‘If we’d read those stuffy economists, the crisis could have been prevented’

Education and science are also responsible for the financial crisis of 2008, believes Irene van Staveren. She appeals for more diversity in teaching economics and in the top journals. Reread those old stuffy economists and look beyond the neoclassics.

It’s probably the most frequently asked question to economists after the crisis: why didn’t you see it coming?

Irene van Staveren, Professor of Pluralistic Development Economics at the International Institute of Social Studies (ISS), part of Erasmus University in The Hague, has an answer. “Most economists assume that we have efficient markets. In financial markets in particular, the risks which all parties take separately should keep each other in balance, so that the net risk is zero. Then you don’t expect a crisis. Furthermore, many economists think that crisis situations are caused by an external factor. It’s not in the model, so as an economist you cannot explain or predict a crisis.”

Yet the question isn’t entirely fair, because some economists did see the crisis coming, says Van Staveren. One problem: these were not neoclassical economists and neoclassical economists are the ones who are mainly published in top journals and taught in economics degrees at universities.

Last month, her new book was published entitled Wat wij kunnen leren van economen die (bijna) niemand meer leest. In this book, Van Staveren discusses the ideas of her ten favourite economists in relation to modern economic problems.

She wrote it out of frustration with the scope of the economic debate and the economic policy. “Take the rising costs in healthcare. That’s a big problem, but people always come up with the one solution: privatization and the operation of market forces. And then everyone’s surprised when so many mergers take place and monopolies are created. You should have seen that coming, because someone like the British economist Joan Robinson predicted that ages ago.” Through her book, Van Staveren wants to offer tips to (future) policy makers. Not by regurgitating ‘those old stuffy economists’, but by providing old answers to modern problems and with modern examples of solutions which those old stuffy economists could have thought up.

Policy makers could have learned more from Frank Knight, for example, who got his PhD a hundred years ago with a thesis in which he made a distinction between risk and uncertainty. Or from Hyman Minsky, who explained that risks strengthen each other by optimism, says Van Staveren. “If economists had devoted more attention to them in their education and if policy makers had remembered and used their wisdom, then monitoring in the financial sector might have been different, the risk models of the banks would have been different and we would not have had to go through the crisis to this extent.”

In the summer of 2009, the leading magazine The Economist had already blamed university economics programmes as one of the reasons for the crisis. On the cover, a melting book –Modern Economic Theory. The message: limitations in the economics education have contributed to the crisis, so we need new economics teaching. “If a magazine like that issues such a message, you’d expect something to change. But the book didn’t materialise.” So Van Staveren decided to write it herself. That resulted last year in Economics After the Crisis, an introductory economics book that presents various schools of thought in parallel.

“There is no other economics book that addresses different theories next to each other,” Van Staveren explains. “Yet every other science starts by doing that. Open any introduction to sociology and you’ll find a list of the main thinkers and how they still influence modern thinking on the subject.” Introductions to economics mainly address neoclassical concepts and models, not Veblen’s institutional approach or Minsky’s instability theory.

That was something that annoyed Van Staveren back in the 1980s, when she was studying economics in Rotterdam. “I couldn’t swallow the concept of mankind being taught at the time.”

And she had questions to which no satisfactory answers were forthcoming, either in lectures or in books. Take the wage differences between men and women, for example: why is there so much difference? Why do so many women work part time in the Netherlands? “Very little attention was devoted to these subjects in Labour economics, for example.”

When she was studying the History of Economic Ideas, she had to skip the chapter about Karl Marx. But tell a curious young adult not to do something and they will do exactly that. “I naturally went straight to De Slegte for a second hand copy of Das Kapital.”

She was strongly tempted to switch to another discipline, says Van Staveren. “Friends asked me: ‘Irene, why make life so difficult for yourself by continuing with such a subject? But gradually I came across more economists who engaged in the type of economics which I feel is a more relevant form of economics, one which is closer to economic reality and which has a more realistic concept of mankind.” This only encouraged her to continue, because she wanted these economists to be highlighted and discussed as well.

After finishing her studies, Van Staveren spent a year working on a research proposal for a PhD place about an Aristotelian perspective on economics, based on Amartya Sen and the feminist economics which was just emerging at the end of the 1980s. “I got no response from professors at the economic faculty. They didn’t feel it was economics. They told me to try sociology, women’s studies or philosophy.”

In the meantime, she had a partner and two children and another job, because she had to earn a living, but her hankering for research continued. Eventually, eight years later, Arjo Klamer returned to the Netherlands and Van Staveren was immediately able to embark on her research under his supervision.

Now, some twenty years later, Van Staveren is Professor of Pluralistic Development Economics, member of the Sustainable Finance Lab and was recently appointed vice chair of the Dutch branch of Rethinking Economics, an international network of critical economics students who want to see more pluralism in economics education. She also sees that little has changed. The neoclassical theory is still dominant.

The neoclassical thinking has two problems, according to Van Staveren. “Firstly, markets are always central, based on the assumption that they generally function well and tend towards balance, and that problems in the market come from outside. That’s a rather limited view of markets which regularly suffer from bubbles or instability. The second problem relates to the rather reductionist assumptions about human behaviour. It assumes that people are rational and concerned with utility maximisation. But what is in your and my utility function is invisible; it’s a black box. Imagine a situation where you are drinking more coffee than you know is good for you. According to a psychologist or behavioural economist, that’s irrational. If you ask an institutional economist, you do it because you are conforming to a particular trend, for example because your colleagues drink a lot of coffee too. But a neoclassical economist will say: ‘Actually, it is rational, because you apparently have a very short time horizon and you don’t factor in that you will eventually become hyper or suffer stomach problems.’ If you transform everything that any other scientist rejects as irrational into something rational, because it is apparently a preference in that invisible utility function, what is then the value of your concept of rationality? I wonder whether such a theory can actually explain a lot of things.”

How has one theory become so dominant? “It’s partly to do with the 1970s and 1980s,” explains Van Staveren. “At that time, a lot of Keynesian policy was implemented and that took us off course somewhat. Not because Keynes was wrong, but because it’s easy for policy makers to spend money in bad years and difficult to keep control of the budget in good years.”

It’s a question of throwing the baby out with the bath water. The same happened with Marx after the fall of the Berlin Wall. “Of course, he was a revolutionary and a communist, but he was also a keen analyst of capitalism. And that keen analysis still works today.”

Van Staveren also thinks that economists are not interested enough in original ideas. “A few years ago, I was working with a Professor of economics and he said, as if it was quite natural: ‘I never read books, I only read articles’. We don’t know economists like Adam Smith, John Maynard Keynes or Joan Robinson from their articles, but from their books. As an economist, if you only read new articles and never refer to old works, you’ll forget them. You won’t then use them in your research anymore, you won’t teach them to your students anymore. Before you know it, it’s become an overgrown pathway that has become blocked.”

“Many neoclassical economists were also really shocked by the crisis and went in search of explanations.” One of those explanations is the too big to fail-argument. The banks became so big that they had to be rescued by the government. “In neoclassical theory, it was always asserted that financial markets would regulate themselves. But if you accept the too big to fail-argument, you must also recognize that such self-regulation failed.”

Neoclassical economists do not take that step, according to Van Staveren. “People in social or institutional economics do go a step further and wonder why the banks became so big. They go back to the abolition of the American Glass-Steagell Act in 1999. For sixty years, this Act was partly responsible for ensuring that we didn’t experience a crisis by separating commercial banks and utility banks. The abolition of the Act left the door open to further deregulation, which is an important reason for the growth of banks.”

So it’s high time that we also embraced those social and institutional economists, Van Staveren believes. Not instead of but as well as the neoclassical theory. “It’s not about telling your students what is good and bad, but offering them a wider pallet. That can only enrich their education. But we’ve a long way to go,” she says. “At the moment, there’s little room in economics for pluralism. Cynics say that we need another crisis first.”