy became a predominant trend in Britain already in the 1890–1920 period. This happened to a large degree through building up power positions in the leading universities and journals, with the ascend of Keynesianism only slowing down, but by no means reverting the tide (Deane 1983). Subsequently, by the 1970s, it had become step by step the feature of top American schools,[7] with their continental European counterparts following suit with much less speed and with a delay of 20–25 years by the 1990s only. By contrast, in Central and Eastern Europe the intellectual battleground is by and large still open, with a pluralism of approaches still being demonstrable in all major universities. In Hungary for instance, both the internationally used intermediate level textbook (Varian 2003: XXIII) and the domestic graduate school textbook (Zalai 2001: 7) emphasize the instrumental nature of applying formal tools to streamline argumentation and ensure the coherence of the argument. But this is motherhood and apple pie, rather than the triumph of methodological exclusionism we tried to document for the leading journals and schools.

In a way typical of the mainstream, a defining figure of the area, both as a textbook author and as a prolific and frequently cited analyst, former MIT Professor and more recently IMF Chief Economist, Olivier Blanchard (2000), in his stimulating and insightful tour d’horizon of the ups and downs of the profession, axiomatically excludes growth theory and the political economy of growth from the subject from the very outset.[8] Although this weighty choice pre-determines much of the outcome of his analysis, he does not even attempt to justify it. Given his personal impressions from advising governments and central banks in “Eastern Europe”, in his concluding remarks he observes that radical changes in institutions should perhaps be included as a modifying factor in the analysis, though this three-line observation does not change at the slightest his overall picture of what the hard core of the profession is, and how it should evolve.

The change of citation practices and the unparalleled geographical concentration of Nobel Prizes signal the growing pre-eminence of the US academy in global economic research, which counts as cutting edge. It would be hard to find authors, decorated with the Prize, who would not be either US citizens or would not have spent their prime academic time at leading US universities.[9] This implies, inter alia, that controversies, which already seemed to have been settled in one way or another in Europe, such as the dissimilarity of social and natural processes and the analytical tools fitting these (Röpke 1942/1992, Hayek 1952/1979), resurfaced in the postwar New World. And what happened in America later became the trend-setter for the rest of the globe. All the more so, as “peripheral” countries often launched educational programs, which aimed at copying US curricula and patterns, while outsourced much of their PhD education and other truly innovative research to the “lonely hegemon”.[10]

Reasons for and Steps in Technicization

In the United States as well as in Britain, the breakthrough of the current orthodoxy in terms of funding and recruitment was due to the needs of managing the Great Depression and later the war economy.[11] This concern remained dominant during the entire period of existence of the bipolar world, emptying the pure science departments in all but the wealthiest universities. Flocks of scientists were hired for the needs of the military and the state administration. Thus, formalized and quantitative orientation had increasingly become a must.

We should by no means forget that the needs of the space programs and the nuclear industry exerted a dominant influence on priority funding for several decades after World War II. The impact of the broader Zeitgeist, which called for more nationalization and planning, cannot be overlooked either. The high academic standing of formalized approaches was well represented by the Nobel Prizes of Tinbergen, Frisch, Koopmans, Kantorovich and of course Samuelson. Gradually, the contemporary refinements of Keynesianism had also become open to formalization.

However, it was a tall order. John Maynard Keynes never emphasized the need for formalization, not even to the degree Alfred Marshall used to, who is known to have used geometrics and algebra as a form of shorthand (which can never replace theory as such).[12] His successor in Cambridge, Nicky Kaldor (1985), was actually in the forefront of fighting the neo-classicals.[13] The founding fathers of growth theory and of panel analysis, such as Domar, Bergson, Chenery and Kuznets, also took it for granted that the ever more complex econometrics of their analysis is a tool, rather than the objective, let alone the very theory itself. Browsing through the postwar book review and book notes sections of major journals, from the Journal of Economic Literature to the Economic Journal, we find a minor, though impressively growing section of contributions of neo-classical orthodoxy featuring as just one stream in the overall output.[14] And not until the mid-1980s do we find that these become pre-eminent, gradually occupying the place of economic theory as such in all major textbooks[15] and journals, starting with the Journal of Political Economy of Chicago and the American Economic Review, both former outposts of methodological and theoretical pluralism. Let us recall the fact, even though it might sound odd for the younger generation, that up until the 1970s, the United States was by no means recognized as the universal trend-setter, especially not in intellectual fields and fashions like classical music, visual arts or philosophy. In his Road to Serfdom, written during World War II for British intellectuals, the then LSE professor Hayek (1944/1991: 46–48) speaks as trivial about Britain being an unconditional importer of (basically continental, often German) ideas since the 1870s, or of the then universal perception of Germany being “at the height of universal civilization” (77–78) or even as a pioneer in social engineering, a model to be emulated for many if not most (179 and Ch. 13) – claims that are richly documented by citations.

There is thus nothing less trivial than explaining the earthquake-like, truly epochal change in the discipline. In order to explain this puzzle we should consider the broader social context, including the lack of major fluctuations and crises in the post World War II period, the flourishing of the welfare state, the technological revolution (exemplified by computers and the sputnik), as well as the eradication of mass poverty in advanced countries. Keynes is known to have understood his theory as the economics of crisis and its management, which were by then gone. But in a much broader sense by the 1960s and 1970s, the spread of blind faith in technology and its inherent capabilities for solving each and every human problem had created a fertile soil for quantitative approaches, which seemed irrefutably scientific producing evidence and results.[16]

In the meantime, the emerging post-colonial states, with their left-wing governments flirting with planning and seeking for non-capitalist ways of economic management based on what is by now the old developmental paradigm, also created a massive demand for people versed in planning and programming techniques (Waelbroek 1998). In the Communist economies, the reliance on planning required an army of appropriately trained specialists, even though mathematical methods in optimal planning, as advocated first in the US of the 1930s by Oskar Lange and Abba Lerner, later by Novozhilov, Nemchinov, the Novosibirsk school and TsEMI (the famous mathematical economic institute where Markov was active) had never become more than an instrumental additional reference point.[17] In reality, command planning based on material balances and quantitative targeting prevailed, as control of the Party over details could not be given up.[18]

It is hardly by chance that the above trend triggered a series of reactions, mostly from individuals of high personal standing and reputation. Besides the already mentioned old Keynesians, the then institutionally and intellectually strong Marxists, the developmentalists, the disequilibrium school, self-declared “trespassers” like Albert Hirschman and John Kenneth Galbraith, as well as various institutionalists who still dominated everywhere except in the US schools, all attacked the irreversible. Criticism seems to have come from all corners. Lord Thomas Balogh (1982), a long-time advisor of Labor Governments and a leading Oxford intellectual, subjected both emerging major lines, i.e., monetarism and equilibrium economics, to devastating critique for being theoretically irrelevant and positively harmful in terms of policy advice.

Critics also emerged from the traditional right, represented by the Austrian school, sounding identical concerns. Ludwig von Mises (1978) called attention to the fact that societal processes are outcomes of human actions. Those human actions are inherently uncertain and thus probabilistic, therefore they cannot, even under the best of circumstances, be adequately formalized and predicted through quantitative methods. Friedrich August von Hayek (1974) devoted his Nobel lecture to explaining the difference between real insights and the pretence of knowledge provided by formal analyses. He also convincingly showed how the Walrasian project, executed to its extreme, had been at the root of policy failures, which translated into stagflation all over the advanced market economies. However, these cautioning words were usually neglected, even ridiculed at the time. Likewise, the valid contemporary analysis of János Kornai (1971) on the trade-off between elegance and relevance was mostly shrugged off, as indicated by the rather cool reception of the book by the dominant schools.

The belief that the future was basically subject to human shaping was predominant, and transnational corporations and state-controlled models of economic management relied equally heavily on planning and programming. It was not until the epochal changes in the post-1973 and post-1979 period that the way was paved for more reflective, probabilistic and less pretentious approaches in the economics discipline. The stagflation of the 1970s, the international financial crises in 1982 and 1987, the largely unforeseen collapse of the Soviet Empire in 1989–91 and the similarly unanticipated 1997–99 financial crises and contagion all contributed to this development.

Although mathematical approaches were often seen by their traditional adversaries as “natural allies” to planning mentality, in reality these – especially general equilibrium thinking – are institutionally neutral.[19] Consequently, it did not require a major ideological twist from the profession to re-emphasize the market and the competitive solution during the neoliberal turn of the 1980s and 1990s. At the same time, the new Keynesians could also easily turn the analytical arsenal to their own use. It is worth noting that truly committed and ideological liberals, such as Friedman, Buchanan and Hayek, had never gone out of their way to offer formalized proofs for their ideas. By contrast, formalists, focusing first and foremost on “science appeal”, include staunch free market believers as Lucas, and market skeptics such as Stiglitz. Formalism and ideological commitment thus remain two different strands,[20] and the latter proved to be decisive after defense needs no longer enjoyed priority (Zalai 2004).

The low level of the institutionalization of the various and competing institutionalist approaches versus the high level of academic embeddedness of the formalist approaches, especially in the US, can be seen as another important factor in the breakthrough of the orthodox interpretation of mainstream economics. David Colander et al. (2004: 5–10) emphasize the importance of the ability to institutionalize and hand down the creed from mentor to disciple – a trait that has been conspicuously missing from the diverse heterodox approaches. They also highlight the usefulness of relatively straightforward organizing principles and testing possibilities, which are readily offered by neo-classical orthodoxy, for the needs of masses of economics students in the expanding graduate programs. This is contrasted to the interest in nuances and controversy in the best few PhD seminars of truly good schools. The criticism of exclusivity and reign of formalism, as offered by the various traditionalists cited above, was seen as institutionally marginal,[21] socially elitist, too philosophical in methodology (thus being beyond the limits of the profession anyway), and first and foremost too hard to adapt to the needs of an average school with average students/teachers, who are confronted with an academic market that requires standardization for most of the output. In other words, economies of scale matter for the academic market as well. Furthermore, the heterodox approaches, while being eloquent on critique, have failed to come up with viable alternatives, not only in theory but also at the policy-making level (Cairncross 1982: 967). This is partly due to the fact that differences across the various heterodox schools can, and often tend to, be bigger than the drift that exists for instance between neoinstitutionalists and the fraction of modern mainstream, which integrates pieces of institutional insights (such as Shleifer, Acemoglou or Becker). Being non-mainstream is unlikely to unify, say followers of Hayek and Marx. And being non-mainstream is also no guarantee for being original and sophisticated; in fact, very often just the contrary is the case (as sometimes not even the methodological common ground and the needed technical elaboration are available).

While this is perhaps a valid description of the overall trend, important qualifications are due as in any scientometric exercise. The actual advancement of science is only very partially captured by academic promotion and other forms of contemporary appreciation by the public, even through (cross-)referencing methods. For instance, among the Nobel Prize Laureates, who also represent the lighthouses in the profession, we find many, who have not followed suit, such as S. Kuznets, H. Simon, F. A. von Hayek, G. Myrdal, M. Friedman, Th. Schulz, J. Buchanan, D. Kahneman, R. Fogel, D. North and A. Sen.[22] Also from among other school-molding personalities, whose overall – not only cross- and mainstream journal – references are literally countless, we find several “outliers”. These authors include L. von Mises, W. Eucken, N. Kaldor, P. Bauer, A. Hirschman, J. Kornai, T. N. Srinivasan, P. Collier, V. Vanberg, A. Krueger, L. Yeager, J. Bhagwati, M. Todaro, I. Kirzner to mention only some of those whose influence on the overall evolution of the profession must be beyond doubt to any impartial observer, who is able and willing to perform the more difficult methods of unbiased and unrestricted impact analysis.

What may then explain the sustained disregard of reality?[23] One factor might be fashion. Who would doubt that in all walks of life, from classical music to car production, it is an important issue?[24] Second, one may think about the aspiration of the guild to carbon copy physics, as the top science in the cold war period.[25] Third, the influence of strong, impressive personalities such as Samuelson, Solow or Lucas, must be acknowledged.[26] Fourth, one should not forget about the emergence of mass universities, a process, which took place first in the US then in Europe. In the latter case, it followed the student riots of 1968 and the expansion of the welfare state in the West, while in the East pressures came from a democratizing society in the post-1989 period. College and university enrollment rates went up from lower single digit percentages to over 40–45 per cent for the cohorts of 18–30 year olds. One obvious way of managing masses is standardization, routinization and the application of objective screening criteria.[27] Quantitative orientation may come rather handy, despite its obvious shortcomings from the educational and employability/professional skill improving perspectives alike for the vast majority of students (Szentes 2007). Fifth, the role of conventions – or what we termed the self-selection of the guild – is particularly important as explicitly stated by Blanchard (2000: subsection 2.4), even if it is somewhat tautological. In a modification of this insight, the Cambridge economist Binca (2008) talks about the predominance of social games, focusing on power and based to a large degree on the psychology of the profession. Finally sixth, the distance from the field of application has long been a feature of the American academic economics profession, which is traditionally much less involved in advancing policy advice than its German, British or French counterparts. The sheer size of the US and its academe combined with the much more limited role of governmental intervention makes this distinction self-explanatory.

Challenges to the Technicist Orthodoxy

However, this state of art is becoming unsustainable for a number of reasons. First and foremost, internal/inherent challenges, coming from within the sanctuary of the academy must be tackled. Advances in the natural sciences in general and within the discipline of physics in particular are posing major challenges. This relates both to the methodology and the epistemological foundations on which Newtonian physics and its emulation in mainstream economic modeling are built. Without wishing to intrude alien fields, let me cite leading authorities in the theory and history of physics (Nagy 2007), who explain the fundamental changes, which were brought about by the evolution of the two pillars of contemporary physics, quantum physics and the theory of relativity. These developments have several consequences. a) Deterministic descriptions – where the predictive power is the basic strength and the quantifiable measure of success – have given way to probabilistic and stochastic approaches. b) The method of measurement immediately influences outcomes and variables.[28] c) Attempts at re-establishing any all-embracing, holistic theories along 19th-century lines have failed during the entire post World War II period. As an outcome of the conflicting interpretations of the novelties, ’exact’ quantitative measurements and thus exact predictions are now replaced by measuring the distribution of results with expected values and stochastic probabilities, while the measurement process itself is known to have prompt spillovers – Rezső Lovas (1988) considers this the silent revolution in physics, which has lasting ramifications.

If the above holds, it would be hard not to see its implications for general equilibrium theory interpreted in a holistic fashion. General equilibrium thinking, derived directly from 19th-century physics, can hardly survive in any other way than Newtonian physics, i.e., as being a mental model of regularizing our ideas in the first run. But this would seem a very soft reading in the majority of mainstream departments, believing – though never proving – that only equilibrium situations lend themselves to comprehension and scientific analysis. As the leading authority put it, “macroeconomics today is solidly grounded in a general equilibrium structure” and for the future “one may hope for an integrated macro model based on only a few imperfections” (Blanchard 2000: 37). However, as we shall illustrate later, it is not only physics, but a series of other natural sciences as well, where paradigmatic changes occurred during the 20th century. If this is the case, these earthquakes can by no means leave economics untouched. This holds a fortiori for its methodology, irrespective of what role we attribute to it in the overall structure of the discipline as a whole.

From the “external” point of view, different problems, mainly related to the application of insights, have emerged. To the general public as well as to most of the profession, mainstream economic analyses are becoming less and less accessible. This translates into low circulation and the previously cited low impact factor for the internally/ professionally most highly esteemed platforms for publications. Meanwhile the traditional ally of economic analysis, the business elite exhibits less and less interest in the output of academic departments. This is becoming a problem, not only in terms of funding, but also in terms of social prestige. Some of the reasons for this development, as openly acknowledged by Nobel winner Robert Engle (2007) decorated for his advances in business risk assessment, include:

a) Mathematical models rely on the same data/time series. Consequently, they act procyclically, and support identical rather than competing/balancing options.

b) The models can reflect and transmit only past evidence, while shocks/crises emerge at times and via means of fundamentally new factors, which become dominant in non-trivial and non-predictable manners.

c) Real world situations tend to be both too complex and a mix of short- and long-term factors, in which not even scenario analysis can substitute for lack of transparency, which is yet another factor that is abstracted away in most of the models.[29]

For these reasons, Engle, while sustaining his commitment to formal models, cautions decision-makers not to make too much out of these and rely on them in blind faith.[30] He also believes that the role for non-quantitative factors, such as intuition, remains vital for any viable microeconomic decision.[31]

This line of argumentation was further advanced by Lord John Eatwell (2007), one of the editors of the New Palgrave a Dictionary of Economics published two decades ago. In his view, the herd behavior/bandwagoning of analysts, which was also described by Engle, exterminates the fundamental features of market coordination, i.e., the contrasting assessments of any situation owing to different levels of information, different mental models and expectations. Furthermore, the focus on the microeconomics of finance only, both of the literature and of the regulator, leads to a false neglect of the macro. Namely, owing to its proclivity to crisis and contagion, the financial system is a prime case for economic activity with major externalities that call for regulation (by public authorities) in order to attain what is more than the sum of the priorities of the individual agents. Avoidance of systemic risk and the need for systemic stability are obvious cases to the point.[32] This has rather immediate ramifications for Basle II, which emphasizes autonomous risk management by each bank as well as enhancing transparency, thereby itself contributing to the reproduction of the ills.[33] In broader academic terms, one may become skeptical about the general relevance for the by now ritual quest for micro-foundations for any macro insight.[34] In this respect, the declaration about the “demise of macro” appears premature.[35]

In a similar vein, in a book published on the eve of the 2007/2009 financial disturbances, Frydman and Goldberg (2007) also blamed the nature of modern economic research – with its exclusive focus on the micro and obsession with ’precise’ predictions while neglecting additional sources of information – for the major misfit between high brow theoretical aspirations and dismal delivery in practice. They contrast the continuously and recurrently false assessment of financial assets by analysts who are trained mostly in math and physics and who take their models at face value, with the practice of those relying on more mundane/ backward sources of information while assessing risks on physical assets. The latter includes examples such as the evaluation of the industrial ’museums’ like General Motors, as well as the object of their own empirical investigation, exchange rate movements. Their common feature lies in the traditionally strong reliance on empirical/factual observation, long data series, historical memory and a number of rules of thumb, which are derived from decades of business experience rather than from any fashionable theory. While the latter by no means replace formal analyses, they complement it and thus yield superior results, whereas the ’pure’ modeling approach, which is still cultivated and appreciated in the academe, has proven to be of little avail. Let us add: first and foremost, it fails on its own terms, i.e., quantitative estimation and forecasting risks and returns.

In addition, from the policy-makers’ perspective the reliance on the output of the most fashionable segments in contemporary academy is becoming less and less a must. On the contrary, this output is often seen as bearing no relationship to the real world issues, which confront decision-makers. The analytical language used is unduly complex, while the conclusions apply only under very restrictive assumptions, which usually do not hold in real world scenarios.[36] Therefore, their willingness to fund, and even to employ, people coming from what is often seen as an overly self-confident, but also insufficiently emphatic clan or guild, has manifestly been on the decrease. The proliferation of public policy and public administration programs, the growing recruitment to top (non-analytical) positions of people with qualifications other than economics (be that mathematics, political science or international relations) and the spread of public administration research have created stiff competition for macroeconomists. For microeconomists, the challenge comes from the flourishing of business schools, which openly delineate their curricula from what is seen as too abstract and of little practical avail for the students. These developments together have created a close to crisis situation in all but the wealthiest schools.

These features have already been diagnosed a decade ago (Krueger 1999: 154–155). For the ’disconnect’ between academic theory and the real world issues as well as the ensuing steady decline in what has increasingly become the predominant market segment (outside the self-reproduction of theoretical departments), the self-interpretation of the profession and the ensuing standardization were to blame. “Product differentiation”, i.e., adjusting to the relevant market segment, took place mostly, though by no means exclusively, outside the walls of the traditional departments – namely, in few programs where policy components, sectoral specificities, environmental issues or “heterodox” approaches such as public choice, have come to the fore. This is all the more surprising as the need for differentiating our product from those of others used to be an age-old insight both in academy and business, similarly to the need for pluralism and competing options. It is hardly by chance that Hayek (1989/1992) always claimed that it is the trial and error nature of the market which makes it superior to any other arrangements that aim to replace its inherent feature of catallaxy with optimizing or planning procedures.

With the advancement of the natural sciences, many axiomatic items in mainstream economics have become subject to criticism. Empirical evidence, for instance, is indicative of the irrelevance of the symmetry axiom[37] in terms of loss and gain, but also of other ‘objective’ quantitative measures for assessing economic attainment by the representative agent (Kahneman and Kruger 2006). Other analyses have experimentally proven the overwhelming relevance of the bounded rationality insight of Herbert Simon (1957) for basically all human actions and far not only in the emotional field (Selten 1998). More recent research has found not just the lack of evidence, but positive/empirical counter-evidence for the occurrence of maximizing behavior, particularly in areas where the intuitive would tell us this to be the case such as in firms and in professional sports (Romer 2006). These findings are in line with the broader insights of modern psychology (Mérő 2001) providing empirical evidence for the limitations of the rationality postulate, which is decisive for the feasibility of traditional economic modeling. It is symptomatic and also encouraging that in a broad survey published several months after the Hungarian version of this chapter had appeared in print, Gliboa et al. (2008) also called for a better understanding of the psychology of model formation since many beliefs that form actual economic decisions are neither realistic, nor necessarily rational.

It has long been argued that the ’butterfly effect’ discovered by the mathematician and meteorologist Edward Lorenz (1963), which means that small changes can trigger enormous modifications in unexpected remote parts of a complex system, is of major relevance for the understanding of economic systems. The financial crises of the 1997–99 period provided ample evidence for the practical and analytical significance of this and related insights. If this holds, sticking rigidly to the arsenal of Newtonian physics and the related mathematics may prove to be positively misleading for the economist since the fundamental analytical assumptions of the analysis do not hold.[38] In the frontrunner natural sciences, such as biology and nuclear physics, the cited insights count among the platitudes for decades.

The fundamental methodological consequences of the above are at least twofold. First, the question emerges to what extent – if at all – complex systems actually lend themselves to mathematical modeling following the Descartian-Newtonian path of simplifying assumptions.[39] The second issue is how far axiomatic thinking can go without relying on the feedback coming from sister disciplines. In the past decades, research paradigms which attempt to integrate fundamentally changed insights and the related uncertainty into economic analysis have been gaining currency. Let us underscore: we are not referring to the heterodox approaches and the surviving quasi-marginal schools, such as neo-Marxism, post-structuralism or old-style institutionalism, despite their obvious presence and sometimes remarkable partial findings. What we find remarkable is the reverse stream, i.e., the penetration of fundamentally different insights from the natural sciences and mathematics into what seemed to be the closed fortress of mainstream economic analysis. If society can be modeled in an imperfect manner only, showing non-linear feedbacks, turbulence is likely to be a major feature – consequently, chaotic outcomes become as probable as in the case of meteorological observations. For this reason, it is conceivable that attempts to adopt chaos theory for understanding economic phenomena (Puu 2000) will show the road for future analyses.[40]

It is perhaps telling that the most receptive audience to this reverse stream could be found not in the ivory towers of academic economics departments, but among people who are closest to the most complex economic phenomena, i.e., those dealing with the capital markets. Very few have properly understood the depth of the quibble of Alan Greenspan in 1996 of the ’irrational exuberance’ of financial markets following their boom-bust cycles – a point, which has since become a journalistic platitude. Likewise, George Soros (2006) in one of his recent books – inspired by a combination of philosophical insights, financial market instinct and decades of experience – also questions the omnipresence and omnipotence of rationality, which is postulated and propagated by formal economic models, most notably by the dominant theory of efficient markets, wich do not exist at all.

A Gradual Penetration of Mainstream by Insights from the Fringes?

The widespread presence of non-rational behavior, lack of symmetries and incalculability all call for the reassessment of our analytical methods. Moreover, if the above cited general insight about the limitations of reductionism as a method holds, the axiomatic nature of the up until recently unquestionable methodological focus, both per se and in its current form, can no longer be taken for granted.[41] And the more we still consider – on grounds of tradition and self-esteem – methodology as a formative component of the discipline, the more it becomes not just commendable but compelling for economic analysis to reflect on the advances made in the natural sciences. This holds for at least three major planes: a) The axioms, i.e., the limited use of Robinsons following arbitrary, predetermined choices or unconditional maximizing behavior disregarding competing considerations (Thaler 2000). b) Modeling via deterministic procedures yielding quantitative outcomes. c) Interpretations – within the econometric model, and for the real world applications (if any) alike, including their respective predictive power.

It tells a great deal about the new standards of the profession that the exposition of neuro-economics was allotted in the distinguished Hahn Lecture for the Royal Economic Society in 2006 (Camerer 2007), where the presence of behavioral economics in the preceding years could best qualify as a trifle.[42] In the subsequent year, the American Economic Association also convened a special session on the topic (as repeated in: American Economic Review vol. 98. no. 2. pp. 163–180.) This line of research is following the traditional microeconomic interest in its search for elementary and observable foundations for individual economic decisions. At the same time, it firmly rejects the basic feature of neo-classical theory, originating with Pareto and Jevons, of taking the mind and thus the process of micro decisions as a black box. Neuro-economics aims to create a microeconomic theory of how the brain works and support it with empirical, experimental observation. It has found that conventional postulates on which rational choice models are built do work in “life and death” decisions (food, sex, danger). In more complex situations, however, the preference for immediacy and the non-linear weighing of probabilities occur. Finally in a third group of observations, preferences tend to be state dependent (unless they relate to biological state or neural system). This research agenda indicates that a more complex and also more robust modeling of human choices and thereby of the economy is in the making, although its implications for macroeconomic or other issues is unclear at the time of writing.

Furthermore in a number of areas, approaches that tended to be marginalized by mainstream orthodoxy are regaining their standing. For instance, the Asian financial crisis rehabilitated, at least to some degree, old institutionalism through its focus on corporate governance – signaled by the fact that the Ely Lecture of the American Economic Association was devoted to this issue (Williamson 2005). The already cited insights of Simon, Kahneman and Selten have long been in use in behavioral finance. With the collapse of the Soviet Empire, but also owing to the limited success of adjustment programs of emerging markets, historically informed analyses, such as the oeuvre of Douglass North (2005) and David Landes (2006) returned to the main stage. Likewise the broad law and economics approach, originating with the Freiburg school in Germany, but rediscovered and broadened by scholars at Berkeley, Yale, Harvard as well as other leading schools, seems to have gained in significance. In the practice of international agencies, this approach revived during the study of the limitations of transplants in improving the performance of emerging economies (Berkowitz et al. 2003).

The articles by Shleifer and Glaeser (2003) and by Djankov et al. (2003) on the crucial role of institutions in explaining economic outcomes was published in the top journals of the profession. Lines of research that seemed esoteric for the technicist orthodoxy, such as the role of inherited legal institutions among the factors of development (Levine 2005, Shleifer et al. 2008) or the role of Islam-related legislations on property rights and growth (Kuran 2004), all figure prominently on the pages of top journals. Importantly, these new, historically informed analyses receive formal support from studies on the implications of Islam for democracy and market economy (Borooah and Paldam 2007).[43] Still, it is hard to overlook the fact that these novelties are published only upon two conditions: a) if they come from people from within the guild/meaning the top US schools and b) if they are presented in a formalized language, again irrespective of the originality of the insight, or whether or not the point could be also conveyed through verbal means.[44]

Let us not skip the re-emergence of the new political economy, an approach broadly within new institutional economics, i.e., not waging a war on the mainstream, but rather conducting institutionally informed analyses and incorporating findings from political science and international relations. This approach has attained more relevance given the obviously unresolved problems of regulation, especially transnational regulation, which emerged as a response to the multidimensional challenges presented by globalization. Also, in the context of the post-Washington consensus and the emerging new developmental paradigm, the task of incorporating the mechanisms of public choices and the role of – formal and informal – institutions mediating economic concepts to social reality, became a pressing and immediate concern.[45]

To sum up: while the technicist orthodoxy still dominates promotion in the academy and most of the leading journals (though by no means what is published in book format, this is probably due to the usual quarter of a century delay in the implementation of any insights, already lucidly observed by John Maynard Keynes (1936 1965: 407–408), rather than to any of the “best practices” regardless of how these are defined. We have thus described a double challenge for the profession. From the outside, both the market (in terms of employment and funding), and the evolution of the natural sciences, are calling for structural changes. These have indeed materialized during the current decade, although in a very incremental and limited fashion. From the inside, as we have seen, similar challenges emerged in response to the limited success of immediate – interpretative, corporate and policy – applications when tested on the ground, especially at times of crises, and in facing limited successes in predicting,[46] interpreting and managing practical matters.

In the light of the Nobel Prizes awarded to numerous personalities working on other than mainstream fields, such as Thomas Schelling (author of a bestseller in international security relations), Daniel Kahneman (regularly publishing in journals of psychology) or Douglass North,[47] the new developments all point to an important direction. This is the inadmissibility of confining economics to a single method of analysis only, void of its own subject matter. Not only because mathematics and philosophy have already taken these functions over the centuries. But rather because for these scholars working on such diverse fields, all winning the Nobel Prize in Economics – not in any other area – the common ground is demonstrably their subject of analysis: how wealth creation and accumulation (though not necessarily maximization) take place and how the related social choices are made; what the rules of repeated games (i.e., institutions) are; and through what methods we can understand these, rather than any other issues. If we give this interpretation to methodology, then the awards of Auman and Granger, or previously of Modigliani, Miller or Vickrey can also be described as covering this common ground.[48]

The more the economics profession is able to interpret itself with a degree of self-confidence that emanates, inter alia, from its common ground, common traditions and common subjects, the more we shall be able to open up to colleagues working in other disciplines. This should not be seen as a new trend or a basic innovation. In fact, besides the examples cited above, we may mention the 2008 Nobel winner Paul Krugman and Anthony Venables (1995) as representatives of the established mainstream who focus on new economic geography and work on the reinvention of space, a dimension also lost during the period of formalization revolution. As their oeuvre shows, being open does not imply giving up either our angle of analysis or the specific analytical methods including modeling. What it does show, however, is that methodology cannot and should not become a purpose for its own sake.

If a less orthodox approach prevails, it helps to re-integrate the work of constitutional political economy scholars, such as James Buchanan (1991) or the rules versus discretion approach of Kydland and Prescott (1977), contributed to the legal formalization of central bank independence during the 1980s and 1990s in most market economies, developed and emerging alike. Thus, their findings directly relate to the political process in which economic decisions are made, and they should become part and parcel of the new understanding of the discipline. If this occurs, then being practically relevant might no longer be counted as a mortal sin for an academic. The insights of the authors mentioned, after having been translated into independent central banks and fiscal rules, sometimes anchored in the Constitutions, have already shown in a pioneering way how to proceed in the future.[49]

Policy-oriented studies, though less appreciated in the past few decades, have traditionally figured high on the agenda of economic analysis. From such classic examples as Ricardo’s fight against protective farm tariffs to more recent cases, such as the Nobel lecture of Ed Prescott (2006) highlighting the need for coherence and sticking to the long-term perspective in the daily doldrums of policy debates, policy induced issues never entirely disappeared from the stage. Certainly, it would be wrong to suggest, even to tolerate, a regress into shallow public debates over individual policy measures. Therefore, if complex issues are raised, such as pension reforms, the regulation of the information technology markets (Internet trade), international financial architecture or poverty reduction, it would be next to impossible to disregard analyses coming from mainstream theory.[50] For instance, quantitative testing of competing theories (on a number of specifications) (Paldam and Gundlach 2008) do not lend support to the idea, emerging as a majority view in recent literature, that the ‘primacy of institutions’ can and should be taken as a given in explaining long-term economic growth in the 20th century. Thus, it is not just the traditional reference to ‘culture’ or ‘institutions’ that is needed, but well-specified propositions about which institutions matter, how, when and for whom. Such an approach is likely to yield insights, which help to operationalize the practical meaning of abstract economic models and concepts. If for no other reasons, side conditions for implementing the optimal economic insights (whatever these might be) by necessity should include the understanding of the workings of social groups, legal norms, state and non-state actors as well as transnationalization in its complexity.

Beyond Newton

Even without necessarily moving to the slippery slope of advancing policy advice, for the understanding of complex outcomes that result from a variety of interactive processes and are shaped by various, often contradicting rationalities, developing a comprehensive analytical framework and a nuanced interpretation has become a must. Examples include the clash between individual and collective rationality, abundantly addressed in the literature on policy reform, short and long term considerations, as formulated in the idea of time inconsistency, or the age-old conflict between media impact and economic efficiency. It is telling that much in line with the arguments of Robert Engle quoted earlier, Alan Greenspan (2008) also considers the elegant models in use ‘too simple’ to cope with the complex and often contradictory signals originating from market players, be that euphoria or panic. In short, he intuitively re-states the lack of symmetry thesis elaborated above, and he contributes to the line of the criticism about overusing the concept of rationality and de-emphasizing the empirically observable in favor of technical elegance.[51] This is in accordance with the insights of physicists about the probability of intuitively incorporating factors triggering chaos, although this is art rather than science in the narrow sense.

This finding received strong empirical backing by the analysis of the 2007/2008 US subprime crisis (Gerardi, K. et. al, 2008. 36–37). In hindsight, models could well have forecast risks and the collapse, had not this eventuality actually been excluded by the model builders. As the study concludes, I’we will never know, wether it was genuine conviction that nominal US house prices wouldn’t fall substantively, or wether industry participants were whistling past he graveyard.’ In short, techniques can never save, let alone, replace broaden judgement based on a variety of factors, colled complexity in academic analyses.

A more attentive stance towards other disciplines is now in the self-interest of economics if it wants to escape the very real danger of being relegated to something unpleasant: a socially and academically irrelevant, entirely self-referential and sterile intellectual activity. In reality, being attentive and receptive to the findings of others is part and parcel of the professional minimum. While we are aware of the substantial difference between our normative vision and reality, micro-incentives may move economists and economics departments alike to a less assertive and more co-operative stance than it had been the case during the second half of the 20th century. In the words of the then-President of the Royal Economic Society (Deane 1983: 11–12):

Since there is no kind of economic truth, which holds the key to all economic problems, no pure economic theory is immune to changes in social values or current policy problems. The scope and method of our discipline needs at all time be defined in relation to social problems, which give purpose to it, and there is room for more than one progressive research program in operation at the same time. We ought indeed to profit from the divergent approaches of leading theorists, provided they avoid the kind of arrogance Adolph Wagner complained a century ago.

In his presidential address to the American Economic Association, Nobel winner George Akerlof (2007: 27–29) goes even further. Referring to the advances made in the natural sciences related to human behavior and organism, he calls for a revision of the exclusiveness of the positive economics paradigm, in which statistical testing is everything, while studying cases and intentions is discarded as anecdotal evidence. If studying a single DNS molecule can foretell the entire story of the evolution of an individual, he claims that the study of norms, intentions and motivations can be no longer excluded from the arsenal of interpreting economic phenomena.[52] Moreover, when non-linear dynamics become important, as in contemporary physics, mathematics, biology, chemistry, meteorology and even in financial economics (Götz 1993), predictive power alone, in the usual sense of foretelling the future in exact quantitative terms, can no longer serve as the measure of what ’true science’ is.

A Heterodox Revival

Summing up our argument, we may agree with Colander et al. (2007/2008) that a Kuhnian paradigm shift in technicist orthodoxy, which is still the current mainstream, is in the medium run at least highly unlikely, despite the obvious challenges that have emerged concerning its most valued methodological foundations. On the contrary, as they observe (op. cit. 8), incremental – i.e., cumulative and evolutionary – change must come from within. As our analysis has tried to demonstrate, it is already well in the making. True, this change is unlikely to be swift or sweeping, as the five split Nobel Prizes awarded to practitioners of the rather uncontroversial game theory in 2005 and 2007 seem to indicate. Still, formative personalities of the mainstream also talk about this change being already in the making. Gary Becker (1992: 15), for instance, claims: “While the economic approach to behavior builds on the theory of individual choice, it is not mainly concerned with individuals. It uses theory at the micro level as a powerful tool to derive implications at the group or macro level.” Furthermore, he states that “a close relation between theory and empirical testing helps prevent both theoretical analyses and empirical research to become sterile” (ibid.). Similarly, Robert Solow, in his recent (2005) addendum to his Nobel autobiography claims that “economic growth theory may be coming back to a more historic view”, a trend we also tried to document.

Should our assessment hold, at least in part, the excessive methodological focus, which led to the exclusionism and intellectual arrogance of the past two decades, is likely to be overcome, in terms of promotion, academic appreciation and access to major forums alike. Instead, a number of traditional/conventional/across-the-board used academic measurements of success, which include the sustainability of new findings and their applicability to real world issues, will be regaining their traditional significance.

The combination of formal/quantitative and interpretative/qualitative approaches, joining institutionally informed and statistical analyses no longer counts as a rarity.[53] It helps answering non-trivial and otherwise only emotionally approachable questions like whether post-communist societies have become “normal developing economies” in the sense of Kuznets (Keren and Ofer 2007), or if the local ownership of reforms was dominant over EU anchoring or IMF advice in implementing academic insights over the two decades of systemic change (di Tomasso et al. 2007). If the rather ambiguous and complex answers provided in these sources survive a decade, they will qualify as sound pieces of science, even if later research may qualify or even disprove them on the basis of new evidence or new methodology. At the end of the day, such results will undoubtedly mark the irreversible return of economics into the row of established sciences, natural and social alike.

What is the value added of this tour d’horizon for the future of economic analysis? There are at least three major lessons. First: the traditional delineation between hard facts and soft interpretations can no longer be sustained, probably not even in introductory textbooks. If – as by Kuhn – a new paradigm is like a new pair of glasses, allowing you to see the same thing in a very different light with different implications. Furthermore, if the way of observation influences the observed object (as in quantum physics), the two issues become Siamese twins and cannot be separated.

Second, methodological pluralism must already be taken as a given, and its open acknowledgement is probably just a matter of time. Since economics receives impetus from a wide variety of disciplines, each formulated according to its own specific paradigm, there is no hope, even in the abstract or in the future, for the re-emergence of any 19th-century type of grand theory of social science or even of economics proper. It is difficult to imagine that the study of the DNS molecule and the study of the history of constitutions could or should be conducted within the same paradigm. Thus, interaction with one or the other might take place side by side, rather than in a seemingly integrated, but on the ground eclectic and incoherent framework. Once again, it is the subject matter – the conditions and mechanisms of wealth creation, distribution and accumulation – rather than any particular methodology of analysis which will remain the unifying principle. This development is in fact quite in line with developments in contemporary physics.[54]

It is reassuring to find that not long after the original (shorter) Hungarian version of this chapter was published, the 2002 Nobel winner, Vernon Smith (2008) advanced similar normative suggestions in his assessment of the future of the economics profession. He also highlights the dangers that follow from the extreme simplifications of the neo-classical approach, which uses axioms for behavioral norms that are positively contradictory to the observations in societies and experimental research of human behavior in the laboratories. These include selfishness (the complete lack of altruistic, aesthetic and playful motives), the lack of voluntary cooperation, perfect foresight, the ensuing full rationality of expectations, ability to assess future financial outcomes, and similar ability to foresee and neutralize failures of regulators, which more often than not lie at the root of crises.[55] Heeding his suggestions naturally melts the still predominant technicist methodological rigor if we interpret it as sticking to one particular way of thinking. Furthermore, his call to consider the findings of sister disciplines, empirical and methodological, positively implies the necessity for across-the-board methodological innovations in economics, and not only in its mathematical formalization.

Third, we hope to have contributed to the more nuanced understanding of how advances in the contemporary natural sciences could and should be incorporated into economic analysis. Our basic contention is the need for organic interaction rather than mere interfaces on the surface, called ‘inter-disciplinarity’. While the subject matter of economic analysis calls for interaction with a variety of sister disciplines, in so doing the nature of the subject matter, rather than the mere availability of an analytical tool or formalization possibilities, i.e., the technical convenience, should be the prime maxim. And while the ‘economic imperialism’ of the Becker type might still be one plane of the interaction, this should be complemented by our incorporation of new, perplexing insights of other sciences, even if these undermine previously axiomatic views such as rationality or the symmetry of loss and gain.

In the following chapters, we shall attempt to test this new theoretical understanding on two partly overlapping empirical subjects: emerging European economies and European integration. While in the next two parts of the book with six by and large empirically driven chapters we focus on the real world, our ninth, concluding chapter on the conditions for lasting and shared growth will feed back the findings to the more abstract theoretical considerations presented in this chapter.

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[1] This is a substantially revised and extended English version of the inaugural lecture to the Hungarian Academy of Sciences, Budapest, 8 March 2008. Useful comments by Professors György Bazsa (Chemistry), Rezső Lovas (Nuclear Physics), Huricihan Islamoglou (Economic History) and Katalin Szabó (Comparative Economics) on previous drafts are appreciated, with the usual caveats. A shorter version of the chapter appeard in: Zeitschrift für Staats- und Europawissenschaften vol. 7. no.1. pp. 4–31.

[2] As the longtime Chairman of the joint selection committee for the Swedish Academy and the Riksbank (Lindbeck 1985: 46) explained, their “suggestions tend to be concentrated on the well-known and highly respected economists, particularly scholars in the field of ‘central’ economic theory as traditionally understood”. Furthermore, they award “in particular originality of the contribution, its scientific and practical importance, and its impact on scientific work and society in general, such as government policies” (ibid. 50).

[3] Journal rankings, no matter how arbitrary, are by now regularly cited by the publishers themselves on the homepage of the journal, without providing extensive justifications for the respective choices. As it is known, some of the output decorated with Nobel Prizes, also in economics, appeared in not very widely cited forums, such as the California Management Review or the Canadian Journal of Economics, to mention just two. Furthermore, impact factors of individual journals or books also vary significantly over time and by the subject matter, and thus become truly relevant only ex post facto.

[4] See more on this issue in the article by the leading figure of Hungarian mathematical economics (Zalai 2004).

[5] Citation of Nobel lectures and evaluations, as well as autobiographies of the award winners (often revised and extended by themselves) can be found on the excellent website of the Nobel Committee: www.nobelprize.org.

[6] Available: http://home.unichicago.edu/~gbecker. Accessed on 16 October, 2007.

[7] Until the late 1940s, the influence of John Commons, Thorsten Veblen and in particular Wesley Mitchell ensured the dominance of various institutionalist streams in the US academy, while the 1950–1970 period can be regarded as the transitory stage with its methodological pluralism.

[8] On page 14 of the NBER version.

[9] Perhaps Leonid Kantorovich, Reinhard Selten, Jan Tinbergen and Sir John Hicks are the few exceptions. Non-American Nobel winners, like Amartya Sen, Maurice Allais, Daniel Kahneman or Trygve Haavelmo have spent several years in the US and have long been integral parts of the US academy before receiving the award.

[10] This is neatly documented in Bourgignon et al. eds. (2007).

[11] On the pre-eminent role of the Cowles Commission and persons working there, as well as for a fine documentation of the channels through which their ideas have spread, see Móczár (2008: 285–310).

[12] Recall his fourth, proverbial dictum among his six commandments: ‘if you cannot put it in plain English, forget about the mathematics.’

[13] He held the personal chair of Keynes – also in the physical sense – until his 1976 retirement.

[14] It is worth noting that until the late 1980s both the JEL and the JPE regularly carried reviews of academic output published in German, Italian and French or in English by non-US publishers. This practice was discontinued and the JPE no longer publishes reviews. References to any non-US output have dramatically dropped in all the leading journals. It is also telling that in mainstream-oriented area studies journals, such as the Economics of Transition, the Journal of Comparative Economics, the Journal of Development Economics or the Economic Systems, reliance on primary sources ceased to be a prerequisite for publishability, while methodological eloquence is decisive.

[15] It is worth recalling that the 1985 textbook of Edmund Phelps, which is over 620 pages long, is entitled Political Economy. Phelps himself, in his lengthy Nobel autobiography considers this as a major piece. His pet project of the 1990s was a political economy course at Yale on what moved the changes in the 20th century. But others, such as the more conventionally used Samuelson-Nordhaus (2003) textbook, even in its 16th English language edition, is not methodologically overburdened either.

[16] For a comprehensive account, see Mátyás (1986).

[17] For a summary of the calculation debate, see Hayek (1940/1995) as well as Nove and Nuti eds. (1972). From the later period with most emphatic assessment and detailed documentation, see Ellman (1989).

[18] Why it was an inherent feature rather than a policy mistake was only partially understood by contemporaries, which is explained and proven ex post in Kornai (1992) in chapters 21, 22 and 24.

[19] Briefly, this means that similar outcomes are conceivable under centralized and competitive institutional arrangements since those are being either presupposed or abstracted away in the modeling process.

[20] Meanwhile, in his Nobel autobiography, which also provides an overall assessment of the state of the profession, Edmund Phelps (2006) rightly notes that the real dividing line since around 1980 does not lie between neo-Keynesians and new classicals, since both are commited to formalization and thus open to a quasi-merger – a point also noted by Blanchard (2000). Rather, the fundamental drift exists between these two and the various followers of the Austrian tradition who never conceptualized the macroeconomy as an engine, liable to precise quantitative interpretation and instrumentalization.

[21] Von Mises never got a proper chair in the US, and von Hayek, though serving many years at the London School of Economics and the University of Chicago, remained isolated. During his Chicago years, he grew increasingly concerned with the philosophy of science rather than the technical economics as redefined by the contemporary period through the competing views of Samuelson and Friedman.

[22] For a good reference volume summary of their works, see Bekker ed. (2005).

[23] This was aptly called so by the late Lord Peter Bauer (2000) who noted the rather palpable unfavorable consequences of indiscriminately applying these abstract academic insight, most particularly the Harrod–Domar model, for developing nations.

[24] Alan Blinder (1987) compares the change to abandoning Manet for Picasso. See earlier ideas of Thomas Kuhn (1970), who identifies aesthetics as a dominant criterion for the success of paradigms in the natural sciences.

[25] This is documented in a number of the overviews, which cite the role of the Cowles Commission and its aftermath. Mirowski (1989) goes perhaps the farthest in drawing this analogy providing a very critical account of this attempt. See also the insightful comparison of Hands (2007).

[26] Likewise, the personality and the uncontested institutional dominance of Gustav von Schmoller in the 1882–1917 period in Berlin and the local academe ensured the exclusive role of the historical school, the contesting paradigm to early mainstream, in contemporary Germany. Only disciples of the latter line managed to achieve professorial appointments for several decades. Thus neo-classicals found themselves as marginalized in Germany- and in culturally German-oriented Central Europe - as institutionalists and the followers of the historical school in Britain.

[27] This is particularly highlighted in Colander and Landreth (2004: 8) with a basic line of thought in the theory of human capital/economics of education.

[28] This point is rightly invoked in a recent article by Török (2007), who notes that results are crucially dependent on the statistical tools/concepts employed, while the latter reflect theoretical assumptions (often implicit ones) that may and often do prejudge outcomes (1523–1524).

[29] Lack of transparency is known to have played a decisive role in the 1998 collapse of the Long Term Capital Management Fund, where the chief analyst was the Nobel Laureate Myron Scholes, decorated in the previous year for his contributions to risk assessment and management methods. Interestingly, a decade later, explaining the reasons for the collapse of one of the largest Swiss bank, UBS, with a loss of 37 bn Euros (!), the departing chief executive officer also mentioned the inability of the investment banking arm of the conglomerate to assess real risks on the US markets properly (Világgazdaság, 23 April, 2008).

[30] True, as Júlia Király reminded me, Engle did not receive his Nobel for his contribution to financial economics. Still, his insights remain valid. All the more so, as following the unmasking of major blurs in the financial modeling of Moody’s by the FT, the competing rating agency, Standard and Poor’s voluntarily acknowledged similar major errors in its own modeling used for asset pricing (Financial Times, 14 June 2008).

[31] Similarly, Phyllis Deane (1983: 11–12), then President of the Royal Economic Society, emphasizes: “If economics is a science it is evidently one where powers of prediction and control are limited, largely because the phenomena it seeks to explain are subject to persistent change, and for reasons that may lie outside the traditional boundaries of the discipline. In these circumstances successful explanation or prediction must depend on the economist’s willingness to renew, discard and adapt theories, concepts and analytical techniques, and even to adjust the boundaries of the discipline.” The Russian economist Ananin (2007: 23–24) goes as far as arguing economics being an art, rather than a science (in line with the parlance of the US academy).

[32] Eatwell contributed this piece to the volume about a year before the collapse of Northern Rock Mortgage Company in the fall of 2007, which illustrated the predictive power of his insight. The event was triggered by the inability of the company to refinance about 80 per cent of its financial flows from the markets, which turned suddenly illiquid. Temporary bailout costs were considered around 50 bn (!) pounds as reported in CNN International, 28 November, 2007. Finally, the bank had to be nationalized in mid-February 2008.

[33] Banks are basically disinterested: good ones are induced to underprovision, and bad ones to doctor their reports.

[34] See also Móczár (2008: 322) joining Solow and Blinder in his criticism.

[35] It is well known that the suggestion of Lord Kelvin, about physics having fundamentally solved all issues about 120 years ago shared a rather similar fate.

[36] True, no science may exist without an analytical skeleton and axioms. However, the road from abstraction to real world application does not allow for the usual shortcuts. And if mainstream authors are intentionally silent on applications, this may exacerbate the situation.

[37] According to Nagy (2007) this was exactly the insight of Heisenberg in operationalizing relativity theory.

[38] There is a world of difference between this claim and the rejection of all analytical/deductive techniques, as traditional opponents of analytical social science, like the German historic school of Marxism, would have it.

[39] This insight emerges from the recent, largely unpublished research of Imre Kondor of the Collegium Budapest Institute for Advanced Study. But the issue of complexity has long been debated in Austrian economics, primarily by Mises and Hayek. For a good summary, see the recent analysis by Czeglédi (2007).

[40] Others suggest a recourse to catastrophe theory in explaining sudden reversals/collapses in financial markets.

[41] Colander et al. (2003: 8–10) list a number of practical considerations why the traditional orthodoxy survives in textbooks and general teaching much more than in graduate schools and the mainstream itself. These range from the difficulty of rewriting textbooks, the convenience of managing the exams for large student numbers to the sheer intellectual laziness and lack of up-to-date knowledge of the output of those working on the edge.

[42] It is telling that many mainstream economists never cite anybody outside their own school, while Camerer in his Hahn Lecture boldly cites those, including two Princeton economists, who – charmingly – qualified his attempt as ‘mindless economics’.

[43] Both sources underscore the distinction between a religious majority of one sort or another (which constitutes no barrier to catallaxy as such), and Islam as a state religion, i.e., the backbone of the legal and political order, as in the cases of Sudan or Iran for example, but not in Malaysia or Morocco.

[44] Actually, as we have indicated with reference to earlier insights by Mises and Hayek, there might be occasions when formalization may be positively misleading especially in complex matters studied by the law and economics school. “Putting numbers” on institutional quality, the level of corruption, or trust-worthiness may be a tall order, and the way the numbers are constructed/indicators conceptualized can easily prejudge the outcomes.

[45] The present author attempted to survey these in the introductory and closing chapters of his preceding monograph (Csaba 2007), where detailed referencing and documentation is provided on how the insights evolved.

[46] As known, the ability to produce sound predictions is perhaps the only measure of academic value on which followers of Friedman and Samuelson would immediately come to an agreement.

[47] Economic history (or historical economics) has developed quite powerfully, as evidenced, inter alia, by the broad impact and high citation occurrence of the works of Angus Maddison, Nicholas Crafts, Kevin O’Rourke or David Landes, just to name a few among those publishing regularly in major economic journals and publishing houses.

[48] Thereby we are back to square one, defining ”economics as a science, which studies human behavior as a relationship between ends and scarce means, which have alternative uses” (Robbins 1935: 16).

[49] Likewise, the work of Edmund Phelps (1997) on unemployment would be difficult to evaluate as a contribution to methodology only. Rather, its value comes from its policy relevance tested over the decades.

[50] For an empirical proof of this claim on the seemingly entirely anti-intellectual US policy-making, see Chari and Kehoe (2006).

[51] We certainly do not consider Mr. Greenspan to be an academic authority. Still, being a seasoned and highly esteemed practical financial manager, his comments may support our intuition, voiced already in the introduction, that the disconnect between modeling and real world phenomena is not an innocent omission, or just a matter of taste. The ensuing reliance on too many and too abstract assumptions, under which certain theoretical claims hold, is per se a sign of weakness. As it is known, in natural science this can hardly be considered as good academic practice. Furthermore these assumptions are at the root of not so innocent failures when tested on the ground. This point would perhaps be a platitude in physics, chemistry or biology, or indeed any of the experimental sciences, but is hotly contested in the current academic economics environment, despite its overemphasis on science appeal.

[52] In a way, this echoes the insight of Hayek (1952/1979: 77–92) that the tendency to objectivism often translates to study what is measurable, rather than what is relevant, which means putting numbers on issues that have no real world meaning and can be justified only by data availability or computational convenience. Let us add: the popularity of composite indices without a positive dimension, such as generalized corruption indices or the aggregate measure of human development, are beautiful cases to the point.

[53] This is also the normative view of the insider/outsider János Kornai (2007), who presided both over the Econometric Society of formalists and the International Economic Association of policy oriented analysts. Such work is being conducted on a large scale in the IIASA and WIDER (on climate change and poverty), the Earth Institute of Columbia University as well as in the influential CEPR and NBER research networks, the Kiel Institute of World Economics, or TÁRKI Social Science Research, Inc. (Budapest).

[54] In a like-minded overview, published a few months after the Hungarian original of this chapter appeared in print, Davis (2008) reminds us of the possible further internal-structural limitations of the discipline to a Kuhnian paradigm shift. He underscores the lasting presence of the standardizing-uniformizing tendency in economics across the oscillations between orthodoxy and heterodoxy in the past 150 years.

[55] This was clearly the case in the 2007/2008 subprime crisis, which uncovered major loopholes in the regulations of the financial sector and prompted the FED to introduce a series of additional regulatory measures.

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