Why Economists Cling to Discredited Ideas: Free-Market Economics May Be at Odds with Reality, but It Fits the Needs of the Rich and the Powerful

By Madrick, Jeff | The American Prospect, Winter 2015 | Go to article overview

Why Economists Cling to Discredited Ideas: Free-Market Economics May Be at Odds with Reality, but It Fits the Needs of the Rich and the Powerful


Madrick, Jeff, The American Prospect


Despite the practical failures of free-market economics, too many mainstream economists have continued to embrace simplistic ideas about how the economy works. Such ideas are often rooted more in ideology than in evidence. These beliefs and the policies that follow led directly to the 2008 financial crisis and the Great Recession. They also centrally contributed to the nation's subpar performance beginning in the late 1970s, and to our widening inequality. They continue to endanger America's economic health.

The mainstream of the profession claims to qualify oversimplified free-market ideas. But when it comes to key policy choices, the premise that markets are efficient usually trumps a more complex analysis. Thus, most mainstream economists are usually for less regulation even when more is required. They argue for reducing deficits even when expanded public outlay is indicated. They favor letting markets set wages without many safeguards for workers, even when the result proves neither equitable nor efficient. The consensus in the profession is that widening inequality must be the result of deficiencies in the skills of the workforce, rather than the result of structural disadvantages inadequately addressed by government.

To be sure, there are dissenting economists. A few even win Nobel prizes. But in the academy, free-market ideas are still the dominant ones.

The neoclassical insights at the core of standard economic thinking were once exciting intellectual breakthroughs. These ideas could still be useful, if adapted to the times, with their limitations understood, and tempered by other kinds of economic thinking. But the profession has largely turned its key ideas into faux-scientific rules of thumb that in fact reflect (and reinforce) the conservative political attitudes of the time. Disguised in technical terms, these ideas have increasingly become mainstream justifications for a reduced role for government in the economy.

THE CENTRAL PROPOSITIONS of free-market economics boil down to these:

The Invisible Hand. The premise of Adam Smith's invisible hand is that buyers and sellers, free of any government interference and merely following their self-interest, will arrive at an optimal distribution of goods and services at the "right" price, as if guided by an unseen hand.

Mainstream economists often say they don't literally believe in the invisible hand. They concede that many assumptions must be made for free markets to produce optimal outcomes. These include transparent access to information and product prices, no undue power for oligopolistic corporations to set prices or control distribution, highly rational buyers and sellers pursuing their self-interest, etc.

But in fact, for the economic mainstream, the invisible hand is the default principle whether or not these assumptions are met. Why, for example, do so many economists oppose increases in the minimum wage? Over the past ten to fifteen years, empirical evidence began to show that an increase in the minimum wage in many communities did not result in more than a trivial number of lost jobs and may have actually resulted in more jobs, as demand for goods and services increased with higher purchasing power. In the real world, a hike in the minimum wage did not perform according to the invisible hand, yet economists assumed it would.

People Get What They Deserve. If labor markets worked according to Adam Smith's principles, you could explain inequality not as a market failure, but as an efficient market mechanism. Some economists do worry about the social costs of unequal wages. But most economists believe a rise in inequality is a signal of the economy's technological progress. The claim that unequal education and skills explain unequal wages is an invisible-hand argument. If people with more education are better qualified, the market will justifiably pay them better. This premise allows mainstream economists to ignore the role of power shifts in labor market institutions and the fact that educational opportunity itself increasingly reflects hardened class lines--who your parents were, principally--more than the acquisition of skills. …

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